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03_top.ipynb
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04_depression.ipynb
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README.md
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README.md

Classic Deflationary Debt Cycle:

  • Debt financed primarily in local currency -> Central bank able to print money in resolve
  • Debt service costs rising beyond economies ability to service
  • Deleveraging strategies put into place to safely and efficiently service debts neccessary to restabalize economy

Policy Maker Levers:

to bring debt and debt service levels back in equilibrium

Deflationary
  1. Austerity (spending less)
  2. Debt Defaults/Restructurings
Inflationary
  1. Central Bank "Printing Money" or Making Purchases/Providing Garuntees
Transfer of Wealth
  1. Money and Credit from the "Haves" to the "Have Nots"
  • Policy makers lower interest rates until they are so low they are no longer an effective tool
  • Print Money? Ofc! Easiest path with the least resistance to short term economy
  • Debt restructurings and austerity dominate - not balanced with economic stimulation

1. Early

  • Sustainable Growth: income growth can service growing debts

2. Bubble

Debt Rising Faster Than Incomes

Bull Market -> Strong Asset Returns and Growth -> Increased Borrower/Lending Capacity -> Encouraging More Lending

Shadow Banks emerge with loosely/unregulated financial products

Stimulative Monetary Policy Continues Inflation

Short-Term Debt Cycle

  • increased borrowing and spending = increased incomes and asset valuations
  • more collateral to borrow against = more lenders can lend
  • borrowing driving growth = affordable
  • central banks lowering interest rates elongates debt cycle
    • raises asset prices = raises wealth
    • lowers monthly payments on credit (keeps debt service burden down)
    • service payments >= amount debtors can borrow
    • debt >= amount of money to service with
  • Deleveraging then begins
  • Add up to become Long-Term Debt Cycle

3. Top

Long | Levered | Overpriced

Occur when Central Bank attempts to tighten policy and interest rates rise

Cycle: Wealth Falls -> Income Falls -> Credit-Worthyness Weakens -> Lending Constricted -> Spending Drops -> Investments Fall -> Selling Out -> Less Appealing to Buy -> ...

  • Wealth effect of asset price movement has a bigger impact on economic growth rates than monetary policy

4. Depression

Risk-Free Interest Rates Can't Be Cut Further
  • Either Already Close to 0, or at 0
  • High Currency Outflows Raise the Floor of Interest-Rates Due to Credit/Currency Risk Considerations
  • Wide Credit Spreads - spread between high-risk borrowers IR and risk-free rate

Deleveraging Dynamic:

  • Driven by supply and demand of/relationships between credit, money, goods, and services
  • Psychology plays only a small roll
  • Debtor's debt is still too expensive for them to service relative to money coming in

Central Bank Prints:

  • Money loses buying power
  • Creditors receiving less buying power than originally anticipated
  • Credit is not real money -> just a promise to pay in the future
  • People discover most of their "wealth" was merely just credit
    • debtors unable to keep the promise, creditors wealth decreases

Credit Contraction:

income not sufficient to service debt -> assets to be sold to service debts -> asset prices drop -> reduces value of collateral -> reduces incomes -> reduces creditworthiness -> net worth and income falling faster than debt -> borrowers less creditworthy -> lenders less likely to lend (one persons debts are another person's assets)

Well Managed Depressions:

  • Lower Interest Rates Quickly
    • if lowering does not work, move to alternative stimulation
  • Right mix of levers will reduce the duration of the depression and determine outcome
  • Wary of "Moral Hazard": party not entering into contract in good faith
    • taxpayers angry that institutions excessive lending caused the crises and don't want them being bailed out
    • policy makers to control amount of debt excess without systemic risk
    • typically slow to provide government supports and debt contration pains escalate quickly
  • Ignorance and lack of authority are bigger problems than the debts themselves

Austerity: natural course of depression forces

  • let the overlevered go down and take everyone involved with them
  • issue: doesn't bring debt and income back into balance

Printing Money: central bank deciding which depositors/lenders to protect from losses

  • determine who is "systemically important" and provide resources to that party
  • help institutions handle "runs"

5. Beautiful Deleveraging

6. Pushing on a String

7. Normalization

  • mark-to-market accounting: fair value asset pricing for assets with constantly changing values (mark in book should reflect current market conditions)

References:

Online