I read an interesting article this weekend by Ray Dalio, of Bridgewater Associates, about deleveraging. He contends that all countries pass through a similar cycle of leveraging up through the use of credit, followed by a phase of deleveraging to return debt-to-income ratios to manageable levels. Deleveraging can occur in four different ways:
1) debt reduction (default, negotiating lower payments, etc)
2) austerity (no new debt)
3) transferring wealth from the haves to the have-nots (taxes on the rich)
4) debt monetization (printing money). Whether or not the deleveraging is painful depends on the mix of methods used.
For the past two decades, Japan has been going through an ugly deflationary deleveraging. Generally speaking, to lower the debt/income ratio countries must have nominal GDP growth in excess of nominal interest rates. Japan has attempted to do this by monetizing its debt, but it has not done it aggressively enough to be effective. Consequently, while the private sector has lowered its debt levels, the government has expanded its balance sheet to prevent massive deflation. It has not been able to do enough, and Japan has suffered from deflation for over two decades.
All of this is about to change as Japan’s premier Shinzo Abe announced this weekend an all-out assault on deflation through aggressive monetization of the country’s debt until inflation hits 2 percent. If successful, this may be what Japan needs to stimulate nominal growth in excess of its nominal interest rate, lowering its debt/income ratio. Interestingly, in the early 1930’s under Takahashi Korekiyo, Japan attempted the same thing and ultimately devalued its currency by 40 percent. The policy was successful, but, following Takahashi’s assassination, policy degraded and hyperinflation set in.
Here at CLS, we believe in investing internationally. As part of our commitment to clients, we continually educate ourselves on historic cycles and current events so that we can make the best allocation decisions.
Comments provided by guest writer Matt Chadwell, CLS Investment Research Analyst.