Guest Post: The Downward Spiral

Tyler Durden's picture

Submitted by John Aziz of Azizonomics blog,

There was once a rough and logical correlation between the level of government borrowing, and the rate of interest on government debt. If the government borrowed more money, the cost of borrowing rose and the private market’s appetite for government debt fell. But that correlation totally broke down around the year 2000:


During the George W. Bush Presidency we saw interest rates remain low, even while borrowing spiked. And during the post-Bush recession we saw borrowing spike to a 30-year high while interest rates crawled lower. During the Obama Presidency, borrowing has inched downward but only to Bush-era levels, and rates have slunk ever lower.

This is weird, counter-intuitive stuff. My logical intuition is that all things being equal, a higher government demand for credit would tend to result in higher borrowing costs. Certainly, there are all manner of other factors like growth, stock prices, growth expectations and the private appetite for debt that might influence interest rates. But given that the intuitive relationship held roughly up ’til the year 2000, it is rather peculiar that it would suddenly break down.

We can explain the lowness of Treasury rates during the Bush years. Treasury rates are strongly correlated with the Federal funds rate:


Greenspan kept the Federal Funds rate low even while large debt-fuelled asset price gains were being recorded in stocks and housing:


Greenspan hiked rates, eventually, but it was too little too late. And a huge debt bubble (defined here in terms of total debt as a percentage of GDP) had formed by the time Bernanke became the Fed Chairman:

fredgraph (18)

Of course, in addition to keeping interest rates at zero, the Fed has expanded its balance sheet by over two trillion, removing Treasuries and various securitised debt from the market, with the intention of further depressing aggregate interest rates. (Although some say that quantitative easing raises interest rates through the expectations channel, the empirical record is clear that every single nation that has engaged in quantitative easing has ended up with lower interest rates following the implementation of that policy).

So the story that prevails is that total debt climbed to an unsustainable level supported by the Federal Reserve’s low-interest policy regime. The divergence of government borrowing levels from government borrowing costs around 2000 was an early warning sign that the markets were filled with distortions. And the 30-year trend of falling interest rates and rising debt was another early warning sign.

In 2008 we hit the Minsky moment, and today we are in the deleveraging phase. The market distortions remain huge — interest rates remain at zero, even while housing and stock prices begin to reflate. The spread between government borrowing costs and government borrowing levels remains huge. And the long, slow grind back to a sustainable debt-to-GDP ratio is slow and depressionary. Japan hit their Minsky moment in the 1990s, and today still remain trapped in the deleveraging phase. While private debt levels have fallen, government debt levels have grown to be the highest in the developed world, and the private sector — encumbered by demographic problems such as a shrinking, ageing population — seems to have little appetite to take on new debt. The Japanese economy remains weak and growthless.

The question that remains unknown is how the distortions will resolve. Will they resolve gradually over a matter of years or decades, or will they resolve quickly and brutally? Well, the speed of private deleveraging tends to suggest that we will not meet another Minsky moment in the immediate future:

While America is nowhere near a sustainable level at well over 240%, at least the trend is downward toward the more-sustainable 1990s, 1980s and 1970s levels. So while the Fed is resorting to more extreme forms of the same policies that fuelled the 00s debt bubble, it is seeming less and less likely that the result - a blowout top in private debt levels, followed by a crushing deflation - will be the same.

Instead, we should probably look to Japan where the economy has remained depressed and weak for the past twenty years, and where government debt has through cycles of stimulus and austerity replaced the private deleveraging. Perhaps Japan is an extreme example, and perhaps its demographic woes have prolonged its malaise. Perhaps that means that once the United States private debt level shrinks to a more sustainable level, the United States will enjoy solid new growth, rather than continued depression. Perhaps a new technological or energy revolution will result in falling energy and transport costs, providing America with a new growth engine for the next twenty years. Perhaps we can look at the low interest rate environment as an opportunity to invest in transport infrastructure, energy infrastructure and basic research and create a backbone for the post-depressionary economy. On the other hand, perhaps a new crisis — and one that won’t go away just by throwing money at it, like a natural disaster, or a war — will suck America into an even deeper depression.

