Dalio Warns of U.S. Bond Supply-Demand Imbalance: Gold and Bitcoin Could Become Hedge Assets in Debt Crisis

In my book "How Nations Go Bankrupt: The Big Cycle," I detail a classic framework to illustrate how situations typically evolve when an unsustainable imbalance arises between the supply and demand for debt. Recently, three things happened simultaneously:

1. The Japanese government sold a portion of its U.S. bond holdings, repatriating the funds to support the yen and Japanese capital markets, while reducing its exposure to U.S. Treasuries. This move helps avoid raising interest rates beyond a level acceptable to it merely to prop up the yen.
2. U.S. Treasury yields hit new highs, led by long-term yields, while the dollar simultaneously weakened. The reasons include both current and future massive bond supply and weakening market demand for these bonds.
3. This week, U.S. Treasury Secretary Beshent announced that the U.S. Treasury Department will purchase U.S. Treasury bonds, although the scale at which it can do so is very limited.

Many have therefore asked me: Do these events fit the classic framework I described in my book? The answer is: Yes. To assess what might happen next, it's worth revisiting this framework.

In the book, I detail how the process of government debt and monetary restructuring typically unfolds. I also made some projections, showing an increasing imbalance between the supply of new and maturing/refinanced debt and the market's inability to keep up with demand. These projections can serve as a template for comparison with real-world situations and help us judge the future.

If you are a market participant needing detailed understanding of this framework to time the market, I suggest you read the entire book. If you don't need that much detail or don't want to spend that much time, you can read the five-minute summary below to understand how this mechanism works.

How This Mechanism Works

The operating logic of central government debt is essentially the same as that of an individual or a business. The difference is that the central government has a central bank that can print money, and printing money devalues the currency; the government can also obtain funds by taxing its citizens.

Therefore, if you can imagine a scenario where you personally or your business could both print money and obtain funds by taxing others, then you can understand the operating mechanism of government debt. But remember, your goal is not just to benefit yourself but to ensure the entire system functions properly for all citizens.

In my view, the credit and market system is like the human circulatory system, delivering nutrients to the various parts that make up the market and economy.

If credit is used effectively, it can enhance productivity, generate income, and enable borrowers to repay debt and interest—this is a healthy state. However, if credit is misused and fails to generate sufficient income for repayment, the burden of principal and interest payments accumulates like plaque in arteries, crowding out other expenditures.

When principal and interest payments become very large, debt servicing problems first emerge, followed by debt rollover problems: creditors become unwilling to roll over maturing debt and instead wish to sell their bonds.

This naturally leads to insufficient demand for and selling of debt instruments like bonds. When demand is insufficient relative to supply, two outcomes typically occur:

1. Interest rates rise, thereby hurting the market and economy.
2. The central bank prints money to buy the debt, causing the currency's value to fall and inflation to be higher than it otherwise might have been.

Printing money also artificially suppresses interest rates, harming creditors' returns. Neither approach is good.

If bond selling becomes so large it cannot be contained, interest rates will rise; and when the central bank has previously purchased large amounts of bonds, rising rates devalue those bonds, causing losses for the central bank and damaging its cash flow. If this continues, the central bank will eventually end up with negative net worth.

When the problem becomes severe, both the central government and the central bank will borrow to pay debt service. Due to insufficient demand in the free market, the central bank will provide these loans by printing money, ultimately forming a self-reinforcing cycle of "increasing debt—printing money—inflation."

In summary, there are three classic indicators to watch:

1. How large government principal and interest payments are relative to fiscal revenue. This is like the amount of plaque in the circulatory system.
2. How large the sale of government bonds is relative to market demand. This is like plaque breaking off and triggering a heart attack.
3. How much money the central bank prints to buy government bonds. **This is done to compensate for insufficient market demand for government bonds, akin to the central bank injecting a massive dose of liquidity and credit to alleviate a shortage, but simultaneously creating more debt to which the central bank itself becomes exposed.

