Contents Acknowledgments Introduction : Endgame Part One : The End of the Debt Supercycle Chapter : The Beginning of the End How Did the Debt Supercycle Come About? Private Deleveraging and Public Leveraging Up Chapter : Why Greece Matters What Does Greece Mean to Me, Dad? Chapter : Let’s Look at the Rules Six Impossible Things Delta Force Killing the Goose But It’s More Than the Deficit Not Everyone Can Run a Surplus Pity the Greeks The Competitive Currency Devaluation Raceway Final Thoughts Chapter : The Burden of Lower Growth and More Frequent Recessions Three Structural Changes Lower Growth, Fewer Jobs, Bigger Deficits, Lower Returns Chapter : This Time Is Different A Crisis of Confidence It’s the Deleveraging, Stupid! Some Parting Words from Rogoff and Reinhart Chapter : The Future of Public Debt: An Unsustainable Path A Bit of Background Drastic Measures The Future Public Debt Trajectory Debt Projections The Challenge for Central Banks Bang, Indeed! The Center Cannot Hold Who Takes the Loss? Chapter : The Elements of Deflation The Supertrend Puzzle The Elements of Deflation: What Deflation Looks Like The Velocity of Money A Slowdown in Velocity The Roadmap Ahead: Bernanke’s Helicopter Speech There Are No Good Choices Chapter : Inflation and Hyperinflation A Dose of Inflation The Characteristics of Hyperinflations The Dangers of Inflation The Problems of Inflation Hyperinflation in the United States? Part Two : A World Tour: Who Will Face Endgame First? Chapter : The United States Yes, We’re Screwed Congress: Blind, Ignorant, and Indifferent What Does It All Mean? The Kindness of Strangers Endgame for the United States The Present Contains All Possible Futures Some Policy Suggestions Chapter 10 : The European Periphery The Euro: A Suboptimal Currency Union Some Countries Recover; Others Don’t Chapter 11 : Eastern European Problems Hungary: Damned If They Do, Damned If They Don’t The Baltics: How to Destroy Your Economy and Keep Your Peg Chapter 12 : Japan The Mother of All Bubbles Japanese Government: Spending Money Like There Is No Tomorrow Japan’s Endgame Chapter 13 : The United Kingdom The United Kingdom Economy: Not as Safe as Houses Northern Rock: A Modern Bank Run The United Kingdom’s Endgame: Higher Inflation Ahead Chapter 14 : Australia The Lucky Country A House of Cards Chapter 15 : Unintended Consequences Bubbles in Emerging Markets Difficult Choices Conclusion: Investing and Profiting from Endgame Epilogue: Some Final Thoughts Notes About the Authors Index Additional Praise for Endgame “There’s clearly something important going on in the world economy Something big Something powerful and dangerous But something as yet undefined and uncertain We are all feeling our way around in the dark, trying to figure out what it is John Mauldin must have night-vision glasses He does an excellent job of seeing the obstacles You should read this book before you knock over a lamp and stumble over the furniture.” —William Bonner, President and CEO of Agora Inc.; author of Dice Have No Memory and Empire of Debt “Endgame not only is a highly readable and informative account of the causes of the recent global economic and financial meltdown, but it also provides investors with a concrete investment strategy from which they can benefit while this final act in financial history is being played out.” —Marc Faber, Managing Director, Marc Faber, Ltd.; Editor, Gloom Boom & Doom Report “I think the book is brilliant It is well written, crystal clear, and hits the spot My favorite chapters are the ones on fingers of instability (which I think everyone in finance should read and reread each year lest they forget), and the one on Eastern Europe as both a leading indicator for what’s in store and a potential land mine that could yet for the euro what Credit Anstaldt did for the gold standard But it’s a tough call Lots of very good stuff in here.” —Dylan Grice, Global Strategy Team, Societe Generale Copyright © 2011 by John Mauldin and Jonathan Tepper All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate percopy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com/go/permission Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002 Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic formats For more information about Wiley products, visit our web site at www.wiley.com Library of Congress Cataloging-in-Publication Data: Mauldin, John Endgame : the end of the debt supercycle and how it changes everything / John Mauldin and Jonathan Tepper p cm Includes index ISBN 978-1-118-00457-9 (hardback); ISBN 