The Phases of the Classic Deflationary Debt Cycle

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by Annapurna__

I’ve started to read The Principles for Navigating Big Debt Crises by Ray Dalio (You can download here: and I found the part about the phases of the classic deflationary debt cycle a very good read for the present times (Pages 16-38 on the book).

Here are my notes on the section:

As of today, we have already gone through the early part of the cycle (2009-2020), the bubble (we skipped this part in my opinion), and the top (Jan-March 2020). We are currently on the depression portion of the cycle (Which started in mid-march for the US)

The Top did not occur due to typical market forces (interest rates rising), it occurred due to an external force (COVID-19) completely stopping spending on it’s tracks (This has never happened before).

The cut in interest rates to 0 on March 15 did little to 1. Produce a positive wealth effect, 2. Stimulate economic activity and 3. Ease debt-service burdens.

The onset of the depression immediately revealed cash-flow problems, which the fed eased by announcing infinite QE and the US govt eased with their first two stimulus bills. Both measures where announced and implemented throughout the last three weeks of March (fiscal policy at a slower pace than monetary policy)

According to Dalio, the policies that reduce debt burdens are the following:

  1. Austerity – Although this policy was not enacted, it’s happening naturally. With 3 Billion people locked at home at it’s peak, we are forced to not spend as much as before.
  2. Debt defaults/restructuring – Also happening, at a slower pace than I expected.
  3. Debt Monetization / Printing – Quickly enacted through QE
  4. Wealth Transfers – Not happening yet, although important voices are already signalling that it better be coming (Larry Fink)

The most ideal way out of a deflationary depression is to a ‘Beautiful Deleveraging’ – aka when the 4 policies above move in a harmonious way where growth grows at a faster pace than debt without inflation spiraling out of control.

We are not even close to a beautiful deleveraging since income is decreasing at the moment while debt is increasing.

Important point from page 32: “People ask if printing money will raise inflation. It won’t if it offsets falling credit and the deflationary forces are balanced with this inflationary force.”

According to Dalio’s table about well managed beautiful deleveraging on page 35, Both The Federal Reserve and the US Government have done a great job by acting quickly. However that doesn’t change the fact that spending is not being stimulated, again because of an external force.

At this point in time (And it’s worth noting, Powell mentioned a variation of this today in his 9:00am video interview), The Federal Reserve is basically out of tools to get businesses and consumers to spend again. It is pretty much out of his scope.

Monetary Policies Enacted:

MP1 – Interest Rate driven: Enacted on March 4 and March 15

MP2 – QE: Enacted from March 8 to March 23

MP3 – Putting money directly in the hands of spenders: Ongoing, but again, hard to incentivize people to spend.


I do believe we are in the depression face of a deflationary debt cycle. The Federal Reserve has done a great job through Monetary Policy so far, and the US Government has done a good job through Fiscal Policy so far. However both are running out of tools in order to solve the last piece of the puzzle: Get business and consumer to SPEND. That lands entirely on the US Government’s Public Health Policy.


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