Original Author: Ray Dalio

Original Title: How Countries Go Broke Dynamic Behind What Happening Now

Original Translation: Rhythm BlockBeats

In my book "How Countries Go Broke: The Big Cycle," I established a detailed template to describe how the unsustainable state of debt supply and demand imbalance can trigger certain evolutions. Recently, three events have occurred simultaneously.

· The Japanese government is selling some of its US Treasury holdings and repatriating the funds to support the yen and the Japanese capital market, while reducing exposure to US Treasuries without needing to raise interest rates further;

· US Treasury yields have risen to new highs, led by longer-term rates, while the dollar has weakened due to the massive current and future supply of Treasuries and weakening demand;

· This week, Secretary of the Treasury Bennett announced that the US Treasury would buy US Treasuries, but his capacity to do so is limited, leading many to ask me: Are these events consistent with the classic template described in the book? The answer is yes. To anticipate what might happen next, it's necessary to revisit this template.

In the book, I detailed how the government-level debt/currency restructuring process usually unfolds, and provided calculations to demonstrate the extent of the imbalance between new debt supply and the demand for debt rollovers. This set of calculations can serve as a template to compare reality and predict the future. If you are a market participant who needs to grasp the details of this template in order to seize market opportunities, I recommend that you read the entire book; if you do not require such depth and do not wish to spend that much time, you can read the following five-minute overview of the mechanics.

How the Mechanism Works

The debt dynamics of central governments follow the same logic as individual or corporate debt dynamics, the difference lies in: central governments have a central bank that can print money (leading to currency devaluation) and can extract funds from the people through taxation. Because of this, if you can imagine how you or your business would operate under the conditions of "being able to print money and tax," you can understand this dynamic. But remember, your goal is to keep the entire system operating smoothly—not just for yourself, but for all citizens.

In my view, the credit/market system is akin to the human circulatory system, delivering nutrients to various parts of the body constituted by the market and the real economy. If credit is used effectively, it can generate enough productivity and income to repay principal and interest, which is healthy. However, if credit is misused, failing to generate enough income to repay principal and interest, the debt burden will accumulate like plaque, squeezing out other expenditures. When debt service payments become excessively large, they will create debt service problems and ultimately evolve into rollover issues—because bondholders are unwilling to renew, wanting instead to sell. This naturally leads to a shortage of demand for debt instruments such as bonds and a wave of selling; when demand runs short relative to supply, either 1) interest rates rise, dragging down markets and the economy, or 2) the central bank "prints money" and buys debt, leading to currency devaluation and an increase in original inflation levels. Printing money will also artificially lower interest rates, harming lenders' returns. Both paths are undesirable. When the scale of debt selling becomes unmanageable and the central bank has already purchased a large amount of bonds, rising interest rates will lead to losses for the central bank, further harming its cash flow. If this situation continues, the central bank will eventually fall into negative net worth.

When the problems become severe, both the central government and the central bank will incur debt to pay for debt service payments. Due to insufficient demand in the free market, the central bank will print money to provide lending, thus initiating a self-reinforcing "debt—printing money—inflation" spiral.

In summary, three classic indicators need to be monitored:

1. The scale of government debt service payments relative to government revenue (like the amount of plaque in the human circulatory system);

2. The volume of government debt sales relative to the demand for government debt (like plaque shedding, causing a heart attack);

3. The scale at which the central bank is purchasing government debt through money printing to fill the gap between Treasury demand and the supply of Treasuries for sale (like the central bank injecting a potent liquidity/credit dose to alleviate liquidity tightness, resulting in more debt, which then becomes an exposure for the central bank).

These indicators usually continue to rise over decades—debt and debt service payments relative to income increase—until they become unsustainable, either because 1) debt service payments excessively crowd out other expenditures and become unacceptable; or 2) the supply of debt to be purchased is so large relative to purchase demand that interest rates must rise significantly, causing the market and economy to plummet; or 3) the central bank, unwilling to watch rates rise and the market and real economy deteriorate, thus prints money extensively and buys government debt to fill demand gaps, resulting in significant currency devaluation. Whichever path is taken, bond returns will be poor until currency and debt become cheap enough to attract demand, and/or the government can repurchase or restructure the debt at a low cost.

This is the simplest depiction of the great debt cycle.

Since these indicators are quantifiable, we can continuously monitor the evolution of debt dynamics, making it easy to see the approaching problems. I have always used this diagnostic approach in investing and have kept it to myself, but today I have laid it out in "How Countries Go Broke: The Big Cycle," because it is too important to keep to myself.

More specifically, you can observe that: debt and debt service payments relative to income are continually rising; debt supply exceeds debt demand; the central bank first lowers interest rates in a response to loosen, then turns to printing money to buy bonds, ultimately suffering losses and falling into negative net worth; the central government continually increases leverage to meet debt service payments while the central bank monetizes debt. All of this leads to a government debt crisis—it equates to an economic heart attack: a contraction in spending supported by debt that cuts off the normal flow of the economic circulatory system.

