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Thoughts from the Frontline

The Cancer of Debt and Deficits

February 18, 2012

Choose your language

We are coming to the point in the United States when even the US government will no longer be able to borrow at very low long-term rates. That point is a few years off, and we have time to change paths; but as I have shown in previous letters, the longer we wait to get the deficit under control, the fewer choices we have and the more painful they are. NO country can run deficits the size we are currently running, along with unfunded deficits over four times the size of the economy and a growing overall debt burden, without consequences. At some point, investors in bonds will start wondering exactly what the process is by which they will be repaid. And what will the value of those future payments be?

One by one, the countries of Europe are losing their ability to sell their bonds at an interest rate that is sustainable for their economies and revenue bases without severe and socially disruptive restructuring, even if a central bank that will accommodate their spending by printing money or other countries will tax their citizens to pay for someone else's debts.

The US will soon be faced with that same problem if we…

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Bill Daugherty 19376

Feb. 18, 2012, 12:35 p.m.

One very large obstacle to the idea of VAT replacing income taxes would seem to be the seniors lobby.  “What?  I paid taxes on my income all my earning life, and now you want to change to tax me on my spending life as well?”  Getting from Here to There will always be a problem.  No solution can be beneficial to all age and earning cohorts.

Craig Cheatum

Feb. 18, 2012, 12:22 p.m.

Wow, thanks for integrating some different ideas into a very coherent argument.  Implementing the tax reform ideas you mention are not a far stretch from where we are now (and much simplified).  There will be some real kickback on external factors such as import and export fees/taxes—the Congress likes to meddle in external affairs.  One idea I read from Thomas Donlan at Barrons is to have flat but variable (over time) fees to avoid knee-jerk reactions and to match federal government needs.  Thanks a bunch for your work, I am very encouraged.

Craig Cheatum

daan joubert

Feb. 18, 2012, 10:58 a.m.

Bigger than the deficits - submitted as an email. Perhaps of value here in the comments section as well.
Hello John

It was with a great deal of interest that I followed the change in your writing from the early days of ‘muddling through’ recession and no mention of the D word, to this latest Letter in which you warn of the dire consequences of out of control deficits (and unfunded obligations) and the risk of a depression. It is not clear to me whether you were completely convinced of your views and whether perhaps you were more deeply concerned than what the contents of your letters show, but preferred to keep your reports less gloomy.

My interest in this trend, as an ex-physicist who became interested in some economics late in life, originated in an essay I wrote in 1999 in which I did a comparison of the annual total increase in US household debt against total disposable income. Since the data was not necessarily apples and apples, the focus was on the trend and not the actual numbers. Looking at the chart from about 1960 to late 1990s, it was clear that the trend was unsustainable - and that to avoid a crisis a reversal would have to be forced quite soon. This of course did not happen; rather the opposite, as the housing bubble and other factors sparked an even more intense borrowing and spending by not only households. We know what happened.

The heading of something worse than the deficits refers to another trend that will result in much more severe breakdown of the US economic system.

During the early to mid 90s, changes were made to the way the CPI was calculated - no longer was the CPI a measure of changes in the cost of living, but it suited the authorities to have a CPI that is substantially less than the true increase in the cost of living. I do not have to list these advantages, except to say that as so often when government meddles, they had unintended consequences. Employers linked increases to the official CPI, while the true cost pf running a household increased - since about 1998 - at perhaps 6-8% higher than the CPI. (See John Williams’ for a chart of the official and alternative CPI’, but you probably have seen it.)

Discounted over the past 14 years or so, this difference between nominal income and the true cost of living has left most if not all working households in very straitened circumstances.

To understand how bad the situation has already become - with no signs that the trend to increased impoverishment of households is ending - ask an assistant to obtain data on the average worker income of, say, hourly and also weekly employees as well as all employee remuneration, say from well before 1980. Discount this series by the official CPI and then with the Shadowstats alternative CPI to see with what amount of real purchasing power working America has to make a living. With up to 70% of GDP coming from consumer spending, it would not be wise to hold one’s breath for a sustained recovery in the economy, at least while this trend rules.

Taxes and cutting deficits are required, but if the consumer cannot spend on anything except living essentials - supplemented by food stamps - the problems will only get worse.
Glad you are enjoying South Africa and your contacts/partners here. It is a good country.

Keep up the good work.


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