The Future of the Global Economy
If you establish a democracy, you must in due
time reap the fruits of a democracy. You will in due season have great
impatience of public burdens, combined in due season with great increase of
public expenditure. You will in due season have wars entered into from passion
and not from reason…
– Benjamin Disraeli, prime minister of England, novelist
In any bureaucracy, the people devoted to the
benefit of the bureaucracy itself always get in control, and those dedicated to
the goals the bureaucracy is supposed to accomplish have less and less
influence, and sometimes are eliminated entirely.... In any bureaucratic
organization there will be two kinds of people: those who work to further the
actual goals of the organization, and those who work for the organization
itself. Examples in education would be teachers who work and sacrifice to teach
children, vs. union representatives who work to protect any teacher including
the most incompetent. The Iron Law states that in all cases, the second type of
person will always gain control of the organization, and will always write the
rules under which the organization functions. [Pournelle's law of Bureaucracy]
– Jerry Pournelle, prolific science-fiction writer, August 7, 1933
– September 8, 2017
This letter will be the first of a series in which I outline my
vision for the next 5–10–15–20 years of global economics. I understand that
there is a substantial amount of hubris involved in such an undertaking, so I
will approach the topic gingerly.
Why even risk such prognosticating? As longtime readers know, I am
actually writing a book on what I think the next 20 years will look like,
technologically, geopolitically, sociologically, and economically. The book is
called The Age of
Transformation. The basic thesis is that we are going to see more
change in the next 20 years than we’ve seen over the past century. Consider how
much different the world will be if a century’s worth of change is compressed
into the next 20 years.
If you do not resolve to adapt to that level of change in your
life and in the lives of your loved ones, you will not be ready to fully
participate in the society of 2038. You’ll also fail to reap the full rewards
of all the years of hard work and dedication you have put in, preparing for
your retirement.
This series on the future of the global economy will shape my
outline for the last 25% of the book. The book will expand greatly on this
series. I feel comfortable opening up my thought process to you, and I welcome
the feedback I’m going to get, because it will only improve the book.
Thoughtful comments from friends are always welcome.
The first 40–50% of the book will focus on the technological and
biological transformations that will happen in the next 20 years. In general,
that is the rainbows and puppies section of the book. There are any number of
books out there that deal with this broad topic in different ways, but nearly
all of them have a somewhat techno-utopian slant. And for good reason. Living
longer and healthier in a world of greater abundance, where the things we want
cost less? What’s not to like?
The next 25–30% of the book will deal with the
geopolitical/sociological/demographic changes that will inexorably force
themselves on us in conjunction with this technological revolution. Some of
those changes will be a reaction to the very technological forces that are
driving the change. This section will conclude with the most difficult chapter
of the book, the one that I have wrestled with the longest over the last two years,
the chapter on the future of work. For some of us that will be quite a bright
future; for others who are unable to adapt, not so much. Globally, hundreds of
millions of jobs that are currently filled by humans will simply not require
humans in the future. We will have to move on to other occupations.
This level of labor transformation is nothing that we haven’t done
in the past. Many of you will recall that 80% of Americans toiled on farms in
1800. Today that number is less than 2%, who produce massively more per capita
in much better conditions. But that change played out over more than 10 full
generations. The changes I am talking about are going to happen in less than
one generation. The transformation of employment will be one of the most difficult
social and political problems that societies all over the developed world will
face. It’s not just that there won’t be jobs, but that many of the new jobs
will require different sets of skills and be in a different locations from
where many of us live today. And while our ancestors may have set out boldly
from other corners of the world to give America a try, never to see their
home-countries and loved ones again, that propensity for relocation seems to
have diminished in present-day culture. How many Americans relish the notion of
moving from region to region anymore?
