Deleveraging Through... Deflation? Has Ending QE Been The Ulterior Motive All Along? Andrew Smithers Thinks So

Tyler Durden's picture

Confused by recent proclamations by Hoenig, Plosser, and other unnamed Fed members, who want an end to QE? Even more confused that this could actually happen? Andrew Smithers, former head of SG Warburg asset management before starting Smithers & Co., may have some iconoclastic insight into this development, which at its core is fundamentally deflationary, and a stark refutation to everything the Fed (presumably) stands for. A paradox? Smithers breaks the "Econ 101" mold in this fascinating interview with Kate Welling. The most provocative perspective: Smithers goes against the grain of every economic textbook which says the only way to inflate debt away (deleverage) is by, well, inflation. Instead, what Smithers suggests is a slow, gradual process of deflation, in which incremental cash flow is converted into equity, and pushes debt out. Indeed, this is precisely what we have been seeing especially in the REIT sector where numerous names, courtesy of BofA, have raised equity on the basis of imaginary valuations, which may just become a self-fulfilling prophecy if enough people buy into them, and by throwing cash at these companies, allow them to lower their debt-to-capitalization ratios. Then again, with another half a trillion in equity needed for the REIT sector to fund itself out of a mid-term funding crisis, that's purely a pipe dream. However the bigger picture of the Smithers perspective is that this deflationary approach is exactly what the Fed may be engaged in. By distracting the increasingly more vocal inflation hawks, who anticipate that inflation is and always will be the driving motive of the Chairman, Bernanke could very well be pursuing just the opposite: a slow-bleeding deflationary trend.

The clincher from the interview which took place in November 2009:

I think that you will find that several economists over the next few weeks and months will be expressing concern about quantitative easing...Because the most damaging thing that could happen to the world economy would be a third asset bubble collapse...Probably the best way of ensuring that is by making sure that asset prices simply don't go up much more.  What we need over time is a rebalancing of the economy in which we get deleveraging going on. And there are only two ways to delever: One is by generating cash flow and the other is by replacing debt with equity, either through bankruptcy, via the banking system, or directly, through the corporate sector. Now if you have deleveraging as the main driving force, you can only achieve that goal, really, if you switch the debt from the private sector to the public sector. Otherwise, you get the attempt for everybody to save more and everybody to invest less and you fall clearly into one of those problems that Keynes identified, where the adjustment process, rational on the individual level, just digs the economy, as a whole, deeper into a recession... [For this plan to be effective] we now want a period of slow contained growth, in which we can get a lot of deleveraging going on - without it having to burden the public sector debt by too much. For that, you need time and helpful markets. The sort of ideal market is one that down a bit - that has periodic bounces. So people can take advantage of the bounces to issue a great deal of equity, which also, of course means that the market is more likely to go down thereafter?

Is the entire equity market merely a plaything in one giant Fed-controlled deleveraging ploy? Are equity prices indicative of anything besides what the Fed wants them to be? Some day, when all the Fed's secrets are revealed, we will know for sure. For now, all we can do, is to continue speculating and pointing out the obvious and ever more increasing irregularities in what was formerly at least passable for an efficient equity market.

Full Smithers interview.

Smithers 2009 November -

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Shameful's picture

Would love to see Uncle Ben not go to the presses, but doesn't that go against everything he has ever said? Sure he is a liar and incompetent but I have a hard time seeing him letting deflation happen. But hell here is to hoping I'm wrong and he will let deflation occur to purge the system. Come on "King Dollar"!

Madcow's picture

could be a giant head fake - 

the Fed needs people to believe in a future with inflation - else financial assets (save USTs) have no value. 


Anonymous's picture

This theory certainly aligns with the above chart. Spike supply then massively pull-back creating Japan like sugar highs all the way down. I'd like to see long term charts of M2, M3 to see how often they actually contract.

Assetman's picture

Smithers thesis is pretty much along the lines of what I think is occuring-- rightly or wrongly.  There's another twist to it, though...

The Fed, I suspect, is likely to cycle between deflation and reflation to meet two different goals.

