Endgame: The End of the Debt SuperCycle and How It Changes Everything (Anglais) Relié – 25 mars 2011
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Descriptions du produit
Revue de presse
Charles Sizemore, HS Dent Research Analyst and Editor of the Sizemore Investment Letter
′It′s the freshest one hot off the press.′ – Seeking Alpha, March 2011
Présentation de l'éditeur
- Reveals why the world economy is in for an extended period of sluggish growth, high unemployment, and volatile markets punctuated by persistent recessions
- Reviews global markets, trends in population, government policies, and currencies
Around the world, countries are faced with difficult choices. Endgame provides a framework for making those choices.
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The transition from the debt supercycle to the endgame is characterized, for the most part, by a transfer of debt, not an extinction of it, from the private sector to the public sector (pp. 24-25). Western governments and central banks have run large fiscal deficits and printed massive amounts of money to reduce the impact of the multiyear balance sheet recession in the private sector (pp. 8; 13; 24-25; 29; 58-63; 98-104; 136-141; 155; 158; 172-174; 227; 230; 252; 267-272). To their credit, Mauldin and Tepper clearly explain why deficits matter. Unfortunately, countries like the United States have mostly not run surplus and pay down debt in good times so that there is room for a policy response in bad times (pp. 54-57; 178-180; 188-196; 224; 235; 249). Unless central banks print money, the financing of large government debt runs the risk of crowding out business investment that relies on savings of consumers and businesses (pp. 53; 121-122).
Mauldin and Tepper are not surprised at all about this policy of kicking the proverbial can down the road that will result into greater systemic instability with more macroeconomic volatility and greater variability of inflation rates (pp. 29; 34-44; 73-89; 154; 240; 254; 271). Most politicians in the developed economies have a hard time to address any long-term problem because most voters prefer to opt out of a long-term gain if a short-term pain is required (pp. 3; 7; 118; 129; 182; 188; 218; 238). The authors warn public decision-makers and their respective electorate that the longer hard decisions are put off, the more pain their country, state, or city will have to ultimately endure (pp. 6; 89; 92; 100; 155-156; 219; 226; 239; 245; 253-259). Like the private sector, the public sector will be hold accountable for trying to borrow its way out of a debt crisis (pp. 41; 55-56; 100; 259).
Mauldin and Tepper recommend that:
1. Americans reduce their personal leverage and save more. Policy makers have relied on debt and income transfers to mask the fact that low-end wages have become too high under the relentless pressure of globalization;
2. The U.S. economy shift from consumption, real estate, and finance toward manufacturing to start addressing the structural decline in its civilian participation rate. Germany has been thriving because the world has been buying its goods;
3. The United States put in place more tax policies to encourage new businesses and therefore new jobs;
4. The United States restructure Medicare, Medicaid, and Social Security thoroughly. No reasonably foreseeable rate of economic growth will overcome the structural deficit associated with these three major programs. Otherwise, a substantial value added tax will be needed to cover the cost and result into even slower growth;
5. The United States, its states, and its cities revisit the total remuneration package of their respective workforce. The status quo is unsustainable;
6. The United States take a cue from Canada by giving a higher priority to legal immigrants with degrees and money for a few years;
7. The U.S. economy reduce its over-dependence on foreign oil through steep taxation on gasoline to make alternatives more competitive that they are today. The tax burden in the United States is low compared to other countries around the world;
8. The United States use some of the proceeds, of a significantly higher taxation, on gasoline to fix its infrastructure, which is badly in need of repair;
9. The United States get serious about the much-touted nuclear renaissance by approving the building of a large number of new reactors (pp. 67-69; 85-86; 88-89; 118-119; 124-125; 137; 160; 167-169; 181-214; 243-244).
