Ray Dalio is one of the brightest minds of our time, someone whose insights I follow closely. His decades of experience have given him a deep reservoir of knowledge, which I continually draw upon for learning and personal growth.
While checking my client emails, I came across a long article from him, well worth reading for any serious student of the markets.
Here is a section:
The debt dynamics work the same for a government as they do for a person or a company, except that the central government has a central bank that can print money (which devalues it) and it can take money away from people via taxes. For these reasons, if you can imagine how the debt dynamics would work for you or a business you run if you could print money or get money from people by taxing them, you can understand the dynamic. Keep in mind that your goal is to make the overall system run well, not just for yourself, but for all citizens.
To me, the credit/market system is like the circulatory system, bringing nutrients to all parts of the body that make up our markets and economy. If credit is used effectively, it creates productivity and income that can pay back the debt and interest on the debt, which is healthy.
However, if it is not used well so it does not produce enough income to pay back the debt and the interest on the debt, debt service will build up like plaque that squeezes out other spending. When debt service payments become very large, that creates a debt service problem and eventually a debt rollover problem as holders of the debt do not want to roll it over and want to sell it.
Naturally that creates a shortage of demand for debt instruments like bonds and the selling of them, and naturally when there is a shortage of demand relative to supply that either leads to a) interest rates rising, which drives markets and the economy lower, or b) the central banks “printing money” and buying debt which lowers the value of money which raises inflation from what it would have been.
Printing money also artificially lowers interest rates, which hurts the lenders’ returns. Neither approach is good. When interest rates rise because the selling of debt becomes too large to curtail and the central bank has bought a lot of bonds, the central bank loses money, which hurts its cash flow. If this continues, it leads the central bank to having a negative net worth.
When this becomes severe, both the central government and the central bank borrow to make debt service payments, the central bank prints money to provide the lending because the free-market demand is inadequate, and a self-reinforcing debt/money printing/ inflation spiral ensues.