I am more optimistic than I was five years ago, or even one year ago. I can see a light at the end of the tunnel, but is still possible that this crisis may end in war or total systemic failure.

In the long run, the data is clear. The Greenspan-Bernanke era Federal Reserve wilfully built up bubbles and distortions, which grew out of control, and sucked the economy into a black hole. At the very best, this has led to a Japanese-style depression.

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A Lunatic's picture

So do you think it's too late to fix this with a Willy Nelson/Bono Economic Aid Concert??

I think I need to buy a gun's picture

buffett will be on cnbc monday morning maybe he'll offer to cancel his social security and if we are lucky his secretary's too......

we all know he doesn't like touching gold and him and charlie will offer none to the country

CPL's picture

Buffet has all the gold would ever need from the 60's and 70's.  Of course he wouldn't buy it if he's got a proper hoard of it, he's had a bio written about him every two years as part of his marketing push.  Check it out, he's played with shiny objects.  He's just really old and memories are short.

Fredo Corleone's picture

"My logical intuition is that all things being equal, a higher government demand for credit would tend to result in higher borrowing costs."

Not to put too fine a point on it, John, but what Institution of Higher Printing has been the predominant Buyer of Record of said newly-issued government debt securities, thus artificially suppressing interest rates across the duration spectrum ? I shall give you a hint: its balance sheet is at all-time, trillion-dollar highs, and its Chairman sports a beard.

Cognitive Dissonance's picture

Can you give me another hint? I almost have it figured out. :)

Spirit Of Truth's picture

Monetarism is the false religion of Mammon.  Our currency states "IN GOD WE TRUST", but the god should be small cap.  The beauty of Capitalism and what really makes it work for society is that profits accrue to those who discover and implement more efficient ways for waring for one another.  However, the pursuit of profit in and of itself can undermine the whole "value maximization" driven by "care", and this is where the system stands today.  Ben and his ilk are leading the charge in the inevitable undoing of free markets out of their love for money instead of God.


MisterMousePotato's picture

Again, the ZH arrow thingie lets us down by just allowing one clap.

Bill Shockley's picture

Anybody know which way coupon rates are going on asset backed commercial paper?


Up or we deleverage?


DoChenRollingBearing's picture

It´s too late to fix, PERIOD.  Save what you can, especially hard assets, because the end will be very ugly.  I do not share John´s view as things being slightly more positive-looking than a year ago.

NOTHING has been solved.

StychoKiller's picture

Oh, but sequestration is gonna cut Govt spending soooo hard...

Gad, that Koolaid tastes nasty!

economics9698's picture

It is already deleveraging, just waiting for the Muppets to realize it.

McMolotov's picture

"I am more optimistic than I was five years ago, or even one year ago. I can see a light at the end of the tunnel..."

That's probably the flash from the mushroom cloud that you're seeing. The shockwave will arrive eventually.

Osmium's picture

Evidently he does not live on the same planet that we do.

bank guy in Brussels's picture

Had a good laugh over this

The young Mr Aziz is amazingly optimistic there will be no crash

Despite 600 trillion of notional derivatives going bust, and the Western banking system going down with it

Yes it would be great if the Western future were *only* as bad as Japan's last 23 years

However ...


Nu Yawks hottest club is's picture

Agreed. I saw this article as a 'cover your ass' play as every talking head likes to be able to claim they were at least partially right in an uncertain future, and given that he's trodden the 'the sky is falling' route pretty heavily ..

NotApplicable's picture

Give the kid another twenty years of experience, and I bet he won't fall for this Hopium again. I see it as the classic "we must be okay after all, as we should've been dead long ago" mindset.

In other words, it's a restatement of the idea that "the market can remain irrational longer than you can remain solvent." When the reset doesn't come right away, people start thinking perhaps it has been averted. Well, at least until they read Mises.

