Ray Dalio Says Stagflation Is the ‘Great Cost’ of Fed’s Fight Against Inflation

Bridgewater Associates Founder Ray Dalio speaks during an event in San Francisco, Calif., on Oct. 02, 2019. Kimberly White/Getty Images for TechCrunch

Billionaire investor Ray Dalio said in a note Tuesday that the Fed’s fight to quell soaring inflation would most likely come at the “great cost” of weakening the U.S. economy and stagflation.

Dalio said in his post on LinkedIn that stagflation, which is a combination of sluggish growth and high inflation, is now his base case for the course America’s economy will take as the Federal Reserve tightens monetary settings after years of easy money.

“Over the long run the Fed will most likely chart a middle course that will take the form of stagflation,” Dalio said, arguing that, by keeping monetary policy too loose for too long, the U.S. central bank is basically stuck with having to adopt inflation-fighting policies that will likely lead to a contraction in private credit growth and weaken the economy.

“The Fed is moving from printing and buying debt at an annual rate of around $1.5 trillion to selling it at an annual rate of $1.1 trillion, and from sharply lowering interest rates to sharply raising them,” he wrote.

“For that reason, we experienced the big lurch forward and are now experiencing the big lurch backward,” he added.

Dalio recalled the days of former Fed Chair Paul Volcker and his “bone-crushing” monetary tightening in response to soaring inflation in the 1970s, with his policies taking the U.S. unemployment rate to 10.8 percent, curbing demand, and lowering price pressures.

“Inflation was reduced by people and companies being painfully squeezed and reducing spending. That’s always the case and will be the case this time,” Dalio predicted.

His reference to the Volcker-era double-digit unemployment comes as former Treasury Secretary Larry Summers said in a recent interview with Bloomberg News that millions of Americans would have to lose their jobs to contain decades-high inflation.

Dalio’s warning comes on the heels of a recent interview he gave to an Australian newspaper, in which he predicted that the pain of stagflation would force central banks around the world to pivot away from tightening and cut rates in 2024.

His predictions that the United States and other economies face a growing risk of stagflation lines up with a recent World Bank forecast of a growing risk of stagflation and recession.

The global economy is “entering what could become a protracted period of feeble growth and elevated inflation,” the World Bank said in a statement that accompanied the release of its latest Global Economic Prospects report.

Yet stagflation is not a foregone conclusion, analysts at the European Central Bank (ECB) said in a note Wednesday, which sought to cool stagflationary expectations.

“Several differences between the current economic situation and that in the 1970s make it less likely that stagflation will develop now,” they wrote.

The analysts pointed to factors like a substantial drop in oil dependence and limited upward wage pressures due to the fact that workers have become less unionized and wage indexation schemes are less common, lowering the likelihood of large second-round inflation impacts and the dreaded wage-price spiral.