The debt levels seen throughout the world, both sovereign and personal balance sheets, while in some ways unprecedented, is not something that hasn't been seen before. However, these debt levels are typically associated with major wars.
So how have economies historical "righted" themselves from debt levels of this magnitude? There have been three primary elements:
1. High Growth
2. High Inflation
3. Financial Repression
High growth is, I think, self-explanatory. And while that is true, policy makers seem befuddled as to precisely what steps to take in order to achieve such growth. In the U.S., we appear to be in a tug of war between "government does it best" advocates and "the private sector does it best" advocates. I suspect that means a blend of the two is what is needed.
High inflation is also self-explanatory. The U.S. government tells us we don't have meaningful inflation in our economy. Can I see a show of hands of those who think otherwise? I thought so!
Financial repression is, I believe, the least understood of the three paths to debt salvation. Wikipedia defines financial repression as "a term used to describe several measures which governments employ to channel funds to themselves which in a deregulated market would go elsewhere." I highly recommend a quick read of the Wikipedia entry as financial repression is certainly underway as defined there.
On a more basic level, financial repression will punish savers. Case in point, if you've been fiscally responsible and saved over the years, what are your fixed income options today? What rates are being offered? Are the real rates a positive return after taxes and inflation? One of the key tools of financial repression is explicit capping of interest rates on government debt. Didn't the Federal Reserve announce just last week that they would be keeping rates low for the next two years? That certainly sounds like interest rate control to me.
Financial repression is simply another form of taxation without the political heat. I fear this will be a feature of our economy for many years to come and investors should prepare themselves for this. I believe a cornerstone strategy for any portfolio should be to seek higher interest rates in private debt markets with instruments backed by real assets as an inflation hedge.