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

Ray Dalio on 2025’s real story, Trump, and what’s next

The renowned investor says 2025’s real story wasn’t AI or US stocks but the shift away from American assets and a collapse in the value of money. And he outlines how to best position portfolios for what’s ahead.

Making sense of record high markets as the world catches fire

The post-World War Two economic system is unravelling, leading to huge shifts in currency, bond and commodity markets, yet stocks seem oblivious to the chaos. This looks to history as a guide for what’s next.

3 ways to fix Australia’s affordability crisis

Our cost-of-living pressures go beyond the RBA: surging house prices, excessive migration, and expanding government programs, including the NDIS, are fuelling inflation, demanding bold, structural solutions.

Is there a better way to reform the CGT discount?

The capital gains tax discount is under review, but debate should go beyond its size. Its original purpose, design flaws and distortions suggest Australia could adopt a better, more targeted approach.

Welcome to Firstlinks Edition 648 with weekend update

This is my last edition as Editor of Firstlinks. I’m moving onto a new role though the newsletter will remain in good hands until my permanent replacement is found.

  • 5 February 2026

Welcome to Firstlinks Edition 646 with weekend update

There’s one surprising area of the market that’s been left behind over the past year: quality stocks. Not only in Australia, but globally. The likes of REA, CAR Group, and Aristocrat may offer opportunities in an overpriced market.

  • 22 January 2026

Latest Updates

Property

The 5% deposit scheme is bad for homeowners and Australia

An ‘affordability’ scheme making the county more vulnerable to economic shocks and contributing to the deteriorating financial situation of everyday Australians.

Investment strategies

Is defensive the new offensive?

Relatively boring, unglamorous, defensive stocks like Kroger and Allstate have quietly outperformed gilded tech giants, offering steady growth, visibility, and resilient returns in a market captivated by AI and flashier industries.

Shares

How the RBA scores on its inflation goal

The Reserve Bank continues to face criticism from all sides. A reminder of the RBA's mandate and a review of their track record in maintaining price stability since the early 1990s.

Investment strategies

Levered credit: A late cycle ingredient for drawdown pain

As credit spreads normalised through 2025, yield‑hungry investors have turned to leverage for high returns, uncomfortably echoing pre‑GFC behaviours. Investors need to be careful to understand the true risk‑return trade‑off.

Planning

The more things change… longevity just goes on increasing

Australia needs a major shift in longevity awareness, attitudes and behaviour if, as a community, we are to reap the benefits of increasing longevity. Adopting a national strategy is well overdue.

Property

The improving outlook of Australian commercial real estate

The sector is positioned to benefit from defensive and resilient income streams supported by embedded rental increase opportunities. 

Property

Seize hidden opportunities among 50+ home buyer schemes in Australia

There is a laundry list of government schemes to help Australian's struggling with housing affordability. Savvy buyers should take advantage to break into the property market.

Sponsors

Alliances

© 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.