Mauldin and Tepper point out that there is no way to know in advance when bondholders will suddenly lose confidence in the ability of a government to pay its debt, even if that debt is denominated in a currency that the government can print (pp. 13-14; 32; 54-55; 57; 94-98; 125-127; 186-188; 259; 263; 279-281). When countries have too much debt, they usually inflate away excessive debt. Devaluation and default on debt are the two other options available to over-indebted countries (pp. 25; 110; 122-125; 128-131; 158; 180; 200; 229). To compensate for this higher perceived risk, bondholders will press for a rise in interest rates, which will further debilitate the capacity of a country to refund its debt (pp. 55; 105; 123; 231). A program of austerity becomes a necessity to bring the debt back to acceptable levels and to reinvigorate the confidence of bondholders (pp. 12; 154). Without the precarious and fickle confidence of bondholders, the ability to roll over (large) debt, especially short-term one, or borrow new debt at affordable rates, crumbles concomitantly with the liquidity of the financial markets and the economy (pp. 94; 96; 278).
Although Mauldin and Tepper do not offer any practical investment advice, they give a non-exhaustive list of possible investments to consider if one believes in either deflation and/or inflation (pp. 284-292; 294-296). The authors believe that deflation will precede inflation (pp. 133; 295). Mauldin and Tepper have a low confidence in the ability of Western central banks, including the U.S. Federal Reserve, to appropriately transition their respective economies from a deflationary era to one of controlled inflation. Therefore, timing will be critical to capitalize on an era of increasing volatility (p. 296).
So why just three stars? First, I didn't think the analysis was all that new or profound. If you are coming to the subject for the first time, then you'll probably learn a lot. However, if it's a topic that you already know a lot about, then you probably won't learn all that much that's new to you. Second, and more seriously in my opinion, is what I consider an ethical breach on Mauldin's part. In the epilogue, the authors (mostly Mauldin, it seemed to me) were giving reasons why we should be optimistic in the very long term. The authors believe that the advances taking place in various areas of biotechnology will be revolutionary and make life a lot better and longer for a lot of people. He talks in general about what's going on, but in one particular case, he mentions a specific company. However, he fails to disclose that he has a personal stake in that company, and so this comes across as shameless stock promotion, and for that I deducted a star. Still, the book is worth the read.
Here is the positive:
1) End Game looks at both sides of the flation argument, as opposed to other books that focus on just 1 or the other.
2) Mr. Mauldin tells you what he believes will be the likely outcmes for several countries around the world. 3) The book is straightforward and easy to read.
1) Too much of other people's thinking. This works for his newsletter as you get a broad perspective from a variety of economists. But for a book it just makes it seem like the authors didn't do enough of their own leg work, and were in some hurry to meet a deadline.
2) The chapter on how you should invest shouldn't be called a chapter, it is 4 pages short.
3) While the authors talk both the drivers of inflation and deflation they do not dedicate much time to discussing how, why, and when one will predominate the other. The most specific they get is to say they believe for hte US we will have deflation then inflation, no degrees of, or time frames or things to look out for as to when the change may be occurring.
Overall, I'm happy I bought the book, simply because Mr. Maulding issues such an outstandng e-newsletter for free, that I feel he deservees his royalty fees from my purchase of his book.
Nowhere in the book can I see reference to the 'exorbitant privilege'
enjoyed by the US in issuing the World's reserve currency. How this plays out against US profligacy is perhaps a topic for another book, but it is highly relevant to the subject at hand.
We know of the high indebtedness of the government and the ageing population. But what about the high level of reserves and Japanese savings? The penultimate paragraph on page 259 merely makes mention that these exist.
I lived in Australia from 1970-1994 so I zeroed in on chapter 14. Selecting the facts to suit a case or assembling facts to make a case? There are sins of omission and of commission.
Nowhere is it stated that Australia has the highest interest rates in the developed World; 4.25% p.a. after a 0.25% cut this December. Consumer debt as a percentage of GDP is very high but Australia's savings rate at 10% is now the second highest in the developed World after Germany, and unlike elsewhere savers have an incentive to save, not being punished by rates close to zero.
Australia has always encouraged home ownership, without engaging in the egregious practices of the GSE's in the US. Mortgage interest on owner occupied homes is not tax deductible. Where in Australia are there the acres and acres of newly built unoccupied homes and useless public infrastructure projects (eg: Don Quijote airport in Spain) that existed in Ireland and Spain BEFORE their busts?
