Outside the Box

Hoisington First-Quarter Review and Outlook

John Mauldin

April 17, 2012

Lacy Hunt kicks things off with a bang in Hoisington's Quarterly Review and Outlook, this week's Outside the Box:

"The standard of living of the average American continues to fall."

The reason, in a word: debt. Lacy explains what happens:

"Efforts by fiscal and monetary authorities to sustain growth by further debt accumulation may produce some short-term benefit. Sadly, these interludes fade quickly as the debt becomes more destabilizing. The net result of increased indebtedness then becomes the opposite of what policymakers intend when they promote economic growth by either borrowing funds for increased government expenditures or encourage consumers to borrow with artificial and temporary incentives."

In other words, you can't get to real, sustained growth of an economy by growing debt after a certain point –one that, sadly, we have already reached.

It gets worse, because, since 2009, private debt-to-GDP has fallen while government debt-to-GDP has surged. And, as Lacy notes, "United States government spending carries a zero expenditure multiplier, as do operating expenditures of state and local governments. Thus, each dollar spent by the federal government creates no sustainable income, yet the interest payment incurred with each borrowed dollar creates a subtraction from future revenue streams of the private sector."

That is, unproductive government debt is killing us. So what gives? It's simple: we either make some big, tough collective decisions, and make them soon; or we come to the "bang point" documented by Reinhart and Rogoff, where the bond market no longer believes the US will pay its bills. Europe and Japan will get there before we do, but the writing is on the wall: we must get our national-deficit act together.

I am doing a road show for Bloomberg in San Francisco, with 8 meetings today and a few more tomorrow. Bloomberg is marketing a very high-end new service called Mauldin Research Trades. My partners Gary Habib and Peter Mauthe have assembled an all-star team of technical trading analysts (who between them have written about 20 books on technical trading), who give us "conviction" trades each and every week. We publish the letter on Sunday evening. I am very pleased with the results so far. If you are interested, contact your Bloomberg Tradebook representative or drop me a note and we will get them in touch with you.

Tonight is dinner with real estate maven John Burns, where I am sure I will pick up a few new insights (I always do with John). Then I'm off to north of Denver for a day, then back home before I fly down to Austin over the weekend to be with Lacy Hunt at his long-delayed wedding reception where the iconic Texas band Asleep at the Wheel will be playing. Lots of friends there at a must-not-miss evening.

And Join me next Tuesday morning in Philadelphia at The 30th Annual Monetary & Trade Conference: Demographics, Politics, and Economic Growth, sponsored by the Global Interdependence Center (click on program title to register). It will be very informative.

Have a great week! I see some great food and conversation in my life in the next few hours.

Your worried about ever more debt analyst,

John Mauldin, Editor
Outside the Box

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Hoisington First-Quarter Review and Outlook

Lacy Hunt and Van Hoisington
Hoisington Investment Management Company

Debt/Income/Productivity

The standard of living of the average American continues to fall. Real median household income today is near the same level as it was fifteen years ago, a remarkable statistic since the debt to GDP ratio is 100 points higher (Chart 1). The cause of this deterioration in living standards can be traced to the excessive accumulation of debt,…

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Comments

Ronald Nimmo

April 26, 2012, 5:34 a.m.

Actually, John F. Nash was a brilliant mathematician, not an economist per se. His revision of von Neumann’s game theory had a powerful application in economics, for which he won the Nobel prize. It was also one of the Rand Corporation’s fundamental tools for designing cold war strategy. But Nash also had great achievements in mathematics unrelated to economics and game theory. For instance, he developed revolutionary methods for solving partial differential equations. He was the math prof featured in the movie “A Beautiful Mind”

Ronald Nimmo

April 26, 2012, 5:16 a.m.

I don’t understand Hoisington’s and Lacy’s use of the term “negative risk premium”. When the risk premium is high, interest rates on bonds are high and the price of the bond asset falls. When the risk premium is low, the interest rate on bonds is low and the price of the bond asset rises. This is the basic framework from which the discounted value of a stock, and hence its “real price” is calculated. Of course low interest rates can be caused by severe economic weakness, which also could cause stock prices to fall. In such a case, the risk premium ( and interest rates) could still be relatively high compared to the rate of inflation because the risk of bankruptcy or default is higher in depressed times.
  Using the term “negative risk premium” to describe the condition that “the total return on the S&P500; was less than the total return on long-term Treasury bonds” seems hard to decipher to me. However, overall, this is a very trenchant and insightful article which lucidly explains the connection between high debt and low growth.

M. Senft

April 19, 2012, 10:06 a.m.

On one hand, debt, or rather the various, combined versions of debt, is of course or approaching crisis level.

However, to limit the problem to public debt only is dishonest and disingenuous.

A good portion of the increase of the public debt in America resulted from the 2008-2009 collapse with decreased revenues, exacerbated by the fiscally irresponsible so-called Bush tax cuts.

