What
Condition My Condition Is In
By John Mauldin
I
woke up this morning with the sundown shining in
I found my mind in a brown paper bag but then
I tripped on a cloud and fell-a eight miles high
I tore my mind on a jagged sky
I just dropped in to see what condition my condition was in
Yeah, yeah, oh-yeah, what condition my condition was in
I found my mind in a brown paper bag but then
I tripped on a cloud and fell-a eight miles high
I tore my mind on a jagged sky
I just dropped in to see what condition my condition was in
Yeah, yeah, oh-yeah, what condition my condition was in
–
Made famous by Kenny
Rogers and the First Edition, 1968
For
the past five weeks, I’ve written an open letter to the next president (whoever
it turns out to be) about the economic realities he or she will face in the
Oval Office on the first day. It is a rather daunting set of challenges. I have
been trying to provide a realistic assessment of “what condition our condition
is in.” The song the lines come from was actually a semi-veiled warning about
doing LSD. My letters have been overt warnings about the economic dangers the
next president and the country and the world will face.
In
this week’s letter we will take a quick look at the condition of a slowing
global economy (the IMF just downgraded its own forecast this last week). Then
we’ll grapple with a Plan B scenario, because I have a confession of sorts: I
am not entirely optimistic that Congress and the new president can get their
act together, so I offer a proposal from former Oklahoma Senator Tom Coburn as
to what we, the people, can do to actually change the country’s direction
without having to depend on a Congress that may prove dysfunctional. Again.
Jeffrey
Snider of Alhambra Investment Partners sent out a note last week highlighting
some of the current conditions. In his piece entitled “Not Just Manufacturing,
the Global Slowdown Is Monetary,” Jeffrey cites a Wall Street Journal article that highlights the
very serious slowdown in orders for new big rigs and other trucks. Inventories
are at their highest level since before the financial crisis, and sales in
March were down 37% from a year ago as fleets remained very cautious about
expanding in this environment. Quoting:
Some
of this reduction in 2016, as the Journal
reports, is due to companies over-ordering in 2014 and 2015 based on the
narrative that the economy was actually healing, or at worse would stay in its
"new normal." It raises the issue as to whether these conditions and
the manufacturing recession they reflect are cyclical or structural, or both.
As
I wrote yesterday, the contraction in goods and the US economy's basis for them
may or may not be heading toward recession. It is clear, however, that whatever
the ultimate cycle reality, there are deeper imbalances that run back several
years, likely traced to decades of financialization that is now overturning,
and thus really supersedes cyclical discussion. What we see in the US is not limited
to the US, however; it is a global phenomenon, which can only mean one possible
explanation.
Jeffrey
offers several charts that I think tell the story better than 1,000 words.
These
charts have slowdown
written all over them. And you can see the trend even more clearly when you
look at factory orders on a non-seasonally adjusted basis over the years since
the recovery:
The
slowdown is not limited to the US. Look at what is happening to China exports:
The
latest quarterly edition of the China
Beige Book was out yesterday. The China Beige Book is just about the only true
gauge of the Chinese economy. My good friend Leland Miller’s firm surveys 2200
Chinese companies every quarter and reports on their findings. Their work is a
must-read in serious economic circles. Leland, one of the savviest experts on
China there is, provided me with a summary:
Led
by rising layoffs at private firms, job growth dropped notably for the second
consecutive quarter, sliding to a four-year low. Expectations of future hiring
took a similar dive. Overall, the share of firms hiring this quarter fell to
half of what we reported in 2012.
This
deterioration has wide-ranging implications. Despite the economy's overall
deceleration, China has been able to defy calls to be more aggressive – either
via reform or stimulus – because of the remarkable stability of its labor
market.
This
bought time, but Beijing hasn't used it wisely. If the weakness in employment
continues, the credibility of government policy will be challenged by those who
matter most: not financial commentators but ordinary Chinese.
Leland
went on to point out that this slowdown in hiring has been brought about by two
rather uncomfortable trends: First, the multiyear slowdown in capital
expenditures is continuing, and now we have seen what almost amounts to a crash
as the number of companies reporting capital expenditure growth has plummeted
by 40%. Reduced capital expenditures, of course, affect hiring.
