The respected Bank Credit Analyst writes:
"This raises the specter of a debt deflation, where the combination of high
indebtedness and falling prices trigger a highly destructive self-feeding
downward spiral in activity. Deflation becomes a dangerous force when it
undermines the ability of individuals and companies to service their debt.
Deflation can cause declines in nominal incomes and in asset prices, but
the nominal value of debt does not change. This may result in forced
selling of assets in order to make debt payments, unleashing a vicious
spiral of falling incomes, imploding asset prices and even greater real
debt burdens. Meanwhile, even if monetary policy is eased aggressively,
deflation can cause real rates to increase. When there is deflation, a
central bank cannot engineer negative real rates. "
The renowned Yale economist Irving Fisher described the destabilizing
interaction of deflation and debt in his famous 1933 article "The
Debt-Deflation Theory of Great Depressions". In Fisher's words, "the very
effort of individuals to lessen the burden of their debts increases it,
because of the mass effect to liquidate". That leads to what Fisher called
the great paradox and the chief secret of most, if not all, great
depressions: "The more the debtors pay, the more they owe. The more the
economic boat tips, the more it tends to tip. It is not righting itself,
but is capsizing".
"Are there any signs that such a scenario is unfolding? With the GDP price
deflator only 1.3% above year-ago levels, it is not far-fetched to
speculate that deflation might unfold. The goods sector of the economy has
faced deflationary pressures for years, but this has been offset by sticky
inflation in the services sector. However, inflation in services is now
slowing and this trend would intensify should the economy fall back into
recession. Debt deflationary dynamics could perhaps unfold even if
aggregate price levels did not decline. For example, a major drop in house
prices could be the trigger for serious problems given that home mortgages
accounted for almost three-quarters of the increase in household sector
debt during the past five years. A broad-based fall in home prices would be
a more potent force than lower equity prices in terms of undermining
consumer balance sheets. The Great Depression was not caused by the stock
market crash but by a series of serious policy errors, including overly
tight fiscal and monetary polices and the introduction of protectionist
trade polices. The Fed is not making that error in the current cycle, and
rates will be cut further if necessary."
Irrational Assumptions
(And Other Earnings Problems)
$50 billion in Phantom Earnings
The Chickens Will Come Home to Roost
A Few Quick Comments
A Guy's Night Out and Much More
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