Over a long-term cycle lasting decades, debt and debt service payments relative to income typically keep rising until this trend can no longer continue. This usually happens for three reasons:

1. Debt service payments severely crowd out other government expenditures to an unacceptable degree;
2. The bond supply that the market must absorb far exceeds purchasing demand, forcing interest rates to rise significantly, thereby severely damaging the market and economy;
3. To avoid rising interest rates and the worsening of market and economic conditions, the central bank prints money extensively and buys government bonds to fill the demand gap, resulting in significant currency depreciation.

Whichever path is taken, bond returns will be poor until currency and debt assets become cheap enough to attract buyers again; or until the government can repurchase or restructure the debt at low cost.

Simply put, this is the basic shape of a big debt cycle.

Because these indicators can be quantified, one can monitor the development of the debt mechanism and relatively easily see problems approaching. I have always used this diagnostic method for my own investments and hadn't made it public before. But now, I explain it in detail in "How Nations Go Bankrupt: The Big Cycle," because it's too important to keep to myself.

More specifically, we will see debt and its service payments rising relative to income, with debt supply exceeding market demand. Faced with this, the central bank will initially stimulate the economy by lowering short-term rates, then start printing money to buy bonds. Ultimately, the central bank will incur losses and may even fall into negative net worth.

Simultaneously, the central government needs to borrow more debt to service old debt, and the central bank monetizes government debt by printing money. All these conditions push a country toward a government debt crisis.

Such a crisis is equivalent to an economic heart attack: spending supported by debt financing is severely compressed, and the normal blood flow of the economic circulatory system is interrupted.

In the early stages of the final phase of a big debt cycle, markets typically exhibit the following characteristics: long-term interest rates rise first; the domestic currency depreciates, especially against gold; and, due to insufficient demand for long-term bonds, the government finance department begins to shorten the maturity of newly issued bonds.

Later in this process, when the problem is most severe, governments usually take seemingly extreme measures, such as imposing capital controls or exerting exceptionally strong pressure on creditors to buy bonds and not sell them.

My book provides a more complete explanation of this mechanism, illustrated with numerous charts and data showing how it happens.

Summarizing the U.S. Government's Situation in the Simplest Terms

Now, imagine you are running a large enterprise called "The U.S. Government." This can help you understand the U.S. government's fiscal position and the choices facing U.S. leaders.

This year, this entity's total revenue is about $5.5 trillion, and total spending is about $7.5 trillion, so the budget deficit is about $2 trillion. In other words, this year it spends about 40% more than its income.

Moreover, there is little room to cut spending because almost all expenditures are either previously committed or essential.

Because this entity has borrowed heavily for a long time, it has accumulated a huge amount of debt. Debt is about six times annual income, or roughly $32 trillion, equivalent to about $240,000 per U.S. household it needs to support.

The annual interest expense on this debt is about $1 trillion, equivalent to about 20% of this entity's income, and also half of this year's budget deficit, which still needs to be covered by borrowing.

But creditors receive more than just this $1 trillion in interest. In addition to paying interest, about $10 trillion in maturing principal must be repaid. The government hopes creditors will relend this money to it or continue providing new loans.

Therefore, to avoid default, the U.S. government needs to pay about $11 trillion in principal and interest combined, equivalent to about 200% of annual fiscal revenue.

This is the current situation.

So, what happens next? We can envision it.

Whatever the final deficit is, the government must borrow to cover it. Currently, there is much debate about the deficit size. Considering recently passed budget reconciliation bills, most independent assessors predict U.S. debt will reach $55 to $60 trillion over the next decade, roughly seven times fiscal revenue at that time, as an additional $25 to $30 trillion in new borrowing will be required during that period.

Of course, a decade later, this entity will face even heavier debt service pressure, further crowding out other government expenditures. If there's no plan to address this, market demand for the debt the government needs to sell is also more likely to be insufficient.

My Three-Part 3% Solution

I am convinced that the U.S. government's fiscal situation has reached an inflection point. If not addressed now, debt will accumulate to a level that cannot be resolved without causing significant pain.

