Dalio on Wealth Transfer Effect (Patreon)

Billionaire investor Ray Dalio, who founded the hedge-fund company Bridgewater Associates, recently explained why the economy isn't slowing down significantly despite the Federal Reserve raising interest rates and tightening monetary policies since last year.

Dalio pointed out that the coordinated efforts of governments have led to positive financial situations for households, while the government's financial standing has deteriorated. The U.S. economy showed resilience, growing at a 2.4% annual rate in the second quarter due to consistent consumer spending and improved business investment.

Governments globally, including the U.S., ran budget deficits in 2020 and 2021, while central banks purchased substantial amounts of bonds. In 2022, in response to rising inflation and low unemployment, there was a shift away from extremely loose fiscal policies and monetary policies that had been keeping bond yields low.

Although both stocks and bonds experienced declines last year, the private sector saw an increase in net worth, lower unemployment rates, and higher compensation. This left central governments with more debt, and central banks and other bondholders faced losses on bonds.

Dalio cautioned that historical patterns suggest potential concerns. In the short term, a period of moderate growth and moderately high inflation, or "mild stagflation," is likely as long as government debt supply and demand remain balanced.

However, over the long term, Dalio predicted that central governments will accumulate large fiscal deficits, and these deficits will likely grow. As the costs of servicing the debt and other budget expenses increase, governments will need to issue more debt, which could lead to a self-reinforcing cycle of debt accumulation. This might result in market-imposed debt limits and pressure on central banks to print more money and buy more debt.

Dalio's comments followed Fitch Ratings' downgrade of the U.S. credit rating from AAA to AA+. This development briefly paused the strong upward trajectory of U.S. stocks, with the S&P 500 and Dow Jones Industrial Average experiencing declines.