How Countries Go Broke: The Big Cycle

Chapter 10 reviews the post-1945 Big Debt Cycle and shows how repeated short-term debt cycles accumulate into one long-term leveraging. It begins with a simple rule: when central banks want to stimulate the economy, they cut interest rates or create money and credit; when rates can’t fall further, they buy debt—especially government bonds. These actions prolong expansions but cause debt to rise faster than income until restructuring or monetization becomes necessary.

He then tracks the U.S. path in the post-World War II era. From 1945 onward, the United States experiences about a dozen short-term debt cycles, each lasting roughly six years, that together build one long arc of rising public debt. Private-sector leverage peaks before 2008 and then declines, while government debt rises to support growth. Debt service relative to revenue increases and, on current projections, threatens to consume an unsustainable share of income. Dalio clarifies that nominal yields combine inflation expectations with real yields—the interest rate after inflation—which measure the true cost of borrowing and return to saving.

From 1980 to 2008, falling interest rates keep debt service manageable even as borrowing expands. Once rates reach zero (as in 2008), private demand for bonds weakens and the central bank begins printing money and purchasing debt, echoing patterns last seen after 1933. Dalio points to yield-curve inversions—when short-term rates exceed long-term ones—and widening credit spreads as signals of stress. He closes by noting that mounting debt burdens and late-cycle pressures extend beyond the United States, appearing across advanced economies and setting the stage for his discussion of postwar monetary regimes.

Chapter 11 outlines the post-World War II order that establishes a gold-linked monetary system, known as Bretton Woods, as the foundation for the U.S. and its allies. He defines this as Monetary Policy 0 (MP0)—a regime in which paper currencies are tied to gold, and central banks promise convertibility at fixed rates. The U.S. dollar becomes the global reserve currency because the United States holds most of the world’s gold and anchors the system.

He explains that MP0 is designed to restrain money creation: if governments issue too many claims relative to their gold reserves, holders can demand conversion, draining national gold stocks. In practice, countries still borrow and create credit faster than their gold supply grows, so claims eventually exceed reserves. Dalio notes the predictable outcome—pressure builds, “runs” on central-bank gold begin, and convertibility breaks down. He places this process within the broader Cold War context, when U.S. leadership funds postwar Europe’s reconstruction through programs like the Marshall Plan and enjoys strong productivity gains from consumer and technological innovation.

Dalio contrasts the U.K.’s experience—burdened by postwar debt, repeated sterling devaluations, and lost investor confidence—with the U.S. position. By the 1960s, America’s “guns and butter” spending and growing trade deficits increase dollar claims beyond the limited gold supply. Foreign holders, notably France, demand redemption, and U.S. reserves fall. Market strain surfaces when short-term rates rise above long-term ones and inflation climbs.

The breaking point occurs on August 15, 1971, when President Richard Nixon ends dollar-to-gold convertibility. The dollar quickly devalues, inflation accelerates, and the system transitions from MP0 to a fiat regime, setting up the next phase of the Big Debt Cycle.

Chapter 12 explains how the end of gold convertibility in 1971 ushers in a fiat regime Dalio labels Monetary Policy 1 (MP1). He defines MP1 as a system where central banks guide borrowing, spending, and money growth mainly by moving interest rates, no longer constrained by gold. He shows how this structural change sets up the 1970s mix of stagnation and inflation—“stagflation”—as easier money lifts prices, erodes real returns to savers, and favors borrowers over lenders.

He then tracks the turn in 1979-82, when the Federal Reserve tightens policy to curb inflation. Dalio links that shift to a broader political swing toward free-market-friendly leaders in the 1980s like President Ronald Reagan and British Prime Minister Margaret Thatcher and notes the hallmark conditions that follow: falling inflation, high real estate interest rates, widening profit margins, and slowing inflation. He observes how tight money and a strong dollar strain businesses and emerging markets, leading to a classic boom-bust cycle, restructuring, and a “lost decade” in parts of the developing world.

Dalio next describes the 1990s when globalization accelerates, major European currencies converge toward the euro, and technology innovations fuel a debt-financed equity boom that ends with the early 2000s dot-com crash. He emphasizes how the MP1 playbook repeats—tightening monetary spending to pop the bubble, then slowly reinvesting as inflation cools. He closes the period with the 2000s: recovery gives way to a new, housing-driven credit and debt cycle that culminates in the 2008 global financial crisis.

In the end, the 2008 recession forces a transition to the next phase (MP2), where central banks create money and buy assets directly to provide stimulus.

Chapter 13 explains how the 2008 global financial crisis pushes the monetary system beyond interest-rate policy and into direct money creation. The collapse of mortgage and real-estate markets spreads through banks, corporations, and households, sending unemployment higher and asset prices lower: By late 2008, the interest-rate-driven approach of the previous regime (MP1) no longer works. Central banks respond by buying debt in large volumes and extending credit directly from their balance sheets—an approach Dalio defines as Monetary Policy 2 (MP2).

