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Kicking the Can to the End of the Road
A crisis is brewing in the US and one is coming to a slow boil in Europe. We visit Greece and Ireland and ponder how this will end. It is all well and good to kick the can down the road, but what happens when you come to the end of the road? The European answer seems to be to haul in the heavy equipment and extend the road. In short, we are watching the biggest bubble of all time, the bubble of government debt, try to keep from popping. My bet is that it can?t. And while the ride will be bumpy, the world our kids get will be better off at the end of the process.
Muddle Through, or Crisis?
This week I finish the two-part letter on the Endgame and give you my thoughts on the economy over the next five years. This is the second part of a speech I gave last week at the Strategic Investment Conference in La Jolla. It is a rather bold forecast, and fraught with peril and likely errors, but that is my job here. I must offer one large caveat! If the facts change so will my forecast, but this is the view into my very cloudy crystal ball as I see it today. As always, remember that those of us in the forecasting world are often wrong but seldom in doubt. Read accordingly.
The Endgame Headwinds
By Endgame I mean the period of time in which many of the developed economies of the world will either willingly deleverage or be forced to do so. This age of deleveraging will produce a fundamentally different economic environment lasting anywhere from 4-6 years. Now, whether this deleveraging is orderly, as now appears to be the case in Britain, or more resembles what I have long predicted will be a violent default in Greece, it will create a profoundly different economic world from the one we have lived in for 60 years.
The 'Miracle' of Compound Inflation
Investors will face the ?zero bound? in interest rates for a while longer. They can sit on their cash and earn nothing. They can fret and wring their hands about a ramp-up in inflation, but the evidence so far does not support it. They can stay in the US dollar, in which case they can watch their dollars weaken relative to the rest of the world. Travelling in Sicily or Rome validates how strong the euro is relative to the dollar. All you have to do is buy a dinner or hotel room.
The Cure for High Prices
Today we once again think about the inflation/deflation debate, turn our eyes to Europe and the very interesting election happening there this Sunday, and speculate a little about what could derail the US economy. The old line is that the cure for high prices is high prices. When prices rise, businesses tend to respond by producing more. If the price of something gets too high, then people buy less, which then leads to too much supply, which lowers prices. Rinse and repeat. Last week I wrote about what I think is the potential for inflation in the US to rise to uncomfortable levels (4-5%)
The Curve in the Road
We have chosen deliberately to take the inflation road. We have not traveled that road for some time. The Fed may think they know what is around the curve and what to do if inflation comes back, but no two crises are the same. I worry about these things. If the Fed and the US government wanted a weaker dollar, the return of inflation, and the potential for yet another boom-bust, they could not have designed better policies than the ones they?re pursuing.
The Plight of the Working Class
Although the headline unemployment number went down to 8.8%, the only way you can get to that number is by not counting the millions who have dropped out of the employment pool, too discouraged to look, but who will take a job if they can get one. If you go back and take the number of people in the labor force just two years ago, the unemployment picture is back over 10% (back-of-my-napkin math).
Unintended Consequences
Governments around the world need to be alert and make difficult choices to deal with a world excess liquidity. From an investor?s point of view, enjoy the current ride in emerging markets but recognize that they are high beta to the U.S. economy and stock markets. The next time the United States goes into recession?and there will be a next time?it is likely that emerging markets will suffer significant losses. So, emerging markets are a trade and not a long-term investment.
The End of QE2?
The Fed committed to buying $600 billion of Treasuries between the beginning of QE2 in November and the end of June. June is 3 months away. What will happen when that buying goes away? The hope when QE2 kicked off was that it would be enough to get the economy rolling, so that further stimulus would not be deemed necessary. We?ll survey how that is working out, with a quick look at some recent data, and then we go back and see what happened the last time the Fed stopped quantitative easing.
Inflation and Hyperinflation
Companies and households typically deal with excessive debt by defaulting; countries overwhelmingly usually deal with excessive debt by inflating it away. While debt is fixed, prices and wages can go up, making the total debt burden smaller. People can?t increase prices and wages through inflation, but governments can create inflation, and they?ve been pretty good at it over the years. Inflation, debt monetization, and currency debasement are not new. They have been used for the past few thousand years as means to get rid of debt. In fact, they work pretty well.
