How Countries Go Broke: The Big Cycle

Chapter 5 begins the detailed walk-through of his archetypal crisis model, explaining how debt troubles spread from the private sector to the central government. In Stage 1, both households and the state take on heavy borrowing. Government deficits widen as spending shifts from productive investment to consumption and social programs, while tax revenues lag. Debt service consumes a growing share of income, and foreign capital inflows finance the gap, creating rising exposure to external shocks.

In Stage 2, private-sector debt problems emerge, forcing governments to intervene as lenders or guarantors of last resort. Public borrowing accelerates as authorities support banks and companies, pushing debt-to-revenue ratios sharply higher. Reserves decline, and the money base tightens until markets can no longer absorb new government bonds.

Stage 3 marks a full-scale debt squeeze. Demand for government debt falls below supply, driving interest rates up and crowding out essential spending. Governments respond with improvised measures—off-balance-sheet borrowing, debt guarantees, forced purchases by domestic banks or pensions, patriotic campaigns, capital controls, and shortened maturities—to delay adjustment.

In Stage 4, selling pressure on government bonds triggers tightening in money and credit, weakening the economy and currency. Central banks attempt to defend exchange rates with higher rates and reserve sales, but the cost becomes unbearable. Eventually, the defense collapses: the currency devalues, reserves run low, and capital flight accelerates. Corporations, banks, and savers move funds abroad or into hard assets, completing the downward spiral that ends the first phase of the crisis and sets up the transfer of strain to the central bank in the next stage.

Chapter 6 explains how a sovereign debt crisis migrates from government balance sheets to the central bank. In Stage 5, markets demand higher yields or stop lending altogether, forcing the central bank to step in as the main buyer of government debt. To stabilize conditions, it creates new money and purchases bonds, crediting banks’ reserves to keep debt service manageable and interest rates low. Governments often shorten debt maturities or rely on domestic financial institutions to absorb issuance—both early warning signs of stress. Central bank balance sheets expand well before the crisis becomes visible, masking underlying fragility.

This intervention, he explains, effectively transfers risk from investors to the central bank. By paying interest on reserves, the bank assumes similar duration and credit exposures, except it can create money to meet obligations. Yet this mechanism is not limitless. In Stage 6, as interest rates rise, the central bank’s interest costs on reserves exceed its earnings from bond holdings, generating losses and potentially negative net worth.

Dalio stresses that moderate losses are not fatal but warns of a “death spiral” when the central bank must print money to finance itself—triggering depreciation, capital flight, and inflation. Policymakers face an impossible trade-off: ease to support the economy and government, or tighten to protect the currency. Typical signs include a bloated central bank balance sheet, falling reserves, and declining reserve-to-money ratios. Together, these mark a shift from confidence to erosion, setting the stage for monetization, inflation, and the later phases of the debt cycle.

Chapter 7 explains how debt crises eventually resolve and reset through a series of deflationary and inflationary adjustments. In Stage 7, policymakers reduce debt burdens by restructuring obligations and by monetizing or devaluing them. Currencies fall, and holders of local debt or cash take real losses until confidence returns in a new monetary framework. Government liabilities shrink relative to real assets like gold, commodities, and equities, while the monetary base expands as central banks accommodate, restoring liquidity. As this happens, reserves stop falling and begin to rebuild because the cheaper currency boosts exports and competitiveness.

In Stage 8, governments, now cash-strained, impose extraordinary measures to stabilize finances. These may include higher taxes on wealth and inheritance, capital or exchange controls to prevent outflows, and temporary administrative fixes such as multiple exchange rates. These tools rarely solve underlying problems but buy time for broader adjustment.

By Stage 9, the crisis has burned itself out, and a new equilibrium emerges. Debt levels become manageable, currencies stabilize, and real interest rates turn positive, rewarding savers and restoring confidence. Fiscal and monetary authorities implement packages to sustain the recovery: realistic debt restructuring, strict fiscal discipline, high real rates, and limits on money printing. As credibility rebuilds, reserves-to-money ratios improve and foreign capital returns. Dalio ends the cycle where it began—with debt, policy, and human behavior setting the conditions for the next expansion and eventual downturn.

Chapter 8 broadens this framework to introduce the Overall Big Cycle, which integrates five interacting forces that shape the rise and decline of nations and world orders: (1) the debt, credit, money, and economic cycle; (2) the internal order—disorder cycle within countries; (3) the external geopolitical order—disorder cycle; (4) acts of nature; and (5) human inventiveness, especially technological change. Dalio explains that short-term cycles, lasting a few years, compound into long-term cycles of roughly 80 years. Productivity improvements push an upward trend line, while the other forces create swings above and below it. The chapter’s goal is to identify the cause-and-effect mechanics behind these shifts so policymakers and investors can anticipate change.

Dalio describes how internal political orders repeatedly evolve as power shifts between competing groups. When democracies face widening inequality, corruption, and paralysis, they often give way to autocratic systems promising order and strength. Externally, world orders alternate between multilateral cooperation and unilateral rivalry, with the latter intensifying as empires peak and decline. Dalio adds that natural disasters and pandemics increasingly strain economies already burdened by debt and division, while technology amplifies both productivity and instability through rapid innovation and speculative excess.

Today’s global system sits late in this long cycle—characterized by high debt, political fragmentation, geopolitical rivalry, environmental stress, and transformative new technologies. As in past turning points, the outcome depends on whether societies choose cooperation and reform or slide toward conflict and collapse, resetting the world order once again.