Friday, November 15, 2013

Can the United States pull off a beautiful deleveraging?

As Ray Dalio points out in a recent video, "borrowers debt levels have simply gotten too big and can't be relieved by lowering interest rates", he explains that there are several ways to tackle a deleveraging which has to occur once we reach this point (cut spending, reduce debt, redistribute wealth & print money):

Dalio's video suggests that in a 'beautiful deleveraging' it takes a decade or more for debt burdens to fall and economic activity to get back to normal (2-3 years of deleveraging/depression, followed by 7-10 years of reflation).

Others believe that the deleveraging will occur over longer period of time, for example David Llewellyn-Smith of MacroBusiness recently wrote:
The GFC was and is the pivot point in a structural adjustment that has only just begun, probably has decades yet to run, and before it’s over will likely change our world to something that looks more like the nineteenth century than our super fast modern version (in the sense of slower moving capital not widespread typhous!).

Put simply, we’re in a long term deleveraging phase for the global economy following a long term leveraging phase. What this means is that pretty much for the rest of your working life, the world is going to be regularly convulsed as its debts are saved against, inflated away, defaulted upon, and even sometimes repaid! It will shake both private and public sectors repeatedly and will afflict both developed and developing economies.

This is neither good nor bad. It is neither bearish nor bullish. It just is.
My response to this post, in the comments below was:
The view that we will see decades worth of readjustment makes the assumption that we don’t see a major event (planned or unplanned) change the entire financial / monetary system as we know it. It makes the assumption that after half a century of imbalances building we will be able to rebalance slowly, but surely, with only the odd crisis to contend with (none of which will spin out of control resulting in a larger collapse or a change to the status quo). I simply don’t buy it.
I think it's very unlikely that the US (or in fact many western economies which have a high level of debt to GDP) will be able to delever so easily this time around. US total credit market debt to GDP is down from the 2009 peak, however has a long way to fall before returning to levels that could be considered sustainable if interest rates were to normalise:

In 1933 US total debt credit market GDP topped at 300% (assisted by a 46% decline in GDP starting in 1929) and took roughly 20 years to bottom:
At the beginning of the Great Depression in 1929, the bulk of US debt was corporate debt tied to the investment bubble in auto manufacturing, electric utilities, household appliances, radio and other sectors that made up the "new economy" of the Roaring Twenties. Corporate debt to GDP collapsed from over 100% in 1933 to under 30% by the mid-1940s. Household debt fell from 50% of GDP in 1933 to roughly 15% in the same time period. Much of the drop in total debt to GDP came during the 1933-1936 period, when the dollar was devalued by 50% and economic growth was very high (albeit from an extremely low base). The ratio rose again when the economy relapsed in 1937-38, but resumed its decline when the economy recovered modestly in the pre-war years. The Dynamist
Today, the US is in an even more precarious position than during The Great Depression. The level of debt to GDP is much higher and more importantly the US is not able to easily devalue the dollar as they did in 1933 when they adjusted the Gold price from $20.67 per ounce to $35 per ounce.

Many other countries left the Gold standard in the 1930's in order to devalue their currencies along with the US. It's not so easy today, the US isn't able to devalue their currency against a reserve asset like Gold as their currency is the defacto global reserve currency. They are only able to compete with other countries to devalue their currency all the while putting on the facade that they have a "strong dollar policy".

The US faces the challenge of trying to reduce their debt burden at the same time as receiving criticism from China and elsewhere over attempts to kick start economic growth & inflation to reduce their massive debt burden (the below just one example of many where they have been criticised for their actions):
A senior Chinese official said on Friday that the United States should cut back on printing money to stimulate its economy if the world is to have confidence in the dollar.

Asked whether he was worried about the dollar, the chairman of China's sovereign wealth fund, the China Investment Corporation, Jin Liqun, told the World Economic Forum in Davos: "I am a little bit worried."

Jin said he was confident that the Obama administration and Congress would ultimately solve the debate over the so-called fiscal cliff, "but of course the printing machine will have to slow down for people to have full confidence in the dollar". Jan 2013, Reuters
It seems to me that the US faces an impossible situation, as they attempt to reduce their significant debt burden, while retaining the US dollar as global reserve currency, a luxury which has allowed them to over spend as long as they have.

It seems to me what the US and the rest of the world could do with is a global reserve asset against which to devalue fiat currencies & extinguish their debt.

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  1. After 5 years of post-GFC study I'm scratching my head to figure out why the whole system hasn't already blown to bits already. Only a few options are possible, some of which: (a) the structural deficiencies are not as severe as popularly maintained, (b) the economics wizards have done a great job of deflecting the deleveraging blast or (c) the system is organic enough to gently transition itself regardless of the machinations from players and opinion of observers or (d) the proverbial has not yet hit the fan or (e) the masters have decided it is not yet time to introduce any real change (wishing to maximize the effect of whatever suits them).

    I think all the options are true to a degree, I suspect in 5 years we may still be arguing the same elements of 'what should be happening'. Any thoughts? What's the bet on how long this black & white movie will go for?

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  3. I hear what you are saying, if you'd asked me 5 years ago where I thought we'd be today, it's not likely my description would match the current state of play (stock market at new highs, inflation benign, USDX still tracking sideways).

