Day 2 here in Vancouver, British Columbia, at the Agora Financial Investment Symposium put on by the folks of The Daily Reckoning newsletter.
Today's speaker was John Mauldin, president of Millennium Wave Advisors. If you haven't heard of Mauldin, you're missing out. He has the rare talent of being unapologetically bold with his ideas while not attracting many (sane) critics. His weekly newsletter, Thoughts From the Front Line, is read by over 1.5 million people. "My closest friends," Mauldin calls them. You Fools voted him second place in our 2007 Investor of the Year award, bested only by Warren Buffett (and I hear he's good).
Below is a partial transcript of Mauldin's speech, The End Game of the Debt Super Cycle, edited for clarity.
On what just happened: We're coming to the end of the debt super-cycle. This will fundamentally alter the economic climate in ways that only our fathers who underwent the Great Depression can understand. It's a deleveraging cycle. That's much different than a recession. It doesn't fix itself in a year or two years. It's 4, 5, 6, maybe 8, 9 years, depending on how high the debt ran up. And ours was pretty high.
On how we got here: We wanted our lifestyles to go up, but our incomes didn't go up. So we borrowed.
[Mauldin then showed a chart of what GDP would have been without people using homes as ATMs during the boom years]:
Look at that chart. If there wasn't this massive credit binge, do you think Bush would have been reelected? God couldn't have been reelected with those results.
When debt is excessive to income, public or private or both, it's excessive. That's it. It doesn't matter whom the money is owed to. The Bank of Dad, or the central bank, or citizens. It doesn't matter. If you can't pay the debt, especially the interest payments, it's Ponzi at that point. And it leads to a debt deleveraging cycle. That's where we are now.
On what we're doing about it: We have to understand what's happened before we can know what will happen. Everyone should read the book, It's Different This Time, by Ken Rogoff and Carmen Reinhart. It's the history of financial leveraging. It's a very important book. All you have to do is read the first chapter and you get everything you need to know: that the most important thing in credit markets is confidence. Greece commands no more confidence and, look, their short-term debt is, what, 10%? Soon its debt will go to 50 [cents on the dollar], then 20, and then zero. Greece will default.
In America and other developed nations, the governments are stepping in where consumers fear to trip. But there's a limit on what you can do. That's what Greece is all about.
Further increasing leverage to try and solve the problem only leads to greater risk. In the short run, Keynes is right: If you pump up government spending, you'll have a reaction in GDP. But it's not permanent. It's a sugar high. It makes a difference in the short run, but not in the long run. Once you reduce government spending, it has a negative effect on GDP. That's important, because we're playing here at the edges of what we can do.
There are only two ways to increase GDP long term: Increase population, or increase productivity. That's it; class dismissed. And when the economy is net dissaving [as a result of government deficits exceeding what consumers are saving], you don't have money for investments, so you have less productivity. The government just starts sucking the life out of the economy. There's a Harvard study showing that $1 of government spending decreases private spending by about $1 long term, with no net benefit to GDP. It's just a sugar high.
On inflation and gold bugs: You can increase the supply of money a lot, but if velocity is falling, you're not going to get inflation. It's the classic "pushing on a string" idea.
Right now, the velocity of money is rolling over. Over time, it's mean reverting, but right now it's way below average. That should scare you. It shouldn't be happening with all the money being pumped it. Gold bugs, I'm sorry. You see all the charts about how much money the Fed has printed, but it doesn't make any difference in terms of inflation. Not in a debt deleveraging cycle.
Now, I'm pretty sure that when a Federal Reserve governor is chosen, they're taken into back room and are sworn to be viscerally opposed to deflation. Until velocity grows, they will print more money. I'm sure of that. I fully expect them to keep printing money as we roll toward deflation. All of the Fed measures of inflation are under 1% as we head into a slowing economy. M2 money supply is flat. Why? Because banks are keeping money at the Fed. When banks can keep money at the Fed and earn interest on it, that's a good business model. It sure beats lending it to someone who can't pay you back. I actually read this morning that banks are now asking homebuyers to put up 20% down payments. Who would want to be in that business when you can just lend to the Fed?
On where we're headed: We could choose the Argentinean route, hyperinflation. I don't think that's going to happen. The Fed is filled with serious people. They'll try to give us inflation. Some inflation, but not hyperinflation. They know what to do with inflation. They've done this before. There's a less than 1% chance of hyperinflation.
I recently had a drink with [historian] Niall Furgerson. He said we could do it like Eastern Europe and just hit the reset button. That would be good, but only if we had a king that could make hard decisions. Congress can't even agree on the simple stuff. Take Social Security. Fixing it is so easy. But we can't get it done. I'll be 62 next year, and I'll start getting Social Security. I'll collect it as long as they offer it to me until they take it away. So will everyone else.
Maybe we'll do it like Japan? Japan is a disease. They're like a bug searching for a windshield. It's a dying country. Nominal GDP is where it was 17 years ago. Plus, the population is very old. When they stop funding their own debt [as a result of retirees ceasing to save], it's going to get ugly. You're going to see the yen valued against the dollar go to 100, and then 120, and then 250, 300. They won't care how low it goes. They can sell more Hondas
What we should do is what I call the Glide Path. We knock a little bit off the deficit each year. Maybe $150 billion each year, whatever. Once you get your deficit under nominal GDP growth, you can run that deficit forever.
The problem with the Glide Path is that it locks in unemployment at uncomfortably high levels that we're not used to. I think Republicans will reclaim this year. And come 2014 when the Republicans own the economy, voters will have to say, 'stay the course' in a situation of uncomfortably high unemployment. If they don't, it's back to the Japanese way. 2014 will be the most important election ever. I actually just spoke with Newt Gingrich, and he agrees with me. If we don't stay the course and demonstrate to politicians that we're serious, we're in trouble.
Final words: Most countries in the developed world have binary options: choose one or the other, and choose well. It's a very interesting and volatile world that we're getting ready to face. It will be much more volatile than what we've seen. If you chose right, it can be a lot of fun.
I'll have more from Vancouver every day this week.
