John Mauldin: The Matterhorn Interview
By Lars Schall
Investment advisor John Mauldin explains his attitude towards austerity measures; a return of the gold standard; the euro crisis; and the willingness to bailout everyone that makes capitalism and monetary systems stop working.
John Mauldin, the President of the investment advisory firm Millennium Wave Advisors, is a renowned financial expert, a multiple New York Times best-selling author, and a pioneering online commentator (see http://www.johnmauldin.com/). His weekly e-newsletter, Thoughts from the Frontline, is the most widely distributed investment newsletter in the world. He also edits the free weekly e-letters Outside the Box and The Mauldin Circle.
Mr. Mauldin, who is a passionate traveler with business partners all over the world, has been published in virtually all financial media and he is a frequent contributor to The Financial Times and The Daily Reckoning, as well as a regular guest on CNBC and Bloomberg TV. His latest book is “Endgame: The End of the Debt Supercycle and How it Changes Everything.“ He regularly speaks to conferences and private groups including The Money Show, The Annual Strategic Investment Conference, The Agora Wealth Symposium, and other investment related venues.
John currently resides in Dallas, Texas, U.S.A.
Question: Mr. Mauldin, one interesting fact about you is that you’re the inventor of the phrase, “Muddle Through Economy.” Is what we are experiencing in the Western hemisphere a “Muddle Through Economy” on steroids?
John Mauldin: That’s a very good question. When I think about “muddle through,“ I think about an economy that’s growing in the, say, two percent range in the U.S. and one percent in Europe — that’s below trend. Both the U.S. and Europe are certainly in muddle through mode and it looks to me like Europe is getting ready to go into a recession. Depending on how bad your banking crisis is and how that works into our system, it could be a recession year all around. Now, eventually we will get through it, as in recessions past. But I think the West in general is in for a muddle through, slow growth, sideways economy for most of the rest of this decade as we dig through the debt supercycle – we borrowed too much money on the country level, at a local level and at a personal level. De-leveraging cycles do not prevent growth per se. Nevertheless, leveraging is a wonderful thing on the way up, but it is a problem on the way down.
Q: In your book, “Endgame: The End Of The Debt Supercycle And How It Changes Everything,“ you make the case that all over the world governments are reaching the limits of their ability to borrow money. If true, what consequences will that have?
JM: The consequences means that governments either have to cut back or they have in extreme cases to default on their debts. Greece is not going to pay 100 percent of its debt back; everybody knows that. It is not going to be too long before Italy will find itself in a position where they literally can’t afford to pay 100 percent of its debt back; they will have to discount their debt in some way. There are ways you can do that without actual technical defaults, but the whole process will have negative impacts on economies. When you start going into austerity, to use the word that you read everywhere, it will affect the growth of your economy. One problem is, for many economies it is not a one-time austerity deal and the effect goes away after about a year. It’s like: we have to cut this year, then we will have to cut some more next year, and then we will have to cut some more the year after that, and then we will have to cut some more the year after that. So you put yourself in a permanent spiral down to get to some place where you have balanced your budget.
This is done by cutting spending or raising taxes, depending on your ability to raise taxes. In the U.S. we have some room to raise taxes; I don’t think it’s a good idea, but we have some room to do so if we decided to. If you’re France, government spending is close to 50 percent of GDP, so you don’t have much more room to raise taxes; the productive part of your population is already handing over a significant portion of their income in taxes. So sometimes you will find yourself in a place where you really have to do cuts, and those cuts are difficult. When the biggest part of your economy is in transfer payments in forms of pensions, Social Security, healthcare or other government services and you have to cut them down, that’s painful. It as much a political problem as it anything else. It definitely impacts the ability of the economy to grow. The transition period is very tough, and politicians like to put off the inevitable as long as they can; but eventually the inevitable comes. Eventually you will reach the end of the road.
Q: Related to debt, is the bond market of the last few decades a dying dinosaur?
JM: No, a dinosaur would imply that the bond markets are going to go away. There always will be bond markets. Governments have been defaulting for hundred and hundreds of years, yet there are still bond markets. It’s not a dinosaur, it is not going to get extinct. But people have come to realize again that governments can in fact default and that there is risk in buying sovereign bonds. Let us look at what a sovereign bond investor really is. This is not a speculator; this is someone who wants to invest his money and get a guarantee of a small amount of return. He doesn’t want to take risk. And when the bond investors realize that there is risk involved in investing in sovereign bonds, they want higher interest rates and they want to make sure that they will get their capital back.
