Big Debt Crises (by Ray Dalio)

Explain how debt crises work to help investors and policy makers make better decisions around them.

• The debt cycle is an important and unavoidable (as long as you borrow):
  • If you borrow today to spend more than you earn, you will need to repay it tomorrow and thus spend less than you earn.
  • You can of course continue borrowing but then the interest will eat all your gains. Eventually you have to deleverage.
  • There ways to reduce debt are: austerity and default/restructuring.
• At the level of the whole economy the situation is similar:
  • Debt is often worthwhile for the goverment. As long as borrowed money can be productively invested to create more benefits than the cost of borrowing, it's all good.
  • Some actors might default on the debts, but if it's not too much, and the cost of those defaults are broadly distributed, it might still be ok.
• However, governments (in addition to austerity and default/restructuing) also have levers that individuals do not:
  • The central bank can print money and control the interest rates,
  • The government can tax those who have too much and redistribute money and credit to those who have too little.
• Template for the big debt cycle:
  • The cycles described above are small, and usually at the end of the cycle the interest rates are reduced so that the debts can continue being larger than at the end of the previous cycle.
  • At some point the interest rate can't go lower and then a big deleveraging has to happen. It can be deflationary or inflationary depending on how much foreign currency debt the country has (inflation is painful if your debt is in foreign currency).