Dear Readers,
It's a sure sign of economic trouble when even the permabulls acknowledge pain is coming down the pike. That is exactly what John Mauldin of Mauldin Economics sees, as he told David Galland in an interview at our Spring Summit, Recovery Reality Check. Watch the video – or read the transcript if that's your preference – to learn why John thinks the period through 2013 is vitally important for the US economy and what he thinks the number-one priority for investors is during that time frame.
I hope you enjoy this timely interview. Doug and I will be back soon.
Sincerely,
Louis James
Senior Metals Investment Strategist
Casey Research
John Mauldin proved to be one of the most popular speakers at last spring's Casey Research investment conference, and we're pleased that he'll be presenting for us again at the upcoming Casey Research/Sprott, Inc. Navigating the Politicized Economy Summit. This timely event, to be held in beautiful Carlsbad, California from September 7-9, features our own Doug Casey… natural resource investing guru Rick Rule… former US Comptroller General David Walker… best-selling author G. Edward Griffin… and many more financial luminaries. Together, they will shine a spotlight on the pitfalls of today's centralized economies and reveal actionable investment strategies you can use to protect and grow your wealth. All the details are right here.
Interviewed by David Galland, Casey Research, Managing Director
David Galland: Hi, this is David Galland. I'm here with my old friend John Mauldin from Mauldin Economics. John is participating in our Recovery Reality Check Conference, and we thought we'd catch a few minutes and get his take on the recovery and whether it's actually happening or whether it's a figment of somebody's imagination. So, John, welcome. First off, I guess the big question in the macro picture here is: are we in a sustainable recovery?
John Mauldin: No. It won't be sustainable until we figure out how to deal with the deficit, so it's just halftime between the last recession and the next problem. But it could be a 40-minute halftime – it could be a Super Bowl halftime rather than a normal game time. It could go longer than we would think. It'll be muddled through. Today we saw 2% GDP. It was goosed by the fact that consumers saved 2% less; otherwise it would have been flat. These aren't numbers that are being driven by increased production, not being driven by exports or private investments.
David: But also a large part of the GDP is government spending.
John: It is; and it's becoming a larger part and that's part of the problem. As we take government spending down – which we will be forced to do, either by the markets or we do it willingly – when we reduce government spending it will reduce GDP in the short run. It boosts GDP in the short run going up, but it has the reverse effect going down. It's just like leverage can increase spending. If I go out and borrow some money, then spend it, that's good for the economy; but the reality is I have to pay it back, so I've spent future monies with my borrowing. And that's what we've done with government spending, increasing it up to its current percentage. We've borrowed from future generations, and we're going to have to pay the piper at some point.
David: It's interesting, when you say that we are at a sort of halftime. There's no halftime for the deficit spending. It's roaring ahead. Debts are continuing to pile up. Actually, I heard in the news today that the House voted to not increase student loan rates. Heavens forbid you do anything that's going to gore anybody's ox, but at the end of the day you can't just keep this spending up – and somebody's ox has to get gored. This is a true statement, right?
John: It is, but you're not going to see any ox get gored by either party prior to this election.
David: But there's always an election. Won't you then see the same thing happen even after this next election?
John: That's why I think 2013 is such a critical year. If we don't do something about our deficit and our debt in 2013 – and it has to be a really significant game-changer; we can't nibble around the edges like we talk about – it's got to be a massive restructuring of our society. If we don't do it in 2013, I don't see how we get it done in 2014, an election year. I don't think we can make it to 2015 before the bond market starts to jerk our chain, which says that 2013 is the year to see something get done. If we're sitting at this conference in 2014 and we haven't dealt with it, rather than me being the most bullish person at this conference – even though I think we've got a great deal of pain in front of us – I’d be just as bearish as poor Doug, which would be very, very sad for the country. One of the things that I'm most fervent about is that I want Doug and Porter to be wrong.
