How Countries Go Broke: The Big Cycle

Chapter 4 describes the archetypical pattern that major debt crises follow when central governments and central banks “go broke.” Drawing on Dalio’s study of 35 major cases over the past century, the chapter distinguishes between hard-money systems, where currencies are tied to assets like gold, and fiat systems, where value depends on public confidence and central-bank policy. In hard-money regimes, crises come suddenly when governments can no longer meet convertibility promises; in fiat regimes, crises unfold gradually through inflation and currency depreciation.

Dalio traces this recurring process through nine stages of final crisis. First, both the private sector and government accumulate heavy debts. As private borrowers default, governments assume their obligations, pushing public debt higher. When investors lose confidence and sell government bonds, interest rates rise and currencies weaken. Central banks then intervene—cutting rates, printing money, and purchasing debt—to stabilize markets. If selling persists, the bank’s liabilities exceed its income, creating what Dalio calls the “central bank’s death spiral” (101).

To escape collapse, nations restructure or devalue debt, impose new taxes or capital controls, and attempt a “beautiful deleveraging” that balances deflationary restructuring with inflationary money creation. The cycle ends when debt, income, and money supply realign—often painfully, through high real interest rates and reduced spending.