The End of the Debt Supercycle Draws Near: John Mauldin

Are developed nations across the globe at the precipice of oblivion? Yep, says pundit John Mauldin. Fresh after the announcement of a new joint venture with Casey Research and the conclusion of his own Strategic Investment Conference in Carlsbad, Mauldin spoke to The Gold Report. He believes that investors have a small window to save their investments from the end of the debt supercycle, but they'll have to move fast.

The Gold Report: What does your new partnership with Casey Research mean for investors going forward?

John Mauldin: We're creating a joint venture, Mauldin Economics, which will have its own brand and publications. We'll be starting out with a fixed-income letter. Casey Research and Mauldin Economics will be sister companies. It's not so much a partnership with Casey as it's a partnership with the team that runs Casey.

There will be a number of other letters, too. Editors and writers whom I like and have worked with will be writing rather than me. My personal letter will still always go out Friday. I'll still be doing Outside the Box and some other services.

David Galland and Olivier Garrett will become the publishing managers. Galland is one of the greatest marketers in the country. This gives me an opportunity to let him run everything while I spend more time on reading, writing and research, which are what I do best and enjoy the most.

TGR: You have spoken about the end of the developed-world debt supercycle and the end of the ability for governments to borrow cheap money. You said this development is bullish because that debt was invested in inefficient ways and now it will be invested in smart ways. How will countries like Germany, France, Spain and Ireland be affected differently from a country like China or Argentina by this endgame?

JM: Those are all radically different countries. The developed European countries—Ireland, Spain, Italy, even France—are going to see their governments forced to shrink. Germany will have to limit its growth in government.

China is different. It didn't get into a government debt bubble. It has its own particular crisis to deal with. It has a housing and banking debt bubble.

Argentina is just a bad case. President Cristina Kirchner is displaying signs of massive economic psychosis. The actions that she's been taking are the opposite of what you would do if you want to be able to stand up and say, "We're a civilized country that respects the rule of law." It is demonstrably bad for equity investors. People who loan money or do business in Argentina in such a way that the government can access their capital deserve what they get.

Ireland has rule of law. I think Ireland is a great place to put a foreign company. It has English-speaking people, hard workers, an educated labor force and low taxes. It set itself up to be the source for international business.

TGR: Ireland was booming for a short period of time.

JM: It boomed too well. It didn't continue because, just like Spain and the U.S., it believed its own housing bubble. Too much of its economy was invested in housing, which is what China is going to have a problem with. It just built too much stuff with too much money, and it's going to have to rationalize.

Australia has a housing bubble. There's a book that came out last week that talks about the Australian miracle and why it's different this time. I think, "Oh, could they ring a bell at the top any louder?"

TGR: The housing bubble is a private-sector bubble, though.

JM: But it affects everything. The government says, "We have to do something to help the poor housing people who are idiots to put the money in to begin with."

TGR: When you were talking about the end of the debt supercycle, you meant government debt as opposed to private-sector debt. You came up with two scenarios. One is somewhat controlled with austerity, reduced costs and increased taxes. One is, I assume, uncontrolled with bankruptcies and defaults.

JM: We won't have uncontrolled default. It will be intelligently initiated, or it will be crisis-induced with less thought and more pain.

TGR: Which is more likely?

JM: I'd put a 60% chance on the U.S. actually doing it right now and doing it best. Most politicians know that if we don't do something, we're, the technical term is, screwed. It will shock us in the extreme, but we have to do it.

Do you think what Greece and Spain are facing now is something they contemplated five years ago? Hell, no. They're in a crisis and they're being forced to do things that they should have done 15 years ago, but they keep putting it off. Bubbles are going to burst. The only way to deal with a real bubble is to prevent it from happening to begin with. Otherwise, you have to deal with the aftermath. The Federal Reserve thinks lower interest rates will help us deal with the aftermath of the next bubble and the crisis. No, they won't. They were one partial cause of it.

TGR: There is some economic dependency between Europe and the U.S. Is there a contagion that will force the U.S. to act more swiftly?

JM: The contagion is that the bond market will watch Europe go through a crisis country by country, then watch Japan go through its own crisis.

Japan is a bug in a search of a windshield. Its savings have gone from 16% down to 1%. And they are going lower and will turn negative because it's just dying. It's very sad. We've never seen anything like this in the history of the world. Japan will have to start printing money in a manner that will shock everyone.

Then the bond market will look at the U.S. and say, "Wait a minute. We've seen this movie twice now. We know how it ends, and it ends in tears. It's a horror show. If you don't mind, U.S. market, we'd like to leave at intermission."

