Bridgewater hedge fund founder and billionaire investor Ray Dalio is concerned about the effects of persistently high inflation and rising interest rates saying that this could drive the economy to stagflation – which is a period of persistent inflation, reduced economic output and increased joblessness.
Inflation rates have risen higher than they have been in over forty years. Oil prices, which were $140 a barrel at the start of the Russia-Ukraine war, have gone down but are still at an uncomfortable level of $100. Gas prices have as a result also increased and are weighing on consumer confidence and retail store visits. The Federal Reserve has responded by hiking interest rates in order to get rampant inflation under control. This has triggered a yield curve inversion and as a result, profit margins for companies have fallen and caused a sharp economic slowdown and will eventually cause joblessness.
Dalio does not have faith in the ability of the Fed to pull off a successful ‘soft landing’. The response of the Fed is to tighten monetary policy in an attempt to deal with inflation, but in the long-run it will lead to too much pain for the markets and economy and eventually the damage will become evident.
It looks like the Fed let inflation run hot and waited too long before doing something about it. And now it might make the same mistake in the opposite direction, overdoing interest rate hikes and quantitative tightening, plunging the economy into one of economists worst nightmare: Stagflation.
The Fed is failing to ‘drive the markets and economy like a good driver drives a car’.
Dalio has joined numerous critics who argue that the Federal Reserve’s response to inflation has been ineffective, citing too slow and overly aggressive means. Comparing the proper response of the Fed to a good driver, he says that Central banks should apply the gas and brakes gently to produce a steady and smooth motion rather than hitting the gas hard and then the brakes hard, causing the car to lurch forward and backwards. The Fed, according to Dalio, hasn’t been a good driver.
Last month, the Fed instituted a third interest hike, the highest in nearly 30 years. The attempt to solve inflation by tightening monetary policy according to Dalio is naive and inconsistent with how the economic machine works. He points out that this solution is short sighted.
In an attempt by the Feds to rein in inflation, Dalio admits to not being able to see a future where the policies put in place do not cause an economic weakening and eventually lead to a recession. The most likely scenario for Dalio is that inflation remains high for a while while the economy slows down and unemployment increases, resulting in a period of Stagflation similar to the 1970s.