Let's start with reflation, since we are knee-deep in it.  As Smithers echoes, we are going through a period where massive government liquidity is supporting the prices of risk assets.  While risk assets are "supported", it makes perfectly good sense to convert as much debt into equity as the (manipulated) markets can handle.  Smithers makes a great examplt of the REITS-- where the end result will be-- greater shares outstanding sharing a lower pool of income.  Who cares, when your stock is up 125% since March of '09?

I order to pull this shell game off, the government will need to raise more debt-- lots of it.  So far, foreign sources have been pulling the load, but Uncle Ben knew this wouldn't last forever.  I think the goal going forward is for "equitized" firms (since the balance sheet have been boolstered) to take another deflationary hit.  This means the poor fools who bought into that recent equity issuance will be hit.

But it also means there will be a likely significant flight to quality-- enough to keep the long end of the curve in check and allow the government to issue the mountain of debt it needs.  At some point, when the equity markets yell "uncle"... well Uncle Ben will come back with another round of reflation (QE) that will start the equitizing process all over again.

I'm not sure the strategy will work, but I think the Treserve will try this for as long as it works.  Under this strategy, I see diminishing returns at best (but still returns) and a black swan at worst-- becuase Europe, China, and Japan are all wild cards.

I'm pretty much in agreement with B9K9 and trav on how it all ends-- there is still too much debt, and the USD is ultimately at risk.  I think, though, that the Treserve can play this deflation/reflation game for as long as Europe is dealing with their own sovereign debt issues.  That could be years, folks.

What it means for the rest of us is that our savings will be depleted-- either through our own ignorance (wrong place, wrong time) or through confiscation of retirement assets. 

What better time to wipe out new retail equity holders with a governement-induced withdrawal of liquidity?  The time is quickly approaching...

What better way to take more savings than to scare investors into owning 2.0% coupon US Treasury notes-- or force retirement savings into long-dated Treasury securities-- right before reflation turns to inflation and wipes out bond returns due to higher interest rates?

If the Fed has their way, I beleive all of this is coming.  And yes, most of us will be skimmed every step of the way.

curbyourrisk's picture

Speculate this!

Its all a game.  We are just the pawns and we are will lose....

MarketTruth's picture

"All the world's indeed a stage
And we are merely players:
Performers and portrayers,
Each another's audience
Outside the gilded cage."

--Rush "Limelight"

Rusty_Shackleford's picture

"Wheels can take you around
Wheels can cut you down
We can go from boom to bust
From dreams to a bowl of dust
We can fall from rockets' red glare
Down to "Brother can you spare..."
Another war
Another wasteland
And another lost generation"


Between the Wheels- RUSH

dark pools of soros's picture

damn Rusty.. if I didn't have such a beat down day I would of got in front of you.. cheers

dark pools of soros's picture

come on now!  Between the Wheels is more apt here

Harbourcity's picture

`Sunny days

Chasing the clouds away

On our way

To where the air is sweet

Can you tell me how to get

How to get to Sesame Street...``


hidingfromhelis's picture

They say that life's a carousel
Spinning fast, you've got to ride it well
The world is full of Kings and Queens
Who blind your eyes and steal your dreams
It's Heaven and Hell, oh well
And they'll tell you black is really white
The moon is just the sun at night
And when you walk in golden halls
You get to keep the gold that falls
It's Heaven and Hell, oh no!
Fool, fool!

--Black Sabbath: "Heaven & Hell"

faustian bargain's picture

So much for the golden future, I can't even start
I've had every promise broken, there's anger in my heart
You don't know what it's like, you don't have a clue
If you did you'd find yourselves doing the same thing too

Breaking the law, breaking the law

Sancho Panza's picture

"This means that when you are really competent and effective you outwardly appear to be incompetent and ineffective, so as to cause the enemy to be unprepared."  Sun Tzu, The Art of War

Shameful's picture

Well I think Ben knows what he is doing, because a child could understand the basics of the system. Though I've had to spend a lot longer then I would like in academia and there is a chance he is as stupid as he portrays. But evil or stupid it does not matter he is still ruinous to the value of the dollar.

