Gold, Price Stability & Credit Bubbles

http://azizonomics.com/2012/08/06/gold-price-stability-credit-bubbles/

The Japanese example shows that crashed modern economies with excessive debt loads can remain stagnant for long periods of time. My view is that such nations are in a deleveraging trap; Japan (and more recently the Western nations) hit an excessive level of debt relative to GDP and industry at the peak of the bubble. As debt rises, debt servicing costs rise, leaving less income for investment, consumption, etc.

Throughout Japan’s lost decade, and indeed the years that followed, total debt levels (measured in GDP) have remained consistently high. Simply, the central bank did not devalue by anywhere near enough to decrease the real debt load, but nor have they devalued too little to result in a large-scale liquidation episode. They have just kept the economy in stasis, with enough liquidity to keep the debt serviceable, and not enough to really allow for severe reduction. The main change has been a transfer of debt from the private sector, to the public sector (a phenomenon which is also occurring in the United States and United Kingdom).

Eventually — because the costs of the deleveraging trap makes organically growth very difficult — the debt will either be forgiven, inflated or defaulted away. Endless rounds of tepid QE (which is debt additive, and so adds to the debt problem) just postpone that difficult decision. The deleveraging trap preserves the value of past debts at the cost of future growth.

Under the harsh discipline of a gold standard, such prevarication is not possible. Without the ability to inflate, overleveraged banks, individuals and governments would default on their debt. Income would rapidly fall, and economies would likely deflate and become severely depressed.

Yet liquidation is not all bad.

Although liquidation episodes are painful, the clear benefit is that a big crash and depression clears out old debt. Under the present regimes, the weight of old debt remains a burden to the economy.