As financial technology evolved over the last century, credit grew to become among the most lucrative and desired assets. We need look no further than the growth of the financial industry for proof of this. While the financial industry thrived, especially in the last few decades, the consumers of credit have become increasingly dependent upon it.
As the amount of credit has grown, so have the prices of the underlying assets. If everyone that wanted a house had to buy it with cash (no mortgage) it would be safe to say that the average price of houses would be much lower.
The growth in credit has penetrated all asset and commodity classes, to a greater or lesser extent, especially since the boom period that started in the late 1980s. It has distorted markets to the point where extreme far-from-equilibrium market prices have started to show when viewed in reference to the average consumer's ability to afford the products.
A few examples of the market price imbalances created by the leverage of credit and debt are:
The housing boom/bust over the last few years.
Student loan debt where default rates are reaching unsustainable levels.
Food stamp programs that now have more than 47 million people on the rolls.
The Greek Debt Crisis.
Healthcare prices driven by the leverage of health insurance.
If the prices of goods and services were lower in reference to the consumer's income, there would be less need for credit and market prices would remain closer to equilibrium.
Since virtually the entire developed world is now struggling with the deleveraging process that was kicked off by the 2008-2009 financial crisis, investors are having to radically rethink the fundamentals of their financial outlooks.
It is quite clear that the current levels of debt are economically unhealthy and unsustainable in the long run. As these imbalances have made themselves evident over the last few years governments have stepped in to shore up and bailout those areas that start to collapse, in the hope of keeping the status quo in place.
Since the governments are democratic and the whole of the people are responsible for the actions of their governments, these bailout programs will become increasingly unpopular as the bill arrives at the voters' doors in the form of higher taxes, slower growth and the effects of monetary easing imbalances.
In other words, the power is starting to shift from the financial sector (the issuers of credit) to the body politic (the people). The financial sector has largely recognized this shift and has been preparing accordingly by taking steps to make their institutions leaner and more efficient.
As this shift continues and intensifies, it is likely that heightened volatility will accompany it. This deleveraging process will likely take many more years considering the size and pervasive nature of the credit super-bubble.
As leverage is being reduced world-wide, it is relatively easy to see that in a normal situation deflation (money becoming more valuable in reference to the price of goods) would result. However, the central banks are committed to fighting deflation through monetary easing; this will likely add to the volatility experienced in this general de-leveraging period.
This major shift, from a generally expanding credit situation to a contracting one, calls for a major shift in thinking about the future value of the U.S. dollar. The many warnings, often from seemingly credible sources, regarding the value of the U.S. dollar (DXY) being at risk due to runaway inflation, presuppose that the underlying fundamentals remain the same as they have been since the 1970s.
The Federal Reserve has gone from defending against inflation, to a stance of locking arms with central banks around the world in a desperate fight against deflation, and it does not appear that the fight is anywhere near over. This major shift in the approach of central banks in regard to monetary stability should not be ignored.
The shift started with the bursting of the housing bubble in 2005-2009. The housing bubble got its start after WWII and was fueled by government programs to increase home ownership. De-regulation of the financial sector in the last half of the 20th century also played a role. For more on this see my article "The Three Headed Monster: Dot-Coms, Housing...Now Credit?"
As the worldwide deleveraging process works itself out there will likely be many opportunities to purchase assets at fire-sale prices. Having a store of value will be key. The most stable store of value over the next few years is likely the primary reserve currency of the world--the U.S. dollar (DXY). In the light discussed, we could refer to U.S. dollars as Treasury Deflation Protected Securities.
Please remember that levered ETFs are designed for short-term trading.