Thoughts from the Frontline

The US jobs report came out this morning, and it was simply dismal. This week we look at not only the jobs report but also “what-if” proffers for the US and global economies. There’s a lot to cover, so let’s jump in.

We are halfway through the year, and what a ride it has been. Today I will share my thoughts on what the next six months could look like, and endeavor to keep it short and simple, as we have a holiday weekend. There will be more than a few charts. What does the end of QE2 mean? What can we expect from Europe? Is a commodity bubble getting ready to burst? Is it really a bubble? There is a lot to cover. I recorded a PBS show a month or so ago, and it is airing this weekend on a number of stations around the country, so look for details at the end of the letter. Now let’s jump in.

I am back from Europe. The last three weeks I spent quite a bit of time talking with money managers and investors from a lot of countries, as well as numerous locals about the European situation. This week’s letter is a collection of my thoughts, as I recover from jet lag. I expect the letter will thus be shorter than usual, but hopefully a few pithy comments will emerge. But first… As you know, I am a firm believer that the state of the global economy is such that we as investors have to be especially agile and focused today. Consequently I spend a great deal of time and effort looking into alternative investment strategies and managers. I'm very pleased to announce that I am relaunching my special newsletter for accredited investors, to share the latest opportunities and pitfalls in alternative assets. The good news is that this Accredited Investor Letter is completely free. The only restriction is that, because of securities regulations, you have to register and be vetted by one of my trusted partners before you can be added to the subscriber roster. They include Altegris Investments in the US, Absolute Return Partners in Europe, Nicola Wealth Management in Canada, and Fynn Capital in Latin America. This is a painless process (I promise!), and just to sweeten the pot, after you register my partner will provide you access to the video of Gary Shilling's speech from my Strategic Investor Conference in La Jolla, as well as those of Martin Barnes and David Rosenberg; and we have just added Louis-Vincent Gave, who focused on China. These guys are all great speakers with absolutely compelling presentations. [[Click here now to register]] and you'll be part of the summer relaunch of my letter exclusively for accredited investors. In the meantime, enjoy the video presentations and benefit from their wisdom as you plot your investment course. Over time, we will make all the conference videos available to the subscribers of the free Accredited Investor E-letter. Those who attended the conference, or have spoken with an Altegris professional, already have access to all the speeches and panels. I do not like limiting the letter to accredited investors, but those are the rules under which I work. This is not of my choosing, and I have worked in front of and behind the scenes to try to change what I think is a very unfair rule. (See important risk disclosures below. In this regard, I am president and a registered representative of Millennium Wave Securities, LLC, member FINRA.) And now to the letter.

Is it possible for the Eurozone to break up? It was so inconceivable when they formed it that there is nothing in the treaty that mentions a member leaving or being removed; but now, if we’re to be honest with ourselves, we need to think about how that would work. This Friday finds me in Kiev for the first time ever, with my youngest son, Trey; and the small tour we went on last night was fascinating. Since I know not if I will ever get to this fascinating city again, I am going to write a briefer missive than usual, and it will center on my thoughts on Europe, as I have just had the pleasure of the company of a number of very diverse people, talking about the issues. Nouriel Roubini has graciously agreed to allow me use his latest private piece (very powerful analysis here), where he analyzes the question of whether the Eurozone could actually break up, so you will get the usual solid content (OK, maybe a little better), with my notes at the end. And I’ll close with some thoughts on Kiev. But first, a quick fix. In last week’s fascinating Outside the Box by Pat Cox on the state of stem cell technology, which you really should read, there was a link to Lifeline Skin Care cream that was faulty. It should have been http://www.lifelineskincare.com.

This week we look at data from the Bank of International Settlements, by which (if someone does a lot of work) you can figure out how much US banks have written in credit default swaps to banks in Europe on Greek, Irish, and Portuguese debt. The details should not make you happy. I meditate on whether one should buy a house now, and then discuss “the way out” of all this mess and why we will Muddle Through. Oh, and I’ll ask you for help on yet another book project, on creating jobs. And all while trying to finish early enough to go to dinner. So let’s get started.