The last section of the book will deal with the future of the
global economy. And there we have some issues, as my kids would say. I don’t
think we end up in some techno-dystopian, cyberpunk Blade Runner-type world,
but the tools we use to measure the economy and the things we are measuring are
going to experience a great deal of volatility. Depending on which side of the
volatility you find yourself on, it may be either extraordinarily beneficial or
harmful. The purpose of my book will be to help you see the general direction
and power of the unfolding transformations, so that you can adapt your
strategies for the benefit of your family, friends, and businesses.
The massive amount of research that I’ve had to work through has
forced me to change my opinions more than a few times as I’ve waded through
material and prepared to put words on the screen. I’m deeply grateful to the
120 volunteer researchers who gave me literally tens of thousands of pages of
material to read and sort through on an extraordinarily wide variety of topics.
I am ultimately optimistic, and the book itself will be optimistic
about the future, but there are difficulties that we as a society will face. We
will have to devise different, and in some cases heretical, ways of operating
in order to bring the benefits of transformation to as many people as possible
in our global society. Make no mistake, political turmoil lies ahead. The
current dysfunction in Washington will seem almost quaint, by comparison, as
the country and the world lurch from one vision of the future to the next.
In trying to predict the future, I feel like a Daniel Boone sort
of explorer, leading a band of compatriots through the wilderness; and we come
to the top of a new pass and peer into the distance. Way off, 50 miles away,
there appears to be another pass in the direction we want to go. The problem is
that, between here and there lie more mountains, valleys, rivers, and potentially
hostile natives. It’s not clear how we get there from where we’re standing. So
our intrepid team plunges on, trusting that our instincts and skills will take
us to that far-off pass, and then to the next one beyond that.
Now we’ve just reached the top of that pass, and we’re peering far
into the blue distance. I’m just trying to get the direction right. The actual
path we’ll take is still a great unknown.
With that thought in mind, let’s survey the main forces that will
drive the future of the economy, and in the coming weeks we will dive more
deeply into each of those forces. What we learn will serve as the backbone for
the final section of the book, which I will write in the coming weeks.
Right up front, I’m going to utter the four most dangerous words
in economics: This time is
different. Oh, I admit a lot of things will be the same, but anyone
who expects the future to look like the past is in for a rude awakening.
There are three main economic forces that are imposing themselves
upon the world, whether we like it or not. Two of them are the largest bubbles
in the history of man.
1. The bubble of global debt
2. The bubble of government promises
3. The shifting of the supply curve
2. The bubble of government promises
3. The shifting of the supply curve
I know longtime readers will be familiar with the first two, but
the last one is going to have a few of you scratching your heads. Let’s take up
each briefly.
There is considerable debate over the exact amount of global debt.
You first have to find it, and parts of it get hidden in many out-of-the-way
pockets. But broadly speaking, global debt is about 325% of GDP, and likely
over $225 trillion as I write. (I am assuming that over the last nine months
debt grew at roughly the same rate as in the preceding nine months, even though
we know the growth of debt has been accelerating.)
This
chart from McKinsey is almost three years old, but it does show the growth
of debt over time, and we know that global debt has grown by about $26 trillion
in the last two years.
The above chart requires a few observations. First, notice that
the growth of household and financial debt has decelerated. Corporate debt
continues to grow at roughly the same pace as before. The real acceleration of
growth in debt is coming from government borrowing. Second, we are on a pace to
grow the debt by significantly more between 2014 and 2021 than we did in the
previous seven years. Last, global debt is growing faster than global GDP. We
are borrowing money faster than we are creating wealth.
US government debt is about 100% of GDP, or $20 trillion, and
growing around $1 trillion a year. Forget what they say when they talk about
budget deficits. They lie, because they don’t want to admit what the true
deficit is. However, you can determine the true deficit simply by looking at
the amount of money the Treasury has borrowed at the end of the year and see
that another $400–$500 billion of “off-budget” debt has been added. If I ran my
regulated investment businesses with the same sort of spurious accounting, the
SEC and a raft of other agencies would shut me down faster than you can say
“MD&A” and ban me forever from participating in the financial industry. As
they should. You simply cannot lie when you have a public trust. Well, you
can’t unless you are Congress and the government. Then you can pass laws that
allow you to lie. But I digress.
