Question

Explain each of Dalio’s four ways of dealing with the debt burden. Next to each method state whether it is deflationary or inflationary, then describe what how each method attempts to deal with the debt burden.

Answer 1

Dalio in his writeup has correctly indicated that managing debt is a tough task for any country and that debt can become too much of a hassle for countries in Asia. He primarily laid stress on countries such as India which have very high exposure to international and domestic debt alike. He gave four primary methods to reduce debt and bring back the economy to life.

These are as follows: -

(1) Austerity

Austerity is a simple measure which reduces debt by reducing the expenses of any government. For example, if a country is going through debt, then austerity measures simply refer to those, whereby we reduce our expenditure and will be able to deal with our problems in a better manner. The reduced expense can go towards debt repayment.

This however is a deflationary method as one person’s expense is another person’s income. If you reduce expenses income also reduces.

(2) Bankruptcy and Debt Restructuring

Another method which he stated was to restructure debts and declare bankruptcy. This is aimed towards declaring some loans which a country or firm may not be able to pay as bad and non-recoverable. This again creates a deflation in the economy because debts are tied to assets. A debt for one is an asset for another person. If you reduce the debt, the asset also gets reduced, thus causing deflation in the economy.

(3) Printing Financial Assets: -

Printing of currency is another way in which some countries deem paying of debt. However, this leads to inflation. When you print currency, even though you may be able to pay off debts easily for a period of time, however the value of our currency reduces and we are able to buy lesser products and services despite having large denominations.

(4) Transfer of Money/Aggressive Taxation: -

Another technique suggested is to increase taxes on wealthy and redistribute this to those who need to pay off debts. This again causes deflation as the wealthy find it difficult to reinvest their money and end up paying a lot of money to the government and prefer not to do business in these countries.

In the theory he further suggests to maintain an equilibrium of the above mentioned 4 ways or methods.

Please feel free to ask your doubts in the comments section if any.