The Debt Super Cycle Economic implications for investors

The ability to assume debt is an important tool for both the public and private sectors. It provides capital for various needs such as business expansion, new technology and infrastructure improvements. The use of debt to finance capital expansion is important to economic growth, but an over reliance on debt can have profound negative effects on the economy. Understanding the debt super cycle is important for investors in managing their assets. Roots of the Debt Super Cycle Prior to the Great Depression, policy makers embraced laissez faire economics. Laissez faire economics is an economic doctrine that opposes government regulation beyond minimal guidelines necessary for free-market systems to operate. In the early 20th Century, the policy of allowing markets to fluctuate freely without government interference resulted in a series of booms and busts, as well as widespread bankruptcies of debtors and banks. This led to the Great Depression which was marked by significant human pain and misery. Good Intentions After the Great Depression, policy makers wanted to minimize the negative effects of economic volatility in the future. Two predominant strategies emerged, Keynesian economics and monetary policy. Keynesian economics is based on the ideas of English economist John Maynard Keynes. It advocates an economy primarily driven by the private sector, but with significant public sector involvement. The use of monetary policy, which is the control of a countrys money supply, is often used to promote economic growth and stability. It is referred to as either being expansionary or contractionary. Expansionary policy increases the total supply of money in the economy more rapidly than usual. It is traditionally used to combat unemployment by lowering interest rates to provide easy credit to entice business expansion. Contractionary policy expands the money supply more slowly than usual. It is targeted at slowing inflation to avoid the devaluation of assets. Unintended Consequences The use of Keynesian and monetary economic policies after the Great Depression were successful. Compared to prior periods since 1945, economic volatility has been relatively mild. However, the process of stabilizing the economy with monetary policy and enacting tax policies which encourages borrowing, cumulative layers of debt grew which laid the foundation for bubbles and instability.

An economic bubble is the rise in the value of assets far beyond their normal levels. These conditions lead to rapid market corrections resulting in unintended consequences. The United States recently experienced this with the tech boom between 1998 and 2002, as well as high housing market inflation between 2003 and 2011. The U.S. Federal Reserves response to the bursting of the tech bubble was to cut interest rates 1% to head off a recession. This worked, but at the cost of sowing the seeds for the housing bubble, with even bigger excesses. The intervention of the Federal Reserve to lower the cost of borrowing increased debt and instability. Once housing values reached a level which could no longer be sustained, the housing market corrected itself, or crashed, as values rapidly fell back to normal levels. An Inflection Point: Gross Domestic Product (GPD) is the value of the countrys total production. Private sector debt has risen from 50% of GDP in 1950 to 160% today. Federal debt is estimated at 69% of GDP for 2011 and, assuming no changes in revenue or expenditure levels, is predicted to reach 350% of GDP in 2050. As this ratio of debt to GDP continues to rapidly increase, more market corrections will likely occur. These trends are worrisome, as economic growth rates and demographics can not support these spending levels. Consumers are not taking on more debt and the housing market has not been recovering as home equity is still falling. The National Federation of Independent Business (NFIB) reports that less than 30% of businesses are borrowing which is the lowest percentage in 25 years of its survey efforts. In addition, baby boomers, who are the population born at the end of WWII until 1960, are placing increasing demands on Medicare and Social Security as they age. With U.S. consumers and businesses not taking on more debt, policy makers have positioned the Federal government to assume an increased economic roll through the issuance public sector debt. Our national debt has now exceeded $15 Trillion, and will likely climb further as decreased revenues are available to reduce the debt burden. As this cycle continues, it will be increasingly difficult for the Federal government to borrow funds at reasonable rates. This may lead to government default on debt obligations and/or hyperinflation. Hyperinflation is the rapid rise of inflation levels which is often characterized by civil disorder. Professional Investment Advice: Clearly debt has played a significant role in economic expansion in recent decades. Without reducing debt levels in relation to GDP, economic instability will continue. Investors can successfully navigate the economic volatility caused by the debt super cycle using various themes. A professional financial advisor can help them manage their assets using market volatility measures, trading in

foreign currencies, buying precious metals, and investing in particular market sectors.
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Eric A. Greschner is a Managing Partner of Regatta Research & Money Management, LLC