978-1-118-05806-0 (ebk.); ISBN 978-1-118-05807-7 (ebk.); ISBN 978-1-118-05808-4 (ebk.) Debt Debts, Public Debts, External Recessions Business cycles I Tepper, Jonathan, 1976– II Title HG3701.M345 2011 336.3'4—dc 222010051231 This book is dedicated to Peter Bernstein Peter Bernstein 1919–2009 Amazing author, devoted husband, loving father Mentor to generations of investment professionals A man whose wisdom was always welcome And who saw The Endgame clearly before everyone You are missed, my friend, now more than ever when your wisdom is most sorely needed Index Accrual accounting, contrasted to cash accounting Age-related government liabilities in Greece in Japan in United States Aggregate demand Aggregate spending, stimulating of Aliber, Bob Alternative minimum tax Argentina Austerity programs and policies deflation and in Greece in Hungary in Latvia in Spain in United Kingdom in United States Australia endgame housing bubble and banking sector in money supply Austria Bak, Per Baker, Gerard Balance of trade See Trade deficits and surpluses Balance sheet recession Balance sheets, warning signs of crisis and Baltic states Bank Credit Analyst (BCA) Bank for International Settlements (BIS) See also Public debt, future of Bank of England Bank of Japan Bank Paribas (BNP) Barnes, Martin Belgium Bernanke, Ben deflation and Bernholz, Peter Biggs, Andrew Blanchard, Olivier Boeckh, Tony Bolton, Hamilton Bond market deleveraging and reactions to increase in government debt Bonnet, Georges Boskin, Michael Bowles, Erskine Brazil Brock, Dr Woody Brown, Gordon Buchanan, Mark Buchannan, James Bundesbank Bush administration Business Dynamics Statistics Caballero, Ricardo California Canada Carroll, Lewis Carry trade, Eastern Europe and Carville, James Cash accounting, contrasted to accrual accounting Cecchetti, Stephen C Central banks See also specific banks attempts to control deflation and inflation fiscal stimulus and GDP future of public debt and inflation and velocity of money and Cheney, Dick China currency devaluation and as emerging market reserves of trade and United States debt and in World Trade Organization Choices, personal and governmental Commercial real estate Committee on the Fiscal Future of the United States Confidence, crisis of United States and Congress, failure to address fiscal problems Congressional Budget Office Continental Illinois Bank Credit default swaps Crisis of confidence, fiscal crises and United States and Critical states, instability and Currency areas, qualities of optimal Currency devaluation competitive deficit reduction and Currency peg, Baltic states and Cyclical debt Cyclical unemployment Czech Republic Dagong Global Credit Rating Company Debt deflation, defined Debt levels, as warning sign of crisis Debt supercycle end of Act I of origins of private deleveraging and public leveraging up Debt-to-GDP ratio in France in Greece in Ireland in Japan in Portugal rise and effect on GDP in Russia in Spain in United Kingdom in United States Default, as option for nation with excess public debt Deflation bad, and lack of pricing power and demand Bernanke and role of central banks central banks’ attempts to control classic definition of economic supertrend puzzle and elements of in European periphery good, and increased productivity investment suggestions for time of in Japan velocity of money and Deleveraging deflation and effect on GDP recessions and Delta (Δ) symbol for change Devaluation of currency competitive deficit reduction and Dollar, as reserve currency Domenici, Pete Dubai Economic Cycle Research Institute Economic growth debt and lower long-term structural change in U.S economy and Economic rules currency devaluation and identity equation and GDP private financing of government debt start-ups, productivity, and GDP trade deficits and Economic volatility See Volatility Economist House Price Index Education levels, employment and Efficient market hypothesis (EMH) Eichengreen, Barry Election of 2008, state debt and voting patterns in El-Erian, Mohamed Emergency benefits, unemployment and Emerging markets exchange reserves and stock performance possibilities Employment See also Unemployment start-ups and job creation suggestions for U.S job policies Energy policy, suggestions for United States Engle, Robert F Entitlements See Age-related government liabilities Estonia Euro Baltic states currency peg and Greece and as suboptimal currency European Central Bank European periphery euro as suboptimal currency for future trajectory of Greece’s entitlement expenses and Spain’s