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

Pareto's picture

Exactly right.  The real economy has to produce enough "stuff" and fetch a high enough price to pay back the debt that is fueling the speculation in the non-wealth generating part of the eocnomy.  But, since you have too much money chasing too few goods (including assets) price rises and the real economy is unable (willing) to pay for "stuff" such that the net revenues from selling the "stuff" are large enough to pay for their cost of production, government taxes, yet still leave enough to service principal and interest.  There is no free lunch.  A debt fueled economy (whether it be for infrasture or whatever) and its first derivative is always negative.  The only time a debt fueled economy is a good idea, is when you don't have to pay it back....EVER.  But that's monetizing the debt.  That's inflation.  And that always ends bad, and certainly worse than any deflationary correction.

There is no light at the end of the tunnel.  Just NDAA officer flashlights coming down on his head for slowing down the food line.

mendigo's picture

While it would be nice to believe that people get what they deserve, I think that that is really just a fairytale used to keep the common folk in check - sort of like the meek shall inherit jack shit.

While it is possible or even likely that the whole thing will blow-up one day I think it is also possible that they will manage a contrlled decline marked by a waisting in the middle. I think there is evidence to say this is already well under way and we are truly enetering a dark age. Already it seems the desired outcome is for older people to giveup on trying to find real employment and we string them along on meager healthcare feed them dog food and cigaretts and big macks and let them die off prematurely or maybe mess with thier heads to get them to commit suicide. If they are so stupid as to keep reelecting the same jerks from the same two parties then they are only getting what they deserve

What I don't see is perspective. When did this manipulation begin in earnest?

fonzannoon's picture

John I usually like your stuff but you are off the charts here. How many on food stamps? How many out of the labor force? What's the student loan situation? People are going broke. Flat ass broke, and when they get there, there is no job for them to start over.

This is not people deleveraging. This is people being extinguished.

What happens the minute the fed takes their foot off the gas John? What happens to rates then? Please tell us about this light at the end of the tunnel.

McMolotov's picture

Unfortunately, the Nine Inch Nails song by the same name applies only too well to our situation:

"A lifetime of fucking things up fixed in one determined flash." —from The Downward Spiral

Nigh Eve's picture

I am about to go on food stamps, myself.
I used to make $84,000/ year.
Employers often tell me I'm overqualified for their openings.

I guess I should have started a business of some kind - but in what?

nightshiftsucks's picture

Thats going to be all of our stories soon.

AllWorkedUp's picture

Me fucking too. Over qualified for a $30,000 a year job a moron could do, much less someone with a brain.

Tango in the Blight's picture

Gravedigging. There's going to be much demand for that soon.

e-recep's picture

Good restaurants and coffee shops seem to be doing fine. But you have to be really good and I tell ya, it's not easy. And no, I don't mean franchise or chain type of thing. You gotta be unique. Well-to-do elderly people still pay quite a sum for good food.

moonstears's picture

Seeing how the dollar menu is keeping McDs afloat (actually it keeps them coming in and then buying the 400% marked up fountain sodas to wash it down), cheap but good home style fare is what I'd sell if I had restaurants.

nightshiftsucks's picture

Japan had trade supluses and a growing world economy,we have neither. Bye bye USA,you were once great.

Calmyourself's picture

Japan has not had 10,000 nukes, Aircraft carriers task groups, etc..  They will stay strong long after they "should" have gone down..

venturen's picture

The bubble is happening right now....check corn, gas, housing prices in certain markets.... Bernanke is going to make Greenspan look like a panty waste

I think I need to buy a gun's picture

thats called "growth" on cnbc

Bunga Bunga's picture

And when you take a look at Bitcoin prices, Bernanke is going to make Weimar look like a fart.

otto skorzeny's picture

I wish bitcoins were a tangible coin-because I would take a monster box of them and shove them up yours and CH1's ass sideways

Bunga Bunga's picture

Hey, your trollin' is fun, especially when it's based on really underinformed crap like yours.

otto skorzeny's picture

"waste"-great play on words

Charles Nelson Reilly's picture

"I am more optimistic than I was five years ago, or even one year ago. I can see a light at the end of the tunnel, but is still possible that this crisis may end in war or total systemic failure"

....... I'm not following your story arc here, John?