Rather than having the three, four or five years that we should have from today, being completely profligate and running crazy deficits, we don't have that much time. The bond market will jerk our chain, which is actually fortunate, because the deeper in debt we go, the harder it is and the more pain we have to go through to get out. That's why Greece is down. Greece should have been trying to figure this out four years ago. The numbers are on the ball. It's arithmetic. It's not rocket science.

TGR: In January, you predicted that the wheels would fall off of Europe this year, but you also said that you think the European Union will stay together. What will be the precursors of a final collapse after years of handwringing?

JM: When the cost of staying together is more than the cost of breaking up.

TGR: How is that calculated?

JM: Europe is going to have to send €1 trillion to bail out Italy in addition to the trillions it has already spent. Then it's going to have to come up with some way to fund the Spanish banks; Spain can't do it. Spain is going to have to go through massive austerity. At some point, the population will get fed up and want out. The Germans are already fed up because they're getting handed the tab constantly.

There are three things Europe has to do if it wants to stay together. It has to solve its sovereign debt problem, the banking crisis and its trade imbalances.

The southern European nations have watched the cost of producing goods rise by an average of 30% against Germany and the cohort nations because their labor has been more productive. The only way to rationalize those trade imbalances is for either German labor prices to rise or for peripheral labor prices to fall. The latter is more likely, but it takes a very long time for wages to fall 30%.

It's not likely that everybody in Spain will agree to cut everything by 30% either. No. You think they were rioting in the streets before? Staying in the euro is a disaster for Spain. Getting out of the euro is just a different form of disaster. Either way, it's a disaster. Spain is in deep, deep chili. There's nothing it can do.

TGR: So, who decides if the cost of staying together is worth it?

JM: It's the pain experienced by the voters. What are we seeing in Greece today? Two factions have had a massive majority in Greece, the center left and the center right. They go back and forth. The same two families control them and have since the early 1970s. It looks like the two of them together may not get 40% in the elections coming up.

Forty percent is required to be able to form a government. The bar is set that low. It's not even 50% as it is in most countries because surely one party can get at least 40%, right? No. The rest of the country is so angry, it's split among 10 different, little itty-bitty parties: hard Communists, hard right nationalists and so on, all of whom hate austerity.

The Irish threw out a government that had been in charge for 80 years because it took on the new debt. The new government claimed it would deal with it. It hasn't, but it will deal with it before the next election. It is going to repudiate that bank debt. Either Sinn Fein will be elected, which means a crazy bunch of people will be put in charge, or the Irish people will vote for somebody who will tell the Central European Bank and the German, French and British banks to go piss off.

TGR: But doesn't that then start the ball rolling on a banking crisis?

JM: Ireland's debt is only €60 billion (B). In the grand scheme of things, it's starting to look like pretty small potatoes.

TGR: But it opens the door for every other sovereign country if Ireland goes back.

JM: Greece just did it. It defaulted on its debt.

TGR: I think it officially wrote it down to pennies under, so technically it did not default.

JM: There will be some euphemism for the Irish debt, too.

TGR: There are winners and losers in each of these crises. How can investors, seeing this collapse coming, either preserve assets and buying power or even profit from it?

JM: There is just no one-size-fits-all answer. I know that's not what investors want to hear. They want to hear, "Buy this, sell this, do this."

Typically, a crisis like this is not good to the equity market. There are certainly specific stocks and areas that will do well. Shorter term bonds with some high yields look pretty good. There are dividend plays from international stocks and maybe in their currencies. A very aggressive move is to go long the Japanese Nikkei and short the yen, because if Japan does print money as I expect it to do, the Nikkei will go up quite high in percentage terms. In dollar terms, it will look as if it's been flat. But if you short the yen, that's a way to play a crisis.

Should investors buy some gold? Yes. I buy coins. My fondest dream is that my gold, like my health and my life insurance, will never be used. I hope I give my gold to my great-great-grandkids and Papa John will say, "I don't know why I bought these silly yellow trinkets. Do you want to play with them? We can use them for checkers or something."

TGR: There never is a one-size-fits-all solution, is there?

JM: No. You need to hedge everything. You need to be aware that there is black-swan risk out there during this. This is not a typical market. We can't use models that we've used in the past and expect markets to behave as they have in the past. Don't throw the models away. They will be useful in four or five years. We can come back after we've hit the reset button. It's like the blue screen of death that some of us remember from the 1980s. You'd be typing along and you'd get the blue screen. It was a "feature" that Microsoft built into its software. You just had to hit the reset and start again. If you hadn't prepared for the blue screen of death, if you hadn't been saving every 30 seconds, you were out of luck.

TGR: That's a great analogy.