housing and Excess production capacity, deflation and Fannie Mae Federal employee wages, in United States Federal Reserve See also Quantitative easing Bernanke and role in deflation ignoring of housing boom Feldstein, Martin Ferguson, Niall Financial innovation, velocity of money and Financial oppression Financial Times Fiscal crises, development of crises of confidence and deleveraging and signs and signals of “this time is different” thinking and Fiscal Investment and Loan Plan (FILP), in Japan Fiscal stimulus, effect on identity equation Fisher, Irving Fisher, Richard France debt-to-GDP ratio Freddie Mac Friedman, Milton “Future of Public Debt: Prospects and Implications, The” (Cecchetti, Mohanty, and Zampolli) Gave, Charles GDP (gross domestic product) See also Debt-to-GDP ratio effect of deleveraging on identity equation and private financing of government debt real vs nominal start-ups, productivity and velocity of money and Geithner, Tim Germany euro and trade deficits and surpluses in volatility in Globalization, volatility and Gold deflation and euro’s similarity to gold standard inflation and velocity of money and Golden Fetters (Eichengreen) Government Pension Investment Fund (GPIF), in Japan Grantham, Jeremy Great Britain See United Kingdom Greece debt-to-GDP ratio deflation and euro and expenses of entitlements in global impact of debt crisis in probable default of sovereign debt crisis in Greenspan, Alan Gresham’s law Grice, Dylan Halifax Bank of Scotland (HBOS) Haltiwanger, John C Hamilton, Alexander Hayek, Friedrich Hedged debt Heritage Foundation Hong Kong Housing, in Australia Housing, in Spain Housing, in United States boom as warning sign deflation and Federal Reserve and boom in owners’ borrowing against and refinancing Hungary carry trade and Hunt, Lacy Hussman, John Hyperinflation characteristics of dangers and problems of distinguished from inflation likelihood in United Kingdom likelihood in United States Iceland Identity equation, GDP and Illinois Immigration, and suggestions for stimulating U.S economy India Indonesia Inflation See also Hyperinflation central banks’ attempts to control dangers and problems of distinguished from hyperinflation economic supertrend puzzle and investments suggestions for time of likelihood in United Kingdom likelihood in United States as option for nation with excess public debt as poor policy response real vs nominal GDP and Infrastructure, in United States Instability, Minsky’s theory of stability leading to Interest rates Bernanke on deflation and fiscal stimulus and GDP reactions to increase in government debt rising faster than growth rates in United States International Monetary Fund Inverted debt Investors economic warning signs in composition of base of endgame tactics and market volatility and Ireland debt-to-GDP ratio deflation and endgame euro and warning signs of crisis in Issuing, Otmar Italy Japan currency devaluation and debt levels and decreased revenue debt-to-GDP ratio deflation and deleveraging needed in effects of stimulating consumption in endgame financial oppression in hyperinflation and inflation and U.S debt and volatility in Japanese government bonds (JGBs) Japan Post Bank Japan Post Insurance Jarmin, Ron S Jefferson, Thomas Jobs See Employment; Unemployment Kan, Naoto Kane, Tim Kauffman Foundation Kaupthing Bank Keynes, John Maynard Keynesian economics Kindleberger, Charles King, Mervyn Koo, Richard Korea Kotlikoff, Laurence Krugman, Paul Latvia Legal immigration, and suggestions for stimulating U.S economy Lehman Brothers bankruptcy Lending, deflation and collapse of Lewis, Michael Lithuania Lloyds-TSB Lynch, Peter Maastricht treaty Malaysia Malta Manos, Stefanos Marès, Arnaud McCulley, Paul McKinsey Global Institute study Medicare See Age-related government liabilities Minsky, Hyman Miranda, Javier Mises, Ludwig von Mishkin, Frederic Mohanty, M S Monetary Regimes and Inflation (Bernholz) Money supply, deflation and Monnet, Jean Mundell, Robert Netherlands Nevada New York Times NICE decade, in United Kingdom Nietzsche, Friedrich Nominal GDP Nonequilibrium systems Northern Rock Novy-Marx, Robert Oil, U.S need to import Orphanides, Athanasios Pakistan “Paradox of thrift” Parenteau, Rob Pathognomonic symptoms Paul, Rand Paul, Ron Pension costs and deficits See Age-related government liabilities Pettis, Michael Philippines PIIGS See European periphery Plosser, Charles Portugal debt-to-GDP ratio endgame euro and Pound sterling Primary balance of government spending Private sector debt supercycle and deleveraging in