How Debt-Asset Bubbles Implode: The Supernova Model of Financial Collapse
Charles Hugh Smith
OfTwoMinds.com
May 30, 2017
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.
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