Bridgewater On Deleveraging

FOR THOSE OF YOU WHO FEEL THE NEED TO READ MORE ECONOMIC WONK MATERIAL, I'VE ATTACHED THE WHOLE DEAL. FOR MOST PEOPLE IT IS A GOOD CURE FOR INSOMNIA.

The US Deleveraging is Progressing, with Some Shifts in the Mix

As we have discussed, a key ingredient in the healing of the US economy has been policymakers' success at engineering an environment in which the overly leveraged US economy simultaneously lowers its debt burdens while experiencing moderate growth. This is what we refer to as a "beautiful deleveraging." After six years of this, aggregate debt levels have declined and the mix of credit balances has shifted, leaving lower debt-to-GDP across the whole economy, with the deleveraging occurring among those private sector borrowers who were most over-leveraged (households, financials), and the impact of their deleveraging cushioned by the leveraging up of the central government, which had room to do so. With the substantial healing that has taken place, growth is now gradually being supported to a greater extent by credit creation, and the rate of decline in debt-to-GDP has slowed. Household balance sheets are still improving, but at a slower rate because there are fewer defaults and more new borrowing. In the financial sector, debts relative to GDP are also falling more slowly as banks are accommodating the increase in the demand for credit by leveraging up. The pace of deleveraging in the shadow banking sector has also slowed, a reflection of the cleansing that has gone on in their balance sheets and the improved conditions of their borrowers. Business debt growth is notably fast, leading to rising business debt levels relative to GDP. As the private sector has healed, the government has been able to reduce its support, allowing sharply lower federal deficits while the economy has sustained an acceptable rate of economic growth. Of course, these improvements in private sector credit creation continue to be augmented by substantial money printing by the Federal Reserve, but the improvements in the private sector mean that the economy is gradually approaching the point where it can operate sustainably without this support. Going forward, the rise in rates which has already occurred will be a moderately restrictive influence, and, as we described earlier this week, if interest rates rise as discounted, sustaining the current deleveraging path at these higher levels of interest rates will require a much faster rate of improvement in private sector credit creation than is now occurring.

John Broussard
State of Louisiana
Department of the Treasury