Book summary: Understanding big debt crisis by Ray Dalio

economic cycle
- tied to production activity and output
credit cycle
- the underlying basis is trust
- capital employed as a means of production
- when trust breaks down and credit starts to tighten credit cycle is said to be in the contraction phase and deleveraging occurs

inflationary deleveraging
- generally occurs when country’s currency is not a reserve currency or when currency is pegged to a specific commodity like gold
- foreign lenders are unwilling to roll over existing credit or provide new credit leading to credit contraction within the economy
- price of good rises during an inflationary deleveraging
deflationary deleveraging
- generally occurs when country’s currency is a reserve currency
- money is hoarded as cash instead of being utilized to support economic activity
- domestic lenders are unwilling to provide credit leading to credit contraction within economy

Austerity – spending less
Debt defaults / restructuring
Central bank print money and making purchases or providing guarantees
- hard to implement if currency is tied to the gold standard
Transfers of money and credit from those who have more than they need to those who have less
- will generally trigger exodus of funds

Reduced debt to income ratio (head to Genesage to understand more about the clockwork behind debts)
improved economic activity
improved financial asset prices
bring nominal economic growth rate above nominal interest rate

Dire income inequalities where 40% of the wealth is owned by 1% of the population
Rise of populism
- Hitler
- Franklin DeRoosevelt
- Winston Churchill
rise of protectionism
- US launches trade war against Canada
Rise of militarism
- Hitler Germany
- Japan
Continue professing by politicians that there is nothing wrong with the economy
- President Hoover attempts to allay fears
Extreme volatility in the financial markets
riots due to economic hardship
sudden shifts from relatively free trade and interconnected supply chains around the world to protectionism and trade war through the use of tariffs
- US versus Canada trade war
Out break of war
- WW2
- increase

GDP will tend to improve during war time as countries involved in war borrow heavily through the issue of bonds to finance production of war equipments
GDP will start to deteriorate after period of war is over as it transits back its prior state
GDP of the loosing faction will tend to be more severely affected during the post war period as they get slabbed with war reparations – WW1
Nature of loans during war period
- Loans will initially be denominated in local currency due to high levels of patriotism
- As war drags on and there are no signs of a positive outcome and loans becomes harder citizens will have either exhausted their loanable assets or are not confidant in the government’s ability
- Further loans will need to be borrowed from foreigners which might result in loans denominated in foreign currencies

investors buy financial assets and utilize increasing financial asset prices as collateral to buy more financial assets
government increases interest rate to tighten monetary policy and bring down inflation
brokerages increases margin interest rates
investors who cannot afford margin interest rates starts unwinding their positions leading to fall in financial asset prices
fall of financial asset prices triggers margin calls on other investors who borrowed to buy financial assets. This vicious cycle continues and confidence starts deteriorating and credit starts unwinding
bankers attempt to prop up asset prices and boost confidence by buying assets. Efforts were not enough, and asset prices continue to decline – as much as 90%
other entities are impacted
- actual companies start experiencing problems getting credit
- banks whose assets are in financial assets experience solvency issue due to rapidly deteriorating
bankruptcies and unemployment rate increases
government steps into prop up the market by lowering interest rate
interest rate is at all time low, investors lacking confidence is unwilling to provide credit many started withdrawing cash from banks causing bank runs. They also started hoarding gold.
There is an international shortfall of USD

Confidence worldwide gets affected by US market deleveraging
Germany whose WW1 reparation denominated in USD experiences were mainly financed through the issuing of bonds experience difficulties finding buyers for new bonds.
investors loose confidence in ability of German government to repay bonds and start believing in the probability of a default
investors started dumping bonds and withdrawing gold from the German economy
inflation ensues
UK have many banks with assets tied to German bonds. Investors are concerned that UK will get affected and started withdrawing gold in droves.
UK government and German government decoupled their currencies from the gold standard, lowered interest rates and allowed exchange rates to decline

USA continues to peg their currency to the gold standard but experiences continued outflow of gold because gold is now considered to be priced too cheap against USD when compared to other European currencies that have gone off the gold standard
USA bans the purchase of gold, decouples their currency from gold and allow exchange rates to float freely
The world economy starts recovering