Download TWO PEAS IN A POD DON`S BLOG 2014.09.15

TWO PEAS IN A POD
DON’S BLOG 2014.09.15
By Way of History
It was the late great Austrian school economist Kurt Richebächer that first drew my
attention to the debt orgy taking place in the U.S., commencing in the mid-1980s. Since
the 1930’s depression, financial people and corporate CEOs were very conservative in their
use of debt. Not so much the Federal government, but at least the private sector was
acting prudently. Then along came Drexel Burnham Lambert, and their star corporate
raider Michael Milken. Exit the huge equity base and enter the LBO (leveraged buy-out).
Debt became king.
Alan Greenspan, whose belief in the omnipotence of Wall Street then started the march
toward bowing to the finance innovators; Wall Street and Washington became joined at the
hip where they remain today. Do you remember Bill Clinton remarking that if he ever came
back in life he wanted to be a bond trader? That was the influence of Robert Rubin. He,
along with the aforementioned Alan Greenspan and Larry Summers made the cover of Time
magazine as its saviors of the world. The date was February 15, 1999 after the bail out of
Long Term Capital. If one had faded the cover of Time magazine, life would have become
abundant.
My point to all of this is two-fold. One, I have been worried about the use of debt blowing
bubbles for a very long time. That, along with Volker’s breaking of the runaway inflation of
the late 1970s, drove me to invest in government bonds for the last thirty-some years.
Two, everyone I knew thought I was crazy, so I had few followers. Being early and
contrarian is quite lonely, but rewarding in the end. That makes me think of the guidelines
of most large pools of investment money. The one most obnoxious to me is the assets under
management rule. Today, $200 million is the threshold. What does $200 million under
management really mean? It means good or maybe even misleading marketing, and that’s
all. It has absolutely nothing to do with the performance and the capabilities of
management. Most investment managers would rather fail conventionally than succeed
non-conventionally. This is one of the reasons pension funds are in trouble. So where are
we today?
The world’s economic scene is made up of crushing debt, little to no disposable income,
and public policies that are absolutely counter to what is needed. Leadership is nonexistent except in the authoritarian societies of Russia and China. Yet most of the world’s
important financial markets are at all-time highs or very near thereto. Does that make
sense to anyone? With very little exception, sovereign countries balance sheets and income
statements are in shambles. The financial strength lies in the hands of the New York and
London financiers and their partners in crime, the politicians. How else can you explain
why only the 1% are prospering and the greatest area of growth in the U.S. is Washington,
D.C.? Again, why you might ask? The answer is public policy favors the ruling class, while at
the same time they preach to the masses that “it’s all for their best interest.” Voters drink
the Kool-Aid and things just get worse. Our illustrations are mostly U.S. based, but the
problem is everywhere and it is not being solved. Safety is being valued more than freedom
and in so functioning, we get less of both.
Lacy’s Economic Outlook
Now, you might think this is a portrayal of one’s life. As a matter of fact, it does look a bit
like my history but I have thrown away the cane by the miracle of knee replacement. What
this is meant to portray is the increasing debt burden which has affected the U.S. and
World’s economy. From little to no debt after the 1930s to a crushing debt burden today,
both private and public debt has put an absolute governor on the growth rate of economic
performance. It is the dominate factor in all things economic and will be so for as far out
as one can see.
Lacy Hunt, citing the research of such notable economists as Böhm von Bawerk, Wicksell,
Fisher, and Keynes has this to say about the state of the economy:
1. One cannot solve a debt problem with more debt (where have you heard that
before?)
2. Today’s low rates are an indication of very slow growth and no inflation (the Fed is
not the only interest rate agent).
3. The composition and the amount of debt are equally important. Zero interest rates
promotes speculation (Ponzi finance).
4. Consumptive debt crowds out productive debt; which means we are eating our seed
corn.
5. Interest rates cannot “normalize.” If they do, financial markets would crash and
depression would be almost certain.
6. The good news is the U.S. will be the last to go down. The following are estimated
total debt to GDP ratios:
a. 345% United States
b. 450% Europe
c. 550% England
d. 650% Japan
e. 320% China (many say as high as 1200%)
7. Quantitative easing (QE) has failed. There is no evidence of the supposed “wealth
effect” taking place. QE has been a major factor in the huge disparity of income and
wealth.
8. Monetary policy was never meant to be a good policy tool to correct overindebtedness. Money growth is running about 6%, which when coupled with negative
velocity leaves nominal GDP at about 3% at most (6%-3%=3%). Then when one takes
out inflation, real growth at best will be 1-2%. This is what is expected for the
foreseeable future.
9. A real growth rate of 2% or less will throw off little income and demand will remain
weak and capacity growth in Asia will probably enlarge the GDP output gap.
10. Historically there is nothing new in what is taking place. Under-saving,
overspending, and huge debt build-ups is just human nature. All great empires have
gone down in this fashion.
Net, net it’s slow to no growth for as far as one can imagine. Where have you heard that
before?
Final Note
I must admit that I did flower Lacy’s comments with a bit of my own thoughts. To him, I
apologize. To you: I say it’s just the way things are. Debt must be paid back sometime,
however it’s growing again. When the market loses confidence there will be no rolling over
of debt. BANG!
There is a natural rate of interest (Wicksell) which places an economy in equilibrium—
supply and demand match. If the nominal growth rate of the economy is above this rate,
then growth is fostered. If the nominal growth of the economy is less than the natural rate
of interest, there can be no growth. That, my friends, is where we are today.