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Ray Dalio – John Mauldin Conversation, Part 6

Ray Dalio – John Mauldin Conversation, Part 6

This is the final letter of the six-part series of my reply to Ray Dalio’s essays. Here are some links to help you wrap it all together.

As Ray notes, the problems he describes really are existential. He and I agree more than we disagree, but our responses differ.

I think that we both agree that the wrong answers will cause much angst and pain for most of our fellow citizens (and that is a severe understatement). And given his reply to me in Forbes, I think Ray would agree with me there are no easy solutions, only very difficult choices vs. disastrous ones. The longer we wait to deal with the problems, the more painful resolving them will be.

And make no mistake, the existential problems we are talking about (and neither of us use the word “existential” lightly) will resolve themselves in a highly tumultuous manner if we as a society don’t face them directly and soon. They are mostly problems of our own making, and since there are no time machines, we must deal with the reality which we created.

Today in my final reply to Ray I sum up my previous letters and describe one possible path for dealing with these problems. My idea will be controversial for most people. I am totally open to another, better solution if anybody knows one.

Ray started his letter as an invitation to a dialogue/conversation. I hope we can continue our conversation and others will join in. And with that, let’s finish my open letter to Ray…

No Easy Solutions

Dear Ray,

Let me see if I can summarize my writing so far and what I believe to be your main concerns, which I share. I do welcome a response.

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Last week I focused primarily on the US deficit and debt situation. Total federal debt is now $22.5 trillion plus another $3 trillion of state and local debt. Annual deficits are running at an average of $1.2 trillion and growing. As I demonstrated, in a recession the annual deficits will likely rise to $2.5 trillion, and certainly no less than $2 trillion, simply using CBO projections and assuming that revenues would drop and then slowly recover similarly to the last recession. I think that is a more-than-reasonable forecast.

That means total US government debt will be at $44 trillion plus maybe $6 trillion of state and local debt by the end of the 2020s, just a decade from now. Not to mention unfunded liabilities, corporate debt, etc. Of course, that assumes no tax increases and no budget cuts. Significant spending cuts are unlikely as the deficits are mostly entitlements, interest, and defense spending. So-called “non-defense discretionary” spending is actually a small part of the total budget. And while deficit hawks might find $100 billion to cut here and there, that wouldn’t affect the grand scheme of things. There is little political will to cut entitlement spending, and to your point, Ray, we may actually need more spending in order to solve the growing wealth and income disparity problem.

That brings us to taxes. Most tax increase proposals would raise rates on “the rich.” Using government data, I showed that a 25% increase on the top 10% of US income earners (roughly those making $120,000+) would produce only $250 billion per year. Ray, I am not certain what you think it will cost to reduce income disparity, but it would certainly eat up a good portion of that $250 billion, leaving little for deficit reduction.

Any such tax increase will be even more difficult if we enter recession within the next few years, which the New York Fed’s forecast shows is not far-fetched. Here is their latest data showing a roughly 33% probability of recession within 12 months.

Source: Peter Boockvar

The longer the yield curve stays inverted and the more it inverts the more probable a recession is. We have now had an inverted yield curve for three+ months and as I write are still in that situation. The New York Fed’s model has never reached a probability of 100% prior to any recession. But if memory serves, there has always been a recession anywhere from nine to 18 months after the model reaches its current level. The timing isn’t precise, but it’s close enough for our discussion.

[Sidebar: To my regular readers, I will further discuss this and other recession indicators next week, plus the political and economic ramifications. Please be patient.]

In any case, at some point there will be a recession, the Fed’s rate cut plans notwithstanding. I think they will keep cutting at least back to the zero bound. You indicate that you believe, and I agree, that it won’t put the economy back on track. Then they will start with quantitative easing.

You also feel that QE won’t help and will likely cause even greater income and wealth disparity. I agree. But I have sat in meetings with participants in the Fed thought process. Confronted with the probability that their actions won’t deliver the desired results, they simply reply that we have to “do something.” I’m sure you’ve had that experience more times than I.

No matter how ineffective we might believe it to be, they are going to keep rates at or below the zero bound and ratchet up quantitative easing, building the Fed’s balance sheet up to levels that today would seem mind-numbing.

