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Friday, October 23, 2009

Too much debt in the public sector = default and hyperinflation?

Richard Koo, author of The Balance Sheet Recovery, recalls how it was during Japan’s long, dark passage:

“We had these false starts… The economy would begin to improve and then we’d say ‘oh my god, the budget deficit is too large.’ Then we’d cut fiscal stimulus and collapse again. We went through this zigzag for 15 years.”

Koo understands what is going on, more or less. Companies and households are paying off debt. He and Paul Krugman believe the feds have to continue pumping money into the system or they’re going to have a “lost decade,” just like the Japanese.

You have to keep the stimulus money flowing “until the private sector de-leveraging is over,” he says.

By our calculations, it will take 5-10 years for the private sector to de-leverage. By that time, the feds will have added trillions in debt to public finances. Since they can’t finance that much from private domestic savings, and since foreigners will be wary about lending that much even if they had it, the Fed itself will have to pony up the money. This will put the dollar in further danger…along with the entire global financial system.

Koo may be right – as far as his thinking takes him. He should think a little further. The problem is debt. Too much debt in the private sector caused bear markets and a bank crisis. Too much debt in the public sector will cause big problems too – a default…and hyperinflation. Worse than a depression.

-- from "How Much Juice is Left in this Bear Market Rally?" by Bill Bonner

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