Guest post written by
Ray Dalio is the founder and co-chief investment officer of Bridgewater Associates, the world's biggest hedge fund.
Because I appreciate thoughtful discussions to try to get at what’s true and how best to deal with it, and because I respect John Mauldin’s thinking about economics, I am happy to explore what’s true about how well capitalism is working and what happens when interest rate cuts and quantitative easings don’t work.
John wrote his comments in response to my two articles, “How and Why Capitalism Needs to Be Reformed” and “It’s Time to Look More Carefully at MP3 and MMT” which are available at economicprinciples.org and on LinkedIn. The first piece was written in two parts and the last one in one part, so there are three parts in total that he refers to.
John summarized his view of them as follows: “I agreed with much of Part 1, with a few quibbles. Ditto for Part 2. But when I read the third piece I found myself thinking, “Ray Dalio is really, really wrong.” I am glad that we agreed on the most important thing, which is that our existing system is not producing the desired results of equal opportunities and that that’s both unfair and threatening to our well-being. To me that’s the most important thing, because if respected capitalists can agree on that, then we will be more likely to move on to explore sensible policies for dealing with that problem. Like John, I don’t want to quibble over the little thing he raises, which is about whether one defines capitalism to include or exclude the fiscal and monetary policies that are being used. While he would prefer to say that the problem is with policies and I described it as with how the profit-making capitalist system is inadequately allocating resources, I’m perfectly happy to say that fiscal and monetary policies need to be reformed to allocate those resources better rather than to say that capitalism needs to be reformed. Let’s unite behind the problem and the need to fix it.
Of less importance, though still worth exploring, is our disagreement about MP3 and MMT. Before going into it I’d like to clarify something about my views about why and how capitalism needs to be reformed. Some people misconstrued my statement that “capitalism needs to be reformed” to mean that I don’t like capitalism. Lest there be any doubt, I am a capitalist who believes that both capitalism and equal opportunity are required for the American Dream to be a reality. What I’m saying is that the system is failing to deliver the desired equal opportunity piece so that we are risking the whole thing falling over unless the system is reformed. I encourage you to read my piece on this yourself to make your own assessment of the evidence and my logic rather than to listen to others’ assessments of it.
Regarding MP3 and MMT, my view is that central banks and central governments will have to coordinate fiscal and monetary policies, and central banks will have to monetize the resulting debts in ways that have similarities with MMT. That can sound like I’m in favor of MMT even though that is not true. Once again, to understand what I’m saying I urge you to read what I said in this article rather than other people’s interpretations of it.
John and I appear to disagree on what happens when the economy turns down and central banks’ lowering interest rates and printing money to buy financial assets (i.e. quantitative easing) no longer work — i.e., when there is “pushing on a string.” As I explained in my piece, there’s nothing “modern” about Modern Monetary Theory. The “pushing on a string” dilemma has happened many times in history. Having studied these dilemmas in the past and thought a lot about the cause:effect relationships that determine how they work, it is my conclusion that central banks will have to turn to what I call Monetary Policy 3 (MP3) in the next downturn. MP3 follows Monetary Policy 1 (which is interest-rate-driven monetary policy), which continues until interest rate cuts can’t be big enough to do the trick. That’s when Monetary Policy 2 (which is central bank printing of money and buying financial assets) happens and continues until that doesn’t work anymore either. MP3 is fiscal and monetary policy working together with fiscal policy producing deficits that are monetized by the central bank. Modern Monetary Theory as it’s described is simply one version of many types of MP3. What I’m saying is that I believe that in the next downturn you will either see some form of MP3 from central banks or you will have terrible economic and social conditions.
To be clear, I’m not saying that such policies don’t have some undesirable consequences, and I don’t think that MMT is the best form of MP3. What I’m saying is that MP3 is the best of the bad alternatives and some form of it will likely happen, so one had better know how it works and how to deal with it. I welcome alternative descriptions of what will happen when both interest rates cuts and QE don’t work to stimulate the economy in the next significant downturn.
While a much more extensive discussion of MP3 and Modern Monetary Theory than can occur in this limited space is warranted, if you’re interested in my views of how the debt works and how all the big debt cycles over the last 100 years worked, you can get these things in my book Principles for Navigating Big Debt Crises which you can get free as a pdf download here or as a print book on Amazon.