Meanwhile, on the private side, debt is already growing again before the so-called pre-existing overhang was sufficiently resolved. This follows from the necessity of consumer debt as a substitute for decades of flat earnings. if the consumers aren’t paid enough to afford it, at least they can be lent the money to buy it. If that lending came to an end, well, it wouldn’t be a good thing (except, maybe, morally).

Also, no one who enables the corruption of the political class has right to criticize the nation’s failed leadership. To believe that the awful crap that comes out of Washington is because of the stupidity and ignorance of politicians or that they have a single-minded focus on serving the people—like two pointless wars, I suppose—is, again disingenuous at the least. Sillier (or more dishonest): essentially taking the position that all the lobbyists are actually failing to do their jobs. I mean, of course all the homeowner relief activities have been complete failures because of pandering to voters and not because of anything pushed by even a single lobbyist….

It’s lovely—informative—to discuss economic issues in the abstract but if you’re going discuss reality, deal with facts, not suppositions, beliefs, hallucinations….

Don Braswell

April 18, 2012, 4:42 p.m.

Interesting aside from this quote:  “The current period of extreme indebtedness in the U.S. constitutes the third such episode since the Civil War. The two earlier cases include the 1860s and early 1870s, and the 1920s and 1930s.” 

It seems that these really big messes come about every sixty years or so, and seem to last for a decade.  Perhaps the biblical YHWH knew something about economics?  The book of Leviticus called for a debt jubilee every 50 years.  During this time, slaves were returned to their families, and debts were supposed to be canceled.  If ALL debt had to be canceled every 50 years, perhaps we could maintain a moving average closer to the mean without the wildly fluctuating 60 year transition cycle. 

Okay, laugh me out of the room - but it does bear some sort of scrutiny when that ancient Jewish practice might be more beneficial than all the ideas from either the Austrian School vs. Keynesian schools of economics.  It captures the psychology cycle of a market.  We make these mistakes when the last generation has died off, and cannot correct our bad behavior.  We seriously started down this road about 1980, when my depression era grandparents were no longer concerned about normal politics and finance.  We correct this behavior when markets force us, and we have about a 60 year collective memory…

jack goldman

April 17, 2012, 1:03 p.m.

As long as bankers create one hundred dollar bills for five cents there will be hell to pay. Faith based money has never worked. Will Rogers had it right. I don’t want a return on my principal I want a return OF my principal. People are afraid they will not be paid back at all in default. The default will occur by the printing press or out right refusal to pay like houses owned by unemployed people. No jobs, no mortgage payment. A $16 trillion dollar debt, created mostly from 2000 (at $5 T debt) is evidence this generation is unwilling to accept adversity. Selling children into debt slavery is not a good option. I would prefer default. It’s just paper. We need a debt jubilee. Otherwise debt grows exponentially and the 1% will own 99% of the world, which is their plan in the first place. I fear this will end in war where the 99% are played off against each other for jobs and food coupons. Protect yourself. Get out of debt.

Craig Cheatum

April 17, 2012, 10:55 a.m.

I agree with Harvey’s idea.  But we also need a debate on the bloated health care and national security sectors.  We spend 2-3 times on health care than our competitors and half of federal revenues on national security—neither of these costs are sustainable and in fact are a waste of money.  There is a lot of potential in sectors such as energy, construction, technology, and manufacturing that would be a lot better place to spend our money to help get us out of this mess.  We also have not reformed the financial sector, so unless necessary reforms are in-place (such as resolution), we are vulnerable to another crash that may be worse than before.

Harvey Ring

April 17, 2012, 7:21 a.m.

Our debt crisis is near the tipping point.  We don’t have 10 years to go before the bond vigilantes wake up one morning and decide we can no longer be trusted to pay them back.  In fact, if we include the new estimated cost of Obamacare, we will be adding another $200b yearly to our debt pile.  Is there a way out of this mess?  Sure, but it maybe politically impossible to do with our spineless political class that remains focused on being reelected instead of fixing the problems they and past generations have created. 
We are running out of lenders so the Federal Reserve is buying about half our debt.  6 years ago, they didn’t need to buy any!  If you believe in American exceptualism, and I do, we can solve the problem, but we must act!  We need to grow our economy as the first objective.  The second is we need to reduce spending in a prioritized way and increase tax revenues by a like amount to stop the debt bomb.  A multiyear plan to cut real spending about $100b yearly and cutting deductions a like amount would not cause a significant effect in a $16t economy, but would begin to slow the growth of our debt.  The resolve to do this over the next 5-7 years would have an immediate affect.  Americans could predict the future and count that marginal rates will not go up.  If we continue for 10 years, we will begin to shrink the deficit and be able to reduce marginal rates for everyone and every entity.  What a concept!  There will be real pain for every American, but we will survive and prosper.

Nelson Swanberg

April 17, 2012, 3:09 a.m.

During that period in the United States, the excessive debt of the 1920s was dramatically reduced and created the basis for post WWII U.S. prosperity (Chart 3).  LMAO

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