Ray Dalio: Inflation is not just around the corner… yet

As I have argued on this site, Ray Dalio also believes that inflation is not just around the corner…yet. In my view, consumer price inflation is cyclical and therefore not embedded, but deflation is secular. That makes a big difference when considering policy responses.  But I have been arguing since October that some austerity is inevitable, if for purely political reasons. So, the present worldwide deleveraging in the public sector will lead to a deflationary outcome.

However, with governments printing money, inflation, now propping up asset prices, will eventually come to consumer prices. First the deflation, then the inflation, I say. Ray Dalio agrees. But, he also has some choice things to say about the situation in Europe.

From this week’s Barron’s:

Barron’s: We last spoke in February 2009, exactly a month before the bottom in the U.S. stock market. A lot of money has been printed.

Dalio: Governments always print money. Last year was very similar to March of 1933, although we hadn’t contracted for nearly as long, and the Federal Reserve was much quicker on the trigger. They didn’t let the economy get so bad; they moved a lot faster and in large quantities. The whole world did — all the major central banks and all the major governments did what was done in March 1933. Classically, there is big monetary stimulation and big fiscal stimulation, and we had that globally in a magnitude that we had never had before…. It caused the stock market to retrace about 60% of its decline, and it caused the U.S. economy to retrace 40% of its decline. But it did not produce new financial assets. There has been very little new lending. The stimulus produced very little in the way of economic activity.

[Barron’s:] A year ago you thought it wouldn’t be until late 2010 that we would get the best opportunity to buy stocks.

The government response was quicker and larger than I thought it would be. But the boundaries of the old highs and the boundaries of the lows in the stock market and in the economy will be with us for a long time. If there were to be a decline in economic activity below the prior low, it would be intolerable, and central banks would print money again. The risk to that right now is that public sentiment has turned more negative about perceived bailouts. There is a lot of criticism about saving financial institutions and running a big budget deficit, but if the government didn’t do those things we would be in a terrible situation. It will be impossible to stimulate that way in the future because politically it is untenable. That’s a risk because, between now and 2012, the economy will probably go down again, and it will be important for monetary policy and fiscal policy to be able to be stimulative, and for the Federal Reserve to be able to purchase assets again.

[Barron’s:] Are you suggesting we will experience something of the magnitude of 2008-09?

No, that won’t be allowed to happen again, although, inevitably, there is another recession out there. It will probably come sooner than most recessions do. Usually, there is about five years between recessions, but for various reasons related to the size of the debt, the next recession is going to come sooner. We are in the equivalent now of a quantitative easing-induced cyclical recovery. But it is a fragile recovery, and credit growth is not picking up very much, and it goes back to the fact we still have too much debt. We have not reduced our debt burdens in any way significantly. What we’ve done is to largely roll them to the vicinity of 2012 to 2014. Corporate balance sheets are much, much better because they extended the maturities of their debt and slashed expenditures by laying off workers. I would be shocked if we saw new lows in the economy, but you can’t go to new highs anytime soon, either…. The average American’s net worth is less, and incomes are less and so the amounts they can leverage will be less — so for a long time spending rates will be less than they were at the peaks.

[Barron’s:] How do you view current developments in Europe?

Europeans are faced with the same three choices we were facing in dealing with debt — print money, redistribute money, or restructure. The European situation is a particularly risky one for a number of reasons. One, the size of the debt dwarfs that of any other debt crisis. It dwarfs the Latin American crisis. It dwarfs the Asian Contagion. These are enormous, enormous amounts. A lot of attention is paid to the sovereign debt, but there are also big private-sector debts. It doesn’t make much difference whether it is government or private, there is way too much indebtedness in these countries….

It’s a very frightening situation because there is a risk here that the Europeans will not move decisively or quickly enough. There is a pulling back of capital at a time when the need for capital is greater. There is rollover risk. Spain, for instance, has to roll over 40% of its external debt, which is about $700 billion to roll over, and because it is running a current-account deficit, it actually has to borrow more than that, which is almost another $80 billion. Just the government has to roll over about 20%, or about $125 billion. Spain will have to borrow more than it has ever borrowed before in the next year at the same time as people’s inclination to lend to Spain is reduced. The government debt of all the peripheral countries in the euro zone that has to be rolled over in the next three years is the equivalent of $1.9 trillion, and that doesn’t include the private-sector debt.

