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Outside the Box

Hoisington Quarterly Review and Outlook

July 24, 2012

The relationship between high total public debt and interest rates is controversial (to some); and in today’s Outside the Box Van Hoisington and Dr. Lacy Hunt of Hoisington Investment Management tackle the subject head-on, in their “Quarterly Review and Outlook” for Q2 2012. They bring important new evidence to the debate, citing three academic studies (including an April 2012 paper coauthored by Rogoff and Reinhart) and an historical retrospective that focuses on the debt-disequilibrium panic years of 1873 and 1929 in the US and 1989 in Japan. In their view, the onus of responsibility for the “Panic of 2008” falls on the sometimes-slumping shoulders of the Federal Reserve, for making money and credit too easily available, and then “[failing] to use regulatory powers to check the unsound lending and the concomitant buildup of non-productive debt.”

It gets worse: “The average low in interest rates in these cases occurred almost fourteen years after their respective panic years with an average of 2% … Amazingly, twenty years after each of these panic years, long-term yields were still very depressed, with the average yield of just 2.5%. Thus, all these episodes, including Japan’s, produced highly similar and long lasting interest rate patterns… The relevant point to take from this analysis is that U.S. economic conditions beginning in 2008 were caused by the same conditions that existed in these above mentioned panic years. Therefore, history suggests that over-indebtedness and its resultant slowing of economic activity supports the proposition that a prolonged move to very depressed levels of long-term government yields is probable.”

It is a constant pleasure to be able to bring work of this quality to the attention of my readers, and I thank Lacy and Van for their help in doing that. Hoisington Investment Management Company ( is a registered investment advisor specializing in fixed-income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $4 billion under management, composed of corporate and public funds, foundations, endowments, Taft-Hartley funds, and insurance companies.

I am in Newport at the Department of Defense Net Assessment Office gathering of a small group of fascinating and forward-thinking individuals working on developing alternative scenarios as to how the future will unfold. It is quite multidisciplinary. This is a very eclectic group and not what one would normally picture as military (witness that I am here). There is a group of officers from various branches, tasked with thinking about the future, as well as experts from a variety of fields. At some point, when the time is appropriate, I hope to be able to share some of what I am learning, as I am simply fascinated with the discussions and debates. Long days, though, so I will hit the send button and get on to bed. These guys believe in early mornings. As those who know me know, I really don’t like to experience what 6 AM feels like. I am more of a late-night guy. But these meetings get the juices flowing, so it is worth it.

Your seeing a much larger puzzle analyst,

John Mauldin, Editor
Outside the Box

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Hoisington Quarterly Review and Outlook

Second Quarter 2012

Interest Rates and Over-indebtedness

Long-term Treasury bond yields are an excellent barometer of economic activity. If business conditions are better than normal and improving, exerting upward pressure on inflation, long-term interest rates will be high and rising. In contrary situations, long yields are likely to be low and falling. Also, if debt is elevated relative to GDP, and a rising portion of this debt is…

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Ronald Nimmo

Aug. 3, 2012, 12:56 a.m.

Re Lawrence Buhler:  What Krugman has to do with it is that he advocates much more deficit spending to stimulate the economy. The Austrian theories are not at all limited to preventing hyper-inflation, but to obviate the multiple negative consequences of trying to prevent down cycles in business with lavish credit schemes and spending with even more borrowed money. They believe that business should not be overstimulated with credit to begin with because that creates mis-allocation of resources. They also believe that down cycles with their attendant credit liquidation should be allowed to run their courses because they are natural self corrective forces. If credit creation has been reasonable during the expansionary phase of an economic cycle, then the de-leveraging phase need not be excessively painful.
  Ireland’s apparent lack of success with austerity is the result of it’s government unwisely agreeing to reimburse foreign banks for their investment losses. Otherwise their program would be producing excellent results. Spain is an example of what John Mauldin describes as the situation where no choice is without great pain. But austerity ideally should be phased in gradually, if creditors are willing to place enough faith in the country’s motivation to follow a realistic path.

James Russo

July 25, 2012, 3:56 p.m.

A well researched article that would be a useful read for the current administration and Fed Chairman, although not certain that would be able to grasp this in the context of the current reckless montary and fiscal “polices”

Gerald Ferguson

July 25, 2012, 11:37 a.m.

