With steady deleveraging and extremely low interest rates, there has been some concern that the U.S. could be headed towards a ‘lost decade’ similar to what Japan has been struggling with for nearly twenty years. With no incentive to spend or invest, Japan found itself in a deflationary trap that it only now may have exited, and after five years of deleveraging, the U.S. household debt has dropped to its long-term average and continues to drop.

Debt consumer business leverage ending

Household debt falls as corporate debt stabilizes

Research from Deutsche Bank analysts Matt O’Connor, David Ho, and Robert Placet show that household debt has fallen to the 36 year average and is still declining. Corporate debt has stabilized, with small businesses owing more and large businesses owing less than their respective long-term averages. While individual saving is usually extolled as a virtue by financial literacy gurus and others, but the transition from a nation of spenders to a nation of savers can also translate into weak demand, inefficient self-financing, and less growth.

Fed tapering, which we’re assured is coming soon without having an actual timeline, has to walk a narrow path. On the one hand, allowing interest to linger for too long risks letting the US fall into the same trap that Japan did in the 90s, but moving too fast could damage portfolios that don’t have sufficient time to change their mix of assets or that have.

Fed’s tapering effects

“If the reversing of easy monetary conditions is serious then, yes, I believe it will go across asset classes,” London Business School professor Helene Rey told the Financial Times. “If the Fed acts slowly, it will be much easier for portfolios to adjust without major losses.”

Rey isn’t the only one to worry that the outflows hitting emerging markets could spread to other asset classes and threaten the economic recovery. Central banks will certainly try to prevent such a chain reaction, but early missteps can spiral out of control before anyone has a chance to react. Citigroup analyst Matt King has likened the situation to a row of dominoes that have no reason to topple over, but which are worth keeping an eye on nonetheless.