Ray Dalio elaborated on the problems facing US macroeconomic policy while speaking Saturday at the China Development Forum.
Although I wasn’t invited this year, it sounds as though Dalio largely reiterated points made earlier this week in a somewhat disjointed missive warning on a kind of bond apocalypse.
Stimulus in the US will create a “supply-demand problem for bonds, exert[ing] upward pressure on rates,” Dalio said Saturday. That, in turn, means the Fed will to “have to buy more, which will exhibit downward pressure on the dollar.”
Read more: Dalio Tells ‘Crazy’ Story, Is Bullish ‘Stuff,’ Bearish ‘Stupid,’ Short Cash
He went on to recap other familiar talking points, including the notion that the world may decide to start “selling those bonds,” which he described as a “situation [that] is bearish” for the greenback.
I spent more than enough time critiquing Dalio in the linked article (above), so I’ll resist the temptation to paraphrase myself. I would note, though, that the vast majority of market participants seem incapable of conceptualizing of Treasurys for what they actually are — just interest-bearing dollars.
Of course, they’re also the collateral that greases the wheels of global finance and a key vehicle for recycled savings, so doing away with them clearly isn’t tenable. But I often speak in extremes in order to stimulate discussion.
In “Zeus’s Catch-22,” for example, I reminded folks that the US government doesn’t really need to “fund” stimulus by issuing bonds. Or by raising taxes. The US government could just create money and send it out as stimulus or use it to pay contractors as part of an infrastructure proposal, etc. The notion that any of that must be “matched” by borrowing or taxing is patent nonsense. If that’s too much for you to digest mentally, then just note that Treasury could always fund at the short-end where the Fed’s control is uncontested.
The figure (below) illustrates Dalio’s point, but it also underscores the absurdity of this charade. If all we’re going to do is issue bonds and buy them from ourselves, why issue them at all? That’s not “funding.” It’s self-referential nonsense. And if scores of critics are going to insist it’s inflationary anyway, then what do you lose (from a public relations perspective) by just issuing the currency unfunded?
In any case, Dalio’s Saturday remarks reminded me of a short note from Deutsche Bank’s Alan Ruskin out earlier this week. In it, he laid out what he described as “ten important reasons why assets markets and FX should expect continued Fed aversion to fighting market forces for higher bond yields.”
I won’t recap them all, as some are self-evident, but Ruskin noted that “absolute yields are still low by almost any measure, and extraordinarily low relative to expected nominal GDP growth – by that measure policy and rates are erring on the side of too easy.”
The figure below (which I utilized earlier this month) uses a bit of creative extrapolation. It takes the average of professional GDP forecasts, tacks on a projection for PCE, and then subtracts the current 10-year yield. This exercise produces a future gap between yields and nominal GDP growth of around 6%. That would be the highest in five and a half decades.
Ruskin also suggested that the Fed may be pleased to see a bit of froth come out of markets, and in that regard, rising long-end yields could be seen not just as a positive referendum on the growth outlook, but also as a check on speculative excess.
“The move in back-end yields is going with the grain of the policy bias towards some desirable tightening in monetary conditions, even if the market may feel like a month or two early,” Ruskin said. He also served up what came across as dry humor, whether he meant it that way or not. You can’t, Ruskin remarked, “have a desired rise in growth expectations impacting real yields and a rise in inflation expectations without a rise in nominal yields.”
Further, he argued that this year, the economy will be “highly interest rate inelastic.” That, I think, is a good point. Higher yields (especially when they’re not actually “high” in a historical context) aren’t likely to overwhelm the impulse from mass vaccination and a grand reopening of the US services sector, into which excess savings and stimulus money will flow assuming the virus variants or some other unwelcome development doesn’t ruin the summer economic renaissance.
Finally, Ruskin implored the Fed not to “shoot the messenger.” “Market signals are invaluable,” he wrote, adding that “expectations, and real yields are… already distorted by QE, don’t add to these distortions.”
Ruskin articulates what I perceive . Thank You Mr H
Agree 100 percent with Ruskin’s analysis. Powell and the Fed are fine with rates going higher and won’t step up purchases (as opposed to a twist) until the yield on the 10yr is above 3%. Sticking with my forecast of 2% by Memorial Day an 2.5% by Labor Day.
How could the China Development Forum not invite you?
The key here is the word “policy” as it relates to current pandemic macroeconomics — keep your eyes on the moving cups and where the pea actually is.
A simplified way to look at this game, was a short piece here:
When MMT Meets The S&P
Vineer Bhansali (Jun 17, 2020)
“Using the language of Stephanie Kelton’s new book “the Deficit Myth”, Uncle Sam is a money issuer, while the nations of the European Union are money users, and therein lies the difference.
So the government, under MMT, does two things: it makes a “horizontal” transformation by re-distributing money, and a “vertical” transformation across time from savers to borrowers, or vice versa.”
==> The nuts and bolts of policy connected to rates, inflation, asset prices and debt are in a state of transformation, because of the pandemic. The pandemic has provided a global opportunity to adjust macroeconomic policy. Global policy had to react to a global systemic threat with the general premise that governments had to save their economies, essentially by any means.
With that said, I don’t think it matters a bit as to what Mr. Dalio thinks or concerns floating around about China, inflation, stocks, housing or soap operas. This period we’re in is not connectable to any prior economic theory or policies, but, the governments around the globe have adapted on-the-fly to provide the means for chaos to be somewhat controlled. In so doing, stocks have gone to the moon and people like Mr. Dalio sit in fear of hyper-crisis outcomes in the short term as well as long term — and that’s the mistake. This era and this policy cycle will phase out and fade-into a period which will hopefully be less dramatic. Volatility and risk will always ebb and flow but the overall pandemic shock will be less shocking.
