How Debt-Asset Bubbles Implode: The Supernova Model of Financial Collapse

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.

In a deflationary supernova, defaults–and the avoidance of additional debt–are the gravity that overwhelms the forces of expanding debt. Once the losses and risk are visible to all participants, the herd psychology changes, and participants no longer believe that central banks “are now the ultimate power in the Universe.”

Central banks can create currency and credit, but they can’t create earnings or productive real-world wealth. These are the limiting dynamics of any debt-dependent system.

The fantasy is that free money–limitless credit to corporations and Universal Basic Income to debt-serfs–will magically create earnings and expand productivity. But this FantasyLand exists only in overheated self-serving imagination: in the real world, free credit is used to buy back stocks and indulge in other financialization trickery, not invest in higher productivity.

And the debt-serfs scraping by on Universal Basic Income have no ability to borrow more and few means to generate meaningful productivity gains.

The other pathway to implosion is to print currency with sufficient abandon that debtors have enough money to service their debts. Emitting sufficient new free money to re-set all the unpayable debt destroys the purchasing power of the currency–a supernova implosion that is little different than the deflationary implosion. The inflationary pathway results in the destruction of the currency, impoverishing everyone holding the currency.

While the idea of debt jubilee is appealing to everyone who doesn’t own debt-based assets (mortgages, auto loans, student loans,etc.), it is anathema to those who do own most of the debt-based assets–who just happen to be the wealthy and powerful who run our pay-to-play “democracy.”

If history is any guide, the wealthy and powerful who run our pay-to-play “democracy” will never relinquish their wealth. Only a financial collapse can re-set the system.

The financial implosion triggers social and political upheavals. Recall that one person’s debt is another entity’s asset. When debt is blown off in either a deflationary or inflationary implosion, all the “wealth” represented by debt is also blown off.

So what survives a financial supernova? There are three classes of things that are still functioning after a debt/fiat-currency supernova: real-world tools/productive assets that were owned free and clear, and non-fiat-currency financial assets that are difficult for failed states and central banks to steal/expropriate.

The third class is human/social capital, i.e. the knowledge and experience in your head. Not only will my Skil 77 power saw still be around, so will my knowledge of how to be productive with this tool.

Proponents of precious metals and cryptocurrencies both see their favored assets as survivable assets that are difficult to steal/expropriate. It’s difficult to predict just how desperate failing Status Quo institutions will get as their debt-fiat-currency dependent “wealth” and “power” implodes, but we are probably safe in assuming they will get fanatically zealous about stealing/expropriating everything they can get their self-serving hands on before the tides of History wash them away.

If they take my Skil 77 power saw, what are they going to do with it? Sell it for pennies to a crony of the central state? How will removing my ability to be productive help sustain their imploding regime? Removing productive capacity and suppressing my willingness to be productive will only hasten the collapse of their failed regime.

The Venezuelan Bolivar is the model of currency collapse: this is not some long-ago history–this is the present:

And how much did expanding debt boost productivity? Oops! Rapidly expanding financialized (i.e. unproductive) debt is Kryptonite to productivity.

Expanding credit has fixed everything! That’s precisely what the Imperial managers think just before the debt supernova implodes.

Federal debt has tripled–no problem, let’s triple it again, and then triple that.There is no upper limit on how much currency the Empire can borrow or print, right? “We are the ultimate power in the Universe now,” etc.

Gravity eventually overpowers financial fakery. Central banks can add zeroes to currency and the super-wealthy can use their unlimited lines of credit to buy up everything in sight, but when the Empire collapses, the debt-assets of the super-wealthy are blown off in the supernova along with all the other artificial constructs of our corrupt, corrupting, rapacious, exploitive system.

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  • cstahnke

    So then, why hasn’t this crash so many, including you, have predicted now for many years not happened? High debt, lower pay for the bottom 80%, hidden inflation and so on has not really stopped the economy from biz as usual since the crash. Why? I think we need to ask that question even if the crash happens tomorrow. Some people believe that the markets are rigged and managed from a collective network of central banks and powerful private banks so that real market forces are essentially bypassed. I think that’s part of the issue.

    I think the efficiencies (for the corporate sector) of globalism is the “gift” that keeps on giving–we have not yet reached the law of diminishing returns particularly due to much lower fuel prices than anyone had predicted a decade or more ago. Finally, what all of us are missing is the underground economy which over a decade ago was said to be nearly 20% of the global economy has, in my view, grown. Mechanisms to hide wealth and income have multiplied and I think a consequence of the gig economy is that it offers many more opportunities to conduct transactions “off the books” in both barter, cash and alternative currencies as respect for custom, law, and regulation has dramatically lowered and corruption in both public and private sectors has dramatically increased.

    I am, like most observers, just grasping at straws because the whole history of the past nine years since the financial crisis simply does not make sense. Again, my guess is that the actual political-economy is still undiscovered country. Something else is at work. Maybe its magic or aliens intruding into human affairs?

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  • Jimmy Robertson

    Here is an article that looks at how we have entered the corporate debt danger zone:

    Thanks to the current ultra-low interest rate fantasy land, the corporate sector in both the United States and the world’s emerging market economies is highly vulnerable to changes in interest rates, largely because it has gorged itself at the cheap debt trough.

  • Zartan

    The problem as to why America has not crashed is because America rules the World. A nation can print money to infinity if everyone accepts it, buys their wares, and no downgrades are enacted. Downgrades are what cause real problems for debt. Now, Who is going to downgrade the US government and risk being droned and murdered? Nobody.

    The US government caused all the problems you see in south America by its cia collusion with bankers to downgrade and topple governments forcing regime change. Nothing about the US government is fair and there are no laws that it cannot subvert and use for its purposes. I would not bet on a US market crash, because it is all being rigged,and therefore, it cannot crash. And the worlds major central banks are supporting it and corporations are buying their own stocks with free government money. Only the American people can bring down the US markets and force downgrades on the US government.

    Only Americans can save the World.

    If the US government is not turned over it will kill the entire Planet.

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