Living on Borrowed Money and Time

02/08/2011 1:10 pm EST


John Mauldin

Chairman, Mauldin Economics

Consumers are dipping into savings and investments to make ends meet, while the federal government just keeps running up its unsustainable debt, writes John Mauldin in Thoughts from the Frontline.

Real GDP grew 3.2% at an annualized pace in the fourth quarter of 2010. This 3.2% followed 2.6% in the third quarter and 1.7% in the second quarter. The trend is your friend.

The really surprising number was the growth of consumer spending, at 4.4%. Is the US consumer back? After all, real final sales rose by 7.1%, a number not seen since 1984 and Ronald Reagan. But real income rose a paltry 1.7%. Where did the money that was spent come from? Savings dropped a rather large 0.5% for the quarter. That was part of it. And there was an unusual drawdown of money market and investment accounts last quarter, somewhere around 1.5%. That would just about cover it. But that is not a good thing and is certainly not sustainable.

The Verdict From Canada

Let’s see what good friend David Rosenberg has to say about those numbers:

“Even with the fourth-quarter bounce, real final sales have managed to eke out a barely more than 2% annual gain since the recession ended, whereas what is normal at this stage of the cycle is a trend much closer to 4%. Welcome to the new normal.


“There is no doubt that there will be rejoicing in Mudville because real GDP did manage to finally hit a new all-time high. The recession losses in output have been reversed (though what that means for the 7 million jobs that have to be recouped is another matter). But, before you uncork the champagne, just consider what it has taken just to get the economy back to where it was three years ago:

  • The funds rate moved down from 4.5% to zero
  • The Fed’s balance sheet expanded by more than $1.5 trillion
  • The printing of M2 money supply of around $1 trillion (the illusion of prosperity)
  • Expansion of federal government debt of $4.8 trillion

“All this heavy lifting just to take the economy back to where it was in the fourth quarter of 2007. As they rejoice in Mudville, the memory is conjured up of Billy Joel bellowing out those famous words ‘Is that all you get for your money?’”

Rosenberg’s right. We (the US) are on an unsustainable path. Did you see the recent Congressional Budget Office estimates of the deficit? The CBO said the fiscal 2011 deficit will hit $1.48 trillion, up from last August's $1.07 trillion estimate. Other estimates, not forced to use unrealistic assumptions, are much higher.


No Easy Way Out

The simple answer is that no possible resolution of the fiscal deficit that gets us to sustainability can be done without real cuts to Medicare entitlements or increased taxes or some combination.

Yet 30% of the electorate is mad at President Obama and the Democrats for not getting a single-payer, full health-care program. They want nothing less than that.

And then there is the 30% or so that are mad about increased taxes, runaway spending, and budget deficits. They will likely punish any Republican who even utters the word “increase” in the same sentence with taxes, unless they are talking about those bad tax-and-spend Democrats.

Right now, neither side seems willing to compromise. Obama has punted on coming up with any real solutions. Offering to freeze spending at today’s level is a joke. It is like one of my kids (and this has happened, kind of) getting my credit card, spending a ridiculous amount of money, and then saying, “Ok, Dad, if you’ll give me the card again I promise I won’t spend more than that!”

But the GOP is saying they want to cut spending around the edges of the budget without dealing with the real elephants in the room, Social Security and Medicare. They have some plans that get us closer, but none that gets us there.

What happens if someone talks about real adjustments to the entitlement programs, or tax increases? Look at what happened to the Deficit Commission and their reports. They were dead on arrival. I thought they had some interesting ideas.

It is hard to get to a real compromise with that level of conversation. But if a compromise is not reached, the end result looks like Greece.

The Bond Market Time Bomb

The lack of compromise is going to run head on into a bond market that will force one, or raise rates until there is truly a crisis of biblical proportions. If you think high rates were bad in the ’70s (and they were, trust me!), think what they would be like in a deflationary environment.

For that is what would happen. We would fall into a severe recession, and recessions are by definition deflationary. And depending on how late we are in getting our act together, it could be worse than a recession. We could drag the whole world down.

I think it is 2013 before we get the real changes. I just see a bubble in complacency. The market is going up, so all must be right with the world.

If we don’t get those real changes, we will need to start thinking the unthinkable.

Can we last until 2013? Most likely, as we are going to see some cosmetic changes and that should encourage the bond market. But as our leaders watch the problems of the rest of the developed world increase then, depending on what they do, they could cut us a much shorter leash. We are approaching the endgame.

[Axel Merk is on the same page, and says Washington is “in denial” on inflation and the deficit. William Poole warns that “many innocent people who thought they had benefits coming to them will be sorely disappointed—indeed, badly hurt in some cases.” But Gary Shilling is forecasting a good year for Treasury bonds—Editor.]

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