Are Booming Economies Good for the Markets?
The important question is whether booming growth is always good for equity markets. On that, the data is mixed. While strong growth usually leads to higher earnings, it typically leads to tighter liquidity. The most dangerous periods for equity markets are typically strong economic activity combined with rapidly rising oil prices. In 34% of the years since 1950 with economic growth have experienced declining EPS growth. A doubling in the oil price is not good for markets. If we begin to work on the deficit with cuts and tax increases, it will be a headwind for economic growth and earnings.
When Irish Eyes Are Voting
Mauldin reviews the Irish economy, citing a recent Vanity Fair article by Michael Lewis. Ireland's housing bubble caused prices to rise approximately 500%. More than 20% of the Irish workforce was employed in construction. Irish banks financed this, using selling bonds to other European banks. The Irish government made good on those debts, burdening its taxpayers. The end results is excessive debt for the EU, which appears to be unsupportable. On the crisis in the Middle East, Bahrain is the key country to watch out for.
A Random Walk Around the Frontlines
Today we do a Random Walk Around the Frontlines, surveying what?s going on in the world. The US economy continues to improve in fits and starts. Inflation for the last six months has risen rather smartly. And for the last three months inflation on an annualized basis is running over 3%. The recent drop in the unemployment rate was entirely due to rather dramatic drops in what is known as the participation rate - fewer people looking for jobs. The Fed needs to end its program of quantitative easing.
The Future of Public Debt
Mauldin looks at an important paper from the Bank of International Settlements on ?The Future of Public Debt.? While the debt supercycle is still growing on the back of increasing government debt, there is an end to that process, and we are fast approaching it. Drastic measures are necessary to check the rapid growth of current and future liabilities of governments and reduce their adverse consequences for long-term growth and monetary stability. This leads the BIS to conclude that the question is when markets will start putting pressure on governments, not if.
An Excerpt from Endgame
Growth does not look that great, and people don?t feel the recovery. This is unlikely to change. The U.S. and most developed economies are currently facing many major headwinds that will mean that going forward, we?ll have slower economic growth, more recessions, and higher unemployment. Three large structural changes have happened slowly over time that we expect to continue going forward. The U.S. economy will have higher volatility,lower trend growth, and higher structural levels of unemployment (The United States here is a proxy for many developed countries with similar problems.)
A Bubble in Complacency
The just released Q4 GDP of 3.2% may be overstated by 0.5% to 1.0% as a result of statistical adjustments. Consumer spending advanced, but that must be tempered by the support from fiscal and monetary policies. The growth in the deficit poses imminent danger of another recession, and the political landscape makes it unlikely a solution will emerge. Mauldin would like to see 'thought leadership' in the upcoming presidential election cycle, in order to build support for viable policies to revive the economy.
The Unsustainable Meets the Irresistible
States are the largest component of US GDP, and states' revenues have declined 10% from their peak. On top of that, federal stimulus support for states is running out. Congress should allow states to declare bankruptcy and force unions to come to the bargaining table. The US is on an unsustainable path. Absent very serious fiscal remedies, long before we get to 2019 the bond markets will have taken away our ability to finance our debt at low rates.
Thinking the Unthinkable
Mauldin criticizes Bernanke's comment that a benefit of QE2 has been rising equity prices, arguing that this would amount to a third mandate for the Fed. He commends Richard Fisher of the Dallas Fed for his comments that monetary policy is not a tool to solve the country's fiscal problems. Mauldin then says that a big treat to his growth forecast is continued sovereign debt problems in Europe. Lastly, he questions whether China can engineer a soft landing for its economy, given rising inflation.
