Big Debt Crises
The beautiful deleveraging: how policymakers try to engineer the outcome.
Summary
This is Dalio's study of how large debt crises unfold, published in 2018 and also circulated under the title Principles for Navigating Big Debt Crises. Bridgewater makes it available without charge. It is in three parts: an archetypal template of the debt cycle, three detailed cases, and compressed data on forty-five further episodes.
The template distinguishes deflationary crises, where debt is denominated in the country's own currency so the central bank can print, from inflationary crises, where debt is in foreign currency and printing does not resolve it. Dalio describes a sequence of phases running from the early cycle through the bubble, the top, the depression, what he calls a beautiful deleveraging, and the pushing on a string phase. The policy analysis identifies four levers available to authorities: austerity, defaults and restructurings, transfers from those with money to those without, and money printing. The outcome depends on the mix, and a well-managed deleveraging requires printing large enough to offset the deflationary effect of the other three without triggering a currency collapse.
The three detailed cases are Germany from 1918 to 1924, the United States from 1928 to 1937, and the United States from 2007 to 2011.
The strengths are the case data and the fact that Bridgewater positioned successfully using this framework in 2008. The weaknesses are that the template is descriptive rather than predictive, that identifying which phase you are currently in is not addressed, that the writing repeats itself heavily, and that the political economy of who bears the losses is treated thinly.
Key takeaways 7
- Debt crises follow a repeating sequence because debt growth eventually exceeds income growth, and the pattern differs by whether the debt is in domestic or foreign currency.
- Policymakers have four tools in a deleveraging, being austerity, default, wealth transfer and money printing, and only the mix determines whether the outcome is orderly.
- A deleveraging goes well when money printing is large enough to offset the deflationary effects of default and austerity without collapsing the currency.
- Austerity alone always fails, because reducing spending also reduces the income against which the debt is measured.
- Debt denominated in a foreign currency cannot be resolved by printing, which is why those crises produce currency collapse and inflation instead of deflation.
- The top of a debt cycle is identifiable when debt service grows faster than income and new lending funds asset purchases rather than productive investment.
- Faster and larger central bank action shortens depressions, which is why the 2008 outcome differed from the 1930s despite similar starting conditions.
Who should read it
Macro investors who want a case-tested template of debt cycle mechanics, noting this is the same work as Principles for Navigating Big Debt Crises.
About Ray Dalio
Founder and former co-CIO, Bridgewater Associates 1975-2022
Principles and the debt-cycle template are primary sources that a large secondary literature now builds on.
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