could be in for a bumpy ride the rest of the year as politicians navigate a
difficult path toward a solution to what is being billed as the fiscal cliff
of $720 billion in expiring tax cuts and mandatory spending cuts. In this
interview with The Gold Report, John
Mauldin, author of Thoughts from the Frontline, shares his insights on
some of the possible twists and turns ahead and how investors can brace
themselves for whatever comes.
The Gold Report: Hello,
John. Now that we know who will be president, investors are turning their
attention to the so-called fiscal cliff facing the country in January. The
combination of the expiration of the Bush-era tax cuts and mandatory spending
cuts could cost a combined $720 billion or an estimated 4.6% of the U.S.
gross domestic product (GDP), according to some estimates. It could sidetrack
the tenuous recovery or even bring on a new recession. Leaders of both
parties have been talking about the need for bipartisanship to deal with the
problem. On Nov. 20, you are hosting "The Post-Election Economy"
video event, featuring Mohamed El-Erian of PIMCO
and Barry Ritholtz of The Big Picture. It is
billed as "A Clear-Eyed Analysis of the Risks and Opportunities for
Investors." What do you see as the options politicians have for coming
to terms with a combined financial hit of the business and alternative
minimum tax hikes and defense and Medicare spending cuts, which could add
$3,500 to the average family's Internal Revenue Service bill, or even more
for high-income earners?
John Mauldin: You're right, JT, that this could
result in a very catastrophic recession, one that is avoidable. You just can't
take that much out of the economy at one time without having an impact. We do
have to cut $1 trillion (T)/year out of the deficit. That's a significant
number. You just cannot do it all at once; you want to do it over time.
TGR: But wouldn't ripping the bandage off
quickly to reduce the debt be better than crafting a compromise or slowly
extracting billions over time and stretching out the pain?
JM: No. Ask Greece,
ask Spain how that works out. I don't want to get into too much wonky
economics, but basically if you pulled 6% of government spending out of the
economy at one time in a combination of tax increases and spending cuts, you
reduce GDP by about that much. That's going to reduce the amount of tax
revenues you get, which makes the problem worse. You get into a spiral.
That's precisely what Spain and Greece are facing.
fiscal cliff would throw us into a serious recession."
Fortunately, the U.S. is not at the end of our debt supercycle. We still have the ability to go to the
markets and borrow money. Spain and Greece don't. We can afford to take some
time. I'm not saying that there are no consequences. It's not a choice of
pain or no pain; it's what kind of pain we want and when we want to take it.
But taking it all at once, at the level of debt we're at, would mean an
extremely serious recession, as bad as or worse than 2008. Unemployment could
become 12–13%. Revenues would go down on employment spending. Welfare
would go up. It would be more difficult to come out of it.
The reality is you would have to raise taxes far more and cut spending
far more to try to do it all at once than if you just said, OK, let's do it
in a matter of, say, a 1% headwind to the economy. It doesn't make it so
difficult that we can't recover and overcome that.
TGR: Is that the worst-case scenario,
doing it all at once? Or is there a compromise that's even worse?
JM: Not doing anything would be the worst
thing of all. The fiscal cliff would throw us into a serious recession.
Trying to do it all at once would result in an even more serious recession.
Kicking the can down the road means we would be OK for a year or two, but at
some point, the bond market says, you guys aren't being serious about this.
It will watch Europe implode, Japan become a bug in search of a windshield
and then start calling the U.S. to task for its lack of seriousness in
dealing with the deficit. That becomes the worst-case scenario. That means we
become Greece or Spain. It is hard to imagine that the U.S. could get there,
but our size just means that we can probably go longer and the fall will be
much deeper and more painful.
is a political decision."
We have to do everything we can to avoid that type of catastrophic
situation and in a way that lets people know exactly how it's going to be
done. Congressional leaders know this. What they are disagreeing on is the
ratio of tax cuts to spending increases and how they're going to handle
healthcare. That's been the issue for the last four years. There's nothing
new about this. There is actually less need to kick the can down the road
today than there would have been if Romney had been elected. Then you would
have been left to try to avoid the pain from a different set of bills. With
Barack Obama reelected, the cast of characters is pretty much not going to
change. That doesn't mean they can't kick the can down the road. Congress
certainly has the potential to do that. The real makings of this deal should
be much larger than $4T. We need something like $8–9T pulled out of the
deficit over the next 10 years.
TGR: You mentioned Medicare. Is that the
most difficult and important thing to deal with, that and entitlements like
JM: Absolutely. Social Security, as Alan
Greenspan recently said, can be solved in 15 minutes and still have 7 minutes
for pleasantries if you had the right people in the room. It's a pretty
straightforward problem. Everybody knows the solution; they just don't want
to do it. You change the way you calculate the benefits a little bit. You raise the retirement age a few more years. You maybe raise
taxes a little bit and you are there. You don't have to get drastic. You
don't have to take retirement age to 75 or recalculate benefits by a half
point. You just tack another couple years on it. That's the easy one.