Forecast 2011: Better than Muddle Through
Mauldin reviews his prior-year forecast. He was right on currencies and gold, but missed the bull market in equities. For 2011, he likes gold relative to the euro, pound and yen, but is less bearish on the pound than he was a year ago. He fears the Kamchatka volcanoes (in Russia) will trigger a spate of bad wealth which will lead to scarce resources and inflation. He is optimistic about the job market and employment, and forecasts that the US economy will grow 2.5-3% in 2011. He fears, however ,that structural problems in the work force will leave many untrained for employment.
Some Thoughts on Market Timing
I have real doubts that there will be ?hundreds of billions? of losses in the municipal bond market. It would take a default by almost every major municipal issuer, and a lot of small ones, to create a hundred billion in defaults, something not likely to happen. States will be forced to make spending cuts. Mauldin also cites three sources who he "highly respects" who advise to hedge US equity portfolios going into 2011.
Kicking the Can Down the Road
A collapse of a major European bank could trigger counterparty mayhem in the US banking system, at least among our major investment banks. The ECB is now earnestly continuing to kick the can down the road, buying ever more debt off the books of banks, buying time for the banks to acquire enough capital. If the ECB were to keep this up, even in a deflationary, deleveraging world it would eventually bring about inflation and the lowering of the value of the euro against other currencies. One country after another in Europe is coming under pressure. This week the debt of Belgium was downgraded.
Unintended Consequences
The recent rise in interest rates is due to the reallocation of globally indexed funds away from sovereign debt and into something else. The may be a prelude to a sovereign default or a more rapid rise in rates, which could unfold very quickly. Global deleveraging is not over. QE2 and the nervousness of investors around the world are pushing up interest rates.
Texas, Ireland and Ten Little Indians
Mauldin contrasts the plights of Iceland and Ireland in dealing with excessive leverage. Iceland devalued its currency, while Ireland must accept a bailout package. Iceland's economy is recovering; Ireland's may take years. Mauldin compares the situation in Spain and Portugal to those two countries. The stronger EU countries must rescue the weak, just as Texas is being asked to rescue fiscally troubled states like California.
Recessions are on the Margin
We had a slate of good news over the past few weeks, including data on business confidence, housing, and unemployment. GDP growth is slowing, but it is still north of 2%. The economy may be able to handle only taking away the tax cuts for those with over $250,000 in income. It will slow things down, but probably not enough to cause a recession. Given that government spending is going to go down (at least I hope so), unemployment is going to take time to get under control; and with the whole developed world in a mess, it is hard to see an environment where we can average 3.5% for this decade.
O Deflation, Where is Thy Sting?
The economy growing between one and two percent. That is better than recession but not good enough to really bite into the unemployment rate, which means trouble. Mauldin examines the construction of the BLI's CPI index and specifically the role of housing: inflation, when you take out housing costs, is a jaunty 1.9%. Right in the Fed target range of 1.5-2%. The Fed's QE program may create inflation where we can least afford it - in energy and food.
First, Let's Lower the Bar
Mauldin responds to criticisms of a recent email he sent regarding healthcare reform. Next, he notes that for the last 18 months the trade-weighted yuan has dropped well over 10%, which he calls extraordinary. On the recently announced unemployment results, he says government "fiddling" with seasonal adjustments distorted the numbers. Last, he comments on the Irish sovereign debt issue.
Thoughts on Liquidity Traps
Lacy Hunt writes that the Oct employment situation was dramatically weaker than the headline 159k increase in employment measures. The most distressing aspect is the loss of another 124K full-time jobs, bringing the 5-month loss to 1.1 million. John Hussman discusses liquidity traps, where investors prefer cash to debt (because of low interest rates) and the central bank loses control. Fiscal policy, not monetary policy, impacts economic growth and inflation - and the proper fiscal measures, such as infrastructure spending, may be the best hope for growth.
Be Careful What You Wish For
Q3 GDP numbers were unimpressive, and it would not surprise Mauldin to see GDP growth be closer to 1% in the 4th quarter, unless we start to see evidence of more inventory building. That is not good for jobs, personal income, tax collections needed to cover deficits at all levels, or consumer confidence. A further threat is posed by large numbers of people whose 99 weeks of unemployment will soon expire. Republicans face big challenges once they gain power, and Mauldin says a VAT is the only way to reduce budget deficits.