Sancho Panza's picture

True, all of his actions over the past  several years have been ruinous to the dollar.  But with all of the outstanding debt, all he has to do to strenghten the dollar is...nothing.  All he has to do is stop printing.

Eventually, Ben will have to choose between depression and hyperinflation.  When the final decision has to be made, one would be wise to consider Ben's principals' interests.  The Fed loses all power if the dollar goes to zero.

faustian bargain's picture

But if we're talking about a catastrophic end game, maybe all Ben wants is a getaway car and a hideout for the rest of his life.

Sancho Panza's picture

Maybe.  But I wouldn't get caught placing all my chips on one outcome or the other.  Simply knowing that the next 10 years will be nothing like the previous 30 is enough to position a portfolio for above average returns.

Anonymous's picture

Very interesting observation in that last sentence.

trav7777's picture

What did FDR do during the last depression?

He devalued.

There is no way out of the mathematics here - a rise in the real value of the dollar, the drop in tax receipts and all the rest of it will crush the USG.  Period.

How many times do I need to get banned from TF for saying this?

The economy CANNOT pay the gov's debts back in dollars with today's value, much less in more valuable dollars.

If the sovereign defaults, its notes and those of its central bank are going to be worthless.

B9K9's picture

Trav, Treasuries, Agencies and FRNs are all worthless regardless whether default or (hyper)devaluation is chosen (or imposed).

In one case, $1 is reset to -0- by a declaration of repudiation. In the other, $1 becomes worth $.0000000000000000000001 or -0- as a result of hyper-inflation.

As has been stated countless times, oftentimes boring many to the point of tears, there is simply too much debt in the system. But what a lot of people don't seem to understand is that all that debt represents claims (assets) by others. Ahem, cough, that would be ... savings, pensions, reserves, etc.

All going to -0-. Think about it.

Fox Moulder's picture

"How many times do I need to get banned from TF for saying this?"

 Banned for disagreeing with KD?

 I am shocked.

Harbourcity's picture

If incompetence hides competence, Bernake must be a FUCKING GENIUS!!


mynhair's picture

Very intruiging theory.  Unfortunatley, Bernhanky doesn't know what he is doing.  He may think he does, but, hate to tell ya, he and the Squid don't control the world - yet.  One good nuke from Imadinnerjerk will bring it all down, if the PIIGS don't do it first.

jdrose1985's picture

Haha imadinnerjerk? wow

Anyways...i just dont get why people are still so stuck on this whole notion that the Fed is out to destroy the value of the dollar.

I mean, I do get it because that's how I once thought and fortunately my timing was correct as the "reflation" trade picked up steam.

But in the long run, the entire planet must deleverage.

Hyperinflation? Name one society who used credit/debt as currency and entered's never happened. Weimar republic? Irrelevant...the war reperations were due in gold, not Marks.

I was once a gold bug but...having studied Japan and similar events...I believe the value of the dollar can only go up from here.

The USD is very cheap. The struggle to grab these funny pieces of green money has just begun.

Hugh Hendry singlehandedly changed my views on such matters. Glad I woke up just at the right time.

Misthos's picture

You can't just focus on the Fed and the deleveraging of the private sector.  State Pensions are near bust.  State budgets and municpalities are near bust.  Social Security and Medicare will be consuming more and more...  and annual interest payment on the trillion plus deficits for the next ten years will only grow.

We're not going to pay for all of the above...  but we will end up paying for most of it.  And we will not default IMF style either.

You can't tame deflation or inflation.  It picks up steam and runs its course.  To choose deflation is to destroy the economy today.  To choose inflation is to destroy the currency over a longer period of time.

The choice has been made.  We will print and deficit spend.

saturno_v's picture


"Name one society who used credit/debt as currency and entered hyperinflation"


Argentina, Brazil, Zimbabwe, Jugoslavia, Hungary...need more???


"it's never happened. Weimar republic? Irrelevant...the war reperations were due in gold, not Marks"


What is your point?? Germany started printing marks and at some point you had the crack-up shortage was the initial trigger..reduced tax revenue and the political impossibility (with a potential deadlocked congress) to raise taxes could be the trigger for the USD.