In the early final stage of the great debt cycle, market performance will reflect this dynamic: interest rates rise, especially led by long-term rates, the currency devalues, especially relative to gold, and the Treasury shortens the debt issuance duration due to insufficient long-term debt demand. Commonly, during this terminal phase, and when the dynamics are most intense, a series of seemingly extreme measures will be introduced, such as establishing capital controls, applying strong pressure on creditors, forcing them to buy and not sell debt. A complete explanation of this dynamic is provided in the book, including many charts and data to show its evolution.

The Situation of the US Government: A Brief Summary

Now, please imagine you are running a large enterprise called "the US Government." This perspective will help you understand the financial situation of the US government and the choices of its leadership.

This year's total revenue is about $5.5 trillion and total expenditure is about $7.5 trillion, resulting in a budget deficit of about $2 trillion. In other words, this institution's spending will exceed revenue by about 40% this year. And the room for expenditure reduction is very small, as almost all spending is previously committed or necessary. Due to this institution's long-standing high levels of borrowing, it has accumulated massive debt—about six times its annual revenue (about $32 trillion), which means that each household you are responsible for bears approximately $240,000. The interest bill on this debt is about $1 trillion, approximately 20% of this institution's revenue, equivalent to half of this year's budget deficit (shortfall)—and this deficit still has to be covered by more borrowing. But $1 trillion is not all you need to pay your creditors, as in addition to interest, you must also repay maturing principal, about $10 trillion. You hope that either creditors will renew the loans or lend you more money. Therefore, debt service payments—that is, the principal and interest that must be repaid to avoid default—are about $11 trillion, about 200% of incoming funds.

This is the current situation.

So, what will happen next? Let's imagine it. You will borrow to fill the deficit, regardless of what the final deficit turns out to be. There are many opinions about what the deficit will be. After accounting for the recently passed budget reconciliation bill, most independent assessments estimate that US debt will reach $55 to $60 trillion (about seven times revenue) in 10 years, as there will also be an additional $25 to $30 trillion in borrowing by then. Of course, in 10 years, this institution will face even heavier debt service payments crowding out other expenditures, and without countermeasures, the risk that its debt for sale will not find sufficient demand will also be greater.

My "3% Three-Part Solution"

I am confident in asserting that the US government's financial situation is at a turning point because if not addressed now, the debt will accumulate to a level that will be difficult to manage without inflicting major harm; and, importantly, this operation should be carried out when the system is relatively strong, not when it is weak. The reason is that when the economy enters a contraction, the government's borrowing needs will significantly increase.

Based on my analysis, I believe this situation needs to be addressed through what I call the "3% Three-Part Solution," which involves reducing the budget deficit to 3% of GDP and finding a balance among three methods of reducing the deficit: 1) cutting spending, 2) increasing tax revenues, and 3) lowering interest rates. All three must progress simultaneously to avoid any one item being overemphasized—because if any one of them is too extreme, the adjustment process will be traumatic. Moreover, these adjustments should be achieved through sound fundamental adjustments rather than coercive means (for example, artificially suppressing interest rates by the Federal Reserve is a very poor practice). According to my calculations, cutting spending and increasing tax revenue by approximately 5% each, with interest rates decreasing by around 1 to 1.5 percentage points, will reduce interest payments in the next decade by 1 to 2 percentage points of GDP and stimulate asset prices and economic activity, resulting in significantly more revenue.

Frequently Asked Questions and My Answers

The book contains much richer content than this brief article, including a description of the "overall big cycle" (composed of debt/credit/currency cycles, domestic political cycles, external geopolitical cycles, natural events, and technological advancements)—it drives all major changes in the world; my views on possible future scenarios; and some perspectives on how to invest amid this sequence of changes. But for now, I will first answer some questions I am frequently asked while promoting this book. If you want to dive deeper, I welcome you to read the entire book.

Q1: Why do large-scale government debt crises and great debt cycles occur?

Large-scale government debt crises and great debt cycles can be easily measured by three indicators: 1) government debt service spending relative to government revenue rises to an unacceptable level that squeezes necessary government spending; 2) the volume of government debt sales relative to demand becomes imbalanced enough that interest rates rise, leading to market and economic decline; 3) the central bank responds to these situations with low interest rates, while low interest rates weaken bond demand, forcing the central bank to print money to buy government debt, resulting in currency devaluation. These indicators typically continue to rise over decades until they become unsustainable—either because 1) debt service payments excessively crowd out other expenditures, becoming unacceptable; or 2) the supply of debt to be purchased is so large relative to demand that interest rates must rise significantly, causing the market and economy to plummet; or 3) the central bank excessively prints money and buys government debt to fill demand gaps, resulting in significant currency devaluation. Whichever path is taken, bond returns will be poor until they become cheap enough to attract demand and/or the debt can be restructured. These indicators are easily measurable, and people can clearly see that they are evolving towards an imminent debt crisis. When the spending supported by debt contracts, the crisis arrives—just like a heart attack triggered by debt.

Throughout history, nearly every country has experienced such debt cycles, often multiple times, resulting in hundreds of historical case studies that date back to the beginning of written records. In other words, all monetary orders ultimately head towards collapse, and the debt cycle mechanisms I describe are the driving forces behind these collapses. The decline of all reserve currencies stems from this, such as the pound sterling, and the Dutch guilder before it. I list 35 recent cases in the book.