Do you feel as if you are suffering from some sort of economic whiplash? Between focusing on the European crisis (and it is a crisis), then looking at softening data in the US and political turmoil in Japan, not to mention the Middle East, you can be forgiven for feeling like someone just slammed into the back of your “economic recovery car.” This week we look at today’s US employment numbers, then at a troubling slowing of economic velocity, precisely at a time when it should be rising, and then consider a powerhouse, must-be-read-twice commentary from Martin Wolf on the European situation. Then I will weigh in with some of my own thoughts. Counterintuitively, the holders of certain European debt are being put at further risk by the bailout. (This letter may be a little shorter and take more work than others –which some of you think will improve it – as I am suffering from Caesar’s Revenge here in Tuscany, although I am getting better!) As you know, I am a firm believer that the state of the global economy is such that we as investors have to be especially agile and focused today. Consequently I spend a great deal of time and effort looking into alternative investment strategies and managers. I'm very pleased to announce that I am relaunching my special newsletter for accredited investors, to share the latest opportunities and pitfalls in alternative assets. The good news is that this Accredited Investor Letter is completely free. The only restriction is that, because of securities regulations, you have to register and be vetted by one of my trusted partners before you can be added to the subscriber roster. They include Altegris Investments in the US, Absolute Return Partners in Europe, Nicola Wealth Management in Canada, and Fynn Capital in Latin America. This is a painless process (I promise!), and just to sweeten the pot, after you register my partner will provide you access to the video of Gary Shilling's speech from my Strategic Investor Conference in La Jolla. I don't need to remind you how insightful Gary is, but if you've never seen him speak, let me just tell you that he's absolutely compelling. [[Click here now to register]] and you'll be part of the summer relaunch of my letter exclusively for accredited investors. In the meantime, enjoy Gary's video presentation and benefit from his intelligence as you plot your investment course. Over time, we will make all the conference videos available to the subscribers of the free Accredited Investor E-letter. Those who attended the conference, or have spoken with an Altegris professional, already have access to all the speeches and panels. I do not like limiting the letter to accredited investors, but those are the rules under which I work. This is not of my choosing, and I have worked in front of and behind the scenes to try to change what I think is a very unfair rule. (See important risk disclosures below. In this regard, I am president and a registered representative of Millennium Wave Securities, LLC, member FINRA.) And now to the letter.

“All political thinking for years past has been vitiated in the same way. People can foresee the future only when it coincides with their own wishes, and the most grossly obvious facts can be ignored when they are unwelcome.” – George Orwell “ Hindsight is not only clearer than perception-in-the-moment but also unfair to those who actually lived through the moment.” – Edwin S. Shneidman, Autopsy Of A Suicidal Mind Brinkmanship is defined as the practice of pushing dangerous events to the verge of disaster in order to achieve the most advantageous outcome. It occurs in international politics, foreign policy, labor relations, and (in contemporary settings) military strategy involving the threatened use of nuclear weapons. This maneuver of pushing a situation with the opponent to the brink succeeds by forcing the opponent to back down and make concessions. This might be achieved through diplomatic maneuvers by creating the impression that one is willing to use extreme methods rather than concede. During the Cold War, the threat of nuclear force was often used as such an escalating measure. Adolf Hitler also utilized brinkmanship conspicuously during his rise to power. (More on ignoring events and Hitler later on.) In the last 48 hours, so much news has come out of Europe that has me frankly shaking my head. It is a strange game of brinksmanship they are playing, and it is one we should be paying attention to (as if the brinkmanship played by US politicians over the debt ceiling is not enough). This week we look at what seems to be European leaders taking random walks through the minefield at the very heart of the European Experiment. As Paul Simon wrote, “A man sees what he wants to see and disregards the rest.” But first… Would You Like to Read Over My Shoulder? As you know, I read scores (if not hundreds) of reports and analyses each week to put together my letters. Wouldn’t you like it if I could filter for you what is important? The few things that you should read? What would it be worth to you to have someone with my years of experience and breadth of resources available to you as your own personal reader/filter? I can be just that. I’ve now launched a new service called Over My Shoulder to bring you the very best 5-10 pieces I read each week. I’ll call your attention to some of the most fascinating analysts out there, people with non-intuitive perspectives on some of the most pressing issues facing us as individual investors. Concerned about inflation/deflation? Wondering about the future for US markets and sovereign debt? Europe? It’s all here. If you need cogent analysis and clear reasoning, this is the service for you. And if you want to see the data, charts, and graphics that back it all up, you’ll get them. Would that be worth just $39 every three months? What is just one piece worth to you that helps you make that critical decision? My job is to find you the best of the best, making sure your radar is pointed at the critical issues and weeding out all the noise. If your time matters as much as your investments, click here to learn more: http://www.johnmauldin.com/overmyshoulder/recent/ And let me hasten to note, this weekly letter will not change. It will still be free, coming to you each weekend. And now on to this week’s letter.

