Time to Do the Hard Thing
Much of the reaction to last week’s Inflationary Angst letter boiled down to, “Get government out of the way and the free market will work.” Others said the opposite: Government must help people even more than it already does. I wish it were that easy. Neither of those options are what we need, and today I will explain why.
We don’t have much time to get our house in order, either in the US or globally. Everything I’ve said today applies, to various degrees, throughout the developed world. Thinking that 2% inflation or zero interest rates coupled with massive deficits will somehow help is beyond wishful thinking.
Muddling for Solutions
Should just being “employed” make people/workers happy? On one level, any job is better than no job. But we also derive much of our identities and self-esteem from our work. If you aren’t happy with it, you’re probably not happy generally. Unhappy people can still vote and are often easy marks for shameless politicians to manipulate. Their spending patterns change, too. So it ends up affecting everyone, even those who are happy.
The Road to Default
We will spend the latter part of the 2020s going through a kind of worldwide bankruptcy. We won’t call it that, and it will take a lot of argument because we won’t have a court to take charge. But we will collectively realize the situation can’t go on and find a way to end it. I’ve taken to calling this “the Great Reset.”
Chinese Chess Game
When the US and ultimately the rest of the Western world began to engage China, resulting in China finally being allowed into the World Trade Organization in the early 2000s, no one really expected the outcomes we see today. There is no simple disengagement path, given the scope of economic and legal entanglements. This isn’t a “trade” we can simply walk away from. But it is also one that, if allowed to continue in its current form, could lead to a loss of personal freedom for Western civilization. It really is that much of an existential question.
Decoding the Fed
In less than 12 months we have seen the Fed raise rates, cut rates, shrink its balance sheet, expand its balance sheet, inject liquidity, withdraw liquidity, and do who knows what else behind the scenes. Either Fed officials are confused or we are at some kind of economic turning point. Or possibly both—there is no playbook. At a minimum, I think we are at a turning point and the Fed is having to improvise policy as events dictate.
Our Nuts Are in Danger
Economic changes have made future planning increasingly difficult for government retirement systems, private pension plans, and individual investors. How do you generate a reliable income stream for an uncertain but potentially lengthy lifespan in a world where interest rates are barely above zero and possibly below it?
Social Security Is Dying Because Baby Boomers Aren’t
Unfortunately, my good news is also bad news for younger Americans, who won’t get nearly as much as my age cohort is collecting. Worse, they could actually see negative real returns despite having paid proportionally more into the system. In investment terms, they are getting screwed.
Last week’s That Time Keynes Had a Point letter brought many more comments than usual. Apparently Keynes is still provocative 73 years after his death, no matter what you say about him. But my real point was about the twisted economic thought that is having dangerous effects on us all. And we can’t blame it just on Keynes.
That Time Keynes Had a Point
The whole debt bubble, the income and wealth inequality angst, a growing deficit which will get worse after the next recession, and lack of economic understanding among voters is all coming home to roost. Better to think about that now, while we can still act and maybe even change things.
Black Hole Investing
At the economic event horizon, we all need to become black hole investors. Relying on past performance as the tectonic plates shift underneath us, as the central bank black holes begin to suck historical performance into their maws, we must look forward rather than backwards to design our portfolios.
Dalio’s Analogue and Mauldin’s Commentary
Ray says our current situation is essentially the reciprocal of the 1970s inflationary blow-off. The last historical parallel to what we now face was the 1930s. Both those analogues, while not perfect, carry valuable lessons we should consider.
Volatile Year Coming
I think the last few weeks marked a turning point in the economic narrative. It’s more than the trade war. A sense of vulnerability is replacing the previous confidence—and with good reason. We are vulnerable, and we’ll be lucky to get through the 2020s without major damage.
Digging a Hole to China
The saddest part is that the world trading system does, indeed, have serious problems, many of which emanate from China. We need to fix them. I fully support that goal. I am glad we have an administration that takes Chinese behavior seriously. But the tariff strategy is making the situation worse, not better, and the focus on trade deficits is entirely misplaced.
What I Learned at Camp Kotok
his year’s conversations focused on three key long-term themes which were discussed one by one. 1. A future where global interest rates remain permanently near zero. 2. Modern Monetary Theory (MMT) and US fiscal strategy. 3. A fundamental change in the US/China relationship
Larry Kotlikoff on The Big Con
Larry Kotlikoff will share some provocative ideas on what caused the Great Recession. As you’ll read, he demolishes the explanations Wall Street and Pennsylvania Avenue want us to believe. Instead, he argues that our financial system was built to fail, failed spectacularly, and was then rebuilt to die another day.
An Opportunity in the Chaos
One reason the economy is so fascinating is the way things just… happen. Growth blossoms if everyone just follows their own incentives and nothing gets in the way. The courage, vision and passion of entrepreneurs and those who risk their money backing them is one of the most inspiring aspects of modern civilization.
Ray Dalio – John Mauldin Conversation, Part 6
Today in my final reply to Ray I sum up my previous letters and describe one possible path for dealing with the deficit and related problems. My idea will be controversial for most people. I am totally open to another, better solution if anybody knows one.