Medicare is a problem. Everything else you can arm wrestle with. But
Medicare is an emotional issue. Everybody wants more healthcare.
I totally get it. I have seven kids, and some of them have health issues.
It's difficult to find a solution that works for anyone. There are two
viewpoints. Some people want to just fund it all and have a European-type
system. We don't have a European-style consumer. We don't have a
European-style medical establishment. To pay for that is going to cost a
great deal of money. To not pay for it is unacceptable to what now seems to
be a majority of Americans. So that's an impasse. That's why it's so
TGR: And you can't stop people from
JM: We can hope that medical technology
will make some things cheaper and make us healthier. But hope isn't a
TGR: So Medicare is the toughie. What
about quantitative easing (QE)-infinity? What impact will that have on the
problem and what role will it play in the solution?
JM: If they come up with a solution,
that's by definition going to be deflationary. It'll shock people, but the
Federal Reserve is going to be able to print more money than most of us could
possibly imagine and get away with it. By getting away with it, I mean it not
being immediately inflationary. Eventually, the economy will start growing
again and when it reaches the +3% inflation cliff, it will become a problem.
So the Fed will have to pull QE off the table, which will provide its own
headwind for growth.
Coupled with the number of boomers retiring, which creates its own
negative mechanism, I see the next decade as a muddle-through world. If
someone came to me today and said for the rest of this decade, you could lock
in 2% growth, I'd say take it. I'd be ecstatic. By the way, when I said that
in 2002, people said, "Oh, John, you're such a bear. You're so
gloomy." Well, as it turned out, the actual returns were 1.9%. So 2%
would have been a good trade. But that was what I expected, and that's what I
TGR: Are you saying that you're expecting
deflation after a compromise is made followed by inflation or hyperinflation?
JM: Not hyperinflation. Hyperinflation is
a political decision. We just don't have the type of government that will
allow a hyperinflation. I know that a lot of people want to talk about that
because it makes great conspiracy theories. We are all upset about what the
government is doing, how Ben Bernanke is running it and how Obama wants to
make a Socialist empire. . . That is just not the way the U.S. works. I was
just in Argentina last week. The U.S. is not Argentina. Now, that's not to
say we're not going to have a 4, 5 or 6% inflation. If it got to 10%,
however, it would be considered completely out of control. The government
would clamp down and we would have a recession. That would really be
inflationary. But we're not going to get to some hyperinflationary moment.
We'll have a reckoning long before that.
the politicians come to an agreement that deals with entitlements and deals
with taxes, that's actually quite bullish for the economy."
TGR: You have brought up Argentina and
some of the other countries that have had debt issues. Is this cliff a U.S.
problem or will what happens here affect the rest of the world and some of
the countries that already are on their own precipice?
JM: It absolutely will affect the world.
We're a huge part of the world economy. We're the engine of the world. The
U.S. slowing down is going to affect everyone, just as when Japan begins to
hit its wall next year, it's going to affect the rest of the world. Japan is
not Greece. Japan makes a difference. Japan is a big country economically.
Europe is a big, big world economically, and the entire continent is falling
into recession. These things will
have an impact on global growth.
TGR: What impact will they have on
precious metals' physical prices?
JM: In terms of what currency? That's the
question. If the U.S. puts itself on a path to a controlled deficit, I
actually think the dollar becomes much stronger and gold in dollar terms will
be challenged. Gold in euro terms or yen terms will be a very good buy. It's
the nature of the currencies and the way those countries will have to respond
to their particular crisis.
If the U.S. doesn't deal with its deficit, all bets are off. By the
way, I will be buying gold if the price goes down. I don't buy gold as an
investment. I buy gold as central bank insurance. Even though I sound
optimistic and am saying that we will solve this, at the end of the day, I
just don't trust the bastards, and I want some insurance.
TGR: I know you've said you're an optimist
except when you aren't. In light of how close the politicians came to the
edge during the debt ceiling debate last year and the devastating impact that
had on the stock market, why do you think they'll come up with a solution
JM: They're facing a calamity if they
don't. The impact on the stock market was temporary, and the politicians
weren't responding to that. Doesn't the uncertainty make the market even more
Volatile and jittery is one problem. An economic potential for a
recession or a depression is a completely different matter. Business cycles
are business cycles. Stupid government policies are the things that make for
really difficult economic times.
TGR: So what makes
you think this time there will be less drama and, therefore, fewer dramatic
headlines to respond to?
JM: I didn't say there would be less
drama. I said we'll solve it. There will be lots of drama. There will be
posturing, finger pointing and name calling. All sorts of issues will come to
TGR: But in the end, you think they will
come to a solution that will not go over the edge or kick the can down the
JM: I hope we don't kick the can down the
road. I don't see them taking us over the edge. It's
such utter folly that it's just hard to imagine. I'm going to interview the
chiefs of staff for Senators Harry Reid and Rob Portman for the video event
next Tuesday. They both get the problem. Their bosses understand it. They
know what they're facing. They just have different ways they want to solve
the problem. That's where the arm wrestling comes in. And they both know that
if they don't solve it, it will be a crisis.
