Endgame: The End of the Debt Supercycle and How It Changes Everything

John Mauldin Also available in audiobook: Download our app for free listening.

Debt super-cycle - when debt growth results in huge debts and credit crises - is affecting several countries in the world. And this includes the developed and powerful like the United States! These nations need to face complicated decisions: seek a debt restructuring or reduce it through austerity measures. In the book, the author introduces the concept of the supercycle of debt and reveals why the world economy will still go through a long period of low growth, high unemployment, and volatile markets. Want to understand a little more about this and prepare for this reality? Come with us!

How we got here: years of uncontrolled spending culminated in crisis

The debt supercycle is defined by decades of debt growth from small, manageable levels to a level where bond markets revolt and debt needs to be restructured or reduced. Many countries in the world are, right now, in various stages of this supercycle.

Economists have yet to agree on the period of economic turmoil facing the world today. On one thing, however, everyone agrees: this turbulence will impose many difficulties for all governments and taxpayers around the world. The problem is that bad choice have bad consequences. So governments need to take responsibility and find ways to improve decision making before it is too late.

On the eve of the 2008 recession, American consumers, business leaders, and even politicians were spending all their savings in an accelerated fashion. As a teenager who can not calculate the long-term proportion of his bad choices, the United States spent a lot of money and spared very little. The irresponsibility of the nation culminated in a major economic change: this time the US will not be able to spend during the crisis. Instead, the country is in a "balance sheet recession," which will take years to improve.

This crisis took decades to form. The ratio of total US current debt to GDP exceeds the peak reached in 1993 during the Great Depression. At that time, US indebtedness-generated by the government, business, financing, and domestic loans-was three times the GDP. But it was so thanks to the fact that the country's productivity fell, not by new debts. In subsequent years, the ratio fell, but in 2009, financial loans outpaced productivity. And currently, debt exceeds 370% of GDP.

This type of loan encourages unsustainable growth. The final days of the "debt supercycle" ended with the collapse of the Leman Brothers in 2008. But of course, the Americans were not the only ones who made many loans. Iceland, with a smaller population than the city of Wichita in Kansas, for example, managed to accumulate € 50 billion ($ 62.7 billion) in debt.

After the mess caused by the supercycle of debt comes the "endgame": a sudden but inevitable return of economic sanity and fiscal restraint. American households have controlled their spending and are paying their debts, but government loans have gone up. Then the debt did not disappear - the company merely transferred it from the balance sheets to the public sector. When the government reaches its lending limits, politicians will have three choices: inflation, default or devaluation. Many economists and analysts mistakenly believe that the 2008 recession was just another setback and that a little stimulus will revive the economy. In fact, the end of the debt supercycle and the beginning of the endgame means that this malaise has no quick and easy solution.

Is a solution possible?

Bankers of the US Federal Reserve usually adhere to the theories of economist John Maynard Keynes. That is why they have responded to the usual global Keynesian debt crisis: relying on liquidity to stop deflation, stimulate the economy, and induce borrowing and spending. But the economic reality is that GDP only grows through real output.

Startups are the top drivers of job growth in the United States. According to surveys conducted by the Kauffman Foundation, large, well-established companies have vacated one million jobs a year from 1977 to 2005. Meanwhile, new companies have made up for this shortfall and added three million new positions a year in the period.

Population growth is another important ingredient to save the economy. The truth is that the only ways to expand an economy are by adding workers or increasing productivity. In nations like Japan, where the population is aging a lot, productivity growth is the only way to economic expansion.

A prosperous GDP is needed for countries that want to get out of debt. As long as a government's debt grows more slowly than its rate of economic growth, borrowing money can be a responsible fiscal policy. Nations that have surpluses in good times are in a better position to borrow when the crisis hits. But debt burdens make savings more volatile. A collapse in trust may come about suddenly, and when the government can not restrict its loans, a disaster can happen. The crisis in Greece offers an example of the worst-case scenario. The United States may be able to get rid of this increase in its national debt by projecting $ 1.5 trillion a year, but this is not a sustainable strategy. Raising debt up to that annual amount means the United States needs to find willing investors to spend $ 1.5 trillion a year in treasury bonds. This has worked so far, but the novelty is that some governments are considering an alternative to the dollar as a reserve currency.

