Ray Dalio: The World's Greatest Wealth Transfer Has Begun.

You can't spend more than you are without getting into debt, and if you have debt, you have to pay back the debt. The only difference is you can print the money. So the question is, what ends that? Or is there no end to that?

Legendary investor Ray Dalio is back in the news, warning investors that the greatest wealth transfer in history is well underway. But unfortunately, it's not all sunshine and rainbows, with this transfer of wealth leaving central governments around the world vulnerable to a massive debt spiral. Dalio recently wrote about this topic over on his LinkedIn page, where the story was quickly picked up by mainstream media and spread across the internet. In this video, I'm going to explain exactly what this wealth transfer is and why it's not really the happy news story you were expecting.

Dalio founded Bridgewater Associates back in 1975, and today it stands as the world's largest hedge fund. Bridgewater's long-standing success skyrocketed Ray's net worth to over $19 billion and has established him as the world's most respected macroeconomic investor. It's ultimately this respect which propels a simple LinkedIn post about the economy into a viral media story published across all major news sites.

So what's this wealth transfer Ray refers to? He's referring to the transfer of trillions of dollars over the last few years from governments and central banks to citizens, which is actually helping Average Joe's handle the current economic downturn. Dalio notes there was a big government-engineered shift in wealth from one, the public sector (aka the central government and central bank), and two, holders of government bonds, to three, the private sector, i.e., households and businesses.

What this led to is households and businesses remaining in relatively healthy financial shape during the economic downturn, while central governments' balance sheets and income statements looked a bit worse for wear. Ray notes that on the citizens' side, we've seen total incomes remain elevated, net wealth is still a lot higher, and unemployment is at its lowest it's been since the late '60s. That's helped employment compensation rise a lot during 2021 and 2022. As a consequence, it's made the private sector relatively insensitive to the Fed's rapid tightening of monetary policy.

But the real problem Ray talks about in this post is that in order to achieve those positive outcomes for the citizenry, the government and the Federal Reserve have taken a hit to their own financial health, a hit which now everybody is going to have to deal with. But how did this situation happen? Ray notes that in 2020 and 2021, the U.S. government saw huge budget deficits; the government spent a lot more than it earned. When the government spends more than it earns, the hole is plugged by going into debt.

This is usually done by the central bank printing money and buying U.S. government bonds, which it did. In fact, across these two years, the Federal Reserve's bond holdings jumped from 18% to 35% of GDP. As we know, a lot of this spending went right into the laps of individuals and businesses. If we look at the personal savings rate in the U.S., we see a major spike around the time of that economic stimulus. But then in 2022, with inflation high and unemployment low, the decision was made to move away from cushy fiscal and monetary policies, which caused a whole lot of headaches.

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But back to the video. As I was saying before, in 2022, with inflation high and unemployment low, the decision was made to move away from cushy fiscal and monetary policies. With interest rates rising, Dalio notes that real bond rates went from negative 1.5% to a more normal level of plus 1.5%. But this increase in interest rates lowered the value of pre-existing government bonds. This meant the holders of U.S. treasuries started suffering large losses on paper. This was the underlying cause of the regional banking crisis we saw earlier in the year, as some banks left themselves exposed to interest rate risk.

But we also have to remember another massive holder of U.S. treasuries; that is, you guessed it, the Federal Reserve. So as interest rates rise, the Federal Reserve's balance sheet, which is packed full of government bonds they hold, looks worse and worse. So that's an issue. But on top of that, the government is arguably suffering even more because it still runs a large deficit. With interest rates now a lot higher, the debt it takes on this year and into the short-term future comes with a much higher interest expense. So debt becomes more expensive to service.

But if you have to take it on, you have to take it on. So what it really means is that the government is going to have more of its income eaten away by interest expenses, which means they'll either need to raise even more money down the track to help them pay for it, or they'll need to either tighten the belt on spending or raise taxes. Because it doesn't really want to do two of those three, the answer is it'll probably keep taking on more and more debt, pushing themselves closer and closer to a debt spiral.

On this topic, Dalio notes, as with people and companies, governments that borrow have debt service payments and eventually have to pay back principal, which is painful. The only difference in their finances is that governments can confiscate wealth through taxes and print money via the central bank. So that's what we should expect to see happen. Will this be a big problem? The answer is probably not much over the near term, but probably a lot later. This is Ray subtly hinting at exactly what I just explained right now.

The easy thing is to just kick the can down the road, but there's only so long we can keep doing that. Looking ahead, Dalio notes over the near term, if there isn't a big supply-demand imbalance in which the amount of government debt sold overwhelms the amount of demand for these debt assets, it appears that a period of tolerably low growth and tolerably high inflation, a mild stagflation, is most likely. Stagflation is, of course, the economic concept Dalio has referred to a lot over the past few years, and it's simply a scenario where inflation remains elevated in an economy that's struggling.

