Ray Dalio says Fed faces tricky balancing act as economy faces 'huge amount of debt'

As the US Federal Reserve made its first interest rate cut since the start of the Covid pandemic, billionaire investor Ray Dalio warned that the US economy is still struggling with a “massive amount of debt”.

The central bank’s decision to cut the federal funds rate by 50 basis points to a range of 4.75% to 5%. The rate not only determines short-term borrowing costs for banks, but also affects a variety of consumer products such as mortgages, auto loans and credit cards.

“The challenge for the Federal Reserve is to keep interest rates high enough that they are beneficial for the creditor, but not so high that they become problematic for the debtor,” the founder of Bridgewater Associates told DailyExpertNews's “Squawk Box Asia” on Thursday, noting the difficulty of this “balancing act.”

The U.S. Treasury Department recently reported that the government has spent more than $1 trillion this year on interest payments on the $35.3 trillion national debt. This increase in debt servicing costs also coincided with a significant increase in the U.S. budget deficit in August, which is approaching $2 trillion for the year.

On Wednesday, Dalio named debt, money and the economic cycle as among the five major forces influencing the global economy. On Thursday, he expanded on his point, saying he was generally interested in “the enormous amount of debt that is created by governments and monetized by central banks. I have never had that magnitude in my life.”

Governments around the world have taken on huge debts during the pandemic to finance stimulus packages and other economic measures to avoid collapse.

When asked about his outlook and whether he expected a credit crunch, Dalio replied that he did not see that.

“I expect a large depreciation of that debt through a combination of artificially low real interest rates, so you don't get any compensation,” he said.

While the economy is “in relative balance,” Dalio noted that there is a “huge” amount of debt that needs to be redistributed and also sold, new debt created by the government.

Dalio worries that neither former President Donald Trump nor Vice President Kamala Harris will make debt servicing a priority, meaning the pressure is unlikely to ease regardless of who wins the upcoming presidential election.

“I think as time goes on, the path will be more and more towards monetizing that debt, a path very similar to Japan's,” Dalio said, pointing to the way the Asian country has kept interest rates artificially low, which has caused the value of Japanese yen and lowered the value of Japanese bonds.

“The value of a Japanese bond has fallen by 90%, creating a huge tax burden because the yield is artificially lower than it is every year,” he said.

For years, the Bank of Japan has stuck to its negative interest rate regime as it has carried out one of the most aggressive monetary easing exercises in the world. The country's central bank only recently raised interest rates in March of this year.

Furthermore, if there are not enough buyers in the market to support the debt, a situation may arise where interest rates have to go up or the Fed has to step in and buy up. Dalio expects that to happen.

“I would watch [the] Fed intervention as a very significant bad event,” the billionaire said. The debt glut also raises questions about how it will be paid for.

“If we were in hard monetary terms, you would have a credit event. But in fiat monetary terms, you have the purchases of that debt by the central banks, which monetize the debt,” he said.

Dalio expects that in that scenario all currencies in the markets will also fall, because they are all relative.

“I think you'll see an environment that's very similar to the environment of the 1970s, or the period from 1930 to 1945,” he said.

Dalio emphasizes that he himself is not a fan of debt assets in his own portfolio: “So if I were to invest, I would opt for an underweight position in debt assets such as bonds,” Dalio said.