Original Author: Ray Dalio, Founder of Bridgewater Associates
Original Compilation: Chopper, Foresight News
Guide: Behind the fluctuations in U.S. Treasury bonds, a grand debt cycle is unfolding. Dalio warns in an article that U.S. finances have reached a critical inflection point. Without timely adjustment, a debt crisis could erupt within a few years. He uses historical patterns to dissect the entire process of a debt crisis from its inception to its outbreak, proposes reform solutions to break the deadlock, and directly addresses the most controversial public concerns: Can U.S. dollar hegemony provide protection? Why can't Japan's high debt serve as a model? Standing at the crossroads of a shift in monetary order, besides gold, Bitcoin, as a non-sovereign asset, is also considered by him as one of the tools to hedge against currency devaluation. The following is a translation of the original article:
In my book *'Principles for Navigating Big Debt Crises'*, I detailed an analytical framework explaining the likely evolution when the supply and demand for debt become unsustainably imbalanced. Recently, three events have coincided: 1) The Japanese government sold some U.S. Treasuries, repatriating the funds to support the yen and prop up the Japanese capital markets; this reduces exposure to U.S. Treasuries without having to raise interest rates to an undesirable level to defend the yen. 2) Influenced by massive existing and new debt supply coupled with weakening demand, U.S. long-term bond yields hit new highs while the dollar weakened. 3) U.S. Treasury Secretary Janet Yellen announced this week that the U.S. Treasury will buy back U.S. Treasuries, but the scale of these operations is very limited.
Following these events, many have asked me if these phenomena align with the classic debt cycle model I described. The answer is yes. To anticipate what might happen next, it's necessary to revisit this analytical framework.
In the book, I elaborate in detail on how the process of government-level debt monetary restructuring typically unfolds. I also provide calculations showing the imbalance between the supply of new and maturing debt needing refinancing and the market's demand for that debt. Readers can apply this framework to real-world events to predict future trends.
Mechanism: Debt is Like Blood, Imbalance is Danger
The debt operation logic of a central government is not fundamentally different from that of an individual or a corporation; the only distinction is that a central government has a central bank that can print money (causing currency devaluation) and can also extract funds from the populace through taxation. To understand this, imagine: if you personally or the business you run had the power to print money and could also obtain funds through taxation, how would debt evolve? You would understand this logic. But remember, the government's goal is to keep the entire system functioning well, considering all its citizens, not just its own interests.
In my view, the credit and market system is like the human circulatory system, delivering nutrients to the various parts that constitute the market and economy. When credit is used efficiently, it creates output and income sufficient to repay debt principal and interest, which is a healthy state. However, if credit is misused, and the generated income is insufficient to cover principal and interest, debt repayment pressure will squeeze out other expenditures like plaque in blood vessels. When the burden of debt servicing becomes extremely heavy, a debt repayment crisis erupts; subsequent debt maturity refinancing also encounters problems: debt holders are unwilling to roll over and choose to sell bonds.
Naturally, debt instruments like bonds will experience insufficient demand and face selling pressure. When supply far exceeds demand, two outcomes occur: a) Interest rates rise, dragging down markets and the economy; b) The central bank turns on the printing press to buy debt, the currency subsequently depreciates, pushing up inflation. Printing money also artificially suppresses interest rates, harming lenders' investment returns. Neither outcome is ideal. When bond selling becomes too large to contain, forcing interest rates higher, and the central bank has already purchased large quantities of bonds, the central bank itself incurs book losses and faces cash flow pressure. If the situation continues to deteriorate, the central bank may even have negative net assets.
Once the situation severely deteriorates, both the central government and the central bank must borrow to repay principal and interest; as free market demand is already insufficient, the central bank can only print money to provide credit, thus forming a self-reinforcing 'debt-printing-inflation' spiral.
In short, there are three core signals worth close attention: 1) The proportion of government debt servicing relative to government revenue (similar to the buildup of plaque in blood vessels); 2) The scale of government bond selling relative to bond market demand (like plaque breaking off, triggering a heart attack); 3) The scale of money printing by the central bank to buy government bonds to bridge the gap between bond supply and market demand (equivalent to the central bank injecting large-scale liquidity into the system to alleviate a liquidity crisis, but simultaneously taking on significant new debt and corresponding risk exposure).
Over long-term cycles spanning decades, these indicators often rise in tandem: debt and debt servicing costs balloon relative to income until the situation becomes untenable. The tipping point can be triggered in three ways: 1) Debt principal and interest payments severely crowd out other fiscal expenditures; 2) The scale of debt supply needing absorption far exceeds market willingness to absorb, forcing a sharp rise in interest rates, severely damaging markets and the economy; 3) The central bank, unwilling to see soaring rates and economic/market collapse, prints money on a large scale to buy bonds, filling the demand gap, leading to a substantial devaluation of the currency.
Regardless of which scenario occurs, bond returns will be poor. Only when debt and currency devalue to sufficiently low levels, attracting market buyers again, or the government can repurchase debt at low prices, completing debt restructuring, will the situation turn around.
The above is an extremely simplified summary of the grand debt cycle.
