Ray Dalio sees rising inflation in his latest interview.
“What we have seen is the need to produce a lot of debt” said Ray Dalio as he referred to the central bank’s response in the wake of the economy being in lockdown due to the pandemic.
Stimulus checks were sent to US households to stimulate the economy by boosting consumption and driving revenue at retailers and manufacturers.
Ray Dalio sees rising inflation triggered by an increase in the money supply (M2) to finance government borrowing
“Those checks came from the government, they wrote those checks” said Ray Dalio. But the government doesn’t produce money, so the central banks had to print a lot of money” said Dalio. To give us some idea about the magnitude of the money creation the CARES Act added trillions of dollars in fiscal stimulus. In three months, the US deficit increased more than the combined last 5 recessions. So, the extent of the current public spending, which is mainly financed by the government going into debt, the issuing of treasury bonds, in the case of the US, has not been this great since WWII.
“what we have seen is the need to produce a lot of debt”
RAY DALIO
Ray Dalio sees rising inflation, which could be spurred on by a US dollar depreciation
Red flags are already waving in the treasury bond market, explained Ray Dalio.
Ray Dalio sheds light on the current dynamics in the US treasury bond market where he links waning demand for treasuries and a depreciating US dollar. When investor demand for US treasuries declines that also leads to diminishing demand for US dollars, thereby leading to the world’s reserve currency depreciating on the foreign exchange.
“When there has to be a lot of selling of bonds, and bonds don’t give a good return, there is a guaranteed negative return in bonds relative to inflation index bonds, which yield minus one percent” said Ray Dalio. In other words, Ray Dalio is saying that the current yield on bonds will not be enough to protect against capital erosion from inflation. But US treasury bonds market, currently valued at $19.8 trillion US dollars is the most widely held global asset. Put another way an air-pocket in the US treasury bond market could potentially crash global stock markets.
“US treasury bonds market, currently valued at $19.8 trillion US dollars is the most widely held global asset”
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“So, there is no return and there is a pile of people who own bonds, they aren’t just Americans they are international investors owning bonds. The government has to sell more bonds. There will not be enough demand to sell those bonds” said Ray Dalio.
“When that happens interest rates rise, that is what we are seeing now,” said Ray Dalio. So, the increase in the supply of treasuries to finance public spending combined with lackluster demand for treasuries is sending treasury bond prices lower and their corresponding yields higher.
“The greatest risk is monetary inflation because it could trigger the risk of a sell-off in the bond market” – Ray Dalio
Ray Dalio sees rising inflation due to the Fed creating more US dollars to buy the treasury bonds that investors are unwilling to buy
Ray Dalio notes that the Fed policymakers are now caught in a dilemma they cannot win. If the Fed Powell lets treasury yields rise, he risks crashing the stock market, damaging the economy, which would increase unemployment. But equally, if the Fed creates dollars to buy treasuries, that would keep yields lower with the unintended consequence of further depreciating the US dollar, which would result in higher inflation and rising yields.
“The central bank is in a dilemma because either interest rates will rise a lot or they will have to print money and buy those bonds to keep yields down. But that accelerates the depreciation in the value of the US dollar and it raises inflation pressures,” said Ray Dalio.
“The Fed in 6 weeks bought more treasuries than they did in 10 years under Bernanke and Yellen” said Stanley Druckenmiller.
Ray Dalio sees rising inflation of the monetary type
“There are two types of inflation. We are used to one type of inflation which is when the economy is too hot, there is a capacity constraint and when demand presses up against existing capacity prices rise, unemployment rates are low. Monetary inflation is where you can have stag inflation, which means even when the economy weakens inflation rises” he said.
“The greatest risk is monetary inflation because it could trigger the risk of a sell-off in the bond market” added Ray Dalio.
“You are seeing a move out of bonds and cash into other assets like stocks and other investment assets” – Ray Dalio
Where is capital flowing if Ray Dalio sees rising inflation?
“You are seeing a move out of bonds and cash into other assets like stocks and other investment assets” he said. Ray Dalio also will “not touch a ten-year treasury with a ten-foot pole.”
“Cash is trash it looks like a low-risk asset to hold but it is not,” he said. Ray Dalio recommends borrow cash and find something that has a return better than zero interest rates. “If you bought average thing inflating 2 percent a year you would be better off,” he said. Ray Dalio also recommends investors to diversify well, in various currencies, country diversification as well as asset diversification.
So, Ray Dalio sees rising inflation where the Fed could be battling rising costs and rising unemployment.
“Think of the economy as being like an individual and their pulse is dropping,” and he added, “When the pulse is dropping the doctors come running in with the stimulant and they inject the stimulant.”
“Now that the economy is rebounding inflation pressures are rebounding. There is not the same pressure to administer that stimulation .” When it becomes a problem, first rising interest rates start hurting rising asset prices, first typically they hurt bonds, then they pass through and hurt stocks. Because interest rates hurt stocks maybe stocks could correct 10 to 15% and the Fed can tolerate that. When it goes beyond that and starts to affect the economy that is when you’ll see the real trade-off has to surface” he said.
If Ray Dalio sees rising inflation, of the monetary type, then could a halt to the US dollar depreciation could be the cure?
If the Fed thinks so, then maybe US dollar decline could be over.