Legal immigration has been encouraged, unemployment at around 5% is relatively low.
The fact that Hong Kong appears next to Australia in The Economist table of property 'overvaluation' (sloppily, no date on the chart and no proper reference to the criteria used) is no coincidence. Restricted land supply and mainland Chinese demand drive the market in Hong Kong. In Australia's case Asian demand and in particular Chinese demand is a significant driver of the market. A slow down in China will hurt Australia's economy. A politically stable democracy, investor friendly, resource rich and relatively free of corruption (how many expanding Asian countries can meet those criteria?) Australia will remain a hard asset haven, and real estate prices will continue to reflect those facts.
To bracket Australia with Ireland is ridiculous. The property market in Ireland ( part of a small island off the coast of Europe, in a Euro straightjacket), bears no resemblance to that of a whole Continent with a freely floating currency.
The authors call Australia's market a house of cards. I'd say they have dealt Australia a very bad hand indeed!
In summary, the book was a disappointment but at least it stimulated my critical faculties and showed yet again that with the right statistics one can prove almost any case!
In Endgame: the End of the Debt Supercycle and How it Changes Everything, Mauldin and Tepper pull no punches and get directly to the point. The crisis of 2008 represented a "massive reset of the global economy." Americans, their financiers, and their elected representatives made a series of irresponsible decisions (or perhaps more accurately failed to make responsible decisions) over the past thirty years that culminated in the greatest financial crisis in a century. We weren't alone, of course. Our counterparts in Japan, Europe, and much of the rest of the world made equally poor decisions. And now, we are left with large debts and no good choices.
Regardless of what our policymakers do, we are looking at a decade of slow growth, high unemployment, and on-again / off-again recessions. The 2008-2009 crisis did not create a garden-variety "business-cycle recession." It gave us a much more malignant "balance-sheet recession" characterized by a long period of debt reduction.
All of this leads us to the "endgame." While a person, company, or government can limp along in technical insolvency seemingly indefinitely, at some point lenders lose confidence and raise rates to punitive levels. Eventually, the debt burden simply becomes unsustainable, and there is a day of reckoning. When people or companies have too much debt, they typically default. But when countries have too much debt, they have one of three options:
1.They can inflate the debt away.
2.They can default on it.
3.They can devalue and hurt any foreigners who are holding the debt.
Each of these comes with its own set of problems, and none are without a good-sized dose of pain.
Before we get any deeper into the book, some introductions are necessary. John Mauldin writes one of the widest-read and best-respected e-letters in the world, Thoughts from the Frontline. He is also the author of the 2004 New York Times best-seller Bull's Eye Investing, and a well-travelled public speaker. Jonathan Tepper is the editor of Variant Perception, a macroeconomic research firm, and a frequent collaborator with Mr. Mauldin.
On a side note, I had the pleasure of first meeting Mr. Mauldin years ago when I was paying my tuition at the London School of Economics by writing articles for a now-defunct British investment magazine. John was gracious enough to grant me an interview, and we discussed his soon-to-be released first book, Bull's Eye Investing: Targeting Real Returns in a Smoke and Mirrors Market.
In that book--which, though now somewhat dated, I still recommend for the wealth of historical research that went into it--Mauldin elaborated on some of the themes he had begun covering during the last years of the dot-com boom. In the wake of the bust he coined the term "Muddle-Through Economy" to describe what he foresaw for the decade to follow. The economy would grow, but given the excesses of the boom that would need to be worked off, it would be at a rate substantially below the long-term trend. He was largely right; growth for the decade of the 2000s was an anemic 1.9%.
In Endgame, Mauldin reiterates this view, arguing that the deleveraging of the financial sector and the fiscal austerity that will eventually be forced on the government will create major headwinds to a robust recovery. Mauldin sees significant parallels between contemporary America and post-1980s-bubble Japan, a country he colorfully refers to as "a bug looking for a windshield."
Endgame is a veritable trip around the world, as Mauldin lays out the uncomfortable choices facing nearly every major country.
