Economics & Crypto Part 2: Understanding the Long-Term Debt Cycle:

The previous article explored the short-term debt cycle, typically lasting between five and eight years. Today, we turn our attention to the long-term debt cycle, a phenomenon that spans 75 to 100 years and one that we find ourselves in the midst of or approaching. By examining these cycles, we can better comprehend our economic position and strategize for financial stability.

The Rising Long-Term Debt Cycle

The short-term debt cycle often concludes with more growth and debt than the previous cycle, indicating a rising long-term debt trend. This expansion leads to increased borrowing, with credit flowing freely. As more people become more indebted to lenders, the credit continues to flow even more. Why? Because everyone is happy as the money flows. People are focused on what is happening now as incomes, asset prices, and the stock market rise and the economy experiences a boom. However, this growth, fueled by debt, creates a debt bubble.

The Unsustainability of Debt Growth

While debts continue to grow and incomes rise to match, this trend cannot last indefinitely. Over decades, debt repayment prices grow faster than incomes, forcing spending cuts and reducing borrowing. People cut back on their spending, and since one person's spending is another person's income, incomes begin to go down. This makes people less creditworthy, which causes borrowing to go down and leads to the peak of the long-term debt cycle, as seen in the United States in 1929, again in 2008, and Japan in 1989.

Deleveraging: A Necessary Evil

Once the long-term debt cycle reaches its peak, deleveraging begins. This process involves spending cuts, income reduction, asset price drops, and social tensions. The vicious cycle of less spending, income, wealth, credit, and borrowing can resemble a recession, but with low-interest rates, traditional monetary policy tools are ineffective.

Bringing The Debt Burden Down

To reverse deleveraging, four strategies are usually employed that first make things worse but must be performed to reverse the out-of-control debt burdens. At this point, the economy looks at depression, and social and political unrest is at all-time highs.

1. Cutting Spending (Austerity):

2. Debt Reduction through Defaults and Restructurings:

3. Wealth Redistribution:

4. Central Bank Money Printing:

When spending is cut, you might think the debt burden would start to decrease, but the opposite happens because one person's spending is another person's income, so incomes fall. This cut in spending is deflationary and painful as businesses are forced to cut costs which means higher unemployment.

This leads to the next painful stage as borrowers cannot repay their debts and default on their payments to the bank. Eventually, this leads people to get nervous that banks won't be able to repay their debts, so they rush to withdraw their money from the bank in a good old fashion bank run.

To protect against this, lenders agree to debt restructuring, meaning lenders get paid back less or over longer periods or at lower interest rates. This allows the lender to get at least something, but it causes incomes and asset values to disappear faster, so the debt burden worsens.

All this debt restructuring with lower incomes and asset values means less taxes for the federal government, so its coffers go down. But it needs to increase spending because employment is low and more people need added support from the government. When the government has to spend more than it can bring in, you have a budget deficit that we've all heard about for many years. The government has to raise taxes or borrow more money to fund the deficit.

When taxes are raised, wealth is redistributed as the government is forced to tax the rich, and money flows from the haves to the have-nots. This creates social unrest because the have-nots start to resent the haves, and the haves start to resent the have-nots. If the depressed economy continues, complete anarchy and social disorder can break out.

Not only can tensions rise within a country they can rise between countries, especially when internal conflicts distract the nation. Ultimately this can lead to political change that can sometimes be extreme like what happened in Germany in the 1930s with the rise of Hitler.

The Magic Money Printer

Remember that the government's central bank has a magic money printer. And after already lowering interest rates to nearly zero, it's forced to print money. But unlike cutting spending, debt reduction, and wealth redistribution, money printing is inflationary. Eventually, the central bank will print money out of thin air to buy financial assets and government bonds. This happened in the US during the great depression and again in 2008 when the US central bank printed over $2 trillion, and other central banks worldwide followed suit. Buying financial assets helps drive asset prices up, making people more creditworthy.

The Delicate Balance of Deleveraging

Policymakers must balance deflationary and inflationary methods to maintain stability. If handled well, growth is slow, but debt burdens decrease. When incomes rise, the economy grows again, leading to the reflation phase of the long-term debt cycle.

Lessons from the Debt Cycle

Understanding the short-term and long-term debt cycles provides insights into economic trends and future directions. Policymakers must ensure that debt doesn't rise faster than income, income doesn't rise faster than productivity, and that efforts are made to raise productivity. Failure to adhere to these principles can lead to a painful period of deleveraging.

Cryptocurrency: A New Financial Frontier

As a crypto enthusiast, I see cryptocurrencies like Bitcoin as a viable alternative currency and a potential new financial system. Unlike traditional assets like gold, cryptocurrencies offer significant advantages, which we will explore in subsequent articles.

Conclusion

The short and long-term debt cycles offer valuable lessons for understanding our economic past, present, and future. By recognizing these patterns, we can position ourselves for financial soundness and explore innovative financial solutions like cryptocurrencies.

Next time, armed with our solid understanding of economic cycles, we'll explore where our economy stands now and how we can best position ourselves to prosper now and in the coming months and years.

Thanks for reading, and feel free to reach out with comments or questions. And don't forget to check out my YouTube channel for more content on how crypto is for all of us.

Until next time,

J. Scott

Not financial advice. Always consult with a financial professional before making investment decisions.