The US trade deficit of $ 500 billion a year marks another weakness. US oil imports are worth $ 300 billion each year, so reducing your need for foreign oil would be a long way to lessen your lack of budget. Developing nuclear power and alternative energy sources are two other solutions.

The government could also spur the transition from truck fleets from gasoline to natural gas, an abundant source of energy in the United States. Another option is to reduce taxes on oil to reduce the demand for imports. The US could impose gas tax increases of two to three cents a month. So after diversifying your energy sources, you could reduce your gas tax. This tax increase would encourage conservation and raise money for improvements in the country's infrastructure.

A report on infrastructure issued in 2009 by the American Society of Civil Engineers gave the United States a "D" rebate, with especially low grades for inland waterways, roads, and dikes.

Structural changes in the economy

After decades of a quiet economy, things are getting tougher for consumers and investors. Here are the things you can expect to happen:

Higher volatility: From the early 1980s until 2008, the US economy kept inflation in order and took advantage of a period of steady growth in GDP and jobs. These years were so quiet that analysts coined the phrase "the great moderation" to describe them. Government bankers seemed to have mastered their roles of managing economies. This surprising stability has led investors to lower their guards. And then, in the fall of the 2008 stock market, the volatility returned with more force.

To get a glimpse of what's to come, let's look at Japan's experience. During the 1980s the Japanese stock exchanges were stable, until, after a fall in 1989, Nikkei suddenly became a Ferris wheel. Globalization also plays an important role in volatility. Now that supply chains are larger and more complex, even mild changes in demand can create a "whip effect," where a small movement results in a much larger reaction in a much larger area.

Smaller growth trend: The world economy is by no means condemned to a permanent recession, but will need to adjust to lower growth rates. Personal incomes, GDP, industrial output and labor markets will grow more slowly than in the past. And recessions will be a bit more frequent. Public debt acts as a backlog of GDP.

Higher structural levels of unemployment: "cyclical" unemployment plummets and flows with the economy, but "structural" unemployment may be more insistent because it is the result of intrinsic changes in the labor market. Highly educated workers resisted the recession very well: in 2009, the unemployment rate for people with a baccalaureate degree was 5.2%, and the average weekly wage was $ 1,025. On the other hand, for workers with only a high school diploma, unemployment was 9.7%, and the average weekly wage was $ 626. People who did not complete high school was even worse, with 14.6% unemployment and a weekly average wage of $ 454 in the United States.

These statistics illustrate the broad gulf between the rich and the poor in the American economy. Also, many of the former employees in sectors such as real estate and finance now find little demand for their formerly valuable skills. Workers who lose their jobs face new job searches that are much longer than in the past - and the longer a person goes without work, the less employable it becomes.

With these factors in hand and federal deficits rising, it is obvious that the safety net for the unemployed, the sick and the elderly will be far less generous. But even the sharp cuts in welfare programs can only go up to a certain limit. Even to keep these policies at a much lower rate than the current rates, the United States will need large amounts of money. This need will probably lead to the creation and imposition of a value-added tax that will further disrupt any recovery of the economy.

The "efficient market hypothesis" is the idea that prices are always right because markets are rational. This concept, which has guided markets for decades, is another by-product of the supercycle of debt. If markets are rational, then bubbles and falls can not happen. That thought blinded most market participants and politicians to the housing bubble that was expanding in the early 21st century. Even US Federal Reserve Chairman Ben Bernanke believed the house price spiral was reasonable. "The American real estate market merely reflects a strong US economy," he said at the end of 2006.

Facing inflation and deflation

Government bankers have always seen inflation as a clear period for world economies. Now, however, deflation has emerged as a real threat. A loose economy with excess capacity drives producers to lower their prices. An increase in personal savings and a decline in consumer spending also contribute to deflation.

In what Keynes called "the paradox of economics," saving money is good for the individual who saves, but bad for the economy in general. As prices begin to fall, consumers have an incentive to delay purchases, which hampers the economy.

Deflation can also ruin banks' balance sheets. When the collateral value starts to decrease, bankruptcies and bankruptcies happen next. As banks raise the criteria for lending, money does not move through the economy as fast as before, creating more deflationary pressure.