    Timing is difficult and probably depends on whether we see a planned transition away from the dollar toward a new system or whether it occurs as a result of crisis. But I can't see the USD retaining it's status as global reserve currency over "decades" as they deleverage (as described by DLS in quote above).

  4. The only other (explanation) for the apparent failure of so many predictive models is perhaps we are viewing events from an 'internet time' perspective, which makes even a modest 10 year collapse/transition process seem like a lifetime.

    But I fully agree - it seems they did not eliminate the deflation, they only stalled it (look no further than ZIRP), the bad debt still needs to be purged and there is a large amount. USD still suffers from Triffens dilemma ... my personal view is we'll see more financial nonsense for another 5 years or so before what is next, takes shape. But I hope it gets resolved before that.

    Thanks for posting - I do love the topic.

  5. You could be right about it seeming slower due to the speed at which information & news is transmitted via the internet (although maybe it will also speed up the process if/once the faith in any fiat currencies starts to take a serious hit).

    The above is the first section of a post I had in the works for awhile without time to complete, so just cut off the top and posted the above. I did make mention of the Triffin dilemma further down in the piece, so there is more on this subject coming when I have time.

    We are seeing some strong movements of physical Gold to the east, so if there are plans for a new monetary system and it involves Gold then we could be witnessing distribution of Gold in readiness (or are we just seeing the east take advantage of low prices on the west's expectation the bull market is over?).

    Oh to have a crystal ball...

  6. I agree with DLS that this is only the beginning and there's more to come. And it'll be deflation, not the inflation gold bugs are hoping for. Gold and silver will only come into their own when the twin threats of global warming and peak oil combine to crush the world's economy (10 to 20 years from now). So IMHO precious metals are a long term play, a really long term play. :neutral:

    BTW, I no longer post at Macrobusiness because I am fed up with Chris Becker, the blog's beefy bully boy, deleting my posts at whim. Becker (also known as DarkMatter) is a closet climate denier, and hates me for pointing it out. He's ruining that site. I've told DLS about it, but while sympathetic, he seems powerless to change the situation.

  7. I think a more likely route will see Gold used in some form of international reserve currency. China has already stated that their days of purchasing US bonds are at an end:

    That they want to see a de-americanized world with a new international reserve currency:

    And a few years ago pointed to a preference for the SDR backed by an asset pool as the favoured solution.

    I think Gold will come into it's own much sooner than 10-20 years down the track. I just think DLS prediction of decades worth of deflation/deleveraging is an unlikely scenario (although possible).

    I haven't had much time to read MB as much as I have in the past or post comments as regularly, but recently the spam filter has been eating most of the posts I've tried to make, so stopped making much of an effort. Are you sure your posts aren't disappearing similarly?

  8. No, I'm pretty sure Becker is deleting them. They actually get published, but an hour later they're gone. He's a total twat, abusing his power there. It's not as if the posts he deletes are even contentious or insulting. I cannot even mention certain issues with them disappearing. Bah.

    Jim Rickards (Currency Wars) also says we're going to see SDRs, so that may be the way things indeed do go (I'm very respectful of his views, he's a really smart guy).

    My basic position that whether it's 5 or 25 years, gold (and silver) have to come back into the mix. If we do end up in a no-growth economy, as many now predict (especially "ecological economists" and other who follow the thinking of Limits to Growth), gold would be ideal.

    You know I am heavily invested in PMs, like you.

    I also have a very bullish outlook for silver:

    1-Vital for space-efficient PV solar panels in era of Global Warming (not used in thin film),

    2-Wide range of industrial uses (no substitutes for most of them),

    3-Poor Man's Gold,

    4-USGS predicts extreme scarcity by 2020,

    5-Carbon taxes will limit mine supply,

    6-Peak Oil will limit mine supply,

    7-Much less of it above ground than gold, so it's a tiny market that can go ballistic[

  9. Here's an example of what happened 2 days ago on Macrobusiness. This is why Becker os destroying the site.

    Some thick prick (calling himself "DarkMatter", who I am almost certain is Becker himself posting under a pseudonym, because the sentiments closely match his oft-expressed views) unloaded this on me:

    Crazy foamymouthed zealots like yourself actually help them get away with it. They hate the light of reason being shone on their carbon taxes and emmission trading schemes. Watch the monkey! – you are the monkey. R2M – have you ever thought you could do a lot more good for your cause if you weren’t such a pea brain?

    Here's my response, which he deleted, TWICE:

    DarkMatter, I’m not sure why you are taking that sneering, dismissive tone with me.

    You comically overlook that my basic opinions on AGW represent the majority opinion in the world, all the peak science academies of all nations, 99% of current climate scientists, and the agreed facts that all governments, even the Abbott government, have acknowledged. You, however, chose to characterize my opinion as that of a “crazy foamymouthed zealot”, which just makes you look utterly ludicrous. If I’m a zealot, so are most people, including the scientists.

    You have yet to show any opinion I have expressed that denotes zealotry. Why am I a zealot? Because I support the science?

    Frankly, I find you supercilious scorn quite distasteful, and your absurd statement that AGW could be “statistical noise” so risible that I see no point in further engaging with you.


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