Deflation = Debt + Demographics + Disruption... But Mostly Debt

One week ago, we showed a quick and simple primer by Bank of America explaining why the pervasive global deflationary wave (in the monetary sense, not in the soaring rent and unprecedented tuition and drug costs - remember, those are simply hedonically adjusted away by the CPI to where they cease to exist) blanketing the world can be explained by the three Ds: debt, demographics and disruption.

This is what BofA said:

  • Disruption: Technological innovation and disruption are driving many goods & service sector prices lower (rent & health care are two important exceptions); extending human life and the propensity to save; fostering wage and job insecurity.
  • Demographics: The size of the working population of the developed world peaked in 2011 and will fall from 833 million to 799 million by 2025, putting downward pressure on potential growth and inflation (Chart 3). And by 2050, the world’s “Silver Generation” will increase by 885 million people, many of whom will save more in anticipation of old age.
  • Debt: Minimal deleveraging since the GFC and a large debt overhang remain impediments to nominal growth; global debt as a % of GDP actually rose from 162% in 2001 to 211% in 2013, an all-time high.

Today, a quick follow up is in order because as CLSA's Chris Wood points out, by far the most important of these three "D's" is debt.  Debt, which ironically, has been unleashed by the very central banks whose stated intention is to push core inflation to a stable 2% annual increase, and instead they have blanketed the world with an insurmountable cover of leverage which no longer can be "grown into" and thus can either be defaulted away or simply hyperinflated.

Here is Chris Wood:

A question raised by an investor in Canada this week makes it clear to GREED & fear that a point of clarification is due. This is that quanto easing is not the core reason that velocity has continued to decline. Rather the core reason is the excessive amount of debt in the system, an amount that has continued to grow since the financial crisis in 2008 as highlighted in a McKinsey report which attracted a lot of publicity when published earlier this year (see McKinsey Global Institute report “Debt and (not much) deleveraging”, February 2015). For the record, McKinsey estimated that aggregate global debt has grown by US$57tn from US$142tn in 2007 to US$199tn at the end of 2Q14, raising the ratio of global debt to GDP by 17 percentage points to 286% (see Figure 15).



If the growing level of aggregate debt is the core reason for velocity’s decline, GREED & fear’s point is that the introduction of quanto easing has failed to combat the continuing decline of velocity but has in fact further contributed to it, as outlined in the manner discussed here last week. Meanwhile, the only way to get velocity to pick up in a benign way is to write off the debt by a meaningful amount. That would have helped in the 2008 global financial crisis if more losses had been imposed on creditors. There then would have been a V-shaped rebound in velocity similar to what happened in the Asian Crisis....



.... But that obviously did not happen in 2008 as the policymakers demonstrated that they did not believe in capitalism. Otherwise, the only other way velocity picks up is by an unhealthy hyperinflationary surge reflecting a loss of confidence in central banks, an outcome that becomes more plausible the more extreme the resort to quantitative easing.

This, in a few very simple sentences, explains what we have said all along: the longer the Fed and its peer banks engage in QE, ZIRP, NIRP, and other zero cost of debt-enabling policies, the longer the deflationary period will last, and the more violent the hyperinflationary endgame, as the inevitable helicopter money is finally unleashed, will be.