Advisor to the Fed Argues Against Further Rate Cuts (Plus a Wee Rant About Japan)

Ray Dalio, founder and chief investment officer of Bridgewater Associates, is no doubt far from alone in being someone whose opinion is solicited by the Fed. Nevertheless, in an interview in today’s Financial Times, he takes a position diametrically opposed to conventional wisdom. He argues that the remedy for our current economic, particularly credit, woes, lies not in further rate cuts but in currency revaluation, specifically of the yuan.

While Dalio’s observations have merit, let me make two observations. First, the Chinese are in the process of letting the yuan appreciate; it rose 6.6% last year. Rising domestic inflation, caused by their efforts to maintain their dollar peg, is becoming politically costly. Moreover, the strong euro is letting Europe become a more important outlet for Chinese goods as US demand falters. China is, at least for now, moving in the direction we want them to, but pressuring them to do more, faster, is likely to be unproductive. The Chinese know they hold the better cards. Thus, the correction that Dalio calls for is unlikely to happen fast enough to salvage the US economy.

However, what surprised me about Dalio’s comments is his failure to mention the yen. Japan has the world’s largest foreign exchange reserves, yet everyone gives it a free pass due to its alleged near depression. Yet Japan too is showing signs of rising inflation despite cutting it microscopic policy interest rate 25 basis points to 0.50%, which was really an effort to shore up the yen that had short lived success.

In an interesting bit of synchronicity, we have a page one Wall Street Journal story, “Growing Reliance on Temps Holds Back Japan’s Rebound.” The thrust of the story is that while Japan’s export sector is doing well, its domestic demand is anemic, and the article argues that a big culprit is the heavy use of temporary workers:

The trend has been good for Japan’s economy in some ways. Use of temps gives companies flexibility and cost control, helping them succeed in highly competitive global industries like manufacturing. Big Japanese companies have reported earnings growth for five straight years.

Yet the heavy use of temps also has created an obstacle to the virtuous cycle typically seen in an expanding economy: When companies make better profits they eventually raise wages, which boosts consumer spending — and leads to more corporate profits.

In the past decade, average wages in Japan have fallen every year except two because of an increase in temps and stagnant wages for full-timers. Consumption by working families declined on a year-on-year basis in six of the past eight quarters. This even though the Japanese are also saving less: A Bank of Japan survey showed that some 23% of households had no savings last year, compared with just 10% in 1996.

The result is sluggish domestic demand and growth that is supported by exports to a lopsided extent. In the July-September quarter, when Japan’s economy grew at an annualized rate of 1.5%, exports were rising at an annualized 11% rate and domestic demand was shrinking slightly. Personal consumption is so weak in Japan that it accounts for only a little over half of the economy, compared with 70% in the U.S.

This story is disingenuous. First, we have more in common with Japan than most like to acknowledge.

We’ve had a period of expansion in which, for the first time on record, a greater share of GDP growth went to corporate profits than to worker pay (either in the form of increased wages or more hiring) and by a considerable margin. But Americans, unlike the Japanese, have kept the domestic economy going by lowering their savings rates to zero. That simply isn’t sustainable. Yet employers seem bound and determined to reverse the practice initiated by Henry Ford, of paying average workers well, that built a prosperous middle class that could in turn could buy more goods.

Second, Japan has every reason to tell the world what miserable shape it is in to forestall pressure to increase the value of the yen. While the erosion of the lifetime employment system is a blow to Japanese workers, it is a modern invention, and was put into place only after World War II. So while workers are worse off on a relative basis than they once were, I am not certain their situation is as bad on an absolute basis as is commonly depicted. What proportion of these temporary workers are young women who still live at home with their parents? That cohort, commonly described in Japan as “parasite singles” enjoys a comfortable lifestyle.

Back to Dalios’ recommendations in the Financial Times. Note that he also argues for lower GDP growth targets. We suggested in an earlier post that part of our problem may be trying to get a free lunch, by stimulating the economy to perform over its sustainable growth rate, then refusing to accept the inevitable slowdown to below that rate.

From the Financial Times:

Ray Dalio, the billionaire fund manager who was among the experts to advise the US Federal Reserve in recent months, has said interest rate cuts are not the solution to the turmoil in the credit markets.

Rather, Mr Dalio, founder and chief investment officer of money manager Bridgewater Associates, said the longer-term solution would involve currency policies – such as a revaluation of the Chinese renminbi – to address the US’s trade imbalance.

“Our current credit problems are the flip side of our balance of payments problem,” he told the Financial Times. “The world has been awash with liquidity and money has been pouring in from abroad, so lots of money had to get invested fast.