I think Japan is the model here. Like the BOJ, the Fed will keep rates ultra-low and buy bonds until there are no more bonds to buy. The government will run massive deficits as long as the market lets them get away with it. And in Japan and apparently Europe, at least, the market seems to have quite a deal of tolerance in that regard. I call it Japanification and it will have roughly the same results here: extremely low growth, if any growth at all, tending towards deflation. Except that the deflation, at least in the price of things government doesn’t affect like healthcare, will likely be worse in the 2020s because of technology.

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That’s not the end of the world, but it is certainly not a world that compares favorably to the 1950s, 1980s, or 1990s. You argue that we need to engage in a new combination of fiscal and monetary policy, something you called Monetary Policy 3, or MP3. Modern Monetary Theory (MMT) may or may not be part of that, and you caution that MMT has significant negative consequences and that you are not endorsing it. Again, I would totally agree. I want to come back to MP3 a little later…

A Radical Restructuring of the Economy and Tax Code

You’ve laid out what you believe to be the basis for how the economy and markets work. Let me offer a few simple assumptions of my own.

  1. There is no political will in either the Republican or Democratic party to reduce entitlement spending, and entitlement spending is on an ever-increasing path.
  1. There is simply no way that we can raise income taxes enough to close the deficit to within striking distance of nominal GDP growth (where debt relative to GDP growth is equal).
  1. As long as debt is expanding as it is now, we will stay in a slow-growth economy at best, if not in recession. Much research shows that increasing debt beyond today’s level will reduce GDP growth.
  1. What we need to do is very difficult: balance the budget, bring deficits and debt under control, so that we can begin to grow our way out of the crisis. But we can’t do that while thinking about revenues as we do now.

So what can we do? The first step toward getting yourself out of a hole is to stop digging.

I would suggest that the US adopt a Value Added Tax or VAT, excluding food and certain other basic necessary items. I would make the VAT high enough to completely eliminate Social Security taxes on both the individual and businesses, giving lower income earners a significant tax break. We could also compensate those below the poverty line for their VAT costs.

Ironically, you and I will both qualify for Social Security benefits soon. I daresay you need it even less than I do. We aren’t the only ones. I think we should consider means-testing Social Security, and the same for all entitlements.

Consumption taxes like the VAT are the least economically damaging of all taxes, at least according to most of the research that I have read. While I personally (or at least the economist in me) would like a VAT high enough to get rid of all other taxes, I just don’t know if it would be politically possible.

One attraction should be that, if the VAT is high enough, say in the 17 or 18% range, we could have much lower income taxes. Just for illustration, maybe there could be…

  • No income tax below $50,000,
  • A 10% income tax on incomes from $50,000–$100,000,
  • A 20% tax on all income between $100,000 and $1 million,
  • A 25% tax on incomes between $1 million and $10 million,
  • and a 30% tax on incomes over $10 million.

… all with no personal deductions for anything. Period. That should certainly produce enough total revenue (along with corporate taxes) to fund the government as currently configured. It might even allow a little bit more for important needs we have deferred (like infrastructure) as well as medical and scientific research.

I totally understand that conservatives are uncomfortable opening the door to a VAT when a future majority might raise income taxes on top of it. I would be among them. In the spirit of compromise, we could amend the Constitution to require 60% majorities in both House and Senate to pass any tax increases. Of course, that would have to be passed by 37 states in order to become part of the Constitution, but that can be part of the negotiation process. Perhaps the new tax regime’s launch could be contingent on adoption by 37 states, which would encourage a more rapid adoption process.

I would also suggest that the tax changes be phased in over three or four years to allow for individuals and businesses to adjust.

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This plan would eliminate the need for higher debts and quantitative easing, and would let the Fed keep interest rates at a more normal level. Retirees could once again look for an actual return on their savings, instead of the brutal punishment of financial repression. (We can have a whole separate conversation on allowing the market to set interest rates rather than 12 individuals sitting around a table.)


I would welcome a further explanation of what you mean by Monetary Policy 3. I agree we need to do something far different than we are now. If we continue down this same path, at some point a more left-wing government will come to power, raise taxes and increase spending, but not really deal with deficits or the burden of ever-increasing entitlement spending. That will not work as well as they hope. I can totally foresee a movement back to the right, which would want to repeal those same policies. Neither side would actually come close to dealing with the real problems. We would remain in a regime of ever-increasing deficits, accompanied by growing debt and quantitative easing.

