TL;DR

This article refers to Dalio’s new book “How Countries Go Bankrupt”, and at the end combines my personal views to sort out the opportunities and risks of the US debt cycle, only as an aid to investment decisions.

To begin, a brief introduction to Ray Dalio—founder of Bridgewater Associates, widely regarded as the “Steve Jobs of Investing,” and known for accurately predicting major economic events such as the 2008 financial crisis, the European debt crisis, and Brexit. Now, let’s dive into the main content.

Traditionally, debt research has primarily focused on the credit cycle, which moves in sync with business cycles (typically around six years, with a ±3-year variance). However, the big debt cycle is more fundamental and significant. Since 1700, the world has seen approximately 750 different currencies or debt markets, yet only about 20% still exist today. Even the surviving currencies have undergone severe devaluation, a phenomenon closely related to what Dalio describes as the “big debt cycle.”

The key distinction between small debt cycles and big debt cycles lies in the central bank’s ability to reverse the debt cycle. In a small debt cycle, central banks can adjust interest rates and expand credit supply to manage deleveraging. However, in a big debt cycle, debt growth becomes unsustainable, making the situation far more complex. A typical response to a big debt cycle follows this path: A healthy private sector → Excessive borrowing in the private sector, leading to repayment difficulties → Government intervention, increasing public sector debt → The central bank prints money and purchases government debt to provide assistance (acting as the lender of last resort).

A big debt cycle typically lasts around 80 years and consists of five key stages:

1. Sound Money Stage: Interest rates start at very low levels, and borrowing yields returns higher than capital costs, leading to debt expansion.
2. Debt Bubble Stage: As debt expands, the economy booms, and asset prices (e.g., stocks and real estate) rise. Growing confidence in repayment capacity leads to further borrowing.
3. Top Stage: Asset prices reach unsustainable levels, but debt expansion continues.
4. Deleveraging Stage: A wave of defaults occurs, asset prices collapse, total demand contracts, and a debt-deflation spiral (Fisher effect) takes hold. Nominal interest rates hit the zero lower bound, real interest rates rise due to deflation, and debt repayment pressure intensifies.
5. Debt Crisis Stage: Both the asset and debt bubbles burst, leading to systemic insolvency and debt restructuring. This marks the resolution of the debt crisis, establishing a new equilibrium and initiating the next cycle.

At each stage, central banks must implement different monetary policies to stabilize debt levels and the economy. Observing these policies allows us to determine where we currently stand in the big debt cycle.

Since 1945, the U.S. has undergone 12.5 short-term debt cycles. In 2024, U.S. debt interest payments are projected to exceed $1 trillion, while total government revenue is only $5 trillion—meaning for every $4 collected, $1 goes toward interest payments.

If this trend continues, the U.S. government will find it increasingly difficult to service its debt and will eventually resort to debt monetization (printing money to repay debt). This will drive inflation higher and significantly devalue the currency. Based on the current situation, the U.S. appears to be on the edge of Stage 3 (“Top Stage”), indicating that a debt crisis may be imminent.

The U.S. Long-Term Debt Cycle (1981–2000): A Historical Review

The U.S. debt cycle from 1981 to 2000 can be divided into several short-term cycles, each shaped by economic policies, inflation, interest rates, and financial crises.

The first short-term cycle, spanning from 1981 to 1989, was marked by the aftermath of the 1979 second oil crisis, which pushed the U.S. economy into a period of “stagflation 2.0.” In response, the Federal Reserve (Fed) aggressively raised interest rates, with the U.S. prime lending rate increasing nine times between February and April 1980, rising from 15.25% to 20.0%. Inflation and interest rates remained at historic highs, prompting the Fed to reverse course. Between May and July 1980, the Fed cut rates three times by 100 basis points (BP) each, lowering them from 13.0% to 10.0% to mitigate economic distress.

Upon taking office in 1981, President Ronald Reagan implemented a significant increase in defense spending, causing government leverage to rise sharply. The total outstanding U.S. debt expanded rapidly, reaching a peak in 1984, with the fiscal deficit soaring to 5.7% of GDP. Financial instability emerged in May 1984 when one of the top ten U.S. banks, Continental Illinois National Bank, faced a bank run and required emergency assistance from the FDIC—marking one of the largest bank bailouts in history.

