“Beautiful deleveraging” is the policy goal, but what we might get is “ugly inflation.”
In a world of rising sovereign debts and an overleveraged, over-indebted private sector, history suggests there are only three possible ways out: gradual deleveraging, defaulting on the debt, or printing enough money to inflate away the debt.
Ray Dalio recently described the characteristics of a “beautiful deleveraging” in which equal doses of austerity, write-downs, and inflation gradually lighten the load of impaired debt. This might be called the Goldilocks Deleveraging, as the key feature of this “beautiful” solution is that each component is “not too hot, not too cold” – inflation is modest, write-downs of bad debt are gradual, and austerity is not too severe. Given enough time, the leverage and debt are worked off without requiring any structural change to the Status Quo.
Understandably, the Status Quo has embraced this solution for the appealing reason it doesn’t change the power structure at all. Everyone currently in charge remains in charge, and everyone who owns outsized wealth continues owning outsized wealth. Rather than falling onto the politically powerful “too big to fail” banking sector, the pain of deleveraging is spread over the entire economy. There is no such thing as painless deleveraging, so the “solution” is to distribute the pain over hundreds of millions of people. That’s what makes it “beautiful” to the Status Quo: It doesn’t cost them either their power or their wealth.
The Status Quo in Japan has pursued this strategy for 20 years, and the Status Quo in Europe and the U.S. have pursued it for the past four years, ever since the global financial system imploded in 2008.