David: Yes. Well, here's the question. Every time over the last few years that the Republicans and Democrats have agreed to sit down and really get this problem fixed, they've come away with absolutely nothing. I forget what the most expansive program they have proposed so far, but it's something on the order of, what, cutting $100 billion over 10 years? It's just complete nonsense. To think that between now and a year, year and a half from now they're actually going to have that sort of "come to Jesus" moment and say "All right, now we're really going to cut a half a trillion out of the deficit"…
John: We're going to have to cut something close to $800 or $900 billion. It's a huge number. It can't be done all in one year. It has to be done over five or six years. We have to have some growth as well. Say you start talking $150 billion a year. You're talking 1% of GDP that we're going to reduce. It'll have an effect for about a year – and then we're going to do it again. So what we've done is we've locked in slow growth. We've locked in a muddled-through economy, and that's without a recession. If we have a recession, it makes the situation worse. We will have a recession during that period. You don't go for 10 years without a recession.
It is problematical. If we don't do it, we get to the place where Greece was or Spain is or Italy is; the markets will begin to force us to do it. Spain would be in a catastrophic situation if it was not for the fact that the ECB put one-point-something trillion euros together. Without Europe, the ECB or somebody putting another trillion euros together, Spain will in fact have their own moment where they can no longer borrow money at rational numbers. The interest rates go hyperbolic on them, and they start having to talk default.
David: It was interesting that Lacy Hunt, who was the former chief economist at the Dallas Fed, I believe, was saying that the Fed doesn't control interest rates. On the long side as we know, this is true. However, when they make a promise that they are going to maintain current low rates through 2014, there's really only one way they can do that, which is to go into the Treasury markets. If there is an insufficient demand to buy the Treasuries, they've got to step up to the plate and create the money. So, in fact, they do still have some way to exercise control over long rates.
John: They've moved out the yield curve. Five, seven, in some cases ten, to bring those rates down. That shouldn't surprise us, because that was precisely what Bernanke said he would do in 2002, when he gave his famous helicopter speech. I'm sure he regrets that now, using the helicopter analogy. That was supposed to be an economist joke. It was told to an association of economists, and I'm sure the economists laughed, because it was kind of an inside chuckle, but the rest of the world didn't get the joke.
But the more important thing than the helicopter-dropping-cash part was that he said: "We'll move out the yield curve if we have to." Because he's a Keynesian, and at their hearts they believe it's consumer spending that drives the economy. Now, a good Austrian like yourself or a quasi-Austrian like me would say: "No, it's productivity and supply." It's the creation of lower-priced goods that will create the demand. You have to have that first. It's an opposite perspective. Right now the Keynesians have the reigning paradigm in the entire developed world and most of the emerging markets – until that thought process is destroyed. They're in the process of doing that in Europe – that experiment is beginning to show itself as not working.
David: Except for the French. It looks like they're going to elect a socialist.
John: Yes. That makes France my candidate – which I've been talking about for some time – for the next really big black swan. Right now nobody is talking about France being a problem on the scale of Spain or Italy. I would suggest that they won't be a problem on a scale of Spain or Italy; it'll be Spain and Italy together and doubled. France will be the final negative outcome, the final nail in the coffin, however you want to call it, to Europe. Hollande only makes it more likely that it will happen. You would like to think that the French could wake up when they walk into the polls and say, "Oh my God, we really can't put this crazy man in." When you look at what he's saying, it's totally absurd, and they're already careening dangerously close to the edge of the cliff. But if they do, then they just get further down the road. France has got some real problems.
David: One of the things that is so interesting in all of this, is that there are a lot of people who view this through the lens of history: "Here's how these things ought to work and where they should go." But it seems to me that there's years and years of a sort of dead wood of building up, laying on the ground of socialism, if you will. People have been educated to expect the government to fix everything. Whenever there's a problem, the first thing they do is they hold congressional committees. My God, they're still chasing after Roger Clemens over whether he used steroids or not. Baseball players have to have a level field, so let's get the government, they can fix that too!
And again Europe – France is a very good example. You have a scenario where the French people are tired of this crisis, tired of the problems, tired of the unemployment, tired of everything that's going on, and they want the government to fix it, damn it! So their solution is, "Okay, the right-wing guy didn't fix it, let's bring in the socialists now. They're going to fix it." But the way they're going to fix it is by putting chickens in every pot. But in reality, they don't have any money. They're broke. All of these big Western economies are broke. So looking from what I would call a less traditional perspective, it seems to me that your phrase "end game" is a very good phrase because it seems like this has got to come to an end. It can't be a soft, fuzzy end, because people want immediate satisfaction and that's understandable.