And
companies, particularly private companies, are borrowing less. Money is
available, but they simply don’t want it. They’re trying to square up their
balance sheets. Other anecdotal evidence from private sources suggests that
what borrowing there is, is being used to pay off dollar-denominated debt. The
debt-fueled growth that has driven China for these past seven years, sputtering
on fumes now, seems headed for an abrupt end. Likewise, the shift from
manufacturing to services seems to have lost momentum.
The
government still reports 6.7% GDP growth, but as Leland notes, China’s weakness
is not about GDP:
With
perceptions about China likely to guide global markets again in 2016, it has
become more important for investors to look beyond headline GDP numbers –
official or private. After all, Beijing didn't seem overly concerned when many
indicators signaled weakness but job growth remained steady. If the opposite
combination persists, China's purported restructuring and reform could lose the
faith not only of markets, but also of the masses.
I will
be writing a detailed letter on Europe in the near future, and quite frankly I
view the European economy to be even more problematic than China’s is.
Brazil
is clearly mired in a recession, amid political turmoil. Commodity-market
economies have recovered a little bit as prices have bounced off their lows.
But the massive dollar-denominated debt in emerging markets is starting to come
due, and most EM currencies are much weaker than they were when the debt was
initially taken on. Major economic problems are brewing in a number of
countries.
I know
the equity markets are close to all-time highs, but I also see real interest
rates negative out beyond 10 years and certainly below 1% even out to 30 years.
Those are not conditions that you see in a dynamic, growing economy.
As
I’ve been saying for almost two years, the admittedly weak US data still
doesn’t give me any real conviction about a particular timeline for a recession
in the US. But with the US economy barely growing at stall speed, an exogenous
shock to the US economy could easily push us into recession. Whenever the next
recession comes, it will not look like the last recession.
In my
last two letters I offered a prescription for how to avoid a recession in the
United States and how to trigger a new era of growth. Doing so would allow (or
perhaps force) the Federal Reserve to normalize interest rates, which would
allow savers to benefit once again from their years of saving. Pension funds
and insurance companies would actually regain the chance to provide the
benefits they have promised.
We may
not see a recession this year, and hopefully not even next year – though that’s
a hope and not a prediction – but sooner or later we’re going to see one; and
if we haven’t completely revamped our incentive and tax structures, allowing
the Fed to normalize rates, monetary policy will be impotent during the next
recession, and Congress will be facing $1.5 trillion deficits with very little
room to provide any real stimulus. I know I have shown you the following chart
in the last two or three letters, but I want you to burn this picture into your
mind. This is what is going to happen to the federal deficit when we go into
recession:
I have
lived through six recessions in my business life – and that’s the point: we do
live through them. This recent recovery has been the weakest we have seen in
the last 40 years, and I will make you a side bet that absent any restructuring
of the tax and incentive systems, the next recovery will be even weaker, with
the real potential for the United States to catch “Japanese disease.”
But we
will suffer the slow-growth, no-recovery symptoms of Japanese disease without
the cushion that Japan’s massive savings and current account surplus provide.
We won’t have 20 years to muddle through as Japan has done.
Unemployment will
rise to uncomfortable levels, and I fear that the Federal Reserve will begin to
experiment with extreme forms of monetary policy, including negative interest
rates. I acknowledge that there are very smart economists who think that
negative rates can deliver positive benefits, but I simply think they are
wrong. The evidence I’m looking at demonstrates that negative rates abuse
savers and distort normal markets by obliterating the signals that the price of
money (i.e., the interest rate) is supposed to send. The total financialization
of the world’s reserve currency will not end well.
As I
laid out in my last letters, our economic future doesn’t have to end this way.
And candidly, the proposals I’ve suggested are not the only way that we can
sort out our tax and incentive structures and achieve positive results. I can think
of quite a few paths we could take. But just tinkering around the edges and
more or less doing what were doing now is not going to get us where we need to
go.
A
recession is an avoidable dilemma, but averting the nasty economic storm that
is brewing now will require leadership and compromise that haven’t been seen in
Washington DC for some time. In general, the feedback I’ve gotten from my
letter to the would-be president series has been quite good – much better than
I expected. But the one real pushback from friends and readers is the very
simple, skeptical question, “John, you don’t really think that this will
happen, do you?”
Sadly,
I must admit that I don’t. I am generally an optimistic person, and I would
like to think that the people we elect this fall will do the right thing. But
we’ve been saying that for about 16 years now. Our so-called leaders’ record on
doing the right thing with regard the deficits and the economy is not cause for
jubilation.
