Where's the Growth?

By John Mauldin

In 1633 Galileo Galilei, then an old man, was tried and convicted by the Catholic Church of the heresy of believing that the earth revolved around the sun. He recanted and was forced into house arrest for the rest of his life, until 1642. Yet “The moment he [Galileo] was set at liberty, he looked up to the sky and down to the ground, and, stamping with his foot, in a contemplative mood, said, Eppur si muove, that is, still it moves, meaning the earth” (Giuseppe Baretti in his book the The Italian Library, written in 1757).

Flawed from its foundation, economics as a whole has failed to improve much with time. As it both ossified into an academic establishment and mutated into mathematics, the Newtonian scheme became an illusion of determinism in a tempestuous world of human actions. Economists became preoccupied with mechanical models of markets and uninterested in the willful people who inhabit them….

Some economists become obsessed with market efficiency and others with market failure. Generally held to be members of opposite schools – “freshwater” and “saltwater,” Chicago and Cambridge, liberal and conservative, Austrian and Keynesian – both sides share an essential economic vision. They see their discipline as successful insofar as it eliminates surprise – insofar, that is, as the inexorable workings of the machine override the initiatives of the human actors. “Free market” economists believe in the triumph of the system and want to let it alone to find its equilibrium, the stasis of optimum allocation of resources. Socialists see the failures of the system and want to impose equilibrium from above. Neither spends much time thinking about the miracles that repeatedly save us from the equilibrium of starvation and death.

– George Gilder, Knowledge and Power: The Information Theory of Capitalism and How It is Revolutionizing Our World

And to that stirring introduction let me just add a warning up front: today’s letter is not exactly a waltz in the park. Longtime readers will know that every once in a while I get a large and exceptionally aggressive bee in my bonnet, and when I do it’s time to put your thinking cap on. And while you’re at it, tighten the strap under your chin so it doesn’t blow off. There, now, let’s plunge on.

Launched by Larry Summers last November, a meme is burning its way through established academic economic circles: that we have entered into a period of – gasp! – secular stagnation. But while we can see evidence of stagnation all around the developed world, the causes are not so simple that we can blame them entirely on the free market, which is what Larry Summers and Paul Krugman would like to do: “It’s not economic monetary policy that is to blame, it’s everything else. Our theories worked perfectly.” This finger-pointing by Keynesian monetary theorists is their tried and true strategy for deflecting criticism from their own economic policies.

Academic economists have added a great deal to our understanding of how the world works over the last 100 years. There have been and continue to be remarkably brilliant papers and insights from establishment economists, and they often do prove extremely useful. But as George Gilder notes above, “[As economics] ossified into an academic establishment and mutated into mathematics, the Newtonian scheme became an illusion of determinism in a tempestuous world of human actions.”

Ossification is an inherent tendency of the academic process. In much of academic economics today, dynamic equilibrium models and Keynesian theory are assumed a priori to be correct, and any deviation from that accepted economic dogma – the 21^st century equivalent of the belief by the 17^th century Catholic hierarchy of the correctness of their worldview – is a serious impediment to advancement within that world. Unless of course you are from Chicago. Then you get a sort of Protestant orthodoxy.

It’s About Your Presuppositions

A presupposition is an implicit assumption about the world or a background belief relating to an utterance whose truth is taken for granted in discourse. For instance, if I asked you the question, “Have you stopped eating carbohydrates?” The implicit assumption, the presupposition if you will, is that you were at one time eating carbohydrates.

Our lives and our conversations are full of presuppositions. Our daily lives are based upon quite fixed views of how the world really works. Often, the answers we come to are logically predictable because of the assumptions we make prior to asking the questions. If you allow me to dictate the presuppositions for a debate, then there is a good chance I will win the debate.

The presupposition in much of academic economics is that the Keynesian, and in particular the neo-Keynesian, view of economics is how the world actually works. There has been an almost total academic capture of the bureaucracy and mechanism of the Federal Reserve and central banks around the world by this neo-Keynesian theory.

What happens when one starts with the twin presuppositions that the economy can be described correctly using a multivariable dynamic equilibrium model built up on neo-Keynesian principles and research founded on those principles? You end up with the monetary policy we have today. And what Larry Summers calls secular stagnation.

First, let’s acknowledge what we do know. The US economy is not growing as fast as anyone thinks it should be. Sluggish is a word that is used. And even our woeful economic performance is far superior to what is happening in Europe and Japan. David Beckworth (an economist and a professor, so there are some good guys here and there in that world) tackled the “sluggish” question in his Washington Post “Wonkblog”:

The question, of course, is why growth has been so sluggish. Larry Summers, for one, thinks that it’s part of a longer-term trend towards what he calls “secular stagnation.” The idea is that, absent a bubble, the economy can’t generate enough spending anymore to get to full employment. That’s supposedly because the slowdowns in productivity and labor force growth have permanently lowered the “natural interest rate” into negative territory. But since interest rates can’t go below zero and the Fed is only targeting 2 percent inflation, real rates can’t go low enough to keep the economy out of a protracted slump.

Rather than acknowledge the possibility that the current monetary and government policy mix might be responsible for the protracted slump, Summers and his entire tribe cast about the world for other causes. “The problem is not our theory; the problem is that the real world is not responding correctly to our theory. Therefore the real world is the problem.” That is of course not exactly how Larry might put it, but it’s what I’m hearing.

Where’s the Growth?

It’s been more than five years since the global financial crisis, but developed economies aren’t making much progress. As of today, the United States, Canada, Germany, France, Japan, and the United Kingdom have all regained their pre-crisis peaks in real GDP, but with little else to show for it.



Where orthodox neo-Keynesian policies like large-scale deficit spending and aggressive monetary easing have been resisted – as in Japan years ago or in the Eurozone debtor countries today – lingering depressions are commonly interpreted as tragic signs that “textbook” neo-Keynesian economic policy could have prevented the pain all along and that weak economic conditions persist because governments and central banks are not doing enough to kick-start aggregate demand and stimulate credit growth at the zero lower bound.

In places like the United States and Japan, where neo-Keynesian thought leaders have already traded higher public debt levels and larger central bank balance sheets for unspectacular economic growth and the kinds of asset bubbles that always lead to greater instability in the future, their policies have failed to jump-start self-accelerating recoveries. Even in the United States, when QE3 has been fully tapered off, I would expect to see the broader economy start to lose momentum once again.

We’ve tried countercyclical deficit spending to resist recessions, procyclical (and rather wasteful) deficit spending to support supposed recoveries, and accommodative monetary easing all along the way (to lower real interest rates and ease the financing of those pesky deficits); but growth has been sluggish at best, inflation has been hard to generate, and labor market slack is making it difficult to sustain inflation even when real interest rates are already negative.