To be able to compare our debt to that of other countries, we have
to include state and local debt, which is another $3 trillion. That means total
US government debt is 115% of GDP. That is certainly less than the 250% of
debt-to-GDP that Japan finds itself saddled with, but Japan does offer us a
clue as to how we are going to have to deal with our burgeoning government debt
in the future. If you had told me 10 years ago that Japan could essentially
monetize well over 100% of their GDP and not have their currency fall through
the floor, I would have laughed at you. (I know, I know, monetize is not the correct
technical term, as the Bank of Japan is simply buying the Japanese debt and
putting it on its balance sheet.) Since the yen didn’t collapse, we start
having to look for other causes and effects. We will get into that in later
letters.
When the next recession blows in, it will likely balloon the US
government deficit up to $2 trillion a year. The Obama administration took
eight years to run up a $10 trillion debt after the 2008 recession. It might
take just five years after the next recession to amass the next $10 trillion.
Here is a chart my staff created in late 2016, using Congressional Budget
Office data, that shows what will happen if the next recession comes in 2018
and revenues drop by the same percentage as they did in the last recession
(without even counting likely higher expenditures next time). And on top of the
$1.3 trillion deficit that this chart predicts, you can add the more than $500
billion in off-budget debt that I mentioned above, plus higher interest rate
expense as rates rise. I will update this chart for the book and later letters,
but it gets the general direction right.
By the early to mid 2020s, barring substantial increases in taxes
or reductions in government benefits and entitlements, the deficit will be
approaching $2 trillion annually. There will be weeping and wailing and gnashing
of teeth.
If you are in the top 25% of income earners in the United States,
you have a big target painted on your income and wealth. The imposition of a
VAT seems almost guaranteed, as that is the only real way to boost revenues to
offset the increases in entitlement spending. And because the Republicans don’t
want to impose a VAT now as part of major tax reform, it will end up being
imposed by a future Democratic administration and congressional majority that
will not be interested in reducing income taxes. I cannot believe the
shortsightedness of the Republican Party leadership, with their futile belief
that somehow or another they are going to develop a “pure” Republican majority
that will look like the current conservative bloc. Their intransigence is the
main reason that things can’t happen in DC. You can simply look at the
demographic trends and political forces at play and understand that they’re not
going to budge on a VAT. Sigh.
We will go into the debt bubble in greater detail, but it is the next
bubble that will drive macroeconomic change in the US.
The US government balance sheet features unfunded liabilities in
the range of $80 trillion to $200 trillion, stemming from future entitlement
program burdens that are, in effect, government promises of future largess. No
constituency is going to vote to reduce their entitlements. (Well, other than
the very well–off, who don’t actually need those entitlements.)
Unfunded pension liabilities at the state and local levels have
swollen to roughly $4–$6 trillion in the United States. And that may be
understating the severity of the problem.
It’s easy to cite Illinois or New Jersey, but let’s look at a
state like Kentucky. The State of Kentucky released a remarkably candid
self-appraisal of their pension liability issues earlier this year. The
report makes for very sobering reading if you are a resident of Kentucky.
If you optimistically (and unrealistically) assume between 6.75%–7.5%
compounded returns for the future, Kentucky still ends up $33 billion
underfunded. To bring that number into focus, total State of Kentucky spending
last year was $32.7 billion, which makes the underfunded portion of their
pension liability larger than the entire state budget. But wait, it gets worse.
They asked themselves, what if we have to assume a more realistic
discount rate for future returns? Assuming returns just north of 5%, the
unfunded portion rises to $42 billion. Assuming a more realistic 4% (given the
likely returns on their fixed-income portfolios), unfunded liabilities rise to
$64 billion, roughly twice the state budget. If you assume a discount rate
equal to the 30-year Treasury rate of 2.7%, the unfunded liability climbs to $84
billion – seven times more than the annual general fund spending would allow.