Edward here.  So what does this mean for investing.  Dalio explains.

[Barron’s:] How are your portfolios positioned?

Our portfolio is mostly skewed to Treasury bonds, gold and emerging-market currencies, especially Asian currencies. We also hold commodity assets that are limited in supply and that high-growth emerging countries need. I want to minimize my exposure to the major developed countries’ currencies — the U.S. dollar, the euro, the British pound and the yen — because those countries have a lot of debt, and they are going to need to print more and more money and will have more sluggish growth rates. I prefer the yen to the others. However, none of these can get too far out of line with the others, and when there is downward pressure on one, there is pressure on all. Just as the notion that the G-7 countries represent the major world powers is obsolete, it is also an obsolete notion that their currencies are the major reserves of wealth.

The depreciation of the major currencies and the printing of money will not cause a significant general level of inflation anytime soon.

[Barron’s:] Explain why the printing of money won’t cause inflation.

The printing of money will offset the deflation that is coming from the weak demand for goods and services due to weak credit growth. For example, in March of 1933 the U.S. printed a whole lot of money, and that had the effect of converting deflation into modest inflation, but not a high rate of inflation…. My point is, in developed countries there is too much of most things at the moment, and that’s creating a deflationary environment. There is too much manufacturing capacity. There is too much labor. There is too much housing stock. As Europe’s economy weakens and its debt crisis worsens, the printing of money does not mean that it will produce an accelerating inflation because simultaneously there is also less being purchased, and the surpluses are already causing deflationary pressures. That is why, contrary to almost everybody’s belief, I believe the bonds in countries that can print money will be good investments.

[Barron’s:] Thanks, Ray.

But, in countries that cannot print money, you have a problem.  The Eurozone is different from the US or the UK as long as it remains intact; unless the ECB starts printing a lot more money ie starting massive unsterilized credit easing via purchases of Greek sovereign debt, the Euro acts as a de-facto gold standard for member countries. Think of the Euro as gold and the Euro countries as having implicitly retained their national currencies with a fixed rate to gold.

Deflationary forces are, therefore, that much greater as we are now realizing. It will either be default for the weakest or socialization of losses and risk contagion within the Eurozone. For everyone loading up on German Bunds, that is something to consider – ie the socialization of losses from weaker debtors to stronger debtors within the Eurozone.

More here on China, emerging markets, and the IMF at the link below (for those who subscribe).


Set Aside Fears of Inflation — Just for Now – Barrons

  1. gaius marius says

    i’m going to go off my rocker for a second and question ray dalio.

    why is it we worry about central banks printing money at all? i don’t know anyone who isn’t concerned about inflation as a result of fed balance sheet expansion — and yet.

    the fed can either print physical notes (most of which end up outside the country) or purchase/repo securities to push cash into the banking system. the former hasn’t been tried and would be of doubtful utility. the latter depends entirely on the ability of banks to make loans to the private sector in order to turn that cash into deposits and real income.

    but the banks have not been lending to the private sector. hiding a negative equity position with par marks awaiting the inevitable maturity of bad assets, banks know they have to improve their capital position. the best way they can is to sink cash into treasuries, as they require nearly no capital reserve — they don’t need to raise as much capital if their assets migrate from formerly-triple-a MBS to treasuries. moreover, finding creditworthy borrowers in this environment is nearly impossible.

    so how — exactly — does fed “money printing” yield inflation? as in japan, i don’t think it does. it can yield massive excess reserves, but that’s about it. i don’t think monetary policy (unlike fiscal policy) has much if anything to do with economic outcomes in this environment.

    that’s not to say we’re japan; we aren’t — china is. they run massive current account surpluses which mean their banks intermediate large excess deposits. the US has the opposite problem, which means a banking system reliant on wholesale funding originating in china and japan. as a result, we will i think be vulnerable to interest rate volatility in a way that japan never was. some may mistake that volatility for the onset of inflation when it comes, but at best it might mean a collapsing dollar crushing out capital account surplus and making imports unaffordable (see iceland for the extreme example). but a classic monetary inflation — meaning credit expansion and a wage-price spiral — it won’t be.

    maybe that — a currency crisis — is all dalio means by eventual inflation. i’d love to hear others poke holes in my argument!

