The Debt Bubble is Deflating

Dear Reader,

The world as we have created it is a process of our thinking. It cannot be changed without changing our thinking.

Albert Einstein

The 22 April 2020 issue of The Rum Rebellion included this chart on US inflation.

For all our lives we’ve been conditioned to believe inflation was an always and everywhere constant.

And the trajectory of that blue line since 1970, is why that belief was not only well-founded, but rock solid.

The Rum Rebellion

Source: Business Insider

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The Fed (and other central banks) had done an exceptional job at consigning deflation to the history books.

Deflation was yesterday’s problem. Inflation was the economic nirvana.

With the right amount of coaxing from fiscal (government spending and taxing) policy and monetary (interest rates) policy, the economy would purr along nicely.

Growth, growth and more growth. What’s not to like about that?

So convinced (or perhaps, conceited) were the central bankers in their ability to apply the ‘not too heavy and not too light’ touch to the economic levers, they even came up with ‘targeted inflation’.

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To quote directly from the Fed and RBA sites…

To meet the price stability objective, [US] Federal Reserve policymakers target an inflation rate of 2 percent.

To achieve price stability, the Reserve Bank uses a flexible medium-term inflation target, with the goal of keeping inflation between 2 and 3 per cent, on average, over time.

Just dial it up or down. What clever little models these PhDs come up with.

But in the real world, there’s a big difference between having a target and hitting it.

After the Fed went ballistic with stimulus measures in 2008/09, the widespread belief was inflation would go well beyond the target.

The prospect of Argentina, Weimar Republic and Zimbabwe sent gold soaring towards US$2000/oz.

But inflation (at least to the level desired by central banks and even more coveted by gold bugs) did not materialise.

Like the Scarlet Pimpernel, inflation was sought here, there and everywhere. But it remained a little elusive.

The upshot of all those decades of growth was too much debt and too much excess capacity in the global system.

Supply and demand are out of kilter.

Inflating the debt bubble was easy

Too many things being produced for people with too few discretionary dollars/euro/yen/renminbi.

With debt commitments to meet, people cannot buy things like they used to…hence the need to have sale signs permanently displayed in shop windows.

Inflating the debt bubble was easy. Making more and more money available at cheaper and cheaper rates doesn’t require any great skill.

In the main, the herd is…well, a herd. Playing follow the leader is one of mankind’s great character flaws. The central bankers know that. The financial institutions know that. It’s just a pity more people didn’t know that.

However, market forces have a way of bringing society up to speed with what happens when, collectively, we indulge in too much ‘cheap money’.

The growth disruptor is called a debt crisis. But some crises are bigger than others.

To paraphrase Mick ‘Crocodile’ Dundee, ‘2008 wasn’t a debt crisis, this (one now) is a debt crisis’.

In 2008, global debt was US$140 trillion. Today, it’s north of US$255 trillion.

Bigger numbers. Bigger crisis. Again, it doesn’t require too much skill or genius to figure that out.

The easy part was blowing it up (as in inflating it). The hard part is to stop it from blowing up.

This is when the numbskulls running the show hurriedly start placing patches on any hissing sound coming from the debt bubble.

Psssshhh…recently downgraded corporate debt, here’s a US$750 billion patch. Quick over here, insolvent states have popped a gasket, whack a trillion-dollar patch on that one!

In some cases, the patches are not big enough or thick enough to cover the leaks. These temporary measures are going to require further reinforcements later.

And, in a bubble this size, there are some leaks for which no patches can be applied.

The following chart — from Deutsche Bank — is an excellent graphic on the pressure that’s been building within the bubble and the size of the patches needed to repair the leaks.

The thin blue line is the G7 Debt to GDP ratio (RHS).

For a little insight on the scale of dollars behind that rising ratio…

Year G7 GDP in USD Inflation adjusted to 2020 dollars % of Debt to GDP USD value

of G7 debt

Population Debt per capita


1970 $  1.9 trillion $13.0 trillion 140% $18.0 trillion 570 million $32,000
2020 $34.0 trillion $34.0 trillion 300% $102.0 trillion 750 million $136,000

On an inflation and population adjusted basis, over the past 50 years, debt has increased more than fourfold.

The dark blue bars (LHS) represent the US dollar value of G7 central bank bailout measures to the various crises since 1970.

The Rum Rebellion

Source: Deutsche Bank

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While the debt bubble was in its early days, the patches were minor…hardly noticeable.

As the debt pressure builds within the system, the scale of the response has escalated.

Look at this latest one…wow! It towers over all the rest. Unbelievable.

That should tell you just how much pressure is in the system.

Trying to keep that pressure confined within the bubble means that many more blue bars are destined to populate this chart in the coming months and years.

The size of that blue bar is what’s (once again) quickened the pulse rate of those advocating a precious metals inflation hedge.

In the longer term — when those anticipated future blue bars dwarf the current one — I expect we’ll see inflation.

But in the interim, it’s looking like deflation is coming to a town near you.

And here’s why.

According to Bond Economics (emphasis added):

The breakeven inflation rate is a market-based measure of expected inflation. It is the difference between the yield of a nominal bond and an inflation-linked bond of the same maturity.

Since investors’ money is on the line, they presumably have an interest in pricing inflation correctly. It is viewed as a more reliable measure of inflation expectations than those measured by surveys. 

Those with a serious amount of skin in the game are placing their ‘bets’ — via the bond market — on a deflationary future.

The following chart tracks the difference between the yield of a nominal bond and an inflation-linked bond for one, two, three, four, five and greater than five-year durations. 

The Rum Rebellion

Source: EPB Macro Research

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The one-year (black line) is currently pricing inflation at around the MINUS 2%. For the record MINUS inflation is actually…deflation.

The three-year (red line) is at ZERO. No inflation for three years.

Even if we look beyond five years, the forecast 1.5% rate is lower than the Fed’s targeted rate.

When you ask yourself why the bond market is not seeing any inflation for the foreseeable future, the only answer is the debt bubble is — in net terms — deflating.

And what I mean by ‘net terms’ is, the amount escaping (defaulting) is greater than the stimulus (blue bar/s) being added.

With each negative inflation reading and GDP number, expect to see the Fed manning the pumps.

Bigger blue bars will appear. But to no great avail. Why?

A few years of deflation will have cured households of the dreaded debt disease.

In an environment where a saved dollar increases in purchasing power, money in the bank becomes attractive. Savings up. Debt down. That’s a complete change of thinking.

Professional investors in the bond market have twigged to society’s altered mindset.

The average mum and dad investor should consider doing likewise.


Vern Gowdie,
Editor, The Rum Rebellion

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Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

The Rum Rebellion