Review of Ray Dalio's "How Countries Go Broke".
It is difficult to focus on important policy issues, as the national media is led around by the president's revolving fixations like a cat by a laser pointer. But focus we must, if we are not going to decline faster than we already are due to incompetent and corrupt leadership. One looming area is the federal budget. As a card-carrying acolyte of MMT economics, it is hard to say this, but there are limits to federal borrowing.
A recent book by super-investor Ray Dalio lays out a set of patterns, which he calls the big cycle, that tracks government solvency over roughly eighty year cycles, which typically start out tight and solvent, using relatively hard money, and end up overextended and in crises that are resolved by some mix of inflation, depreciation, and restructuring / reneging on debts. It is a perpetual and international set of cycles. As an investor, he is not much of a writer or economist, so the book is repetitive, poorly written, and markedly incurious about the origins of the patterns he finds. But still, it makes some significant points.
First is that the cycle happens for all monetary systems, whether fiat and borrowing domestically, or hard currency and borrowing in foreign currencies. But the consequences are far more severe for the latter than the former. Having your own currency, as MMT economists well know, is a blessing when you want to borrow and manage a domestic economy. Second is that even with a fiat currency, the limits are different, but there still are limits to government borrowing, which we are gradually running into.
 |
| Trajectory of US government debt. |
 |
| Trajectory of interest compared to other US government spending. |
At the beginning of a big cycle, the foregoing crisis has scared everyone into hard currencies, like gold, or some properly revalued local currency backed by a solvent government. Probity is everything. Later on in the cycle, the money is softened up due to increased borrowing and laxer standards. Eventually, there are private debt crises, where the central bank is obliged to take on a large part of the private debt and expand its balance sheet. Eventually, the central bank no longer bothers to unwind its balance sheet after such crises, and holds on to both private debts and government debt that it monetizes. And at the far end of the cycle, the debt service paid by the government threatens to become so onerous that a crisis develops- investors flee, interest rates go up, inflation goes up, and the debts, fiat though they are, become unsustainable. There is "restructuring".
This is a big cycle because it is superimposed on the regular business cycle that takes much shorter time- something like five to ten years. And it concerns the government's management of the money, not the private sector's vacillating enthusiasm about business conditions. Turkey is currently in the far end of such a cycle, plunged into high inflation and struggling to find a way to put itself back on a sound basis after massive mismanagement. And obviously the US is somewhere late in the same continuum. The issue is not the size of the federal debt, or its relation to GDP, but the amount we have to pay in interest from the annual budget. That is heading towards one trillion dollars, and if interest rates remain where they are, (given the inflationary pressures from the current administration's bad policies such as tariffs, oil shortages, and tax cuts), there is danger of a growing spiral of higher revenues going to interest, and less money available for government functions, increased monetization by the central bank, and ultimately, loss of faith in the currency.
A fascinating case is that of Japan, which both Dalio and MMT economists focus on for its unique approach to monetary policy. Since its debt bubble in the 90's, Japan has shifted lots of private debt and public debt to the central bank's balance sheet, which stands at about three times GDP- far beyond what other countries would deem acceptable. This can be sustained because the bank of Japan has kept interest rates very low- in the zero to one percent range. Thus the cost of all this debt is manageable, and will remain so unless and until interest rates go up. But this also means that the bank can not use interest rates to manage the economy and foreign exchange. In consequence, Japan's currency has weakened enormously on the international currency markets, making imports (such as of oil, significantly) much more expensive, while improving the competitive position of Japanese export manufacturers. Additionally, Japanese banks and businesses have been reluctant to unwind bad debts, which leads to the stagnation and lack of overheating that the low interest rates would otherwise foster. Everyone kicks the can down the road, waiting for either a crisis, or a resolution, neither of which seem in the offing.
But more interesting than the economic drama is the larger cultural cycle which Dalio alludes to as well. For this is not just an economic big cycle, but something deeper. For the US, Dalio starts with the civil war, but I think it is much more instructive to include the cycle before, which started with the Revolutionary War. These wars, plus World War 2, mark the three big cycles that the US has been through. Each started with war, and with currency disruption. The Continental Congress issued reams of Continental currency that had, by the end of the war, become worthless. So, one big objective of the ensuing constitutional order was to put the newly minted dollar on a sound footing, as also the finances of the federal government. This led to decades of growth, prosperity, and (the war of 1812, and various Native American extermination campaigns aside) peace. The middle of this period also saw a progressive cultural flowering, with the transcendentalists, various experimental communes like Brook Farm, and the Great Awakening. All this stability allowed people to envision a better society. However, what happened instead was increased division and conflict, leading to the Civil War.
Here again, paper money was issued and resulted in significant inflation, as the accumulated hatred tore the country apart. But in its wake, prosperity again reigned, with rapid technological advancement, peace, and, eventually, and progressive movements for women's suffrage, temperance, anti-corruption and anti-monopoly, and the Settlement movement. All this was reset in the Depression and ensuing world war, which then began a new cycle of conflict avoidance enshrined by the US role in the UN, NATO, and a very sedate and conventional media environment. As peace and stability took hold, a new progressive movement rose- the hippies, the anti-war, civil rights, and feminist movements. Did these foster peace and togetherness? Not exactly. One can sense that the culture was eager for truth, for not sugar-coating things anymore, for honesty and, indeed, for conflict. Humor shows became more cutting, movies more biting, tinged with horror and apocalypse. And here we are, in a country where the two parties can't stand each other and are headed towards something that smells distinctly martial.
All this conflict has smothered discussions of actual policy, which anyway has gone to the dogs in the new administration. For example, a high level of federal borrowing is more defensible if it builds US productive capacity, through investments in future-oriented technology and education. But the current adminstration is spending billions to cancel renewable energy contracts that had already been entered into. This is money not just down the drain, but subtracted from future productive capacity.
Is Dalio sanguine about our prospects? Not particularly. But nor does he view them as terribly dire. In the first place, the gulf between sovereign, fiat-issuing countries and others comes out starkly in his many graphs and analyses. The latter get into much more difficult straits when they borrow too much of someone else's money. Secondly, rather modest adjustments now, to federal spending, to taxation, and to interest rate policy, can change the trajectory we are on, from spiraling to sustainable. I would focus particularly on the tax side, which has so egregiously been attacked by the current administration, in its contempt for making the rich pay anything. Dalio mentions, however, that the most consequential lever is that of interest rates, which, as Japan shows, can, if low enough, make eye-watering debts quite easy to carry. But given a system where we want to retain the interest rate as a lever of macro-economic policy, (and capitalist motivation), it would be best to approach rates not by fiat, as Japan has done, but by good policy on the other fronts, which will naturally lead to lower interest rates, if properly handled.