In the long run, experts are worried about inflation and even hyperinflation, which happens when prices rise 50% or more in a month. Around the world, hyperinflation has become much more common in modern history, since nations have abandoned the gold standard. Free of gold, paper money is under the control of lawmakers who borrow and spend for political purposes. The rulers are creating huge deficits and issuing much more money to cover spending, causing hyperinflation. An extreme example occurred in Germany in the 1920s, when inflation reached 29,500% in a single month.

If you believe that deflation is at stake, you need to manage your portfolio by buying treasuries, revenue-producing securities, and dollars, while disposing of stocks of construction companies, banks, and consumer goods manufacturers. If on the other hand, you believe that inflation is more likely, you need to buy precious metals and commodity-based currencies like New Zealand, Canada, Norway, Brazil, and Australia (but beware of the real estate market in Australia).


The United States exemplifies endgame periods well. The deficits are huge, but the political disposition is minuscule. Solving the US budget deficit will require an aggressive reform in Social Security and public health, but politicians know that they propose cuts at their own risk. Wages and benefits of federal workers have far outpaced the salaries of private sector employees.

American taxpayers have no way out of this mess. The nation could follow the taxing and spending approach that Japan created after the crisis, and that resulted in 20 years of stagnation. But the point is that politicians have some ways to soften the blows. A value-added tax seems inevitable, but if the American government cut corporate taxes, the nation could maintain its global competitiveness. The United States could also emulate Canadian immigration policies, allowing rich and well-educated foreigners to enter the country.

Although the US situation is complicated, Europe is even worse. Its unpleasant reality is that a sub-optimal currency union supports the euro. Ideally, a currency union allows workers to move freely, and employers set wages and prices freely, all within a region with uniform business cycles. Unlike the United States where workers can move from state to state to look for jobs and employers are free to raise wages to attract employees, in Europe they do not have that same mobility, and Europe has seen salary gaps very disconcerting. In Greece, for example, public sector workers have earned up to three times more than private sector workers.

Despite all the gloomy predictions, the citizens of the world have much to look forward to. Advances in biotechnology, telecommunications, and education will improve the lives of many people around the world. Changes are inevitable, so look for opportunities and enjoy them!

Japan's Problem

Japan spent 20 years trying to recover from one of the biggest bubbles of the modern era. Even today, the country is still trying to get rid of the problems of deflation. Japan is very important since it is one of the main examples of the effects brought about by the declaration in a country.

The country's bubble in the 1980s was partly caused by a very loose monetary policy. In 1985 the rulers decided to intervene in the dollar that was very strong and the yen gained a lot of strength after that. As a result, the Japanese faced a currency loss in dollar-controlled assets - such as US government bonds. And so the Japanese started bringing the money home. The Japanese bank tried to resolve this by lowering interest rates, and the official discount rate dropped five times by 1987 to help Japanese exports. With inflation above the discount rate, the money circulated freely.

Low rates and strong currency encouraged the housing boom in Japan and the stock price. Japanese companies have bought a lot of real estate in Hawaii and California, including in luxurious places like the Bel Air Hotel in Los Angeles. But eventually, the bubble exploded. The peak of the bubble happened in 1989 when the Nikkei reached historical notes. Two years after that, stocks fell about 60 percent of value - the only next example of what happened during the Great Depression.

Then in 1989 changed monetary policy and 1990, after the stock market began to fall, the official discount rate rose to 6%. Also, the government has caused banks to restrict real estate financing. The problem was that this stricter monetary policy only made things worse. In 1993 the government finally recognized the collapse of the bubble, but it was too late, and deflation began to take effect. Prices fell 1.1% in the first quarter and in the middle of the year prices of goods fell at a rate of 4.2% per year. In 1990 Japan accounted for 14% of the world economy. In 2010, it was only 8%, and there are no Japanese companies in the top 10.

Japan was a healthy and dynamic economy, but today it has a public debt that corresponds to 200% of GDP. The number can get even worse if we look at debt as a percentage of private GDP: almost 240%. Debt levels are so high that they can only be compared to countries with hyperinflation. Japan now joins countries like Zimbabwe, Lebanon, Jamaica, Sudan and Egypt.

Final Notes

After analyzing all these situations, what can you do to protect your investments? In case of deflation scenarios you can: buy treasury bonds; buy dollar; sell stocks; sell junk bonds; sell most commodities and so on.

But if you believe you are living in an inflationary scenario, seek to buy things that the government can not "print or create." You can invest in precious metals; short-term corporate bonds; currencies based on commodities and so on.

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