It is especially important to make this adjustment while the entire system is still relatively strong, not after it becomes weak. Because once the economy contracts, the government's borrowing needs increase substantially.

According to my analysis, this problem needs to be addressed through what I call the three-part 3% solution. Its goal is to reduce the fiscal deficit to 3% of GDP, balancing three means of deficit reduction:

1. Cut spending
2. Increase tax revenue
3. Lower interest rates

These three things need to happen simultaneously, avoiding any single adjustment being too large. Because if any one is overused, the adjustment process will inflict serious pain on the economy.

Furthermore, these changes should come from good fundamental adjustments, not be forced. For example, if the Fed forcibly suppresses interest rates unnaturally, the consequences would be very bad.

According to my projections, adjusting government spending and tax revenue by about 5% each relative to current plans, and thereby reducing interest rates by about 1 to 1.5 percentage points, could lower interest expenses by 1% to 2% of GDP over the next decade. This would also push asset prices and economic activity higher, generating more revenue for the government.

Some Common Questions and My Answers

The book contains much more than this, including a description of the overall big cycle. The overall big cycle is composed of debt, credit, and monetary cycles; domestic political cycles; international geopolitical cycles; natural events; and technological advancements—all driving major changes in the world.

The book also includes my views on possible future directions and some perspectives on how to invest amid these changes. But here, I'll first answer some questions people frequently ask me when discussing this book. If you wish to delve deeper, I welcome you to read the entire book.

Question 1: Why do major government debt crises and big debt cycles occur?

The formation of major government debt crises and big debt cycles can be clearly measured by three indicators:

1. Government principal and interest payments relative to fiscal revenue continuously rise, eventually severely crowding out necessary government spending.
2. The debt the government sells is too large relative to market demand, causing interest rates to rise and the market and economy to decline.
3. The central bank responds to these situations by lowering interest rates, but this in turn makes bonds less attractive, eventually forcing the central bank to print money to buy government bonds, causing currency depreciation.

These conditions typically worsen gradually over a long-term cycle lasting decades until they can no longer continue. Because eventually one or more of the following outcomes occur:

1. Debt service payments severely crowd out other expenditures.
2. The debt supply that must be sold far exceeds purchasing demand, forcing interest rates to rise sharply, causing the market and economy to decline significantly.
3. The central bank prints money extensively and buys government bonds to fill the market demand gap, leading to substantial currency depreciation.

Whichever occurs, bond returns will be poor until bonds become cheap enough to attract buyers again, or the debt is restructured.

These indicators are easy to measure, so we can see the situation moving step by step toward an impending debt crisis. When debt-financed spending begins to contract, it's like an economic heart attack triggered by debt.

Throughout history, this type of debt cycle has occurred in almost every country, usually more than once, so there are hundreds of historical cases to study. As long as there are written records, similar events can be found.

Put another way, all monetary orders in history have eventually collapsed, and the debt cycle I describe is precisely the mechanism behind these collapses. The decline of all past reserve currencies, such as the British pound and, before it, the Dutch guilder, was caused by this process. My book presents the 35 most recent cases.

Question 2: Since this process repeats, why do people still not understand the underlying operating mechanism?

You're right; this mechanism is indeed not fully understood. Interestingly, I couldn't even find existing work specifically studying this complete process.

My speculation is: In countries with reserve currencies, the collapse of the monetary order typically occurs once in a generation; and when it happens in non-reserve currency countries, people often think it's just those countries' own problems and won't happen in countries with reserve currencies.

I discovered this mechanism because I witnessed it happening firsthand while investing in sovereign bond markets. This prompted me to study a large number of similar historical cases to better respond, such as during the 2008 global financial crisis and the subsequent European debt crisis.

Question 3: How worried should we be about a heart attack-style debt crisis in the U.S.? People have heard about impending U.S. debt explosions for many years, but the crisis hasn't happened. What's different this time?

I think we should be very worried because the conditions mentioned earlier are now present.