All About Deflation
Mauldin is one of the few analysts out there who really "gets" inflation and deflation. In clear thinking, Mauldin differentiates between "good deflation" and "bad deflation." The laptop computer that I am using to write this review is an example of good deflation. It costs one-fourth the price of the laptop I used when I interviewed Mr. Mauldin the first time, back in my LSE days, yet is many times faster and more powerful. This is "supply-based" deflation, and it is the result of technological progress and productivity enhancements that boost supply and lower costs to consumers. Free trade is also a major driver of good deflation.
Unfortunately, our economy is currently plagued by "bad deflation," which is an entirely different animal. Bad deflation is caused from a fall in aggregate demand rather than a rise in supply or a technological breakthrough; this is the deflation of excess capacity. When no one wants to buy your merchandise and you have to lower the price, this sets in motion a vicious cycles of falling demand and falling prices, the likes of which we haven't seen since the Great Depression. Suffice it to say, bad deflation is very bad indeed, and the fear of it is what forced Fed Chairman Ben Bernanke to launch his now wildly unpopular quantitative easing campaigns.
Mauldin also touches on another one of our favorite subjects of recent years, the velocity of money. Most contemporary disagreements about inflation and deflation revolve around a fundamental misunderstanding of what money velocity is and how it works. People get money supply. But money velocity is more abstract and harder to pin down.
Mauldin explains money velocity with characteristic Texas bluntness: "If you print money but it doesn't go anywhere, you won't get inflation."
That pretty well sums it up. Money velocity is the rate at which a dollar circulates through the economy. It makes no difference to the GDP level or the inflation rate whether you spent $2 on two widgets or we pass the same $1 back and forth buying one widget each from each other.
This is why the Fed's doubling of the monetary base has had not led to the hyperinflation that many feared. The Fed has made unprecedented levels of credit available, but the banks have failed to lend it out and consumers have shown little interest in wanting to spend it. (As both Mauldin and ourselves have pointed out, this is the fatal flaw in Milton Friedman's monetarist statement that "inflation is always and everywhere a monetary phenomenon," indicating that money supply alone determined to what extent we had inflation or deflation. Friedman failed to take into account variations in the velocity of money, which he naively assumed to be constant.)
Don't expect money velocity to increase much any time soon. The primary driver of both credit creation and money velocity in the 2000s was financial innovation and securitization. With the mortgage market crippled, this money-churning machine broken is for the foreseeable future.
Though he sees deflation being the dominant force for the time being due to the continued deleveraging of the private sector, Mauldin does acknowledge the possibility that the government's attempts to fight deflation might be too successful and lead to inflation or even hyperinflation. He sees this as being more likely in the United Kingdom and, eventually, Japan rather than the United States, but acknowledges that it is possible here if the Fed loses its independence and acquiesces to an irresponsible Congress: "Hyperinflations are not caused by aggressive central banks; they are caused by irresponsible and profligate legislatures that spend far beyond their means and by accommodative central banks that lend a helping hand to governments."
Around the World
While Mauldin's analysis of the American debt problem is sobering, his comments on Europe are downright frightening.
The focus in the financial press has been on the "PIIGS," the European periphery countries of Portugal, Italy, Ireland, Greece and Spain. The crisis facing these countries is not going away any time soon, but Mauldin points to an enormous risk in tiny Austria that no one else is talking about.
The evolution of a garden-variety recession into what became the Great Depression was triggered, in part, by a bank failure in Austria that created a ripple effect across the global financial system. Ominously, Austria's banking system again looks very risky.
Due to high interest rates in the Hungarian forint, Hungarian home buyers were very interested in lowering their monthly payments by taking out mortgages dominated in lower-yielding currencies like the Swiss franc. The banks in neighboring Austria were only too happy to help.
Sure, it seemed like a good idea at the time. But what about now, when Hungarians find themselves forced to pay back those loans in a depreciated currency? Given Hungary's fiscal condition, additional currency depreciation may be inevitable. What happens then? Will Hungarians choose to strategically default en masse, like many of their American brethren in states like Florida?
