The Biggest Deleveraging in History has Begun

The biggest deleveraging in history has just begun, and it can't be stopped. The global financial system has more leverage than it ever has in history. Whether you want to take a look at the national debt, almost $31 trillion, or household debt skyrocketing to all-time highs, or the debt that corporations have on their balance sheets right now, levels never before seen, or the amount of loans outstanding that banks have issued. By any measure, we are more over-leveraged today than we've ever been in history. And that just looks at the debt; that doesn't even take into account the derivatives market, which by many estimates is many times larger than the debt.

And one thing is certain about leverage: that it is always followed by deleveraging. It is not avoidable. And given the sudden collapse of systemically important banks like Silicon Valley Bank and Credit Suisse, it looks clear right now that a deflationary deleveraging has begun. The only question is, how far will it go?

Now, if you've been watching my channel for a while, you may recognize that in September of 2021, I made a video about this very topic, saying that the deleveraging would be coming soon and that it could not be stopped. Well, now the deleveraging has begun, and so I am updating this topic with a new video explaining what is going on right now and where we may head now that it has actually started.

First, we have to understand the nature of what leverage really is. When I talk about leverage here, most of what I'm talking about is debt. When we talk about debt, a lot of times we miss what is actually happening. In its most basic form, debt is pulling purchasing power from the future into the present. Take, for example, your own individual paycheck. Let's say you make $10,000 in one month. The only way for you to spend more than $10,000 in one month is if you have saved money from a prior month or if you will save money in a future month. So, you make $10,000 and you want to spend $11,000. Let's say you've never saved, so every single month you've spent 100% of your paycheck and you have no savings. You're going to have to swipe the credit card. You're going to borrow that $1,000 to be able to spend $11,000 this month. But that means next month, when that bill comes due, you're only going to be able to spend $9,000 because that extra $1,000 from your $10,000 paycheck will have to go to pay the credit card company back. Leverage is followed by a deleveraging.

Now, that's a personal example, but it fits with the entire economy as well. That's still how it works because an economy is just made up of a bunch of different individuals who all have their own debt balances, their own incomes, and their own expenses. And so, as debt builds up in the system, that's just another way of saying a lot of individuals have a lot of debt that they owe back. And so, what follows that is deleveraging. And many times, at least for individuals and households, that is through austerity, which is one method of deleveraging. That simply means you take your future income that you've already spent, and it goes towards deleveraging, paying off that debt.

This is an example of a deflationary deleveraging because when that debt gets spent, those are new dollars being loaned into existence, so the money supply increases. And to the extent the money supply increases, prices go up. If the money supply were to double, then prices on average would also likely somewhat double. This is why when they printed $3 trillion in 2020, eventually we saw prices start to skyrocket upwards as that new money worked its way throughout the economy. And then, if that debt does get paid off through a deleveraging, a deflationary deleveraging with austerity, then you would see prices come back down as the money supply shrinks back down to where it was as that debt gets paid off.

Now, normally throughout history, this is what happened. You had booms and busts that took place as a result of the money supply being artificially expanded and then it contracting as the debt grew, and then the deflation happened as the deleveraging happened and prices fell back down to where they were before the boom and bust cycle. Now, recently, central planners have tried to avoid the boom-bust cycle from happening. And so they do things to try and keep the boom keeping on going. Even though that's not possible, this means when the bust does start, it's just actually a lot worse. So instead of austerity fixing the slightly big problem and getting back to normal, then you have defaults happen, and it is much more painful.

Go back to your own individual situation again. You have $10,000 as your income, but you load up on a bunch of debt and you spend $100,000 on your credit card. You're not going to be able to pay that off next month because you only make $10 grand. And so you might not even be able to pay that off in the next year or two. So you might just say, you know what, and let's say, for example, you lose your job. Well, you default on this. And so because of that economic pain and that default, your credit score takes a dump. Now you don't have enough money to pay back your other debt, your interest rates skyrocket, you can't roll over your balance to a new card. Financially, you are in severe economic pain. All would have been avoided if you wouldn't have taken on that $100,000 credit card debt that first month. So the greater the boom from the credit expansion, the greater the bust. Since it can't be handled through austerity, you get the defaults again. Still a deflationary bust here because no money to go around, less money to go around, can't afford stuff.

But as we all know, over the past few decades, central planners have gotten very skilled at prolonging the boom. Is this going to make the deleveraging worse? Yes. However, it does mean that we haven't experienced a deflationary deleveraging in a long time, to the point where many people think it's not possible anymore. And because of this, throughout history, we've seen examples of inflationary deleveraging. So how would this look from a personal example? You'll find out at the end that this is a little bit of a bad example, but just hang with me for a second here. You make $10,000. You take out $1,000 on your credit card. But next month, when you go to pay that back, you actually got a raise at your job. You got a new skill, you got a promotion, so you're making $11,000 now. And so you're able to take that additional income to pay off the debt. Or maybe you buy a car when you're making $10,000, and your overall expenses go up by $300, but you get a raise that more than pays for that $300 extra every single month. In either case, you've got more dollars coming in, and so that allows you to deleverage, or at least not experience the pain of that deleveraging, because the additional dollars coming into your local system pay for it.

