Principles For Navigating Big Debt Crises is a series of 3 books by Ray Dalio, the founder of Bridgewater Associates, a global asset manager and the largest hedge fund in the world. My blog post would be reviewing the first book of the 3-part series. I was interested in this book because I felt that it would be good to learn from the lessons of the 2008 financial crisis (this is covered in detail in Part 2, which includes detailed case studies of the debt crises). I did not experience the 2008 crisis from the perspective of an investor, and the only market correction I’ve experience was during late 2015 and early 2016, due to fears of a hard landing for the Chinese economy, as well as crashing oil prices; and perhaps also early this year as well as the recent volatility in the markets. I believe that as even these relatively mild corrections can be rattling for many investors, I can’t help but to wonder how we would react in the event of a crash of similar magnitude to that of 2007 – 2009, when equity prices declined by more than 60%. It has only been about 10 years since the Great Recession, but it seems as though complacency has begun to set in again.

Today, people are still irrational as ever, as evident from the cryptocurrency hype last year, driving Bitcoin to $20,000 before the bubble burst. Greed and fear of missing out drives investors to pile money into ‘investments’, (or rather, speculation) in hope of making a quick buck. Undeniably, there are those who made huge returns through cryptocurrencies, and the underlying blockchain technology is set to bring about many practical benefits. However, as described in the book, bubbles form when the boom encourages new buyers who don’t want to miss out to enter the market (although the book is focused on debt fuelled bubbles, which wasn’t the case for crypto).

Given that we are still in the longest bull market since World War Two, many of us have questioned whether the next crisis would be approaching. This book describes how debt cycles are formed, and that by studying many cases, we would be able to see patterns that repeat itself over time.

The key points that the book covered were 1) the deflationary debt cycle, 2) the inflationary debt cycle (currency crises), and 3) the spiral to hyperinflation. The deflationary debt cycle is probably best characterised by the 2008 subprime mortgage crisis, while hyperinflation is what Venezuela is experiencing now.

The book begins by discussing how “debit” and “credit” underpins our entire economy, and that having too little growth in debt can be as bad as having too much debt, because of the forgone opportunities. Dalio includes a good analogy using the Monopoly game as a simplified example of how debt cycles are formed. Bubbles occur when unrealistic expectations and reckless lending results in high levels of bad loans, and when increasing amounts of money is borrowed to service debt payments.

Dalio listed seven measurable characteristics of bubbles as follows:

1) Prices are high relative to traditional measures

2) Prices are discounting future rapid price appreciation from these high levels

3) There is broad bullish sentiment

4) Purchases are being financed by high leverage

5) Buyers have made exceptionally extend forward purchases to speculate or protect themselves against future price gains

6) New buyers have entered the market

7) Stimulative monetary policy threatens to inflate the bubble even more, and tight policy to cause its popping

However, Dalio notes that debt ratios of the entire economy may not be adequate as compared to specific debt service abilities of the individual entities, which are often lost in the averages.

For policymakers to manage debt crises, Dalio notes that the following methods have been employed – the four levers:

1) Austerity – cutting government spending and raising taxes. Dalio believes that this is a mistake during depressions

2) ‘Printing’ money – guarantee liabilities, providing liquidity, supporting the solvency of systemically important institutions and recapitalising/nationalising systematically important financial institutions.

3) Debt defaults/restructuring – balance the benefits of allowing broke institutions to fail with the risks that failures can have detrimental effects on other creditworthy lenders and borrowers. Ensure that the pain is distributed across the population, and spread out over time.

4) Redistributing wealth – through taxes, politically attractive but rarely impactful.

Dalio notes that the four levers have to be moved in a balanced way to reduce intolerable shocks; balancing the inflationary forces against the deflationary ones. Additionally, it is much harder for policymakers to manage debt crises when the majority of the debt are denominated in foreign currency.

Overall, I picked this book because I believe we all want to be able to spot the peak of the bubble – and adjusting the position of our portfolios. Imagine shorting CDOs in 2008, as depicted in “The Big Short” movie. While Dalio described the typical indicators of spotting bubbles, the book didn’t exactly cover how investors should react during a debt crisis; instead, it was more about what policymakers could do to mitigate the effects of debt crises. 

However, I still feel that this was a worthy read, as it allowed me to understand more about the macroeconomic factors affecting our economy, as compared to the individual company level or industry level analysis that I have been familiar with. My blog post has mainly covered the deflationary debt cycle, as I had found it challenging to fully appreciate the chapters about inflationary depressions and currency crises, and I did not want to write any misinterpretations of what these chapters cover. I’ll be reading the detailed case studies in Part 2 of the series in the coming weeks.

I’d recommend anyone interested in understanding debt crises from a macroeconomic perspective to read this book. Lastly, if you have read a good book regarding investing or personal development in general, please leave a comment below and I’d be glad to check them out. Thanks in advance!

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  1. Hey - thanks for sharing this review. I have been reading this book, and I find myself strongly disagreeing with his viewpoints of basically rescuing the banks every time! It's as if we are pushing the problem further ahead, because we don't want to face reality in the eyes. Yes, I understand that if markets plummeted to where they are "supposed to be", repercussions that we cannot even anticipate could happen. But what would they be? Would EVERYONE become poor? Would EVERYONE lose their house? Would ALL businesses go out of business? No! It would give us an opportunity to start afresh, and unite us even more - but putting the dollar back in line with the gold standard. Or is there something I'm not getting??

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