In MP2, the central bank becomes the main buyer and holder of government debt, supplying liquidity when private demand is insufficient. Because it can print money, the central bank can tolerate losses or even negative net worth, preventing cascading defaults. Dalio tracks the surge in central-bank balance sheets and the monetary base, noting that most developed economies follow the U.S. Federal Reserve’s example. Asset prices recover, yields fall, and cheap money favors borrowers over savers.

Dalio shows the social and political consequences of these shifts. Job losses from globalization and automation, combined with post-crisis bailouts and wealth concentration, deepen inequality and fuel populist movements across the political spectrum. He observes these dynamics in Europe, where the Eurozone debt crisis forces the European Central Bank (ECB) to launch its own large-scale purchases while debtor nations restructure. Dalio closes the period with the 2016 political realignments, late-cycle policy tightening, and the arrival of COVID-19—the final shock managed under the MP2 framework.

Chapter 14 explains how the COVID-19 shock triggers a shift to Monetary Policy 3 (MP3)—an era in the difference between fiscal and monetary policy shrinks. Dalio defines MP3 as a system in which large government debts are financed by central-bank purchases and converted into a monetary value, which the bank can sell. Policymakers finance fiscal spending with the sale of government debt and central-bank support.

From 2020 onward, governments launch unprecedented spending programs while central banks expand their balance sheets to absorb the surge in new debt. Money and credit grow rapidly, asset prices rise, and large-scale borrowing remains cheap. The COVID-19 crisis accelerates inflation, increases supply-chain disruptions, and creates geopolitical conflicts. In response, central banks tighten their policies: interest rates climb and profits decline. Asset valuations—especially for long-duration, low-profit firms—decrease.

Dalio highlights the distributional effects of MP3. The wealth gap widens as asset holders reap gains and average citizens struggle with inflation. Political polarization deepens; leadership shifts occur in 2020 and beyond, and right-leaning movements resurface amid climate stress and rapid advances in artificial intelligence. Private-sector businesses remain relatively healthy because governments and central banks absorb much of the debt and mark-to-market losses.

In the 2020-2025 stage of the Big Cycle, debt burdens rise, domestic tensions intensify, power rivalries deepen, and technological change accelerates. Dalio uses China and Japan as examples for this phase.

Chapter 15 traces China’s Big Cycle from the late-1940s domestic reset to the present, placing it within Dalio’s five-stage framework. He begins with the “Century of Humiliation” (268), which precedes the 1949 Communist victory and the founding of the People’s Republic. Under Mao Zedong, political isolation and rigid central planning suppress economic growth and lower living standards, even as Mao consolidates political power and stabilizes the social order.

Deng Xiaoping’s leadership from 1978 to 1989 marks a structural turn in China’s economy. China opens to foreign investment and technology, adopts free market mechanisms, and prioritizes economic growth through export manufacturing. Competitive industries, trade surpluses, and new capital transform living standards and expand business opportunities. But by 2009, financial imbalances increase—particularly in real estate and state-linked corporations—as debt rises faster than output.

The 2010s pivot with President Xi Jinping’s anti-corruption campaign and  renewed political centralization under the banner of “common prosperity.” In the 2021 debt-bubble burst, policymakers seek to balance growth with stability as China rises in a great-power rivalry with the United States. These shifting global power dynamics are intensified by technology controls, supply-chain realignment, and tensions around Taiwan and the South China Sea.

Dalio concludes by mapping China’s position across the five forces: late-cycle debt strains, tighter internal governance, escalating U.S.-China competition, pandemic and climate stress, and rapid—if uneven—technological progress. China still has tools to achieve a “beautiful deleveraging,” given its domestic creditors and control over local-currency debt though trade-offs and geopolitical risks remain high.

Chapter 16 examines Japan’s experience as a heavily indebted reserve-currency country that struggles to manage its debt restructuring after the 1989-90 asset-bubble collapse. Although Japan’s debt is denominated in its own currency and largely held by domestic creditors, authorities delay addressing nonperforming loans for nearly a decade. They also hold interest rates steady for more than 20 years. This prolonged inaction traps banks and corporations in a “zombie” state, producing deflation and stagnation rather than the balance and recovery seen in better-managed economies.

The situation shifts after 2012, when Prime Minister Shinzo Abe and Bank of Japan Governor Haruhiko Kuroda launch the “three arrows” of Abenomics—monetary expansion, fiscal stimulus, and structural reform. Massive bond purchases and deficit spending finally push interest rates below nominal growth, spur mild inflation, and weaken the yen, restoring some competitiveness. These policies make government bonds poor stores of wealth: Japanese debt holders, including the central bank, incur significant real and relative losses as inflation erodes value.

Five dynamics recur in Japan’s adjustment: (1) government deficit spending supports private-sector deleveraging; (2) the central bank monetizes debt to hold down yields; (3) currency depreciation acts as an implicit tax on savers and foreign investors; (4) domestic purchasing power declines more slowly than external buying power; and (5) cheaper labor and assets improve competitiveness. Dalio concludes that Japan illustrates both the costs of delayed reform and the eventual necessity of debt monetization for aging, high-debt economies.