Economic Question of a Generation

This past weekend I had the privilege of attending an investor conference in San Diego hosted by John Mauldin and Altegris Investments.  The line up of speakers was exceptional — in addition to John, whom I consider one of the best minds in the country in understanding the economic events of the day, the speakers included John Paulson, Marc Faber, David Harding of Winton Capital, the editor of the Bank Credit Analyst and others.

The room was filled with nearly 500 investors all asking essentially the same question.  What is the implication of a Federal Reserve balance sheet that looks like an Apollo moonshot … a federal fiscal deficit that has doubled the debt of the United States in a very short period of time, and if not abated,will easily have the United State’s debt in excess of 150% of GDP — only once in world history has a country survived with a debt restructuring over this level … having a country like Japan already with debt at 200% of GDP with a declining population and declining working population coupled with a savings rate that in a few short years will be negative as the Japanese start being a net seller rather than buyer of government bonds … demographics of Europe which almost certainly guarantees that the problems in Greece are only a beginning for the Euro Zone, and we need to include the United Kingdom in the list of countries in serious long-term financial trouble.

The world has seen many recessions.  The world has seen many countries that defaulted on sovereign debt and restructured that debt.

But the world has never seen the potential of default on such a large scale and by some of the biggest economic powers in the World.  Japan is the prime example.  There is no hope of Japan surviving financially in its current form.  But as long as the credit markets continue to have confidence in Japan, they will be able to tap world credit markets.  But a day will come, and probably sooner rather than later, that the Japanese people stop buying Japan’s bonds, and in fact start selling.  Retirees need cash, not a piece of paper.  And Japan is becoming full of retirees.

While that’s the most stark example, Europe has the same problem.  Birth rates that guarantee a loss of population, and a continual aging of the population.  Aging not because the Baby Boomers are becoming senior citizens, but rather because of a lack of babies and a birth rate that is well below replacement.  Yet Europe’s debt continues to growth.  At some point, how will Japan, or Europe, or the United States continue to service the debt.

And on the day that a little confidence is lost, the cost of borrowing for the offending nation skyrockets.  Greece is paying over 20%, versus 3.25% for ten year Treasuries this morning for the United States.   A 200 basis point increase in rates in the U.S. adds another $280+ billion to the annual deficit, which then needs to also be funded at higher interest rates.

The implications of the demographic changes and 70 years of debt expansion is the most important economic question of our lifetime.

Get it right, and we will have resources to take advantage of one of the great buying opportunities of all time, which could occur as early as 2020.

Get it wrong, and we will not have the resources to take advantage of anything — in fact we may be scrambling for resources to eat and keep a roof over our heads.

I thank John and all the presenters and others who worked to put on the conference.   I have volumes of notes to process and to consider.  I’m convinced that there is a “right” answer to inflation vs. deflation, higher or lower equity, commodity and real estate prices.   Normally we see the “right” answer in hindsight.  This time we need a road map to make sure we stay on the right path.  For to detour could be a disaster.