A Template for Understanding Big Debt Crises

by Ray Dalio

So, what do I mean by that? Basically, income needs to grow faster than debt. For example: Let’s assume that a country going through a deleveraging has a debt-to-income ratio of 100 percent. That means that the amount of debt it has is the same as the amount of income the entire country makes in a year. Now think about the interest rate on that debt. Let’s say it’s 2 percent. If debt is 100 and the interest rate is 2 percent, then if no debt is repaid it will be 102 after one year. If income is 100 and it grows at 1 percent, then income will be 101, so the debt burden will increase from 100/100 to 102/101. So for the burdens from existing debt not to increase, nominal income growth must be higher than nominal interest rates, and the higher the better (provided it is not so high that it produces unacceptable inflation and/or unacceptable currency declines).