He describes the current economic situation as being "mid-cycle" - after all, everything goes in cycles - and "Goldilocks", i.e. not to warm and not to cold, so just cosy. Debt levels which were very high have come down, interest rates are low and there is plenty of liquidity, in other words money is available. But there are significant long-term problems, in particular high debt and non-debt obligations and limited abilities by central banks to stimulate if the need arises, that are likely to create a squeeze. Also social and political conflicts are near their worst for recent decades and conflicts get worse when economies worsen.
So while he sees no near-term economic worries for the economy as a whole, he worries about what these conflicts will become like when the economy has its next downturn.
The central banks’ powers to rectify these problems are more limited than normal, which adds to the downside risks. This is because they have limited abilities to lower interest rates from the historically low levels where they are now and because increased QE would be less effective than normal "with risk premiums where they are". (Personally, I'd say that this weapon has been overused and there aren't so many obvious target assets for central banks to buy if they need to increase liquidity). He also says that effective fiscal policy help is more elusive because of "political fragmentation". I take this to be polarisation in the US but he may mean more broadly. Either way, he fears that whatever the magnitude of the downturn that eventually comes, whenever it eventually comes, it is likely to produce much greater social and political conflict than currently exists.
He goes on to look at how the economic position has evolved over the long term globally and in the major trading blocks. By the standards of the last 50 to 100 years, the amount of slack in the world economy shows we are as close to equilibrium as things get, asset prices look about right from trends over the same time periods but debt is pulling away from our ability to service it as a proportion of GDP and productivity growth - the key to raising living standards - is weak and slowing while his measure of conflict - the share of US newspaper articles covering political conflict - is at a high and rising (but then we do have President Trump, so I'm not entirely convinced about that measure!)
He concludes "Downturns always come. When the next downturn comes, it’s probably going to be bad."
I'll leave you to look at the graphs and read his analysis of the US, Eurozone, Japan, China and emerging markets excluding China for yourselves*. Thought provoking stuff, but the sun is shining at the moment so we should make hay (or mend the roof to quote an ex-politician, even though he didn't actually do it, which does make me nervous).
Indeed, my economics guru, David Smith, ran with the theme of borrowing storing up trouble in his column the week before last**. He noted that the Bank of England has expressed concern about the rapid growth in consumer credit, currently rising the fastest since the financial crisis. The Prudential Regulation Authority, part of the Bank and responsible for regulation and supervision of banks, other credit providers and insurance companies, is looking into whether credit quality is suffering and the Financial Conduct Authority is examining assessments by lenders of the creditworthiness of borrowers. Along with several other commentators, Smith has picked up the large increase in unsecured debt on new cars bought with finance, which is now 86.5% of new cars bought in the UK. Some have gone as far to suggest this is another sub-prime banana skin in the making. I find this a bit surprising as cars are a fraction of the cost of houses, the debt is much shorter term and the finance arms of the big car manufacturers catching a cold doesn't seem likely to me to tilt the world into recession, unlike major bank failures. But a number of non-financial journalists have only just seemed to realise why there are so many new cars on the road these days and how come young people can afford to drive round in fancy new SUVs. I'm not sure where they have been sleeping - I hope the Bank of England hasn't been sleeping either. It would be a spectacular own goal to have introduced the remarkably tight controls that they have on mortgages only to treat car loans in the same lax manner as credit cards.
Whatever, the rise in unsecured borrowing since 2013 is causing debt to rise again, after it had fallen in cash terms following the credit crunch. People seem to have got comfortable with high debt again and that makes Smith uneasy (and therefore me too). Smith notes that this has happened before memories of the crisis have faded, a process that has been aided by ultra low interest rates. Which of course are part of the problem. In a pattern that the MD of Fathom Financial Consulting says is familiar from Japan and elsewhere, any pauses in the rise in debt are short lived, as the record low interest rates encourage more debt to be taken on. The problem for central banks is that further cuts in rates, or any other relaxation of monetary policy, have little effect, but raising interest rates, even by a small amount, would have significant negative impact because of the high debt levels. We have got ourselves into a position where only a small increase in rates is needed to make people squeal with pain, with all the implications that has for impact on the overall economy.
While the Bank of England does not expect to raise interest rates soon, if the economy develops in line with its latest forecast (which presumably factors in Brexit) it does not expect to keep rates on hold until 2019, as markets had been expecting. Smith notes that the crunch would come if a situation arose where rates needed to be pushed higher because of inflation, which would plunge quite a few households into distress. Accordingly he expects only small increases, with the Bank aiming for a "new normal" of 2%, though not for some time. Even that rate, he notes, may be too high for many. After all, incomes have stopped growing faster than inflation, after a brief interlude of increasing living standards, so debt ain't going to get paid down very much.
But, while I am very reluctant to differ from my guru, I guess that small increases in rates would therefore have an accentuated effect in squeezing out inflation and so my concern is more on the lines of Dalio's: if economic storms hit, then further quantitative easing will have less effect and interest rates are already close to zero, so the central banks won't have levers that will work. To state the blindingly obvious, the world has not returned to normal economic times when interest rates have been at record lows for record lengths of time, with no sign of a return to anything like normal norms. (Are there any other type of norms? Answers on a postcard....)
*https://www.linkedin.com/pulse/big-picture-ray-dalio?trk=eml-email_feed_ecosystem_digest_01-hero-0-null&midToken=AQEDAoAJ9yrzzA&fromEmail=fromEmail&ut=2dGfJRxpJva7M1
**Our Nation of Borrowers is Storing Up Trouble, Sunday Times 14 May 2017
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