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Boeckh Investment Letter

Investment and economic commentary by J.Anthony Boeckh and Robert Boeckh

Debt and Deleveraging

 Virtually all developed countries need to deleverage. However, the distribution of debt between sectors varies widely among different countries. For example, Japan has a government debt problem, but private non-financial sector debt is fairly modest. The reverse is true for Canada. The PIGS, on the other hand, managed to accumulate excess debt in both the public and private sectors.

In order to assess the progress various countries are making towards deleveraging, it is useful to look at the aggregate debt levels of both the public and private sectors combined. In the wake of a financial crisis, the bad debts accumulated by the private sector during the bubble years are usually dealt with through a combination of bankruptcies and write downs. Where large systemic risk exists, for example with a threatened the collapse of the financial system, the alternatives are accepting a prolonged deep recession or absorbing certain private debts by expanding public sector debt, i.e. transforming private to public debt.

Ultimately, the goal is to walk a fine balance enabling private deleveraging while avoiding depression by sustaining aggregate demand, through a combination of monetary policy, fiscal stimulus, and devaluation where possible. This necessarily involves the deterioration of public sector balance sheets in the short run. It can be argued that this is an appropriate trade-off to avoid permanent damage to the labor force and impairment of potential GDP growth, but only if the rise in public sector debt does not risk insolvency of the government.

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