Ray Dalio is warning that a dynamic capitalism is based on is crumbling.
Speaking at The New York Times Dealbook conference last week, the head of the hedge fund Bridgewater Associates said that what lies ahead could be a real challenge for central bankers and the global economy.
But right now, we’re in the good part of the economic cycle.
“Now, I think it’s a good environment,” Dalio said. “We’re long equities and we’re holding those positions and it’s a relatively good time. W
hat I worry about is if we were to take it a year or two in the future, what the effectiveness of monetary policy will be, particularly in a deflationary environment.”
Now, when Dalio talks about a “deflationary environment” he is basically talking about this chart, highlighted by Gerard Minack back in our latest Most Important Charts feature:
The idea behind Minack’s chart and Dalio’s “deflationary environment” is that the peaks and troughs in interest rate cycles since 1980 have been falling steadily.
Those trends are headed toward zero. Then what?
Dalio, at least, is sceptical about how much more we can get out of our economic status quo.
“We are almost at the end of the ability to squeeze more out of it,” Dalio said. And by “it,” Dalio is talking about “spread,” which is basically how much you are compensated for taking risks.
“If you look at capitalism,” Dalio said, “it’s the spread that is the transmission mechanism: everybody’s looking for spread. And it’s that spread that makes lending go through.
“And then there’s lowering interest rates, which lowers debt service payments. That dynamic that capitalism is based on is going to become decreasingly effective in the longer-term future.”
And so the predicament facing central banks like the Federal Reserve, the European Central Bank, and the Bank of Japan is that interest rates have been at zero as credit spreads have narrowed.
For Dalio, this means that going forward, it will be harder for these central banks to enact effective policies because they can no longer use interest rates as a policy tool, and they may no longer be able to rely on the existence of “spread” in the economy.
As Dalio said: “I think it will be a big difference in the world economy.”