Ray Dalio - John Mauldin Discussion, Part 5
This is part of an ongoing series of a discussion between Ray Dalio and myself. Today’s installment, adapted from a letter I wrote several years ago, addresses the philosophical problem he is trying to address: income and wealth inequality.
Ray Dalio-John Mauldin Discussion, Part 4
I was quite pleasantly surprised to read a very generous and gentlemanly reply from Ray in Forbes last week, in which he clarified some of my understanding of what he wrote. I encourage you to read it after this letter for more context. I’ll continue responding to his original material but first a short piece responding to his letter in Forbes.
Ray Dalio Is Kinda, Sorta, Really Wrong, Part 3
Ray Dalio has done us all a service by pointing out some rarely mentioned elephants in the room (some tinged with pink). We discuss various parts but seldom the entire creature. By that, I mean the rapidly growing potential for “progressive” control of both Congress and the White House.
Ray Dalio Is Kinda, Sorta, Really Wrong, Part 2
Last week, I basically agreed with Ray’s analysis of US income and wealth disparity. It obviously exists. The question is what, if anything, can we do about it? I think this is an important conversation, not just between two people but throughout the entire nation. The answers will make a huge difference to both our society and our children’s futures. Not to mention our own futures.
Why Debt Won’t Spark Inflation
Like Japan, the US will see yet more quantitative easing and extraordinarily low interest rates, along with annual federal deficits of $2 trillion and higher. Alternatives like restructuring the tax code and balancing the budget will be nowhere in sight.
Your Pension May Be Monetized
Defined benefit plans, usually those sponsored by state and local governments, labor unions, and a dwindling number of private businesses. Many sponsors haven’t set aside the assets needed to pay the benefits they’ve promised to current and future retirees. They can delay the inevitable for a long time but not forever. And “forever” is just around the corner.
Time to Change Strategy
Friends don’t let friends buy and hold. At a minimum, you need some type of hedging program on your equity portfolios. Using a simple 200-day moving average to signal the time for going to cash, while not the best, will help protect you from the worst of a massive bear market.
How I Learned to Love the Debt
The Treasury Department will sell bonds and run up the debt. That’s a given. Then there will be a recession, as there always is, and then the Federal Reserve will take interest rates down to the zero boundary (otherwise known as financial repression and the devastation of savers), followed by unprecedented amounts of quantitative easing… just like Japan has done.
Japanified World Ahead
I think the rest of the world will enter a period something like Japan endured following 1990, and is still grappling with today. It won’t be the end of the world; Japan is still there, but the little growth it’s had was due mainly to exports. That won’t work when every major economy is in the same position.
Capitalism Gone Wild
Recession is coming. We can debate the timing, but the economy will turn decisively downward at some point. My own analysis, looking at the data available on April 4, says recession isn’t likely this year but unfortunately looks very probable in 2020.
No Free Lunch, Part 2
Matching the stock market’s long-term average returns sounds like it should be easy, if you’re patient enough. But in fact it is remarkably difficult. In last week’s letter, Ed Easterling and I showed you why it is a longshot bet in almost every market environment. Returns over a decade or two are usually well above or well below average. Most of all, it’s fairly predictable which side of average will occur. Today Ed and I will expand on that discussion.
The Fed Is Playing a Dangerous Game
I would prefer that the market set rates at the lower end as opposed to the Federal Reserve, again, except in times of crisis. I don’t believe 12 people sitting around a desk, no matter how brilliant and educated they are, can arrive at a proper market-clearing rate better than the market itself. Seriously, LIBOR was set for decades without government intervention.
Capitalism Without Competition
Today’s capitalism has a contradiction that is increasingly hard to ignore: lack of competition in key markets. That’s a problem because competition incentivizes producers to get more efficient and reduce prices for consumers. Without competition, you end up with bloated monopolies that may be highly profitable for the owners, but don’t serve the greater cause of economic growth.
What Should We Then Expect (From Investing)?
Today we’ll look at what we should expect from our investing. In case you haven’t noticed, financial markets are really a giant expectations game. A company can report great quarterly results and still get crushed if earnings are less than analysts expected.
How Should We Then Invest?
It makes little difference to our portfolios whether recession strikes in 2019 or 2020. The benchmarks will drop between 40 and 50%—some more, some less. To the extent that you are exposed to stocks and other financial markets, your portfolio is going to take a hit.
Bull in the China Shop
This week’s letter focuses on China’s economy. We’ll look at some numbers showing the challenges China faces, but they don’t explain something important. The way China will meet those challenges is going to be substantially different than we would see in the West.
Something Wicked This Way Comes
Americans like to think we are insulated from the world. We have big oceans on either side of us. Geopolitically, they serve as buffers. But economically they connect us to other important markets that are critical to many US businesses. Problems in those markets are ultimately problems for the US, too.
The Year of Living Dangerously
I expect to spend this year Living Dangerously. Yes, I’m thinking of the 1982 film starring a very youthful Mel Gibson and Sigourney Weaver, based on an earlier Christopher Koch novel. It has an Asian setting and features corrupt politics, neophyte journalists, international intrigue plus a gender-bending Chinese dwarf. If you aren’t sure how all those fit together, then welcome to 2019. We are all stuck in this craziness and can only make the best of it.