Guest Post: The Deleveraging Trap

Tyler Durden's picture

Submitted by John Aziz of Azizonomics

The Deleveraging Trap

Hayekians and Minskians agree on one key thing: an increase in debt beyond the underlying productive economy is unsustainable.

In my view, the key figures in defining this are total debt as a percentage of GDP, and its relationship with industrial production. Debt as a percentage of GDP tracks how much debt there is relative to one measure of economic activity, GDP. Yet GDP is a very limited tool of measurement; all GDP really tracks is the circulation of money. To get a clearer sense of the true relationship with underlying productivity, it is useful to compare the ratio of debt-to-GDP with the level of industrial production.

Up ’til the ’70s, debt-to-GDP grew more slowly than industrial production. That is healthy and sustainable. While the total market debt may grow in tandem with GDP, and with industrial production — indeed, this can be the case even under a gold exchange standard (as the gold supply increases) — there is no sensible reason for the ratio of debt-to-GDP to grow faster than industrial production. Indeed, this is symptomatic of just one thing — consumption without income, enjoyment without effort, living beyond the means of productivity. This is just an unsustainable bubble.

As the ’90s turned to the ’00s and the United States gains in industrial production ceased to accumulate, while GDP and most concerningly (and hilariously) while the debt-to-GDP ratio continued to increase. This was classical bubble behaviour, and the end came very poetically; the recession and the industrial production collapse hit just as growth in the debt to GDP ratio (as indexed against 1953 levels) finally surpassed growth in industrial production. Indeed, I hypothesise that a very strong indicator of a Minsky moment — when excessive indebtedness forces systemic deleveraging, leading to price falls, leading to widespread economic contraction — is the point when long-term growth in the debt-to-GDP ratio exceeds long-term growth in industrial output.

The debt-to-GDP ratio is gradually falling, yet it is still at a far higher level than the historical average, and it is still proportionately higher than industrial output. And at the same time, consumers are re-leveraging, and government debt is soaring. And industrial production is barely above where it it was a decade ago, and far below its pre-2000 trend line. We have barely started, and already this has been a slow and grinding deleveraging; rather than the quick and brutal liquidation like that seen in 1907 where the banking system was effectively forced into bailing itself out, the stimulationist policies of low rates, quantitative easing and fiscal stimulus have kept in business zombie companies and institutions carrying absurd debt loads. Like Japan who experienced a similar debt-driven bubble in the late ’80s and early ’90s, we in the West appear to have embarked on a low-growth, high-unemployment period of deleveraging; and like Japan, we appear to be simply transferring the bulk of the debt load from the private sector to the public, without making any real impact in the total debt level, or any serious reduction in the debt-to-GDP ratio. 

Cutting spending — for both the private sector and public sector — is problematic. My spending is your income; as spending falls, income falls, which leads to more consumers, producers and governments attempting to deleverage. This leads to more monetary easing, simply to keep the zombie system stable, and keep the zombie debt serviceable. More consumers and producers can take on debt, at least for a time, but the high residual debt level makes any great expansion of productivity or growth challenging, as consumers and producers remain focussed on paying down the pre-existing debt load. It is a vicious cycle.

Quantitative easing does not even tackle the main challenge: reducing the debt load. In fact, it is targeted at precisely the opposite — increasing the debt load, by encouraging lendingBut lending into a society that is already heavily indebted leads to no great uptick in productivity, because consumers and producers are already over-indebted to begin with, so few can afford new debt. And banks — flush with cash — have no real incentive to lend; the less they lend, the more deflationary conditions are prone to become, increasing the purchasing power of their excess reserves (on which the central bank already pays interest). The outcome is greater economic stagnation, ’til the next round of monetary easing which leads to a brief uptick, and then further stagnation.

