End Game: A Cure For Optimism
Have you been feeling better about the global economy recently? Do you have an irresistible urge to buy stocks at any slight dip? Well, I've found a sure fire cure for the malady of over-optimism that afflicts so many investors. Get thee over to Amazon and buy yourself a copy of John Mauldin and Jonathan Tepper's new book, End Game. If a reading of this non-fiction page-turner about the worldwide debt crisis doesn't cure your optimism you might want to have your doctor adjust your anti-depressant dosage.
The sub-title of the book is "The End of the Debt Supercycle and How It Changes Everything" and after a thorough reading one thing is obvious. The authors have done their homework and in the process a great public service by detailing the depth of the worldwide debt problems. US investors tend to have a decidedly parochial view of economics, but as the authors make clear in chart after chart, over indebtedness is a worldwide phenomenon with worldwide implications.
The debt supercycle, a concept originated by the team at Bank Credit Analyst, has been building for decades and will have to come to an end eventually. As the authors relate, BCA believes the cycle has yet to exhaust itself but they seem to think differently. Only time will tell but if BCA is right, it only means the potential fallout will be that much worse when the end finally does arrive.
The most sobering thing about the analysis is that the US situation, while serious, is just the tip of the iceberg the world economy is steaming towards. I think of myself as well informed but the book made me reassess that belief. I knew for instance that the UK was deeply in debt but I had no idea their total debt to GDP ratio was higher than Japan's, indeed the highest in the world.
Everyone knows about the debt problems in Greece, Ireland, Spain and Portugal but the book makes a good case that the problems in Eastern Europe are at least as bad and maybe worse. Hungarians for instance, not only ran up large debts, they did it in Swiss Francs thanks to some friendly Austrian bankers. In case you've missed it, the Swiss Franc has been appreciating like crazy recently because of its status as a safe haven. That makes the debt burden in Hungary particularly difficult to solve and leads to the inevitable conclusion that some Austrian banks may have some tough years ahead of them.
Probably the most surprising section of the book though is the analysis of Australia, an economy that has been lauded by many for their ability to withstand the recent crisis. As the authors say, sit down and get yourself a drink before reading that section for it is truly sobering. According to the authors, Australia has a huge property bubble driven by rapid credit growth from highly leveraged banks dependent on short term funding. In addition, half of mortgages are interest only and there is a substantial portion of the low doc, nonconforming variety. Sound familiar?
The authors call Australia a house of cards and speculate that a slowdown in China, Australia's largest trading partner, could be a potential trigger for the unwinding. One interesting aside from the authors is that the only other country to avoid a drop in real estate prices after the financial crisis is a country much closer to home - Canada. They don't go into details but I've read some convincing analysis recently that Canada's situation may be quite similar to Australia's.
Mauldin and Tepper make a very good case that current world government spending and debt accumulation is unsustainable. There is a section devoted to an interview with Kenneth Rogoff and Carmen Reinhart, authors of This Time is Different, a book the authors obviously read thoroughly. Rogoff and Reinhart, if anything, are more pessimistic than even the authors and believe we don't have much time to address our debt addiction. Rogoff says:
"What I'm getting at is the debt situation in the United States, on the whole, doesn't offer you I think the length of time that many politicians think we have because of the reasons I just enumerated."
Mauldin has talked for a number of years about a "Muddle Through" economy, where we face slow growth, more volatility and higher levels of structural unemployment. The weakest portion of the book, their policy suggestions for the US, reflects this fairly benign, if still pessimistic, view of the end game. Having spent so much of the book outlining the depth of the problem, the policy suggestions seem like small potatoes in comparison. One suggestion is to change our immigration policies to encourage wealthier, more educated people to immigrate and start businesses. They would also offer green cards to foreign graduates with advanced degrees. I have my doubts about whether these things would fly politically but even if they were enacted, the effects would be minor and take a long time to make a difference.
Another policy suggestion is to raise gas taxes and apply the proceeds to infrastructure spending. I don't disagree with the obvious truth that our infrastructure needs upgrading but I have serious doubts about raising taxes of any kind right now without an offsetting cut somewhere else. I have advocated a carbon tax offset with a cut in payroll taxes as I share their views about the trade and current account deficits. The authors, however, demonstrate a faith in government spending and efficiency I don't share. A big pot of infrastructure money for politicians to dole out to their favored contributors is just a recipe for more corruption and waste.
Rogoff's sentiment concerning the time the politicians have to address our problems is one with which I agree wholeheartedly. Monetary policy is not sufficient to solve our economic problems. As Richard Fisher of the Dallas Fed put it, QE II is merely a bridge loan to fiscal sanity. It seems the politicians will require more market therapy before they finally get the message. Time is short and the bridge loan comes due in June. We need big policy changes and we need them soon.
End Game is an eye opener about the current state of the global economy. It is not a policymaker's handbook and it isn't an investment guide. But this is very serious stuff written in a very readable style. It is a wake up call for investors and policymakers alike. Read it and you'll be better prepared for the coming End of the Great Debt Supercycle.
