Short post today I have a very early obligation with the fire department this morning.John Mauldin's post this week, via Barry Ritholtz, goes over some of Mauldin's ongoing concerns specifically the debt we appear to be on the way to building. One very simple way Mauldin says to think about the magnitude of the debt and when it really might be big trouble is if it ever gets bigger than GDP.
He says that we can go on with a large (vague on purpose) debt load for quite a while but that the real problem will come when debt exceeds GDP. I've started to read him some lately and he seems to expect very bad things to come our way and unfortunately like many articulate people spelling out a bear case his comments are very compelling.
"Unfortunately" from the standpoint of hoping he is wrong.
If Mauldin and others making similar arguments are wrong then the portfolio changes needed will be far less radical--we don't really need to protect against things working out just fine. If these guys are right then people will have to make big changes to their portfolios. Taken to the extreme it would no make sense to own domestic anything save for maybe a defense contractor.
If you read investment blogs then you are probably already disposed to learning more about everything related to investing which is good because if Mauldin et al are correct it will be crucial.
The picture is from Molokai on the trail down to Kalawao.
10 comments:
Roger,
Great Article. The portion that I did not know is "In terms of energy, the data indicate that earthquakes become four times less likely each time you double the energy they release. Mathematicians refer to this as a “power law,” a special mathematical pattern that stands out in contrast to the overall complexity of the earthquake process." Very interesting application to finance. Minsky stuff ... just fantastic.
Happy Fire fighting.
Jeff from Milan, Italy
I've enjoyed Mauldin's writing for years -- he's a very smart man -- and agree that a deficit approaching GDP is a real concern but felt the same concern when Reagan, Bush I and Bush II were driving the deficit up too. With the exception of Reagan's first two years times were mostly better back then but all the more reason we should have been saving -- what was it Joseph told Pharaoh, years of plenty will be followed by years of want? -- but, that said, the country went to 125% of GDP during WWII, suffered a very bad recession afterward, and came back strong given appropriate expansive policy.
And therein lies the rub for me: What policies show promise of pulling us out? What industries show promise in rebuilding our base, growing jobs? Are we headed the way of Japan, expending precious dollars supporting business that should be closed instead of opened? Is the frugality pendulum going to swing so far the other way that we choke new industry when it is most in need of venture capital?
IMHO there is abundant historical evidence that we could withstand a deficit close to GDP or even over it if we can avoid a deflationary death spiral. A recent economic letter from the Dallas Fed regarding this "adverse feedback loop" is available at http://tinyurl.com/yaertq5 and I recommend reading it; closely. The possibility of hyperinflation is worth worrying about for sure but a serious deflation can be worse.
IMO one of the things that all that money going into bonds is telling us is that there are a lot of people with a lot of money who think adverse feedback likely and are buying appropriate insurance. I'm inclined to doubt someone with Mauldin's connections has trouble hearing them.
Hope your Sunday is restful: I foolishly got tempted by a distressed house (nice location) and a 4.25% mortgage so I'm going to be busy for awhile; I swear I'll never learn -- a life of sloth requires more careful planning than I seem capable of.
a life of sloth requires more careful planning than I seem capable of
great one liner. best of luck with the house!
Does anyone know what Mauldin's actual returns are for the past ten years or so for his clients? I like reading him too, but after awhile he does sound a bit perma-bearish and he always follows those nightmare scenarios with pimp-jobs for his funds or "great new managers for those with fewer millions to invest"... I have looked through his materials but have never actually seen his returns... anyone?
Ajw
I too like reading Mauldin, but think it would be foolish to invest with the hedge funds he advertises.
On debt I think the discussion of private debt over the last few months dwarfs the US government debt and is the real problem we face.
I also had a morbid fascination with Mauldin's take, but there are reasons to demur from his conclusions.
First, a big debt doesn't have to lead to Armageddon. Japan has muddled along decently enough with it for decades.
Second, he seems to be assuming a static GDP (he didn't spell this out). But all this Keynesian spending is going to raise the GDP--first, because it creates jobs and investment opportunities, and second because it creates inflation. So maybe the debt won't look as ferocious in 10 years as current projections would suggest.