To break out of the deleveraging trap, the debt load needs to be drastically reduced. In my mind there are three potential pathways there, each with various drawbacks and advantages:

  1. Liquidation; when a debt-driven crash happens, the central bank stands back and lets it happen, as happened in 1907. Prices will drastically fall, many companies and banks and debt will be liquidated, until the point at which prices have fallen to a sustainable level. But we may have missed the boat — the crash already happened, the system has already been bailed out, and the financial system today has already become zombified. And under a system where the central bank determines the availability of money and the level of interest rates this approach has in the past led to excessive central-bank-enforced liquidation, from which the economy may struggle to recover, as happened after 1929.
  2. (Hyper)inflation; the central bank prints money and injects it into the economy via the banking system. Prices rise, wages rise, and the nominal debt remains the same, thus reducing the debt burden. While most economists who advocate such an approach advocate a slightly elevated level of inflation, the higher the rate of inflation, the more the residual debt load will be devalued; under a Weimar-style regime, mortgages could be repaid in a week. Unfortunately inflation is nonuniform; whoever gets the money first (i.e. banks) can buy up assets on the cheap, and pass the cost of the inflation down the chain of transactions. As Keynes himself noted: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.” Inflation discourages savings and capital formation, which are necessary for new growth. And most significantly — as the Fed’s experiment with QE shows — inflation unless it is very severe will not even necessarily have much bearing on reducing the debt-to-GDP load. The results of a severe (hyper)inflation could be very chaotic and dangerous.
  3. Debt Jubilee; the central bank prints money, and injects it into the economy via the citizens, with the explicit condition that they use it to clear their debts. This will have the desirable effect of directly reducing debt levels, and lifting over-indebted consumers and producers out of the deleveraging trap. Additionally, the inflation would be uniform and so not to the advantage of the banks or the financial elite. However introducing a large quantity of money to the system — even directly as a medium for debt-cancellation — does itself carry a high inflationary potential.

Certainly, the current status quo of high unemployment, low growth, sustained over-indebtedness and zombie banks and corporations surviving on government handouts is not sustainable in the long run. We shall see which route out of the deleveraging trap we take. Liquidationism seems unlikely, as central banks are afraid of the concept. Inflation (or its unintentional corollary, currency collapse) seems risky and dangerous. A debt jubilee would at least address the real problem of excessive debt, although it is in modern times uncharted territory, and would surely face much political opposition.

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fonzannoon's picture

So is the debt jubilee the $3,000 for "thingamajigs" and how does that not lead to hyperinflation? Also how do our creditors feel about watching Americans paying down debts with money out of thin air? Or maybe they won't ever get a lunch break at Foxconn to notice?

FEDbuster's picture

Right now "money out of thin air" flows to some in the form of EBT, welfare, medicaid, housing vouchers, etc....  Others are getting money for nothing and lending it to the government with a 2 pt. spread to give to the first group.  The money for nothing comes out of thin air at the FED, beneficiaries are it's member/owner banksters.  Politicians get to kick the collapse can down the road and buy some votes.

It would be nice to see the FED drop $10K in the mail to everyone that earns between $5K and $250K to be used to pay off debt, invest it or buy some crap with it.   That way the "free" money just doesn't flow to the bottom 25% or the top 1%, throw a bone to the 74% in between.

fourchan's picture

why would the slave owner reverse the process that took 100 years to complete.


the program of enslaving a free society to debt, and confiscating all the property, has worked perfectly.


Bob Sacamano's picture

"The program" worked masterfully for those who decided to become enslaved to debt.  Some who lived significantly below their means for decades (and therefore did not fully "enjoy" the debt financed consumption binge of the past 40 years) have fared better.  Although the inflation ramp game plan outlined in #2 and #3 of the Aziz post above is squarely directed at punishing the prudent in favor of the irresponsible (which seems to be the chief role of government). 

sessinpo's picture

My post is not specifically to Bob but to all the above. Quantative easing in any manner does not solve the problem because it does not teach the abusers to manage their money properly. Even Steve Keen is wrong on that and I will leave it at that.

vmromk's picture

My friend, your articles are for the most part spot-on, however you state: "the crash has already happened".

Unforunately, what happened in 2008/2009 was not the crash.

The real crash will take place when the derivatives bubble holding interest rates low for US Treasurys collapses. The first sign of which reared its head in J.P. Morgan's book. No paper asset will be safe. Everything paper will become "worthless".

As Bachman-Turner-Overdrive sang: "you ain't seen nothing yet."

