Xinhua News

22nd November 2022 – (Hong Kong) The unprecedented fiscal and monetary stimulus adopted by the United States has put policy makers in Europe and developing countries in a very difficult position, founding investor of Bridgewater Associates Ray Dalio has said.

In a recent written interview with Xinhua, Dalio said the stimulus has prompted the U.S. Money Supply M2 to rise by 40 percent in the two years following February 2020, with the Federal Reserve Banks’ total asset more than doubling. Excess in money supply is viewed as one of the causes of America’s rampant inflation which broke a 40-year record in June.

To clamp down on inflation, the Fed has taken a hawkish stance, tightening the U.S. monetary policy. However, in the absence of a coherent framework, monetary tightening alone risks being deficient, said Dalio.

Commenting on the inflation-inducing deglobalisation policies such as “friend-shoring,” domestic subsidies, and export restrictions in the technology industry, Dalio said he expects chronic high inflation to last so long as deglobalisation continues restraining supply in addition to fueling monetary inflation.

“Tightening monetary policy to fight inflation would increase one type of pain for another, inflation is taking purchasing power away from people. Tightening money would do the same, which would bring down the inflation because of the weakness in demand it would cause,” said Dalio, affirming that central banks will have to choose how much of each type of pain to take to “navigate a middle course.”

Though the euro zone is less culpable for flooding the economy with liquidity compared to the United States, Dalio said he believes the European Central Bank (ECB) today is nevertheless caught in a race to hike interest rates.

“It’s true that the United States printed and handed out a lot more money, so it has caused more monetary inflation. However, it is now tightening a lot. Whereas Europe is not tightening as much and is keeping real rates low, which is causing the currency depreciation and European inflation to rise relative to U.S. inflation,” he said.

Speaking from the investors’ perspective, Dalio expects more capital outflow from Europe and an even weaker euro if the ECB cannot catch up with the Fed’s rate hikes.

On 2nd November, the Fed raised the benchmark rates by 75 basis points for the fourth consecutive meeting, setting the federal funds target range between 3.75 percent and 4 percent, whereas the ECB announced on 27th October its third rate hike of the year, with the key interest rates rising consecutively by 200 basis points since July.

Taking into account the budgetary disparity in the euro zone, a delicate balance also has to be struck between creditors’ interest and that of the debtors, and the uncertainty makes markets uneasy on top of already unfavorable economic conditions, Dalio said.

“This is putting the ECB and fiscal policy makers in the very difficult position of trying to navigate between these bad alternatives which will produce stagflation and fiscal supports that cause big deficits that require more selling of debt. This is bad for the bonds and for the currency. It is also bad for their equity markets and economies,” he said.

Dalio deems the developing economies most undermined in the tightening monetary environment, due to the mounting financial burden of their U.S. dollar-denominated debt and their lack of access to imported commodities, and he expects the problem to get worse.

For Dalio, the U.S. dollar and the other major currencies may suffer “a big decline” relative to gold when the Fed’s tightening cycle ends.

In addition, “for many reasons including because of the desire to avoid being hurt by the weaponisation of the dollar, the appeal of the dollar, which is held as dollar debt (as a storehold of wealth), will be poor. What replaces it as a both a good medium of exchange and a good storehold of wealth is tough for me to say,” he predicted.