Chris Lau - Seeking Alpha

Monday, May 25, 2009

Notes from John Mauldin's Newsletter

In Mauldin's newsletter entitled "The Paradox of Deficits," Mauldin analyzes the problem of running deficits. He describes the macroeconomic trading between the US and Asia over the past few decades, how the US debt will have difficulty being sold, and the expectation for higher taxes for the years ahead. A discussion of the weakness in European banks and the weak real estate market in Spain was discussed but excluded in my excerpts. Please read his original newsletter if you are interested in the latter topics. My comments are below.

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  • Total US debt is $11.3 trillion and rising rapidly. The Obama Administration projects that to rise another $1.85 trillion in 2009 (13% of GDP) and yet another $1.4 trillion in 2010
  • Congressional Budget Office (CBO) projects $10 trillion in additional debt from 2010 through 2019. Just last January the 2009 deficit was estimated at "only" $1.2 trillion.
Mauldin notes that the CBO then projects GDP growth of 50% over 10 years, higher revenue (through higher income tax), and higher unemployment (8.9%). This is contradictory. How can there be GDP growth when unemployment is still rising, even using a 0.1% projection?

About De-leveraging:

"The world is deleveraging. Debt is being drawn down. Securitization of various types of debt has seriously slowed. Banks are cutting back on lending. Home prices are dropping all over the world. Commercial real estate is rolling over, and banks all over the world are exposed. "Recession turns malls into ghost towns" is the headline in today's Wall Street Journal. Personal savings are rising and retail sales are flat to down. Unemployment is rising.

All this should be massively deflationary. Interest rates should be falling or at least not rising. But a funny thing is happening. In the past two months, the yield on the ten-year bond has risen by 1%. It has moved 0.38% or almost "4 big handles" in just two weeks.

The Paradox of Deficits

Call it the Paradox of Deficits. We have been running a large trade deficit in the US for years, because the people (China, Japan, and the Middle East) who wanted to sell us "stuff" were kind enough to turn around and invest the money in our bonds. This in turn created Greenspan's conundrum, as it helped keep down US (and global) interest rates. Combine that with a massive increase in leverage, a few bubbles, and we now arrive at a true crisis.

Deficits are not necessarily a bad thing if kept in check and restraint is shown. But everyone cannot run deficits at the same time. If we don't buy $700 billion in goods, then that money cannot be recycled back to our debt. It is that simple.

(Sidebar: And now, China and Brazil are moving to do their trades in their own currencies rather than dollars. Very smart on their part.)


Long before we get to 2015, let alone 2019, I think the bond markets will have called a halt to $1 trillion deficits. There will be a real crisis. The deficits will not be funded at anywhere close to an interest rate that will not break the budget. Taxes will get raised beyond what they were in the Clinton years. And Obama's budget makes some very optimistic judgments about how much will be saved in medical costs, as if no one has tried to rein in medical costs before. The crisis may come much sooner if his universal health-care bill is passed as proposed without offsetting cuts somewhere else.

Watch the bond market. Rates should be going down, not up. The bond market is telling us the deficit simply can't be financed down the road. Now, maybe a few cool heads in the Democratic Party will prevail in the US Senate and the deficits will be brought under control. (The Republicans have so far seemed as clueless as they are impotent.) We could (theoretically) run $400 billion deficits for a very long time, as GDP would be growing somewhat faster.


I am increasingly inclined to think that as the world comes out of its current malaise – and it will – US investors should think more globally with their investment portfolios. That is something we will explore over the coming year. But that's enough for today.


US Bonds took a big dive last week and this may be explained by trading partners settling the balance using their own currency. This is why the US dollar dropped over 10% from its peak in March. The stock market rally is also creating greater confidence for investors to divest itself from US assets/currency. The long-term question is whether growing GDP through a deficit year after year is sustainable or not. Between March and May 2009, the stock market focussed on the "growing" aspect of this paradox. Over the next few weeks and months, I suspect that economic fundamentals will act like gravity for the stock market if the information continues to support Mauldin's points.