How Countries Go Broke
In its article, “Bit by bit, the world economy’s resilience is being worn away,” The Economist notes that the U.S. ran a deficit of 7% of GDP even as the economy continued to grow. Britain’s attempt to cut benefits for the disabled ended in political failure, while French pension reforms appear similarly stalled. With each rise in fiscal burden, governments’ capacity to respond effectively to future crises becomes increasingly constrained. It is widely understood that debt burdens across the developed world are projected to grow substantially in the coming decades. The central question is: what roles can, and should the private sector, central banks, and governments play in this environment?
Ray Dalio’s book, How Countries Go Broke (March 2025), offers a timely framework for understanding and addressing these growing fiscal pressures. As multilateralism declines and unilateralism rises, Dalio argues we are witnessing the late stages of a "big debt cycle." Through historical case studies and his principles-based approach, Dalio provides a compelling lens through which to interpret today’s shifting monetary, political, and geopolitical dynamics.
A key insight Dalio offers is the distinction between GDP and government finances: while GDP is commonly used, it can be misleading. What truly matters are government revenues and expenditures. A country running a current account deficit may not be in immediate fiscal trouble; rather, it reflects inbound capital attracted to that country’s markets. However, when the need to rapidly issue debt and print money undermines that attractiveness, foreign selling of the currency and debt can become a major vulnerability.
How Countries Go Broke identifies five major forces shaping the big debt cycle: Debt, Civil War, International War, Acts of Nature, and Technology. The book traces the current cycle back to 1945, when a new monetary and geopolitical order emerged post–World War II. Drawing on decades of experience as co-founder of Bridgewater Associates, the world’s largest hedge fund, Dalio offers grounded insights into today’s economic landscape.
He points to Chapter 8, which discusses the "Overall Big Cycle," as the book’s most important. For readers interested in how markets and economies have evolved since 1945, Chapter 10 provides a concise review of the debt cycle from then to the present. Part Three of the book surveys key historical periods, 1865–1945, 1945–1971, 1971–2008, and 2008–2020, allowing readers to focus on the sections most relevant to their interests. My review of the book will highlight key takeaways, including major risk indicators, insights into the debt cycles of China and Japan, and broader observations useful for navigating today’s complex economic environment.
Interest Rates and Inflation
How Countries Go Broke underscores the crucial relationship between interest rates and inflation. When interest rates are high relative to the inflation rate, individuals and institutions are incentivized to save, as the real return on savings is positive. Conversely, when interest rates are low relative to inflation, there is a stronger incentive to borrow and to hold assets that benefit from inflation and growth—such as equities, real estate, or commodities. In such environments, debt becomes cheaper in real terms.
To stimulate economic activity, central banks typically lower interest rates below nominal GDP growth, inflation, and bond rates. However, this becomes increasingly difficult when interest rates approach zero or are already near the lower bound.
Real Bond Interest Yield
According to Dalio, the real bond interest yield—the inflation-adjusted return on risk-free government bonds—is the most important figure in the financial system. It serves as a key tool for central banks to modulate both credit availability and overall economic activity.
This yield reflects the real, inflation-free return available on wealth and serves as a guidepost for whether it's more advantageous to be a borrower (debtor) or a lender (creditor).
Policy Tools for Reducing Debt Burdens
Dalio outlines four primary levers available to policymakers when seeking to reduce high debt burdens:
Austerity – Cutting spending, which can be counterproductive because one person’s spending is another person’s income.
Debt Defaults or Restructurings – Writing down or renegotiating debt terms.
Monetary Expansion – Central banks "printing money" to buy assets or provide guarantees, which increases liquidity.
Redistribution – Transferring money and credit from those with excess to those in need, either through taxation or subsidies.
The Role of Politics
Dalio argues that when democracies fail to address internal crises, autocracies often rise in their place. This typically occurs in environments marked by widening wealth and value gaps, deteriorating economic and social conditions, and weak or fragmented leadership within representative democracies. The democratic model, which relies on compromise between opposing factions, tends to break down during periods of deep polarization. As compromise becomes impossible, political sides begin pursuing victory at all costs, undermining institutional norms and legal frameworks.
In these conditions, populist movements on both the hard right and hard left tend to gain strength, while centrist leadership becomes increasingly ineffective. When law and consensus no longer hold, financial, political, and military power become more decisive than legal authority, and authoritarian models of governance often prove more effective than fractured, democratic collectivism.
High-Level Takeaways for Investors
Avoid government bonds in periods of extreme debt monetization; their real value may erode rapidly.
Fiscal tightening paired with monetary easing is a healthy policy mix, but rarely implemented due to political constraints.
A sharp decline in private debt alongside a surge in government debt is a leading signal of financial instability.
Net selling of government debt—particularly by foreign investors—is a major red flag, signaling waning confidence.
When central banks incur large losses on bond holdings, it suggests a transition into a more advanced and fragile phase of the Big Debt Cycle.
Large social safety nets often become politically untouchable, even as they strain public finances (e.g., the U.S. and Brazil).
Countries with high debt levels, large deficits, low savings, and rapidly rising interest rates face heightened risk of debt crises or devaluation events.
Economic reform often requires transitioning to a more market-oriented system, which can be politically and socially challenging.