StychoKiller's picture

"What to do if you're trapped under a huge boulder with no hope of rescue:

First, consider how lucky you are that life has been good to you so far.  If, on the other hand, life hasn't been good to you so far, (which given your present circumstances, seems more likely) consider how lucky you are that it won't be troubling you much longer!"  -- Hitchiker's Guide to the Galaxy.


Rustysilver's picture

Meanwhile in US:

..." a new report shows a huge drop in what it average Americans are earning. According to Commerce Department personal income fell by three point 6% in January that's the biggest month to month -- like twenty years."

q99x2's picture

Thank God. There will be a world by the time I receive my PhD.

I knew everything was going to be ok. I just knew it.

TrustWho's picture

Please tell me you are getting a PhD in a real field.

WTFUD's picture

Yes! PHELATIO ( Gag Nam Style ) Honours Stylie

TrustWho's picture

Chimps can do it without any classes. If you borrow the funds and pay, they will teach. What a fucking bubble! (pun for emphasis)

WhiteNight123129's picture

WHat matters is not whether or not Japan did ~quantitative easing~. What matters is the magnitude of debt monetization. The monetary base of Japan grew by 5% between and prior to Fukushima in nominal terms. If the debt grew as fast, the ratio of debt to base money is unchanged = deflation.

To get out of deflation you need to shrink debt to base money. The Austrian school does that by wacking credit and massive bankruptcies, so did Iceland and Latvia and they are back on track quickly.

The Keynesian say it is too painful and we should play with the denominator (what the US is doing). The base money rises way faster than debt in the US as opposed to Japan.

Japan did not want to wack bad credit in teh bank neither explode the monetary base by 4 times in 5 years. So they are stuck with a large quantity of (bad) debt to base money. Germany is trying to do the same, which will make Europe stuck in permanent depression.

Choose your camp, either accept bankruptcies, or explode the monetary base, but the result should be the same, that is lower percentage of debt to base money, whether you are an Austrian or a Keynesian.

So the comparison with Japan is not appropriate because the bulk of the debt sold by the Japanese Gov was funded by existing deposit. In the US, since it is bought by the Fed instead of being debt it vanishing and so the US Gov instead has pure base money to spend in the economy. (The DEbt on the balance sheet being permanently rolled-over, it is not debt anymore. If you get base money in exchange for a promise to never repay, you have no debt but free money to spend).

So that is the key difference between Japan and US. That is also why you see now Japanese Yen weakening and Stock market rallying. You need to have a velocity of the base money expanding faster than debt to get out of deflation.


celtic_mist's picture

You epitomise the problem with economists, everything is relative, there is no fundamental base with which to measure. Basically, all economic commentators talk bullshit! That said, there are, as always, real worries about the economic future..

hardcleareye's picture

Excellent article!

AllWorkedUp's picture

and yet gold and silver and mining stocks go down every single fucking day. Why? Because everything we put our fucking hands on in every market is rigged.

These pieces of shit can keep this rigged, bullshit game going for fucking ever. No fear of reprisal, no fear of jail, no fear of any consequences at all.

I hear this "sky is falling crap" every day and guess what? The sky ain't falling yet! The recession/depression might or might not be here now, but they can paper it over to infinity with freebies for Joe six pack. Until the fucking sheep can't eat, the DOW will go up forever AND THERE WILL BE NO CONSEQUENCES FOR THE FINANCIAL CRIMINALS THAT WALK AMONGST THEM!

Thanks. I feel much better now.

fonzannoon's picture

calm down you are going to get your self all wor.....nevermind...

AUD's picture

No, it's because most gold and silver mining stocks don't mine any gold & silver, & even fewer pay a dividend if they do. They are up to their eyeballs in debt.

Most gold and silver mining stocks are Ponzi schemes, currently out of favour with the 'investment community'.

NotApplicable's picture

Not to mention that their debt is all collateralized with their properties (thanks to GS advisors, I believe).