The Subprime Debacle: Act 2, Part 2
Buyers of mortgage-backed securities may be able to join together and force issuers to buy back those securities, if the loans they contain are defective. This is further complicated by the fact that some of those buyers were non-US entities. Bank of America is badly exposed through its acquisition of Countrywide, as are "dozens" of other banks.
The Subprime Debacle: Act 2
The housing market has not yet begun to recover, and it is not only going to take longer but the decline in prices may be greater than many have forecast. But the real problem is the foreclosure crisis, where banks have foreclosed in situations where they had no right to do so. Several options exist for resolution, including sorting out the details of each case in a legal forum. A more ominous outcome would be to force investment banks to buy back securities with faulty titles.
The Ride of the Keynesian Cowboys
Mauldin reviews the just-released employment statistics, concluding that the "job picture is terrible." Add to that forecast weak GDP growth, lack of consumer spending, and feeble credit demand, and the Fed is left with one more "bullet" - QE2 - which is advocated by "Keynesian Cowboys" at the Fed. Others at the Fed, though, have warned about the unintended consequences of a possible QE2, and Mauldin doubts it will "work."
The Morality of Chinese Growth
Mauldin provides highlights from a recent conference. John Hofmeister is the former president of Shell Oil. He paints a very stark (even bleak) picture of the future of energy production in the US unless we change our current policies. David Rosenberg argues that GDP growth has been helped largely by inventory rebuilding, which is not sustainable. The analysts at GaveKal discuss the tension between Chinese policies toward economic growth and the social welfare it provides for its citizens.
Pushing on a String
The Fed will move forward with aggressive quantitative easing (QE), unless economic growth reaches 1.5 percent to 2.0 percent. The Fed's QE efforts thus far have been ineffective, because funds remain on banks' balance sheets. Future efforts would likely lower interest rates or possibly devalue the dollar, but it is unlikely it will stimulate growth.
The Chances of a Double-Dip
This commentary features a letter from Gary Shilling on the chances of a double-dip recession. Shilling notes that investors early this year believed that rapid job creation and the restoration of consumer confidence would spur retail spending. A funny thing happened, however, on the way to super-charged growth. In April, investors began to realize that the euro zone financial crisis, which had been heralded at the beginning of the year by the decline in the euro, was a serious threat to global growth. Stocks retreated, commodities fell, Treasury bonds rallied and the dollar rose.
The Last Half
Mauldin provides another excerpt from his forthcoming book. He argues that growth in government spending comes at the expense of private sector growth. Fiscal stimulus will not work in the current environment, because we are now at the end of an unprecedented debt cycle. The preferred solution is for a country to grow its way out of debt, but that requires running a trade surplus, which cannot be accomplished by all countries simultaneously.
The Last Chapter
Mauldin presents content from his forthcoming book. He reviews some fundamental precepts of economics, focusing on the Keynesian approach the US is taking to revive the economy. He presents data from Woody Brock showing that the US debt may rise by as much as $1.5 trillion per year. Ultimately, he says, the bond market will revolt and interest rates will rise and the results will be very unpleasant. Using taxes or savings to handle a large fiscal deficit reduces the amount of money available to private investment.
The Dark Side of Deficits
At the start of each bull cycle, the markets had single-digit P/E ratios, with no exception. No secular bull market ever began with high P/E ratios, even though significant rallies often started from high P/E ratios. The lesson of history is that all periods of high valuations come to an unhappy end. The most significant driver of stock market returns is the valuation embedded in the P/E ratio. We are still in a secular bear market. Valuations, while lower, are still not at what could be called historical cyclical bottoms. Patience is the order of the day. We will get there.
How We Get Through This Mess
Don't expect a v-shaped recovery, but GDP may still grow in Q3. Unemployment and deficits will remain high. It is going to be a tough environment for the next 6-8 years. Growth opportunities will be in entrepreneurial ventures that can adapt to this environment and to future unforeseen hurdles.
