Bridgewater, founded by the famous investor Ray Dalio, is one of the biggest hedge funds in the world. The company has about $140 billion in assets under management, and Ray Dalio in particular has been focused on big macro trends over the past few years (you’ve probably walked past his books in a book shop or been suggested one of his videos on YouTube).
In this article, Bridgewater’s three Chief Investment Officers share their view on the current inflation story and what it could mean going forward. They may be some of the world’s best investors, but they certainly are not the clearest communicators. So we’ve tried to distil a few key points in the following paragraphs.
They start by explaining the mechanism behind the recent surge in inflation and how this can be tamed. Basically, there are two ways to get inflation under control. Firstly, a lower level of nominal spending – basically less money in the economy chasing the good and services available. Or secondly, a higher level of output – basically the elevated amount of money in the economy but chasing more goods and services.
The CIO’s don’t think this second option is likely, given that unemployment is so low and productivity is unlikely to take a massive step higher. So Bridgewater suggest that the only way out is a reduction in nominal spending growth, which requires less money available to be borrowed through higher interest rates.
While interest rates have been raised over the past few months, they’ve have barely been lifted from their all-time, record lows. As a result, Bridgewater are not seeing a meaningful change in the trajectory of nominal spending in their data. Meaning, Bridgewater believe a lot more interest rate rises will be needed to get inflation under control. And they doubt whether policy makers will do what needs to be done.
“We expect that a lot will be required to rein in nominal spending and inflation and that policy makers will do less than that, given their prior experiences and the risks they face.”
This leads to the biggest concern of the Bridgewater team. As economies reach “capacity constraints” where they cannot generate more goods and services (because we’re nearing full employment and can’t get more productive) all of the money in the system is absorbed in higher prices. If you can’t buy more stuff, you’re willing to pay more for existing stuff. This creates the risk of stagflation – where we have high inflation and low GDP growth. Stagflation then becomes a nightmare situation for Central Bankers and policy makers – do you increase interest rates to control inflation? Or do you lower interest rates to promote growth?
This is an excerpt from our Thought Starters email. Once a week we send you 5 interesting articles that have caught our attention, to get you thinking. No spam, we guarantee.