Hostage to mountains of debt, economies and banks become zombies

The Wall Street Journal talked with Bridgewater Associates Robert Prince about his views on where the economy is headed.  His focus was on how working through the mountains of debt is effectively turning the economies and banks of the US, UK and Europe into zombies.

Despite the fact that Japan is already in its third lost decade from its credit bubble, Mr. Prince thinks that the western economies have only 10 to 15 more lost years to work through their credit bubble.

As ZeroHedge likes to phrase the problem of the mountain of debt

the greatest threat to the modern financial system: a debt overhang so large, at roughly $21 trillion, that one of 3 things will have to happen: a global debt restructuring/repudiation; global hyperinflation to inflate away this debt, or a one-time financial tax on all individuals amounting to roughly 30% of all wealth. That's pretty much it, at least according to mathematics.

Regular reader know that your humble blogger thinks that the best and fastest way to fix the financial system and work through the debt bubble is ultra transparency.

Specifically, by requiring banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, the distortion in asset prices caused by regulatory forbearance is eliminated.

With this information, market participants will value every exposure for each bank.

As a result, the focus of banks changes from hiding losses (think extend and pretend) to addressing their bad debt and minimizing their losses.

The alternative to ultra transparency that has been tried unsuccessfully in Japan, the US, UK and Europe is to continue hiding the debt in the financial system and try to inflate it away.  This alternative has numerous problems, not the least of which is that it results in both the economies and banks being zombies.

Bridgewater Associates has made big money for investors in recent years by staying bearish on much of the global economy. As the new year rings in, the hedge fund firm has no plans to change that gloomy view. 

Robert Prince, co-chief investment officer at Bridgewater, and his managers at the world's biggest hedge fund firm are preparing for at least a decade of slow growth and high unemployment for the big developed economies. Mr. Prince describes those economies—the U.S. and Europe, in particular—as "zombies" and says they will remain that way until they work through their mountains of debt. 

"What you have is a picture of broken economic systems that are operating on life support," Mr. Prince says. "We're in a secular deleveraging that will probably take 15 to 20 years to work through and we're just four years in." 

In Europe, "the debt crisis is [a] long ways from over," he says. The economic and financial morass will mean interest rates in the U.S. and Europe will essentially be locked at zero for years....

In a conference room at Bridgewater's headquarters, where the water from the Saugatuck appeared to almost lap at the glass walls, Mr. Prince paints a grim picture of the challenges facing the U.S. and European economies. 

Recent better-than-expected news on the U.S. economy is unlikely to be the start of a healthy expansion, he says. The uptick in economic growth has been fueled by a decline in the savings rate, which, without material income and employment gains, is unlikely to be sustainable as long-term credit growth also remains weak, he says. 

The problem for the U.S, says Mr. Prince, is that it is on the wrong side of a long-term debt cycle. 

"We were in a leveraging-up period for 60 years, from the early 1950s to 2008," he says. This debt bubble was self-reinforcing on the way up, and "when it tipped over, it set about a self-reinforcing process on the way down." 

As evidence for the long slog facing the U.S economy, he notes that the level of leverage, as measured by comparing household income to net worth, is still higher than it was before 2008.
"The most likely environment is moderate growth with wiggles up and down and this is one of those wiggles up," he says.... 

Europe, meanwhile, is headed into a potentially deep recession, with policy makers boxed in by an interconnected banking and sovereign-debt crisis. 

"You've got insolvent banks supporting insolvent sovereigns and insolvent sovereigns supporting insolvent banks," he says.

This is where ultra transparency and a credible deposit guarantor come in.  With ultra transparency, the banks can absorb the losses on the insolvent sovereign debt.  With the deposit guarantor, the banks can continue in operation while they rebuild their book capital.