Maybe your personal debt isn’t falling very fast. Maybe you have a kid in college and your debt is actually growing. This would put you in questionable company with entities like the U.S. government and Japan, whose debt is also increasing.
However, there is one sector where debt is falling fast…
This is something we’ve talked about for years. While falling debt means shrinking credit and weak or falling GDP, it also means that inflation is no threat at all and we are at least on the path to a healthier economy. The trouble is, the process of eliminating debt is painful and could take a while.
So what sector is shedding debt…?
The finance sector… that weird place where derivatives were born, where lenders would make no documentation loans and leverage reached over 40 times.
The Federal Reserve reports on the amount of debt outstanding in several categories every quarter, and by its measure debt in the finance sector exploded from just under $10 trillion in 2000 to $17.1 trillion in 2008.
During those eight years, financial institutions like investment banks would borrow short (for 30 days) and lend long (for 30 years). When these companies got into trouble they could no longer borrow… and the entire process unraveled (which is what happened to Lehman Brothers and Bear Stearns).
Since the meltdown in early 2008, we have been in the process of winding down the worst of the borrowing and lending practices in the financial sector. It has unburdened itself of as much as $3.4 trillion. But this comes with a price. This reduction in debt is not always a calm, deliberate process. Sometimes it is sudden and messy. Like mortgage foreclosures and credit card charge-offs.
The key is that these things are happening, albeit slowly. And when overall credit shrinks, so does the amount of funds chasing goods and services. This is why we have been adamant that inflation is not, nor will be, the problem. The biggest danger is deflation.
Falling Prices, Falling Wages
When credit shrinks quickly the vacuum that is left creates falling prices and falling wages. That’s exactly what we’ve got right now…
Roughly 30% of homes with mortgages are underwater. Homeowners in general have lost trillions of dollars in equity. At the same time, wages are at levels from the early 1970s and median household income is back to levels from the early 1990s. As I recently said in a weekly Boom & Bust update, “We’re working like it’s 1999.”
The process isn’t fun and the Fed has tried to stop it, creating inflation in food and energy along the way. But the Fed won’t win. The tide of debt reduction continues and the Fed is fighting it with a garden hose.
By our calculation the financial sector will contract by another $3.7 to $5 trillion. This slashing of credit outstanding will continue to limit the amount of funds available, and therefore the amount of spending done, in the U.S. and around the world.
The affects over the next several years are clear – continued pressure on economies, stifled prices and depressed wages.
While this scenario unfolds it’s very difficult to have breakaway growth or expansion in the economy. That means only one thing will get rewarded… cold, hard cash.
We often point back to our Boom and Bust portfolios, where we focus on grabbing investment opportunities AND building steady streams of income… and we do so for good reason. We see a difficult time down the road and we want you to be prepared.
Those invested for income should ride out the storm nicely.
P.S. Because we want you to be prepared for the difficult years ahead, Harry has made an unusual decision. He’d like you to cancel your subscription to Boom & Bust. He makes his reasons crystal clear.
Ahead of the Curve with Adam O’Dell
No Recovery in Sight for Financials
With between $3.7 trillion and $5 trillion of deleveraging left to go, the financial sector is still retrenching.
And while all other sectors have made a meaningful recovery, financials never really…