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Dec. 18, 2021, 10:18 a.m. EST

Ray Dalio warns Fed’s hands are tied and higher U.S. inflation is sticking around. Democracy, maybe not.

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By Jonathan Burton

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See: I’m done with Illinois! I want to retire in a small town in a neighboring state — so where should I go?

Also: I want to move to the South, I want the beach — and a liberal mindset. Where should I retire?

I want individuals to understand the mechanics of this, which is why I wrote the book. For example, I’d like them to see historical cases and fundamental cause-effect relationships to understand what it means to produce a lot of debt and a lot of money, so I wrote a chapter on the value of money.  

MarketWatch: What could this situation mean for U.S. investors? You’re describing a very different America to consider.

Dalio: Right. I want people to be well-informed and worry about what they should worry about.

I have a principle: If you worry, you don’t have to worry. And if you don’t worry, you have to worry. If you worry, you’ll take care of the thing you’re worried about. If people worry about the fighting and they worry about the finances, then they can work together and deal with these things.

Financially, the way it works is when the government needs to send out checks, it could either get the money from taxes or from borrowing. If it can’t get all the money it needs from borrowing, the central bank can print the money. That devalues the value of money.

Central banks can create a lot more money and debt, but that won’t raise living standards. I’d like to help people see how money and credit move through the system to drive things. I’d like to show people how money and credit are created and how a person who gets the money and credit buys goods, services and financial assets, which makes those things go up in price.

I’d like to help them understand the reasons why cash is so bad in this type of environment. People think the safest investment is cash, but they don’t look at the inflation-adjusted return.

Don’t hold cash. It’s better to hold a liquid, diversified portfolio of assets — if it’s balanced. Make sure you’re well-diversified outside of cash — stocks /zigman2/quotes/210599714/realtime SPX -0.30% , bonds /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y +1.07% , inflation-indexed bonds, commodities and gold /zigman2/quotes/200593176/composite GLD -0.11% , and across many countries, particularly those with stronger income statements and balance sheets. An “all-weather” portfolio has currency diversification, asset-class diversification, country diversification and industry diversification.

MarketWatch: So you’re thinking that higher U.S. inflation is not transitory. It’s going to stick.

Dalio: Yes. There’s two types of inflation. There’s inflation when the demand for goods and services rises against the capacity to produce them. That’s normal, cyclical inflation. Then there’s monetary inflation — the creation of a lot of money and credit relative to the quantity of goods and services. The U.S. is having both.

When I look at the country’s financials going forward, what the size of the deficit will be and how much money is produced, that’s a concern. There’s also the risk, or even the probability, that those who are holding cash and bonds will choose to sell those to move into other things. If that happens, the U.S. central bank will have to decide if it raises interest rates, which will hurt the economy — and I don’t believe they can do that in a significant way. It would be bad for the economy, politics and the markets if they tried to rectify that by allowing interest rates to rise. So they’re probably going to have to print more money, and that causes more monetary inflation.

Don’t miss: All those doves at the Fed have suddenly become hawks, writes Rex Nutting

Today it doesn’t cost anything to borrow. Right now if you take out debt, you have practically no interest rate and principal payments can be deferred, so money is essentially free. With the cost of money negative and below the nominal growth rate, it’s very profitable to borrow and invest in anything that can grow at the inflation rate or more. That’s what’s priced into the markets now. And if they change things — raise interest rates to be higher than is priced into the markets — asset prices will go down and there will be more of an economic problem. 

Central bankers, especially the Fed, are between a rock and a hard place . They need to tighten quite a lot to restrain inflation, yet if they do they will hurt the economy. Imagine what would happen if there was a tightening of monetary policy in the classic way of first causing asset prices to go down and then the economy to contract.

Politically, imagine what that would be like. People are at each other’s throats and they’ve been given a lot of money. I’m afraid of another economic downturn. We can’t even get along on whether we can wear masks or not. You can’t allow another economic downturn. You can’t raise interest rates enough to bite. Interest rates have to be significantly below both the inflation rate and the nominal GDP growth rate.

It’s easy to see what type of policy biases will exist by looking at whether circumstances favor debtors or creditors being favored. High real interest rates will exist when circumstances make it better for the creditor to be helped and credit growth to show while low real rates will exist when central banks want to help debtors and want to stimulate credit growth. 

History shows that when countries need more money and don’t have other ways of getting it that they will produce more money. Producing money doesn’t take money away from anyone so it’s politically easier because it’s a hidden tax. Nobody’s complaining about where the money came from. If you get it through taxes, everybody squawks. History has shown that the easiest way is to print more money and give it out. If instead you tighten, it has consequences.

MarketWatch:  Bitcoin and other cryptocurrency also is politicized. Crypto has become a political statement as much as a way to make and lose money.

Dalio: There’s a lot of money chasing all sorts of things, crypto among them. It has been an amazing accomplishment for bitcoin /zigman2/quotes/31322028/realtime BTCUSD +0.60% to have achieved what it has done, from writing that program, not being hacked, having it work and having it adopted the way it has been. I believe in the blockchain technology; there’s going to be that revolution, so it has earned credibility.

I’m not an expert on bitcoin, but I think it has some merit as a small portion of a portfolio. Bitcoin is like gold, though gold is the well established blue-chip alternative to fiat money. 

Key Words: Fed’s Powell says he doesn’t see cryptocurrencies as ‘financial stability concern’

However, bitcoin has a number of other issues. If it is a threat to governments , it will probably be outlawed in some places when it becomes relatively attractive. It may not be outlawed in all places. I don’t believe that central banks or major institutions will have a significant amount in it.

I have a little bit of it because I believe a portfolio should start off with, under a worst-case scenario, what assets protect it and make sure it’s diversified. It’s almost a younger generation’s alternative to gold and it has no intrinsic value, but it has imputed value and it has therefore some merit.

Read on: Can the Federal Reserve taper without causing a tantrum in the markets? So far, so good

Also see: Why it matters that workers feel they matter: Valued employees do a better job for employers and customers

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