Although, with that said, he does admit he's finding the future particularly hard to see right now due to variables such as politics, geopolitics, the environment, and the impact of technology. So he could very well be wrong. But anyway, that's what Ray sees over the short term. But it's where he starts talking about the longer-term picture that things start to get more worrying. He says over the long term, from looking at history and penciling out what is likely, it is virtually certain that central governments' deficits will be large, and it is highly probable that they will grow at increasing rates.

As increasing debt service costs, plus increasing other budget costs compound upward, and as they increase, governments will need to sell more debt. So there will be a self-reinforcing debt spiral that will lead to market-imposed debt limits, while central banks will be forced to print more money and buy more debt as they experience losses and deteriorating balance sheets. It's this self-reinforcing debt spiral that can topple economies. So Ray is a big proponent of strategies that help us avoid that scenario.

The most obvious is that the United States needs to fix its deficit, and once that's stabilized, work to reduce its debt. The problem is taking steps in that direction is painful and unpopular politically, as it means cutting spending or raising taxes—not really the way to win votes. But with enough willpower, a country's financial position can be turned around. Dalio talks about this at length in his YouTube video, "How the Economic Machine Works." He describes a rare but possible economic scenario where an economy can go through what he describes as a "beautiful deleveraging."

A deleveraging could be ugly, or it can be beautiful. Usually, spending is cut first. As we just saw, people, businesses, and even governments tighten their belts and cut their spending so that they can pay down their debt. This is often referred to as austerity. As we've seen, this cut in spending is deflationary and painful. Businesses are forced to cut costs, which means less jobs and higher unemployment. Cutting spending is now what many countries are looking to do as taking on increasing amounts of debt at higher interest rates snowballs you faster to that debt spiral that Ray was describing before.

The problem is, as we saw from that clip, cutting spending across the board generally leads to lower income for the citizenry and higher unemployment. This leads to the next step: debts must be reduced. Many borrowers find themselves unable to repay their loans. A borrower's debts are a lender's assets. When a borrower doesn't repay the bank, people get nervous that the bank won't be able to repay them. So they rush to withdraw their money from the bank. Banks get squeezed, and people, businesses, and banks default on their debts.

Many lenders don't want their assets to disappear and agree to debt restructuring. Debt restructuring means lenders get paid back less or get paid back over a longer time frame or at a lower interest rate than was first agreed. Somehow a contract is broken in a way that reduces debt. Lenders would rather have a little of something than all of nothing. The problem here is that although debt is reduced, debt restructuring causes incomes and asset values to disappear faster, and the debt burden gets worse. Like the first step of the process, cutting spending, debt reduction is deflationary.

All of this impacts the central government because lower incomes and less employment means the government collects fewer taxes. At the same time, it needs to increase its spending because unemployment has risen. Many of the unemployed have inadequate savings and need financial support from the government. Additionally, governments create stimulus plans and increase their spending to make up for the decrease in the economy. Government's budget deficits explode in a deleveraging because they spend more than they earn in taxes. This is what's happening when you hear about the budget deficit on the news.

To fund their deficits, governments need to either raise taxes or borrow money. But with incomes falling and so many unemployed, who is the money going to come from? The rich. This is the third pillar of a beautiful deleveraging: redistribution of wealth. This isn't taking money from the government and giving it to the people; rather, it's taxing the haves and giving to the have-nots. Because the government needs to fix the deficit, and wealth is so concentrated in the hands of a small few, naturally the wealthier cop higher tax rates in order to improve the government's income statement. This third element of deleveraging is also deflationary.

But then we hit the fourth pillar, which we are all very familiar with, which is inflationary. Unlike cutting spending, debt reduction, and wealth redistribution, printing money is inflationary and stimulative. Inevitably, the central bank prints new money out of thin air and uses it to buy financial assets and government bonds. You see, the central bank can print money, but it can only buy financial assets. The central government, on the other hand, can buy goods and services and put money in the hands of the people, but it can't print money.

So in order to stimulate the economy, the two must cooperate by buying government bonds. The central bank essentially lends money to the government, allowing it to run a deficit and increase spending on goods and services through its stimulus programs and unemployment benefits. This increases people's income as well as the government's debt; however, it will lower the economy's total debt burden. This is a very risky time. Policymakers need to balance the four ways that debt burdens come down. The deflationary ways need to balance with the inflationary ways in order to maintain stability.

If balanced correctly, there can be a beautiful deleveraging, and that's the balance that needs to be found. Over in the U.S., we've seen a lot of money printing because it's easier, but that's also brought the consequence of high inflation. Now the U.S. needs to cut its spending and raise taxes in order to fix its ever-worsening deficit and avoid a big debt spiral. Ray's concern is whether the U.S. can actually do this or whether they'll slip into printing more and more money, kicking the can down the road and sending the U.S. down the road of a big debt spiral.

But with that said, those are Ray Dalio's thoughts on the current U.S. debt situation. Definitely leave a like on the video if you did enjoy it, subscribe if you'd like to see more, and with that said, I'll see you guys in the next video.