This blog covers the general topic of financial markets.

Ray Dalio's Big Debt Crises

first posted: 2018-09-16 12:03:48.476926

Ray Dalio, a hedge fund manager, has published Big Debt Crises. This book is intended for the public and policymakers.

Short-term and long-term credit cycle

As a preliminary, Dalio explains that credit helps an economy grow so that credit that pays for productive investment is a good thing. Naturally, as lenders and creditors tend to become more optimistic as economic conditions improve, they don't stop lending until creditors start to experience defaults.

At this stage, the withdrawal of credit causes negative feedback in the economy. The whole cycle of economic and credit expansion followed by a credit crunch and recession is the credit cycle.

Dalio distinguishes between two kinds of situations:

  • debt is held in the country's own currency (USD, JPY, GBP)
  • debt is held in a currency that the country cannot print (Emerging market) and the country has a domestic currency that it can print

He also mentions that deleveraging is hard because it implies limiting one's spending. It can be achieved through four means:

  • austerity
  • default/restructuring the debt
  • transfers of wealth from the wealthy
  • printing money


Deflationary Recession

This case is what generally happens when deleveraging first occurs. Goods and services can be paid for with money or credit, and credit is being wiped out. Dalio's prescription, in this case, is to print enough money to replace some of the credit that was destroyed. The amount printed should be sufficient to stave off deflation, but it should not be so much as to cause inflation.

This prescription is working particularly well in the case where the debt is held in the country's currency.

Inflationary Recession

This case occurs when much of the debt is held in a foreign currency. In such a case, the domestic currency may face devaluation pressure. Dalio's prescription is to let devaluation happen because it is good for the country's competitiveness. This devaluation is accompanied by local inflation.

Countries that try to defend a currency peg by using up currency reserves or increasing interest rates delay a worse devaluation. Ultimately, the burden of paying out the foreign creditors is shifted towards the domestic creditors as they are paid back with the devalued local currency.


Hyperinflation happens when printing continues despite inflation rising. In such case, consumers and companies no longer trust the domestic currency as a store of value, capital and wealth flee the country, and inflation anticipations run very fast.


This book is a follow up to "How the economic machine works". It brings several ideas:

  • Credit, by being conventionally made available with 3Y or 5Y bonds that fully redeem create a dependence of issuers to capital markets. If bonds could be structured with 50Y amortization and step up and convertibility provisions at 3Y or 5Y, this would reduce the amplitude of the credit cycles.
  • The US, despite having a trade deficit since the 60s, consumers that are net debtors and a government deficit that widened since the Reagan era still attracts foreign investment. While some thought 2007 was the moment of reckoning for the United States, it did not lose its reserve currency status. The US dollar devalued 30% to 40% against other currencies, helping the economy to become competitive.
  • Ray Dalio seems concerned that foreign investors may stop buying US treasuries, and that this cause a larger devaluation of the USD.
  • Another concern for Ray Dalio is that the rise of inequality is increasing popular discontent and breeding populist political movements.