Ray Dalio, founder of Bridgewater Associates, the world’s largest hedge fund manager, says raising rates by the Federal Reserve to curb inflation is not a panacea for the economy.
“I’m hearing it now that it’s widely said that inflation is the big problem. So the Fed needs to tighten up to fight inflation, which will ensure things get back on track once inflation is brought under control,” he wrote on LinkedIn.
“I think that’s both naïve and inconsistent with how the economic machine works. … This approach focuses only on inflation as a problem and seeks the Fed as a cost-effective measure. I’m looking closely at what will improve things once inflation goes away. But it is not.”
How does the Fed work? “While tightening lowers inflation because people spend less, it doesn’t make things better because it takes away purchasing power,” Dalio said.
“It just shifts with inflation to squeeze some of the people out by giving them less purchasing power. The only way to raise living standards in the long term is to increase productivity, and central banks are not doing that.”
What the Fed is doing is “producing short-term credit cycles (aka business cycles) that typically last about seven years,” Dalio said.
“These short-term credit cycles add up to long-term credit cycles, which typically last about 75 years…. That’s because most people want volatility, not volatility,” he said.
“So the stimulus and credit that central banks create usually adds up over time and recedes until the debt and liabilities become unsurprisingly large.”
This is being done “through a mixture of inflation…, debt restructuring and debt service repayments in non-depreciable money…” Dalio said. “We experience that.”
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Bottom line, Dalio says:
“There is nothing the Fed can do to fight inflation without creating economic weakness.
“As debt assets and liabilities remain elevated and expected to rise due to government deficits and the Fed selling government debt, it is likely that private credit growth will have to slow, weakening the economy.
“Over the long term, the Fed will most likely take a middle ground in the form of stagflation.”
Bearish view of Goldman Sachs
Meanwhile, economists at Goldman Sachs see the prospect of a recession rising.
“The Fed has hiked rates more aggressively, expectations for terminal rates have risen and financial conditions have tightened,” he wrote in a comment.
Economists said that these strict regulations are “putting a lot of pressure on growth…”.
“Additionally, we are increasingly concerned that if energy prices continue to rise, even as activity slows sharply, the Fed will be forced to respond aggressively to higher headline inflation and higher consumer inflation expectations.”
Economists are predicting that there will be a 48% chance of a recession in the next two years, up from 35% previously.