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Exclusive Interview: John Mauldin on the U.S. Economy and the Fiscal Cliff

For investors of any level, understanding the economic climate and directional trends of the market is critical to forming sound strategies. That's why so many market watchers have followed John

For investors of any level, understanding the economic climate and directional trends of the market is critical to forming sound strategies. That’s why so many market watchers have followed John Mauldin’s insight into the macro economy so closely for many years. His very fittingly titled weekly newsletter, Thoughts from the Frontline, is one of the most referenced and recommended readings in the investment community with over one million subscribers. It was one of the first publications to provide investors with free, unbiased information and guidance. He is also a New York Times best-selling author with books such as Endgame: The End of the Debt Supercycle and How It Changes Everything, as well as Just One Thing: Twelve of the World’s Best Investors Reveal the One Strategy You Can’t Overlook.

Part of Mauldin’s deep understanding of the market and current economic trends comes from his work at both Mauldin Economics and as president of Millennium Wave Advisors, through which he provides readers access to his unparalleled network of money managers and investors, which are literally those on the frontlines of the investment realm. spoke with John to discuss his current focus at Mauldin Economics, what the U.S. can do to avoid a fiscal and economic disaster, and how investors should be thinking about the market.

EQ: Just to start off, can you talk about your work at Mauldin Economics and Millenium Wave Advisors?

Mauldin: I’m doing what I’ve done for many years now, which is write an economic newsletter on the markets that I distribute to my readers. What we’re doing with Mauldin Economics is trying to put some flesh to these concepts so people can find real investment ideas to put their money to work.

I also bring together people from all angles of the market that I’ve worked with for many years to find these ideas, and at Mauldin Economics we’ll try to translate them into actionable advice as opposed to the normal global macro work that I do in my regular weekly letter.

EQ: In your latest book, Endgame, you discuss how global economies that have funded their economic growth through decades of debt is hitting an end point. How are global economies forced to change now that the very thing funding their growth is now the thing that threatens it?

Mauldin: Well, if you’re Greece or Spain, you’ve already hit that wall. Portugal and Ireland are clearly dealing with their own level of fiscal crisis. So each country is moving in its own path in the developed world. Canada and Sweden, for instance, have already gone through their crises in the 1990s, and they’ve set their fiscal houses in order. Now, much of the rest of the developed world—including the rest of Europe, Japan and the United States—are coming into their inability to borrow money at sustainable rates.

The U.S., fortunately, has enough time to deal with their debt before it becomes a crisis. We don’t have to become Spain, Italy or Greece, but that does require us to do something. We just can’t sit and continue to run trillion-dollar deficits and expect things to go on the same way tomorrow as it did yesterday.

EQ: In your latest Thoughts From the Frontline, you start to explore why the current economic models being applied to the current sovereign debt issues just don’t work. Why is that?

Mauldin: I used an analogy of what’s called a Singularity, which is a concept I borrowed from physics. The thing that we think of that describes the situation best is a black hole. A black hole keeps all the light that comes near it from escaping, and when you get near a black hole, the mathematical models of relativity theory begin to break down. The models just no longer work at the event horizon. So in my concept of the black hole of debt, that event horizon is the confidence of the markets. If the confidence of the market becomes increasingly at risk, the models that guide our policy and tells us what interest rates should be and what the future will look like become increasingly suspect, and eventually they break down and our models won’t work. It will be just like the models that suggest light, gravity and how other things are supposed to work begin to lose their ability to forecast as you get closer and closer to the black hole.

EQ: Did the Federal Reserve’s quantitative easing policies help to address that confidence problem in the market?

Mauldin: I can’t argue that the Fed’s policies haven’t done something, but what it’s done mostly is increase the cost of commodities and the things we buy. It’s not been good for the average citizen because it hasn’t translated into an increase in household incomes. It’s translated to an increased stock market, which is kind of odd. If you went to most of the economists that are in favor of loose monetary policies and you talk to them about supply-side economics, they would immediately start talking about trickle-down economics being derisive. But quantitative easing, for all intents and purposes, is trickle-down monetary policy. The concept is to make the rich wealthier through their stock market holdings, and that will hopefully translate into more spending, which will make life better for everyone. That’s trickle-down monetary policy. I know that most people of the Fed will reject that characterization, but that is in effect what we’re talking about.

EQ: How much does the Fiscal Cliff, and the government’s ability to address it, affect the market’s confidence?

Mauldin: I actually wrote about the fiscal cliff in my recent newsletter. The fiscal cliff has several components. Technically, if all the spending cuts and tax increases were enacted, we’d have about $600 billion that came off the table, which is about 4 percent of the GDP. Your basic equation is GDP is the sum of consumer spending, investments, government spending, and net exports. If you decrease government spending, and/or reduce savings by increasing taxes, you’re going to impact GDP by 4 percent in the very short term. That would be a serious recession by anybody’s standards from where we are today, especially with the economy currently growing at less than 2 percent.

So the fiscal cliff is real, but part of that will probably go away. The alternative minimum tax and the Medicare “doc fix” are most likely going to get pushed back like they do every year. Also, it’s unlikely that we’re going to see middle-class tax cuts that were enacted under the Bush administration go away because both parties want to see that stay. So there seems to be some agreement that the number is more like about $300 billion of reductions to the deficit through tax increases and spending cuts, which is about 2 percent of GDP. While that is substantial, it’s not quite the disaster of what the full-on assault would be. Even that, however, in a 2 percent world, is very problematic.

EQ: How would you suggest that Congress should approach reducing the national deficit?

Mauldin: You have to put all of these things into the equation and figure out how you want to go about reducing the deficit. My suggestion would be that you don’t try to do it all at once, but rather quarter by quarter. Are we going to have to reduce the deficit by 5 percent or 6 percent of GDP over the next five or six years? Absolutely. I just don’t want to do it all at once. I want to do it in a more controlled and measured way. So we should ease into this rather than doing $300 billion next year; $150 billion is just fine, thank you. Let’s make sure that it’s $150 billion this year, then another $150 billion next year, and keep doing that and, at the same time, hold the line in spending. In some cases, it’s about just simply saying that we’re not going to increase the spending for certain things and just make due with the same budgets as last year. So holding that line on spending while the economy is growing at a nominal basis would help us get rid of the deficit. There are ways this can be done that aren’t terribly draconian, but they will have an effect nonetheless.

EQ: You’ve stressed the importance of compromise on Capitol Hill in order to address the deficit. Given the current polarized state of politics, is compromise even possible?

Mauldin: I think it’s going to be a requirement, otherwise we hit a wall. We have to have some kind of compromise within the 90 days of the administration and this election is really about the direction of that compromise.

EQ: How do you suggest investors handle this market as the U.S. economy, market and government are all dealing with these headwinds?

Mauldin: I think you have to be very concerned about tail risk. So you have to have some hedges in your portfolio because you can’t just take a blind, long-only approach and expect everything to work out for you. That may not get you to where you want to be and I know that taking a hedge approach hasn’t been the best strategy over the last year or so, but in the coming year or so, we’re going to see the wisdom of being more conservative.

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