If you don't have any savings in the bank, you're living hand-to-mouth, you could lose your house, you lost your job, and you can't find a new one – which applies to an awful lot of people – you want a solution and you want it now. You're not going to wait five years down the road for that chicken in the pot. So there's a good chance, it seems to me, that the public are going to lose patience with this. But the solutions that they're going to want to see are not the solutions that would actually fix the problem. That is to say: going back to freer markets to lowering taxes, even on the wealthy, reducing regulations, and reducing the amount of services the government provides. It seems like that's the complete opposite of what people would actually politically accept. What's your general view on that?
John: Greece is a good example, and they're the easy example. Greece has a choice between the disaster of staying in the euro or the equally bad but different disaster of leaving the euro. They only have a choice of which disaster they want to choose. One is a long, slow disaster – staying in the euro because their wages have to equalize. That's a depression for another 5-10 years. Leaving the euro, going to the drachma, would be a deep and quick recession. If they went into the drachma and tried to recover with the same set of rules they have now, it will halt and make their recovery much more difficult. You've really got to hit the reset button on not just the currency but on a whole host of things.
David: This is not just Greece…
John: It's now becoming Spain. Without the European Central Bank being willing to put in another trillion dollars and hold those interest rates down, Spain has the same problems. Spain becomes Greece. Europe has got to spend trillions of euros to give their governments the time – Spain, Italy, Ireland, Portugal – to be able to reduce their deficits and get their balances into a primary surplus. Without concerted monetary printing that can't happen.
David: But don't stop in Europe. We also have Japan.
John: Well, Japan – I'm well known for my bearish views on Japan.
David: So, basically, it really is a global phenomenon.
John: It is a global phenomenon of the developed world. The good news, if you were Brazil, was that nobody would lend you money at reasonable rates, so you didn't get in debt. There are a lot of countries that aren't in debt, and they're going to be able to just chug right along, thank you very much.
And it's not like the United States or Europe is going to go away. What I was trying to say, semi-tongue in cheek today, was how bullish I am because we're coming to the end of the ability of governments to borrow money. We're going to stop misallocating capital via government spending, and we're going to start allocating it properly to productive resources. Well now, that transition is very difficult. It's either very bumpy and it's a slow muddled-through grind or it's a crisis here in the US. But either way you get to the other side of it. I don't think it's going to take more than about five years. One way or another, we're going through this by the latter half of this decade. Then it becomes quite bullish because we then can have some certainty we've restructured. We've rationalized the debt in one form or another, and we can start moving forward. But the ride between here and there – the difficulty for investors is that we have to make sure we get as much of our capital that we have today, as much as our earning power that we have today, to the end of this process.
David: And the best way to do that?
John: We don't know and probably won't know for another 15-18 months. The best thing to do now is to hedge your bets, diversify. I want income. I want to be able to make as much money on my assets as I can, but I don't want to have to commit to a 5- or a 10-year process.
If I could buy distressed real estate that will produce income – that I can be reasonably sure there will be people who will lease it for industry, either business or individuals – that's a productive asset. If we have an inflationary episode – which I think is the more probable scenario, not the hyperinflation that Porter's talking about, but inflationary – real estate will be a good asset to own, if you bought it at distressed prices today. Even if Lacy's right and we see a true deflation (which is hard for me to see where we get long-term that way – I could certainty see that in a short three- to five-year term span) you've still got a productive asset.
I want to own companies that are producing things that people want to buy. The advance of technology is not going to slow down. There are places to put money to work. There are opportunities that we have to get our money from A to B to C. But the traditional index funds, the traditional things that people have most of their pensions and their savings in, is not where you want to be.
David: There's a huge amount of money that of course has gone into bond funds in recent years, and that trade is probably getting a bit long.
All right, well I think that's a good place to leave it; and thank you. We could probably just sit here and do this all day.
John: Well, let's do it again.
David: We shall do it again, and thank you for coming to the conference.
John: Thank you.