I have been doing a lot of reading this week, and today we look at some of the thoughts that keep coming to my mind. We’ll think about the declining importance of economic theory (which is a tragedy) and then cast our eyes to Europe, where a truely tragicomic drama is being performed. Who needs the movies when you have the EU? There is a lot to talk about. But first, some of my thinking has been deeply colored by some recent Conversations I have had with Neil Howe, Lacy Hunt, Dylan Grice, and George Friedman. Those audios and transcripts will soon be on the Conversations website, and others will join them shortly. Conversations with John Mauldin is my subscription service, where I offer subscribers audio and transcripts of conversations I have with thought leaders about the topics of the day. It is just as if you were sitting at the table with us, listening in on our exchange. The service has been very popular, and the reviews are quite good. And the education you’ll get, the ideas that are generated, will help you as you create your own investment strategy. You can go to http://www.johnmauldin.com/conversations/ and type CONV in the coupon code to get a discount. And the Conversations I am lining up for later this summer will be just amazing, I assure you! Now, let’s jump into the letter!

The Biggest Bubble of Them All This week we turn from the crisis brewing in the US to the one that is coming to a slow boil in Europe. We visit our old friends Greece and Ireland and ponder how this will end. It is all well and good to kick the can down the road, but what happens when you come to the end of the road? The European answer seems to be to haul in the heavy equipment and extend the road. I am asked all the time what my biggest worry is, and I quickly answer, the European Sovereign Debt Crisis. Of course, then we have to think about the Japanese Sovereign Debt Crisis, followed by the one in the US; but today we will focus on Europe. The biggest bubble in history is the bubble of government debt. It is a bubble in a world full of pins. It will take a great deal of luck and crisis management to keep it afloat, without wreaking havoc on the financial system and markets of the world. The rumors have been flying all this week. Greek is going to leave the euro. No, it won’t. Germans are demanding debt restructuring, and then they say no. A German newspaper is reporting that the EU, IMF, and Germany want a Greek debt extension, while the ECB (holders of Greek debt) and France oppose it. Greek two-year bonds are now paying 25% if you care to buy them in the open market, which is effectively the market voting for some type of debt restructuring or outright default. I sat down this week and read two lengthy reports on how Greek debt could be restructured in an orderly manner. One was from HSBC and the other from Roubini Global Economics. There are ways it can be done. But the costs of the various options may be more than the affected parties want to bear. It is not a matter of pain or no pain; it is a decision as to who will bear the pain.