Call me a heretic, but I take a different view than the economists in charge. To my mind, the sluggish recovery is a sign that central banks, governments, and, quite frankly, the “textbook” economists (despite their best intentions) are part of the problem. As Detlev Schlichter commented in his latest blog post (“Keynes was a failure in Japan – No need to embrace him in Europe”), “To the true Keynesian, no interest rate is ever low enough, no ‘quantitative easing’ program ever ambitious enough, and no fiscal deficit ever large enough.” It’s apparently true even as debt limits draw closer.

While the academic elites like to think of economics as a reliable science (with the implication that they can somehow control a multi-trillion-dollar economy), I have repeatedly stressed the stronger parallel of economics to religion, in the sense that it is all too easy to get caught up in the dogma of one tradition or another. And all too often, a convenient dogma becomes a justification for those in power who want to expand their control, influence, and spending.

Whereas an Austrian or monetarist approach would suggest less government and a very light handle on the monetary policy tiller, Keynesian philosophy gives those who want greater government control of the economy ample reasons to just keep doing more.

Schlichter expands his critique of the logic of pursuing more of the same debt-driven policies and highlights some of the obvious flaws in the pervasive Keynesian thinking:

Remember that a lack of demand is, in the Keynesian religion, the original sin and the source of all economic troubles. “Aggregate demand” is the sum of all individual demand, and all the individuals together are not demanding enough. How can such a situation come about? Here the Keynesians are less precise. Either people save too much (the nasty “savings glut”), or they invest too little, maybe they misplaced their animal spirits, or they experienced a Minsky moment, and took too much risk on their balance sheets, these fools. In any case, the private sector is clearly at fault as it is not pulling its weight, which means that the public sector has to step in and, in the interest of the common good, inject its own demand, that is [to] “stimulate” the economy by spending other people’s money and print some additional money on top. Lack of “aggregate demand” is evidently some form of collective economic impotence that requires a heavy dose of government-prescribed Viagra so the private sector can get its aggregate demand up again.

Generations of mismanagement have left major economies progressively weaker, involving

1. dysfunctional tax/regulatory/entitlement/trade policies created by short-sighted and corrupt political systems,
2. private-sector credit growth encouraged by central bank mismanagement, and
3. government expansion justified in times of crisis by Keynesian theory.

But rather than recognizing real-world causes and effects, neo-Keynesian ideologues are making dangerous arguments for expanding the role of government spending in places where government is already a big part of the problem.

We are going to delve a little deeper into this thesis of “secular stagnation” posited last year by Larry Summers and eagerly adopted by Paul Krugman, among others; and then we’ll take a trip around the rich world to assess the all-too-common trouble with disappointing growth, low inflation, and increasingly unresponsive labor markets. Then I’ll outline a few reasons why I think the new Keynesian mantra of “secular stagnation” is nothing more than an excuse for more of the same failed policies.

I think we’ll see a consistent theme: fiscal and monetary stimulus alone cannot generate “financially stable growth with full employment.” In fact, such policies only make matters worse. And funny things happen in the Keynesian endgame.

USA: Secular Stagnation or Public Sector Drag?

This latest theory – “secular stagnation” – argues that powerful and inherently deflationary forces like shrinking populations…...



… and potentially slowing productivity growth (as posited by Northwestern University professor Bob Gordon)…...



 … are adding to the deleveraging headwinds that always follow debt bubbles. According to the “stagnation” theory, structural forces have been bearing down on the natural rate of interest and weighing on the full-employment level of economic growth since the early 1980s; but the slowdown in trend GDP growth has been masked by a series of epic bubbles in technology stocks and housing.



Even before the 2008 crisis, the argument goes, the real interest rate required to restart the business cycle had been trending lower and lower for years, and the average level of growth experienced during business cycles has fallen.

Moreover, it has taken longer and longer to recoup the jobs that were lost in each of the last three recoveries.



It’s hard to argue with the data, but it’s really a matter of how we interpret it. While the five-year-old “recovery” is still the weakest business cycle in modern US history…..



… I quite frankly still believe the effects on growth are temporary. Difficult and long-lasting, for sure (as Jonathan Tepper and I outlined in our books Endgame and Code Red), but temporary nonetheless as private-sector deleveraging continues. We have encountered a massive debt crisis and still have a long way to go in dealing with the sovereign debt bubbles that are being created in Europe and Japan – with the potential of one’s ballooning out of control in the US unless we turn ourselves around.



It may take a crisis, but the forces that plague rich-world economies will eventually shake out and usher in a new era of technology-driven growth. In other words, this too shall pass… but continuing with the same old policies is highly likely to create another crisis through which we all must pass first.

Yes, shrinking workforces, private-sector debt overhangs, and technological innovation are making it difficult to achieve “financially stable growth with full employment” (quoting Summers); but governments and central banks are themselves becoming an increasing drag on rich-world economies. Our governments have saddled us with excessive public debt, onerous overregulation, oppressive tax codes, and their attendant distorted market signals; while our central banks have engaged in currency manipulation and monetary-policy overmanagement. Those in power who rely on Keynesian policies almost always find it inconvenient to cut back in times of relative economic strength (as Keynes would have had them do). And if, according to their arguments, the economy is still too weak even in periods of growth to enable the correction of government balance sheets, then perhaps their reluctance has something to do with debt piling up, market signals being distorted, and governments being empowered to encroach on every aspect of the lives of their productive citizens .

My friend Grant Williams used this chart in a speech yesterday. It shows that we have come to need ever more debt just to produce the same amount of GDP. With a deleveraging in the private sector underway, it is no wonder that growth is under pressure.



Debt is simply future consumption brought forward. Another way to think about it is that debt is future consumption denied. But there comes a point when debt has to be repaid, and by definition, from that point forward there is going to be a period of slower growth. I have called that point the Endgame of the Debt Supercycle, and it was the subject of my book Endgame.

As a result of central bank and governmental machinations, Keynesian growth is ultimately debt-fueled growth (either through the swelling of public debt via deficit spending or the accumulation of private debt via credit expansion); and eventually, public and private balance sheets run out of room to expand anymore. It has taken decades for cracks to show up in the prevailing theory, but now the cracks are everywhere.

One place where the crack-up is especially evident is Japan, where an uber-Keynesian combination of aggressive fiscal deficits and a planned doubling in the monetary base started to lift real GDP and inflation numbers last year before falling back into a deflationary trap. Yet the Japanese experience has seemingly convinced ECB President Mario Draghi that similar policies should be implemented across the Eurozone.
Last quarter, the Japanese economy shrank by an annualized 7.1%; business investment fell by 5.1%; and residential spending was down 10%. This is after one of the most massive Keynesian quantitative easing efforts in the history of the world.

