Friday, June 6, 2008

Debt Deflation

It appears these comment I made back in Feb are becoming more of a problem, US home prices are still falling, and many OECD countries are witnessing the same problem.


The causes of asset deflation and the serving of that debt came about because of banks and individuals and some corporations were unable to service existing debt with overinflated assets.  Once the cycle of asset deflation starts it starts the process of the upwind in reverse.  Asset inflation allows banks and corporations to lever more. That process started to unwind in the US in 1925, with the unwinding of Florida real estate, the inflation in assets moved to stocks in the late twenties, while there signs that the economic was already slowing dramatically.


Debt deflation, indebtedness-overinflated assets- asset prices fall-losses- repayment-distress selling- -money contraction-spending=deflation


The feedback of assets falling started a process of feedback of continued selling to get out of debt.  Banks were calling in loans and this accelerated the process. Once you stated to see layoffs the consumption and continued pullback continued, then as incomes fell again to service the debt became a further problem.  I will not go into the governed polices that made the situation worse.


Fisher, Bernanke, and Minsky all agree that all tried to reduce their level of debt accelerate the process of selling assets, understand that as assets fell the balance sheets of banks, the contraction of money supply during the thirties was in part of debt being reduced as prices continued to contract.  It became an endless loop.  Counter to many arguments the Fed and the authorities did nothing, what they could to stop the last great unwind, but it all came down to servicing the debt, which are affected by assets values, employment and income.  Take one or two or even three, the economy can survive, give the economy over inflated assets with debt levels that are brought upon by very low interest rates, and financial engineering then it is only a matter of time before the house of cards starts to unwind. 


The only way to continue this supercycle of debt are much lower rates, much higher inflated assets, more of Wall Street’s creative financial engineering, that can only come about if assets have not started to fall, once it breaks it’s over.



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These are my own views, please enjoy these insights