This is where we have a little bit of a breakdown between individual actions and the system as a whole. Because when we go out of the system, we realize that the only way for more money to come into the system is not from increased productivity, not from increased wealth, but from printing. And so when the national debt skyrockets like this, and the United States government needs to borrow more and more money, they don't have enough people to borrow from. So they go to the central bank, the Fed, and the Fed prints money into existence in order to lend to the United States government. This means that the United States government can pay off its old debt, roll over its debt, pay off its old bonds with newly printed dollars. Inflationary deleveraging.

There's another form of inflationary deleveraging as well, beyond just printing. And that is jubilees. Jubilee is an Old Testament biblical word that just means debt forgiveness. And so we are seeing this pop up from time to time as well. When you see things like student loan forgiveness being talked about, when you see things like mortgage payments not needing to get paid for a year, two years, when you see interest rates move extremely low, and people are able to get new debt to pay off their old debt, and their new payment is a lot lower. These are all forms of partial or full debt forgiveness, debt jubilees. These increase the total money supply, decrease the debt burden, the service cost of that debt. And so these are deleveraging through inflation.

But as we all know, there's no free lunch. And the inflationary deleveragings just make things more expensive. That's because you don't create more wealth, you just create more money. And so when you're comparing apples to apples and you disregard price, what happens in either case? Whether you're deleveraging through deflation or deleveraging through inflation, the net result of both, again, ignoring price, is that it's harder to get the things you need. It's harder to afford the things you need. Whether you have less money to buy things at the same prices, or you have more money to buy things at even higher prices, it is costlier to afford to get the things you need. This is a mark of deleveraging. Whether the deleveraging looks like lower prices or the deleveraging looks like higher prices, it's a deleveraging either way.

Now, we had a couple of years of inflation following the attempt by central planners to stop the crash, prolong the boom by printing money. That didn't work. And now the deflationary deleveraging has begun. We are seeing bank failures. We are seeing political action to increase regulations, which makes it harder to make money. Deflationary. We are seeing banks tightening their lending standards across the board for all forms of debt, whether mortgages, auto loans, or other. Deflationary deleveraging has begun.

Now, I want to pause and address the default situation because many people are confused at how defaults could be a deflationary deleveraging. Wouldn't they be inflationary? So we take, for example, our individual who makes $10 grand, spends a grand on a credit card, and then defaults. You would look at that and say, hey, if he's not paying that debt back, then those dollars are still out there in circulation, and so that would be inflationary. If those dollars get paid back, that would be deflationary. But if he defaults, those dollars are still in circulation. And on a very small scale, this can be true. But on a wide scale, every person's income is another person's expenses. One person's bank deposit is another person's loan, which is another person's deposit, which is another person's loan. And so when we get something like large defaults, we experience default deflation. Just like we're experiencing with Silicon Valley Bank right now. Everybody tries to go get their dollars for one reason or another. Well, guess what? Banks actually don't have your money. Bank shuts down. Now all those dollars that people thought were there, everybody realizes and is now officially zero. That money's not there, which means that that money now can't be used and sent as their expense to somebody else's income. And that means that next person has a high degree of likelihood of defaulting themselves. And as that contagion spreads, we see that dollars we thought were in the system suddenly vanish, officially and really vanish. And so on a large scale, defaults turn deflationary because the dollars that we think are there are actually not there. If the debt gets defaulted on to too high of a degree, and that one dollar that got loaned from me to you to somebody else to somebody else to somebody else, 50 times, now every single step along the way, those dollars go from one dollar to zero dollars. And the total dollars in the system shrink rapidly as the defaults roll through.

But the question with all of this is, how far will it go? Will we see another Great Depression era of deleveraging through deflation, where the money supply shrinks to the point where you can't even get $10, you can't even find $5, it costs a penny for a loaf of bread? Well, most likely no. If you take a look at the Federal Reserve's balance sheet, they were trying to stop inflation for a while, so they were letting assets bleed off their balance sheet. But over the last week, to deal with the fallout of the banks, they've increased the size of their balance sheet by $300 billion. This happened through their new facility, the Bank Term Funding Program, which offers loans of up to one year in length to banks. This allows banks to take their assets like treasuries that are underwater, they're worth less than what they paid for them. They can loan them for full price to the Federal Reserve, and the Federal Reserve will give the banks cash for those. These are loans of up to one year. And so that trade, at least for now, they say will have to be unwound. And so it's possible that the Federal Reserve ending QT and restarting QE with a bang may not be inflationary. And in fact, that's what many very smart people are saying. I'm going to have to do a deep dive and make a video on that for you next.