So, I
think the more likely outcome is that we’ll have a recession and $1.5 trillion
deficits and mountainous deficits as far as the eye can see, because it is
really quite an impossible task to balance the budget without new taxes and
growth incentives and without the massive fiscal stimulus that could come by
repurchasing the Federal Reserve’s balance sheet to invest in infrastructure
that would create 2 million+ jobs.
It was
Rahm Emanual, the beleaguered current mayor of Chicago (why on God’s green
earth did he want that job?), who once said, “Never let a good crisis go to
waste.”
While
the next recession will surely plunge us into a crisis, that crisis will afford
an opportunity that those who want to restructure our federal government. The
attempt will, quite frankly, require an end run around Congress. Thankfully,
the founders of the republic stuck a helpful little section for that purpose
into the Constitution. It’s called Article 5. It allows for 34 states to call a
Convention of States to propose amendments to the Constitution, which then have
to be sent back to the various state legislatures to win the approval of 38
states – no small feat. I will readily admit that it will take a crisis to push
some of the needed states into the “let’s just do it” category. Getting 34
states to agree is a daunting task, but we might just get the crisis we need to
accomplish that, and hopefully the country will not waste it.
The
next section is a letter authored by former Oklahoma Senator Dr. Tom Coburn,
one of my personal heroes. Tom was demonstrably the most fiscally conservative
member of the Senate, constantly trying to figure out how to reform the process
and get back to a balanced budget like the one we had in the later Clinton
years. Unfortunately, Tom developed cancer (which is now apparently under
control, thank God) and term-limited himself. We have corresponded and met off
and on, and he is a personal inspiration as well as an enthusiastic believer
that things can be changed. We need more like him, and I wish he were back in
the Senate.
There
are six states that have already passed the legislation necessary for calling a
Convention of States. There will be another four or five that do so this year
and perhaps between 10 and 12 next year. The organization pushing this issue
will thus be able to focus their time and budget on getting the remaining
states to make the call. So without further ado, let’s look at how we can take
the process of fixing the problems in Washington DC back to the people.
Problems
By Senator Tom Coburn
Precision
in numbers is critical to accountants and important to economists. But for most
other people, there is a point at which a number gets so big that its increase
seems irrelevant. This is a variation of the law of diminishing returns: the
bigger the number, the less impact it has, because it is so far removed from
anything people can relate to.
That
is what has happened with the numbers reflecting our astounding national debt.
Nineteen
trillion plus (and rising rapidly) dollars of debt on the books. One hundred
forty trillion dollars of unfunded liabilities to boot. How many Americans can
truly have any concept of what those numbers mean? If the deficit soon balloons
to $1.5 trillion, the problem will become more
severe.
And
as the numbers continue to grow higher (what comes after a trillion?), ordinary
Americans become inoculated to rational concern about the looming disaster they
represent. We keep hearing these astronomical figures, but we go on about our
business as usual and feel no impact of the predicted storm. Some people even
dare to hope that if the “right” candidate is elected President this year, they
will receive more goodies from an increasingly generous Uncle Sam who maintains
every outward appearance of being flush with cash.
Unlike
a natural disaster, which sometimes comes with little warning and always
through no fault of our own, our nation’s impending financial crisis is
completely predictable and is the outcome of a machine we created and continue
to operate. It is an outcome of the federal government over which we, the
people, have ultimate control.
We
got into this mess because we have allowed the feds to operate far beyond their
specific, enumerated constitutional powers. However well-intentioned the
politicians who envisioned a national government program, policy, or regulation
as the answer to every human need or problem, they were wrong. And now we are
staring down the hard consequences of glossing over the original meaning of the
Constitution, which never allowed for the type of plenary federal government we
have today.
This
is a hard truth and is difficult to actually process. But what we think is more
important to grasp is that our responsibility for causing the crisis is just
the flipside of the truth that we hold the power – indeed the duty – to make a course
correction.
Having
spent time in Congress, I am just as disillusioned as the next guy with the
idea that there is some political solution to the situation that has any
realistic prospect of succeeding. Every member of Congress knows that whichever
Congress actually passes financial reforms that shut off the flow of money from
D.C. will be fired. And politicians tend to want to keep their jobs.