Ideally, the stimulus could be mostly paid for by closing tax loopholes (think UBS x 100s) and cuts in the military budget (military spending, especially jet fuel and overseas occupations, does little or nothing for the domestic economy).
In addition, a good healthcare plan, in the unlikely event that we get one, can help us by reducing costs to small businesses and corporations and increasing productivity.
Roger,
John Mauldin and a picture of Moloka'i....that's a winning combination! I've read him for years. Try some of our Molokai-grown coffee to sip while you digest his thoughts.
Albert Boyce
Owner
www.coffeesofhawaii.com
@ AAlan: We need to get away from this "deficits don't matter" nonsense. Sure, the deficit hasn't been catastrophic to date, but that doesn't mean it won't become so. The power of compounding works against us here even if that rate of compounding is low. A person may increase their debt by 2 or 3% per year by using credit cards. You can go a long time at that rate without reaching a point of reckoning. Eventually, you get to where the minimum on the cards are greater than what you can afford. Next stop, catastrophe.
And pointing to Japan as an example doesn't put my mind at ease. It frightens me. They haven't muddled through as much as languished. The yo-yo between recession and growth has gone on for 20 years.
A case could be made that their debt isn't as detrimental for a couple reasons. One, their GDP is just under a third the size of ours. So they can run deficits of 100% to GDP, and it requires only $4 Trillion in debt issuance. If we get to 100% debt to GDP (for government here) we are looking at $14 Trillion. Much tougher to find funding at that level. Second, the Japanese citizens have a saving rate of 15% or more for years so they have been able to self-fund their debt. We clearly cannot.
I also don't agree with the argument that deficit spending by the government will create jobs and economic growth. At best, the government pulls future economic activity from the future to the present. So the country gets a boost now and then faces an economic deficit when it comes time to pay for the boost in the future. Secondly, the government is ineffective when it deploys capital relative to the private sector. I guarantee a small business owner will deploy assets in a better fashion than some a bureaucrat in Washington who has zero incentive to maximize return on investment. And, Washington is merely taking money from its citizens to create the short term boost in economic activity.
Also, comparisons to WWII deficit are inappropriate. After the War, the government slashed spending and taxes. Plus, the citizens had finally lowered their debt from the depression years and had a large savings surplus. We are in the opposite position. Does anyone believe the governments stands ready to slash spending? And, our citizens have a debt to GDP ratio of 80%. And, don't believe the hype about health care savings...won't happen. See the point above about government inefficiency.
So the argument that deficits haven't caused a crisis so they won't isn't that strong. I fear we might eventually find out that deficits do eventually matter, and it wont' be an easy lesson.
@Kirk: Hey, I didn't say deficits don't matter--that was Dick Cheney!!
I said deficits don't lead us straight to Armageddon, which is what Mauldin is suggesting.
And if you think private capital is so much more efficient than government spending, you are welcome to GM, AIG, Wachovia, and all the rest of them. Where I live, the streets get paved, water flows through the tap, and sewage gets treated at very efficient pricing.
@ AAlan: I didn't mean to say you were Dick Cheney...I would never insult anyone that way.
I have been reading John Mauldin for a long time, and he isn't someone who believes that deficits result in Armageddon. He does say that deficits reaching 100% of GDP does create instability. Right now, we borrow 40% of our government spending. Peter Bernholz, Professor Emeritus at the University of Basel in Switzerland, wrote a book "Monetary Regimes and Inflation..." where he analyzed twelve hyperinflationary economies. All of them had one fact in common, and that was the government reached a tipping point when annual deficits reached 40% of expenditures. The US is insulated somewhat since we are the reserve currency of the world, but this can't last long.
Also, you may get your roads paved and sewer/water from the guv, but do you have any basis for comparison to the free market? It could very well be cheaper if we outsourced this function. Many governments have the citizens pay for their trash disposal, typically a government program, because it was done cheaper and more effectively by the free markets. Just a thought.
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