Now, this is all before we take into account a potential
recession, which has in the past meant an average 40% loss on stock market
equities, which would make Kentucky’s (and everyone else’s) pension woes even
worse. Further, as we shall see in future letters, the massive increases in
debt, both in the US and globally, will make the next recovery and future
growth even more laggardly than the tepid recovery we have experienced in the
past decade.
The next financial crisis will not look anything like the last
financial crisis did. But it will rhyme. This next chart depicts an extreme
example of what is happening around the world. Scary levels of junk-bond debt
with covenant-lite options – coupled with the Frank Dodd rules that don’t allow
banks to operate in the corporate bond market as market makers – are going to
mean that corporate debt, from the worst right on up to the best, will take a
massive yield hit, as the flight for cash rhymes with what we saw in 2009.
Remember, in a crisis you don’t sell what you want to sell; you
sell what you can sell.
And at a bargain-basement price. We have monster mutual
funds and ETFs investing in these high-yield corporate markets, and the
redemptions from them are going to force selling into a market where there are
no buyers. If you’re wondering what will push the country into recession, look
to the financial markets. That’s where the excesses are being created. And for
the record, I could spend another four pages showing charts like the one above.
Neo-Keynesian economists in the government and at the Fed have
been doing everything they can to stimulate demand in terms of dollars spent,
believing that they will stimulate a recovery. They are missing part of the
equation. Let’s go back to economics 101 and look at possibly the first graph
you ever saw in that class: the classic supply and demand equilibrium price
graph.
If you push the supply curve to the right, i.e., you provide more
of a particular good, then the price of that good is going to go down to find a
new equilibrium.
I was talking with an economist yesterday who has John Deere as a
client. As he was touring their factory, they pointed that they were making the
same parts for 40% less today than they did just a few years ago. Improved
quality and lower prices.
Everybody latches onto the fact that real wages haven’t risen all
that much in 40 years. Well, if you look just at the standard economic numbers,
that is true. But compare what you could get 40 years ago to what you can buy
today (assuming equivalent purchasing power). Do you think TV quality was
anywhere close to today’s? Telecommunications? Automobiles? Almost everything
is far better today, more abundant, and less expensive than it was in 1977. The
same amount of money today buys a far more desirable basket of goods.
Not to mention that some of those goodies didn’t even exist back
in 1977, like our computers and cell phones. Our automobiles were clunkers that
maybe got 12 miles to the gallon and started to go belly up at 70,000 miles.
And don’t even get me started about the quality of healthcare. We all bitch and
moan about the cost of healthcare, much of which is government-generated, but
oh my, the quality of care is so vastly superior.
Personal example: My family has a history of tinnitus. Mine has
been getting steadily worse over the last 10 years, to the point that I have to
consider hearing aids. I sat down two days ago with my audiologist, who gave me
a loaner pair of hearing aids until the latest and greatest from Switzerland
show up in about four weeks. Those will connect to my iPhone and computer. I
kid you not. And when she began to explain the power of the microchips in those
little devices, I was totally blown away. The amount of real-time,
instantaneous analysis that these hearing aids can perform on the sounds around
you is truly stunning. They can change the output to your auditory nerve on the
fly, depending upon the acoustic characteristics of your situation.
Shane came home, and it was some time before she noticed that I
even had the hearing aids in. You can barely see them unless you’re looking.
Then we went to dinner at the local watering hole and sat outside, where I
admit it has been hard for me to carry on a conversation, and I was amazed at
everything that I could hear.
Or ask somebody about their latest knee or hip replacement. Or
whatever. Anybody who wants to go back to the good old days of 1977 is welcome
to them. Count me out.
