The debt bubble bursts

When increasing debt becomes unsustainable, the credit bubble bursts threatening bonds, equities, and the entire credit system. The fiat dollar itself becomes a bad debt.

Introduction

Very few economists and investors realise that after 54 years of post-Bretton Woods fiat-currency expansion, freed from the constraints of gold standards we have never experienced such a large debt-cum-credit bubble. At the centre of it all is the US federal dollar, which has acted as the international trade pricing and settlement medium in place of gold.

By way of precedent, in financial history there have been other periods of excessive credit expansion, eventually failing to be sustained and undermined by bad debts being exposed. Tulipomania in 1636—37, Mississippi, and South Sea bubbles both in 1720 were noteworthy. And the Roaring Twenties leading to the Wall Street Crash in 1929—32 was the last such event, though there have been times, such as the lead up to the dot-com bubble of 2000 and the crisis of 2008—09 which threatened similar financial devastation.

In common with 1929, today we have a combination of a credit bubble and new trade tariffs. In 1930 it was the Smoot-Hawley Tarif Act, which lifted US tariffs by about 20% on average. This time the bubble is far larger; and the consequences of the Trump administration’s tariffs are likely to be considerably more destructive to a more international global economy with extensive supply chains, and to the US economy as well.

When this bubble blows, a process which may have already started, the consequences are likely to be at least as far-reaching as the Wall Street Crash which led to the 1930s slump and failure of 9,000 US banks. Behind every credit bubble implosion are bad debt problems which lead to a domino effect of cascading failures, even taking out otherwise healthy businesses.

Defining today’s debt problem