Debt crises are best anticipated by tracking interrelated dynamics—not by relying on a single metric like debt-to-GDP.
Debt Risk Assessment Framework
Dalio identifies the four most critical indicators to assess debt risk being:
Debt relative to income
Debt service (interest and principal payments) relative to income
Nominal interest rates relative to:
a) Inflation
b) Nominal income growth (i.e., inflation + real growth)
c) Debt and debt service relative to national savings or reserves
Common National Responses to Excessive Debt
When faced with unsustainable debt burdens, countries often resort to historically familiar strategies:
Pressure allies and institutions to purchase their debt (e.g., British historical precedent)
Freeze or seize foreign assets, particularly from adversarial nations (e.g., U.S. action against Japan in 1941 and Russia recently)
Restructure or monetize debt to reduce burdens (e.g., Germany post-1933)
Impose confiscatory taxes and capital controls to prevent capital flight
Revalue or manage government assets, including creating new forms of money (e.g., digital or sovereign alternatives)
Case Studies in Big Debt Cycles: Japan and China
Japan
Dalio traces Japan’s modernization back to the Meiji era, a period of reform that adopted Western models of education, economics, and military development. These transformations enabled Japan to rise as a major power. However, Japan’s debt cycle, as outlined by Ray Dalio, began with rapid post-WWII growth and culminated in an asset bubble in the late 1980s. When the bubble burst, the private sector entered a long deleveraging phase, leading to weak demand and stagnation. To compensate, the government increased public spending, resulting in extremely high national debt. Combined with demographic decline and an aging population, Japan has faced decades of low growth and deflation. Today, Japan’s per capita GDP is significantly lower than the U.S., and its declining economic standing abroad reflects the long-term impact of this debt cycle.
China
Dalio presents China as a more recent example of a nation that transformed itself through market reforms and open-door policies. China’s strategy of leveraging low-cost labor and productivity gains allowed it to supply the world with competitively priced goods. Much of the income from exports was recycled into U.S. debt, creating a symbiotic—though increasingly fraught—relationship with the American economy.
As China’s wealth and geopolitical influence have expanded, so too have its internal wealth disparities and international tensions. Dalio warns that without a “beautiful deleveraging,” China’s debt mostly held domestically and denominated in yuan could become a long-term drag on growth. However, China's monetary sovereignty gives its policymakers tools to manage the situation, provided they act decisively.
Long-Term Fiscal Risks: A Point of No Return?
Dalio issues a stark warning: the long-term risk of U.S. government debt is “very high.” Current and projected levels of debt, debt service costs, and refinancing needs are historically unprecedented. If these trends continue, they risk triggering a self-reinforcing “debt death spiral,” where borrowing to service existing debt drives interest rates higher, further undermining investor confidence.
In contrast, Dalio sees short-term risks as moderate, given relatively stable inflation, modest growth, low credit spreads, and manageable real interest rates. Moreover, the private sector’s financial position is relatively strong, providing a potential tax base to stabilize public finances if necessary.
Dalio’s “3% Solution” and Fiscal Reform
The U.S. is currently running a fiscal deficit of 7% of GDP. Dalio proposes reducing it to 3% through a combination of:
Spending cuts
Tax increases
Interest rate reductions (the most impactful lever)
He highlights the 1993–1998 period, when the U.S. moved from a 4% deficit to a 1% surplus, as a successful precedent. In today’s terms, that would equate to trimming the deficit by approximately $1.5 trillion.
Dalio emphasizes two key points:
The Federal Reserve, not Congress, has the largest influence on deficits via its control of interest rates.
While both fiscal and monetary tightening help reduce deficits, they have opposing effects on growth, inflation, and tax revenues. Balancing them carefully can reduce the deficit without destabilizing the economy.
He cautions that if Congress fails to reach a debt limit agreement, it will reflect a breakdown in reason and compromise, not a lack of viable solutions. The electorate, he argues, should hold leaders accountable for fiscal inaction.
Looking Ahead: Big Risks and Bigger Unknowns
In the book’s final chapter, Dalio outlines his vision for the future, identifying several core challenges and opportunities:
Despite public sector stimulus and wealth transfers, income inequality continues to rise. The bottom 60% of Americans remain in a precarious position, while the top 1%—highly educated and invested—benefit disproportionately from asset and productivity booms.
Unpredictable geopolitical realignments are likely. Dalio suggests that U.S.-Russia or Europe-China alignments, while once unimaginable, may emerge given the fluidity of current power dynamics and the fragility of existing alliances.
Technological innovation from AI, robotics, and biotech to quantum computing may offset some of the negative forces in the Big Cycle, just as the steam engine and electricity once did during previous periods of global upheaval.
Final Thought: Human Nature and Cooperation
Dalio concludes with a critical insight: the most powerful variable is how people deal with one another. Societies that choose cooperation over conflict, especially during crises, achieve the best outcomes. While technology has advanced, human nature remains largely unchanged, making widespread collaboration difficult.
Ultimately, the countries that will thrive are those that:
Educate their people well,
Spend within their means,
Maintain internal order, and
Adapt well to technological and geopolitical changes.
As Dalio puts it, "having great human capital will matter most." How Countries Go Broke is both a cautionary tale and a call for capable leadership, reasoned compromise, and informed policymaking in an era of accelerating uncertainty.
