• John Prior

"Why in the world would you own dollar debt?" Ray Dalio

Why in the world would you own dollar debt? Ray Dalio

In an article recently published on his Linkedin page, Ray Dalio of Bridgewater posted an article in which he questioned why an investor would hold US debt (and hence by extension US dollars). Below is a link to the original article and a reproduction of the highlighted quotes from within it, to give you a sense of the main thrust of the argument.

We think this article is of particular significance and worth highlighting for those who have not read it; not just because we agree with the sentiments within (we do), but for the following reasons:

- Ray Dalio based his main investment strategy (risk parity) around owning dollar debt with leverage. No one has made more money owning dollar debt. The fact that he now sees it as uninvestable, merits attention.

- This is not a fringe asset or speculative pocket of the market. The US dollar is the global reserve currency, and the US Treasury is the global reserve asset. We are talking about the asset upon which in the entire financial system is based.

- Why now? The arguments on which Dalio’s claims are made have been in place for some time. Is the timing coincidence or is there a catalyst?

“Why in the world would you own bonds when bond markets offer ridiculously low yields.”

“The economics of investing in bonds (and most financial assets) has become stupid.”

“The world is a) substantially overweighted in bonds (and other financial assets, especially US bonds) at the same time that b) governments (especially the US) are producing enormous amounts more debt and bonds and other debt assets.”

“If bond prices fall significantly that will produce significant losses for holders of them, which could encourage more selling.”

“Imagine what would happen if, for any or all of these reasons, the holders of these debt assets wanted to sell them.”

“History and logic show that central banks, when faced with the supply/demand imbalance situation that would lead interest rates to rise to more than is desirable in light of economic circumstances, will print the money to buy bonds and create “yield curve controls” to put a cap on bond yields and will devalue cash.”

“Based both on how things have worked historically and what is happening now, I am confident that tax changes will also play an important role in driving capital flows to different investment assets and different locations, and those movements will influence market movements. If history and logic are to be a guide, policy makers who are short of money will raise taxes and won’t like these capital movements out of debt assets and into other storehold of wealth assets and other tax domains so they could very well impose prohibitions against capital movements to other assets (e.g., gold, Bitcoin, etc.) and other locations. These tax changes could be more shocking than expected.”

“For these reasons I believe a well-diversified portfolio of non-debt and non-dollar assets along with a short cash position is preferable to a traditional stock/bond mix that is heavily skewed to US dollars. I also believe that assets in the mature developed reserve currency countries will underperform the Asian (including Chinese) emerging countries’ markets. I also believe that one should be mindful of tax changes and the possibility of capital controls.”

The key lesson that we take from the above and the answer to the “Why now?” question is that the pandemic has changed the Overton window significantly and forever as it pertains to the real value of sovereign debt and by extension, the currencies in which those debts are denominated. Said differently, paying the positive real yields and running the sustainable deficits that would be necessary to maintain the real purchasing power of their creditors and hence their currencies (a bond is just an agreement to deliver a fixed amount of currency at some point in the future) is no longer an option.

The Biden administration is leading the way in this direction but sooner or later the pressure on other advanced democracies to follow suit will be overwhelming. As economies begin to open and activity naturally rebounds, helped by ongoing stimulus, they will recover much of their lost output. However, when the next slowdown arrives, will governments stand aside, or will they use their new economic orthodoxy to deliver better outcomes for their constituents? The implication of Dalio’s article is that a) they will have no choice and b) that this cannot be achieved without real losses being taken by holders of fiat currencies and debt contracts denominated in them.

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