US debt hits danger zone: Ray Dalio explains why a ‘Big Debt Cycle’ could trigger a crisis

The US economy may be approaching a dangerous point in its long-running debt cycle, according to billionaire investor Ray Dalio, who says a combination of rising debt, weakening demand for US government bonds and higher long-term borrowing costs is beginning to resemble the pattern he has studied across past debt crises.

In a detailed post on X (formally twitter), the Bridgewater Associates founder said recent developments, including Japan selling some US Treasury holdings, rising US bond yields alongside dollar weakness, and the US Treasury’s decision to buy bonds are consistent with the debt dynamics.

Debt problem in simple terms  

Dalio compares the credit system to the human circulatory system. Debt can support economic growth when it finances productive activity that generates enough income to repay principal and interest. But when borrowing rises faster than the ability to service it, debt payments begin to crowd out other spending.

Eventually, creditors may become less willing to buy or roll over government debt. That creates a gap between the supply of bonds governments need to sell and the demand for them.

At that point, Dalio sees two broad choices: allow interest rates to rise to attract buyers, potentially damaging markets and economic activity, or have the central bank create money and purchase government debt. The latter can weaken the currency and increase inflationary pressure.

He identifies three indicators investors should watch closely: government debt service relative to government revenue; the amount of government debt being sold relative to demand; and the extent to which central banks create money to purchase government debt.

Warning sign: long-term yields & a weaker dollar

Dalio's numbers paint a stark picture. He estimates US government revenue at around $5.5 trillion against expenses of approximately $7.5 trillion, implying a deficit of about $2 trillion. He puts federal government debt at roughly $32 trillion, excluding intergovernmental holdings, while annual interest costs are around $1 trillion.

More significantly, the US has around $10 trillion of principal coming due in addition to interest payments. Dalio therefore estimates total debt-service requirements at roughly $11 trillion; about twice annual government revenue.

That does not mean the US has to find $11 trillion in fresh money every year; maturing debt can be refinanced. But Dalio's point is that the system increasingly depends on creditors continuing to roll over enormous amounts of government debt.

And that dependence becomes more problematic if demand for Treasuries weakens.

Dalio says the late stages of a major debt cycle typically show up through a combination of rising long-term interest rates, currency weakness and declining appetite for longer-term government debt.

That is why he is paying particular attention to the recent rise in US bond yields and weakness in the dollar. He argues that the combination of enormous current and prospective debt issuance and softer demand for that debt could put increasing pressure on the US financial system.

Japan's actions add another dimension to the story. Dalio says the Japanese government has been selling some US bond holdings to repatriate funds and support the yen and Japanese capital markets.

Dalio's proposed solution

He argues that the US still has an opportunity to address the problem before it becomes a full-blown crisis. His preferred approach is what he calls a "3% 3-part solution": bring the budget deficit down to around 3% of GDP through a combination of spending cuts, higher tax revenue and lower interest rates.

He argues that none of these measures should carry the entire burden. A balanced adjustment, in his view, would reduce the risk of a severe economic shock while helping lower the government's interest burden over time.

When could a crisis hit?

He said the timing would depend on policy decisions and external shocks such as wars or major political changes. If the deficit were reduced significantly, the risks could fall. But if the current trajectory continues, Dalio's estimate is that a crisis could arrive in roughly three years, plus or minus two years.

Dollar's reserve-currency status may not be enough

One of the strongest arguments against a US debt crisis is the dollar's dominant position in the global financial system. The US can borrow in its own currency, and Treasury securities remain central to global markets.

Dalio, however, argues that reserve-currency status does not permanently protect a country from debt-cycle pressures.

His argument: previous reserve currencies, including the British pound and Dutch guilder, eventually lost their dominant position. In his view, currencies retain that status only as long as they remain effective stores of wealth. Excessive debt and currency devaluation can eventually undermine that confidence.

He points to Japan's debt-to-GDP ratio of around 215% and argues that years of heavy borrowing, low interest rates and central-bank purchases of government debt demonstrate how a country can postpone a conventional debt crisis while still imposing significant costs on bondholders and the currency.

Dalio says Japan's experience illustrates his broader theory that very high debt can eventually translate into poor returns on government bonds and currency weakness.