These indicators can all be quantified, allowing us to track debt dynamics in real-time and detect approaching risks early. I have used this analytical diagnostic tool for my own investments but hadn't made it public; now I've fully written it into *'Principles for Navigating Big Debt Crises'* because this knowledge is too important to keep hidden.
To be more specific, the complete evolution path is: Debt and debt servicing costs rise relative to income, debt supply exceeds market demand, the central bank initially stimulates by lowering short-term rates, then shifts to printing money to buy bonds. Eventually, the central bank incurs losses, net assets turn negative, the central government borrows more new debt to service old debt, and the central bank directly monetizes the debt. All these factors together drive a government debt crisis. When debt-driven spending contracts, cutting off the normal flow of the economic cycle, it triggers a crisis equivalent to an 'economic heart attack.'
In the early final stages of a grand debt cycle, these market signals appear: Long-term interest rates rise first; the currency (especially relative to gold) depreciates; due to insufficient long-term bond demand, the Treasury shortens the maturity of newly issued debt. In the later, most severe stages of the cycle, a series of seemingly extreme measures are often implemented, such as capital controls, exerting great pressure on creditors to force them to buy and not sell debt.
The U.S. Situation: Deep in Debt, Danger at an Inflection Point
It's easier to understand the U.S. fiscal situation and the choices facing policymakers by imagining the U.S. government as a giant corporation.
U.S. total fiscal revenue this year is approximately $5.5 trillion, total expenditures about $7.5 trillion, leaving a fiscal gap of about $2 trillion. In other words, this 'corporation' is spending about 40% more than its income this year. And the government has almost no room to cut spending, as the vast majority are rigid expenses already committed from the past.
Long-term heavy borrowing has led to massive accumulated debt, roughly six times the annual revenue (about $32 trillion), which translates to a debt burden of about $240,000 per household. Interest payments on the debt are about $1 trillion, constituting 20% of fiscal revenue and half of this year's fiscal deficit, a portion that needs to be covered by new borrowing. But $1 trillion isn't the total amount to be paid to creditors: besides interest, there's maturing principal of about $10 trillion, which the government can only hope creditors are willing to roll over.
Therefore, to avoid default, the total amount needing payment (debt servicing pressure) is about $11 trillion, equivalent to 200% of annual fiscal revenue.
This is the current reality.
So what happens next? Let's project: Regardless of the final deficit size, the U.S. must borrow to fill the gap. There is debate about future deficit levels. Based on recently passed budget reconciliation bills, most independent agencies estimate: U.S. debt will reach $55-60 trillion in 10 years (about 7 times revenue), with $25-30 trillion in new borrowing during that period. If no viable solution is found, in 10 years, debt servicing will further crowd out fiscal expenditures, and the risk of insufficient market absorption for Treasuries will further increase.
The Path Forward: A Three-Part Solution, Stabilizing to 3%
I believe U.S. finances are at a critical inflection point. If not addressed now, debt will continue to balloon. Trying to adjust after the situation spirals out of control will inevitably come with significant social pain. The best window for adjustment is precisely when the system is still relatively robust, not when the economy is already in recession. Once the economy declines, government borrowing needs will surge further.
Based on my analysis, what should be adopted is what I call the 3% three-part solution: reduce the fiscal deficit to 3% of GDP, using three deficit-reduction tools in balance: 1) cut fiscal spending; 2) increase taxes; 3) lower interest rates. All three must be advanced simultaneously to avoid the severe shock of over-reliance on any single measure; if one is pushed too hard, the adjustment process will be very painful. The adjustment should rely on sound fundamental reforms, not forced intervention (e.g., the Fed artificially forcing rates down would have severe consequences).
According to my calculations: based on existing plans, a spending cut of about 5% and a tax increase of about 5% would drive interest rates down 1-1.5 percentage points; the share of interest expenses in GDP would fall 1-2 percentage points over the next decade, while boosting asset prices, stimulating economic activity, and generating more fiscal revenue.
Frequently Asked Questions
The book contains much more, limited by space here, including the 'Big Cycle' (encompassing debt/credit cycles, domestic political cycles, external geopolitical cycles, natural disasters, technological progress) driving major global changes, my judgments about the future, and thoughts on how to invest during these grand cyclical shifts. Below, I answer a few frequently asked questions when discussing the book. For deeper understanding, please read the original book.
Question 1: Why do large-scale government debt crises and grand debt cycles happen?
Large-scale government debt crises and grand debt cycles can be identified through three sets of observable indicators: 1) Government debt servicing as a proportion of revenue rises, severely crowding out necessary fiscal expenditures; 2) The scale of government bond selling far exceeds market absorption capacity, interest rates rise, and stocks and the economy subsequently decline; 3) The central bank cuts rates to counter the crisis, further weakening bond appeal, then the central bank prints money to buy bonds, and the currency depreciates.
These phenomena worsen over cycles spanning decades until a tipping point arrives: 1) Debt servicing severely crowds out other public expenditures; 2) The scale of debt to be issued far exceeds market absorption capacity, interest rates rise sharply, markets and the economy decline deeply; 3) The central bank prints money on a large scale to buy bonds, filling the demand gap, and the currency depreciates significantly.