The simple fact of the matter: We don’t know how much debt the markets will be willing to give to the United States. As in actually having the cash, not to mention the willingness, to buy government debt. $44 trillion is a lot of money, which is why I think we will be encumbered with quantitative easing and zero interest rates until there is a significant structural change in how we manage revenue and spending.

We simply don’t want to know what the limit is on the amount of debt the United States can sustain. If we ever find out, it will be too late. We will be in a crisis.

Unfortunately, I think my proposal or any other compromise solution is simply not possible in today’s partisan world. That being said, I think this is an important conversation to have. When that crisis does happen, maybe somebody will pull one of the compromise plans off the shelf and say, “Let’s try this.”

What I don’t want to see is a repeat of what happened at the beginning of the Great Recession. When the powers that be finally realized the financial world was collapsing down around our ears, they had no plan. They were making it up as they went along. While they put out the fire, they also did a great deal of damage. This was not the best way to deal with the problem. But it was probably the best they could do at that moment, given the realities on the ground.

That’s why it is important to make this discussion become both public and national. I would hope that others will join us in thinking about how to restructure the US economy into a more self-sustaining and hopefully more equitable system. Having plans available for consideration in the next crisis will help create a willingness to compromise.

I think this may be the most important decision that our nation makes in my lifetime. If we continue down this path, at best we are consigning ourselves to more of the same meager growth. At worst, we will have a crisis that ends with what I call The Great Reset, where the world has to radically restructure its debt in ways that will not be pleasant. (That is an understatement along the lines of calling the Great Depression merely “unpleasant.”)

All this will be happening as technology improves our lives but also slowly eliminates higher-paying jobs, causing many people to earn less than they thought their education would justify. We will see more become “underemployed,” creating a great deal of political and social frustration. I hope we can avoid this type of Blade Runner outcome. There is the potential for a far more abundant and pleasant future for everyone, if we can reconcile these economic conundrums.

This has been a conversation well worth having. Ray, I want to sincerely thank you for starting what could be a very, very important national engagement. And politely ask for a little bit more elucidation on what you mean by MP3. Seriously… I really want to know.

A Brief Commercial

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I know that many readers are small business owners, especially investment advisor/broker-dealer firms. One of the problems in the investment advisor business (as well as others) is that many of us are getting older and need to transition our businesses to younger successors who need financing. One of the partners in my network of recommended services is a national bank called T-Bank, which specializes in SBA (Small Business Administration) loans. They have done numerous SBA loans for small businesses that are transitioning to the next generation.

SBA loans also have other purposes and T-Bank is an excellent source. T-Bank also develops cash balance retirement plans that let owners save more tax deferred income (I have a cash balance plan and it indeed works!). You can learn more by listening to a podcast (or reading the transcript) I did on the SBA process by clicking here. There is also a direct number at the end of the transcript/podcast. I hope you find it helpful. (Note: I receive a standard referral fee from T-Bank as part of my business income.)

New York, Maine, and Montana

Early August sees me in New York for a few days before the annual economic fishing event, Camp Kotok. Then maybe another day in New York before I meet Shane in Montana to spend a few days with Darrell Cain on Flathead Lake.

I met with my partners Olivier Garret and Ed D’Agostino in Boston two weeks ago. We were making longer-term plans for Mauldin Economics, as we do from time to time. They have done a very good job of growing the business and I am happy with it. But they also expressed very clearly that I need to stop talking about writing a book about the future and actually begin writing. I am mentally ready, but structurally I am not always the most organized.

Writing a book is simply a massive undertaking, especially when it is as all-encompassing as “the future,” whatever that is. But to underline their insistence, they laid out a plan and offered help. It made sense and I am now actually beginning to write. The goal is to have a book in our hands sometime in the spring.

Much of the writing has already been done in one form or another; the problem is pulling it together, not to mention sorting through the thousands of pages of research on my computer and in links that I have saved, and much that has been sent to me by teams of my readers (thank you!). The good news is my travel schedule is not all that demanding over the next five to six months. And if Puerto Rico can avoid another debilitating hurricane, this is a great place to write.

Years ago, I took my family to Venice where a reader graciously offered to be our guide for a few days. He took us out to one of the small islands nearby where Ernest Hemingway actually wrote some of his novels. It was quite the idyllic location. I can’t complain in the least about my own location and circumstances, so I simply need to get on with it and crank out a chapter or two a week for the next five months. Plus my regular letters.