For many investors already (me included) the UST are not worth the paper they are printed on (with QE and "mysterious" buyers around), as far as I'm concerned the USD did reach the crack-up boom (loss of faith in the currency) already.


We are able to keep the going going at the moment mainly because:


1) Every country in the planet is doing it...noboby is in the Gold standard, so there is not system of better reference


2) We still have the ultimate backing for the dollar at the moment....10 aircraft carrier battle groups...


3) Gigantic delusional mindset from investors....and many funds (pension or otherwise) are contractually forced to buy only securities deemed safe with the stamp of approval from the big 3 rating agencies.....the same ones that slapped "AAA" status on subprime garbage, so there is somewhat a floor to the bid.


Deleveraging and deflation should be the normal cure for the problem but no government want to face reality.

Finally, in a deflationary environment (the "value" of money is rising) a debt based currency simply vanish into thin air and debt becomes increasingly hard to be serviced....hyperinflation in the Weimar republic was a godsend for the German industrial and financial elite (owner of real productive assets) which was able to repay their debt with depreciating marks....when the currency was reduced to toilet paper they still owned the factories and real estate...owners of real producing assets come out ahead in a monetary "reset".


Everybody wants inflation (except pensioners) and NOBODY wants deflation


Inflation advantages:


- The working slaves can hope for increasing value for their homes (they plunge in a deflationary environment) and keep spending

- The government can reduce its real debt load and so the financial-industrial elite

- The financial oligarchy enjoy rising asset prices (they plunge with deflation)...and asset go up much faster than wages (the opposite it's true in a deflationary environment)


I do not buy this theory that the Fed really want deflation to engineer a debt-equity conversion in order to reduce leverage....too convoluted and not guaranteed to work.


What the Fed really want is a long period of sustained (but still under control) inflation..this is what they are shooting for. 


Hendry is an Hedge Fund manager...his investment horizon is measured in months not years

jdrose1985's picture


"Argentina, Brazil, Zimbabwe, Jugoslavia, Hungary...need more???"

These nations did not use a credit-based monetary system such as ours. Don't get me wrong, I'm not saying our system isn't rigged...but you're confusing currency with debt. You can print currency. You can't force people or corporations to take on debt.


"For many investors already (me included) the UST are not worth the paper they are printed on (with QE and "mysterious" buyers around), as far as I'm concerned the USD did reach the crack-up boom (loss of faith in the currency) already."

How many investors successfully shorted JGB?


Totally agreed re: aircraft carriers. Don't like it yet don't disagree.


RE: crack up boom and loss of faith in currency? Ask those who are on unemployment and with families to feed, debt to pay...what is their number one need? Currency.


I believe we are facing grocery inflation in a deflationary environment. Remember, gold could hyperinflate against food. The largest threat is not debt inflation/hyperinflation. There are a number of scenarios which I see playing out before a hyperinflation.


Hugh Hendry says this has Japan written all over it and having researched well past his insights, I totally agree. Those with cash will be picking shit up for pennies on the dollar when this deflation has run its course. No government can stop it unless we change our monetary system. Hugh has been risk averse since early '08. His investment horizon is such that he is always wrong...until proven right.





saturno_v's picture



Yes these nations used a credit based monetary system (all fiat currencies from the 20th century are)...and the blow up worked always in the same fashion...the Central Bank buys the government debt....


Japan never entered CPI always managed to have inflation in that department....but it had asset deflation.

Japan had the highest saving rate in the world, significant trade surplus and experienced deflation in a high growth world economy environment (demand for their products) the system could absorb their idiotic monetary policy.


They spend ton of money in bridges and train to the end of the day they still had state of the art infrastructure left...we are trillions into it and nothing to show for it..just zombie banks, no bridges...

We all know that, so far, they still can get away with 200% of Debt/GDP..I do not think our limit is that high...

"Ask those who are on unemployment and with families to feed, debt to pay...what is their number one need? Currency."


The crack-up boom would start from outside not inside (think, for example, about the mythical failed bond auction goldbugs are waiting for) and that is particularly disruptive in a heavy import dependant economy.....I'm not saying it will happen for sure nor anybody can pinpoint when it will...but if exporters start to refuse US dollars, it is a matter of time that it will propagate to the local population.


