A Template for Understanding Big Debt Crises

by Ray Dalio

If a currency falls in relation to another currency at a rate that is greater than the currency’s interest rate, the holder of the debt in the weakening currency will lose money. If investors expect that weakness to continue without being compensated with higher interest rates, a dangerous currency dynamic will develop. That last dynamic, i.e., the currency dynamic, is what produces inflationary depressions. Holders of debt denominated in the poorly returning currency are motivated to sell it and move their assets into another currency or a non-currency store hold of wealth like gold. When there is a debt crisis and economic weakness in a country, it is typically impossible for the central bank to raise interest rates enough to compensate for the currency weakness, so the money leaves that country and currency for safer countries. When so much money leaves the country that lending dries up, the central bank is faced with the choice of letting the credit markets tighten or printing money, which produces a lot of