So, let’s go to Japan, which may now have to retitle itself “the land of the setting sun,” since it is facing the steepest expected decline in population and in workforce-to-population ratio on the planet.

Land of the Setting Sun

Japan’s long-awaited “recovery” is already losing steam without the effective implementation of Prime Minister Shinzo Abe’s “third arrow” of structural reform, which to my mind was always the most critical element of his entire “Abenomics” project (and of course the most politically difficult). Despite massive fiscal and monetary stimulus and a desperate attempt to boost tax revenues by hiking the sales tax this past April, Japanese GDP collapsed in Q2:



Let’s review how Japan got there.

Prime Minister Abe took office in late December 2012 and, together with his (initially reluctant) colleagues at the Bank of Japan, quickly fired the first two fiscal and monetary policy arrows, which aimed to propel the world’s third-largest economy out of its deflationary trap. The third arrow has yet to fly.

Source: Wall Street Journal, March 2013

Since January 2013 the Bank of Japan has expanded its balance sheet by 78% (42% on an annualized basis)…



… and pushed the USD/JPY exchange rate to a six-year low of a fraction under 109 yen per dollar as of the market close yesterday.



In true Keynesian form, the Japanese government ran a massive fiscal deficit in 2013, equivalent to 8.4% of GDP. This was its 22^nd consecutive year of deficit spending, starting in mid-1992…



… despite the fact that the Japanese public-sector debt-to-GDP ratio is quickly approaching 250%:



While inflation has popped to its highest level since the early 1990s…..



… headline CPI has been decelerating since May and could quickly revert to deflation in the event of continued economic weakness, as was the case after the 1997 tax hike… which would then bring on even more “money-financed” deficit spending.

Abe advisor Etsuro Honda was very clear on this point: “Regardless of the next sales tax hike, it could be that additional monetary easing might be called for if inflation and demand fail to pick up and the output gap doesn’t narrow…. I can fully see the possibility that such a situation will occur.”

Of course, the party cannot go on forever. More than twenty years of constant deficit spending and public-sector debt growth have finally led to a situation where debt service and entitlements are crowding out the government’s general budget.



And now the situation is turning dangerous. Japan has been flirting with current account deficits for the past few years, and the trend looks decidedly negative over the coming decade. That, in turn, could force the Abe administration to look for foreign investment to fund its ongoing operations, pushing interest rates up dramatically to the point that debt service and entitlements could consume more than half the annual operating budget.



Bottom line: Abenomics has delivered a bounce in economic growth and inflation, but it’s failing to push Japan into a self-sustaining recovery. Without a detour through structural reforms (which would be quite painful), this road leads to higher public debt balances and even more dysfunction in the medium term, leaving Japan only a shock away from disaster. As predicted here three years ago, I continue to believe that the yen will be over 200 to the dollar by the end of the decade, and possibly much sooner.



Keynesians argue that Abe had the right idea, he just didn’t spend enough and will need to spend a lot more in the near future. In other words, fiscal and monetary stimulus can lift inflation and boost growth in the short term… but the problem is that you can’t have that stimulus if you want to consolidate the national debt and boost tax revenues at the same time.

Some economists would argue that Abe’s policies don’t necessarily have to add to the debt load, as long as the government has a firm commitment from the central bank to monetize the debt along the way. The fact that that would destroy the buying power of the yen doesn’t seem to be a consideration for them. The elderly on fixed incomes might disagree.

So with their highly leveraged banking system and already crushing sovereign debt loads, why wouldn’t the Europeans embrace the same model?

Draghi’s Turn at Abenomics?

I’ve written extensively on the Eurozone in recent months, so I will keep this section brief.

Much of Southern Europe has been mired in depression, with hopelessly slow or negative growth rates, low inflation or outright deflation, and extremely high levels of unemployment (especially among young workers), for several years.

It’s a toxic situation for a multi-country monetary system that still lacks the underpinning of banking or fiscal unions. Demonstrations in the Catalonia region of Spain, inspired by this week’s Scottish referendum, reveal the very real political risks that are only growing with voter frustration.

Perhaps it was just talk, but Mario Draghi laid out a three-point plan similar to Abe’s in his presentation at the recent Jackson Hole meeting of central bankers. It quickly acquired the sobriquet “Draghinomics.”
Draghi recently cut the ECB’s already-negative interest rates and has promised a large round of quantitative easing. But the core problems facing Europe are not interest rates or a lack of liquidity but rather a structurally unwieldly labor market, too many regulations being dreamed up in Brussels, a lack of capital available to small businesses, and major regulatory headwinds for business startups.

Compound all that with the significant structural imbalances between Northern and Southern Europe, dramatically overleveraged banks, and an obvious sovereign debt bubble, and you have all the elements of a major crisis in the making.

That the Eurozone is a fragile and politically unstable union will come as no surprise to Thoughts from the Frontline readers who have been diligently perusing my letters for the past several years, but it is a critical point that we cannot ignore. How, I wonder, can Draghi even hope for a successful European implementation of a three-point plan like Japan’s – where a leader who started with very strong approval ratings has burned through most of his political capital before structural reforms have even gotten off the ground?

Draghi simply does not have the political power to make the changes that are necessary. All he can do is prop up a failing system with liquidity and low rates, which will ultimately create even more serious problems.

The Failure of Monetary Policy

There are many economists, with Paul Krugman at their fore, who believe that Keynesian monetary policy is responsible for the United States doing better than Europe. I beg to differ. The United States is outshining Europe due to the combined fortuitous circumstances of massive new discoveries of unconventional oil and gas, new technologies, and an abundance of risk-taking entrepreneurs. Indeed, take away the oil boom and the technology boom centered in Silicon Valley, and the US would be as sclerotic as Europe is.

None of the above has anything to do with monetary policy. In fact, I would argue that current monetary, fiscal, and regulatory policy is getting in the way of that growth.

Robert A. Hefner III, chairman of The GHK Companies and the author of The Grand Energy Transition: The Rise of Energy Gases, Sustainable Life and Growth, and the Next Great Economic Expansion, wrote a wonderful piece in last month’s Foreign Affairs, entitled “The United States of Gas” (hat tip, Dennis Gartman).

Consider how much can change in one year alone. In 2013, on properties in Oklahoma in which the GHK Companies hold interests covering 150 square miles, one large U.S. independent company drilled and completed over 100 horizontal wells. Had those wells been drilled vertically, they would have exposed only about 1,000 feet of shale, whereas horizontal drilling allowed nearly 100 miles to be exposed. And rather than performing the 100 injections of fracking fluid that a vertical well would have made possible, the company was able to perform between 1,000 and 2,000 of them. The company’s engineers also tinkered with such variables as the type of drill bits used, the weight applied while drilling, the rotation speed of the drill, and the size and number of fracking treatments.