This week I finish the two-part letter on the Endgame and give you my thoughts on the economy and how it all plays out over the next five years. This is the second part of a speech I gave last week at the Strategic Investment Conference in La Jolla. It is a rather bold forecast, and fraught with peril and likely errors, but that is my job here. Damn the torpedoes, etc. I must offer one large caveat! If the facts change so will my forecast, but this is the view into my very cloudy crystal ball as I see it today. As always, remember that those of us in the forecasting world are often wrong but seldom in doubt. Read accordingly. But before we get there, two quick things. I want to really show my strong appreciation for the work done by my co-hosts, Altegris Investments, at the 8th annual Strategic Investment Conference. We had a packed house with almost 500 people come to see what I think was the best line-up at an investment conference this year. Each year we say there is no way to get any better, and each year we somehow manage to do so. And that is due in no small part to the considerable effort of the team at Altegris. I am proud to be associated with them. This year we did video many of the speakers and panels, and over time we will figure out how to make some of this available. I will keep you posted. Enemy of Spain Second, Endgame continues to do well, so thanks to those who have purchased it, and if you haven’t already got your copy you should go to www.amazon.com/endgame and do so! And quick kudos to my co-author, Jonathan Tepper, brilliant young Rhodes scholar and head analyst at Variant Perception. Apparently, he’s on a small but prestigious list of enemies of Spain, according to El Mundo, one of the biggest Spanish newspapers, for the sin of pointing out that Spain is in a crisis (we have a whole chapter on Spain on the book). Their article appeared in print in the weekly finance edition, but is not online. Other papers have been called by government officials and asked not to quote him. Oddly, the people who helped inflate the enormous construction bubble and the incompetent government officials who denied for years there were any problems are not enemies of Spain. Go figure. I guess if you have to be on an enemies list, you could do worse than Spain (where, oddly enough, Jonathan spent most of his childhood growing up in a drug-rehab facility). Congratulations, young man! (Oh, and a publisher in Korea picked up the Endgame Korean-language rights, so we will soon be in bookstores in Seoul.) And now to the second part of the Endgame. And for those who want to review the first part, you can read it at http://www.johnmauldin.com/frontlinethoughts/the-endgame-headwinds/.

I have written repeatedly about the Endgame in the weekly letter, as well as in a New York Times best-seller on the same topic. By Endgame I mean the period of time in which many of the developed economies of the world will either willingly deleverage or be forced to do so. This age of deleveraging will produce a fundamentally different economic environment, which the McKinsey study referenced below suggests will last anywhere from 4-6 years. Now, whether this deleveraging is orderly, as now appears to be the case in Britain, or more resembles what I have long predicted will be a violent default in Greece, it will create a profoundly different economic world from the one we have lived in for 60 years. This makes sense, in that the prior world was defined by ever-increasing amounts of leverage. Outright reductions in leverage or even a significant slowing of the rate of growth is a whole new ballgame, economically speaking. In all this I have explained the various options facing the developed world, but I have refrained from putting forth my own estimates as to what will actually happen and what the environment surrounding that outcome will be. That is about to change. I have been giving this a great deal of thought and research. While my conclusions will be somewhat controversial (I know, surprise, surprise), with enough to offend almost everyone on some point, I hope that I can muster enough clarity to help you think through your own personal views and how you will respond to what I think will be yet another crisis on the not-too-distant horizon. Whether that is Crisis Lite or Crisis Depression is up to us and the politicians we elect. I argue that we need to choose most wisely, because we are at a crossroads that is as critical as any since 1940. As I start this letter, I am on a flight to San Diego, where I will co-host my 8th annual Strategic Investment Conference. As usual, I will be the last speaker on Saturday. This letter will be the beginning of that speech, and we will conclude (hopefully) next week. What I hope to do here is summarize the main points, add some new ones, and then move on to how I think the Endgame will play out. These next two e-letters will be among the more critical ones of the last few years. Feel free to forward, and if you are reading this letter you can join my one million closest friends and sign up for my free weekly letter at www.johnmauldin.com. (This letter may print longer than usual, as it will have a significant number of graphs.) But before we jump in, many of you know that I am a serial entrepreneur. I look for business opportunities for inclusion in “the Mauldin companies.” My “hobby,” if you will, is looking at cutting-edge biotechnology. You have been asking for details and an update on one I mentioned last year. We partnered with a very serious biotech research firm, International Stem Cell Corporation, whose scientists discovered a patent-pending formula that rejuvenates skin. We continue to partner with them to help augment this breakthrough and, most importantly, to help fund their therapeutic research to find cures for very serious diseases. You can learn more at www.lifelineskincare.com/antiagingbreakthrough. Now, let’s get into the letter.

Albert Einstein is famously quoted as saying, “Compound interest is the eighth wonder of the world.” And compounding is indeed the topic of this week’s shorter than usual letter, but compounding not of interest but of inflation. As you might expect, I am giving a great deal of thought as to how we get out of our current financial dilemma of too much debt and deficits that are far too high. While I will use US data for our illustration, the principles are the same for any country.