Ray Dalio Spells Out America’s Worst Nightmare

(Bloomberg Opinion) -- Ray Dalio, the billionaire hedge fund manager who founded Bridgewater Associates, effectively spelled out what doomsday looks like for the U.S. on live television.

In an interview with Bloomberg TV on Wednesday, Dalio expressed his concern about two years from now, when, in his view, the economic recovery is likely to sputter out. It won’t just be a debt problem this time around, he said, but rather a story about unfunded pension and health-care obligations. To address that looming crisis, the U.S. will need to ramp up issuance of U.S. Treasuries.

And that’s where it all unravels.

“We have to sell a lot of Treasury bonds, and we as Americans won’t be able to buy all those Treasury bonds,” Dalio said. That means foreign investors will have to step up. And they probably would, as long as the dollar remains strong. Otherwise, Treasury’s dollar-denominated interest payments to buyers in China, Europe and Japan will be worth less and less.

But, to Dalio, that’s not going to happen.

“The Federal Reserve at that point will have to print more money to make up for the deficit, have to monetize more and that’ll cause a depreciation in the value of the dollar,” he said. Pressed by interviewer Erik Schatzker, he said, “You easily could have a 30 percent depreciation in the dollar through that period of time.” For context, the Bloomberg Dollar Spot Index fell 8.5 percent in 2017, and that was considered massive.

It all leads up to this critique of how the U.S. has gone on a borrowing binge in recent years. Remember, the $15.3 trillion Treasury market was the $4.9 trillion Treasury market a decade ago.

“We have the privileged position of being able to borrow in our own currency because we have the world's leading reserve currency. We are risking that by our finances — in other words, borrowing too much.”

The idea that the U.S. dollar would lose its status as the world’s reserve currency is an existential threat unlike just about any other to the U.S. government and financial markets as a whole. It’s a talking point that encourages debate, until people realize something else would have to fill that void. And, for that reason, such an Earth-shattering proposition is cast aside.

Coincidentally, Moody’s Investors Service released a report at almost the exact same time that Dalio made his comments, with the conclusion that “The U.S. dollar will remain the dominant foreign reserve currency for the foreseeable future,” which plays “an important role” in maintaining the country’s Aaa credit rating. Here’s more from the report about the dollar:

“Its formidable sovereignty has been maintained through global recessions, defaults by other sovereigns, the rise of Chinese trade and the introduction of the euro. … The size of the U.S. economy and the level of trade are not the only reasons the U.S. dollar is the principal foreign reserve currency. The transparency of the U.S. financial markets as well as the stability and predictability of U.S. monetary policy reinforces the safe-haven legacy that the U.S. dollar holds.”

The caveat in the report, though, is that reserve currencies should be stable and the issuing country should be “highly unlikely” to experience a financial crisis. In Dalio’s view, the U.S. could ultimately face a reckoning, and just how bad it gets depends upon the rest of the world’s faith that the dollar will hold up.

He’s right that fiscal stimulus toward the end of an economic cycle isn’t ideal, in theory. But time and again, the bond markets have shown that deficits don’t really matter. For all the hand-wringing about the increasing size of Treasury auctions, the 10-year yield is still below 3 percent. Inflation is rising but appears contained.

Figuring out an endgame to this period of rampant government borrowing and unconventional monetary policy is a challenge, and Dalio deserves credit for at least trying to picture it. But for just about everyone’s sake, we should hope that he’s wrong.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

©2018 Bloomberg L.P.