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The Long-Term Debt Cycle and Its Implications for Global Economies

Educational Series

In a recent Rebel Capitalist Pro Q&A session, Lyn Alden was asked the question:

I hope all is well. I was reading Ray Dalio’s book on navigating big debt cycles. In there, he talks about Deflationary depression and Inflationary Depression. I’m confused as to which road we are most likely currently on in the USA. I´m having a bit of trouble clearing up the fine differences.”

Below is a summary of Lyn's answer. You can also watch Lyn's full response by clicking play above. 

Renowned investor Ray Dalio provided his thoughts on the different types of economies based on how they denominated their debt.

Generally, Dalio divides economies into two categories:

  • Those whose debt is denominated in their own currency and
  • Those whose debt is not.

This distinction is also what separates developed markets from emerging markets.

Countries like Brazil and Turkey are considered emerging markets because a lot of their debt is denominated in foreign currencies, such as the US dollar or the Euro.

Global creditors prefer to lend in hard currency because it provides them with greater certainty and stability, which means that emerging markets are often subject to more volatile economic conditions.

In contrast, developed markets like the United States, Canada, the UK, and Japan typically have their debts denominated in their own currency.

This means that they are less vulnerable to currency fluctuations and tend to experience more disinflationary recessions and debt crises.

However, there is a caveat to this rule. If a developed market experiences an energy shortage, it can replicate an emerging market's experience.

Nevertheless, the type of debt a country has tends to impact its economic stability significantly.

When it comes to long-term debt cycles, after a country has racked up super-high debt and has already experienced years of low-interest rates, it can be challenging to reduce interest rates further.

This can result in growth and supply-side problems. Countries often resort to printing more money, which tends to be inflationary.

Another way to characterize debt crises is by distinguishing between public and private debt crises. Private debt crises are often disinflationary.

An example of a private debt crisis is the banking crises of 1929 and 2008. In these cases, many private sector debts defaulted, leading to the destruction of broad money.

Money was destroyed, and people became poorer, leading to less consumption and a deflationary spiral.

In contrast, public debt crises tend to be highly inflationary, where the public sector has massive debts and prints money to cover the difference. To some extent, the 1940s and the 2020s are examples of public debt crises.

Overall, it is not a straight line, but the current environment seems to be characterized by a more inflationary type of debt crisis.

As investors, we should pay attention to these economic indicators and adjust our strategies accordingly.