Billionaire hedge fund manager Ray Dalio recently offered his take on whether rising interest rates could help improve the economy.
Higher Interest Rates Are Not A Solution: It's "naïve and inconsistent" to think that the Federal Reserve needs to raise interest rates to control inflation, Dalio said in a LinkedIn post.
Dalio, who is the founder of Bridgewater Associates (considered the world's biggest hedge fund firm) noted that prices rise when "the amount of spending increases by more than the quantities of goods and services sold increase."
Central banks can "fight inflation" by "taking money and credit away from people and companies to reduce their spending," he added.
By doing this, the central bank is also reducing the buying power, Dalio said. Thus, the money that goes toward paying interest increases, and at the same time, the money toward spending declines. Higher interest rates also lower the value of investment assets due to the "present value effect," which further lowers buying power, he added.
Monetary policy tightening reduces inflation as people spend less, but it does not make things better as it reduces buying power as well, the analyst said.
"It just shifts some of the squeezing of people via inflation to squeezing them via giving them less buying power," Dalio said.
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Dalio's Recommendations: Raising productivity seems to be the best foot forward for improving the standard of living, but the Fed is not vested with that responsibility, Dalio said.
He recommends that the Fed wield its power to drive the markets and economy with "gentle applications of gas and brakes to produce steadiness, rather than by hitting the gas or brakes hard."
Second, the central bank should keep debt assets and liabilities relatively stable and not allow them to get too large to manage, he explained.
"To do this they should not allow interest rates and availabilities of money to be either too good or too bad for the debtors or the creditors," Dalio said.
And yet, Dalio added, "there isn’t anything that the Fed can do to fight inflation without creating economic weakness."
"With debt assets and liabilities as high as they are and projected to increase due to the government deficit, and the Fed also selling government debt, it is likely that private credit growth will have to contract, weakening the economy," he said. "Over the long run the Fed will most likely chart a middle course that will take the form of stagflation."
The SPDR S&P 500 ETF Trust (NYSE:SPY) opened Wednesday's session at $370.62.