Thanks to that continuous experimentation, plus the savings from scale (for example, ordering tubular steel in bulk), the company managed to slash its costs by 40 percent over 18 months and still boost its productivity. The result: in 2014, six or seven rigs will be able to drill more wells and produce as much oil and gas as 12 rigs were able to the year before. Since the shale boom began, over a decade ago, companies have drilled about 150,000 horizontal wells in the United States, a monumental undertaking that has cost approximately $1 trillion. The rest of the world, however, has drilled only hundreds of horizontal wells. And because each borehole runs horizontally for about one mile (and sometimes even two miles) and is subjected to ten or more fracking injections, companies in the United States have fracked about 150,000 miles of shale about two million times. That adds up to around a thousand times as much shale exposed inside the United States as outside it.

There is a divide in the United States, and indeed in the world, between those who believe (and the emphasis is on believe) that government in all its various shapes and sizes is the font of all growth and progress and those who believe that it is individual effort and free markets that “move the ball down the field” of human progress. Count me in the latter group.

Government is necessary to the extent that we need to maintain a level playing field and proper conduct, but with the recognition that wherever government is involved there are costs for that service that must be paid by the private market and producers. For example, almost everyone thinks that the government’s being involved in student loans is a public good. We should help young people with education, right? Except that John Burns released a report this week that shows that student loans will cost the real estate industry 414,000 home sales. Young people are so indebted they can’t afford to buy new homes. Collateral damage?



The unintended consequences of government policies and manipulation of the markets are legendary. But often unseen.

Monetary policy as it is currently constructed is only marginally helping private markets and producers. Monetary policy as it is currently practiced is an outright war on savers, which sees them as collateral damage in the Keynesian pursuit of increased consumer demand.

It is trickle-down monetary policy. It has inflated the prices of stocks and other income-producing securities and assets, enriching those who already have assets, but it has done practically nothing for Main Street. It has enabled politicians to avoid making the correct decisions to create sustainable growth and a prosperous future for our children, let alone an environment in which the Boomer generation can retire comfortably.

It is a pernicious doctrine that refuses to recognize its own multiple failures because it starts with the presupposition that its theory cannot fail. It starts with the presuppositions that final consumer demand is the end-all and be-all, that increased indebtedness and leverage enabled by lower rates are good things, and that a small room full of wise individuals can successfully direct the movement of an entire economy of 300 million-plus people.

The current economic thought leaders are not unlike the bishops of the Catholic Church of 16^th-century Europe. Their world was constructed according to a theory that they held to be patently true. You did not rise to a position of authority unless you accepted the truth of that theory. Therefore Galileo was wrong. They refused to look at the clear evidence that contradicted their theory, because to do so would have undermined their power.

Current monetary and fiscal policy is leading the developed world down a dark alley where we are all going to get mugged. Imbalances are clearly building up in almost every corner of the market, encouraged by a low-interest-rate regime that is explicitly trying to increase the risk-taking in the system. Our Keynesian masters know their policies and theories are correct – we must only give them time to more perfectly practice them. That the results they’re getting are not what they want cannot be their fault, because the theory is correct. Therefore the problem has to lie with the real world, full of imperfect people like you and me.
What our leaders need is a little more humility and a little less theory.

Washington DC, Dallas, Chicago, Athens (Texas), and Boston

I find myself in the Hill Country north of San Antonio, Texas, attending the Casey Research Summit, where I speak tomorrow. I’m surrounded by many friends in very pleasant circumstances. And when I hit the send button, I will have two days of fascinating conversations ahead of me. I am doing a number of videos with various interesting personalities, which we will post on the Mauldin Economics site in the coming weeks. More on that later.

On Monday I fly back to Dallas, where I will stay until the end of the month, then head off to Washington DC. In the middle of October I’ll visit Chicago, Athens (Texas), and Boston, all in one week.

I can't hit the send button without noting that Jack Ma, the Chinese ultra-billionaire founder of Alibaba, was at the New York Stock Exchange for the launch of his IPO and sought out my friend Art Cashin, saying “I can't leave without a picture with Art Cashin.” As one of Art's friends subsequently wrote on our round-robin group email, Jack is clearly a man who understands who is really running things. The incident also shows that anyone can be a groupie. But what really intrigues me is that here is one of the richest men in the world, a force in China, obsessively focused on creating a merchandising machine, and yet he is so in touch with the world of investment and business that he watches CNBC enough to know who Art is. And to appreciate the character and class that Art has shown us for years – and want to meet him. Jeff Bezos may have his work cut out for him in the coming years.

Have a great week and tell a struggling businessman that you appreciate his work.

Your ready for some fun conversations analyst,

John Mauldin

The article Thoughts from the Frontline: Where’s the Growth? was originally published at mauldineconomics.com.

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Europe Takes the QE Baton

By John Mauldin

If the wide, wide world of investing doesn’t seem a little strange to you these days, it can only be because you’re not paying attention. If you’re paying attention, strange really isn’t the word you’re probably using in your day-to-day investing conversations; it may be more like weird or bizarre. It increasingly feels like we’re living in the world dreamed up by the creators of DC Comics back in the 1960s, called Bizarro World. In popular culture "Bizarro World" has come to mean a situation or setting that is weirdly inverted or opposite from expectations.

As my Dad would say, “The whole situation seems about a half-bubble off dead center” (dating myself to a time when people used levels that actually had bubbles in them). But I suppose that now, were he with us, he might use the expression to refer to the little bubbles that are effervescing everywhere. In a Bizarro French version of very bubbly champagne (I can hardly believe I’m reporting this), the yield on French short term bonds went negative this week. If you bought a short-term French bill, you actually paid for the privilege of holding it. I can almost understand German and Swiss yields being negative, but French?

And then Friday, as if to compound the hilarity, Irish short term bond yields went negative. Specifically, roughly three years ago Irish two year bonds yielded 23.5%. Today they yield -0.004%! In non-related un-news from Bizarro World, the Spanish sold 50-year bonds at 4% this week. Neither of these statistics yielded up by Bloomberg makes any sense at all. I mean, I understand how they can technically happen and why some institutions might even want 50-year Spanish bonds. But what rational person would pay for the privilege of owning an Irish bond? And does anyone really think that 4% covers the risk of holding Spanish debt for 50 years? What is the over-under bet spread on the euro’s even existing in Spain in 50 years? Or 10, for that matter?

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We might be able to lay the immediate, proximate cause of the bizarreness at the feet of ECB President Mario Draghi, who once again went all in last Monday for his fellow teammates in euroland. He gave them another round of rate cuts and the promise of more monetary easing, thus allowing them to once again dodge the responsibility of managing their own economies. The realist in me scratches my already well scratched head and wonders exactly what sort of business is going to get all exuberant now that the main European Central Bank lending rate has dropped to 0.05% from an already negligible 0.15%. Wow, that should make a lot of deals look better on paper.

