Credit: H. Lawrence
2. The private sector suffers a debt crisis of some sort (e.g., massive loan repayment defaults, bank lending crisis) and the government goes deeper into debt trying to bail out the private sector.
3. The government experiences a "debt squeeze" where public demand for its debt falls well short of supply and/or holders of existing government debt begin to sell it in large quantities.
4. The government's continued selling of new debt results in a tightening of money and credit, weak economy, declining government reserves, and downward pressure on the currency. The central bank lowers interest rates to take pressure off the government's debt repayment obligations.
5. When interest rates cannot be further lowered, the central bank "prints" vast amounts of new money. [It does not actually print paper currency notes but creates "money" credits from thin air to purchase some of the increasing quantity of new government debt].
6. Bond yields rise due to the growing supply and weaker demand. The low interest rate bonds previously purchased by the central bank lose value. It also loses money paying higher interest to banks on their reserves than it makes in interest from the bonds it bought from them. The central bank suffers a negative cash flow, a "big red flag" signaling the central bank may be entering a death spiral.
7. Public and private debts are "restructured" hurting creditors, or the debts are "monetized" where the central bank buys the debt with new money, passing the loss onto all taxpayers in the form of "price inflation" (i.e. devalued currency).
8. The government employs extreme measures such as confiscatory taxes, often coupled with currency controls (prohibitions against transferring money out of the country) to trap its citizens in the continuously devalued national currency.
9. Theoretically, the actions taken in 7 and 8 bring debt and debt service costs back into balance. Dalio describes such an outcome as a "Beautiful Deleveraging". However, in the cases he studied, that never happened. All thirty-five governments and/or their central banks collapsed.
You might consider where your nation is on this continuum. For the US, the Federal Reserve Bank's cash flow turned negative in 2022 - the first time in 107 years that it sustained an operating loss. That continued in 2023 with the Fed losing $114.3 billion, a further loss of $77.6 billion in 2024 and $242 billion in 2025. In typical governmental misdirection, the Fed carries these losses on its books as "Deferred Assets". Thus, the US has passed the Stage 6 and is in the process of "restructuring" its debts (Stage 7). It is doing that by repaying its bond holders with devalued currency (i.e., defaulting on its honest obligations).
The process of nations going broke always starts with the government accruing a large and growing stock of debt that far exceeds its ability to repay, coupled with rising debt servicing costs. This debt resulted from a rising share of government revenues being devoted to consumption and social service expenses and a declining share going to increases in productivity. As the crisis continues, there is never any political will to reduce social service costs and, instead, there is growing pressure to increase them. Thus, the only way to reduce the country's mounting debt servicing costs is for the central bank to force interest rates lower - but doing so invariably ignites price inflation. This puts the central bank in a classic Hobson's choice. It will choose to lower interest rates to below the rate of inflation. Economists call this "financial repression" - we call it government embezzlement of your savings.
Central banks are forced to step in to relieve the fiscal pressure on their governments by transferring government liabilities onto their own balance sheets. They can only do that by creating massive credits (money) out of thin air which, of course, further debases the currency - hurting retirees, the middle and lower classes the most. According to Dalio, a tell-tale signal that things are getting worse (another red flag) is when the Treasury shortens the maturity dates on its newly issued debt due to rapidly falling demand for its long-term debt (no one wants to buy long term bonds when the currency is being actively and openly, devalued). The US Treasury has been shortening its maturity dates for several years. Thus, "extreme measures" (Stage 8) are up next.
There are other ways desperate governments can try to put off their day of reckoning but all have very negative consequences. For example, they can "temporarily" defer making interest payments on their outstanding debt (a "payment moratorium") but that clearly constitutes a "default". The downside is it will scare off purchasers of new debt that must be sold. They can "freeze" debt and interest payments that are owed to "hostile" countries, as the US Treasury did to Russia at the beginning of the Ukraine war. But that discourages foreign investors from buying new debt fearing they may be next to have their assets frozen.
They can also try to "restructure" their debt by stretching out maturity dates (i.e., a default without admitting a default). They can impose draconian taxes on their citizens in an effort to recapitalize themselves at the expense of their citizens - who will be furious about that. They can trap their citizens' wealth within the country to be further confiscated in due course by imposing capital controls. They can "revalue" some of their assets (e.g., gold holdings) in an attempt to make them look "less broke". As a last resort, they can issue a new currency ostensibly backed by something tangible (e.g., government owned lands) hoping to convince their citizens and foreigners that it is now safe to buy more of their debt.
