Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 385

Beware of burning down the barn to bury the debt

As this country knows all too well, fires usually end up being much harder to put out than they are to start.

In the decade since the global financial crisis, there’s been a large build-up in sovereign debt by almost all Western nations. As with so many things this year, the COVID-19 pandemic has accelerated the trend. At some point, policymakers will have to turn their attention to the task of deleveraging, to somehow work off these large debt burdens.

Fire versus ice policy moves

They face a difficult set of choices. Do they go down the path of deleveraging via fire (inflation) or ice (deflation)?

If we take history as our starting point, there are four pertinent examples.

1. Japan has been attempting to deleverage through deflation since the late 1980s. The good news is that economic conditions have muddled through; the bad news is that Japan’s sovereign debt position is now well more than 200% of GDP. The result is a chilled-down economy, but with little success at debt reduction.

2. Another example of deleveraging with deflation is the 1930s Great Depression in the US. Here, the reduction in debt was very successful – but this came with an enormous hit to the economy and widespread destruction of wealth. So, deleveraging was achieved by freezing the economy almost to death.

3. During the same period, Germany also underwent a debt reduction. The Weimar Republic reduced its ruinous load of reparations debt, although the vast monetary expansion that enabled this led to hyperinflation and widespread destruction of wealth. So this was deleveraging by raging conflagration, at the cost of burning the whole economy to the ground.

4. However, there is one historical example of a successful deleveraging process that did not entail widespread wealth destruction. In fact, it occurred during a period of prosperity and it was brought about with the nice warm glow of moderate inflation. How was this happy outcome achieved?

After peaking at 116% in 1945, US sovereign debt-to-GDP more than halved over the next 15 years. This was achieved by limiting the interest rate payable on US Treasury bonds, limiting the ability to sell these bonds, and a demand set-up to fuel a decent level of inflation.

Financial repression

This resulted in low nominal returns to bonds, and negative real returns. In other words, holders of US debt lost their purchasing power year after year for 15 years, but with no damage to the broader economy.

They effectively locked bondholders in the barn and then burnt down the barn.

This policy manoeuvre has become known as 'financial repression'. As Carmen Reinhart observed in an IMF working paper in 2015, this 'financial repression tax' is a transfer from creditors to borrowers.

Three ticks in the policy boxes

So could we see policymakers following the same playbook today? We are already seeing evidence of this around the world, and even here in Australia.

1. Limits on the rates payable on government bonds? Tick. In March, the RBA announced a target for Australian three-year debt of 0.25%, with the potential to extend this into longer durations. This is also known as yield curve control (it's now 0.1%).

2. Limits on the ability to sell bonds? Tick. Prudential regulations imposed on banks have gradually increased their requirement to own government debt. The budget’s recent measure to scrutinise superannuation funds’ performance could also result in funds owning more government debt to be more in line with bond indices.

3. Set up for inflation? Tick. The RBA’s stance is to "maintain highly accommodative policy settings" until inflation is within the 2-3% target band.

This playbook is unlikely to play out in the next year or so, since – hand sanitiser and face masks aside – the effects of the pandemic are broadly deflationary. But, in time, the extreme fiscal stimulus being deployed in Australia and elsewhere is likely to have a tightening effect on prices.

 

Kate Howitt is a Portfolio Manager for the Fidelity Australian Opportunities Fund. Fidelity International is a sponsor of Firstlinks.

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL 409340 (‘Fidelity Australia’), a member of the FIL Limited group of companies commonly known as Fidelity International. This document is intended as general information only. You should consider the relevant Product Disclosure Statement available on our website www.fidelity.com.au.

For more articles and papers from Fidelity, please click here.

© 2019 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity International and the Fidelity International logo and F symbol are trademarks of FIL Limited. FD18634.

 

  •   24 November 2020
  •      
  •   

 

Leave a Comment:

RELATED ARTICLES

The three main factors when the next storm hits

Investors face their own Breaking Bad moment

The role of financial markets when earnings are falling

banner

Most viewed in recent weeks

Does your will qualify for the discretionary testamentary trust exemption?

Treasury has confirmed the exemption many families were hoping for. But buried in the fine print are two conditions that could leave some wills on the wrong side of the exemption, despite years of careful planning.

Ranking three common retirement strategies

The defining challenge of retirement isn't just about building wealth, it's about converting your lifetime savings into sustainable income. A holistic understanding of different strategies can improve long-term outcomes.

Are you making these SMSF mistakes?

After four decades advising investors, there are a few common mistakes I've seen SMSF investors make. From holding too much cash and chasing yield to overtrading and trusting tips. Are these errors costing you?

Australia has saved $4.5 trillion for retirement. Here's what matters more

Most Australians approaching retirement can tell you the exact dollar value of their super account. But success depends on more than a sizeable balance. Here's four key questions to ask yourself at the start of the financial year. 

Lithium's latest drop and what it means for ASX investors

Lithium's latest sell-off has punished ASX miners as prices remain hostage to shifting expectations. The key challenge is navigating a market prone to extreme volatility despite a strong case for the long-term demand outlook.

Retirement spending is not one-size-fits-all

New data challenges the idea that Australians are underspending their super. The bigger issue may be helping retirees navigate complexity, make confident decisions and use their savings to support security, wellbeing and choice.

Latest Updates

Retirement

Will you run out of money in retirement?

Fear of running out has become a defining retirement anxiety. Why do some retirees die with substantial wealth while others deplete their nest egg? Evidence suggests the answer is more complicated than we think. 

Investing

The investment that sidesteps the new tax traps

Tax rules have changed, but many investors are still using yesterday’s strategies. Insurance bonds may offer advantages for those seeking greater control, tax efficiency and certainty about their wealth.

Shares

The role of shareholder yield in a portfolio

Investors may be overlooking a timeless source of returns in a volatile market. The companies that consistently generate and return cash to shareholders have often proved remarkably resilient through uncertainty.

Shares

Australian inflation still well above the RBA's target

The RBA has spent more than three decades pursuing its 2%-3% inflation target. But the numbers tell a far more complicated story than the headlines. The results may surprise both its strongest critics and most loyal defenders.

Retirement

Retirement in reality - 5 months in

Retirement planning doesn't end when work does. Five months in, Joanne reflects on retiring at a different time to your spouse, coping with setbacks and the importance of rest. Some lessons only become clear after the fact.

Latest from Morningstar

What 6 key market indicators are telling investors right now

Are markets still expensive? There are the seven key indicators every investor needs to know. From gold and equities to bonds, oil, bitcoin and the US dollar. The data reveals where opportunities and risks may lie for investors today.

Investing

Can you ride the AI bubble without overpaying?

AI may prove as transformative as the internet, but markets are behaving as if success is guaranteed. As capital races towards unprecedented levels, investors should ask whether enthusiasm is getting ahead of reality.

Sponsors

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.