Rise & fall, A Debt cYCLE sTORY

In this article, I would like to give you a closer look at how an economic cycle comes to life. A debt cycle, as we already know (see article 1 and article 2), involves a phase of credit expansion followed by a phase of contraction. This rising and falling can be more or less disastrous for a country, but the extent of the damage often depends on:

• The amount of debt accumulated and the methods by which it was accumulated
• How the crisis is managed at the monetary and political level

Well, by now you should be familiar with this topic, but the question remains:

So how does a Debt Cycle begin and end?

Let us start with the difference between a short-term cycle and a long-term cycle:

• Short-Term Cycle (5 to 8 years): Spending is limited only by the willingness of lenders to provide credit and of borrowers to receive it. The situation is quite straightforward. When credit is available and expanding, the economy grows. When credit becomes scarce, the economy falls into recession. The Central Bank is the entity that stimulates or slows down the economy through various monetary policies, such as lowering interest rates to encourage lending.

• Long-Term Cycle (75 to 100 years): In the case of long-term debt, the main factor that drives the expansion or reduction of credit and debt is essentially one, although the matter is far more complex:

People continuously spend more than they can afford. The problem? States do the same.

The debt cycle is self-reinforcing

According to Ray Dalio, debt can become self-reinforcing when borrowing fuels growth in a way that is unsustainable.

For example, during a credit boom, individuals and companies borrow heavily to invest or consume, causing asset prices to rise. Rising asset prices increase the value of collateral, encouraging even more borrowing. This creates a feedback loop where debt drives growth and growth justifies more debt. However, once incomes fail to keep up with debt obligations, borrowers struggle to repay, and the cycle reverses.

a clear example:

A clear example is the 2008 financial crisis, where excessive mortgage lending inflated housing prices until defaults triggered a rapid contraction. As confidence collapses, lenders tighten credit, spending declines, and the economy contracts. This self-reinforcing nature makes managing debt cycles particularly complex and dangerous if not addressed early through policy intervention.

When these debt cycles reach their tipping point, the resulting economic downturn can take the form of either a deflationary or an inflationary depression.

Deflationary depressions

A deflationary depression occurs when debt levels are too high relative to available money and credit. Prices fall, wages decline, and unemployment rises, as seen during the Great Depression of the 1930s. In response, central banks typically lower interest rates and increase liquidity to revive demand.

Inflationary depression

Conversely, an inflationary depression arises when authorities respond to excessive debt by printing too much money, leading to inflation that erodes purchasing power. A historic example is Weimar Germany in the 1920s, where hyperinflation devastated the economy and public trust in the currency.

While both types of depression result in severe economic pain, their causes and remedies differ significantly, underscoring the importance of correctly diagnosing the underlying issues in a debt crisis.

In the next article (the final one!), we will delve deeper into how governments and bankers can act to stop the depression.

We’ll explore all the measures in place to prevent potential financial catastrophes.

See you there!

Website you may want to see:

• One of Dalio’s websites: https://economicprinciples.org/
• The “Big Debt Crises” PDF: https://www.bridgewater.com/big-debt-crises/principles-for-navigating-big-debt-crises-by-ray-dalio.pdf