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The Long-Term Debt Cycle: How Did We Get Here and What's Next

Published 04/13/2023, 09:09 AM
Updated 07/09/2023, 06:31 AM

Long-term, structural economic growth is mostly driven by two factors: demographics and productivity.

Both peaked in the late 80s, and we chose to fix the problem with a ton of debt.

It worked until now, but we are at very late stages of the long-term debt cycle.

Healthy demographics and high fertility rates facilitate a growing labor force: retirees are more than offset by new young workers, and hence the share of working-age population as % of total increases.

More workers, more potential for growth.

Over the next decades though, the share of working-age population will decline across many countries: for instance, the Chinese workforce is likely to shrink by 250-300 million people – a hard hit for global growth.

Working Age Population

Total factor productivity (TFP) growth measures how productive are capital and labor resources.

Effective capital allocation and technological progress contribute to achieving positive productivity growth.

As the marginal benefit from technological progress declines over time and capital misallocation took center stage over the last 1-2 decades, TFP growth stagnated around 1% per year – not exciting.

US Productivity Growth By Decade

As per the early 90s, labor force and productivity growth trends weakened materially.

Potential GDP growth started declining to socially and politically unacceptable levels – so, how did we fix that?

With a ton of debt.

Public + private debt levels as % of GDP amongst developed economies skyrocketed from

Total Economy Debt as % of GDP

Be it mostly through government (Japan) or the private sector (China), credit creation was the ‘’easy fix’’.

To be precise: cheaper and cheaper credit.

Real interest rates relentlessly declined for 3 decades, allowing a system with lower structural growth offset by more and more leverage at cheaper and cheaper borrowing costs to thrive.

The more unproductive debt, the lower real yields must be for the system to survive.

US 30-Yr Real Yields Chart

This long-term debt cycle is at its very last innings.

Fighting inflation requires higher real yields, and our over-leveraged system can’t bear that.

And once you deleverage a credit-based system, it’s hard to get it back on its feet.

Just ask Japan.

***

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Latest comments

The solution to the problem is simple, increase money supply and make available interest free loans for anybody to start anything they want - let his go on and on for a decades, let the environment and children pay for it... oh wait, that's what we've been doing! Oh well - might as well play the game out and see where we land.
Great start is to write off the excessive public pensions and start from zero. Millions back to work after short government work stints. Then set a minimum federal tax in America and problem solved.
Great article! Economy always looked to me pyramidal, like a Ponzi scheme. It seems that, lacking productivity, economy maybe is a Ponzi scheme based in demography and debt!!!
Humanity is a ponzi scheme
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