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24 September 2013 By Martin Hutchinson

Ray Dalio is offering a YouTube clue to U.S. economic torpor. The billionaire founder of the $150 billion hedge fund Bridgewater Associates argues that Uncle Sam is stuck in a deleveraging recession. Federal Reserve policy largesse, meanwhile, keeps prices stable as debt declines. It’s a useful idea.

In a new video based on a paper developed over several years, Dalio distinguishes between conventional downturns – typically associated with central bank interest rate increases designed to fight incipient inflation – and long-term deleveraging recessions. The latter, caused by the unwinding of excessive borrowing, occur only on a 70 to 80 year cycle, according to Dalio. They are eventually resolved by reduced spending, debt restructuring and wealth redistribution.

Those are all deflationary shifts and could produce a downward spiral if unchecked. By printing money and buying government bonds, the Fed can offset this risk and allow deleveraging to occur in a less painful, if still eventually problematic, manner.

Dalio’s analysis has a number of implications. First, it could help explain why inflation has remained stubbornly low despite five years of lax Fed policy. Second, it suggests that the current economic sluggishness could be prolonged. After peaking at 192 percent in 2009, the ratio of U.S. non-government credit outstanding to GDP has declined by an average of 5.1 percentage points per annum to the first quarter of 2013, according to Fed data. At that rate, it will be early 2020 before leverage falls to the average seen between 1978 and 2007 of about 138 percent.

Were the Fed to keep interest rates low for that long it would damage the economy, as negative real rates encourage speculation and discourage saving. However, with the Fed offsetting price deflation through its asset purchases, Dalio’s argument allows the possibility of the Fed lifting the federal funds rate to more normal levels, perhaps 3 percent given inflation is running between 1 percent and 2 percent. This would avoid the worst effects of easy money while also encouraging lower, healthier debt levels.

At current purchase rates, unfortunately, the Fed’s balance sheet would tip the scales at $10 trillion by 2020. But that would be a problem for next decade. And even if that isn’t the answer, Dalio’s thesis is one worth spreading. If nothing else, his scale of investment success entitles him, more than most who take to YouTube, to a hearing.


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