US Economy Still in Deep Water

07/17/2012 8:00 am EST

Focus: MARKETS

John Mauldin

Chairman, Mauldin Economics

As a veteran investor, it pays to be optimistic to the extent that you're usually more focused on available opportunities than looming danger signs...but you can't make a swim of 20 miles thinking it's only three, observes John Mauldin of Thoughts from the Frontline.

I want to start with a simple observation. I am described by most of my readers and certainly most of the press as "bearish."
I am not. I am actually quite the optimist.

I have a very positive outlook on the rise of the human condition and the accelerating pace of technology, and believe we are at the brink of an unimaginable era of abundance. My personal investment portfolio is weighted far too heavily on the venture capital end for someone of my (ahem) age. (I would be aghast if anyone I was consulting with had a portfolio that looked like mine!) My personal business is nothing if not based on an optimistic view of the world.

Yes, I have long made the case that we are in a secular bear market in the US (and much of the developed world). But that simply means that I think equities in general offer little upside potential at today's valuations. These periods run in very long cycles, and to ignore them is simply, well, dumb.

So we look for opportunities elsewhere than in index investing. What makes it particularly challenging today is that central banks are pushing interest rates down and forcing investors to work far harder for their returns. Simple bond investing will not give us the returns that most of us need for our retirement and desired lifestyles.

I prefer to think of myself as an optimistic realist. Rather than trying to force or vainly hoping for a return that is not there, I choose to look elsewhere. There are always opportunities somewhere. In preference to index investing, I look for specific targets. You might say that I prefer a rifle to a shotgun.

Of course, if your worldview is consumed by US equities, if you live and die by every move of the market, then I might seem like a bear to you. I would suggest that if that is the case, you might want to broaden your investment horizons.

What I am bearish on, however, is governments gone wild with ever-increasing taxes and spending, and especially governments that take on too much debt. When governments decide to spend today more than they can collect in taxes; when they borrow ever-greater amounts to live a national lifestyle that is beyond their means, obliging our children to pay in the future for our spending today to maintain that lifestyle; we know that there will eventually be a day of reckoning.

That day comes when the debt is growing faster than the economy. The final "Bang!" moment happens when the total interest on the debt overwhelms the nominal growth of the economy. When that happens, whether to a family, a company, or a nation, either spending must be slashed or taxes raised (which will hurt overall growth), or there will be a default.

There comes a moment when investors start to worry more about the return of their capital than the return on their capital. Rates begin to creep upward and the process turns into an ever-tightening spiral of rising taxes and falling spending (which we currently call austerity), which hampers the growth of the nation and makes it ever more difficult to escape the debt trap.

In the course of human experience we have watched this process unfold literally hundreds of times, yet we never seem to learn. Somehow, we always manage to tell ourselves that this time is different. Someone else can pay more taxes. We can grow our way out of the problem, just like we did the last time. Or we settle for the desperate, cynical belief that future generations will sacrifice their lifestyles so that we can get paid our unfunded pensions and health care.

My friend Mike Shedlock chronicled this week a rather sobering set of statistics. The US now has more people on government pensions than workers in the private workforce.

  • As of June 2012 there were 111,145,000 in the private workforce.
  • As of June 2012 there were 56,174,538 collecting some form of Social Security or disability benefit.
  • The ratio of SS beneficiaries to private employees just passed the 50% mark (50.54%).

This chart, from the St. Louis Fed, shows us that the problem is rapidly growing. The accelerating growth in recent years is just going to increase, because the Baby Boom generation is just starting to retire (sadly, I am now eligible for Social Security, if I want to "retire" early). Keep in mind, this is just Social Security; health care is far worse.

chart
Click to Enlarge

The same story can be told in many countries throughout the developed world. The US is in worse shape than Europe as a whole, though many countries in Europe are in much worse shape. And forget about Japan. But back to our original topic.

I am bearish on much of the developed world, because the majority of "developed nation" governments have simply gone too far in debt creation. By "gone too far," I mean that the debt is now too large for them to grow their way out of it. Dealing with the debt is, at best, going to hurt growth, and at worst will result in depressions.

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