That’s why certain countries have to pay more. We have already seen that Italy had to go to 6 percent, and if it wasn’t for the European Central Bank (ECB) stepping in, I think the interest rates would be 9 to 10 percent – and Italy makes a big difference because it’s the third biggest bond market in the world. So if Italian rates go through the roof, then Italian debt becomes suspect, the loses are huge, and in fact too big for the private market to absorb, and then there would be a very disorderly crisis. To keep them going off that cliff, the ECB has to figure out how to give money to the Italian banks so that they can buy Italian sovereign debt if the ECB is not willing to do it directly itself. That is an interesting problem.
Q: But can one solve the current debt crisis with more debt?
JM: No. It’s like I’m drunk and my solution is to get another bottle of Jack Daniels. The problem is that there is already too much debt – though in the short term, supporting debt can help as a bridge loan to have positive cash flow. In Italy’s case, such bridge loans might help to get there. So another little drink of Jack Daniels could help, if you will.
Q: Quite a lot of people forget about the exotic derivatives that were a major factor in causing the global financial crisis, as if this problem doesn’t exist anymore. Do you think that the roughly $1 quadrillion in various worthless derivatives alone could be enough to bring the global financial system to its knees?
JM: Well, you’ve got to be really careful by what you mean when you say “derivatives.“
JM: There are derivatives of this sort, and there are derivatives of that sort. An option for IBM is a derivative, something in the futures market is a derivative, and I don’t think that those types of derivatives will bring the system down. They can go exponential, and while it may not be a useful financial exercise, they are not going to put the whole system under threat. That is a completely different thing than to say that a derivative like a Credit Default Swap is not a problem. This market could in fact bring the system down, and it could bring it down in a very ugly, disorderly manner, that’s true.
Q: How would a healthier monetary system look if the choice was yours? And do you think that governments have enough sense to introduce such a system?
JM: Well, the monetary system that we’ve got would be just fine, if you didn’t have the leverage, the credit and the deficits that we have. We have to come back to the natural check in a capitalistic system, and that is bankruptcy and default. You should just let them do it. When you are stupid enough to put your money in a currency and in debt where the government does stupid things, debases its currency and hurts the value and the buying power of that currency, you should lose your money. This teaches you to be more careful where you invest it the next time. That is the tool that makes capitalism work. When you don’t allow defaults and losses, when you try to bail everybody out, that’s when capitalism and monetary systems stop working.
Q: As you know an increasing number of people are stating that we should go back to the gold standard. What is your attitude to that question?
JM: I have two attitudes. Number one: it’s a non-starter, it will never happen. We can talk about it all we want, it is just a nice theory. For all practical purposes, Greece is now under a gold standard, which is called the euro, and they are in a place where they can’t get out of their unfortunate position, they can’t work out of it, they can’t print their own currency and devalue, their labor is overvalued, etc. That’s quite similar to the classical gold standard.
If you want to go on a gold standard, fine – but you have to recognize the limitations that you will have. The main problem that you face with being on a gold standard or not being on a gold standard is the willingness of central bankers and politicians to get rid of limitations and debase their currency. And I think most people when they say: I want to be on a gold standard – what they are really saying is: I don’t trust central bankers and I want to have some neutral currency.
I totally agree with that. I mean, I buy gold every month and take it in physical delivery. I hope I will never need it, though. For me it’s insurance; I don’t see it as an investment – I buy it because I don’t trust the banksters.
JM: I am an optimist, I hope it all will work out well, but just in case, I buy it like I buy car insurance and health insurance – I hope I don’t need either. Nevertheless, there are mechanisms of the growth of the money supply where you don’t have a debasement issue of your currency. It’s when you start to have Quantitative Easing, when you start to mess with the system, then you’re running into problems. The Swiss haven’t had a problem, they don’t need a gold standard – they are the standard. The problem are rather central banks and governments who want to fix something, because every time the governments want to fix things, they create more problems to fix. It’s the fixing of the problem that creates the problem, if you will.
Q: Do you believe the euro, that you once called an ‘experiment’ rather than a currency, is a thing that will last?
JM: If the question is about the euro as it is today, the answer is certainly no. There is going to have to be some serious adjustments. An adjustment could be a fiscal union, if the voters in the various European countries vote to submit themselves to a central authority – or in other words, if the German government get its will and create a father figure in Brussels, who tells the others how to run their budgets correctly and otherwise they got to do their homework.
Q: But let’s assume you were a European citizen. Would you like to have such a father figure that lords over a core element of the sovereignty of your country?
JM: Well, what the Germans are asking for is a balanced budget. Or you can only run a 0.5 to 1 percent structural deficit. And that’s a really good idea. This is what Keynes said in his original work, not what is said about him today. Keynes’ original concept was in the good times you pay down the debt, and in the bad times you can borrow money – but you pay it back when things get better.