By 1985, economic concerns led to the Plaza Accord, a multilateral agreement aimed at devaluing the U.S. dollar. Following this, the Gramm-Rudman-Hollings Act of 1985 was enacted, setting a goal for the U.S. federal government to achieve a balanced budget by 1991. In October 1985, Federal Reserve Chairman Paul Volcker acknowledged the need for lower interest rates to support economic growth. Consequently, the Fed gradually reduced interest rates from 11.64% to 5.85%. However, the appointment of Alan Greenspan as Fed Chair in 1987 brought a shift back to tighter monetary policy, increasing borrowing costs. This led to reduced corporate and household lending, contributing to the 1987 Black Monday stock market crash—one of the largest single-day market collapses in history. Economic growth slowed, and in 1987, President Reagan signed legislation to reduce the fiscal deficit, leading to a decline in government leverage growth. By the end of 1989, the increase in overall social leverage began to stagnate, marking the end of this short-term cycle.

The second short-term cycle, covering 1989 to 1992, began with the 1990 Gulf War, which caused a sharp increase in global oil prices. Inflation surged, with the Consumer Price Index (CPI) reaching its highest level since 1983, while GDP growth turned negative in 1991. As the economic downturn deepened, unemployment rose sharply in March 1991. To counteract the effects of stagflation, the Fed pursued an expansionary monetary policy, cutting the federal funds rate from 9.81% to 3%. However, war-related fiscal spending led to a significant increase in government leverage, pushing up the overall societal debt ratio in 1991. In April 1992, the global financial environment deteriorated further when Japan’s stock market crashed, with the Nikkei index plummeting to 17,000, a 56% decline from its 1990 peak of 38,957. Stock markets in the UK, France, Germany, and Mexico also suffered downturns due to worsening economic conditions. In response to global recession concerns, the Fed cut interest rates by another 50 BP in July 1992 to stimulate growth.

The third short-term cycle, from 1992 to 2000, began with the election of President Bill Clinton, who focused on balancing the federal budget through tax hikes and spending cuts. While these measures initially constrained fiscal policy, the post-war economic environment and improved growth expectations boosted corporate and household borrowing. This increase in leverage led to economic expansion, pushing inflation higher. In February 1994, the Fed launched a tightening cycle, raising interest rates six times, totaling a 300 BP increase to 6%. By December 1994, the rapid rate hikes caused an inverted yield curve, where short-term interest rates exceeded long-term rates, leading to the 1994 global bond market crash, which wiped out $600 billion in U.S. bond value and $1.5 trillion in global bond losses.

By 1997, the Asian financial crisis erupted, followed by Russia’s debt crisis in 1998, which triggered the collapse of Long-Term Capital Management (LTCM), one of the largest hedge funds in the U.S. On September 23, 1998, Merrill Lynch and J.P. Morgan led a private bailout of LTCM to prevent systemic financial instability. In response, the Fed cut interest rates by 50 BP in Q3 1998 to stabilize markets. At the same time, the dot-com boom fueled investor enthusiasm, driving non-government leverage growth to its highest level since 1986. The cycle came to an abrupt end in 2000, when the dot-com bubble burst, causing the Nasdaq to plummet by 80%. The bursting of the bubble led to a decline in corporate and household debt expansion, GDP growth slowed, and social leverage decreased. The resulting economic recession and deflationary pressures forced the Fed to shift back to monetary easing, marking the end of this long-term debt cycle.

The Debt Cycle After 2000: From Crisis to Monetary Expansion

Following the 2008 financial crisis, the U.S. unemployment rate soared to 10%, and global interest rates fell to zero. The Fed initiated the largest debt monetization program in history, printing money to purchase government debt and expanding its balance sheet through quantitative easing (QE). Between 2008 and 2020, the Fed conducted multiple rounds of QE, suppressing interest rates and injecting liquidity into the financial system. However, by late 2021, the Fed began tightening monetary policy to combat inflation. As a result, U.S. Treasury yields surged, the dollar strengthened, and the Nasdaq fell 33% from its peak in 2021. At the same time, higher interest rates led to substantial financial losses for the Fed.