As my dad would say when we started a big project, “Son, that’s no hill for a stepper.” And with that, it is time to hit the send button. Let me wish you a great week.

Your getting ready to step up analyst,

John Mauldin Thoughts from the Frontline
John Mauldin

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Brian Gladish
July 14, 2019, 3:36 p.m.

Cut the spending. Otherwise it is simply rearranging the deck chairs on the Titanic.

James Whitelaw
July 14, 2019, 10:26 a.m.

VAT is regressive, most especially in a consumer driven economy. Is it wise to force lower income citizens to seek government payback of their money? (unless VAT refunds will be available at point of sale by producing a ‘poor card’).

There are no easy choices - my suggestion is to equalize capital gains and income tax. The distinction between ‘earned’ income and ‘investment’ income perpetuates Marx’s critique of capitalism. We’re all in this together, and we should all pay the same tax. The level of that tax rate should be scaled (or not!) to the amount of income we receive, however we receive it.

Mike Leach
July 13, 2019, 8:37 p.m.

Good letter, John - and a good series - one of your best.  It will go in my permanent files.

As a conservative who has long been vehemently opposed to a value added tax (both for principled and practical reasons), you have helped to convince me, with great reluctance and after considerable soul-searching, that a VAT will have to be a part of the solution.  In fact I agree with most of your proposals.  With one important exception.

Reform of Social Security is obviously required.  But to means test benefits to beneficiaries is not just bad economic and social policy; it would be profoundly, MORALLY wrong!  To penalize middle class retirees (yes, it would get down to that level) who were disciplined enough to save and invest for their futures by reducing or eliminating their benefits in order to provide additional benefits for those - some of whom would have identical lifetime earnings, but consumed all the made rather than save anything for retirement - would be an abomination! It would rank among the greatest injustices in US history.

Here is how this must be done:  All Social Security beneficiaries (individuals and couples) will have to be guaranteed a minimum monthly benefit at least equal to the federal poverty level; perhaps even 10% over the federal poverty level.  Yes, that will likely require that benefits be Increased to the poorest beneficiaries.  After that is done, if sufficient resources are not available to pay promised benefits to everyone else - and they clearly will not be - then EVERYONE takes an equal, proportionate cut.  If only 90% of benefits can be paid, than every beneficiary above minimum - from the richest to the poorest, regardless of other income or assets - takes a 10% cut.  If only 80% can be paid, it would be a 20% cut.  No one goes below the minimum (poverty level +10%, or whatever is set), but everyone else gets the same proportionate reduction.  I could live with that - and expect to live with that.

But means testing of benefits would be an abomination - totally unacceptable under any circumstances.  If it comes down to that, I would be voting H—L NO on any reform that included means testing!  If that were to result in the whole system collapsing, and we get your contemplated “Day of Jubilee” debt reset - even if it means we end up with “Mad Max Beyond Thunderdome” in places like California and New Jersey - so be it!  That is how strongly I feel about this issue.  And yes, I agree that my total intransigence on this would likely be regarded as shortsighted and even immoral by some.

But I suspect I will be far from alone.

John Perreault
July 13, 2019, 5:46 p.m.

Hi John,

I have read you writings and books for most of your career so look forward to your new one in planning.

The Dalio conversation has been interesting.  But I think you both know that the federal government has always spend more than it has taken in no matter how much tax revenue has increased.  As a consequence no tax, VAT or otherwise, will be successful [except in increasing inequality which some argue is the intent] unless there is someway of imposing fiscal responsibility. What is your solution to imposing fiscal responsibility at all levels of government?


July 13, 2019, 5:09 p.m.

You have probably already written about it in previous newsletters, but I missed it. In this and previous TFTFL’s there has been a focus on the national debt and deficit. Any thoughts on private sector debt (indebtedness of non-financial corporations and households and non-profit institutions serving households) as percentage of GDP and impact on the economy, especially if there is a recession?  Correct me if I am wrong, but private sector debt exceeds national debt (close to 200% of US GDP).  Whew!!!!

P.S. I am retired now, but I was an SBA loan officer at Wells Fargo. Great program.
July 13, 2019, 4:08 p.m.