Q2: If this process happens repeatedly, why is the underlying mechanism not well understood?

You are right; this mechanism is not well understood. Interestingly, I have not found any research on how it operates. My speculation is that it is not understood because the collapse of the monetary order typically only happens once in the lifetime of reserve currency nations; and when it occurs in non-reserve currency countries, people assume it is a problem that reserve currency nations can avoid. I was able to discover this mechanism only because I witnessed it in sovereign bond market investments, prompting me to study numerous relevant historical cases to respond calmly (for example, in response to the 2008 global financial crisis and the subsequent European debt crisis).

Q3: How concerned should we be about a "heart attack"-style debt crisis in the US before it explodes? People have heard too much about the "upcoming debt crisis" that has never happened. What is different this time?

I believe we should be very concerned, for the reasons I mentioned earlier. I think those who were worried about a debt crisis when the situation was not as severe were correct because addressing it earlier could have prevented the situation from deteriorating to today’s level, just as doctors warn patients to avoid smoking and overeating early on. Thus, I speculate the reason this issue has not drawn wider concern is partly due to a lack of understanding, and partly because previous premature warnings have led to considerable desensitization. It’s like someone with arteries already full of plaque, continuing to eat a lot of high-fat food without exercising, telling their doctor: "You have warned me for a long time that not changing my lifestyle would cause problems, but I haven't had a heart attack yet. Why should I believe you now?"

Q4: Today, what might catalyze a debt crisis in the US? When will the crisis occur? What will such a crisis look like?

The catalysts will be the convergence of the various influences mentioned earlier. As for timing, policy and external factors—such as significant political shifts and wars—can accelerate or delay its onset. For example, if the budget deficit decreases from about 7% of GDP, as I and most others expect, to around 3%, the risks will substantially decrease. If a significant external shock occurs, the crisis will arrive sooner; if not, it will be delayed or might not happen at all (provided it is managed well). My guess—I estimate this is a bad prediction—is that if we do not change our current course, the crisis will arrive within three years, with a two-year margin of error.

Q5: Are you aware of any examples of significant budget deficit reductions that have resulted in good outcomes?

Yes, I am aware of several. My plan would reduce the budget deficit by about 4 percentage points of GDP. The most similar successful precedent is the US from 1991 to 1998, when the budget deficit was reduced by 5 percentage points of GDP. I also cite several other similar cases from other countries in the book.

Q6: Some believe that due to the dollar's dominant position in the global economy, the US is generally less vulnerable to debt-related problems/crises. What do you think those with this view overlook?

If they believe this, they do not understand the mechanisms and historical lessons behind it. More specifically, they should study history to understand why all previous reserve currencies eventually ceased to be reserve currencies. To put it bluntly: currency and debt must serve as effective stores of wealth; otherwise, they will be devalued and abandoned. The dynamics I describe represent how reserve currencies lose their effectiveness as stores of wealth.

Q7: Japan, with a debt-to-GDP ratio as high as 215%, the highest among developed economies, is often cited as a prime example of "a country that can remain safe at high debt levels without a debt crisis." Why do you not take much comfort from Japan's experience?

The Japanese case is confirming, and will continue to confirm, the issues I describe; it is a manifestation of my theory in reality. Specifically, due to Japan's extremely high level of government indebtedness, Japanese bonds and debt have consistently been poor investments. To compensate for low-interest levels favoring itself while meeting domestic demand for Japanese debt assets, the Bank of Japan has printed money extensively and purchased large volumes of Japanese government bonds, resulting in investors holding Japanese bonds incurring losses of 51% compared to those holding US dollar bonds and 76% compared to those holding gold since 2013. Since 2013, when adjusted for common currency, the wages of ordinary Japanese workers have declined by 55% relative to American workers. I delve into the Japanese case in depth in a full chapter of the book.

Q8: What regions in the world have particularly outstanding financial problems that may be underestimated?

Most economies have similar debt and deficit issues—Britain, the EU, China, Japan all face such challenges. Hence, I expect that most economies will undergo similar debt adjustments and currency depreciation processes; that’s also why I expect non-government-produced currencies like gold and Bitcoin to perform relatively well.

Q9: How should investors respond to this risk/how should they position themselves for the future?

As a general recommendation, I advise everyone to diversify across asset classes and countries, favoring those that have sound income statements and balance sheets, with no severe domestic political conflict or external geopolitical conflict; underweight debt assets like bonds, and overweight gold and a small amount of Bitcoin. Allocating a small portion of funds—around 10% to 15%—to gold can reduce the risk of a portfolio, and I believe it can also enhance its returns.

免责声明：本文章仅代表作者个人观点，不代表本平台的立场和观点。本文章仅供信息分享，不构成对任何人的任何投资建议。用户与作者之间的任何争议，与本平台无关。如网页中刊载的文章或图片涉及侵权，请提供相关的权利证明和身份证明发送邮件到support@aicoin.com，本平台相关工作人员将会进行核查。