What is Long Term Debt Cycle

The long-term debt cycle is a concept popularized by Ray Dalio, which describes the extended periods of economic growth and recession driven by the accumulation and eventual deleveraging of debt.

Ray Dalio views the economy as a system driven by both short-term and long-term debt cycles, each playing a crucial role in economic fluctuations and long-term financial stability"

• The short-term debt cycle is essentially the business cycle, which lasts around 6 years on average (plus or minus 3 years). It involves the cyclical rise and fall of debt, economic activity, and asset prices within a particular monetary/credit regime.
• The long-term debt cycle encompasses multiple short-term debt cycles and lasts around 75 years on average (plus or minus 25 years). It represents the broader accumulation and deleveraging of debt over decades.

Each short-term debt cycle contributes to the gradual build-up of debt levels during the long-term cycle. As described in and , the short-term cycles involve credit expansions that fuel economic booms but leave higher debt levels after each bust.

The long-term cycle reaches an inflection point when central banks can no longer stimulate the economy through traditional monetary policy tools like interest rate cuts, as rates approach the zero bound. This typically happens after decades of debt accumulation from the short-term cycles.

Here are the key elements of the long-term debt cycle:

Phases of the Long-Term Debt Cycle

• Initial Low Debt and Hard Money: The cycle begins with low levels of debt and a stable monetary system, often referred to as "hard money" .
• Increased Debt and Credit Expansion: Over time, credit becomes more accessible, leading to increased borrowing. This phase is characterized by rising asset prices and economic growth as borrowing fuels spending and investment .
• Debt Accumulation: As borrowing continues, debt levels rise faster than incomes. This creates a self-reinforcing cycle where increased spending leads to higher incomes and asset prices, which in turn encourages more borrowing .
• Debt Saturation and Economic Overheating: Eventually, the economy reaches a point where debt levels become unsustainable. The central bank's ability to stimulate the economy through interest rate cuts diminishes, especially when rates are already near zero .
• Debt Crisis and Deleveraging: A debt crisis occurs when borrowers can no longer service their debts, leading to defaults and economic contraction. This phase involves significant deleveraging, where debts are reduced through defaults, restructurings, or inflation .
• Economic Reset: The cycle culminates in a severe economic downturn or depression, which resets the financial system. This reset can be deflationary or inflationary, depending on various factors such as the currency denomination of the debt .

Where Are We in the Long Term Debt Cycle

Ray Dalio estimates that we are about 85% through the current long-term debt cycle. This suggests that we are nearing the end of this cycle, which typically involves significant economic restructuring and potential debt crises.

Characteristics of the Late Stage

• High Debt Levels: Debt assets and liabilities are already very large and projected to rise further, making it increasingly difficult to manage interest rates and monetary policy effectively.
• Economic Imbalances: The late stage is characterized by imbalances where central banks and governments have deteriorated their balance sheets to support households, creating a safer environment for the private sector but increasing public sector debt.
• Potential for Restructuring: There is a high probability of major restructuring of debt assets and liabilities, which could involve money printing, debt monetization, and defaults.
• Historical Context: The current long-term debt cycle began in 1945, following World War II, and has lasted about 78 years. This aligns with Dalio's observation that long-term debt cycles typically last around 75 years, plus or minus 25 years.
• Economic and Political Implications: The end of the long-term debt cycle often coincides with significant economic and political changes, including shifts in the world order, monetary system restructuring, and potential internal and external conflicts.

What Happens at the End of a Long Term Debt Cycle

After reaching the final stage of a long-term debt cycle, a major debt restructuring or reset typically occurs. Here are the key points about what happens after the final stage:

• Debt Saturation and Crisis: The final stage is characterized by unsustainable debt levels, where central banks have limited ability to stimulate the economy through traditional monetary policy tools like interest rate cuts. This is because interest rates are already near zero, and further cuts are ineffective.
• Deleveraging and Defaults: A debt crisis emerges when borrowers can no longer service their debts, leading to defaults and a broader economic contraction. This phase involves significant deleveraging, where debts are reduced through defaults, restructurings, or inflation.
• Monetization and Currency Devaluation: Governments and central banks typically resort to monetizing debt by printing money, which devalues the currency. As Ray Dalio states, "When one can manufacture money and credit and pass them out to everyone to make them happy, it is very hard to resist the temptation to do so."
• Economic Reset and Restructuring: The cycle culminates in a severe economic downturn or depression, which resets the financial system. This reset often involves restructuring of debts, changes in the monetary system, domestic political reforms, and shifts in the international order.
• Deflationary or Inflationary Reset: The reset can be deflationary, involving debt defaults and tight credit conditions, or inflationary, involving currency devaluation and debt monetization. The path chosen depends on various factors, including the denomination of debt and political considerations.
• New World Order: After the reset, a new world order emerges, with a new monetary system, political systems, and international dynamics. This marks the beginning of a new long-term debt cycle with low debt levels and "hard money".
• Potential Conflicts: The end of the long-term debt cycle is often accompanied by internal conflicts within countries, driven by economic disparities and social tensions, as well as potential external conflicts or wars between nations.