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.”
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.”