Starving Argentinians or Zimbabweans wanted dollars, euros or even gold not Pesos or ZWD.


Yes hyperinflation and deflation can co-exist in different categories...for example we are experiencing fairly high inflation in food and energy and serious deflation in real estate...even in Zimbabwe price of luxury goods and real estate actually declined in real term (who could afford it??)

Hyperinflation usually hit the hardest in goods the people need the most (food, energy and other necessities)


I totally agree that deflation in the current situation is the natural course of event...however  TPTB want avoid that scenario and they will use every weapon at their disposal to do so...deflation is kryptonite for a debt based fiat currency....nobody wants it....if the only solution is to hyperinflate they will...again, owner or real productive assets (the oligarchy) will come out mostly unscathed.


Argentina experienced deflation just prior the hyperinflationary collapse.....monetary authorities always think that they can pull the plug just in time....not it doesn't work that way...once the trust is gone, it's gone.


The math is very simple...a credit based currency need constant increase in the debt level to sustain itself...deflation is not contemplated.

jdrose1985's picture

thanks for your insights...I appreciate it.


I really wish I had more time to study..I work full time as an electrician and about 80% of my spare time is invested in designing a highly profitable small metal fabrication business doing business signs and estate gates. My focus is becoming "too small to fail" and targeting wealthy individuals whom I have a lot of contacts with. Especially people in the equine business. Anyways.


I'm by no means married to my views. All i can do is read as much as possible and look for the truth which lies some place in the middle.


The number one thing which I keep in front of my mind is that we hold the world reserve currency. IF it were to hyperinflate, the ensuing shit storm would be so spectacular as to totally explode the world supply chain. Gold bugs harping on and on and on for this scenario don't fully understand what they wish for, IMO. A new dark age is not something i wish for. However, I have retained some physical AU/AG in case i am wrong.


Gold is not the panacea. learning to be self sufficient, having a place to escape to far away from roving bands of mad max style hillbillies, learning basic medical care, etc will prepare you for an event far more  than having a pile of gold which would be sniffed out and stolen from your possession about 3 minutes after you tried to redeem some for food.


The powers that be are not so willing to give up their strangle hold over debt holders, i think. I know many people loaded to the gills with debt who are virtually slaves. Americans are so docile as to allow TARP, etc and not do a fucking thing about it. They will continue to lay down and take it up the ass, dry. Deflation is highly beneficial to me who pays up front for everything and has no debt, mortgage, etc.


I look at it like we are entering WWIII which is looking like a repeat of WWII, albeit a financial war. No matter how painful it gets here, the rest of the world is in far more trouble IMO. In the land of the blind, the proverbial one-eyed man is king. Agreed?



Anonymous's picture

"You can't force people or corporations to take on debt."

The government can force you to do a lot of things if they really want. They can put you in jail or they can send you to die in a foreign country.

They can even bail out AIG to save GS.

They don't even need to force you, they can e.g. offer "tax incentives".

And they can change the rules: if the current monetary system stalls, just change it. First, there was consumer credit. Then, there were government deficits. Now, we have QE. Just imagine, there might be further ways to throw fresh money into existence...

jdrose1985's picture

Okay, I give you that much. I've done a stretch in prison myself, basically a political prisoner as it was drug related. Anyways.

Why or how is our situation today so different than Japan? They've done QE 1, 3, 7, 11, etc. 0% interest rates for a long time.

This time it's different this time, right?

The system will collapse, this much we can all agree on. The quadrillion dollar question is...when?

kurt_cagle's picture

Not sure that everyone would rather have inflation. Deflation has its own benefits:

  • Reduces the net imbalance between the haves and have-nots. For those on salaries (vs. investment income) deflation may mean a loss of perhaps 10-15% of their earning power, but for investors, deflation is typically far more devastating.
  • Eliminates under-competitive businesses or those whose business model no longer reflects reality, making way for alternative approaches. While the number of businesses started during deflationary periods remains more or less constant, the number of successful businesses after a decade is far higher for those started in deflationary periods, because the poor businesses are weeded out more quickly.
  • Establishes stronger fiscal discipline among both consumers and businesses.
  • Recalibrates notions of value and credit viability to more properly reflect the real world values of assets.

