The End May Be Closer Than You Think
We hear plenty about fiscal cliffs, the problems in Europe, and out-of-control government budgets every day. But tucked away in our comfortable homes, watching satellite TV and living the dream, these threats to interrupt our good life seem to be only abstractions.
Books about an impending financial collapse are a dime a dozen, and besides, we're already done the collapse thing. Thanks to Ben Bernanke's money geyser, we can all get cash from the corner ATM, and live happily ever after.
Don't bet on it.
The 2008 crash was just the beginning of the end, according to John Mauldin and Jonathan Tepper, authors of the readable, yet sobering Endgame: The End of the Debt Supercycle and How It Changes Everything.
Plenty of financial commentators and prognosticators want to treat this Great Recession as the average garden-variety gully washer. OK, stocks and real estate went down in price, now buy them and watch patiently while they go up. Of course, that boat has been missed in both regards. Stocks have more than doubled and house prices are bouncing.
The authors make the point that the entire world is connected. If you think Greece can collapse without repercussions on this side of the pond, you're wrong. The problem is debt. The Greeks didn't fund their own debt, the European banks did. And when that debt goes bad, so will the European banks. It will be 2008 all over again and then some.
Government debt, corporate debt, personal debt: It's all been piling up for 60 years. This debt must be liquidated. Piling on more debt on top of defaulted debt, recognized or not, will not solve the problem. Central bankers and government bureaucrats haven't figured that out yet, but investors must understand. Their financial lives depend on it. Thankfully, Maudlin and Tepper not only make their case convincingly that more trouble is ahead, but provide advice on what to do to protect yourself.
People make the mistake that the past provides a good indication of what the future will be. Aptly, the authors begin the book with a quotation from Jean Monnet: "People only accept change in necessity and see necessity only in crisis."
This goes especially for politicians, who talk about fixing the debt crisis when we all know nothing will be done until there is a crisis. After all, while they don't always act like it, politicians are human.
It takes a Minsky moment to wake the world up, and there are plenty of those coming. The economist Hyman Minsky did plenty of great work framing the causes and series of events leading up to financial collapses. The overriding Minsky message is that financial stability breeds instability, or as the authors repeat throughout Endgame, "The more things stay the same, the more complacent we get, until Bang!"
What that "bang" will look like is an open question that the authors don't exactly commit to. That's what makes Endgame such interesting reading. Mauldin and Tepper don't try to cram a point of view down the reader's throat. Will we have deflation? Or will it be inflation, or even hyperinflation?
The authors don't pretend to be clairvoyant. They make compelling cases for each possibility. What they believe for sure is that volatility will roil the financial markets going forward. Stocks for the long term -- or anything for the long term, for that matter -- is a prescription for a money-losing disaster.
The bond market will be tested, despite the world's deleveraging. Not even Japan has a homegrown source of bond demand anymore. The day will come again when cash will be dear as countries and corporations compete for funding. This will turn the notion that it is economic strength that forces interest rates on their head. Punk economies will lead to even greater strain on government receipts at the same time more money is needed to service debt.
There are two ways for governments to default: outright repudiation and inflating the debt away with central bank money creation and monetization of the debt. The latter is the modern solution for governments that can print their own currency, such as the United States. Greece doesn't have this luxury. Nor does California.
But how long can the Fed keep buying U.S. Treasuries with impunity? In a Wall Street Journal Op-Ed piece this spring, former Treasury official Lawrence Goodman wrote,
Last year, the Fed purchased a stunning 61% of the total net Treasury issuance, up from negligible amounts prior to the 2008 financial crisis. This not only creates the false appearance of limitless demand for U.S. debt but also blunts any sense of urgency to reduce supersized budget deficits.
The Fed has taken the place of Japan and China as major buyers of Treasury debt, and in time, the results will be catastrophic.
This information comes after the 2011 publication of Endgame, and I can't help but think the author's chapter on the potential for U.S. hyperinflation might be different, given the latest information concerning Bernanke's bond-buying spree.
The authors devote a chapter to Carmen Reinhart and Kenneth Rogoff's book This Time Is Different: Eight Centuries of Financial Folly. In addition to quoting liberally from that book, Reinhart and Rogoff sat down for an illuminating interview. For those who look at the Japan experience and believe America has plenty of time to work itself out its problems, the authors of This Time think differently. Even John Mauldin was shocked and scared by what they have to say.
For the most part, Maudlin and Tepper manage to stay away from debates about what should be done to fix the problem. For example, advocates of the Austrian School of economics (like this writer) say get rid of the Fed, let the banks fail and let the system cleanse itself. The authors don't have time for this sort of ivory tower theorizing. "We find that a boring and almost pointless argument."
After all, "The people in control don't buy Austrian economics," they explain. "It makes for nice polemics, but is never going to be policy."
Well, fair enough. Instead, Mauldin and Tepper use 100 pages to lay out what the end of the debt supercycle will look like in various countries and regions around the world. Unfortunately, in this section, they drift into policy suggestions that require more government, rather than less, and their claim that it was the gold standard that lengthened the Great Depression is just not true. It was instead FDR's massive government intervention that kept the economy from correcting and, in turn, reviving.
While the authors' outlook is grim, in broad strokes, they provide investment advice for both the inflation and deflation scenarios. And ever the optimists (at least they keep telling the reader they are optimistic), they end on a high note, reminding us of the many technologic advances that make our world amazing today and speculating that future advances will be just that much more incredible.
Governments cannot print their way out of this mess. The end may be closer than you think. Read Mauldin and Tepper to get ready.
Douglas French is president of the Ludwig von Mises Institute and author of Early Speculative Bubbles & Increases in the Supply of Money, the first major empirical study of the relationship between early bubbles and the money supply through the lens of Austrian Economics. It is the only book to solve the most famous bubble in history – Tulip mania.