borrowers. When this happens enough that the holders of this money and debt assets realize what is happening,
they seek to sell their debt assets and/or borrow money to get into debt that they can pay back with cheap money.
They also often move their wealth to other storeholds of wealth like gold, certain types of stocks, and/or
somewhere else (like another country that is not having these problems). At such times central banks have
typically continued to print money and buy debt directly or indirectly (e.g., by having banks do the buying for
them) and have outlawed the flow of money into inflation-hedge assets and alternative currencies and alternative
places.
Such periods of reflation either stimulate another money and credit expansion that finances another economic
expansion (which is good for stocks) or devalue money so that it produces monetary inflation (which is good for
inflation-hedge assets such as gold). Earlier in the long-term debt cycle when the amounts of outstanding debts
aren’t large and when there is lots of room to stimulate by lowering interest rates (and failing that, printing money
and buying financial assets), the greater the likelihood that credit growth and economic growth will be good, while
later in the long-term debt cycle when the amounts of debt are large and when there isn’t much room to stimulate
by lowering interest rates (or printing money and buying financial assets) the greater the likelihood that there will
be a monetary inflation accompanied by economic weakness.
6) Then Comes the Flight Back into Hard Money
When taken too far, the over-printing of fiat currency leads to the selling of debt assets and the earlier-described
bank “run” dynamic, which ultimately reduces the value of money and credit, which prompts people to flee out of
both the currency and the debt (e.g., bonds). They need to decide what alternative storehold of wealth they will
use. History teaches us that they typically turn to gold, other currencies, assets in other countries not having these
problems, and stocks that retain their real value. Some people think that there needs to be an alternative reserve
currency to go to, but that’s not true as the same dynamic of the breakdown of the monetary system and the
running to other assets happened in cases in which there was no alternative currency to go to (e.g., in China and in
the Roman Empire). The debasement of the currency leads it to devalue and have people run from it and debt
denominated in it into something else. There is a whole litany of things people run to when money is devalued,
including rocks (used for construction) in Germany’s Weimar Republic.
Typically at this stage in the debt cycle there is also economic stress caused by large wealth and values gaps, which
lead to higher taxes and fighting between the rich and the poor, which also makes those with wealth want to move
to hard assets and other currencies and other countries. Naturally those who are governing the countries that are
suffering from this flight from their debt, their currency, and their country want to stop it. So, at such times,
governments make it harder to invest in assets like gold (e.g., via outlawing gold transactions and ownership),
foreign currencies (via eliminating the ability to transact in them), and foreign countries (via establishing foreign
exchange controls to prevent the money from leaving the country). Eventually the debt is largely wiped out,
usually by making the money to pay it back plentiful and cheap, which devalues both the money and the debt.
When this becomes extreme so that the money and credit system breaks down and debts have been devalued
and/or defaulted on, necessity generally compels governments to go back to some form of hard currency to rebuild
people’s faith in the value of money as a storehold of wealth so that credit growth can resume. Quite often, though
not always, the government links its money to some hard money (e.g., gold or a hard reserve currency) with
promises to allow holders of the new money to make that conversion to the hard money. Sometimes that hard
money is another country’s. For example, over the past decades many weak-currency countries have linked their
money to the US dollar or simply dollarized their economy (i.e., used the dollar as their own medium of exchange
and storehold of wealth).
To review, in the long-term debt cycle, holding debt as an asset that provides interest is typically rewarding early in
the cycle when there isn’t a lot of debt outstanding, but holding debt late in the cycle when there is a lot of it
outstanding and it is closer to being defaulted on or devalued is risky relative to the interest rate being given. So,
holding debt (e.g., bonds) is a bit like holding a ticking time bomb that rewards you while it’s still ticking and
blows you up when it goes off. And as we’ve seen, that big blowup (i.e., big default or big devaluation) happens
something like once every 50 to 75 years.
These cycles of debt and writing off debts have existed for thousands of years and in some cases have been
institutionalized. For example, the Old Testament provided for a year of Jubilee every 50 years, in which debts