But that's not the only thing the Federal Reserve does. Fed also raises interest rates, and they have been doing that to fight inflation. And economists are now wondering whether the Federal Reserve will continue to hike rates because banks have started to collapse. And if they stop hiking rates too early, or if they even start to lower rates, these would be considered highly inflationary moves, especially considering they haven't yet killed inflation. It is still running hot. And so because of the inflation problem, many people still expect the Federal Reserve to hike too much instead of not hiking enough. So it is possible that we see a resurgence in inflation, and this deleveraging tips over into an inflationary deleveraging rather than a deflationary one. But as of right now, all signs are still pointing to a deflationary deleveraging.

It's important to note that there is economic pain either way. When you remove price from the equation, the actual experience that people go through is, I don't have enough money to get the stuff that I need or want. Whether that happens through the amount of money you have decreasing facing more than the prices decrease, or whether that happens through prices increasing greater than the amount of money you have increases, either way, that's what deleveragings look like. So why is that? It's because leverage is spending future purchasing power, not future dollars, future purchasing power. So when we lever up as individuals or as a total economy, we are spending the purchasing power from the future, bringing it into the present. That means when we get forward into the future, the purchasing power itself has already been spent. Whether that shows up by prices skyrocketing and we don't have enough money to buy those higher prices, or whether that lack of purchasing shows up through prices falling, but the amount of money we have falls more, so we don't have enough purchasing power to buy this stuff either way, that's how the economic pain shows up because the deleveraging is the realization that that purchasing power has already been spent.

Which brings up the big question. The biggest question is, is it possible to avoid this pain? Not the deleveraging, but the pain? Because the deleveraging happens no matter what. That future purchasing power has already been spent, and that can't be avoided, can't be changed. But can the pain of experiencing the deleveraging be changed? And the answer surprisingly is yes. We've been here before. If we take a look at 1946, when the debt to GDP ratio was at its first all-time high, we were able to come down from that. That was as a result of a massive increase in productive output. So yes, we were deleveraging, but at the same time, we were increasing the amount of wealth. We are increasing the amount of wealth, stuff, goods, services, at a much faster pace than the deleveraging. This goes back to why I said in the beginning of the video, the example of the individual who makes $10,000, then gets a raise to pay off his debt. Well, I said that was a bad example of that, because really, that's a good example of increasing productive output. Yes, you're deleveraging, but you don't experience the pain of deleveraging because you have more wealth to compensate you for that. Yes, the future purchasing power was spent in the past, but you don't feel the pain of that because there's so much more wealth now to compensate.

So systemically, yes, we absolutely can avoid the pain of deleveraging by having an equal or greater increase in productive output. Usually, that means more employees, more workers, more people, more immigrants, or more people who are not working joining the workforce or working towards creating wealth, not necessarily getting a job, but creating their own companies, creating products, goods, services. But you can't control what other people do. You can't control the regulations, you can't control the interest rates, you can't control the inflation, you can't control the deflation. All you can control is yourself.

So individually, is it possible to avoid the pain of deleveraging? And the answer again is yes. Thankfully, the answer is actually the same: increasing productive output. So you'd experience the most pain individually if you de-leverage through defaulting. You want to avoid that. So the best way is to do it with a combination of austerity and increasing productivity, increasing your individual income. You can't save your way to a million dollars if you're making $10,000 a year. So yes, you need to make sure that you are saving, but you can't just focus on that, you also have to increase your income. Nobody ever became a millionaire from coupon clipping. You have to live below your means, and you have to increase your means. It's not one or the other, it is both. It is starting a side hustle, starting your businesses, starting consulting, doing things on the side, learning skills to get the promotion, to get the raise, to become more valuable to your company, to your customers, to your businesses. And it is also not blowing all that. It is deleveraging as you increase the income, getting rid of the risk, deleveraging, but not having to experience the pain of that deleveraging because you're not doing it through strict austerity and trying to pay off $100,000 when you're only making $30,000 a year. It's increasing your own productive output while you're being smart with what you make.

And whether we as a whole experience the inflationary deleveraging or the deflationary deleveraging, that combo of being smart with what you make, keeping as much as possible, but also making more and more and more, will be the key is the equation to success in either outcome. Because the primary problem in deflation is the cost of the debt. So de-leverage. The primary problem in inflation is not enough money. So make more money. Living within your means plus increasing your means equals success through deleveraging, no matter what type.

As always, really appreciate you guys. Thank you so much for watching. Have a great day.