Aziz's picture

Sure. There will be bigger crashes down the road unless we deal with the excessive credit creation problem (derivatives and shadow intermediation are both symptoms that if plotted in the graph would make the data FAR uglier). Liquidation would quickly and very, very painfully fix it. The problem is that central bankers will not let markets liquidate. So the next bailout, and the bailout after are already kind of written in stone unless (say) Jim Grant becomes Fed chairman (unlikely). So we have to deal with the status quo, which is likely to get very ugly whichever way we go.

kito's picture

debt to gdp ratio is whaaat? Falling???

caustixoid's picture

Good work kito.  whaaat? indeed.  Economic growth is flat and trillion-dollar deficits as far as the eye can see -- the debt-to-GDP ratio is now increasing almost linearly.   Perhaps it's the growth in debt-to-GDP ratio that's "falling"?!?  (because it's a $1.2T deficit instead of $1.6T???  woo-hoo!)

Then there's this statement: "there is no sensible reason for the ratio of debt-to-GDP to grow faster than industrial production".   Since we've reached Keynesian stimulus exhaustion I think the correct statement is "there is no sensible reason for the debt-to-GDP ratio to grow".


vmromk's picture

Bernanke and his cohorts are most certainly dealing with the excessive credit creation, by doing all they can to create more credit. Hence, this is the precise reason why the government is on a borrowing and spending binge. If Bernanke does not create more credit this year than the credit + interest accrued in the prior year, we will see a deflationary spiral the likes mankind has never seen.

Bernanke has already stated he will not allow deflation to happen.

Deflation has already begun.

You will see the deflation's acceleration when the S&P drops 20-30% by election time.  That is when uncle Ben takes out the bazooka and launches a massive QEIII.

Only problem is that when QEIII gets announced, countries like dominoes, will begin to renounce usage of the dollar. That is when the derivatives bubble will begin to blow and when gold and silver go parabolic.

fourchan's picture

the fed only counts core ie wage inflation, we have exported all our jobs and all possability of wage inflation.


get ready for 5 dollar a gallon milk and 10 dollar a gallon gas, neither of which would move the fed.

Caviar Emptor's picture

Heard a commentator on MSM radio today cheering that credit card use is up!! But still 10% below pre-crisis levels. 

Think about what a horrible tel that is: today people use credit cards for a cup of coffee, and all sorts of stuff that were always paid in cash before, with credit cards reserved for big ticket items. Better credit card swipe technology has amde it all possible. 

So despite increased use of credit cards for convenience and just because plastic is so cool and cash is soooo 2007, we are STILL 10% BELOW pre-crisis levels!! Joe public sure ain't the big spender he/she used to be

fonzannoon's picture

so would you want to own stock in a CC company knowing people are paying 29% interest or would you want to short them knowing no one can pay 29% interest?


sosoome's picture

I don't think CC companirs carry that debt; they are in it for the fees.

fonzannoon's picture

fair point and I am not sure. I guess my question is who takes it in the nuts when people tell the cc companies to eat that debt?

chunkylover42's picture

CC companies like V and MA don't bear the risk of the debt, they just process the payment (and collect fees along the way).  The card-issuing bank eats the defaults when they occur and holds reserves against future defaults.

DFS, AXP and COF do bear the risk of the debt in addition to operating payment networks.  They hold reserves against future defaults also. 

CrashisOptimistic's picture

Yet another analysis oblivious to oil scarcity and its complete trumping effect on all other matters.

roccman's picture



most all are.


oil...smoil...we don't need no stinking oil...wez gotz 1 billion years on.

NidStyles's picture

Oil has no effect on Inflation. Try again.

sessinpo's picture

Incorrect. Any commodity that is a cost to input (input is a additional price to produce or transport the product) has an effect. The truth is that there is no oil scarcity. Add to that is there are alternatives to oil in the form of other carbon fuels such as natural gas.

You are correct that the original poster should try again with real facts and logic.

Whoa Dammit's picture

OT: FBI offers $20,000 reward for small fry bankster  (Doesn't say if he's wanted dead or alive). 

There seems to be an alarming new trend in banking of falsifying investment account statements (see PFG). Perhaps there is a DIY chain letter circulating amongst the banksters recommending this scam with how to instructions...


