Perspective On National Debt

Ray Dalio’s fix

Ray Dalio calls it the “3 percent solution,” and it’s gaining attention with White House officials and senior Republicans as a potential fix to America’s fiscal woes even as the party pushes ahead with a mega spending bill that’s roiling the bond markets.

For the past couple of weeks, advance copies of Dalio’s forthcoming book, “How Countries Go Broke: The Big Cycle” — and Dalio himself — have been making the rounds with policymakers in Washington and investors in New York.

The hedge fund mogul has been warning for some time that America’s soaring deficits risk economic calamity, and Dalio recently met with the chairman of the House Budget Committee, Representative Jodey Arrington of Texas, and its members.

What’s the solution? It aims to bring the annual deficit-to-G.D.P. ratio down to 3 percent, from around 7 percent. According to Dalio, this can be accomplished only by pulling “three levers” — cutting spending, raising tax revenue, and the corresponding lowering of interest rates.

“The 3 percent solution is very practical,” he told me by email. “It has worked many times in many places, most recently in the U.S. from 1991 to 1998.”

Dalio argues the interest rates lever is the most consequential.

The problem: Everyday interest rates are tied to the budget. We’re seeing that connection play out in real-time. The bond market has started charging a higher interest rate to buy U.S. government debt as confidence in the government’s fiscal discipline sours.

If Congress can get serious, Dalio argues, it will send a huge signal to the markets. Treasury Secretary Scott Bessent had made a similar argument. But he has recently gone quieter on that message as the bill, which is expected to add significantly to the deficit over the next decade, advanced through the House.

A fiscally responsible budget would ease volatility in the bond market. Any economic slowdown caused by reduced spending could be offset by lower interest rates, which is what a heavily indebted nation needs most.

The challenge: All three levers need to work in tandem. Both parties have shown little interest in meaningfully cutting spending. Raising taxes, too, is a nonstarter. The upshot is a stalemate in Washington and higher interest rates.

“All the political decision makers on both sides of the aisle that I spoke with agree that we are likely headed for a terrible outcome if the deficit isn’t cut down to about 3 percent of G.D.P.,” Dalio continued. “So I feel it’s like being on a boat headed for the rocks in which everyone agrees that we will crash if we don’t change our course, but they’re too hung up arguing which way to turn.”

The question is, even if he is right — which he probably is — what would actually push lawmakers to act and avoid the rocks?

“The forcing mechanism will likely be a debt crisis and all that goes with it,” he wrote.