A popular theme in the financial media is to talk about deleveraging.
We don’t see it. The alleged “deleveraging” that began in 2007 is barely a small dent in an otherwise hockey stick growth curve in credit instruments.
Here’s a closeup of the alleged period of “deleveraging.” Does this look like a cleaning house for the financial system? We didn’t even unwind $2 trillion… less than 4% of the credit instruments that existed at the time.
Why is deleveraging so terrifying to the Fed?
Take a look at this chart comparing total credit instruments to the Gross Domestic Product. If anything shows how absurdly leveraged the US financial system has become, this is it.
Things were relatively normal until the 1990s at which point debt/ credit began to grow exponentially.
It’s not as this bubble of debt was buying rapid economic growth either.
· In the 1960s every new $1 in debt bought nearly $1 in GDP growth.
· In the 70s it began to fall as the debt climbed.
· By the time we hit the ‘80s and ‘90s, each new $1 in debt bought only $0.30-$0.50 in GDP growth.
· And today, each new $1 in debt buys only $0.10 in GDP growth at best.
Put another way, the growth of the last three decades, but especially of the last 5-10 years, has been driven by a greater and greater amount of debt. This is why the Fed has been so concerned about interest rates.
Have we reached the end of this debt-fueled bubble? Looking at that chart compared to other bubbles (2000 Tech bubble, the current Biotech bubble), we have not quite reached escape velocity just yet. But we're getting close.
The Fed managed to pull a rabbit out of a hat last time... by resorting to extraordinary policies. In doing so, it's used up most of its ammo. So there's no telling what will happen if we get another systemic deleveraging again.
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Phoenix Capital Research