The End of the Debt Supercycle

07/29/2010 10:13 am EST


John Mauldin

Chairman, Mauldin Economics

John Mauldin, editor of Thoughts from the Frontline, says the period of borrowing and leverage is coming to an end, and its unwinding will be painful for everyone.

The Debt Supercycle is the decades-long growth of debt from small and easily-dealt-with levels to a point where bond markets rebel and the debt has to be restructured or reduced or a program of austerity must be undertaken to bring the debt back to manageable proportions.

The end of the Debt Supercycle does not have to mean calamity for each country, depending on how far down the road they are.

Take the US. We are some ways off from the end. We have time to adjust. But let's be under no illusions: We cannot run deficits of 10% of [gross domestic product] forever. At some point, the Federal Reserve will either have to monetize the debt or the bond market will simply demand an ever-higher interest rate.

How did we get here? We simply kept borrowing ever greater amounts of money at an increasingly rapid pace. In the beginning, each dollar of debt brought about a corresponding dollar of increase in GDP. But that early money was invested in houses and in the means of production, which helped grow the economy.

As time went on, and especially after the 1980s, more and more of the debt was used for consumption (of which much has come from foreign sources) and not for the increase of productive capacity. Towards the end, it took $3.00 of debt to create a $1.00 rise in GDP in the US.

The US cannot borrow $15 trillion in the next ten years. It's just not there. Long before that, the bond market will simply rebel, rates will rise, and the aftermath will make the last crisis seem like a cakewalk.

It's all well and good to say that you want fiscal rectitude; it's another thing when it is hitting budgets near and dear to you. And to get back to a remotely sustainable deficit is going to take pain in every corner. It is going to hit near you, gentle reader.

And this is the case in every country running large and out-of-control deficits. The Irish are in what can only be called a depression, along with the Baltic states and Hungary. Greece will soon be there, once they have to meet market rates for their debt, or force their labor markets to endure a very serious deflation to make themselves more competitive.

All of the developed countries that are in trouble have hard decisions to make. To pretend that we know exactly what that involves requires a fair degree of hubris. And even for countries that, relatively speaking, have kept their act together, we are talking about a large part of world GDP at risk.

Each country will have to make its own political choices. Could we see hyperinflation in the US or Great Britain or Japan? It is possible, with bad policy decisions. I doubt that it gets to that. But could we see inflation? The answer is yes.

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