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Ray Dalio

HOW COUNTRIES
GO BROKE

The Big Cycle

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The Critical Questions

Why This Study Matters

  • Are there limits to a country's debt and debt growth?
  • What will happen to interest rates if government debt growth isn't slowed?
  • Can a major reserve currency country like the US go broke?
  • Is there a "Big Debt Cycle" we can track to know when to worry?
“

I don't come to this subject as an economist. I come as a global macro investor who for over 50 years has been through many debt cycles in many countries and has had to navigate and understand them well enough to bet on how they would go.

— Ray Dalio

A Stark Discovery

The Scale of Debt Cycles Throughout History

~750
Debt/Currency Markets Since 1700
Only about 20% remain
80%
Have Been Severely Devalued
Through mechanistic processes
~80
Years Per Big Cycle
Give or take 25 years
48
Major Debt Crises Studied
Between 1918 and 2018

Part I

Overview of the Big Debt Cycle

The mechanics of money, credit, debt, and economic activity — and how they create the Big Debt Cycle.

How the Machine Works

The Fundamental Mechanics

  • Credit is the primary vehicle for funding spending and it can easily be created.
  • One person's spending is another's earnings — credit creation drives economic activity.
  • Credit creates debt that must be paid back, creating the opposite (contractionary) effect.
  • This dynamic is why the credit/spending/debt cycle is inherently cyclical.

The Short-Term Debt Cycle

What Everyone Knows

Recession
Economic activity and inflation are low
→
Stimulus
Central banks lower rates, provide credit
→
Expansion
Borrowing increases, asset prices rise
→
Bubble
Growth becomes unsustainable
→
Tightening
Central banks raise rates
→
Contraction
Economy slows, cycle restarts

Short-Term Cycles Add Up to Big Cycles

What Almost Nobody Recognizes

  • Each short-term cycle typically ends with HIGHER debt than the previous one.
  • Policymakers try to end recessions by lowering rates enough to get borrowing going again.
  • Debt rises over time, creating successively higher peaks and troughs.
  • The capacity for debt is different early vs. late in the Big Debt Cycle.
  • Late in the cycle, debt burdens become too great to be sustained.

The Five Stages

Of the Big Debt Cycle

From sound money to debt bust — the archetypical progression.

Stage 1: The Sound Money Stage

Strong Foundation

  • Net debt levels are low, money is sound, the country is competitive.
  • Debt growth fuels productivity growth — incomes are more than enough to pay back debts.
  • Money is "hard" (gold, silver, Bitcoin) — not easily increased in supply.
  • Risky assets are relatively inexpensive compared to safe assets.
  • Example: Late 1940s — US stock earnings yields were ~4x bond yields.

Stage 2: The Debt Bubble Stage

Warning Signs

  • Debt and investment growth exceed what can be serviced from incomes.
  • Money is readily available and cheap — debt-financed economic boom.
  • There is always a "most popular meme" that everyone believes — reflected in prices.
  • Wealth is created out of nothing — imagined wealth vs. actual wealth.
  • Debt spiral reaches point of no return: borrowing just to service debt.

Stage 3: The Top

The Bubble Pops

  • The popping occurs due to tightening money + unsustainable debt growth.
  • A self-reinforcing contraction begins — debt problems spread like aggressive cancer.
  • Can be temporarily reversed by more credit/debt — until it can't continue.
  • Then a big deleveraging must occur.

Stage 4: The Deleveraging

The Painful Adjustment

  • Debt problems spread from private sector → central government → central bank.
  • Net selling of debt assets is a big red flag.
  • Debt "death spiral": rising rates → problems → selling → higher rates/more printing.
  • Cutting spending at such times typically INCREASES debt-to-income ratios.
  • Central banks must choose: hard money (defaults) or soft money (devaluation).
  • They always eventually choose to print and devalue.
“

When managed in the best possible way, the deflationary ways of reducing debt burdens (through restructurings) are balanced with the inflationary ways (by monetizing them), so the deleveraging occurs without unacceptable amounts of either deflation or inflation.

— Ray Dalio

Stage 5: The Crisis Recedes

A New Equilibrium

  • Debt/money must be sound enough to be a viable storehold of wealth.
  • Debt and debt service burdens must align with incomes.
  • Creditors and debtors must believe the system is viable.
  • Central government must earn more than it spends and/or central bank makes money hard again.
  • Interest rates need to be high enough to compensate for currency weakness.

The Six Phases

Of Monetary Policy Evolution

As the Big Debt Cycle progresses, central banks must change how they run monetary policy.

MP0: Linked (Hard) Monetary System

1945 — 1971

  • Currency is convertible to hard money (gold) at a fixed price.
  • Limited amount of paper money and debt outstanding.
  • Ends when debt bubble bursts and "run on the bank" dynamic begins.
  • Limited hard money causes massive defaults — creating desire to print.

MP1: Interest-Rate-Driven Policy

1971 — 2008

  • Fiat money system — interest rates, bank reserves, and capital requirements control credit growth.
  • Provides more flexibility but less assurance against money printing.
  • Ends when interest rates hit 0% and/or private demand for debt falls short of supply.

MP2: Debt Monetization (QE)

2008 — 2020

  • Central bank creates money to buy investment assets (government debt, mortgages).
  • Used when interest rates can't be lowered further and private demand is insufficient.
  • Good for financial asset prices — disproportionately benefits those with financial assets.
  • Doesn't effectively deliver money to those most stressed financially.