public debt and crisis of confidence public debt’s financing by trade deficits and surpluses Productive capacity, inflation and Protectionism, risks of Public debt debt supercycle and leveraging up monetizing of options for overleveraged governments private debt and crisis of confidence private financing of rollover of short-term trade deficits and surpluses Public debt, future of central banks and increasing debt-to-GDP ratios and fall in revenue sovereign debt and trajectory Quantitative easing in Australia in United Kingdom in United States (QE2) Quantity theory of money Ratings agencies Rauh, Joshua Recession current, as balance sheet recession current, deleveraging and as decrease in productivity in future higher volatility and likelihood of, in United States Reinhart, Carmen Reserve Bank of Australia Richebacher Letter, The Rivlin, Alice Rogoff, Ken Romer, Christina Royal Bank of Scotland (RBS) Russia Saudi Arabia Securitization, in United States debt supercycle and velocity of money and Shadow banking system Shilling, Gary Simpson, Alan Smithers, Andrew Social security See Age-related government liabilities Sornette, Didier Soros, George South Africa Spain credit rating of deflation and endgame euro and housing crisis in projected debt-to-GDP ratio sovereign debt crisis in warning signs of crisis in Sri Lanka Stability, Minsky’s theory of leading to instability Start-up businesses, as source of growth and productivity States, budget shortfalls in Stein, Herbert Stock, James Stockman, David Stravinsky, Igor Structural changes, in U.S economy higher levels of structural unemployment higher volatility and likelihood of recessions implications of lower trend growth Structural debt Structural unemployment Sweden Switzerland Taiwan Tajikistan Tang, Chao Tanzi effect Tawney, R H Taxes as distortion of resource allocation effect of increasing in Japan in United Kingdom in United States VAT tax Their’s law This Time Is Different (Reinhart and Rogoff) Time zones, psychological Trade deficits and surpluses China and economics of European periphery and Germany and United Kingdom and United States and volatility and Transversality condition Trichet, Jean-Claude Turkey Ubiquity: Why Catastrophes Happen (Buchanan) Uhlig, Harald Ukraine Unemployment See also Employment deflation and inflation and lack of growth and long-term structural unemployment insurance and cyclical deficit Unfunded liabilities See Age-related government liabilities United Kingdom borrowing in own currency credit rating of debt levels and decreased revenue debt supercycle in debt-to-GDP ratio deflationary forces in deleveraging needed in endgame financial oppression in hyperinflation and inflation and trade deficits and surpluses unemployment in warning signs of crisis in United States See also Structural changes, in U.S economy borrowing in own currency Congress’s failure to address fiscal problems currency devaluation and debt, lack of revenue, and possible collapse of confidence debt supercycle in debt-to-GDP ratio deflationary forces in endgame financial oppression in fiscal stimulus and GDP foreign ownership of debt of gold standard abandonment by inflation and infrastructure in Infrastructure Report Card for likelihood of default need to shrink size of government policy suggestions states’ budget shortfalls trade deficits and surpluses warning signs of crisis in VAT tax Velocity of money, deflation and Vietnam Volatility higher, and likelihood of recession in United States as warning sign of crisis Volcker, Paul Wadhwa, Vivek Wall Street Revalued: Imperfect Markets and Inept Central Bankers (Smithers) Wealth destruction, deflation and Weimar Germany Weisenfeld, Kurt Weldon, Greg “Who Creates Jobs? Small vs Large vs Young?” (Haltiwanger, Jarmin, and Miranda) Why Stock Markets Crash (Sornette) Wolf, Martin Wood, Chris World Trade Organization Yen Yuan Zampolli, Fabrizio Zimbabwe Zimbardo, Philip G Zweig, Stefan ... visit our web site at www.wiley.com Library of Congress Cataloging-in-Publication Data: Mauldin, John Endgame : the end of the debt supercycle and how it changes everything / John Mauldin and. .. Jonathan Tepper p cm Includes index ISBN 97 8-1 -1 1 8-0 045 7-9 (hardback); ISBN 97 8-1 -1 1 8-0 580 6-0 (ebk.); ISBN 97 8-1 -1 1 8-0 580 7-7 (ebk.); ISBN 97 8-1 -1 1 8-0 580 8-4 (ebk.) Debt Debts, Public Debts, External... Acknowledgments Introduction : Endgame Part One : The End of the Debt Supercycle Chapter : The Beginning of the End How Did the Debt Supercycle Come About? Private Deleveraging and Public Leveraging Up