Only time will tell. But don't be surprised if the next crisis to roil the European Union starts in Hungary and Austria.
A Bug in Search of a Windshield
Mauldin saves some of his best comments for the chapter on Japan and correctly attributes the country's woes to bad demographics. Mauldin is no stranger to demographic analysis, and he routinely uses population statistics in his books and in his e-letters. Unfortunately, he falls into the same analytical trap that many others--including academic heavyweights like Ben Bernanke and Jeremy Siegel--fall into. He focuses almost entirely on the supply side of demographic analysis, ignoring what we consider to be the more important demand aspects.
Mauldin is largely correct in pointing out that "There are only two, and only two, ways that you can grow your economy. You can either increase your working age population or increase your productivity." This is a case of the tail wagging the dog, however. The post-industrial economy has turned Say's Law upside down.
Supply may or may not create its own demand, but demand certainly creates the incentives to produce more supply. Automation and outsourcing can compensate for lack of human labor; they cannot, however, compensate for a lack of consumers. The economics of the Industrial Revolution were made possible by the promise of ever-increasing population growth. The economist John Hicks openly asked if "Perhaps the whole Industrial Revolution of the last two hundred years has been nothing else but a vast secular boom, largely induced by the unparalleled rise in population."
Mauldin writes that Japan has been unable to grow its economy in over 17 years because government debt has crowded out productivity-enhancing private investment that could have boosted production. But production really isn't the point. In the absence of aggregate demand--which Japan's aging demographics have sapped--new production would simply mean overcapacity and even worse deflation.
Still, he is spot on in his analysis of the impending doom of the Japanese bond market. Mauldin writes,
94 percent of all Japanese government bonds (JGBs) have been bought by Japanese. Optimists point to a large pool of Japanese savings. However, that savings pool is already invested in JGBs, so it isn't the stock of savings that matters but the flow. The flow has been steadily decreasing. Japanese savings rates are now approaching the low that we saw in U.S. savings rates just a few years ago. And this is not due to the Japanese somehow becoming profligate Americans but almost entirely due to demographic necessity.
As Japan's retirees begin to spend down their savings, the country can no longer depend on its citizens to absorb its massive debts. Because of this, Japan will soon be forced to access the international bond markets for really the first time in modern economic history. International investors are far less likely to lend to Japan at current low rates give that outstanding debt is already 200% of GDP. When rates start to rise, then comes the endgame. Japan will finally rocket out of deflation into a hyperinflationary currency collapse. It won't be pretty.
What Happens Now?
Mauldin is very clear that, with the possible exception of Japan, whose fate is all but sealed, the endgames are not set in stone. Actual outcomes are path dependent on what decisions are made today. Will we take our medicine now, embrace austerity, and accept lower growth for several years in order to build a better foundation for the future? Or will we bury our heads in the sand and continue to rack up debts that will be horrendous burdens to future generations? It's not a question of pain or no pain, but rather a question of how much, when, and taken by whom.
We could succumb to the "Argentinean disease" and simply print money until it generates enough inflation to effectively erase our current debts. Or we could take the libertarian "Austrian solution" favored by some in the Tea Party, abolish the Fed, let the banks fail, and embrace massive deflation and high unemployment to purge the system of its excesses.
Neither of these solutions is politically realistic, of course. Mauldin's preferred solution is what he calls the "glide path," which would be a 5-6-year plan to gradually hack the deficit back down to lower than the GDP growth rate. This would (hopefully) prevent the bond markets from rebelling and pushing interest rates higher. It won't be fun to live through, but it would ultimately be much less painful than the alternatives.
In any event, Mauldin reaches the conclusion that we are likely looking at a period of higher-than-normal unemployment, a tepid economy, rising taxes, and lower levels of government service. We can't realistically grow ourselves out of this one.
We recommend you pick up a copy of Endgame. Given the noise dominating the newswires, it is refreshing to find clear, coherent thinking. Our compliments to Messrs. Mauldin and Tepper on a job well done.
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