The U.S. Economy Just Hit a Major “Inflection Point” (Ray Dalio Interview)

Ray, back in September you said that the United States you think will be facing a debt crisis. Do you still think that that's the case? Ray Dalia is currently predicting that the US economy is at a critical inflection point in relation to its ongoing debt crisis. You can see it in the numbers; we are near that inflation point. Dario, one of the world's most respected macroeconomic investors, took the time to talk with CNBC last week, and in this discussion, which is currently going viral around the internet, he explained the exact position of the US economy, why he doesn't expect interest rates to fall substantially anytime soon, and why, unless drastic action is taken, the United States seems to be at an inflection point where the debt snowball could really start to gather momentum.

So, in this video, let's break down why Dario is sounding the alarm and what we need to do about it. Also, just quickly on a personal note, I just want to say a massive thank you to literally everybody who signed up for new money education so far. As you guys saw on Friday, we just relaunched our course platform, and it's so good to see so many of you guys getting on board, particularly with that Black Friday pricing. So, as a reminder, that is still ongoing, but it does end tonight. It's a killer deal; you get both of our investing courses for the introductory price of introduction to stock analysis. So, if you want to get in on the action at the lowest price you'll ever see, please check out the link in the description or the pinned comment. Now is the time if you want them, but overall, thank you very much for the overwhelming support, and let's get back to Ray Dario.

The first thing Ray explains is exactly how investors think about bond yields, and this is important groundwork to understand the very heart of the US debt crisis. The bond yield, roughly speaking, has got to be about what we determine the expected inflation rate will be over the period of time. That number probably is settling into the vicinity of three, three and a half percent. That's the right number. There has to be a real interest rate above that; in other words, those who are holding debt assets have to receive a return above the inflation rate by something probably in the vicinity of one and a half to two percent. So that is going to get you in the vicinity of four and a half to five percent interest rates, and you're seeing the movement around that level.

When we think about the yield we're locking in by buying government bonds, investors break that analysis down into two components: the likely inflation rate out into the future, and then your real return on top of that. So, if you buy a bond at three percent and inflation is three percent, your real return is zero. If inflation is one percent, your real return is two percent. If inflation is five percent, then the real return is negative two percent. You get the picture.

As Ray says, the general consensus now is that inflation is going to stick probably somewhere near three percent. So, that means when investors factor in, say, a real return of one and a half percent, you get bond coupon rates that are around four and a half percent, which is what we're seeing. The point is that bonds are only attractive if they can offer you a return above what you consider inflation to be. So, inflation right now in the US is around three point two percent. If the government wants to sell its bonds, it needs to offer a coupon rate at least higher than that; otherwise, nobody would be interested.

That sets the stage for Ray's next point. Then there's the big question of the supply and demand for bonds. In other words, the government produces a certain amount of bonds that is equivalent to roughly the size of the deficit. That means they are going to have to sell a lot of bonds. Because the US runs a deficit, aka, it spends more than it earns, the government needs to sell a heck of a lot of government bonds to investors. The gap in spending and income either needs to be closed or it needs to be plugged. They plug it by selling a boatload of bonds.

The problem Ray is seeing is this: the US needs to sell record levels of bonds and will need to sell more and more as time goes on, but he's concerned that the buyers for those bonds are now drying up. Then we look at who are the buyers of those bonds and do they have an adequate appetite? That's a big risk because many who own those bonds have had losses in that. That's not just banks; that is central banks, Japanese investors, and so on. There's a supply-demand issue. You'll have these wiggles around there, but those are the fundamentals that will drive it.

Ray's concern, fundamentally, is that at the end of the day, the US needs to sell a lot of bonds they can't avoid unless they fix their deficit immediately. The problem is buyers for those bonds are starting to wane. Even the treasury themselves acknowledges that there is a weaker demand for US bonds. For one, the Federal Reserve has stopped buying them, but beyond that, take a look at the other major buyers of US treasuries: Japan, China, and the UK. All these big foreign buyers are really having their patience tested, given the ongoing mismanagement of the US debt situation and also the obliteration of their treasury bond portfolios over the past few years.

Because this is all supply and demand, Ray's concern is the bond coupon. So, the interest rate the US will need to pay on the bonds they sell will need to stay very high for a very long time because there's going to be a heck of a lot of bonds that they need to sell, and they need to have a deal that entices the buyers enough to actually get them all sold.

This, however, causes another problem because all that fresh debt the US is taking on then comes with a very high-interest rate that they'll have to pay going forward, which takes more and more money out of their pocket. This is the inflection point we're starting to hit. So as we look forward, we have a debt problem because you can't keep adding to debt faster than you add to income without that problem. We're seeing the need for the rise in real interest rates so that the creditor gets an adequate return at the same time as we have a supply-demand balance.