Let me wrap up here. I am telling you that in the next 20 years
the amount of high-quality goods that are going to be supplied to the world is
going to drive the prices of almost everything down – except of course the cost
of government, which is only going to go up. Fact: The poverty level in the US
has been flat for almost 40 years, but spending on government poverty programs
is up 900%. Government has no incentive to be efficient. And in fact, as Jerry
Pournelle told us at the beginning of the letter:
In any bureaucracy, the people devoted to the benefit of the
bureaucracy itself always get in control, and those dedicated to the goals the
bureaucracy is supposed to accomplish have less and less influence, and
sometimes are eliminated entirely. [Pournelle's law of bureaucracy]
In any event, the ever-increasing amount of supply is going to be
massively deflationary over time and will offset the massive needs for
quantitative easing and debt relief, etc. We are going to do things in the next
20 years that simply defy our current imagination – mostly because we will be
forced into them in order to avoid utter disaster.
Let me close with this note to the wise. We are putting the
finishing touches on the next Strategic Investment Conference, to be held March
6–9 in San Diego. We are going to spend a great deal of time on these issues
that will be so utterly critical to us as we learn how to steer our portfolios
through future storms. You should look at your calendar and set aside those
dates. We will be accepting early-bird registrations within a few weeks. See
you there.
I want to first thank all my readers who have been generous with
their time and money in helping the victims of Hurricane Harvey. The toll is
staggering, with tens of thousands of homes totally destroyed and another
hundred thousand damaged and requiring repair that will take a long time to
complete. To put this disaster in perspective, if the Houston area were a
country, it would be the 17th largest by GDP in the world.
And now here comes Hurricane Irma. As I work on final edits while
flying to Boston, I meditate on the fact that Florida is even bigger than
Houston. I have been in contact with many friends who are planning to ride the
storm out in Florida, and I will admit I worry about them. And the entire
country will be faced with another large relief effort. Floridians will be in
our thoughts and prayers and hopefully benefit from our efforts and money in
the next few days.
Tomorrow I have to take a quick flight to Boston, where I will
spend a few days. But then I’ll be home until the end of the month, when I fly
up to Chicago for a couple days (Sept. 26–28) for a speech to the Wisconsin
Real Estate Alumni Association. Then I’m off the next day to Lisbon. I return
to Dallas to speak at the Dallas
Money Show on October 5–6. You can click on the link for details. I
will speak at an alternative investments conference in Denver on October 23–24
(details in future letters). I will again be in Denver on November 6 and 7,
speaking for the CFA Society and holding meetings. After a lot of small
back-and-forth flights in November, I’ll end up in Lugano, Switzerland, right
before Thanksgiving. Busy month!
And just for the record, I probably have about one third of The Age of Transformation
done or nearly so. I am not going to set an ETA for the final copy, because I
know the editing and rewriting process is going to be grueling and
time-consuming. There are going to be numerous copies out there for people to
read and provide comments on – either the total book or sections. I want this
one done right.
I was saddened to learn yesterday of the death of one of my
science-fiction heroes, Jerry Pournelle, who has given me so many hours of
reading pleasure over the last (at least) five decades and has contributed some
gems to this letter. Little-known fact: Back in 1985 he was kicked off of
ARPANET, the precursor to the Internet, because he had the temerity to write
about it in one of his columns. Those early intrepid Internet explorers from
MIT? They were all afraid that if Congress found out what they were doing, they
would shut the thing down as a boondoggle, as it was still being funded by
DARPA. The back-and-forth messaging is actually a
hilarious read, as viewed from 2017. But their brainchild was just another
one of those inventions that has radically shaped and improved supply. I doubt
anyone remembers those internet pioneers very much anymore, but in any case,
Jerry Pournelle’s stories will live on for a long time. May he rest in peace
(or stir up a bit of trouble where it needs stirring).
Time to hit the send button. Your assignment is to figure out how
to get to San Diego. As for me, I have to deal with my inbox. Have a great
week!
Your optimistic about humanity but concerned about government
analyst,
John Mauldin
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