Ray Dalio Explains How the U.S. Economic Crisis is Unfolding.

So in either case, we're going to have a debt problem, and the question is how quickly does it evolve.

Uh, in the way that I described, world-famous investor Ray Dalio has been back in the news lately discussing his thoughts on the monster US debt problem and the 2023 recession. Unfortunately, spoiler alert, the news wasn't as rosy as what we were all hoping for. With many now breathing a sigh of relief that the US debt ceiling got suspended, Ray is quick to point out that, well, unfortunately, this only makes the underlying issue worse.

These three forces are the biggest in our lifetime. You just touched on one: the largest amount of debt offerings and monetization of debt.

What is money worth? What is the supply-demand? So, what's the deal? Well, because the US has spent more than they've earned for a very long time, they've had to finance this spending by selling lots and lots of bonds, aka the government handing out IOUs to investors. The annual deficit means the more they have to borrow to survive.

But now the US has $32 trillion of debt, and they've recently kicked the can even further down the road by suspending the debt ceiling until 2025. But the longer the government stays in deficit, the closer they get to a full-blown debt crisis because the debt does need to be paid back.

We just passed a debt ceiling deal; there was a big sigh of relief on Wall Street about that, and we're going to get a lot of Treasury issuance. There are some concerns about liquidity issues and whether that's going to come out of bank reserves. But you're thinking much bigger about what we're facing as a country in debt, right?

Let's look at the mechanics of it a little bit. The economics of a country are no different than the economics of an individual or a company in that you can't spend more than you earn without getting into debt. If you have debt, you have to pay back the debt. The only difference is you can print the money. That's it, which we do, which we do.

So the question is, does this have an end, or is there no end to that? Is there a Day of Reckoning?

Okay, there are two things that end this. First, the debt service payments to those who are holding the debt, who need it for reward; they want to get paid back plus an interest rate. So you have to have those debt service payments. Those debt service payments increasingly encroach on your spending. In other words, either this thing compounds, and that means somebody's wanting to buy all that debt, but you have to pay back in one way or another.

When that happens, it encroaches on other spending. Here, Ray explains the obvious point that the more debt you take on, the more you have to pay back at some point in the future.

Now, back a few years ago, when interest rates were very low, the government didn't have to pay back much interest to the bondholders. But now, obviously, interest rates are a lot higher. So fresh debt being issued by the government now is going to be a lot more expensive to service than the debt sold a few years back.

And here's Ray's point: going into debt can work in your favor. It works in your favor if the money you get upfront can help you grow your income by more than the cost of the debt. If a business takes on a loan to build a new store, they're betting that the cost of taking on the debt will be more than accounted for by the new store bringing in lots more money when it opens.

However, debt can be detrimental if the opposite happens. If you take on the debt and are unable to raise your income enough to at least cover the cost of that debt, then that means you're in a worse situation than when you started.

And as it goes with companies, when this happens, usually the solution is to take on another bigger batch of debt to pay for the old one. This can cause a negative spiral in two ways: because either the debt pile increases at an ever-expanding rate, and also, as Ray Dalio says, the more debt you have, the bigger the interest payments, which start eating away at the total pool of money you've got to spend, aka you have less and less cash to play with to actually grow your economy.

What Ray's questioning in that last clip is whether the US actually has the capability to compound their economy fast enough to make the debt worthwhile at current interest rates. It's a tricky topic to understand, especially if you've never learned about economics.

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But back to Ray Dalio's explanation. So yes, the struggle of debt servicing is one big potential cause of a full-blown debt crisis in the United States. But beyond that, there's another big problem looming that doesn't get spoken about as much.

So that's debt service as one, and the other big one is the supply-demand balance issue. In other words, when it happens that people don't want to buy enough debt that needs to be sold, you have a bigger crisis: a debt rollover question. If there aren't enough buyers of US Treasuries when the time comes to roll over the debt, then, well, who has to save the day? It's the Federal Reserve.

They will need to print money to buy the surplus government bonds, which will further devalue the US dollar. So let's say, as we're now going to issue another huge amount of debt, and the owners of that debt—there are a lot of owners of that debt—who own too much of it. In fact, the main problem that's existing today is with banks and with other governments, and others is they own too many Treasuries that are losing money.