Recessions are the financial equivalent of diets - unpleasant to go through, but the results, in the long run, are usually healthier systems.

kurt_cagle's picture

Of course, this also rests on what seems curiously to have become a heretical notion - that giving more purchasing power to the consumer in the long run is ultimately a good thing. Most contemporary financial investment activity is not in fact to spur the development of better businesses - it is to seek the highest yield and highest dividends from that investments, usually based upon what amounts to gambling on Markov Chains (Drunkard's Walk).

As such, it is in fact typically a drain upon the economy overall. The irony is that someone with a net worth of $100 million dollars spends far less into the economy overall than 2,000 people with a net worth of $50,000, which means that the more super millionaires and billionaires you have, the less economic activity you have. While you can tax the billionaires more, most simply move their real assets into non-taxable vehicles. Thus, in the long run the only way of increasing the velocity of money (economic activity) is to deflate.

saturno_v's picture




These are exactly the reasons why TPTB do not want deflation.

I agree that deflation should be the way to go.

Orly's picture

Don't "wake up" just yet.

As the central banks rotate through currency weakness (first the dollar, now the euro, next the yen...), watch for USD to continue losing strength against the Japanese yen.  Once the euro has tanked against all the majors (and we have about three months more to go in that regime...), the spring will be wound so tight for an upside burst in the USD/JPY pair.

Look to get long the dollar v. the yen at about the end of May.  The bounce off the near all-time lows is going to be the trade of a lifetime.

Make you rich.


trav7777's picture

Dude...are you serious?

Look, man, the Fed is CHOCK FULL of crap mortgages.

The USG and the 50 States are BANKRUPT.

The debts CANNOT be repaid in today's dollars!  It's as simple as that.  We're simply bankrupt under any accounting analysis.

Dollars MUST be devalued because the government and all the other sovereigns OWE MORE OF THEM than they can get!

jdrose1985's picture

Trav I respect what you say, I see you writing a lot of good stuff.

What've we printed...2-3 trillion? What's that in the face of a 15 trillion evaporation? There is a shortage of dollars. I'm not saying the system wont fail.


Can anyone get their mind around the fact that markets dont crash...they are crashed?


Easy way to fund government a stock market/real estate collapse, driving capital into UST. Did you not know, the Fed is offloading those crap mortgages into the MMMF's? After they wash their hands, look out below in equity markets.

THE DORK OF CORK's picture

Hey we just want to get fed and hang around the sty , we don't want no trouble

Anonymous's picture

this is more voodoo economics...if this author thinks that deleveraging is moving debt from the private sector to the publc or the fed, he is advocating shell games..."Now if you have deleveraging as the main driving force, you can only achieve that goal, really, if you switch the debt from the private sector to the public sector."....

so i bequeath this quack the double fucktard award for his keynesian horsecrap and his shell game hocum....

Gordon Shumway's picture

Not directly related but I have not seen posted anywhere on the site yet, and though it was pretty awesome

Anonymous's picture

That was fucking great!

Anonymous's picture

Thanks for that. It feels good to laugh once and awhile.

JohnG's picture

Keynes mixed the Kool Aid first....

Anton LaVey's picture

This was posted on ZH weeks ago.

buzzsaw99's picture

Bennie is pumping the banks full of copious bucks while bleeding the rest of us dry. He pumps with one hand and strangles with the other.

Anonymous's picture



aurum's picture

do you all realize that we CANNOT have deflation and we cannot have a strong dollar...there is no possible way to repay 100 trillion in obligations without inflation....otherwise we default...its simple math

THE DORK OF CORK's picture

What about those special purpose vehicles ......

Lloyd fire up those engines we have some more ungodly work to do

 - Oh I love it when we get all Greccey Mammon -

Anonymous's picture

The private sector debt is MUCH larger than the gargantuan federal debt of 14 trillion... The private sector is paying down more debt than even our glutunous government can borrow. Game over, deflation is here.

faustian bargain's picture

excellent, Smithers.