We should note that lowering an already ridiculously low lending rate was not actually Signor Draghi’s goal. This week we’ll look at what is happening across the pond in Europe, where the above-mentioned negative rates are only one ingredient in a big pot of Bizarro soup. And we’ll think about what it means for the U.S. Federal Reserve to be so close to the end of its quantitative easing, even as the ECB takes the baton to add €1 trillion to the world’s liquidity. And meanwhile, Japan just keeps plugging away. (Note: this letter will print longer than usual as there are a significant number of graphs. Word count is actually down, for which some readers may be grateful.)

But first, I’m glad that I can finally announce that my longtime friend Tony Sagami has officially come to work for us at Mauldin Economics. Tony has been writing our Yield Shark advisory since the very beginning, but for contractual reasons we could not publicize his name. I will say more at the end of the letter, but for those of you interested in figuring out how to increase the yield of your investments, Tony could be a godsend.

The Age of Deleveraging

Extremely low and even negative interest rates, slow growth, unusual moves by monetary and fiscal authorities, and the generally unseemly nature of the economic world actually all have a rational context and a comprehensible explanation. My co-author Jonathan Tepper and I laid out in some detail in our book End Game what the ending of the debt supercycle would look like. We followed up in our book Code Red with a discussion of one of the main side effects, which is a continual currency war (though of course it will not be called a currency war in public). Both books stand up well to the events that have followed them. They are still great handbooks to understand the current environment.

Such deleveraging periods are inherently deflationary and precipitate low rates. Yes, central banks have taken rates to extremes, but the low rate regime we are in is a natural manifestation of that deleveraging environment. I’ve been doing a little personal research on what I was writing some 15 years ago (just curious), and I came across a prediction from almost exactly 15 years ago in which I boldly and confidently (note sarcasm) projected that the 10-year bond would go below 4% within a few years. That was a little edgy back then, as Ed Yardeni was suggesting it might go below 5% by the end of the following year. That all seems rather quaint right now. The Great Recession would send the 10-year yield below 2%.

Sidebar: The yield curve was also negative at the time, and I was calling for recession the next year. With central banks holding short-term rates at the zero bound, we no longer have traditional yield curve data to signal a recession. What’s a forecaster to do?

I was not the only one talking about deflation and deleveraging back then. Drs. Gary Shilling and Lacy Hunt (among others) had been writing about them for years. The debt supercycle was also a favorite topic of my friend Martin Barnes (and prior to him Tony Boeckh) at Bank Credit Analyst.

Ever-increasing leverage clearly spurs an economy and growth. That leverage can be sustained indefinitely if it is productive leverage capable of creating the cash flow to pay for itself. Even government leverage, if it is used for productive infrastructure investments, can be self sustaining. But ever increasing leverage for consumption has a limit. It’s called a debt supercycle because that limit takes a long time to come about. Typically it takes about 60 or 70 years. Then something has to be done with the debt and leverage. Generally there is a restructuring through a very painful deflationary bursting of the debt bubble – unless governments print money and create an inflationary bubble. Either way, the debt gets dealt with, and generally not in a pleasant manner.

We are living through an age of deleveraging, which began in 2008. Gary Shilling summarized it this week in his monthly letter:

We continue to believe that slow worldwide growth is the result of the global financial deleveraging that followed the massive expansion of debt in the 1980s and 1990s and the 2008 financial crisis that inevitably followed, as detailed in our 2010 book, The Age of Deleveraging: Investment strategies for a decade of slow growth and deflation. We forecast back then that the result in the U.S. would be persistent 2% real GDP growth until the normal decade of deleveraging is completed. Since the process is now six years old, history suggests another four years or so to go.

We’ve also persistently noted that this deleveraging is so powerful that it has largely offset massive fiscal stimuli in the form of tax cuts and rebates as well as huge increases in federal spending that resulted in earlier trillion dollar deficits. It has also swamped the cuts in major central bank interest rates to essentially zero that were followed by gigantic central bank security purchases and loans that skyrocketed their balance sheets.  Without this deleveraging, all the financial and monetary stimuli would surely have pushed real GDP growth well above the robust 1982–2000 3.7% average instead of leaving it at a meager 2.2% since the recovery began in mid-2009.

The problems the developed world faces today are the result of decisions made to accumulate large amounts of debt over the past 60 years. These problems cannot be solved simply by the application of easy-money policies. The solution will require significant reforms, especially labor reforms in Europe and Japan, and a restructuring of government obligations.

Mohammed El-Erian called it the New Normal. But it is not something that happens for just a short period of time and then we go back to normal. Gary Shilling cites research which suggests that such periods typically last 10 years – but that’s if adjustments are allowed to happen. Central banks are fighting the usual adjustment process by providing easy money, which will prolong the period before the adjustments are made and we can indeed return to a “normal” market.

How Bizarre Is It?

We are going to quickly run through a number of charts, as telling the story visually will be better than spilling several times 1000 words (and easier on you). Note that many of these charts display processes unfolding over time. We try to go back prior to the Great Recession in many of these charts so that you can see the process. We are going to focus on Europe, since that is where the really significant anomalies have been occurring.

First, let’s look at what Mario Draghi is faced with. He finds himself in an environment of low inflation, and expectations for inflation going forward are even lower. This chart depicts inflation in the two main European economies, Germany and France.



Note too that inflation expectations for the entire euro area are well below 1% for the next two years – notwithstanding the commitment of the European Central Bank to bring back inflation.



But as I noted at the beginning, ECB policy has already reached the zero bound. In fact the overnight rate is negative, making cash truly trash if it is deposited with the ECB.



With inflation so low and a desperate scramble for yield going on in Europe, rates for 10-year sovereign debt have plummeted. It is not that Italy or Spain or Greece or Ireland or France is that much less risky than it was five years ago.

Note that banks can get deposits for essentially nothing. They can lever those deposits up (30 or 40 times), and the regulators make them reserve no capital against investments made in sovereign debt. Even after their experience with Greek debt, they essentially claim that there is no risk in sovereign debt. If your bank’s profits are being squeezed and it’s hard to find places to put money to work in the business sector, then the only game in town is to buy sovereign debt, which is what banks are doing. Which of course pushes down rates. Low interest rates in Europe are as much a result of regulatory policy as of monetary policy.

Next is a chart of 10 year bond yields. We’ve also included the US, Japan, and Switzerland. Note that Japan and Switzerland are in the 50-basis point range. (Japan is at 0.52%, and Switzerland is at 0.45%). Italy and Spain now have 10 year bond yields below that of the US.



