When you get at the late part of that cycle where you’re creating a lot more debt and then you’re monetizing it, that’s near the end of a long term debt cycle and that produces its own set of problems. Speaker 2
Ray D’Alessio recently did an interview with Bloomberg Finance. And in this interview, he said that’s a bit of a warning. He explained why we are in the later stages of the debt cycle and why this is a problem. Speaker 1
What we’ve seen this go around is the need to distribute to produce a lot of debt. Where did those checks come from? They came from the government. The government wrote the checks, but the government can’t produce money. The central bank can produce money. So the central bank had to print a lot of money to lend to the government to do that. And that’s monetization. When you get at the later part of that cycle where you’re creating a lot more debt and then you’re monetizing it, that’s near the end of a long term debt cycle. Speaker 2
So let me explain that sometimes it can be a little bit hard to grasp exactly what Daliah is getting at. I’m not entirely sure if you’re aware of this or not, but we’ve had a pandemic over the past year and a bit. This pandemic has produced a number of things, including business troubles, job losses, a struggling economy. And this, in turn means we’re in need of a lot of money from the governments. So the government says, yeah, I guess I’m forced to give you this money, but it’s got to come from somewhere. So I’m going to get my friend, the central bank to give me this. And so Jerome Powell, head of the central bank, says, yeah, I guess I have to give you this money. And he goes and says, infinite money, prints and starts, engines rolling, prints, a lot of money. Obviously, it’s all done online now. And he lends it to the governments. This is called debt monetization. This type of behavior, Dalio says, is typical of what happens in the late stages of the cycle Speaker 1
when there has to be a lot of selling of bonds and bonds don’t give any good return. There is a guaranteed negative return in bonds relative to inflation, and there’s a pile of people who own bonds. And this isn’t just Americans, but these are international investors owning bonds and they have to buy a lot more bonds because when the government has to sell a lot more debt, that means they have to buy a lot more bonds. There will not be enough demand for those bonds. When that happens, interest rates rise. That’s what you’re seeing now. And the central bank is put in a dilemma. Speaker 2
So here’s the situation. Let me break this down piece by piece. First of all, we’ve talked about this. The government is in a situation now where they have to sell bonds. They just need the money to fund all of their spending. And then we take a look at these bonds that pretty terrible. OK, so right now you get one point seven percent a year on a 10 year Treasury bond. Being straightforward, that is bad because inflation on average is around two to three percent a year. So if you own one of these, you actually lose money each year. So we’re in a situation now the government has to sell a lot of bonds to fund itself, but the selling a poor product, so to speak, because with inflation, you actually lose money on these bonds. So this causes a big dilemma for both the governments and the Fed. No one wants to buy their bonds, and if no one buys them, then the government doesn’t have any money to give out as stimulus checks or loan for businesses who need us. And then the economy risks a collapse. So the Fed can either allow this risk to occur or they can print money and buy the bonds themselves. The problem, if they do, the second option is first, you risk the devaluation of the dollar because you put more dollars into the system and because there’s more, they become worth less. And secondly, you risk inflation. So the Fed is stuck between a rock and a hard place. And a the decision that they make has severe consequences. And the other thing, as if this wasn’t bad enough, the current holders of government bonds, a lot of them aren’t happy with the returns that they’re getting because it’s negative once you account for inflation. So these holders of government debt could potentially start selling their bonds. Foreign investors and US investors who own most of the debt might just decide, hey, there’s much better places to put my money. And so if they start selling the government bonds, plus the government needs to sell more of its own bonds, as Dahlia says, that could produce a real dilemma. That’s classic lites, a long term debt cycle. Type stuff. Speaker 1
Think of the economy as being like an individual and their pulse is dropping. When the pulse is dropping, the doctors come running in with the stimulant and they inject a stimulant. Now that the economy is rebounding and inflation pressures are rebounding, there’s not the same pressure to administer that stimulation. When it happens, when it becomes a problem is first. The rising interest rates start hurting financial asset prices first. Typically, they hurt bonds. Then they pass through and hurt stocks because still interest rates affect stocks. And when that starts to affect stocks, that’s one thing. Maybe the stock market can correct 10 or 15 percent and the Federal Reserve can tolerate it when it goes beyond that and starts to affect the economy. That’s when you see the real trade off have to surface. Speaker 2
So over the past year or so, a big talking point when it comes to investors is the rise of the 10 year Treasury bond. It went from about zero point six percent to one point seven percent, almost tripling. So this is affected bond holders a lot. The next stage, as Dahlia talks about and we haven’t seen this yet, is when it starts to affect stock prices, because the more these yields go up, the more investors start saying, hang on, maybe it’s better that I get out of the pricey stock market and into something more safe, like long term bonds. As Dalio said, maybe we see a 10, 15 percent correction in the Federal Reserve can tolerate assets, but after it’s gone through bonds and it’s gone through stocks, the next stage is it starts hurting the economy because people think instead of spending this money in the economy, I can just save it at a higher rates. They think I’m not going to borrow as much because rates are higher. So I have to pay more on my debts and therefore they borrow less and put less money into the economy and the economy gets hurt. And so you’ve got this thing where bonds get hurt. Then what’s next? The market gets hurt, then the economy gets hurt. And there’s not a great recipe for success. We can just say that these are the signs of the late stages of the cycle. Speaker 1
So let me start with the debt cycle. You know, in 1945, we began a new world order. 1944, we created a new monetary system, the Bretton Woods monetary system, and then we created that new world order. And that created a bull market in stocks and an American world order. For the most part, there’s a cycle that we’re used to in which whenever you have a economic downturn, the central bank hits the gas and can create debt expansion, and that produces an increase in demand. And that happens in three phases of the cycle. Normally it’s interest rates, you lower interest rates and the economy turns up. But when you hit zero interest rates, which happened in 1932, that crisis, 1932, we had zero interest rates. Speaker 2
So there’s a couple of phases that we need to get our head around. Three key phases. Just remember these first is when the Fed decides to bring interest rates down or close to zero. This happened in 1932 and it happened and the current cycle in 2009. But once interest rates are at zero, you can’t lower them anymore. So you’ve got to try something else that leads to the second type of monetary policy, which is where the Fed prints money and buys financial assets. This has happened only two times throughout history. In 2008 09 and in 1932, zero interest rates, print money and monetization. But that only goes so far. Sometimes you end up at a place where the money injected into the system does not trickle down and does not go to all the places it needs to go. For example, what happened recently, which was the banks just hold on to the money as excess reserves. Now, this is where monetary policy three comes in and the Fed starts working with the government’s fiscal policy and monetary policy, a line the Fed buys government debt and the government uses this money to give to people and businesses.
As Dalio says, that is the late cycle of an expansion. That’s what’s driving the markets and the economy. Now, is this the last puff before we see the end of the cycle? Well, it could be, but we just don’t know how long this late stage will last for what we do know as they have gone through a lot of their levers already. Interest rates can’t use that anymore, buying financial assets that’s become less effective, a growing wealth gap and values gap is clear now. A bunch of debt is rife throughout the economy, 20 trillion dollars right now. All of these are signals of the late stages of the cycle.