The downside to all of these things is that it may cause the government to lose its "mandate from heaven" (support of the people). That could result in a new form of government arising either peacefully - or chaotically. Prior "peaceful" changes have led to catastrophe. In post-World War I Germany, Hitler came to power promising to address the collapse of the nation following its military defeat, destruction of its industries and painful reparation payments imposed by the victors. The German legislative body, the Bundestag, democratically voted to give him expansive powers to address these crises. He did not come to power through a usurpation or revolution. He came to power peacefully - and then became a tyrant. Dalio writes,
Plato called the person who typically leads the revolutionary changes from democracy to autocracy a "demagogue". Demagogues [whether from the right or the left] manipulate public opinion, stir up emotions, and use extraordinary means to gain power. They typically rile up populist sentiment, promise easy solutions to complex problems (often at the expense of truth or rational discourse) and use propaganda and bullying to gain and increase power.... This typically leads to the eventual replacement of democracy with a more centralized, dictatorial form of government.... In most of these cases, the transfer from the democracies to autocracies takes place within the rules of the democracy and becomes increasingly extreme over a few years, usually around three to five....
In times of great conflict, aggressive leaders work to eliminate the opposition by threats and damaging action, by making changes in the law that give the leaders special powers, and by taking increased control over the media to produce pro-government propaganda.
In the US, Democrats engaged in incessant and abusive "lawfare" (endless civil litigation and criminal prosecutions) against Trump prior to, during his first term in office, and after he left office, all intended to eliminate him as a political opponent. Upon his return to office Trump is now engaging in the same tactics as "payback" for the Democrat's former abuse of him by the legal system. This is a new, and very ugly, development. Political disagreements have evolved into bitter hatreds. Neither side has any interest in working with the other to arrive at compromises. All that matters is getting your team back into control - at any cost - the welfare of the nation be damned.
Trump has done some commendable things - such as closing the southern border to the flood of unvetted immigrants. However, any nation with a shrinking native population must be open to some controlled immigration to do the work that natives can no longer do or will no longer do. But many of his actions have brought on a firestorm of protests. It is to be expected that the political left will excoriate him for anything he does. That is a given. But some on the right complain that serious problems are being ignored. Ambrose Evans-Pritchard, a writer from the Telegraph,
Fitch Ratings expects the [US] fiscal deficit to hit 7.3pc of GDP this year. The International Monetary Fund has etched in 8pc as far as the eye can see, even at full employment, and even allowing for tariff revenues. US savings rate 3.4pc of GDP, viz the UK (9.5pc) or France (19pc).
There are critical issues Trump has failed to address: the rapidly growing national debt that is nearing $39 trillion, ever-larger annual budget deficits, and soaring interest payments that will consume much of future revenues. No president in the last decades has had the spine to address these catastrophes in the making. At some point, the US will face the crisis Ray Dalio describes above. The longer these problems are ignored, the greater the breadth and depth of the disaster.
During times of such crises, people will seek to protect themselves and their savings by avoiding the devalued national currency and holding "good" (or at least "better") money. However, governments always work to prevent them from doing so in order to ease the transfer of wealth from the people to the government. President Roosevelt did exactly that in 1933 when he ordered all Americans to turn in the gold coins that were in common circulation. He did so on the pretext that the people were "hoarding" money when, in fact, all they were doing was saving their money during the very hard times that followed the Great Depression.
The government paid $20.67 per ounce for the gold the people turned in. Then, Roosevelt revalued gold to $35 per oz. (i.e., devalued the dollar by 40%). The long and the short of it is that the government confiscated 40% of the people's savings. This was done in the "Land of the Free and the Home of the Brave" with the consent of Congress and the Supreme Court. You can plane for the fact that confiscation of the people's wealth will be done again, during the next crisis.
How Fares the American Worker?
From 1971 (when Nixon broke the dollar's last link to gold) to 1981 (just ten years), the Fed increased the money supply by 100% - M2, a larger view of money, rose by 180% with the predictable result of rampant price inflation. Goods and services prices exploded 140%. Holders of ten-year US Treasuries lost 40% of their money in inflation-adjusted terms. You do not need to be a PhD economist to understand that holding long-term government debt during inflationary or crisis times is madness.
