Ray Dalio’s Warning: America is Headed Towards an Economic “Crisis”

We in a debt crisis, or are we headed for one? Um, we are at the… in my opinion, we are at the beginning of a billionaire investor Ray Dalio is warning about a $34 trillion debt-fueled tsunami that is about to strike the US economy. With each passing second, the storm is getting larger and larger, making it even more painful when it finally does hit, the fallout of which will likely be felt for generations.

Listen to Dalio explain: "Are we in a debt crisis, or are we headed for one? Um, we are at the… in my opinion, we are at the beginning of a very classic late cycle, late big cycle debt crisis. When the supply-demand gap… when you're producing too, too much debt, and you have also a shortage of buyers. What's happening now, as we have to sell all this debt, is we then have to have enough buyers. There are changes now in terms of the quantities in the world that are being held by large investors around the world that have lost money in these treasury bonds and so on. And then there are geopolitical changes which are having an effect. In some cases, some countries are worried about sanctions, and then there's this geopolitical shift."

So when I look at the supply-demand issue, there's a supply-demand issue for that debt. There's a lot of debt that has to be bought; it has to have a high enough interest rate. So a crisis, that's, you know, if we continue down this path in terms of what's likely over the next, you know, five and ten years, then you reach the point that that balancing act becomes very difficult.

How will we know? And is it really a function of not having enough buyers for the federal debt? Is there any evidence of that so far? Um, we’re right at the brink of starting to find out that the amount of selling of government debt collapsed. Right? We didn't issue government debt, and now we're going to issue a lot of government debt. So when one looks at… when we look at the buyers, there appears to be a significant shortage of buyers for that government debt. But we're now at the brink of being able to see what that supply-demand picture looks like as we go over the next year and two.

With each passing second, the US national debt grows, adding fuel to the potential debt crisis Dalio mentioned. In that clip, however, until relatively recently, this hasn't mattered much. But according to Ray Dalio, things are now finally starting to change, and here's why.

For the better part of the last 100 years, US government bonds have been considered by many the safest investment in the entire world. The US economy is absolutely massive, and the country is home to many of the largest companies on the planet. This dynamic provided protection in the eyes of investors, the thought being that if you lent money to the US government, you didn't have to worry about whether or not you were going to get paid back. As the taxing authority of the world's largest economy, if the US government ever ran into trouble, it could simply raise taxes and use that money to pay back borrowers.

Because of this, US government bonds have been viewed by investors and the finance community as the only truly “risk-free” investment that exists. This commonly accepted belief has led to US government bonds being extremely popular investments for everyone from individual investors to pension funds to banks and even other countries. The supply of investor money wanting to purchase government bonds has consistently exceeded how much money the government has needed to borrow. As a result, borrowing money has always been relatively cheap for the US government.

However, that dynamic may finally be starting to change, the ripple effects of which could be felt throughout the world. Let me explain. The cost for the US government to borrow money is determined by the laws of supply and demand. This concept can be easily explained with this graph here. On this line, we have the supply of money willing and able to be lent to the US government; think of this as the amount of money individuals, corporations, and countries are willing to let the US government borrow.

The willingness of investors to lend money to the government can change due to everything from the health of the economy to geopolitical issues and everything in between. This line here represents demand from the US government to borrow money; think of this as the amount of money the government needs to borrow to pay its obligations. The point at which our two lines cross represents the cost for the US government to borrow money. Just like other loans, that is expressed in an interest rate.

So, the higher the interest rate, the more expensive it is to borrow money, as the borrower will be paying more each year in interest. On the other hand, the lower the interest rate, the cheaper it is to borrow money, as the borrower will be paying less interest on that loan. What I'm about to say gets to the core of Dalio's warning, and it is super important. The US national debt is currently at a whopping $34 trillion and is getting larger by the day. This is up from $22 trillion in 2019 and from roughly $5 trillion in national debt back in the year 2000.

As Dalio explained, the US is heading towards a tipping point. The national debt has grown so large that there is a real possibility that there is more government debt outstanding than the money available from investors to buy it. If this turns out to be true, the consequences will likely be dire. Here's how. Going back to our supply and demand graph, let's shift our demand line up and see what happens. Moving our demand line up represents the US government needing more money to cover its ever-growing debt.

Notice how now, the two lines cross at a higher interest rate. If government debt grows while the supply of money available from investors remains the same, the US government will be forced to pay a higher interest rate to borrow money. Let's push our demand line even further up. As you can see, the two lines cross now at an even higher interest rate. Higher borrowing costs for the US government would be extremely painful for the country and its citizens, given the massive amount of national debt the country has.

Here's a thought experiment for you to demonstrate what I mean. As mentioned earlier in the video, the US national debt is roughly $34 trillion. If we assume a 2% annual interest rate on that debt, that means the US government has to pay $680 billion in interest each and every year just to stay current on its debt. This is easily calculated by taking the debt outstanding and multiplying it by the interest rate. For reference, in 2023, the US government had an annual budget of $6.13 trillion to cover all of its spending for the year. This spending includes things such as social programs, education, healthcare, the military; the list goes on and on, but you get the point.

