The earliest known occurrences of sovereign states defaulting on their debts are the Greek city states in the 4th century BC. Cities such as Rhodes and Byzantion refused to pay tributes to Athens. The consequences stretched beyond economics to the decline of Athenian power.
A recent example of Greek creditworthiness is their recovery from the debt crisis. Their government bonds are now performing at historically positive levels due to the extraordinary improvement in their public finances.
These are all reminders that confidence in the debt of a country reflects the performance of their economy and a confidence in future prospects.
However, it is not just a passive indicator. It also contributes to economic growth or decline. Low interest rates make government borrowing affordable.
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This funds investment. Alternatively, high rates of interest can cause big problems.
Ray Dalio is a famous founder of one of the most successful hedge funds in the world. He is now imparting his economic wisdom through a sequence of books.
The latest, How Countries Go Broke, is an immense reflection on the causes of the loss and recovery of national creditworthiness. While occasionally technical, this is an analysis of the epic trends of history: why countries rise and fall.
It explains the importance of short- and long-term debt cycles and how governments and central banks respond to their development.
Short-term cycles last for approximately six years. Central banks create additional credit to revive a flagging economy. Rising inflation causes a change in policy that results in lower growth and higher debt.
The author is precise in his analysis of economic history. With some authority, he concludes that the United States has experienced 12 complete short-term debt cycles and has completed two-thirds of the 13th cycle.
A longer debt cycle is the gradual build-up of indebtedness due to the accumulation of shorter-term cycles. This eventually leads to efforts to make debt more sustainable. Dalio writes that this creates a “period of big market and economic turbulence”.
The gradual interplay between short- and long-term dynamics creates the Big Cycle. Over a longer time period, changes in productivity and the impact of this long-term debt cycle will shape the rise and fall of economies.
Five important factors influence the Big Cycle. They include the operation of the normal economic cycle, acts of nature and the impact of human creativity through the development of new technologies.
The author acknowledges the role of political and social decisions in causing the cycle. Changes in the order of societies have repercussions for the performance of economies. This occurs when “those who don’t run the existing order acquire more power than those who do and want to change it”.
Dalio examines 180 years of economic history through this framework. He concludes that two full cycles have been completed in the US and within the wider global economy.
The decision by president Nixon, on August 15th, 1971, to cease the conversion link between the dollar and gold was a seminal economic moment. It increased the ability of central banks to create money and credit.
Authorities were now able to “more freely create money and credit than in the past ... and this affects all mediums of exchange and storeholds of wealth”.
The consequences of these changes for China and Japan are examined. These chapters are full of insights. The changes in the living standards of Japanese workers and the growth of debt in China are just some examples of this analysis.
This book also lucidly explains how central banks and governments co-ordinated their policies to support economies during the pandemic.
The explanation of his Big Cycle framework and the validation of it through economic history sets the stage for the most interesting part of the book. The concluding chapters look to the future, and paint a bleak picture of volatility.
Conclusions are grim. Dalio writes that “the current configuration of conditions is most analogous with those that existed in 1905-14 and 1933-38″. He forecasts major debt difficulties and is very pessimistic about the future of international co-operation.
One hope is the benefits that technology will create. The best recipe for national success, in this harsh scenario, is to keep debt under control and invest in people.
This work understates the importance of growth as an ingredient in the elixir that infuses the ebb and rise of economies. It also underestimates the political difficulty of the most important economic decisions.
How Countries Go Broke is oddly thrilling and extremely relevant, full of wisdom, mostly expected and all forensically explained. Dalio cautions of the need to look for signals amid the intense noise of the everyday.
It explains his huge success as an investor but, more importantly, offers policies for economic safety and security as our world rapidly changes. These recipes apply both to the individual investor and to a country.
Paschal Donohoe is the Minister for Finance and president of the Eurogroup
