Worthy Of Investor Attention: The Long-Term Debt Cycle

by: John M. Mason


Ray Dalio of the hedge fund Bridgewater Associates has called our attention to something called the debt supercycle or the long-term debt cycle, which he contends is ending.

In this longer-term cycle, spending is financed by money and debt until a limit is reached in which interest rates are very low and risk premia are tiny.

At such times, central bank policy becomes ineffective and further debt increases cannot really finance real spending, a state Mr. Dalio sees the United States and the world.

In such a situation, central banks cannot just operate to bring back "normal" financial conditions again.

I have written recently about "Why Is Economic Growth So Slow?" This post focused upon the longer-term factors that are influencing economic growth in the United States and in the world and why it might be the case that the future of performance might be slower than was exhibited in much of the twentieth century.

Now, Ray Dalio, founder and head of Bridgewater Associates, LP, has brought to our attention another phenomenon that investors should pay attention to.

He labels this factor "the debt supercycle," or "the long-term debt cycle."

Bridgewater Associates focuses upon global macro investing, so the emphasis there is upon trends in inflation, currency, economic growth and other macro-factors that might create opportunities to take advantage of dislocations in economies that need to adjust.

The debt supercycle can create investment opportunities resulting from global weaknesses and deflationary pressures.

Within the current debt supercycle, Mr. Dalio contends that the world is facing such a disequilibrium in which the Federal Reserve stands at the center. Because the United States economy appears to be out-of-sync with much of the rest of the world and the Federal Reserve is the most important central bank in the world and the US dollar is the most important currency in the world, and "because the risks are asymmetric on the downside" a real dilemma exists for Federal Reserve policymakers.

Consequently, a real investment opportunity exists for others.

The debt supercycle, Mr. Dalio contends, lasts from 50 to 75 years.

The debt supercycle is created by spending growth that is financed by debt and money…something I have referred to over the past decade as credit inflation.

The argument is that "there are limits to spending growth financed by a combination of debt and money. When these limits are reached, it marks the end of the upward phase of the long-term cycle."

When these limits are reached the "world's reserve currency central banks" find that their ability to continue to stimulate continued spending is seriously reduced because "interest cannot be lowered and risk premia are too low to have quantitative easing effective."

Furthermore, at such times, "debt and debt service costs are high in relation to income, so that debt levels cannot be increased without reducing spending." And, of course, if spending decreases, economic growth also softens.

"At such times the risks are asymmetric on the downside…."

Therefore, central banks, the Federal Reserve in this case, cannot just assume that the short-run business cycle is on the upswing and begin to raise interest rates.

In fact, raising rates under such a condition can only ultimately have bad results.

So, we have longer-term constraints upon economic growth keeping economies throughout the world from expanding more robustly and we have longer-term debt issues that must be worked off before central banks can become effective again.

Not a pretty picture.

But, if you are a global macro investor you look for the dislocations that can make you a lot of money. That is what hedge funds like Bridgewater Associates, LP, do.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.