MP3: Coordinated Fiscal & Monetary Policy

2020 — Present

  • Central government fiscal policy and central bank monetary policy are coordinated.
  • Money and credit are directed to those who need it most.
  • Temporarily alleviates debt problems but does not rectify them.
  • The final stage before the big deleveraging.

MP4 & MP5: The Breaking Point

What Comes Next

  • MP4: Big Deleveraging — massive reduction in debt through restructuring and/or monetization.
  • MP5: Return to Hard Money — restoring soundness of money and debt.
  • For great countries, the end of the Big Debt Cycle typically means the end of their prominence.

Part II

The Archetypical Sequence

The 9-stage sequence leading to central governments and central banks going broke.

The Sequence of Collapse

How It Unfolds

Stages 1-2
Private sector overborrows
  • Healthy borrowing turns speculative
  • Debt growth exceeds income growth
  • Asset prices become inflated
Stages 3-4
Private debt crisis hits
  • Bubble pops
  • Self-reinforcing contraction begins
  • Defaults and restructurings start
Stages 5-6
Crisis spills to government & central bank
  • Government borrows to bail out private sector
  • Central bank prints to buy government debt
  • Death spiral begins
Stages 7-9
New equilibrium & new cycle
  • Debt burdens reduced
  • Monetary order restructured
  • Cycle begins again

Part III

Looking Back

Historical case studies: The US since 1945, China, and Japan.

US: 1945 — 1971

The Hard Money Era

Bretton Woods
Dollar linked to gold at $35/oz — a hard money system
Post-War Boom
US debt/GDP was ~100%, fell to ~30% by 1970s
Growing Imbalances
Vietnam War spending + Great Society programs increased debt
1971 Break
Nixon closed gold window — end of hard money system

US: 1971 — 2008

The Fiat Money Era

High Inflation
1970s stagflation — oil shocks, loose monetary policy
Volcker Shock
Fed funds rate raised to 20% to crush inflation
Great Moderation
1982-2007 — declining rates, rising debt, multiple bubbles
2008 Crisis
Global financial crisis — Lehman, housing collapse

US: 2008 — 2020

Debt Monetization Era

Zero Interest Rates
Fed cuts to 0%, begins quantitative easing (QE)
QE Expands
Multiple rounds — Fed balance sheet grows from $1T to $4.5T
Wealth Inequality
Asset prices soar, benefits concentrate at top
COVID Response
Massive fiscal + monetary stimulus — MP3 begins

US: 2020 — Present

The Breaking Point

  • Government debt surged from ~$23T to over $35T.
  • Fed balance sheet peaked near $9T — unprecedented monetization.
  • Inflation returned — highest in 40 years.
  • Interest rates rose sharply — debt service costs exploding.
  • The US is now in the late stages of the Big Debt Cycle.

China's Big Cycle

A Different Path

  • 1949: Communist revolution — new monetary and political order.
  • 1950s-70s: Central planning, isolated from global economy.
  • 1978: Deng Xiaoping's reforms — opening up, market economy begins.
  • 2001: WTO entry — export-led growth accelerates dramatically.
  • 2008-now: Massive debt-fueled investment boom — now facing deleveraging.

Japan: The Lessons

Further Along the Cycle

  • 1989: Asset bubble peaks — stocks and real estate at all-time highs.
  • 1990s-2000s: "Lost Decades" — deflation, stagnation, 0% rates.
  • BOJ pioneered QE — bought stocks, bonds, kept rates at 0%.
  • Debt/GDP reached ~260% — highest in developed world.
  • Bond holders lost 45% vs. USD, 60% vs. gold since 2013.

Part IV

Looking Ahead

What the indicators show and what the future may hold.

What the Indicators Show

US Debt Metrics

$35T+
Federal Debt
And growing rapidly
120%+
Debt/GDP Ratio
Highest since WWII
$1T+
Annual Interest Payments
More than defense spending
37x
Debt to Gold Ratio
Was 7x in 1945

The 3% 3-Part Solution

Ray Dalio's Proposal

  • Cut the deficit to 3% of GDP through smart fiscal consolidation.
  • Raise revenues without killing growth — broaden tax base, reduce loopholes.
  • Restructure spending — prioritize investments that raise productivity.
  • The key: spread the paying back over time at a sustainable rate (~3-4% per year).

Key Principles

Timeless Truths

Core principles for understanding and navigating debt cycles.

Principles to Remember

★ If we don't agree on how things work, we won't be able to agree on what's happening or what is likely to happen.
Big debt crises are inevitable because lending is never done perfectly.
It pays to build up savings in good times so there are savings to draw on in bad times.
★ A debt is a promise to deliver money. A debt crisis occurs when more promises have been made than there is money to deliver on them.
If debts are in a country's own currency, its central bank will print money to alleviate the crisis — but this reduces the value of money.
All debt crises can be managed well by balancing deflationary restructurings with inflationary monetizations.
Debt crises provide great risks and opportunities — they have destroyed empires and created great fortunes.

Where We Are Now

The Big Picture

  • We are heading into a period in which central governments and central banks will "go broke" in the ways that have happened hundreds of times before.
  • The Big Debt Cycle is just one of five interrelated forces that make up the Overall Big Cycle.
  • The other forces: internal political cycle, external geopolitical cycle, acts of nature, and human inventiveness/technology.
  • These changes happen about once in a lifetime — roughly every 80 years.
  • Understanding the template helps you see what seems improbable today will make perfect sense tomorrow.

HOW COUNTRIES
GO BROKE

The Big Cycle

"If you try to focus on debt cycles precisely or focus your attention on the short term, you won't see them. It's like comparing two snowflakes and missing that they are pretty much the same because they're not exactly the same."

— Ray Dalio

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