Ray Dalio says the Fed faces a difficult balancing act

As the US Federal Reserve made its first interest rate cut since early in the Covid-19 pandemic, billionaire investor Ray Dalio noted that the US economy is still facing a “tremendous amount of debt.”

The central bank cut the fed funds rate by 50 basis points on Wednesday to a range of 4.75% to 5%. The rate not only determines short-term borrowing costs for banks, but also affects various consumer products such as mortgages, car loans and credit cards.

“The Federal Reserve’s challenge is to keep interest rates high enough that they are good for the creditor, and not keep them so high that they are problematic for the debtor,” the founder of Bridgewater Associates told CNBC’s “Squawk Box Asia Thursday, noting the difficulty of this “balancing act.”

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

On Wednesday, Dalio named debt, money and the economic cycle as among the five major forces affecting the global economy. On Thursday, he expanded on his point, saying he was generally interested in “the enormous amount of debt created by governments and monetized by central banks. This magnitude has never existed in my lifetime.”

Governments around the world have taken on record debt loads during the pandemic to finance stimulus packages and other economic measures prevent a collapse.

When asked about his prospects and whether he sees an impending credit event, Dalio said no.

“I see a big depreciation of that debt due to a combination of artificially low real interest rates, so you’re not being compensated,” he said.

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

Dalio’s concern is that neither former President Donald Trump nor Vice President Kamala Harris will prioritize debt sustainability, meaning these pressures are unlikely to ease regardless of who wins the upcoming presidential election.

“I think as time goes on, the path will move more and more towards monetizing those debts, on a path very similar to Japan’s,” Dalio stated, pointing to how the Asian country kept interest rates artificially low which has devalued the economy. Japanese yen and reduced the value of Japanese bonds.

“The value of a Japanese bond has fallen by 90%, so it’s imposing a huge tax by artificially giving you a lower return every year,” he said.

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

Furthermore, if the markets don’t have enough buyers to take on the supply of debt, a situation could arise where rates would have to rise or the Fed would have to step in and buy up, which Dalio said would happen.

‘I would look [the] The Fed’s intervention is a very serious bad event,” the billionaire said. The oversupply of debt also raises questions about how it is paid.

“If we were working in hard money terms, there would be a credit event. But in fiat monetary terms you have the purchases of those debts by the central banks, converting the debts into money,” he said.

In that scenario, Dalio expects the markets to see all currencies fall as well, because they are all relative.

“So I think you would see an environment very similar to the environment of the 1970s, or the period from 1930 to ’45,” he said.

As for his own portfolio, Dalio claims he doesn’t like debt: “So if I were to take the plunge, it would be an underweight position in debt like bonds,” he said.