John Mauldin is president of Millennium Wave Investments and is a renowned financial expert, a many-times New York Times best-selling author, and an online commentator. His weekly e-newsletter, Thoughts from the Frontline, was one of the first publications to provide investors with free, unbiased information and guidance. Today it is one of the most widely distributed investment newsletters in the world, with a subscriber base of more than one million readers. It appears in English, Chinese, Spanish, and Italian. He is called on to comment regularly by TV and national media.
In your most recent book, Endgame: The End of the Debt Supercycle and How It Changes Everything, with Jonathan Tepper, you argue that developed economies are facing the end of a 60-year-long debt supercycle. Can you take us through your view of this debt cycle?
The concept of the debt supercycle probably goes back to the famous economist Irving Fisher in 1933, when he talked of the long debt cycle leading up to the Great Depression. The term “supercycle” was originally developed by the Bank Credit Analyst (BCA) more than 50 years ago. A. Hamilton Bolton, the founder of BCA, used the word to refer to a cluster of things, including money velocity, bank liquidity, and interest rates. Then Tony Boeckh used the term in the 1970s, in a simpler form, to refer to what he saw as spiraling private debt. The current editor of the BCA, Martin Barnes, took up the concept and expanded it greatly. Back in 2007, the BCA pointed out that “the history of the US is characterised by a long run increase in indebtedness, punctuated by occasional financial crises and subsequent policy reflation.”
It warned that the supercycle would end if foreign investors ever turned their backs on US assets, but added that this would probably not happen in the immediate future. Barnes argues that because the government has stepped in to ratchet up debt as private debtors begin to deleverage, there is no immediate end in sight to the debt cycle. Jonathan Tepper and I argue in our book that although the end has not yet happened, the signs of the end are now starting to be visible. Greece matters. The case of Greece is a highly visible instance of the fact that there is a limit to how much debt any country can pile on. Without massive assistance, Greek debt would be unmarketable and, even with that assistance, by April 2011 the interest on Greek three-year bonds had reached an unsustainable 21%.
What that tells you is that, even with the inducement provided by the opportunity to earn astounding rates of interest for holding Greek debt, investors are seeing the writing on the wall. They expect Greece, despite the support of the European Central Bank (ECB) and the International Monetary Fund, to be unable to repay its debts in full, and they are turning away. What is a 21% return if you are likely to suffer a 50% or greater loss of capital? For Greece, the debt cycle is already in its endgame, and the Greeks now have nothing but extremely painful choices ahead of them.
This was the point of Endgame, to warn that as the crunch moment approaches a country rapidly runs out of reasonable choices, and those options left to it become more and more painful. The state of being in the endgame is a qualitatively different state from the one we are used to. It is akin to what scientists call a “phase transition,” as when water turns to ice. Different rules apply, and they mean that life becomes much tougher. Greece is already in the endgame. It is close to ungovernable, and if the present socialist government is unseated and a more radical left-wing government is able to use public discontent at austerity to get itself elected, the country’s position will become even more painful. You cannot vote yourself more debt once the markets are closed to you. Even austerity doesn’t help that much because massive cutbacks provoke a deep depression, and that hammers government tax revenues—which makes it even harder to service debt interests. The market sees this and raises the interest rates that it wants to hold more debt, which makes the debt still harder to repay.
In the end the only options are default, which shuts the country out of the debt market until it has got its house in order, or hyperinflation. Greece does not have the option of hyperinflation since it cannot print euros. That is the privilege of the ECB. The Greeks are out of good choices. Our concern is that the United States and many European countries also face some painful choices. They are not as painful, by a long stretch, as those facing Greece—and now Ireland—but they need to be made while there is still time to make them.
It follows from our argument that the worst option of all is to postpone decisions and do nothing. Time does not heal here. Doing nothing means that the deficit grows, while the passage of time means that the not-so-painful choices vanish and all you are left with is a handful of really painful choices. In the case of Greece, this will inevitably mean not just a diminution in the standard of living for many, but also the dismantling of much of their social welfare system. This is happening now, but the cuts will deepen as the state becomes clearly unable to pay for anything like the current level of benefits. That will be extremely painful for many, but particularly for the old and the vulnerable. Unemployment levels will soar. That is what we mean by painful choices.