JM: So you don’t run up never-ending debts and build up a supercycle of debts. In the U.S. in the late 1990’s we actually reduced our total debt. And if we had kept on that path, if the Bush government and the Republicans – I say this as a Republican – wouldn’t have run deficits, in 2008 we would have come into the credit crisis with very little debt.
So I think it is a good thing when the Germans are saying in essence that they want a limit on the ability of governments to run deficits, a limit on the ability of governments to spend money and create financial crises. This is reasonable. But they have to do it themselves, too.
Q: Yes, of course, that’s quite ironic right now.
JM: Yes, nevertheless, in theory it’s a good thing. Will they do it? No. That is one of the reasons, if I am buying gold as an investment, I am not buying gold in dollar terms, I am buying gold in shorting the euro, I don’t buy gold in euro or yen terms, because I think they are in worse shape than the dollar. Given the make-up of all the major currencies around, the U.S. dollar is the prettiest girl in a ugly girl contest.
Q: Why is the dollar in better shape?
JM: Because we still have an opportunity to dig our way out of this hole that we are definitely in, but we have to make that decision.
Q: With what kind of emotions do you have when you look at the housing bubble in China? Do you think the Chinese economy will receive a very rude awakening?
JM: Eventually yes. They haven’t learned to repeal the business cycle. But it can go on for a lot longer than anyone of us can imagine. If you have a closed capitalist system, which they do, and you’re simply willing to tell your banks to lend money to which they are, it can go on for quite some time. Now, are they trying to bring their housing bubble down? Yes. Will they be able to bring it down to a level where it can’t lead to a crisis? Maybe. Do they in principal have more people that want housing than they have adequate housing? Yes. The question becomes: adequate housing at what price? So they may have to go through a pricing adjustment mechanism. But that will really be a short term problem.
Do I expect China to have a bigger economy, that’s more successful and more intimidating in ten years than it is today? Absolutely. But to think that they can go through this without some type of serious slowdown or recession for ever and ever, that is just not a reasonable thing. You can’t grow to the sky. Eventually you have to begin to settle the debts out and figure out how you get in balance.
Q: What advice would you give our readers in order to survive the hard times we’re going to have?
JM: I think that readers should recognize that the hard times will be over sooner or later. In the next five to ten years, it’s hard to say, because politicians can try to kick the can down the road a lot longer than we can imagine – but we’ll get through it. Your goal now as investors should be to try to go through to the other side with as much capital and as much buying power as you possibly can — because when we get to the other side, when the dust settles, I believe there will be a tremendous boom in the world.
That boom will be probably more in the emerging markets, but there will be tons of new technologies, there will be tons of new things within Europe and within the U.S., in which you will be able to invest. To give you an example: we used to think of Japan as a problem, but there is a market over the last few years within Japan that’s been up 50 percent, and it’s their robotic stocks. If you had just invested in robotic stocks a couple of years ago when they were at the bottom, you would have done just fine. Why? Because robotics is a booming industry, and its becoming more and more profitable. A couple of days ago I was told about a Panasonic factory in Japan that makes two percent of the flat screen TVs in the world – with fifteen engineers. That’s it. It’s all robotics. That’s a profitable business. So there are places where we are going to find to invest money, and I want to be as cautious as I can during this inter-period, I want fixed income, I want hard assets, I want things that going to pay me money and that are going to get me to the other side, but I think there will be a big booming bull market coming, and we want to get as much capital as we can, we want to save as much as we can in order to get to that opportunity when it does come.
Q: Do you think it is “too late to jump on the gold wagon“ and invest in gold if one sees it as an investment? (1)
JM: If one sees gold as an investment, probably not, and certainly not if you are living in Europe, if you’re in the euro zone – no. But what you have to watch closely is: If you think that Greece, Portugal and Italy will leave the euro, then the euro will become a lot stronger and you should sell your gold in euro terms. If you see Germany leaving, then the euro could be a real screaming sell in terms of gold, and so your gold would become quite valuable in terms of euros. So it depends what you believe will happen in the case of a break-up, if the strong countries leave or the weak countries leave; I don’t think it’s clear yet. My guess is that the weak countries will be the ones that leave. So in the long term, two years from now, three years from now, the euro will be stronger, but in the meantime it will go down against the dollar.
Q: Thank you very much for taking your time, Mr. Mauldin!
(1) Compare Egon von Greyerz: "TOO LATE TO JUMP ON THE GOLDWAGON?", published at GoldSwitzerland on August 15th, 2011 under: http://goldswitzerland.com/index.php/too-late-to-jump-on-the-goldwagon-question/