“The dollar being the world’s dominant reserve currency, coupled with the major surplus countries having their currencies pegged to the dollar, has led to a dollar denominated debt bubble – a lot of irresponsible lending in dollars. The mortgage crisis is just one reflection of this.”

Mr Dalio called for the Fed to stop cutting interest rates and to set a “realistic” target rate for US growth of 2.2 per cent a year. That would be the lowest since the 1930s, and below the 2.5 per cent that is the Fed’s target.

“The basic problem is that, at current exchange rates, Americans will not earn enough income to pay for their spending, so they will either get deeper into debt or sell off their assets to make up the difference,” he said.

“When the Fed lowers interest rates, it just postpones the problem because it causes debt-financed consumption to pick up.”

The views of Mr Dalio run counter to the prevailing wisdom that interest rates are key to economic management. His opinions are widely followed in the money management world.

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  1. s

    An absolutely fanatastic article. Dalio is 100% right. Dispensing with rate hikes would be the most forward thinking action the US could effect; I suppose this is why we shold expect another 50bps.

    It is interesting to contrast this with Gross who gets on TV and talks his 700 billion bond book wioth repeated calls for slash and burn policy. Who is right?

    This article which goes to the heart of the problem facing the United States – you touch on it with the Yen/carry reference. First, the long term growth rate for the United States should be much lower – as some have recently advocated to the chagrin of the perma bulls. The implication here is that the terminal growth rates for US companies should be lower which would re-rate the valuations down (multiple contraction not exapansion – think european multiples). Second, the Fed should be raising interest rates to choke out the shorts in the bond market as opposed to artificially killing those trying to reconcile overvalued equities with the current fundamentals (hence cutting interest rates and repeatedly burning those who are short the market). The implication for equities here is again a re rating lower as higher discount rates are applied to the valuation. Third, while not officially saying it, he is talking about the labor arbitrage that is not going away and the perverse blowback from globalization.

    In view of all this it is interesting that Citigroup’s strategist is calling for a 1700 S&P by year end. He predicates his argument on multiple expansion (?) and that the housing situation is overplayed. The later is overplayed because it is only 15% or so of the increase in wealth over the past five years while rising equity markets account for the other side of that appreciation. Perhaps he uis spending too much time thinkjing about the equity market and ignoring the interest rate that were/are the pump primer.

  2. minka

    “What proportion of these temporary workers are young women who still live at home with their parents? That cohort, commonly described in Japan as “parasite singles” enjoys a comfortable lifestyle.”

    In the USA, marriage and kids has become more of an upper middle class phenom, due to the lack of good jobs. I wonder whether what you decry here is actually a symptom of declining quality of jobs for young people. A point in my favor: the very, very low birth rate in Japan.

  3. minka

    “the remedy for our current economic, particularly credit, woes, lies not in further rate cuts but in currency revaluation”

    But if the Fed continues to cut rates, the Chinese will revalue because otherwise they’ll be facing increased inflationary pressures.

    Where is the pressure to revalue going to come from without rate cuts? The Chinese do not seem to be susceptible to jawboning.

  4. s

    many pundits argue that a yaun revaluation will not have the desired impact if they simultaneously allow greater financial flows like the propose actions in London, HK and USA. That would allow mush stranded capital to flee and bouy the dolalr and presure the yaun. That said so many moving paarts who knows. but raising interest rates would certainly protect FDI flows on the fixed income side as oopposed to simply pushing out the hgorizon of the eventual reckoning. The hole is so deep that there is no we can ease our way out over the next few years.

  5. sean s.

    Keep in mind that Henry Ford introduced the five-dollar day because annual turnover on the new assembly line was something like 800 percent. Paying workers enough to buy Fords and other consumer goods was an after-the-fact rationalization to build Henry Ford’s image. Employers don’t have to worry about this sort of turnover now, even if working conditions and pay deteriorate. Where are their employees going to go?

  6. Yves Smith


    To your first point, I’m not certain (and I mean this) that young women not having children isn’t a defacto revolt against the lousy deal married women have in Japan. The parasite singles by all accounts have a good lifestyle; they hang out with girlfriends shop, and have a high level of discretionary income. Married women, even ones with husbands that have good income, hardly ever see their men (salarymen stay out late with their colleagues and come home drunk most of the time) and get no help with childrearing and household chores. And since Japan doesn’t permit meaningful immigration, there is no cheap labor pool for them to hire domestic help (things may have changed, but I never heard of Japanese having nannies). Would you want to have kids under those circumstances? So I’m not convinced the state of the economy is as much the explanation as social forces, namely birth control and labor market participation giving women new choices.

    Sean S,

    You may well be right about the impetus, but the result was a virtuous circle; a middle class that could consume the output of a growing industrial base, creating more demand and more jobs. Japan is a cautionary example of what happens when that process goes in reverse.

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