Even though most data seems disconnected and chaotic, I still enjoy looking at relationships at FRED. In terms of MMT or cycle oddities, I had posted yesterday how I felt this pandemic period will boil down to GDP growth. I continued pondering the disconnect between the Real GDP decline and stock market growth, finding an interesting recent connection between the GDP growth rate and the 10 year Treasury yield. It’s easy to understand that GDP growth has been low for many years — just like treasury yields.
Therefore, I decided to look closer at the spread between the 3-month yield and 10 yr (which was always a way to look at recessions and growth) but then connect that spread to GDP growth (as a percent, related to change). Perhaps it’s mixing too many apples and oranges, but this link shows the very serious disconnect in stock growth versus economic growth.
That gets us back to MMT thinking, wondering what happens with the economy and the relationship with an exploding stock market and subpar GDP growth. Perhaps that becomes an issue that makes Mr. Dalio’s thoughts useful, but policy as we know it, has never been this disconnected — I can’t find the words for this … it’s like MMT, Capitalism and economics are all irrelevant. Yet, this cycle seems entirely unsustainable in every respect.
https://fred.stlouisfed.org/graph/?g=Ccxy
In other words, “TINA”?
Yah, TINA, until it doesn’t work out.
Another thing that is mind-blowing is how to think about how all the economic disconnections work in terms of housing, so once again turned to FRED apples and oranges looking for ways to connect GDP to housing price increase during 40 years, and then compare that to stocks. TINA probably will fuel more home price increases — but then that connects to increasingly growing list of things that seriously are not sustainable within the context of time and reality. I see the next story has Larry Summers, but all the knee slapping in the world isn’t going to solve this mess/ In all honesty, seems like the Fed, Biden and everyone involved is just buying time and hoping a massive crash can be kicked down a very long road — but, the pandemic serves as a nice reminder as to how things can just sorta unfold really fast …
FRED: https://fred.stlouisfed.org/graph/?g=CcKq
Thanks for the link. A very interesting graph. Certainly supports that we are in uncharted waters. I just read a long article by Hussman linking classical stock price to future cash flows. With that perspective, the market is very over-valued. Is traditional investment strategy dead or are we in some new alternative reality? Can high market valuations become the new normal because enough investors believe. When I buy in now am I just really clapping for Tinkerbell?
For the last few decades, people have been able to make capital gains in bonds ( wow- in hindsight that was so easy) and that period of time might be/is coming to an end. I expect some turbulence but no crash landing. Hopefully, I am not wrong.
I think you must be right. Otherwise there wouldn’t be a life insurance company in existence the Europe or the US.
Mr H. Sometimes you report on dealer gamma levels and I’m curious as to where we are with that right now. Thanks.
how about foreign buyers (half UST market), is that perhaps “funding”?
People habitually mischaracterize that too. The US doesn’t need to “source” its dollars from China or Japan or anywhere else. That’s a nonsensical way to conceptualize of things. There is nothing priced in dollars that the US can’t buy. If it can be purchased in USD, then the US government can by definition “afford” it because the US government has a monopoly on the legal issuance of USD.
If everything in the world could be purchased with your authentic signature (i.e., if your signature was the world’s reserve currency), what could you not afford? Would you need to “borrow” your signature from China if you wanted to buy something? No. You could buy anything you wanted as long as your hand still worked.
The idea that the US government needs to “borrow” or “source” USD from China to fund stimulus checks or infrastructure makes no more sense than saying the government needs to convince Japan to “fund” the purchase of military hardware from Lockheed or Raytheon. That’s not how it works. If the government wants missiles, it just creates dollars and buys missiles. The “offset” (via borrowing or taxing) comes later. Or not at all.
Again: This whole conversation is usually couched in nonsense terms.
Even if you strip away that layer of nonsense (which is what MMT does), you’re still left with nonsense because “money” and “dollars” aren’t real things. They’re made up human constructs. If humans disappear tomorrow, so do dollars. All that would be left of “the dollar” in that scenario are green pieces of paper which would either be eaten by animals or else just disintegrate into dust over the years.
This is why it’s so maddening to listen to ostensibly intelligent people debate whether we “can” or “can’t” spend “money” to save lives and livelihoods. The answer is: “As long as everyone believes in this nonsense then yes, we can, and should, leverage our monopoly over the fairy tale to alleviate suffering.”
If you want to argue that once too much of it gets issued or once we stop pretending to need the offsets (i.e., stop pretending like we need to tax or borrow to “fund” spending) then people will stop believing the fairy tale and hyperinflation will ensue, well then at least you’re starting to make sense because you’ve acknowledged that it’s all made up in the first place.
But at that point, you need to explain how hundreds of millions of people who can barely do math and read (i.e., Americans) are going to suddenly wake up one day and go through the thought experiment above in order to discover the nonsensical nature of it all. Finally, you have to explain what’s going to replace it. Euros? Yen? Is the world going to just switch to the Aussie or the kiwi overnight? Does everyone want CAD bonds? Or beaver pelts? Or bitcoin?
all pricing is relative. but markets (and/or perceptions) matter. capital gets redirected. stuff gets repriced. “can i get that in reichsmark please?” 🙂
Money is the impersonal, efficient, consistent way to tell someone they can’t have something. The fiction about sovereign budgets is a corollary of that.