Debt Deflation: The Massive Problem Threatening the Global Recovery

Nothing to report from Wall Street. Dow down a little yesterday. Gold up a little. The most telling stories are coming from the global economy, not its manipulated markets.

The price of copper is collapsing. The Baltic Dry Index is dragging along the bottom. Seven years after the start of the debt crisis the global economy is still struggling.

Hedge-fund-turned-family-office-manager George Soros says Europe could be in for a 25-year slump. Bloomberg reports:

Billionaire investor George Soros said Europe faces 25 years of Japanese-style stagnation unless politicians pursue further integration of the currency bloc and change policies that have discouraged banks from lending.

 Europe “may not survive 25 years of stagnation,” Soros said in the interview with Francine Lacqua.

It was in the spring of 2007 that the first crack appeared in the weakest part of the debt structure: US subprime mortgages. By March 2007 the value of subprime mortgages had risen to $1.3 trillion. But mortgage rates were rising. Defaults and foreclosures followed.

The following autumn, the rate of subprime mortgage delinquencies had tripled from the year before. By January 2008, it had quadrupled. And by May it had quintupled.

It was a classic debt deflation. Homeowners had taken on more debt than they could afford. Now, the debt was going bad and investors were getting queasy.

Toxic sausages
Defaults were bad news for marginal homeowners. They lost their houses. They had to move.

They were bad news to the people who owned the mortgages, too. Wall Street had sliced and diced America’s mortgage deluge and sold it all over the world in the form of mortgage-backed securities — structured products that cleverly concealed, with the tacit backing of the ratings agencies, the junk hidden beneath the surface.

Sellers, too, seemed to forget what was in this sausage; they didn’t realise it was about to make them throw up.

First, Bear Stearns ran from the room, holding its stomach. Then it was Lehman Brothers. At that point, the feds came in with every quack cure they could think of. Bailouts, cash for clunkers, ZIRP, QE — one estimate put the total cost at more than $10 trillion, or about three times the cost of the Second World War.

The problem with the cures was always a fundamental one. The crisis was caused by too much debt. And all the feds had to offer was…more debt. As Bloomberg reported last week, the world’s stock of toxic sausages has exploded to $100 trillion:

The amount of debt globally has soared more than 40% to $100 trillion since the first signs of the financial crisis, as governments borrowed to pull their economies out of recession and companies took advantage of record low interest rates.

 The jump in debt as measured by the Basel, Switzerland-based BIS in its quarterly review is almost twice the US economy.

Debt is stopping the future
Debt is an obligation laid upon the future by the past. The larger it gets, the harder it is for the future to happen.

There is a correlation between extreme levels of public debt and low economic growth. This has been demonstrated by several studies, most prominently by professors Rogoff and Reinhart. There were some errors in their math, which critics rejoiced in, but the conclusion was solid: High levels of debt-to-GDP have been historically associated with low levels of economic growth.

That is what has been happening in Japan for the last 23 years…and in Europe and the US for the last seven. These economies are still fighting deleveraging, resisting debt deflation and pretending that they can continue to add debt forever…and that somehow this will get them out of their debt traps.

But they are doomed. Without growth they can’t pay the debt. With so much debt, they can’t grow.

Bill Bonner
Markets and Money 

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Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.

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