“‘There was a big government-engineered shift in wealth from 1) the public sector (the central government and central bank) and 2) holders of government bonds to 3) the private sector (i.e., households and businesses). This made the private sector relatively insensitive to the Fed’s very rapid tightening to a more normal monetary policy.‘”
That’s billionaire investor Ray Dalio, founder of hedge-fund giant Bridgewater Associates, explaining in a Wednesday post on LinkedIn why the economy isn’t slowing more convincingly despite an aggressive round of Federal Reserve interest rate increases and other monetary policy tightening since March of last year.
“As a result of this coordinated government maneuver, the household sector’s balance sheets and income statements are in good shape, while the government’s are in bad shape,” Dalio wrote.
Data last week showed that a resilient U.S. economy grew at a 2.4% annual pace in the second quarter, propelled by steady consumer spending and a rebound in business investment.
In the U.S. and around the world, governments ran big budget deficits in 2020 and 2021, and still are, while central banks bought boatloads of bonds. Then in 2022, as inflation soared and unemployment remained low, there was a move toward “less insanely easy fiscal policies,” Dalio said, while central banks moved away from insanely easy monetary policies that had produced negative real bond yields.
As stocks and bonds both tumbled last year, “the private sector’s net worth rose to high levels, unemployment rates fell to low levels, and compensation increased a lot, so the private sector was much better off while central governments got a lot more in debt and central banks and other government bondholders lost lots of money on those bonds,” Dalio said.
The historical record around similar episodes rings some loud alarm bells, Dalio has argued.
In the near term, however, a period of “tolerably slow growth and tolerably high inflation” — or a “mild stagflation” — is the most likely outcome provided there isn’t a big imbalance between the supply and demand of government debt.
But over the long run, “it is virtually certain that central governments’ fiscal deficits will be large, and it is highly probable that they will grow at an increasing rate as the increasing debt service costs plus increasing other budget costs compound upward, and, as they increase, governments will need to sell more debt, so there will be a self-reinforcing debt spiral that will lead to market-imposed debt limits while central banks will be forced to print more money and buy more debt as they experience losses and deteriorating balance sheets,” he warned.
Dalio’s remarks come a day after Fitch Ratings delivered a downgrade of the U.S. credit rating to AA+ from AAA. U.S. stocks, which have been on a strong run to the upside, paused their rally, with the S&P 500
SPX
dropping around 1.3%, while the Dow Jones Industrial Average
DJIA
declined around 330 points, or 0.9%.
See: What Fitch’s U.S. credit downgrade means for investors
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