  2. Tomlindmark says

    A very, very good post.

    Do you honestly believe, though, that the Germans will sacrifice their economy for the greater good of the Eurozone?

    1. Marshall Auerback says

      The Germans will sacrifice their economy if they let the euro zone
      collapse. The European authorities, led by Germany are simply trying to localize
      the income deflation in the “PIIGS” through strong, orchestrated IMF-style
      fiscal austerity, while seeking to prevent a strong downward spiral of the
      euro. But the contradiction in this policy is that a deflation in the “
      PIIGS” will simply spread to the other members of the euro zone with an effect
      essentially analogous to that of a competitive devaluation
      internationally. That’s eventually going to impact on Germany’s own economy in a big way.

      In a message dated 5/29/2010 10:07:39 Mountain Daylight Time,

  3. Daniel says

    EZB kauft griechische Staatsanleihen


    I still think that the whole rescue package is a huge red herring and the ECB will buy as much bonds as needed to keep yields down. But they couldn’t sell that to the (german) public

    Das goldige Geschäft mit der Angst


    Do you have any idea what would happen if greece defaulted? I mean, the ECB can print money, but they could also want that somebody pays them for the losses. I think this is a similar situation to the FED-Maiden lanes. Who pays for the losses that will almost certainly occur?

    1. Marshall Auerback says

      Daniel, you might well be right. Then the question becomes: do they try
      to sterilise the purchases? If they do, it will be ineffective, but if they
      don’t, then you are effectively creating new euros and this could help to
      mitigate the credit strains now emerging within the banking sector.

      In a message dated 5/29/2010 14:57:41 Mountain Daylight Time,

  4. Edward Harrison says

    Consumer price inflation and full employment/full capacity are related. It is really hard to stoke consumer price inflation if there is a massive out put gap as there is today across much of the developed world. So that means the Fed can inject liquidity without worrying about its inflationary effects.

    The ECB claims it is not doing the same because its credit easing is sterilized but I suspect, as does Daniel, that this is not the case. In any event, banks flush with excess reserves but fewer reasonable incremental lending opportunities are not going to sit on their hands and watch their return on assets plummet. They will invest, if only in government securities. However, some of the excess liquidity will make it into the system for speculation since low rates and easy money allow this. That’s part of why you saw stocks in a massive melt-up.

    In my view, unless the household sector deleverages, the risk of a debt deflation remains and that necessarily means easy money. The whole goal is to keep the gravy train going and that means resisting the household sector deleveraging process. If we don’t have a massive debt deflation, eventually the output gap will close even while household sector debt levels are high. That’s when we’ll see inflation because the central banks will not want to choke off demand for fear of that debt deflation. But that’s well down the line and presupposes no GDII scenario.

    I will write some of this up. when I get a chance.

    1. Marshall Auerback says

      I think you’re right Ed. There’s another big problem with much of the
      discussion about debt. Private and public debt are somehow merged as
      equivalents. You might appreciate by now that this logic is just plainly false. The
      debt that a household, which uses the currency, carries is a burden on its
      future capacity to consume because it has to be funded in some manner. The
      debt that a government holds does not constrain its capacity to spend in
      the future. There is never a solvency issue with sovereign government debt.
      This is not to say that I advocate rising public debt levels. In fact, if
      we didn’t have these stupid rules whereby Treasury by law is supposed to
      issue debt dollar for dollar to “finance” its expenditures (a relic of the
      gold standard era), I would advocate letting Treasury run an overdraft at the
      Fed, and issue very little public debt. Treasury could then keep the rates
      at the short-end of the yield curve close to zero in perpetuity. I would
      then make all the spending adjustments necessary to keep nominal demand in
      line with real capacity via changes in taxation, not interest rates.

      In a message dated 5/29/2010 15:37:48 Mountain Daylight Time,

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