Global Debt
Fri Jun 10 2022
With the recession looming, asset values dropping, and inflation impacting everyone’s bottom line, how bad will it get before it gets better? Some scenarios are more likely and others are less likely. To be prepared for the future, we must consider likely as well as less likely scenarios. The further we zoom out, the more certain we can be of broad strokes of outcomes excluding of black swan events of a certain magnitude. Some trends will appear more clearly than others and history can offer better examples to draw from to understand why.
One of the most likely scenarios is a 10 year stagflation similar to that experienced between 1971 and 1980. The broad outlines of this scenario is the following: Feds will increase rates slowly but not enough to shut down inflation. The root cause of inflation — supply shocks in the form of oil and wheat out of Ukraine and Russia will not be resolved by Fed rate increases and so inflation will continue. A period of low grown cause by inflationary headwinds causes stagnation on all assets except for real estate, gold, and bitcoin, which tracks inflation in some cases and surpasses inflation in other cases.
However, many differences exist between 1971 and now. In 1971, the global financial system was in the middle of the long-term debt cycle. Now, the global system is at the end, with debt servicing a huge drag on global economy. Developing countries sometimes clear their debt though hyperinflation. Hyperinflation is a natural part of any fiat, debt-based monetary system — this is because paying off interest necessarily means printing more money, an endless cycle that grows exponentially. Only by basing monetary standards on some rare and universally accepted store of value can hyperinflation be avoided. The US has avoided hyperinflation thus far by exporting its inflation to the rest of world as the global reserve currency. This can only go on so far and we are near the end.
With this in mind, a more complicated scenario emerges. As the Fed rates increase and decrease, hyperinflation will begin to afflict countries backed by the dollar. As the dollar exports its own inflation worldwide, smaller countries dependent on the dollar will be pushed beyond the brink. As this becomes clear, countries will experiment with other global reserves to stabilize their currency and their country’s economy. This is the moment that Bitcoin has been waiting for. Any country that uses Bitcoin as its reserves will be subject to its price volatility but also will have a non-inflationary reserve. In an era of hyperinflation and economic collapse, a country a non-inflationary reserve will benefit greatly. Many countries will go back to gold, if they can acquire it, and others will go with bitcoin, at whatever price they can acquire it. As all countries move off the dollar, their hyperinflation will ceases. Debt laden countries will want inflation to continue until their currency has dropped by 90% or more so that productivity can again rise above debt servicing. This is the reason they have yet to back their currency with a more solid reserve.
If the inflation happens too fast, economies will collapse and change of government will be all but guaranteed. If inflation happens too slow, debt is not wiped out and will continue to be a drag on economy. Not all countries be able to manage this fine balance and some governments will collapse. War and additional supply shocks continue to create more inflationary pressure, making the central bank’s job extremely difficult. Assuming the US manages the fine balance, the US economy will have over a 10 year period devalued its currency by 10x or more and put its money back onto solid footing with either gold or bitcoin as its reserve. European countries will benefit from the close financial collaboration with the US. More debt laden countries such as Spain and Greece will be worse off as they are subject to higher rates and takes longer to deleverage.
Liberalism, which brought with it high tax rates and large social programs will no longer be in favor as countries shift to a lean, low debt approach to improve chances of deleveraging successfully. Along with the breakdown of liberalism will also be lower tolerance for authoritarian regimes and an even stronger us vs them mentality. The populism we saw with the trump administration will spill over into every country and every society. This makes global war very likely as countries and peoples become less tolerant of each other. After this, the global world order will be different. Something like a new Bretton woods may develop, but it’s also just as likely that a multi-currency world will prevail for the time being with alliances jockeying for position until an undisputed leader emerges.
If none of this comes to pass, then we have yet to begin deleveraging. If inflation stops and goes back to business as usual, we will see lower productivity, higher discontent and continued assaults on neighbors by autocratic regimes. This will not reset the clock and the next crisis has the potential to set off similar sequence of events until the deleveraging happens as debt services become increasingly unbearable.
Global deleveraging of debt can happens smoothly and without much fanfare. Debts can be paid back and reduced relative to productivity as inflation raises slightly. Western countries can mount a measured response to autocratic regimes. Asset prices can recover and we things will mostly stay the same. Over the next 10-30 years, we will see countries move to gold or bitcoin slowly to counter future inflation fears.