The
solution we need and can implement is not merely a political one. It has to be
a structural one. It requires us to close the constitutional loopholes that
allowed the feds to move beyond their proper, limited authority and initiate
programs, engage in spending, and create agencies that are way outside federal
jurisdiction under the original meaning of the Constitution.
The
way we can realistically do this is through an Article
V convention for proposing amendments to the Constitution. This is a
state-initiated, state-led, and state-controlled process for proposing
amendments that don’t sit well with the power-hungry elitists in D.C. It
requires two-thirds of the state legislatures (34 states) to pass applications
for a convention to propose amendments on a given topic. States then appoint
and instruct delegates to represent them at the convention. Any proposals that
garner support from the majority of the states (on a one-state, one-vote basis)
are then submitted to the states. Proposed amendments must be ratified by three-fourths
of the states (38 states) in order to become part of the Constitution.
There
is already a massive, nationwide effort underway to trigger an Article V
convention for the states to consider proposing a series of very limited
amendments that impose fiscal restraints on D.C., limit its power and
jurisdiction, and set term limits for federal officials – including federal
judges.
It’s
called the Convention
of States Project, and it has made huge strides in just a few years. Six
states have already passed their applications. Approximately thirty-four more
will take up the issue this year. Over 1.2 million people are engaged at some
level—from volunteer leaders in all 50 states to Facebook followers.
The
project has been endorsed by some of the greatest statesmen, economic experts,
and legal minds in the country, including Sen.
Marco Rubio, Governor
Greg Abbott, Thomas
Sowell, Mark Levin, Michael Farris, Randy Barnett, Robert P. George, Chuck
Cooper, and countless others.
Imagine
what America would be like if Congress’s taxing and spending power could only
be used in relation to its specifically enumerated powers in Article I, as
originally intended.
Imagine
if we had a robust, functioning federal system again, with the states deciding
the lion’s share of the policies that govern their citizens rather than doing
the bidding of Washington, D.C. as it holds their citizens’ tax dollars
hostage.
Imagine
if businesses and industries weren’t assaulted on every side by rules and
regulations being crafted by unelected bureaucrats in ivory towers at a rate of
over 80,000 new pages a year.
America
could be, again, what the Founders intended and designed: a constitutional republic
suited for a free, industrious, self-governing people.
Once
we do realize that a natural disaster is coming, we take the concrete,
necessary steps to prepare for it and protect the lives and property in its
path. It must be no different with the national financial crisis we see on the
horizon.
We
must repair our constitutional levees by mobilizing the states to forcibly
impose discipline on a fiscally irresponsible Washington, D.C. And we must
ensure that this self-made storm can never be re-created.
Learn
more and get involved in the Solution as Big as the Problem, at Convention
of States Action. Senator Coburn can be contacted at SenatorTomCoburn@cosaction.com.
The Convention
of States Action website has a great deal of information, and I encourage
you to look it over carefully. But let me give you some of the highlights. One
of the criticisms is that a Convention of States could be a “runaway”
convention. That is not the truth. To call an Article V convention, the states
must all pass the same very specific legislation, which limits the agenda of
the convention. The convention that is currently being proposed is not meant to
deal with a social agenda; it is all about fiscal constraints and process.
What
might come out of it would be a series of proposed amendments, such as a
balanced budget amendment, a term limit amendment, a definition of what the
“general welfare” clause of Article I of the Constitution actually means, and
other amendments that would reduce the power of the federal government in favor
of the states on fiscal and operating matters.
But a
proposed amendment is just that, a proposal. It then has to be approved by the
legislatures of 38 states. That is a tall order. I can see from looking at the
proposed agenda for this Convention of States that among the amendments that
would be proposed there are some that I would enthusiastically endorse and some
about which I would be a little bit reluctant.
It is
supposed to be difficult to amend the Constitution. That was by design. I can
see a balanced budget amendment possibly getting passed by 38 states, but some
of the other proposals might have more difficulty. The states would have the
ability to pick and choose among the amendments. They would not have to adopt
all in order to get one. That is the genius of the structure of the Article V
convention.
When
you talk, as I have, to the people who are driving this process, you see that
they understand the need for any major change in the budget-control process to
be phased in over time. You couldn’t make the shift in just one year.
Term
limits might have a more difficult time getting through some state
legislatures, but I think the amendments to allow the states more control over
their internal operations might have a great deal of bipartisan support in many
states.
