Ray Dalio was featured in Barron’s at the weekend. He spoke about the various options available to effect a private sector deleveraging. He sees three ways which he calls austerity, restructuring, and money printing.
Below is an excerpt of his commentary:
Barron’s: You’ve called the current phase of the U.S. deleveraging experience "beautiful." Explain that, please.
Dalio: Deleveragings occur in a mechanical way that is important to understand. There are three ways to deleverage. We hear a lot about austerity. In other words, pull in your belt, spend less, and reduce debt. But austerity causes less spending and, because when you spend less, somebody earns less, it causes the contraction to feed on itself. Austerity causes more problems. It is deflationary and it is negative for growth.
Restructuring the debt means creditors get paid less or get paid over a longer time frame or at a lower interest rate; somehow a contract is broken in a way that reduces debt. But debt restructurings also are deflationary and negative for growth. One man’s debts are another man’s assets, and when debts are written down to relieve the debtor of the burden, it has a negative effect on wealth. That causes credit to decline.
Printing money typically happens when interest rates are close to zero, because you can’t lower interest rates any more. Central banks create money, essentially, and buy the assets that put money in the system for a quantitative easing or debt monetization. Unlike the first two options, this is an inflationary action and stimulative to the economy.
How is any of this "beautiful?"
A beautiful deleveraging balances the three options. In other words, there is a certain amount of austerity, there is a certain amount of debt restructuring, and there is a certain amount of printing of money. When done in the right mix, it isn’t dramatic. It doesn’t produce too much deflation or too much depression. There is slow growth, but it is positive slow growth. At the same time, ratios of debt-to-incomes go down. That’s a beautiful deleveraging.
We’re in a phase now in the U.S. which is very much like the 1933-37 period, in which there is positive growth around a slow-growth trend. The Federal Reserve will do another quantitative easing if the economy turns down again, for the purpose of alleviating debt and putting money into the hands of people.
We will also need fiscal stimulation by the government, which of course, is very classic. Governments have to spend more when sales and tax revenue go down and as unemployment and other social benefits kick in and there is a redistribution of wealth. That’s why there is going to be more taxation on the wealthy and more social tension. A deleveraging is not an easy time. But when you are approaching balance again, that’s a good thing.
What makes all the difference between the ugly and the beautiful?
The key is to keep nominal interest rates below the nominal growth rate in the economy, without printing so much money that they cause an inflationary spiral. The way to do that is to be printing money at the same time there is austerity and debt restructurings going on.
Personally, I’m not so sure the ‘money printing’ is inflationary in the sense of embedding consumer price inflation. What I have seen is transitory price rises from portfolio preference shifts to commodities and other risk assets. In the absence of real wage gains, food and commodity price inflation during a period of deleveraging destroys demand and is reversed.
It is interesting that Dalio sees financial repression as a staple of deleveraging. It certainly was in Britain’s great deleveraging.
Also see Dalio’s views on Europe and his comparisons to the United States during the Revolutionary War. I recommend reading this one.
Source: Dalio’s World, Barron’s