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How Debt-Asset Bubbles Implode: The Supernova Model of Financial Collapse

by Charles Hugh Smith, Of Two Minds:

Gravity eventually overpowers financial fakery.

When debt-asset bubbles expand at rates far above the expansion of earnings and real-world productive wealth, their collapse is inevitable. The Supernova model of financial collapse is one way to understand this.

As I noted yesterday in Will the Crazy Global Debt Bubble Ever End?, I’ve used the Supernova analogy for years, but didn’t properly explain why it illuminates the dynamics of financial bubbles imploding.

According to Wikipedia, “A supernova is an astronomical event that occurs during the last stellar evolutionary stages of a massive star’s life, whose dramatic and catastrophic destruction is marked by one final titanic explosion.”

A key feature of a pre-supernova super-massive star is its rapid expansion. As the star consumes its available fuel via nuclear fusion, the star’s outer layer expands. Once there is no longer enough fuel/fusion to resist the force of gravity, the star implodes as gravity takes over.

This collapse ejects much of the outer layers of the star in an event of unprecedented violence.

The financial analogy is easy to see: when rapidly expanding debt consumes a critical threshold of earnings (fuel), the equivalent of gravity (default, inability to service the enormous debt) triggers the collapse of the entire debt/leverage-dependent financial system.

As I explained yesterday, if earnings stagnate or decline while debt races higher, eventually earnings are insufficient to service the debt and default is inevitable. The other problem that arises as more and more of earned income goes to debt service is that there is less and less disposable income left to support consumer spending–the lifeblood of economies worldwide.

Once debt service absorbs a significant chunk of household earnings, recession is the inevitable result as spending collapses once more debt cannot be loaded on households. In other words, debt is limited by earnings. If earnings decline, or fall far behind the expansion of debt, eventually borrowers can no longer borrow more, or refuse to borrow more.

At that point, consumer spending falls and recession generates a self-reinforcing cycle of declining sales, profits, employment and wages. Recession further reduces the ability and appetite for more debt, and this acts as “gravity” in the super-massive debt-star.

Financial supernova collapse has two pathways which we call deflationary and inflationary. But the key point here is these are simply different pathways to the same result: the collapse of the financial system.

In a deflationary supernova, defaults–and the avoidance of additional debt–are the gravity that overwhelms the forces of expanding debt. Once the losses and risk are visible to all participants, the herd psychology changes, and participants no longer believe that central banks “are now the ultimate power in the Universe.”

Central banks can create currency and credit, but they can’t create earnings or productive real-world wealth. These are the limiting dynamics of any debt-dependent system.

The fantasy is that free money–limitless credit to corporations and Universal Basic Income to debt-serfs–will magically create earnings and expand productivity. But this FantasyLand exists only in overheated self-serving imagination: in the real world, free credit is used to buy back stocks and indulge in other financialization trickery, not invest in higher productivity.

And the debt-serfs scraping by on Universal Basic Income have no ability to borrow more and few means to generate meaningful productivity gains.

The other pathway to implosion is to print currency with sufficient abandon that debtors have enough money to service their debts. Emitting sufficient new free money to re-set all the unpayable debt destroys the purchasing power of the currency–a supernova implosion that is little different than the deflationary implosion. The inflationary pathway results in the destruction of the currency, impoverishing everyone holding the currency.

While the idea of debt jubilee is appealing to everyone who doesn’t own debt-based assets (mortgages, auto loans, student loans,etc.), it is anathema to those who do own most of the debt-based assets–who just happen to be the wealthy and powerful who run our pay-to-play “democracy.”

If history is any guide, the wealthy and powerful who run our pay-to-play “democracy” will never relinquish their wealth. Only a financial collapse can re-set the system.

Read More @ OfTwoMinds.com

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1 comment to How Debt-Asset Bubbles Implode: The Supernova Model of Financial Collapse

  • Ed_B

    “Once debt service absorbs a significant chunk of household earnings, recession is the inevitable result as spending collapses once more debt cannot be loaded on households. In other words, debt is limited by earnings. If earnings decline, or fall far behind the expansion of debt, eventually borrowers can no longer borrow more, or refuse to borrow more.”

    Agreed. But, there is another aspect of this that often goes unnoted. That aspect involves the creation of fiat currency at interest. As long as the economy is growing and generating more than enough profit to service this interest payment, which MUST be paid BEFORE all else is paid, then the process continues whether it is good for the economy in the long term or not.

    As always happens in fiat money systems, however, there comes a time when the economy doesn’t grow fast enough to cover the cost of the fiat currency that is being created. This is when the financial SHTF. This is why the US economy has been in the toilet for the past 8 years, regardless of all the pump-priming of the Fed. The growth necessary to cover the cost of the inflation that is built into our currency simply isn’t there and hasn’t been since late in 2007. As has often been said, “When something isn’t sustainable, it WILL end”.

    It is not within our range of choices as to whether or not it will end. Our only choices involve taking economic pain early on in order to save the system from its cancer OR delay giving it the harsh medicine it really needs as long as possible. If we choose the latter route, we avoid the early pain but eventually get past the point where the disease CAN be treated and enter the part where nothing we do can save it from its own seeds of absolute destruction.

    I believe that 2008 may very well have been the inflection point where the former choice transitioned into the latter choice. Preferring to delay the strong medicine that the US economy REALLY needed meant that the economic pain largely was avoided early-on but at the price of terrible cost later. 2008 was the near-miss of a fully-blown all-out economic collapse. It was bad but it was also an opportunity to choose a sustainable path going forward. Those in charge at the time chose poorly… and we, our children, and our grand children WILL be paying for that lack of foresight on their parts for decades to come. With luck, our nation will survive intact. But I would not bet on having that much luck just when it is most needed.

    Got preps?

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