The following chart is a screenshot of a table from Bloomberg, listing 10 year bond yields around Europe. Note that Greece is at 5.48%. Hold that thought while you look at the table.



This next chart requires a minute or two of analysis, and looking at it in black and white probably won’t work. Essentially, this is the spread of the yields of 10-year bonds of various European countries over German bunds. Note that only two years ago Greek debt paid 25% per year more than German debt did. Anyone who bought Greek debt when that country was busy defaulting has scored big. (While I probably take far too much risk in my portfolio, I will readily admit to not having enough nerve to do something like that.) The other thing to note, and it is a little bit more difficult to see on this chart, is that for all intents and purposes the market is treating European-wide EFSF debt as German debt. There are only 10 basis points of difference.



Now let’s take a little stroll through history and view a chart of the yield curve of French debt. The top dotted line is where the yield curve was on January 1, 2007. We took our first look at this chart last Tuesday in preparation for this letter, noting that short-term French debt was at the zero bound. It went negative on Thursday, and negative all the way out to two years! Note that a 50-year French note (which I’m not sure actually trades) yields a hypothetical 2.5%, only modestly more than a 30-year would yield. You might have to have the patience of Job, and I’m not sure quite how you would go about executing the trade, but that has to be one of the most loudly screaming shorts I’ve ever seen!



Here is the equivalent chart for the German yield curve going back to January 2007. Note that German debt has a negative yield out to three years!!!



While it should surprise no one, German long-term bond yields are at historic lows. I recall reading that Spanish bond yields are lower now than they have been at any other time in their history. I actually applaud the Spanish government for issuing 50-year bonds at 4%. I can almost guarantee you the day will come when Spain looks back at those 4% bonds with fondness. (I assume that the buyers are pension funds or insurance companies engaged in a desperate search for yield. I guess the extra 2% over a ten-year bond looks attractive … at least in the short term.)

And finally, let’s really widen our time horizon on German yields:



Time to Ramp up the Currency War

The yen hit a six-year low this week (over 105 to the dollar), creating even more of a problem for Germany and other European exporters to Asia. The chart below shows that Germany’s exports to the BRIICS except China are down significantly over the past few years, partially due to competition from Japan as the yen has dropped against the euro.

The yen-versus-euro problem (at least from Germany’s standpoint) is exacerbated by the remarkable appetite of Japanese investors for French bonds. This has been going on for over a year. In May and June of this year alone, Japanese investors bought $29.3 billion worth of French notes maturing at one year or more (presumably, this was before rates went negative). Note that even with minimal yields, the Japanese investors are up because of the currency play. (Interestingly, Japanese investors are dumping German bonds, again a yield play.)

Japanese analysts say that Japanese investors are hesitant to take the risks on the higher-yielding Italian and Spanish bonds, but for some reason they see almost no risk in French bonds. (Obviously not many Thoughts from the Frontline readers in Japan.) This behavior, of course, helps to drive down the price of the yen relative to the euro. (Source, Bloomberg)



Interesting side note: the third-largest country holding of US treasuries behind Japan and China is now Belgium. When you first read that, you have to do a double-take. Digging a little deeper, you find out there’s been a 41% surge in Belgian ownership of US bonds in just the first five months of this year. As it turns out, Euroclear Bank SA, a provider of security settlements for foreign lenders, is based in Belgium and is where countries can go to buy bonds they are not holding in their own treasuries. This buying surge is helping hold down US yields even as the Federal Reserve is reducing its QE program. Further, there is serious speculation, or rather speculation from serious sources, that Russian oligarchs are piling into US dollars by the tens of billions, again through Belgium.

Europe Takes the Baton

It is probably only a coincidence that just as the Fed ends QE, Europe will begin its own QE program. Note that the ECB has reduced its balance sheet by over $1 trillion in the past few years (to the chagrin of much of European leadership). There is now “room” for the ECB to work through various asset-buying programs to increase its balance sheet by at least another trillion over the next year or so, taking the place of the Federal Reserve. Draghi intends to do so.

Risk-takers should take note. European earnings per share are significantly lower than those of any other developed economy. Indeed, while much of the rest of the world has seen earnings rise since the market bottom in 2009, the euro area has been roughly flat.


Both the US and Japanese stock markets took off when their respective central banks began QE programs. Will the same happen in Europe? QE in Europe will have a little bit different flavor than the straight-out bond buying of Japan or the US, but they will still be pushing money into the system. With yields at all-time lows, European investors may start looking at their own stock markets. Just saying.

Draghi also knows there is really no way to escape his current conundrum without reigniting European growth. One of the textbook ways to achieve easy growth is through currency devaluation; and as we wrote in Code Red, the ECB will step up and do what it can to cheapen the euro in competition with Japan.
Just as the world is getting fewer dollars (in a world where global trade is done in dollars), Draghi is going to flood the world with euros.

Bank of Japan Governor Kuroda has steered the BOJ to where it now owns 20% of all outstanding Japanese government debt and is buying 70% of all newly issued Japanese bonds. The BOJ hoped that by driving down long-term rates it could encourage Japanese banks to invest and lend more, but bond-hungry regional Japanese banks are still snapping up long-term Japanese bonds, even at 50 basis points of yield. Given the current environment, the Bank of Japan cannot stop its QE program without creating a spike in yields that the government of Japan could not afford. Hence I think it’s unlikely that Japanese QE will end anytime soon, thus putting further pressure on the yen.

The BOJ is going to continue to buy massive quantities of bonds and erode the value of the yen over time in an effort to get 2% inflation.

In a world where populations in developed countries are growing older and are thus more interested in fixed-income securities, yields are going to be challenged for some time. Those planning retirement are going to generally need about twice what would have been suggested only 10 or 15 years ago in order to be able to achieve the same income. Welcome to the world of financial repression, brought to you by your friendly local central bank.

Introducing Tony Sagami

When we first launched Mauldin Economics some two years ago, my partners and I thought there was a need for a good fixed-income letter with a little different style and focus. My very first phone call was to my longtime friend Tony Sagami, to ask if he would write it. I have known Tony for almost 25 years. We have worked together, he has worked for me, and we have been competitors, but we’ve always been good friends.

Even though he now lives in Bangkok most of the year, we still visit regularly by email and Skype, and try to make a point of catching up in some part of the world at least twice a year. In addition to his talents as a writer, Tony brings a seasoned perspective and huge experience as a trader and investor. (Seasoned is a technical term for getting older, having made lots of instructive mistakes in your early years.) He has a way of taking my macro ideas and efficiently and effectively putting them to work. I know Yield Shark subscribers must be happy, because our renewal rates are very high by industry standards.

