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Hedge fund titan Ray Dalio has witnessed and maneuvered his way through many economic, credit and leverage implosions, including  stagflation, the dot-com collapse and the Great Recession. To grasp the mechanics of financial crises, Dalio expands his timeline to examine the underpinnings of downturns dating back to the Roman Empire. His comprehensive research makes for a dense, technical read, but Dalio offers executives and investors a lens through which to identify economic calamities, as well as a roadmap for steering through the tumult.

Credit and debt are two sides of the same coin.

Hedge fund titan Ray Dalio begins with the basics: A lender extends purchasing power to a beneficiary through a loan, and the beneficiary is obligated to repay that debt. Stakeholders, the author maintains, must realize that there is always some percentage of debt that will default; their ability to mitigate these losses through time or portfolio diversification is critical. In any economic cycle, the act of borrowing sets in motion both the expansionary phase of an economic cycle and its contractionary phase. A contractionary period includes, Dalio makes clear, financial losses for lenders from borrower defaults, as well as a slowdown in economic activity throughout both the national and global financial ecosystem.

While credit and debt crises each present unique qualities, in the aggregate, a commonality persists. Dalio’s review of some 48 historical financial downturns – each denoted by a GDP drop of more than 3% – offers a variety of fascinating insights. A debt implosion often begins when payments required on existing obligations exceed the income streams needed for that repayment. Central bankers can alleviate some of the debt burden by reducing interest rates, but this only provides stimulative effects for so long. When interest rates reach zero, central bankers retain little ammunition, and a painful deleveraging process commences.

About the Author

Ray Dalio is the founder, co-chief investment officer and co-chairman of Bridgewater Associates.

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