"During an 18 month period, federal investigators believe Price stole, misappropriated and embezzled over $21 million from MB&T. To cover up his fraud, investigators say Price also provided bank officials with bogus account statements which falsely indicated the bank's capital was safely held in an account at a financial services firm."

 "Wendy Cross said she invested $300,000 with Price, and months of bogus statements from Price's investment firm led her to believe she had about $360,000 in her accounts.         

She said she had worked her entire adult life to save that money for her retirement. She currently runs a food truck which she may have to sell."

Bobbyrib's picture

You get your reward right after Corzine gets indicted..

Tirpitz's picture

"...there is no sensible reason for the ratio of debt-to-GDP to grow faster than industrial production."

Unless I want to enslave a populace by the chain of debt.

NidStyles's picture

Exactly, but this writer can't understand that little detail, much like the majority of the populace. 

NidStyles's picture

This article argues from the basic standpoint that the Central Banking systems are in control, and have nothing to do with the current situation. It also give the impression that the Central Banks and printing are the solution, while suggesting that the previous situation of 1907 was a period when the Central bank had a clue. There were no Central bankers in the country in 1907. The key distinction between then and now should be pointed out, but this writer failed to do so. 


The Central Bank and single currency without tangible value is the problem, not any of the crap this writer suggests. 

earleflorida's picture

the content that Aziz fails to mention should be a prerequisite for most if not all ZH's to have foretold knowledge of,... or would you prefer a dissertation that your small mind would find drooling off into a confused state

Aziz's picture

Two points:

1/ In 1907 there was no central bank; the central bank was created in 1913. So, yeah.

2/ I have written lots of articles on ZH talking about negative changes directly correlated with going off the gold exchange standard in 1971; massive increase in income inequality, massive decrease in total factor productivity, massive increase in M2 above the productive capacity, massive increase in bank assets, etc.

So, yeah. There's no chance central banks today will try and return to the gold standard. People who want to have gold need to buy their own.

Bobbyrib's picture

I suggest they don't buy gold through electronic transactions. Buy in cash and don't let anyone know you have it. When the dollar eventually collapses, the thieves will be looking for anything of value to rob next.

sessinpo's picture

Income inequality was greater in 1929 then now.

Hype Alert's picture

Unfortunately inflation is nonuniform; whoever gets the money first (i.e. banks) can buy up assets on the cheap, and pass the cost of the inflation down the chain of transactions. As Keynes himself noted: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

Hello!  Ever wonder why the FED targets 2% inflation?  Look at what that does to your retirement savings over your lifetime!   Whatever happened to the mandate of stable prices?


As for #3, With all the baby boomers that are close to retirement, this would and is wiping out their nest egg for the few that have them.  The inflation might be uniform, but the ability to survive would not.  Plus, as the younger people saw what happened to their parents when their lifelong savings vaporized via inflation, there would be zero incentive to save.  Which fits right into the government's playbook to rely on it cradle to grave.

NidStyles's picture

I've often argued that Inflation can be measured linearly, but the cheapening of goods due to advances in manufacturing reduces the prices of said good, which gives the impression that those said goods have had stable prices. This in turn makes it appear to the masses that their purchasing power has remained reletively unchanged, when in fact it has not. 

Bobportlandor's picture

"advances in manufacturing"

along with shipping of jobs overseas.

Soon wages will bottom and there will be knowhere to hide the inflation.

fonzannoon's picture

if the younger people watch their inheritance vaporize that would leave them with what assets they have managed to save themselves which is squat.  I guess if that is in their playbook then it's checkmate.

eaglefalcon's picture

I guess if that's in their checkbook then it's their playmate

Bobbyrib's picture

It's true that they will have a hell of a lot less than the Baby Boomers, but if they invest it properly then they could be OK.

michigan independant's picture

Thats the rub for sure for any savers of inflation theft, finanacial repression on interest rate, and the final event for Plan O on the hill when the election is done they invade many portend. A lifetime of work to fund those who cannot understand the leviathon as they deride boomers against x and gen y in there smug beltway hubris. We will see soon enough because they do not even pretend anymore and the taxpayer vote means nothing since the FDR takeover as to size up to the threat matrix of intent.

eddiebe's picture

"Keynes himself noted: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.” Inflation discourages savings and capital formation"


This is exactly what is happening. Great if you are a bankster.

q99x2's picture

Let me live in a country with and Open Source Closed Monetary System and I'll care not who controls their army nor their politicians.

