Thoughts from the Frontline

Collateral Damage

By John Mauldin

December 31, 2011

Choose your language

What Next? Where Next?
A World with Too Much Debt
Debt Restructuring and Write-Offs
The Euro Zone: Pouring Fuel on the Flames
What If… ?
The Year(s) Ahead
Auld Lang Syne

"Whoever cannot seek the unforeseen sees nothing for the known way is an impasse."
― Heraclitus, Fragments

Which path will we take? If we could only grow our way out of our sovereign debt problems. But growing debt creates even more problems if not dealt with, making it even more difficult to deal with; yet getting the debt and deficit under control brings its own form of pain. As I keep pointing out, there are no easy choices left. Some countries must choose between difficult and very bad, and others are faced with either disaster or calamity. Greece simply gets to choose what it wants to be the cause of a depression. Long and slow or fast and deep? Choose wisely.

It's that time of year when we start thinking about what the next may hold for us. I am reading and thinking a great deal about my annual forecast issue next week, taking some time off from my usual Friday missive; so this week we look at what I think is one of the best pieces of analysis I have read in the past few months. It is from a private letter for the Boston Consulting Group, and Dan Stelter graciously allowed me to let my friends read it.

Follow this thinking carefully and then think through their outline of what a country would have to do to leave the euro, which starts at the subhead entitled "What if… ?". Then ask yourself what do you need to do. The short answer from me is that you need to consider more what you already own rather than what you should buy.

At the end of the letter is a link to an in-depth review of what scenarios businesses should be considering, but it will also work for individual investors. Now, let me turn it over to Dan and David.

Collateral Damage

What Next? Where Next?

What to Expect and How to Prepare

David Rhodes and Daniel Stelter

January 2012

This paper covers some familiar ground in order to remind readers of the interplay among the most important economic developments, considers the scenarios for which companies should prepare, and suggests some steps that prudent companies may wish to consider. For those readers who are well acquainted with the economic scenarios…

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Comments

Peter Halligan

Jan. 2, 2012, 11:02 a.m.

John Mauldinâ??s seekingalpha.com reposted article from Dan and Dave is flawed in two key ways.
One is that terms such as austerity/recession/no way out rather miss the point. Consumption is running way ahead of that which is affordable by consumers, whether these are Governments, companies or individuals. It is not austere, or recessionary or â??boxed into a cornerâ? to amend bad behaviour to a level which is affordable and rational. If those in work cannot pay for their consumption (on houses that are too big, cars that are too expensive, diet that is excessive and leisure time that has not been earned) then either they find future lenders for odious debt at usurious interest rates (think vendor financing of all products, including weapons, houses, cars and electronics) or they â??get realâ? and only spend what value they create.
Secondly, monetisation of fiscal or financial excesses (odious debt creation) cannot and never will work for the simple reason that if it did work, we need not pay taxes, ever. We simply print money.
It is about time these points enter mainstream thinking and we stop â??scaringâ? people out of seeking a balanced life style and assuming that â??big governmentâ? and central bank intervention has any value at all.
The solution is simple. Work out a trajectory for repaying debt by ear-marking a special â??debt reduction taxâ? that retires 5% of outstanding debt every year, until the debt is a manageable proportion of the personal and corporate tax take. I think this is equal to a steady state 2.5% real GDP growth + 2.5% inflation, divided by 10% of the tax take. In the case of the US this would equate to a total (Government + Company + Personal) level of debt of 50% of GDP. It will take about 40-50 years to get to this point, allowing for the reduction of 275% debt to GDP from Exhibit 2 in the article. 
This is the penalty (5% of our income per annum to make up for the same rate of benefit) we all have to pay for electing tin horns, snake oil sellers, liars and cheats over the last 40 years or so.

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