Dalio: The Federal Reserve Faces a Difficult Balance, "Massive Debt" May Require Intervention!

When there aren't enough buyers in the market to absorb debt supply, interest rates may have to rise, or the Federal Reserve may need to intervene and make purchases, which Dalio believes the Fed will do.

With the Federal Reserve cutting interest rates for the first time since the early days of the COVID-19 pandemic, billionaire investor and Bridgewater Associates founder Ray Dalio pointed out that the U.S. economy still faces the issue of “massive debt.”

The Fed has decided to lower the federal funds rate by 50 basis points to a range of 4.75% to 5%. This rate not only determines the cost of short-term borrowing for banks but also affects consumer products like mortgages, auto loans, and credit cards.

In an interview, Dalio said, "The challenge for the Fed is to keep interest rates high enough to benefit creditors but not so high that it causes problems for debtors," highlighting the difficulty of this “balancing act.”

The U.S. Treasury recently reported that the government has spent over $1 trillion this year to service the interest on its $35.3 trillion national debt. The increase in debt servicing costs coincides with a significant rise in the U.S. budget deficit in August, with the deficit nearing $2 trillion this year.

On Wednesday, Dalio identified debt, money, and economic cycles as five major forces influencing the global economy. On Thursday, he elaborated on his view, expressing particular interest in the “massive debt created by governments and monetized by central banks.” He noted, “These levels are unprecedented in my lifetime.”

During the pandemic, governments around the world accumulated record levels of debt to fund stimulus programs and other economic measures to prevent economic collapse.

When asked about his outlook and whether he foresees imminent credit problems, Dalio responded that he doesn't see that happening. He said, "What I see is that, due to artificially low real interest rates, the value of debt will be significantly depreciated, so you won't get compensated."

Although "the economy is relatively balanced," Dalio pointed out that there is a “massive” amount of new government debt that needs refinancing and selling.

Dalio is concerned that neither Trump nor Harris will prioritize debt sustainability, meaning that no matter who wins the upcoming presidential election, these pressures are unlikely to ease.

“I think the path of debt monetization will increasingly resemble the situation in Japan over time,” Dalio said, referring to how Japan devalued the yen and reduced the value of Japanese bonds by artificially lowering interest rates.

He noted, “The value of Japanese bonds has fallen by 90%, resulting in massive taxation through artificially low yields each year.”

For years, the Bank of Japan has maintained its negative interest rate policy, initiating one of the most aggressive monetary easing practices in the world. It wasn't until March this year that the Bank of Japan raised interest rates.

Additionally, when the market lacks enough buyers to absorb debt supply, interest rates may have to rise, or the Federal Reserve may need to step in and make purchases, a scenario Dalio believes is likely. "I think the Fed's intervention will be a very significant negative event," the billionaire said. The excess debt also raises the question of how it will be repaid.

He added, “If we were operating under a hard currency system, you would face a credit event. But under a fiat currency system, you will see debt purchased by the central bank, which is debt monetization.”

In this case, Dalio expects all currencies to depreciate since they are relative to each other.

He concluded, "I expect we will see an environment very similar to the 1970s or the period from 1930 to 1945."

As for his own investment portfolio, Dalio said he does not favor debt assets: “So if I lean in any direction, it’s toward an underweight position in debt assets like bonds.”

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