As I mentioned early in the letter, for contractual reasons we haven’t been able to name Tony as the editor of Yield Shark. I’m really pleased that we can do so now. Tony was recently in Dallas, and we did a short video together so that I could introduce him. You can watch the video and learn more about Tony here. You will soon be receiving information from my partners about a new newsletter that Tony will also be writing, which we are tentatively calling The Rational Bear.

San Antonio, Washington DC, Chicago, and Boston

My respite from travel will be over in a few weeks as I head to the Casey Research Summit in San Antonio, September 17-21. It actually takes place at a resort in the Hill Country north of San Antonio, which is a fun place to spend a weekend with friends. Then the end of the month will see me traveling to Washington DC for a few days.

I'll be back in Dallas in time for my 65^th birthday on October 4, and then I get to spend another two weeks at home before the travel schedule picks back up. I will make a quick trip to Chicago, then swing back to Athens, Texas, before I head on to Cambridge, Massachusetts, for conferences. There are a few other trips shaping up as well.

My time at home has been well spent, as I’m catching up on all sorts of projects, spending more time in the gym, and just enjoying being home. Surprisingly, being at home has allowed me to see more friends than usual as they’ve come through town. Dennis Gartman was in yesterday, and we spent two pleasant hours catching up over lunch. He is one of the truly consummate gentlemen in our business and a bottomless reservoir of great stories. A perfect evening would be Dennis Gartman and Art Cashin holding court at the Friends of Fermentation after the market closes. You’d just sit there and scribble notes.

The other thing about being home is that it makes me want to get on a plane and go see even more friends! Yesterday I caught up with George and Meredith Friedman on the phone, and we realized it has been well over a year since we’ve seen each other, which is unusual for us. I really enjoy them, and they are their own source of endless stories. George and Meredith travel much more than I do, and all over the world at that, doing speeches and research and the like; but we agreed that sometime in October we will make a visit happen, whoever is doing the flying. I think one of the reasons that God made planes was so that friends could see each other more often.

A special hat tip goes to my associate Worth Wray for finding and creating most of the charts for this week. Plus helping me think through the letter. He has been a huge help this last year.
You have a great week and take a friend who tells great stories to lunch. It will do wonders for your outlook on life.

Your still can’t believe negative French interest rates analyst,

The article Thoughts from the Frontline: Europe Takes the QE Baton was originally published at mauldin economics.com.

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The Lions in the Grass, Revisited

By John Mauldin

“In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

“There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

“Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil.”

– From an 1850 essay by Frédéric Bastiat, “That Which Is Seen and That Which Is Unseen”

I’ve come to South Africa a little bit ahead of my speaking tour next week to spend a few days “on safari.” Which is another way to say that I am comfortably ensconced in a game lodge next to Kruger Park, relaxing and trying to get some time to think. We’ve been reasonably lucky on the game runs: besides the usual lions, rhinoceri, water buffalo, etc., we’ve seen both cheetah and leopard, two animals that avoided my vicinity on every other trip to Africa. I’m here at the end of the rainy season, so everything is lush and green, and you have to get a little lucky to find the animals in the dense bush.

In several moments here, I was reminded of an essay I wrote two years ago called “The Lion in the Grass.” So I went back and read it and decided to update it fairly extensively in order to talk about the hidden lions we don’t see today that could catch us unawares tomorrow. Just like the African bush I am surveying at this moment, the economic landscape out there could harbor some serious but still unseen problems.

I have been captivated by the concept of the seen and the unseen in economics since I was first introduced to the idea. It is a seminal part of my understanding of economics, at least the small part I do grasp. It was introduced by Frédéric Bastiat, a French classical liberal theorist, political economist, and member of the French assembly. He was notable for developing the important economic concept of opportunity cost. He was a strong influence on von Mises, Murray Rothbard, Henry Hazlitt, and even my friend Ron Paul. (I will have to ask Rand about his familiarity with the Frenchman the next time I see him.) Bastiat was a strong proponent of limited government and free trade, but he also advocated that subsidies (read stimulus?) should be available for those in need. “[F]or urgent cases, the State should set aside some resources to assist certain unfortunate people, to help them adjust to changing conditions.”

Today we explore a few things we can see and then try to foresee a few things that are not quite so obvious. The simple premise is that it is not the lions we can see lounging in plain view that are the most insidious threat, but rather that in trying to avoid those we may stumble upon lions hidden in the grass.

But first, I really want to urge you to consider joining me in San Diego May 13-16 for my Strategic Investment Conference. We are continuing to fill out the strongest list of speakers we’ve ever had in our 11 years at this. My good friends George Gilder, Stephen Moore of the Wall Street Journal, and Neil Howe (who wrote The Fourth Turning) have all agreed to come and join Niall Ferguson, Newt Gingrich, Kyle Bass, David Rosenberg, and a dozen other A-list speakers from around the world. You can see who else will be there by clicking on the link above or here.

And I’m especially honored and pleased to announce that Vice Admiral Robert S. Harward, Jr., has agreed to join us on Wednesday night as a special keynote speaker. The three-star admiral (just recently retired) is a Navy SEAL and former Deputy Commander of the United States Central Command. In addition to his numerous other positions and awards, he also held the title of “Bull Frog” from 2011 until 2013 (longest-serving SEAL on active duty).

This is simply the finest economic and investment conference anywhere in the country. Don’t procrastinate; make your plans to come and register now.

The Lion in the Grass

When I was discussing this concept with Rob Arnott (of Research Affiliates and the creator of Fundamental Indexes) in Tuscany a few years ago, he mentioned the following photo, which he took on the savannah in Tanzania. I think it’s a perfect way to start out our discussion of the lions in the grass.



Going back to Bastiat, let’s look at that first sentence:

In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

It is natural to focus on the apparent dangers in front of us. That is part of our evolutionary heritage from the time when humans were first dodging lions and chasing antelopes on the very African savannah in Rob’s picture. But we soon learned that, if we were to survive, it wasn’t enough to dodge the lions we could see. It is the hidden lions that may spring upon us suddenly and take an arm or a leg.

Below I have once again reproduced Rob’s picture. Even when I knew there was a hidden lion, I couldn’t find it. But after it was pointed out to me, it is now the first thing I see. And there is a direct analogy there, to both economics and investing.

So, before you go to the next page, I suggest you go back and look one more time to see if you can spot the hidden lion. Just for fun, you know.

I showed this to a friend of mine who is a hunter, and he found it almost immediately. But then he has taught himself over the years to look for hidden game. And as Bastiat noted, it is the skilled economist who looks for the effects that are hidden, the surprises that are unseen. It should be a habit to look at the potential second- and third-order consequences of what we can see happening before our eyes. That way, we not only avoid the hidden lions, we also turn what would hunt us and do us harm into the hunted. Sometimes, the dangers themselves can be turned into a very nice trophy indeed – if you can act in time.

