Most Important Concepts:

Action Points:

• The time to purchase debt is after the deleveraging process, when the central bank links the currency to a hard one.

Chapter Recap:

Introduction

Part 1: Overview of the big debt cycle

1 - The big debt cycle in a tiny nutshell

• For the short-term debt cycle, its contraction phase can be reversed with a heavy dose of money and credit.
  • But the long-term debt cycle’s contraction phase cannot because noone will want to hold debt assets that they believe are poor storeholds of wealth.

2 - The mechanics in words and concepts

• Ray’s model for price = amount spent / quantity sold.
• The rate of change in buying debt will inevitably slow because the buying is being financed by financial institutions leveraging up their balance sheets, and that would have to slow as they reached their regulatory leverage limits.
• What separates a sustainable debt cycle from an unsustainable one is whether the debt creates sufficient income to pay for the debt service.
• A sure sign of moving toward a debt crisis is when there is a large and rising amount of borrowing that is being used to pay for debt service.

3 - The mechanics in numbers and equations

• To calculate the severity of the debt burden, consider:
  • Future debts relative to future income.
  • Future debt service relative to future income.
  • Nominal interest rates relative to a) inflation rates and b) nominal income growth rates.
  • Debts and debt service relative to savings (e.g. reserves).

Part 2: The archetypical sequence leading to central governments and central banks going broke

4 - The archetypical sequence

• Sequences differ between cases involving hard money vs fiat money.
• Currency regimes typically go back and forth between hard and fiat because they each led to extreme consequences and required movements to the opposite.
  • Hard currency regimes broke down with big devaluations because the governments couldn’t maintain debt growth in line with their monetary constraints.
  • Fiat currency regimes broke down because of the loss of faith in the debt/money being a safe storehold of value.
• Nine stages of the final crisis:
  1. The private sector and government get deep in debt.
  2. The private sector suffers a debt crisis, and the central government gets deeper in debt to help the private sector.
  3. The central government experiences a debt squeeze in which the free-market demand for its debt falls short of the supply of it.
  4. The selling of government debt leads to a simultaneous:
     1. Free market driven tightening of money and credit, which leads to
     2. A weakening of the economy
     3. Declining reserves, and
     4. Downward pressure on the currency.
  5. When there is a debt crisis and interest rates can’t be lowered, the central bank prints money and buys bonds to try to keep long rates down and to ease credit to make it easier to service debt.
  6. If the selling continues and interest rates continue to rise, the central bank begins to lose money. This becomes a big red flag when the central bank has a significant negative net worth and is forced to print more money to cover the negative cash flow.
  7. Debts are restructured and devalued.
  8. At such times, extraordinary policies like extraordinary taxes and capital controls are commonly imposed.
  9. The develeraging process reduces the debt burdens and creates the return to equilibrium.