Combatting Debt in the Age of De-Leveraging

Gold is still getting up. Hemlines are going down. That’s all you need to know.

Gold rose toward $1,230 yesterday. Why? Reports said investors were worried about Europe.

Well…yes…Europe…and Asia…and North America…

The problem in the world economy is debt. There’s too much of it. Investors who aren’t delusional know that too much debt spells trouble. And when government adds more debt it’s not really going to make things better. It’s going to make them worse.

What kind of trouble will it cause?

Well, that’s what we’re going to find out.

Inflation…deflation…bankruptcies…defaults…bear markets…our guess is that we’re going to see it all. But not necessarily in that order.

Gold buyers are stocking up on insurance against trouble. They’re using GLD – a gold ETF – as a kind of “people’s central bank.” It’s a way of maintaining do-it-yourself monetary reserves.

The private sector is now de-leveraging – getting itself out of debt. Banks are building up their own reserves. Corporations are cutting spending and beefing up profit margins. Households are cutting back too. Everybody wants reserves.

But reserves take money out of the active economy…causing the symptoms that are so disturbing to economists and politicians – unemployment, bear markets, and deflation.

Doesn’t bother us. We like corrections. They wipe away mistakes and set the stage for new growth. And as near as we can tell everything is still happening as it should. The private sector went too far into debt. Now, it’s straightening itself up.

We were puzzled when savings rates declined earlier this year. It looked like our de-leveraging hypothesis might be wrong after all. But why shouldn’t savings go down. Consumers are probably as confused as Nobel prize-winning economists, Fed chairmen and the US Treasury Secretary. They probably thought the economy really was recovering. So why not spend?

But then, the savings rates rose again…and de-leveraging was back on course.

The next problem is in the public sector. As expected, governments reacted to the debt problem by going deeper into debt! And now, they’re in trouble too.

Small sovereign governments…as well as state governments – have already begun to de-leverage too. The bond market told them to cut back; who were they to argue?

Meanwhile, investors who are paying attention are selling. Alan Abelson reports that the smart money is getting out of stocks. Insiders are selling 3,933 shares for every one they buy, he says. This sends stocks lower too. Yesterday saw another 112-point drop in the Dow, for example.

But investors should be more careful. When they dive into the bushes for cover, they roll right into the poison ivy. They try to protect themselves from stocks and Greek debt by buying US debt. They feel safe. For a while, they are safe. Then, they start to itch!

Bill Bonner
for The Daily Reckoning