Regardless of the path, bond returns will continue to deteriorate until prices fall low enough to attract buyers again, or debt is restructured. These indicators can all be quantified, allowing early prediction of debt crises. When a crisis breaks out, debt-driven spending contracts, triggering a debt-induced 'economic heart attack.'
Throughout history, almost all countries have repeatedly experienced such debt cycles, with hundreds of historical examples for reference; they are visible everywhere in recorded history. In other words, all monetary orders have eventually disintegrated, and the debt cycle I describe is the root cause. The decline of past reserve currencies like the British pound and the Dutch guilder was driven by this mechanism. The book includes the 35 most recent typical cases.
Question 2: Since this process repeats, why is the underlying logic not widely understood?
Indeed, this mechanism is not fully recognized by the public. Interestingly, I couldn't find dedicated literature studying this evolution process. My speculation is: reserve currency countries experience the collapse of a monetary order perhaps only once per generation; when non-reserve currency countries have debt crises, people assume reserve currency countries are immune to such risks.
I discovered this pattern because I witnessed crises firsthand while investing in sovereign bond markets, so I analyzed numerous historical cases to be able to navigate such situations (e.g., the 2008 global financial crisis, subsequent European debt crisis).
Question 3: Many have heard warnings about a U.S. debt crisis, but it hasn't materialized. How concerned should we be about a debt crisis as an 'economic heart attack'? Why is this time different?
Based on the conditions mentioned earlier, I believe we should be highly concerned. In the past, when the debt environment was less dire, those issuing crisis warnings weren't wrong; if addressed then, it wouldn't have evolved into today's more difficult situation. It's like a doctor warning people early not to smoke or overeat.
I think the public hasn't paid sufficient attention to this issue, partly due to the high cognitive barrier of the mechanism itself, and partly because early multiple warnings didn't materialize, leading to widespread complacency. It's like someone with heavily plaque-filled arteries still eating high-fat diets, not exercising, and asking the doctor: 'You warned me long ago that not changing habits would lead to trouble, but I haven't had a heart attack yet, why should I believe you now?'
Question 4: What could be the trigger for a U.S. debt crisis now? When might it erupt? What would the crisis specifically look like?
The trigger is the confluence of the multiple factors mentioned earlier. As for the timing, external shocks like policy changes or geopolitical conflicts can either accelerate or delay the crisis. For example, if the fiscal deficit drops from the estimated ~7% of GDP to 3%, the risk would significantly decrease. If a major external shock occurs, the crisis would come sooner; without external shocks and with proper policy handling, it could be delayed or even avoided.
Based on my guess, if the current policy path remains unchanged, the crisis is likely to arrive in about 3 years, plus or minus 2 years.
Question 5: Are there historical examples of large-scale fiscal deficit reductions with good outcomes?
Yes, there are several. My solution requires cutting the fiscal deficit by about 4% of GDP. The most comparable case is the U.S. from 1991-1998, when the fiscal deficit reduction reached 5% of GDP, with a positive outcome.
Question 6: A common view holds that the U.S. dollar's dominant role in the global economy makes the U.S. less prone to a debt crisis. What do proponents of this view overlook?
Those holding this view do not understand the operating mechanism of debt currency and ignore historical lessons. They should study history: how all past reserve currencies gradually lost their reserve status. Simply put: a currency and its corresponding debt must be able to effectively store wealth; otherwise, they will be devalued and abandoned. The cyclical logic I describe precisely explains how reserve currencies lose their wealth storage function.
Question 7: Japan's debt-to-GDP ratio is 215%, the highest among developed economies, often cited to prove a country can sustain high debt long-term without a debt crisis. Why doesn't the Japan case make us optimistic?
Japan's current situation precisely confirms the theory I describe; the problems discussed in the book are playing out in reality. The Japanese government has high debt, and Japanese bonds have long been poor investments. To compensate for insufficient market demand for JGBs in a low-interest-rate environment, the Bank of Japan has printed vast sums of money to buy its own bonds. Since 2013, holders of Japanese bonds have incurred a 51% book loss relative to holding U.S. dollar bonds; relative to holding gold, a 76% loss. Comparing in unified currency terms, the wages of ordinary Japanese workers have fallen 55% relative to U.S. worker wages since 2013.
Question 8: Which other countries have fiscal risks underestimated by the market?
Most economies face similar debt and deficit issues, including the UK, EU, China, and Japan. Therefore, I predict most economies will undergo a round of debt adjustment and currency devaluation. This is also why I favor non-government-issued monetary assets like gold and Bitcoin.
Question 9: How should investors respond to such risks and manage asset allocation?
General advice: Diversify adequately, choosing countries and asset classes with sound income statements, balance sheets, minimal internal political conflict, and low external geopolitical tension; allocate a small portion to debt assets like bonds; allocate a significant portion to gold, and a modest allocation to a small amount of Bitcoin. Allocating a small portion of total assets (around 10-15%) to gold can both reduce portfolio risk and potentially enhance overall returns.