As I noted, that previously invisible lion is now the first thing I see. And that is the way with economic lions in the grass. Once someone points one out, it’s obvious, so obvious that we soon convince ourselves that we would have seen the lion without help. How many people told you they “knew” all along that subprime debt was going to end in tears? Or that the housing market was a bubble? Or that we would be plunged into the Great Recession?

I remember that in the fall of 2006 I was beginning to talk about the probability of a recession, in this letter, in speeches, and in numerous media interviews. (There is one such episode still up on YouTube.)  I was told I was ignoring what the market was telling us, and indeed the market proceeded to go up for another six months or so. Being early is lonely. Me and Nouriel. J

Today there are a lot of people who tell us they knew there was a recession coming all along. In fact, the farther we get from 2006, the greater the number of people who remember making that call. It now seems I had no reason to feel so lonely out there on that limb, scanning the tall grass of the savannah. In retrospect, it seems that limb was rather crowded.

So, with that in mind, let me show you where the other lion is. Then go back and look at the first picture. After a few times you will see the hidden lion almost before you see the obvious ones.



Black Swan or Hidden Lion?

I should note that a lion in the grass is different from a black swan. A black swan is a random event, something which takes us all by surprise. Economic black swans are actually quite rare – 9/11 was a true black swan. Other than Nostradamus some 500 years ago, who saw it coming?

The last recession and the credit crisis were not true black swans. There were those who saw it all coming, but few paid attention. They were dancing right along with Chuck Prince to the rousing music of a bull market and swelling profits.

As we know now, a few people saw the subprime crisis coming and made huge fortunes. Sadly, pulling that off generally required one to risk a small fortune to play in that game. So while I talk about the lions hidden in the grass, remember that if you can figure out how to play it, there can be large profits betting on that which is unseen by the markets.

Now, let’s look at a few obvious lions and then see if we can spot a few hidden lions lurking nearby.

The Lions in Europe

By some miracle, Mario Draghi and his team at the European Central Bank (ECB) continue to get from their communication tools what most central banks have to take by force. Widespread complacency has washed over the region in the months and quarters since July 2012, when Mr. Draghi introduced the Outright Monetary Transactions (OMT) facility and adamantly promised to do “whatever it takes” to preserve the euro system.

As a result, government borrowing costs are converging back to pre-crisis levels even as falling inflation brings the next debt crisis forward … and markets are clearly still responding to the ECB’s increasingly hollow commitments.

Without changing the ECB’s main policy rate at this week’s monetary policy meeting, Mr. Draghi once again attempted to talk his way to a policy outcome by suggesting that he has the broad based support to authorize quantitative easing, if and when it is needed. It will be needed – and maybe soon.

As I wrote late last year, European banks are in terrible shape compared to U.S. banks. We think of German banks as the epitome of sobriety, but they have been on a lending binge to creditors who now appear to be in financial trouble; and with 30- or 40-1 leverage, they could easily see their capital fall below zero. Despite modest bank deleveraging across the Eurozone since early 2012…



… public and non-bank private debt burdens have not improved:



Low inflation is also seriously disrupting government debt trajectories. The analysis below from Bank of America Merrill Lynch shows how low inflation, near 0.5%, raises debt trajectories in France and Italy that would be a lot lower under a normal, 2%, inflation scenario. As the charts show, persistent “lowflation” for several years could add another 10% to 15% to the public debt to GDP ratio in each country … even if rates stay where they are today.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

 

The article Thoughts from the Frontline: The Lions in the Grass, Revisited was originally published at Mauldin Economics

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SP500, Russell 2K, Dollar Index and Gold’s – Fake out or Shakeout?

 From The Technical Traders.......

Today has been quite a trading session with risk assets rocketing higher after Mario Draghi of the European Central Bank reiterated what has already been stated. The S&P 500 Index (SPX) is posting some nice gains, but price has not taken out the recent ascending trendline illustrated in the daily chart of SPX shown below. Until that ascending trendline is taken out, the bears remain in control of the price action.

S&P 500 Index (SPX) Daily Chart

Today’s rally has certainly served to work off short term oversold conditions. With the first GDP estimate for the 2nd Quarter scheduled for tomorrow things could get interesting. In the meantime, the closing price today is key. My expectation is that we will not see the S&P 500 Index push back above the ascending trendline today. For the price action to flip back bullish, we need a much stronger than expected GDP result tomorrow.

Another key daily chart which helps provide support that the bears remain in control of the price action is the Russell 2000 Index (RUT). The RUT has given back roughly 50% of its entire move and at this point has failed to even regain the 200 period moving average on the daily chart. Price action would need to climb over 20 points to simply backtest the breakdown level illustrated below.

Russell 2000 Index (RUT) Daily Chart

As long as the RUT holds below the key rising trendline, the bulls must be questioned. However, should the S&P 500 Index and the RUT push back above the ascending trendlines on their daily charts I will become much more constructive regarding the short to intermediate time frames for risk assets.

The other key chart of the day can be found no further than the U.S. Dollar Index futures. The U.S. Dollar Index futures absolutely collapsed today and move all the way down to test the 50 period moving average on the daily chart. So far, the short-term rising trendline has offered support along with the 50 period moving average and the Dollar has bounced sharply higher.

U.S. Dollar Index Futures Daily Chart

As long as price holds above the short-term rising trendline, the Dollar will be able to continue to push higher from this level. Should a breakdown occur we have even more support below around the $81 price level. After a move this strong, it could take days and maybe even weeks for the Dollar to regain its footing. However, the forthcoming Federal Reserve announcement next week will likely seal the Dollar’s fate.

Gold and silver futures are both trading nicely higher on the session in light of the weaker Dollar. However, both precious metals have faded later today as the Dollar started to drift back to the upside. Gold and silver are trying to breakout, but we need to see some continuation before I intend to get involved.

Gold Futures Daily Chart

Sometimes weak breakouts in price action can lead to ugly reversals. I’m not suggesting that a failed breakout will occur in gold and silver futures, but I remain cautious as the breakout so far does not have me totally convinced. Volume in silver is not spiking like it should be and gold volume is also weak considering the possibility that major breakouts are taking place.  Another element that is simply not confirming with strong price action or volume is the gold miners. On a day like today, all that they can muster is a relatively small gain on super light volume. Caution is warranted!

Oil futures are also not shooting considerably higher even though the Dollar remains under pressure. To me, today seems like it could be a misdirection day based on the price action and lack of volume we are seeing to the upside in hard assets like gold, silver, and oil. In addition, volume in the major equity indices and futures is super light. For now, I am going to remain cautious and will likely look to avoid taking on any major risk until the dust settles on the GDP number and the Fed’s future decision. Sometimes sitting in cash is not so bad after all!

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