Hedgetard55's picture

So, we can solve the problem by printing money and giving it to the 99%? Cool, let's do it. Uh, how many trillions does Ben need to print?

steve from virginia's picture


First of all, the central banks cannot create anything new, they cannot create value, they cannot cause inflation because they are collateral constrained.

If central banks offer unsecured loans under current (or other) circumstances they are instantly insolvent, there is no lender of last resort. The outcome is catastrophic. Why do you think the central bankers are not offering more credit now? They are both collateral- and credibility constrained. They can lend no more because there is little remaining good collateral, if they lend they are as bankrupt as their clients, themselves insolvent b/c of leveraged lending.

The private sector creates new money by making unsecured loans. The finance sector has been front-running a recovery since 2009. It has not arrived and cannot because the affordable resources required-to-waste do not exist.

Jubilees cannot work because industrial enterprises require debt to function at all. Forgive the debt on Monday and new debt in amounts equal to that forgiven will be needed by Wednesday. Otherwise, there are no pet industrial enterprises.

There is no such thing as a productive industrial economy. All industrial enterprises are children of debt and entirely dependent upon more of it. To believe there are productive industrial enterprises is to believe in fairy tales. What industrialization does is steal from the many to give to the few. Better to cut the few's heads off with samurai swords and be done with it.

Life is easy for the bankers now but finance is in the crosshairs and the precious private sector. At some point blood will run in the streets and it won't be a metaphor.


Bill Shockley's picture


Some methods of industrial production are more productive than others, like the assembly line for instance. Henry Ford was the hero of many old company men for good reason.

It is the corporations that are unproductive, it's their blood that will run and should.

Companies will return after the reset.

Now for the rich in amerika. These fuckers don't need to deleverage or if they do it's a painless process therefore I recommend anal electricution for them as a wake up call.

It's a system that sucks who pays Stevo. That's how they like it.

The rich and the corporate live in a bubble, not me/us.

Read 1984 and A Tale of Two Cities. It's either rats in the face or chop chop.

Guns and Gold, a bicycle, a garden, a kayak, farm land, a big dual sport motorcycle, firewood.

A good woman.

Welcome to my life.



oops, forgot the family, sons and grandchildren, stable relationships, busy hands, solid skills in mechanics and carpentry. Those without are fucked or have a learning curve to work out. Well they probably plan to scram the country or live like rats. Goodby, good luck.


sessinpo's picture

Collateral constrained? Let me introduce you to rehypothocation. How about fractional reserve banking? How about having paper markets that well exceed the physical markets ability to deliver? How about being on the verge of collapse and having the government (tax payer) bail you out? How about taking your toxic non performing assets and throwing them into another subsiderary so it's off your main books?

dangni's picture

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Stuck on Zero's picture

Winston Churchill said it.  The United States will try everything imagineable before taking the right course of action.  There are not just 3 ways to deleverage.  There are hundreds.  The U.S. will try every single one before doing something right.  An the current regime in Washington will err on the side of the banksters every single time.


Bobbyrib's picture

The Fed is doing the right thing right now (nothing). Churchill had his own agenda and was not to be trusted.

Bear's picture

The First Default comes from the First One:

Mr. Obama on 12/12/2012:

"We have to do something about our future right now, or when it comes it won't be there. In light of this I am issuing my 478'th Executive Order: "Invest in America Now" … which when enacted will bring an end to the oppressive debt that has been heaped upon the next generation through high cost universities and higher education institutions. To accomplish this I have asked Treasury Secretary Geithner to notify all student loan holders that they are no longer required to make payments on their loans. After careful consultation with the FASB, I have determined that these loans can appropriately be marked to market and they can consequently be written off immediately as worthless assets of the Federal Government." 

Bobbyrib's picture

You can dream, but that will not happen.