This is the most important big picture macro chart, in my opinion.
It shows the tight relationship between total economic debt levels (orange, RHS) and real interest rates (blue, LHS inverted): the higher public and private sector debt burdens, the lower real interest rates must be for the system to keep afloat.
Since the early 90s, most developed economies faced the same dilemma: working-age population growth and productivity stalled, leading to sluggish organic GDP growth.
Hence, the only way to generate socially and politically acceptable growth levels was through the use of debt.
As a result, most developed market economies grew their private and public debt to GDP ratios from 100% to over 300% in 2 decades and even China was forced to follow the same path later on.
But how can these gargantuan debt loads be ”affordable”?
The only way this works is through lower and lower real interest rates.
Think of it this way: maybe you can’t afford a $500k mortgage at 5% interest rate, but you probably can do that at 0% rates.
Lower real yields made leverage ”affordable” and incentivized a buildup in debt which translated into stronger cyclical growth and a boom in asset prices.
Yet, this macro model is now at crossroads:
1) Higher asset prices have resulted in a massive wealth gap, with obvious frustration from the middle class resulting in political and social unrest;
2) Short-term, as Central Banks raise real interest rates to fight inflation this highly leveraged system will be further under pressure;
3) Long-term, the next cycle of 0% interest rates and QE will lead to more debt but how low can we really push real yields if nominal yields are stuck at 0% already?
However you look at it, we might be at the late stages of the long-term debt cycle as Dalio calls it.
So, what causes the big transition?
Historically, no policymaker willingly deleverages the system or challenges the existing status quo – it’s always a big geopolitical event that triggers a radical revision of our macro and monetary system.