JM: We're in the process of hitting the reset button. Investors need to be prepared for when the blue screen of death comes along. They better make sure to hit the save button. When they restart the computer, their assets will come back up and they can start working on them again. It's key for investors to act because we have a limited period of time before we get another blue screen of death.

TGR: You're predicting this will happen within five years—not another decade.

JM: We don't have a decade, maybe three years. Spain doesn't even have three years. Europe has to deal with Spain now. It thought €1 trillion bought it a year; it bought it a month. It has to do something.

TGR: But "has to do something" and "doing something" don't always go together.

JM: For the Europeans they do. They'll have meetings. They'll call together the finance ministers. They'll talk frankly with each other. They'll come up with some type of joint statement and solidarity. They'll kick the can down the road. That's what the Europeans want to do. They have this massive desire to be European. They may be able to do it. I hope they do. I'm thinking a united Europe is better for the world than a bunch of countries, but that might not be my view if I were Italian or Spanish.

TGR: There is a lot of talk about savings. In an environment where there is potential to have more quantitative easing by Europe, China and the U.S., doesn't that in essence wound the saver?

JM: Savers are getting wounded now if they're buying Treasuries. They don't have to buy Treasuries. There are opportunities, especially for smaller savers, to find pockets of real yield. It's pretty tough if you're trying to run a $1B portfolio, but if you're trying to run a $100–500K portfolio, you could buy pockets of orphan bonds in the market that can pay a nice level of interest, well above inflation. They're shorter in duration. They're good credits. You can find solid foreign companies that pay very nice dividend yields of around 8%, too.

TGR: Why not dividend yields in U.S. companies?

JM: There are some companies in the U.S. that have dividend yields that are attractive, but not many. Most of them have dividend yields that are lower than what I can find in a more stable municipal bond that's shorter term and tax-free. Do I want a 2% dividend yield from a single-A company? It's a nice thing, but I'd rather have 5% tax-free money from a municipal. Investors ask where to find tax-free. You go find orphan bonds. You do your homework. There are no funds out there that do this stuff. You have to pay attention. If it were easy, everybody could do it. There are no hot stock tips. It's work.

TGR: You moderated a panel on inflation versus deflation at the Casey Conference at the end of April. Do you think that government will reverse the natural deflation tendencies and push us into hyperinflation, as some people here have said?

JM: No, that's total rubbish. Hyperinflation in the U.S.—really? What world are they living in? Could we have inflation? Could it get to 10%? Yes. The Fed would have to crank it down and it would be very embarrassed. We are not Argentina. That's just not a realistic scenario. That's black-helicopter-type talk.

TGR: Amid all this doom and gloom, I feel that you are quite optimistic about U.S. citizens. You talked about the dysfunctional U.S. gross domestic product, but you said you were bullish on the innovative power of the U.S. Can Americans turn the country's economics around by inventing things?

JM: Yes. Once we get to the other side of the blue screen of death, there will be more new technology, new business and innovation in the next 10 years than we saw in all of the last century. It's going to be a fantastic set of opportunities for investors and entrepreneurs. It will be the most exciting period in history. I just hope that someone can figure out how to make me young again—and they're working on it.

For more information on the strategic Investment Conference go to https://hedge-fund-conference.com/2012/invitation.aspx.

John Mauldin has been the author of New York Times best sellers four times. They include Bull's Eye Investing: Targeting Real Returns in a Smoke and Mirrors Market, Just One Thing: Twelve of the World's Best Investors Reveal the One Strategy You Can't Overlook and Endgame: The End of the Debt Supercycle and How it Changes Everything. He also writes the free weekly Thoughts from the Frontline e-letter and edits the free weekly Outside the Box. Mauldin also offers The Mauldin Circle, a free service that connects accredited investors to an exclusive network of money managers and alternative investment opportunities. He is a frequent contributor to publications including The Financial Times and The Daily Reckoning, as well as a regular guest on CNBC, Yahoo Tech Ticker and Bloomberg TV. Mauldin is president of Millennium Wave Advisors, an investment advisory firm registered with multiple states. He is also a registered representative of Millennium Wave Securities, a FINRA-registered broker-dealer.

Mauldin gave more details about the demise of the debt supercycle at the Casey Research Recovery Reality Check Summit. You can hear his entire presentation—entitled End Game Scenarios—as well as every other recorded summit session with the Summit Audio Collection. It features over 20 hours of sobering economic analysis, round-table discussions, updates of stocks from the natural resource sector, actionable investment advice and much more from 31 of the world's foremost financial experts (including famous contrarian investor Doug Casey and Porter Stansberry of End of America fame. More information is available here.

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