In my opinion, here is a situation in which, starting with the present situation, AI and algorithms could be developed to model various inputs to forecast the most likely outputs. As we move forward, the actual inputs could be incorporated real time and AI could then continue to predict the most likely path our economy, political environment, and social environment will take. This could then be used to back bills to put the USA and globe on the best path vs voodoo economics and blustery political rhetoric. We have the tools now, let’s use them!

Clive Anderson
July 13, 2019, 3:40 p.m.


I’ve read your proposed revamp of the US tax system in Part 6 of your series to RD and it reminds me of the experience of my own country (New Zealand) over the period of the 1970’s from an inefficient economy, subsidising the wrong economic activities, based on past trading relationships with the UK. At the time we built cars, made our own clothes and subsidised meat production - poor quality economic activities linked to a previous time. We hit “the wall” in the early 80’s and it was a Labour i.e. left wing government that, upon election, set in motion radical changes to the economy including bringing in our version of VAT (GST = goods and services tax) now set at 15% on all activities w/o exemptions to keep things simple.  Personal taxes were reduced at the same time.  It was a tough period for the economy to adjust to the changes over the next few years but we now have, in my view a robust economy with low levels of govt debt wrt the rest of the world (about 20-25% of GDP).  While you will find a variety of political opinions on how well it has worked in my view we have a financial system that works in a logical fashion, that Europe, Japan and the US are striving for. Most likely you are familiar with it but in case, as a small economy, we have slipped below your radar I thought I’d bring it to your attention as an example of an economy that went through what you propose re politician recognition of the need for radical change and instituting a VAT.  If you are not familiar with NZ then study of our experience with economic change following the early 80’s will provide evidence that may help refine your ideas on what the US needs to consider for its future.  kind regards Clive
July 13, 2019, 2:51 p.m.

I’m really glad you’ve been writing this series of articles in response to Ray Dalio’s missives. They have been interesting at a fundamental level, though I think your thinking has been constrained to remaining within the bounds of conventional financio-economics and I’m not sure tweaking the system “budget cuts and tax changes” will work in the next crisis.

I did wonder whether you’d rather see “a more left-wing government will come to power, raise taxes and increase spending” or a more right-wing government come to power *lower* taxes and still increase spending (i.e. what we’re seeing now).

As author and blogger, Paul Anlee , I’ve also taken on this topic (I mostly write sci-fi), so I’ve read what you and Ray say with great interest. I’m not sure either of you have quite got to the root of what I see as an inherent problem with the system. I offer this blog article for your readers to consider:

Capitalism, and the fiat money/credit system that underlies its modern incarnation, has a problem. Its over reliance on continuous growth is beginning to make the system fray at its poorer edges. Capitalism needs perpetual growth or it becomes unsustainable. Yet, modern capitalism is running up against very real limits to growth in terms of natural resources and the resilience of the planet to tolerate increased human industrial activity. It is also running up against demographic limits as an aging population puts an impossible strain on young workers. Those young workers are facing their own limits in terms of how few of them will be required by future corporations (and their owners/investors) to maintain economic activity. As jobs become more and more scarce due to a combination of globalisation, automation, and AI, young workers will find it increasingly difficult to earn the income to support the retired population. All of these competing constraints are inherent to the interaction between capitalism that demands perpetual growth and the limited ability of Earth to provide that perpetual growth. These limits are reflected in inflation,  the perpetual growth of debt, and the perpetual devaluation of fiat currencies.
July 13, 2019, 1:31 p.m.

“... as technology improves our lives but also slowly eliminates higher-paying jobs, causing many people to earn less than they thought their education would justify.”

John, love the work of your whole group. Thanks, many times.

But I must disagree with the above quote.

That technology, and it’s improvement, is the work of bright, trained, focused minds in such disciplines as electrical engineering and programming. The technology is replacing less capable and more costly workers doing dangerous/repetitive/error-prone work. Low paying jobs are being eliminated. High paying jobs are being created. This is reflected in the current job stats.

On a further note, the US is focused on mail order degrees in trivia and the exploits of the housewives of Des Moines and the latest rap thugs—Asia is focused on training bright, focused minds in such disciplines as electrical engineering and programming. Uh-oh.
July 13, 2019, 11:18 a.m.

Your VAT proposal will end up just like England.  High VAT on top of high income tax and national health insurance levies.  You can’t make it that easy for Congress to enact a tax increase and expect anything but catastrophe.

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