Wednesday, January 4, 2012

Must Reading: The Great Deleveraging

FT's Alphaville blog has must reading for anyone trying to understand our economy these days.  They quote Bill Gross of the bond company Pimco, a market authority, in his attempt to describe the Great Deleveraging we are seeing.  I touched on this in a previous post that tried to explain our balance of payments crisis and the underlying structural imbalances.  Gross is talking about the private lending that buoyed the system and underwrote these imbalances.

Since 1971, when the U.S. went off the gold standard and the Bretton Woods system evaporated, banks have been able to use "credit and the expansion of debt to drive growth and prosperity" with no anchor.  Credit became "a substitution for investment in tangible real things - plant, equipment, and an educated labor force."  The Great Recession of 2008 marked the limit of this credit expansion, or leveraging.  Gross goes on to say, "The financial markets are slowly imploding - delevering - because there's too much paper and too little trust."  Because the system cannot create any more credit, it must deleverage.

The FT's blogger, Izabella Kaminska summarizes, "Whether it's via deflation or inflation, time depreciation of money (or wealth) is now guaranteed."  That is scary stuff.  What is scarier is that if capital continues to flow into safe securities, it will "lead to an inevitable giant tidal wave of deflation" just like the Great Depression.

The only out of this, in their telling, is for the government to encourage the money "to flow into productive assets," i.e., invested in real things such as plant, people, and infrastructure.  This is the role that I think the welfare state must take, both investing in public goods and encouraging private investment in productive assets, rather than paper.


  1. As a sidenote, I'm the son of a MBA who specialized in finance; my dad's a big fan of Bill Gross (he gives you what he thinks for free, in PDF format no less!), and I've acquired a taste by osmosis. That is the problem with the welfare state, no, isn't it? - the rent-seeking and inefficient porkbarrel politics of elected officials means that coherent policy is hard to maintain. (For a somewhat similar although not identical take, see Olson, "Rise and Fall.") Hence, investment in public goods, private investment in productive assets, etc., is perhaps at a suboptimal level. Maybe the capitalist developmental state (Chalmers Johnson's moniker, I think) - the East Asian Tigers are what I have in mind - are the way to go, although I'm not sure the Japanese stagflation of the last 20-odd years or the 1998 Asian financial crisis (crisis of the chaebols, etc.) would bear this out.

    Incidentally, I stole this from Drezner's FP blog - although I've been a fan of the Eurasia Group some time, albeit with limited access to their product(s) - and you might be particularly interested in #3 and Eurozone under "Red Herrings."


  2. ADTS,
    Yes, it is Chalmers Johnson. And I cite Olson's "Rise and Fall" in the book and mention it in the article since I'm hoping against hope to publish it somewhere that doesn't use citations. This is all much more fascinating than what I'm about to go do at work, which is write information papers that won't be read...