In our example here, the $680 billion annual interest on the national debt makes up roughly 11% of the entire annual budget. That means that 11% of the annual budget is spent not on providing services and resources to citizens, but instead just paying interest on debt the country incurred in the past. You are able to see how this can create what is referred to by Dalio as a debt spiral. Let's see what happens when interest rates increase. Let's take the interest rate on the debt up to 6%. That annual interest expense jumps up to roughly $2 trillion. Now, the annual interest expense on the national debt makes up 33% of the entire national budget.

Let's take things up one step further and bump the interest rate up to 10%. That annual interest expense skyrockets all the way to a whopping $3.4 trillion. This annual interest expense would take up a staggering 55% of the entire federal government’s current annual budget. You can see now why Dalio is referring to this as a crisis. While this is of course just an example, according to Dalio, it is a likely outcome unless some significant changes are made.

However, Dalio doesn't seem too optimistic about what's to come. Listen to him explain: "Given the challenges that we face, the fiscal challenges that you describe, we need a political process that will help us get out of it. Do we have that? As goes to the second issue that you always deal with, which is internal conflict. Well, the things that you see happen over and over again when you look at history is when you have a financial, not good situation at the same time as you have large wealth gaps, you start to see the emergence of populism. And we see extremism in both of the political parties.

Okay, we see that split. A populist is an individual or a leader or a political person who will win at all costs, that the rules of the game don't matter as much. The political system, in terms of primaries and the parties, tends to create that sort of polarity. I think it's very clear that there is only one good outcome, if we can, and that's a strong bipartisan middle because either of the extremes is not going to be able to be dominant—the small right or even the small left. And as a result, we're seeing a fragmentation geographically. You're seeing people move to different areas not just because of taxes, but of differences in values and so on.

And so you're seeing this separation. I think over the next two years, the real question is can we maintain… can we have a strong bipartisan middle, or are we going to have that kind of fragmentation? We have three things aligning that are concerning on this short-term debt cycle. I call it, you know, the seven-year cycle. We're about halfway through. In other words, interest rates are now at a level that they're probably going to stay at, but they're probably not going to rise much from here. And there's tightness, and the consequences of that are going to be a weaker economy going forward.

It doesn't have to be a big downturn because of the household sector, but it is a balance sheet kind of recession. I think you're going to see things get worse in the economy. There's a financial issue at the same time as you have this internal conflict, so I think that that's going to make for a risky situation."

As the interest expense required for the US government to service its debt increases, the government is left with two basic options. First, it can cut back spending dramatically, cutting things such as spending on military, social security, healthcare, and education. The second option would be to significantly raise taxes. Both of these options would understandably be extremely unpopular with citizens.

Additionally, the negative economic shockwaves from drastic government spending cuts or higher taxes would be severe. It's estimated that government spending accounts for 37% of the United States economy as measured by GDP. Additionally, a rapid increase in the federal tax rate would leave less money in the hands of individuals and businesses to spend. While all this may sound scary, there's actually a ray of hope—a way the United States could avoid a debt crisis.

For this, we have to look at history. As Dalio says, it's important to study history because the past can teach us a lot about the present and what can happen in the future. This chart here shows the size of the US national debt relative to the size of the economy. To find a time when the US faced similar challenges relating to its debt, you have to go all the way back to the World War III period of the 1940s. As we can see in this chart, the cost of financing the military pushed the debt up sharply from around 40% of GDP before the war to a peak of nearly 110% of GDP.

As the war ended, the US was able to avoid a complete financial and economic crisis. In fact, the post-war period was one of the most prosperous times in American history. So how exactly was the United States able to dig itself out of this massive hole? Two words: economic growth. Yes, the US government did exhibit remarkable financial constraint in the post-war period; however, arguably even more important, the US economy grew itself out of the problem.

You see, a country's debt only really becomes a problem when it grows too large relative to the size of the country. That is why a popular metric to measure the severity of a country's national debt is the public debt to GDP ratio. This simple ratio is calculated by taking a country's government debt outstanding and dividing it by the size of the country's economy, measured by GDP. The higher the ratio, the worse situation a country is potentially in.

Look at the United States: the current size of its national debt is roughly $34 trillion. The size of its economy is $27.6 trillion as of the most recent reading. This gives the US a public debt to GDP ratio of a staggering 123%, a higher reading than any time period in the history of the country. One option to get this number down would be to sharply reduce national debt. As mentioned earlier, this would be incredibly painful for the economy.

Additionally, with a drastic reduction in government spending, any benefit from the reduction in national debt could also be offset by the economy shrinking, ultimately resulting in no true reduction on the debt burden. The better alternative, and what happened after World War II, would be if national debt stopped growing and the US economy would “grow into” its debt. Look at how the numbers would work.

Let's say over the next five years the US economy wants to grow from its roughly $28 trillion current size to $34 trillion. That would bring the public debt to GDP ratio down to 100%. If another five years pass and the economy grows to $40 trillion and national debt remains the same, that ratio falls further to 85%. If we jump forward an additional ten years and the US economy is now $50 trillion, this ratio would have come all the way down to 68%. Still elevated by historical standards, but more on par with levels last seen in the mid-1990s.

In the end, only time will tell how all of this will play out. However, I do think it's definitely worth paying attention to what Dalio has to say, given his impressive track record. I think it's fair to say he knows a thing or two about what he's talking about. So, there we have it! Make sure to subscribe to the channel because it's my goal to make you a better investor by studying the world's greatest investors. Talk to you again soon!