The Next Phase of the U.S. Debt Cycle

With the U.S. approaching the “Top Stage” of the big debt cycle, what will happen when the cycle reaches the central bank level? Debt monetization, central bank losses, a potential death spiral, debt restructuring, and a new equilibrium are key developments to watch. The Fed may continue expanding its balance sheet and purchasing debt, resulting in further losses as interest rates remain high. If these losses persist, a debt selloff could lead to stagflation or recession. The government might be forced to restructure its debt, devalue the dollar, or implement capital controls and emergency taxation. Eventually, a new monetary cycle could emerge, potentially with the Fed pegging the dollar to hard assets like gold to restore confidence.

Future Investment Outlook

Given the current macroeconomic environment, potential investment strategies include holding gold as a strong asset while being cautious of long-term U.S. bonds. Investors should monitor Fed rate cuts and the movement of 10-year Treasury yields. Bitcoin remains a resilient risk asset with long-term potential, while U.S. stocks, particularly in the tech sector, could offer strong returns if bought during market corrections.

The current U.S. fiscal situation faces a severe problem—borrowing new debt to repay old debt. The government is issuing bonds to fill fiscal gaps, but these new debts come with higher interest costs, pushing the U.S. into a “debt spiral” that could eventually become unpayable.

Given this unsustainable trajectory, the U.S. debt crisis will not be resolved anytime soon. Ultimately, the government will have to follow one of the two historical debt crisis solutions: monetary easing (lowering interest rates) or fiscal adjustment. The Federal Reserve is likely to choose the former—reducing interest costs to ease the burden of debt servicing. While rate cuts won’t solve the debt problem, they can temporarily relieve the interest payment pressure, buying more time for the government to manage its massive debt load.

The idea of interest rate cuts aligns closely with Trump’s “America First” policy. The market consensus is that if Trump returns to office, his tariffs and fiscal policies could drive the U.S. deficit out of control, leading to a decline in U.S. creditworthiness, higher inflation, and rising interest rates. However, in reality, the dollar’s strength is mainly due to global interest rate differentials, with other economies lowering rates more aggressively than the U.S. As a result, the dollar appreciates while U.S. bond prices decline (causing yields to rise). This short-term yield surge is typical within a broader downward interest rate cycle.

As for inflation concerns, a reflation scenario is unlikely unless Trump triggers a fourth oil crisis. There is no logical reason to assume he would deliberately push inflation higher, as that would go against the interests of American consumers.

So, why has the Fed delayed rate cuts despite market expectations? The constant fluctuations in rate-cut expectations this year suggest the Fed wants to avoid prematurely exhausting its easing tools. Keeping a “hawkish” stance now creates room for more impactful rate cuts later.

Looking at historical patterns since 1990, the Fed paused rate cuts in August 1989 and August 1995 to assess economic conditions before determining the pace and magnitude of further reductions. For example, after a “precautionary” 25bp rate cut in July 1995, the Fed held rates steady for three consecutive meetings. It was only after the U.S. government shut down twice due to budget disagreements that the Fed finally cut rates again by 25bp in December 1995.

This historical precedent suggests that the Fed may not rush into rate cuts but will instead adopt a wait-and-see approach, ensuring it has sufficient flexibility to respond to future economic conditions.

Therefore, following the market consensus for predictions often leads to misjudgments—it is better to think in reverse and act accordingly. So, what are the potential opportunities moving forward?

1. From a U.S. asset perspective, gold remains a strong investment, while U.S. Treasuries, especially long-term bonds, are poor assets due to rising debt concerns.
2. At some point, the U.S. will be forced to cut interest rates, either actively or passively. Investors should anticipate this shift, closely monitoring the 10-year U.S. Treasury yield as a key indicator.
3. Bitcoin remains a resilient, high-quality risk asset, maintaining its value despite market fluctuations.
4. If the U.S. stock market experiences a significant correction, a buy-the-dip strategy with gradual accumulation of tech stocks could offer strong risk-reward potential over the long term.

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