That's how it looks to me. As Ray says, we need to keep that interest rate up to entice the creditor, but that, of course, is a real problem in and of itself because high-interest rates really hurt the people. People have to give up a lot more of their money in the form of higher mortgage payments, which puts an uncomfortable squeeze on what's happening in the economy. A lot of money was sent out in the form of checks and the like and went out to a lot of people. The household sector did well because the government sector did poorly; they got themselves in deeper debt intentionally so that the household sector and the business sector could be better off.

Then there's the rise in interest rates. What happens from that is that that savings of money gradually goes down, and also the debt maturities, as they roll forward, gradually go up and create a squeeze. Now, we are at a point where, sure, the government sold all these bonds, and the Federal Reserve pre-printed a whole lot of money to buy them all. However, over time, that debt comes due, aka the US government has to pay back the Federal Reserve. Now, when that time comes, the government doesn't really pay it back; they just print more treasuries and raise more money to pay for the old ones coming due.

But that leads to a situation where a lot of debts start rolling over in an environment where interest rates are very high. So they're refinancing that debt but committing themselves to much higher interest payments. This is the inflection point we're coming to, the moment where debts can start to snowball. The deficit gets worse, so the government has to print more and more bonds at higher rates. The old debts are being rolled over at higher rates, and what that means is that paying the interest becomes a much bigger task, a task that may be completed by, you guessed it, the government selling even more bonds to raise money to cover interest. But then, who's there to buy the bonds? If we sell more bonds, we need to entice the buyers more, so the interest rate has to go up more.

Ah, and then it’s a debt snowball. The longer term is that we are at a point in which we are borrowing money to pay debt service. There is a process by which, when you keep having debt growth faster than income growth, then that means you have debt service encroaching on your spending. That's the same for the government as it is for us. As that happens, and you want to keep spending at the same level, there is the need to get more and more into debt, and the way that works, it's like a... it accelerates. We are at the point of that acceleration, which creates the supply-demand problem.

So just like when we have to make higher monthly repayments to our mortgage, the government too has to make higher monthly repayments on its debt. Now, when we're faced with higher mortgage payments, the way we have to go around that is by reducing our spending. But for the government, they really struggle to reduce their spending. So for them, their solution is to instead go deeper into debt and raise money to pay for the increase in costs. But, as we were just talking about before, and as Ray Dario mentions, that's the start of the debt snowball. That leads on to deeper issues of finding buyers for all the debt without needing to offer even higher coupons just to entice bond sales.

That's a really tricky issue, considering the buyers of US Treasury bonds are already getting more hesitant to put more and more money into them. The internal political issue, the internal social conflict issue, is something that is affecting foreign demand for bonds. About forty percent of our debt is sold to foreigners, and so there is a concern about the American politics of the controlling of this debt crisis. These types of things are really tough to hear because the United States actually does have a way out of this hole; they genuinely do.

As Ray would say, they just need to fix the deficit. You need to earn more, and you need to spend less. The only problem with that is that when it comes to an entire country, earning more means raising taxes, and spending less means pulling back on things like health care, social security, infrastructure, the military, etc. Now, both of these options are obviously unpopular politically, and that's why the government will always try to kick the can down the road and hand the growing problem onto the next guy. But that obviously doesn't help the issue.

Now, the US has pushed it so far that, as Ray says, you have debt service encroaching on spending. We're drifting into territory where cutting spending or raising taxes might be unavoidable because the only other option is a debt crisis that bankrupts the country. That's what's really choking up demand for US debt. Foreign countries used to jump in with no worries; there was no chance the US could default. But now they see how bad the US government has let the debt situation get and how they refuse to take decisive action to reverse course, and they're thinking, "Well, actually, maybe we should steer clear in the case of the whole thing blowing up."

So with that in mind, what's the solution here? What does Ray suggest we do? So, we come back to the same basic question: how good, how strong are we going to be? When we talk about "strong," what I mean is also economically strong. Economically strong means financially strong. That means it's just a basic thing: financially strong means do you earn more than you spend? Do you have a good income statement as a country? Do we have a good income statement, and do we have a good balance sheet, more assets than we have liabilities? The worse that gets, the more we are going to have that long-term problem.

You can see it in the numbers; it's just a matter of numbers. We are near that inflection point, and that's where we're at. Focus on the country's income statement, aka, raise the revenue and lower the expenses until you finally get back to a profit. Once the income statement is looking healthier, fix the balance sheet; pay down the debts, use that cash you generate to lower your debt load. It's obviously a big economic problem, but that's what it boils down to.

Anyway, I hope that helped make sense of Ray's recent interview. As a reminder, please do check out new money education if you're interested in the killer introductory pricing. The clock is ticking on that, so please jump on board. Thank you very much if you do decide to pull the trigger and help our efforts here on YouTube. With that said, thanks very much for watching. I'll see you guys in the next video.