In just the last six years, consumer prices have risen more than 25% after the government increased the money supply by nearly $6 trillion. Nearly two-thirds of all dollars in existence today were created in just the last fifteen years. Because the Fed can freely create money, you can be assured that it will continue to do so. Richard Cantillon noted that the effects of money printing do not affect all people equally. He observed that those who receive the new money first, benefit the most, because they can buy assets at current prices.
Banks are the first in line for the new money when they are bailed out by the central bank that was expressly created to serve this purpose. As the new dollars slowly work their way through the economy, they lose value. Workers (at the tail-end of the economy) bear the full cost of the devaluation. Their real wages (inflation adjusted) are significantly eroded. This chart shows the many ways the working classes have been left holding the bag since late 2019.
Source: Visual Capitalist @VisualCap
While price inflation continues and workers' real wages fall, assets owned by the wealthy increase in price (real estate, stocks, art, precious metals). The next chart shows average hourly earnings increases as a percentage change, year-over-year. They are currently averaging about 3.75%. That sounds good until you learn that the real cost of living is, and has been, increasing around 8% a year.
The result is that 65% of US workers say they are living paycheck-to-paycheck (per ADP survey) and are in no position to save anything. Even if they mange to squirrel away a few dollars and put them in a bank, they earn negative real interest of about 4% - meaning they are losing money. Thus, they have no incentive to save. Price inflation (currency devaluation) is always caused by your government. Neither you, your employer or any retailer has the ability to increase the money supply. It always inflicts the most pain on those least able to protect themselves from it.
Source: Wolfstreet.com
So, how do the middle and lower wage earners make ends meet during inflationary environments? They do so by incurring debt, typically with credit cards and consumer loans. Here is a chart showing these rising balances (that do not include mortgages and student debt). Credit cards often incur interest rates in excess of 20% (meaning unpaid balances will double in 3.6 years). This has crisis written all over it.
Source: Wolfstreet.com
Why do we hear so much about the housing "affordability" issue? Because real estate prices (blue line) have soared ahead of income (red line), making home ownership increasingly out of reach for so many.
Home Prices v. Median Household Income
Evaluating Your Position
When you look at your investment statements bear in mind you are looking at "nominal" dollars - meaning dollars at their currently debased value. Those dollars (your stock's "current price") may look impressive considering the number of your "invested" dollars (your stock's "purchase price") but those invested dollars have been continuously devalued by your government.
Assume you bought an $80 stock in 1980 and held it to date where it is now priced at $320. You may think you hit a "home-run". Sadly, that is all an illusion. Consumer prices have risen at the same rate. So you have, in fact, made no money on the stock - not one red cent. The price rise is all attributable to price inflation (dollar devaluation). Your $320 today is worth $80 in 1980 dollars. If you sell the stock, you will have to pay capital gain taxes on a fictional $240 "gain" even though you have made no real gain at all. If you did so, you would be worse off than when you started. Bear in mind, the CPI rate shown below is calculated by the government which is incentivized to under-report the real rate of inflation hoping to keep voters from marching on Washington with pitchforks and torches.
Issue: should you hold on to your inflated assets to avoid incurring capital gains taxes or should you take some money off the table? That is a tough question. If you think that your investments will continue to rise in value, holding on to them is very tempting. But doing so ignores the substantial "risk of loss" that a recession or depression would bring about. Risks must never be ignored. If your nation slips into a fiscal crisis as described by Dalio, it is reasonable to assume that asset prices would fall precipitously as people rush to sell them to raise money to live on, wiping out much if not all of your paper gains. That would leave you in dire straits - especially if you are near or in retirement. You should discuss this vexing problem with your investment advisor. Should he or she try to minimize the risks discussed by Dalio, you might look for another advisor.
One might hope that voters will finally wake up and elect wise representatives who will take the bull by the horns and seriously address the nation's dire problems. Is that a realistic hope? Dalio observes,
The challenge in the US is that there is and has been a deep and pervasive rot in our education, family, and social systems that has resulted in many children not being brought up to lead productive, civil and healthy lives.... The bottom 60% [of earners] are doing terribly. They are net costs rather than net contributors [to the economy]. On average, they have attained less than a sixth-grade reading level and get more in public assistance payments than they pay in taxes.
How likely is it that 60% of voters will elect a candidate who promises to reduce their public assistance payments? If you conclude that likelihood is "zero", you need to take proactive measures to protect yourself - now, rather than later.
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