In the past, some worried about debt crises when the situation was less severe; I think their concerns were correct at the time. If action had been taken earlier, the situation could have been prevented from deteriorating to today's level, just like doctors warn patients early not to smoke or eat unhealthy food long-term.

I suspect this issue hasn't gained wider attention partly because people don't fully understand it, and partly because past warnings came too early, leading over time to societal numbness and complacency.

It's like a person with significant plaque buildup in their arteries, still eating high-fat foods and never exercising, saying to the doctor: "You've always warned me something would happen if I didn't change my lifestyle, but I haven't had a heart attack yet. So why should I believe you now?"

Question 4: What could be the trigger for a U.S. debt crisis today? When might it happen? And what would it look like?

The trigger will be the confluence of the various factors mentioned earlier.

As for timing, both policy and external factors could bring the crisis forward or delay it, such as major political changes and wars.

For example, my prediction, along with most others, is that the U.S. budget deficit will be about 7% of GDP. If it can be reduced to around 3%, risks would decrease significantly.

If a huge external shock occurs, the crisis would come earlier; without external shocks, it would be delayed. If policies are handled properly, the crisis might not happen at all.

If the current course doesn't change, my guess is the crisis would occur in about three years, plus or minus two years. Of course, I suspect this timing prediction is likely inaccurate.

Question 5: Historically, have any countries dramatically cut fiscal deficits as you describe and ultimately achieved good results?

Yes, I know of several cases.

My solution would reduce the fiscal deficit by about 4% of GDP. The most similar case with good results is the United States from 1991 to 1998. At that time, the U.S. fiscal deficit fell by 5% of GDP.

My book also lists several similar cases that occurred in other countries.

Question 6: Some argue that because the U.S. dollar holds a dominant position in the global economy, the U.S. is generally less vulnerable to debt problems or debt crises. What do you think this view overlooks or underestimates?

If they truly believe that, it shows they don't understand the operating mechanism and haven't learned from history.

More specifically, they should study history to understand why all past reserve currencies eventually lost their reserve status.

Simply put, a currency and debt denominated in it must be able to effectively store wealth. Otherwise, they will be devalued and eventually abandoned.

The mechanism I describe explains precisely how a reserve currency gradually loses its ability to store wealth.

Question 7: Japan's government debt is 215% of GDP, the highest among all developed economies. Japan is often cited as a classic example to prove that a country can maintain high debt for a long time without experiencing a debt crisis. Why doesn't Japan's experience reassure you?

Japan's situation is a classic case of the problem I describe, and it will continue to prove this in the future. It actually demonstrates how my theory operates in reality.

More specifically, because the Japanese government is over-indebted, Japanese bonds and other debt assets have been very poor investments.

At interest rates low enough to be favorable for Japan, market demand for Japanese debt assets is insufficient. To fill this gap, the Bank of Japan has printed money extensively and purchased large amounts of Japanese government bonds.

The result is that since 2013, holders of Japanese bonds have lost 51% relative to holders of U.S. dollar debt assets and lost 76% relative to holders of gold.

Converted to the same currency, since 2013, the wages of the average Japanese worker have fallen 55% relative to the wages of the average American worker.

My book has an entire chapter analyzing the Japan case and providing an in-depth explanation of this issue.

Question 8: What other regions in the world have particularly problematic fiscal conditions that may not receive enough attention?

Most economies have similar debt and deficit problems. The UK, EU, China, and Japan all have them.

Therefore, I expect most economies will undergo similar debt adjustment and currency depreciation processes. This is also why I think currencies not created by governments, such as gold and bitcoin, may perform relatively well.

Question 9: In the face of such risks, how should investors respond and allocate assets?

As general advice, I think investors should diversify sufficiently across different asset classes and different countries.

Choose countries with healthy income statements and balance sheets, not deeply embroiled in severe domestic political conflicts or external geopolitical conflicts.

Regarding asset allocation, underweight debt assets like bonds, overweight gold, and allocate a small amount to bitcoin.

Allocating a small portion, perhaps 10% to 15%, to gold can reduce the overall risk of an investment portfolio. I believe doing so may also improve the portfolio's return.