By its
very nature, Congress is not going to discipline itself. If there is going to
be any discipline, it will have to come from the states taking back control
from Washington DC.
Right
now, many of you are looking at the federal government and wondering, “Where’s
the crisis? Why the urgency?” When the markets are in turmoil in a few years,
when unemployment is high and rising, when Boomers who have retired can make
almost nothing on their savings or investments, there is going to be a crisis
and a demand for real change. I hope we don’t waste that crisis.
The Convention
of States Action organization needs your help. If you would like to get
involved, they can put you in touch with the people who are already active in
your state. As with any project this big, they need money; and in a year when
we are going to spend billions on the political process, a few extra million
invested here could actually make a difference. And when you meet or contact
your state legislators, give them a heads-up on the Convention of States and
tell them it’s something we need to do. Get them thinking about it now, as they
will likely be voting on it – if not this year then next year.
This
convention won’t be convened in time to help us avoid the next recession, but
it can help change the economic reality of the recovery, and maybe that is the
best we can realistically hope for. But the best we can more optimistically
hope for is that Congress and the new president will see that the Convention of
States process is beginning to snowball and decide together to go ahead and do
the right thing.
Day
I will
be speaking in Dallas on April 28 for the 14th annual Commerce
Street Bank Conference. Then the next week I will again speak in Dallas for
the seventh annual Inside
Retirement conference, May 5-6. They have a great lineup of speakers, but I
am most excited about getting to hear and maybe even speak to my personal
writing hero, Peggy Noonan. I will admit that I’m a total fan boy of anything
she writes. Then the following week I fly down to Houston to speak at the S&P
Dow Jones Art of Indexing conference on May 10. The conference is for
financial advisors and brokers who are trying to understand how to manage risk
while maximizing returns in the current environment.
I will
be in Abu Dhabi the third week of May and then come home and almost immediately
go to Raleigh, North Carolina, to speak at the Investment
Institute’s Spring 2016 Event. I’m looking forward to hearing John Burbank
and Mark Yusko (who will also be at my own conference the same week) and then
being on a panel with them. Afterward, I make a mad dash for the airport,
arrive back in the Dallas late Monday night, and start to prepare for the
Strategic Investment Conference, where upwards of 700 of my closest friends
will gather to discuss all things macroeconomic and geopolitical. It is really
going to be a great week.
On a
fun but also quite serious note, as many longtime readers are aware, I’ve spent
a bunch of time researching and thinking about the jobs of the future. One
conclusion I've reached is that in our globalized, UBER-controlled,
task-oriented marketplace, raising kids to understand entrepreneurship and
financial literacy is of crucial importance. A really good friend of mine
in Dallas (and a reformed hedge fund manager), Reid Walker, agrees with me and
is co-founder of Lemonade Day Greater Dallas.
Lemonade
Day is all about teaching kids these important lessons by encouraging them,
with the support of caring adults, to open their very own businesses: lemonade
stands. The kids who get involved are paired with mentors who help them to
put together a business plan, get a loan from a local business or bank based on
that plan, and then actually sell the lemonade and pay back the loan, keeping
the profits. Here in Dallas last year I found all sorts of businessmen,
investors, and other financial types working with the kids, who present their
business plans at the Dallas Federal Reserve.
Lemonade
Day, which was founded in Houston nine years ago, has spread to more than 58
cities across the US and is expanding around the world, with over 220,000 kids
participating last year. It’s not too late for you to register your child
and join the movement on Saturday, May 7th. And if you go to the
website and don’t see your city involved, then maybe you should pick up the
baton and see about starting to train the next generation of entrepreneurs. The
photo below is from a recent Lemonade Day, with your humble analyst, Reid
Walker, and Danielle DiMartino Booth surrounded by some of the kids who
participated in Dallas.
It
really is about building the future.
It is
time to hit the send button. Recently, I haven’t been finishing the letter
until later in the weekend, but this Friday afternoon I actually polished it
off and sent it to the editing team. If I hurry I can make a movie or at least
a fun dinner. So let me tell you to have a great week and move on down the
road! And in the mood for a little nostalgia may want to watch
a very young Kenny Rogers and the First Edition. This was from his TV show Rollin’ on the River in the
early ’70s. Hard to believe he is now 77. Where have the years gone?
Your
hoping we can turn things around analyst,
John Mauldin
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