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.

 


 

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

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Latest Updates

Investment strategies

Finding income in an income-starved world

With term deposit rates falling, bonds holding up but with risks attached, and stocks yielding comparatively paltry sums, finding decent income is becoming harder. Here’s a guide to the best places to hunt for yield.

Economy

Fearful politicians put finances at risk

A tearful Treasury chief, a backbench rebellion, and crashing bonds. What just happened in the UK and why could Australia’s NDIS be headed for the same brutal fiscal reality?

Shares

Investing at market peaks: The surprising truth

Many investors are hesitant to buy into a market that feels like it’s already climbed too far, too fast. But what does nearly a century of market history suggest about investing at peaks?

Shares

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Investment strategies

Will stablecoins change the way we pay for things?

Stablecoins have been hyped as a gamechanger for the payments industry. But while they could find success in certain niches, a broader upheaval of Visa and Mastercard's payments dominance looks unlikely.

Infrastructure

An investing theme you can bet on for the next 30 years

Investors view infrastructure as a defensive asset class rather than one with compelling growth prospects. These five tailwinds for demand over the coming decades suggest that such a stance could be mistaken.

Investment strategies

A letter to my younger self: investing through today's chaos

We are trading through one of history's most confounding market environments. One day, financial headlines warn of doomsday scenarios. The next, they celebrate a new golden age. How can investors keep a clear head?

Sponsors

Alliances

© 2025 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.