This is exactly what we saw happen with Silicon Valley Bank, for example. They became too dependent on US Treasuries, and as interest rates went up, the value of those bonds fell, and they had to recognize losses from these bonds that eventually collapsed the bank.

But it's not just companies that are suffering from unrealized losses on US government debt; countries are too. Japan, China, the UK—they are all major holders of US Treasury bonds.

But Ray's point is that if the US continues to spend, spend, spend, and offers a boatload of Treasuries moving forward, we could face a problem where there's simply not enough buyers out there for US debt, especially if countries deem their balance sheets are already too loaded up with US Treasuries.

So this would increase the supply, but it would also reduce the demand. And if that happens, as Ray is about to explain, you know, we've got a bit of a problem. Silicon Valley Bank losses and so on and the banking system's losses are largely due, including the central banks' losses, the reserves losses are largely due to holding bonds that have gone down in value, therefore lost money, and funding it with an interest rate that's too high.

So that dynamic is very, very risky. What Ray's referring to here is the problem banks around the world are currently facing. A few years ago, they got a billion dollars' worth of customer deposits; they give the customer 0.5% in their savings accounts, and they would simply buy long-term government bonds, perhaps yielding 1%.

It sounds great because they'd then get to pocket the difference. The problem now is that with interest rates a lot higher, the interest that banks are paying out to depositors has risen quite a lot, but they're only ever going to get 1% on those bonds each year until maturity, aka the bank is now taking a loss.

The annoying thing for the bank is they're kind of trapped in this situation because the value of those original bonds in the open market has fallen so much that they don't want to sell them either. It's unsustainable.

And the question is when it's made more unsustainable by certain things in geopolitics. For example, China doesn't want to hold as much of our debt; maybe that's one. Other countries, too, are increasingly feeling worried about sanctions.

In other words, could they be sanctioned? These types of things can affect the demand for the bonds. If you get them to sell the bonds, then it's a real problem.

So what Ray is saying is that geopolitical tensions between the US and other countries around the world, particularly China, could add to the problem. China has already been looking to reduce their purchases of US Treasuries.

Ray raises another point that if a country is worried about, say, sanctions from the US, they will try and reduce their involvement with US dollars. With the Russia-Ukraine war, we saw the US impose widespread sanctions on Russia, which effectively cut off Russia's central bank, sovereign wealth fund, banks, and certain individuals from entering into US dollar transactions.

Other countries fearing sanctions from the US might move away from US debt in the future. So this further adds questions to the demand problem for US Treasuries.

As if there isn't demand, as Ray's about to explain, you either have to crank up interest rates to make the bonds look more attractive, or the Federal Reserve will have to step in and buy them. Then we've got the same situation that we've seen over the last couple of years.

If you get them to sell the bonds, then it's a real problem because that means either interest rates go up a lot or central banks have to come in and print a lot. And that's the thing that we have to be wary of.

So in either case, we're going to have a debt problem, and the question is how quickly it evolves in the way that I described. Debt service payments or rollovers—so they're the two big issues that Ray currently sees that could lead to a big US debt crisis.

Either the US struggles with servicing the interest payments, or Ray sees a world where the US struggles to find buyers, and the Federal Reserve will have to print a lot of money to save the day yet again, which could trigger even more inflation.

And that's why, unfortunately, Ray simply doesn't see interest rates coming down anytime soon. One of the big raging questions is our long-term interest rates. For this purpose, I guess I mean really real interest rates. Are they going to remain elevated, or do you think they'll come back down?

Okay, so the level of interest rates is that you have to satisfy a debtor and a creditor, and so that means interest rates have to be high enough that the creditor gets a real return higher than their money. If you don't do that, you create the cycle that we had before where money is essentially free.

Interest rates are even then; the supply-demand is not adequate. There's not enough demand to buy those bonds, and so the Federal Reserve's got to come in there and print money and buy those bonds and redistribute wealth.

So there's no doubt the US faces a big debt problem. The question now is whether it gets resolved or continues to balloon into a full-on debt crisis.

So let me know your thoughts down below. Please like the video and subscribe if you did enjoy it. But guys, with that said, I'll see you all in the next video.