The Gulf Oil Spill Disaster
The ecological destruction from the oil spill that was first feared is not going to be as bad as once thought, for a variety of reasons. It is not good, but it is not the unmitigated disaster it could have been. The government should have allowed certain ships to assist in the cleanup. The ban on offshore drilling should be lifted.
The Problem With Pensions
A report just out from the Center for Policy Analysis indicates that state and local pension funds are drastically underfunded. By the authors' calculations, state and local pensions are underfunded by $3 trillion. Pension funding in some states will be required by law to consume 25-30 percent or more of tax revenues. That is going to mean much higher taxes or reduced services. John Mauldin also discusses a possible surprise from President Obama concerning Fannie Mae and Freddie Mac, and provides an economic update on China.
Are We There Yet?
The reported Q2 GDP growth was unimpressive. If we take away housing and project slower inventory growth and less government spending, we could see the GDP number for this quarter fall to the 1% range and stay there for the rest of the year. Deflation is a real fear, analogous to driving our economy "without a spare."
Some Thoughts on Deflation
We face the deflation of the Depression era, and central bankers of the world are united in opposition. This is due to excess capacity, high unemployment and massive wealth destruction. Deflationary pressures are the norm in the developed world (except for Britain, where inflation is the issue). The US has mild (1 percent) inflation now, but if it trends to deflation, the Fed will react by monetizing the debt.
The Debt Supercycle
The Debt Supercycle, as posited by the Bank Credit Analyst, is the decades-long growth of debt from small and easily-dealt-with levels, to a point where bond markets rebel and the debt has to be restructured or reduced or a program of austerity must be undertaken to bring the debt back to manageable proportions. The consequences for each country will be different, and the U.S. is a long way off from "the end." A key point will be the 2014 elections, when critical budget decisions must be made.
It's More Than Just Birth-Death
Mauldin examines the methodology used by the BLS when it calculates unemployment. He reviews claims by Jeff Miller of New Arc (which we published on Thursday) that distortions caused by unreported data are greater than those of the birth/death model. Mauldin also discusses a conversation he had with Mohammed El-Erian, who said that unemployment may now be a leading (instead of lagging) indicator of economic growth.
The Dismal Science Really Is
Yesterday's unemployment numbers were very bad, and Mauldin explains how they were calculated and the implications of adjustments, such as the birth/death model. Personal income was also down, which is a very rare occurrence. Other indicators, including the money supply, are not indicative of economic growth. The Fed will act aggressively to thwart deflation.
The Risk of Recession
The risk of recession is 50/50, but several things could make it less likely: if the expiration of the Bush tax cuts are not as harmful as expected, if those tax cuts are extended, or if there is a pickup in bank lending. The ECRI leading indicators and the M3 money supply numbers are indicating a recession is likely. If there is a recession, it will be deflationary and the Fed will react with another dose of quantitative easing.
The Frog in the Frying Pan
Jonathan Tepper of Variant Perception, a research firm in London, writes this column as a guest contribution. He says that Mauldin's Muddle Through Economy is the product of several major structural breaks in the economy, which have important implications for growth, jobs, and the timing of a future recession: lower GDP growth will lead to more frequent recessions and higher economic volatility; high unemployment rates will be the norm, especially for less educated workers.
There's a Slow Train Coming
The question before the jury is a simple one, but the answer is complex. Is the US in a "V"-shaped recovery? Are we returning to the old normal? Mauldin concludes that the fundamentals are too weak to support robust growth, as typically follows a recession. He cites data from the Consumer Metrics Institute Growth Index, which suggests there will be a 2% GDP contraction in the third quarter, which he doubts will happen, but says the consensus 3% seems quite possible. He warns that if we go back into recession, the market on average drops 40%.
Six Impossible Things
You can run a trade deficit, reduce government debt and reduce private debt but not all three at the same time. Choose two. Choose carefully. The UK will likely allow the pound to devalue to reduce its deficit, but will face higher costs of imported goods. Greece, in contrast, has no good options, and ultimately will default on its debt.
Results 701–750
of 851 found.
