Times They Are A-Changin'
The three mighty economies of the 20th Century are in the midst of adapting to the new conditions of the 21st Century, and how successfully they manage that is where the rubber hits the road, notes John Mauldin in Thoughts from the Frontline.
Think back to 2001. It was the opening of a new millennium. While that was auspicious enough, several events then ensued that shaped the future for decades to come.
1. China was admitted to the World Trade Organization, leading to a revolution in its production and global trade.
2. The euro was launched with much fanfare-and a minor chorus of criticism. We are now in a midst of a great trial that will determine whether the euro will be a brief experiment or a durable currency. This has dramatic implications not only for Europe but for the world.
3. Of course, the tragic events of 9/11 shaped a new global perception of what constitutes threats to democracy and security.
4. Finally, and possibly most importantly for us, a secular bear market had just begun, which diminished returns for retirees. Economic activity in the developed world has yet to recover to the pace of the previous century; and many analysts predict an even slower pace of global growth for the rest of this decade.
A fear of deflation prompted Alan Greenspan to lower interest rates to levels that eventually created a housing bubble and encouraged Congress, through lower debt costs, to run up huge deficits prior to the economic collapse of 2008. Since then, our deficit and debt have only gotten worse.
You can read all sorts of economic predictions for this year. Some expect a return to the growth rate of last century and a new bull market. Some see a recession, a major downturn. But no matter what your view of the next 12 months, there is a pervasive sense that the current system of swelling government debt and entitlement promises cannot be sustained.
Politicians may persist in kicking the can further down the road, but anyone with third-grade math can see that the system is unsustainable. The US cannot pay an estimated $200 trillion (and growing) in entitlement obligations (Burns and Kotlikoff, The Clash of Generations), although others say that we owe a "mere" $80 trillion-plus.
Japan cannot continue to borrow 45% of its government budget at 1% when debt is at 230% of GDP and rising over 10% a year. Europe cannot postpone the consequences of an unequal currency union forever.
We live in an unsustainable world. To extend the thought of Herb Stein, we must change the world to one that will be more sustainable. That has been an implicit theme in this letter for years, but this year it will be an explicit theme that we will visit often. That transition to a more sustainable world is going to involve uncomfortable changes for many, if they do not prepare for it.
At the outset, let me state that this "unsustainability" is not a reference to the Malthusian arguments that the world is running out of food, energy, or the other necessary commodities to insure economic progress for a growing world. I reject those arguments. I have a great deal more faith than that in our ability to transition to new forms of food and energy production.
I am in fact quite optimistic about the future of the world. No one will want to go back to the good old days of 2013 in 2033. Our age will seem a quaint time of poor health care ("Can you imagine, people died of cancer back in those days?"), scarcity, and a soul-sappingly dreary manufacturing system.
The transition we are undertaking to a new world of innovation and technology will be unsettling to many people, but those changes are by and large positive ones, and they will be welcome.
As I was finalizing this letter, my friend Barry Ritholtz at The Big Picture sent this note: "The deficit scolds have been warning for years that hyperinflation is imminent. I have been hearing these ominous warnings my entire adult life. 'This is unsustainable! Inflation is about to explode!' But inflation has been rather tame, and we are not experiencing anything remotely like hyperinflation. They keep using that word 'unsustainable,' but with all due respect to Inigo Montoya, I do not think that word means what they think it means."
I am definitely in the deficit (and debt!) scold camp, but I give little credence to the US hyperinflation believers. Very different animals. I also believe that we can get the deficit under control if we so choose-or the market may force us to do so.
One Bubble to Rule Them All
The unsustainability I refer to is that of the largest bubble in human history: government debt in tandem with government promises that cannot be fulfilled. And unlike 1993, when only the developed countries of Canada and Sweden had to deal with unsustainable debt, bloated budgets, and unrealistic promises, this time the bubble countries comprise the largest economies and the majority of global GDP.
This is not a short-term matter. There are three distinct economic ecologies that will have to change and will do so on their own timetables. And owing to their size and the significant abilities of a committed establishment to resist change, no matter how inevitable, we are talking years of transition, not months.
The economic ecologies I refer to are of course Europe, Japan, and the United States. One could argue that a fourth center of unsustainability exists: China. However, I am not convinced that anything more than the usual garden-variety recessions are in store for China.(I'm not forecasting Chinese recessions, just pointing out that not even the Chinese can repeal the business cycle forever).