A government-engineered shift in wealth has protected the public from the worst of the Fed's rate hikes, hedge fund veteran Ray Dalio believes, but added the move may have pushed the government to shoot itself in the foot.
Writing on LinkedIn, Dalio, worth $19.1 billion, said there had been a "big government-engineered shift in wealth" from the public sector and government bondholders to the private sector.
This has made the private sector "relatively insensitive" to the Fed's rate hikes, Dalio adds: "As a result of this coordinated government maneuver, the household sector’s balance sheets and income statements are in good shape, while the government’s are in bad shape."
Dalio explained that during the pandemic years of 2020 and 2021, central governments spent a lot of money to support businesses and citizens and took on a lot more debt, and their balance sheets deteriorated as a result.
Meanwhile, central banks printed a lot more money—causing inflation to rise—and bought a lot of the debt itself to get money into the hands of the private sector.
As a result, Dalio estimates, the private sector is in "relatively good shape"—while the government is not.
High inflation
To cool down the hot economy caused in part by all this government spending, central banks raised interest rates.
With inflation hitting 8.5% in July last year the Federal Reserve has raced to quash the rise—raising rates repeatedly from March 2022 to its current ceiling of 5.25% to 5.5%.
And although inflation has now begun to drop—standing at 3% in June, its lowest point since early 2021—the rate rises have not caused consumer spending to slow anywhere near as quickly as the Fed was hoping.
Indeed, while the Commerce Department said last month that there was a minor slowdown in consumer spending—less than 0.1%—consumer spending has remained stubbornly resilient.
This means that while life in the private sector is relatively unscathed—with GDP growing 2.4% in Q2 2023—governments are footing the bill.
"[In 2022] the private sector’s net worth rose to high levels, unemployment rates fell to low levels, and compensation increased a lot, so the private sector was much better off while central governments got a lot more in debt and central banks and other government bondholders lost lots of money on those bonds," Dalio wrote.
Who pays the price?
The shoppers propping up the economy are 'YOLO' (You Only Live Once) spenders, claims Wharton Professor Jeremy Siegel, who are spending the last of their cash reserves on traveling and enjoying the summer.
That means the spending boom may be finally coming to an end. But that isn't likely to help government finances in Dalio's view.
Economists had bordered on panic when a White House debate over raising the debt ceiling reached the eleventh hour, and although an agreement was reached the debt headache has not dissipated.
"Does it matter that the central governments and central banks have such bad balance sheets and income statements if the real economy is in pretty good shape?" Dalio questioned. "Of course it does!"
The founder of the world's biggest hedge fund, Bridgewater Associates, explained: "As with people and companies, governments that borrow have debt service payments and eventually have to pay back principal, which is painful.
"The only differences in their finances are that governments can confiscate wealth through taxes and print money via the central bank (so that’s what we should expect to happen)."
This won't be a "big problem" in the near future, Dalio believes, but may be in the long term.
He warned that central governments could spin themselves into a "self-reinforcing debt spiral" by taking out more loans in order to cover the service payments on their existing debts, which Dalio estimates will be large.
