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The System is Broken

Actually, “the world has gone mad and the system is broken.” That’s the title of an article(1) published by Ray Dalio (Co-Chairman of Bridgewater Associates, commonly recognized as the world’s largest hedge fund) on November 5, 2019.

Unfortunately, I fear things will get really crazy before anything breaks and snaps us back to reality.

Dalio makes several important points about the state of our economic system that are worth sharing:

(1) Central banks continue to push money into the system to drive economic activity and inflation up. But recipients of those monies (investors) are investing it rather than spending it. “As a result of this dynamic, the prices of financial assets have gone way up and the future expected returns have gone way down while economic growth and inflation remain sluggish (emphasis added).”

(2) We have very large government deficits (even in the 11th year of economic expansion!) with more coming, requiring governments to sell more debt. “Where will the money come from to buy these bonds and fund these deficits? It will almost certainly come from central banks, which will buy the debt that is produced with freshly printed money. This whole dynamic in which sound finance is being thrown out the window will continue and probably accelerate, especially in the reserve currency countries…”

(3) We are getting closer to the time when pension and healthcare liability payments will come due en masse. There are three ways to deal with these obligations: cut benefits (i.e. default), raise taxes, or print money (at least at the federal level). “While none of these three paths are good, printing money is the easiest path because it is the most hidden way of creating a wealth transfer and it tends to make asset prices rise.”

It’s obvious that our economic system is not well. Even after a record period of expansion, and with US unemployment below 4%, investors got nervous in 2018 about whether the economy could handle a 10-year Treasury yield > 3% - yes, just 3%! The debt continues to pile up, temporarily papering over underlying problems. So long as the Fed and other central banks are intent on maintaining the narrative that everything is wonderful, it seems asset prices will reflect the remarkable associated stimulus….at least for now.

1. https://www.linkedin.com/pulse/world-has-gone-mad-system-broken-ray-dalio/

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