Another problem is a lack of allowance for the change from the gold standard to a fiat money system. The ‘debt’ is presumably owed to the Treasury, and would be repaid to itself. For example, with a negative trade balance, to make up for loss of dollars, (which shrinks the size of the economy), the Treasury issues dollars, this is called ‘printing money’, just what a central bank should do. In a fiat money system, money can be always issued, short of causing hyperinflation. So both the the US and Japan, like all the other nations not on the gold standard or Euro, cannot default without intent.

Simon George

July 24, 2012, 4:51 p.m.

To me the biggest lesson from this article is that monetary authorities have to have the foresight and fortitude to step in and tighten up credit availability when those areas of the economy vulnerable to unproductive speculation begin to show signs of such speculation.  And that governments have a role here too to encourage investment in productive enterprises rather than in the speculative and unproductive.  When the monetary authorities and the government get these things wrong at the same time, that’s when the trouble starts.  Inevitably the most speculative parts of the economy teeter and then fall as confidence disappears.  Loss of confidence sweeps through the whole economy.  When that happens monetary authorities, governments, households and businesses all have deal with the aftermath as it’s not just governments that can make poor borrowing / investment decisions.  For governments this aftermath period is particularly challenging as economic and political pressures meet head on.  Yes governments can spend more in this situation but the lesson is that it should only be on productive enterprise which the private sector is missing because of lack of confidence or backing to make it happen e.g. infrastructural investment.  The fact that we still have these periods of debt driven unproductive investment followed by recession indicates monetary authorities and governments have yet to learn the lessons around too easy credit availability leading to investment in over risky and largely unproductive schemes.

ian caton

July 24, 2012, 2:03 p.m.

Maybe the article is right in terms of economic growth, but doesn’t cover how ordinary people would be able to eat in the short term.

Somebody had to fill the hole in the money supply left by the implosion of the banks.

Jay Mackey

July 24, 2012, 9:46 a.m.

I really don’t know if there is any value in following Mauldin or not. I keep seeing things that give me hope that he’s not completely clueless, but then he starts spouting the Keynesian line, and I have to throw up my hands. Here we have an article that appears to show (and I agree with this) that Keynesian prescriptions in the past few years (if not the last two decades) have only worsened the fundamentals. Then the conclusion is to buy 30-year bonds and be happy with 2% returns??? This sounds… wrong?

The average inflation last year was 3%. Am I missing some trick where 2 - 3 = profit!? If the Fed was targeting 0% inflation/deflation, maybe this would make sense for some people (not me), but the Fed is TARGETING 2% inflation, which if you have any real wisdom at all, you should read that as they have no intention of letting the rate fall below 2%, and so far I see no evidence that they are incapable of achieving their intentions.

So I’m supposed to invest in something that, if all goes to plan, gives zero return, and is likely to give negative return. What am I missing here?? I could put my money in a mattress (intelligently, by buying gold, or silver, or some other real asset) and be better off. (And for you gold-bubble-heads, if I buy this article, how is gold in a bubble? It simply ain’t. It will continue to go higher, and the historical trend of the market going to 1:1 with the price of gold will happen yet again. Furthermore, if the dollar is so strong, indicating gold is really a bubble and not an indicator of the dollar’s demise, then why has the Canadian standard of living surpassed that of the US?)

Hans Sammer

July 24, 2012, 9:33 a.m.

What has happened to the bond vigilanties, that plaqued the Carter Administration, that led to higher interest rates?  Why is this time different?  HHS

Don Braswell

July 24, 2012, 8:42 a.m.

The study and evidence do seem to support the future outcome of both Europe, Japan and the U.S.  However, none of the previous three cycles studied had the monetary “benefit” while acting as the world’s reserve currency.  It would have been more interesting (and more relevant) to compare the British pound during a similar crisis?  It appears that with the reserve currency status, we may have more leeway than the Greeks, but eventually must face the piper for money owed.

Alfred Holzheu

July 24, 2012, 7:13 a.m.

I am curious, there is a mention in this article of the futility of current monetary tools, so what might be an alternative approach that the Gov/Fed might take to encourage growth without impoverishing the bulk of the population in the process.  What can/should the Gov/Fed have done in 2008…. instead of the the debt based stimulus, arguably a temporary band-aid that seems only to have prolonged the problem?

Thomas Busch

July 24, 2012, 6:15 a.m.

As George wrote it depends how the money is spent: if you pay for other governments in foreign countries, how can you expect any growth in your country? If you recapitalize banks and/or guarantee a number of bad banks, how can you expect any growth ?

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