Monetary System Visual and a Fundamental Flaw of Decentralized Cryptocurrencies

I've been reading Ray Dalio's Big Debt Crises to better understand the Fed's current quantitative easing attempts and I haven't found a good visual that puts deflationary and inflationary crises along with the Treasury and Fed controls into perspective, so I created my own. This is obviously an incredibly simplified representation, but I found it to be a useful exercise nonetheless.

The deflationary portion of the cycle is fueled by lending. Credit is given assuming that income growth will continue and hence, the debt will be easily repaid. So long as income growth exceeds debt growth, the debt is being used productively. But of course, the added income growth is a result of the debt and the creditor obviously demands a premium for the money that he has lent. The process is self-reinforcing because the increased spending in the economy due to easy credit fuels the increase of incomes and net-worths which increases the capacity for more debt. The increased productivity of the country strengthens its currency.

Eventually the country's capacity for productive debt is exhausted and many are left with debt that simply cannot be repaid in the slowing growth environment. The ability to deploy debt productively becomes increasingly difficult and hence, creditors demand very high interest rates to compensate their risk of not being repaid. Debtors become desperate for real money to repay their debt, which creates demand for more debt, which raises interest rates even higher, which creates more demand for the currency, which raises its value even higher, which makes it more difficult to obtain, and soon the monetary system becomes illiquid.

At this point, the Treasury prints money and the government delivers it to the economy by exchanging it for bonds. The added currency improves liquidity of the markets allowing for debts to be repaid. Other existing debts are restructured and postponed until a future date. The inflationary cycle has now commenced.

In the inflationary portion of the cycle, falling interest rates slowly incentivize more people to take on debt once again in exchange for assets with the assumption that they'll be able to re-exchange their assets for more money in the future. The process is self-reinforcing because assets generate more and more returns as debt becomes easier to acquire in the falling interest rate environment because the debt is being used to buy the assets, which further increases demand for the assets, which further increases the value and returns of the assets, which further incentivizes people to take on more debt in exchange for assets and so on.

Because the debt is so easily paid off by asset returns, interest rates fall as creditors expect to be easily repaid.** Of course, the increasing supply and availability of the currency erodes its value and the economy begins to experience inflation as assets rise in price to sustain their real value.

At this point, the government sells bonds to extract currency from the economy. The Fed increases interest rates to deter people from taking on more debt to limit the money supply and erosion of the currency's value. The government may limit its imports to restore its balance of payments.

**It's important to understand that in an uncontrolled inflationary period creditors will begin to raise interest rates to outpace the inflationary rate to maintain a real return. In this case, the real value of the currency would begin to negatively correlate with interest rates and appear as a negative exponential function of time as the currency's value continually approaches zero.

In a vacuum, the debt cycles and controls of the monetary system appear to be very simple. Central authorities with controls and constraints of the monetary system of a sovereign currency save capitalism and human nature from themselves. A monetary system without these controls, such as one comprised of cryptocurrency would be subject to a one-way deflationary period of death.