TGR: Would you be willing to name a date
when you think a deal will be reached?
JM: If you held a gun to my head, I would
say whatever the last possible date is; if it's Dec. 31, then a deal would be
reached Dec. 31.
TGR: In light of what could be a very
volatile rest of the year, how can investors protect themselves or even
profit from each of the different scenarios we have talked about today?
JM: That's one of the things we're going
to be talking about with my friends—Barry Ritholtz
of FusionIQ, Mohamed El-Erian
of PIMCO, Gary Shilling, Rich Yamarone of
Bloomberg. In general, you really have to pay attention to the headlines. You
have to look through the smoke. If they kick the can down the road, you have
to protect yourselves from possible inflationary issues and a bond debacle on
If Congress and the president deal with it in time and in size, then
we have deflationary pressures in front of us. To tell an investor right now
it's going to be one or the other is simply a guess. The politicians don't
know. They know what they need to do. They know they need to solve the total
problem. This $4T that was on the table two years ago doesn't solve the
problem. It only gets us halfway there.
TGR: What if the politicians decide to let
the economy just go over the cliff? What would you do to your portfolio?
JM: If the politicians decide to go off
the cliff, I would get deflationary. I would reduce my equity exposure to
negative, let alone neutral. That's an economic disaster.
TGR: If the politicians come to an
agreement that deals with entitlements and deals with taxes, what does that
mean for investors?
JM: That's actually quite bullish for the
economy. That doesn't mean we won't have recession. There are no easy
solutions here but long term, I think that's quite bullish.
TGR: What if dealing with taxes means raising
taxes on high net-worth individuals and/or changing capital gains taxes?
JM: If they increase the capital gains
tax, that's going to mean pressure on the stock market. That will reduce the
value of equities, and reduces the value of potential profits. If they allow
dividends to rise to regular rates, that's going to significantly impair
seniors and income portfolios. I don't have an easy solution here.
TGR: So without certainty, how are you
adjusting your portfolio?
JM: I'm not really adjusting it. I'm
still investing in hard assets, technology, fixed income, small businesses,
stuff that's optimistic in the long term and protective in the short term. I
try not to buy anything that I can't have enough staying power to handle for
the long run. I'm probably a little bit more liquid.
TGR: Is there an indicator, a headline or
a decision that you are looking for before buying or selling physical gold or
JM: I'm buying physical gold every month.
I've been buying the same amount on the same day of the month every month for
years now. I don't think there's a single indicator. There is just a
confluence of things. The world is just not so simple that you get a single
indicator. If anybody tries to give you some kind of simplistic answer,
laugh, close your portfolio and walk away.
TGR: Thank you for your insights, John.
Mauldin will be a featured guest, along with Mohamed El-Erian,
Barry Ritholtz and other top economic faculty, in a
FREE online event that will air on Tuesday, November 20th at 2 p.m. Eastern.
This free event, The Post-Election Economy, will answer your questions about
what to do with your money after the election. For more information or to
register, click here.
John Mauldin is a
world-renowned economist and financial writer of the New York Times best-selling books Bull's Eye Investing, Just One Thing and Endgame. His most recent book is The Little
Book of Bull's Eye Investing.
Mauldin's free weekly e-letter, Thoughts from the Frontline, is one of the most widely distributed
investment newsletters in the world. Launched in 2000, it was one of the
first publications to provide investors with free, unbiased information and
Mauldin is also the chairman of Mauldin Economics, a company created
to provide individual investors with his big-picture thoughts on the global
economy as well as actionable investment and trading strategies typically
deployed by institutional money managers on behalf of their high-net-worth
clients, but at a fraction of the cost.
Mauldin is the president of Millennium Wave Advisors, an investment
advisory firm registered with multiple states. His track record of success
vetting and consulting with money managers spans over three decades. His
passion is to understand the world of economics, investment, politics and
science, and determine how it may all come together in the future. As a
highly sought-after market pundit, Mauldin is a frequent contributor to
publications such as The
Financial Times and The Daily
Reckoning, and is a regular guest on
CNBC, Yahoo! Daily Ticker
and Bloomberg TV and Radio.
read more Gold Report
interviews like this? Sign up for our free e-newsletter, and you'll
learn when new articles have been published. To see a list of recent
interviews with industry analysts and commentators, visit our Interviews page.
From time to time, Streetwise Reports LLC and its directors, officers,
employees or members of their families, as well as persons interviewed for
articles on the site, may have a long or short position in securities
mentioned and may make purchases and/or sales of those securities in the open
market or otherwise. Interviews are edited for clarity. John Mauldin was not
paid by Streetwise Reports for participating in this interview.