The Great Reflation: How Investors Can Profit from the New World of Money

Chapter 2. The Debt Supercycle, Illiquidity, and the Crash of 2008–2009

Debts are nowadays like children begot with pleasure, but brought forth in pain.

—Molière

As the crash and banking collapse start to fade into the past, there will be a growing tendency for people to forget the cause—too much private debt. This would be a huge mistake. The debt must be dramatically reduced if we are to gain a solid footing to support the currency and financial system. However, private-sector debt reduction is not easy and has consequences.

The effort to reduce debt, called deleveraging, will happen one way or another and will profoundly shape the future of financial markets in a complex way. On the one hand, it is deflationary; people save more, spend less, sell assets, and do what is necessary to pay down debt. This reinforces the weakness in the economy and lowers price inflation even to the point of outright deflation. On the other hand, the govern-ment is trying to offset those depressing forces by printing money, running up big deficits of its own and subverting the need for borrowers to reduce their debt. These actions are initially anti-inflationary but ultimately become inflationary. In the next few years there will be a tug-of-war between these two forces. The outcome is not at all clear and unfortunately leaves investors in a quandary as to where to place their bets. Investors need to follow this saga closely on account of its critical importance, a theme on which this chapter, and the ...