The Zero-Sum Game

John Mauldin |


In's latest interview with John Mauldin of Mauldin Economics and Millennium Wave Advisors, we ask John his thoughts on the current state of the U.S. economy, and the potential impact of excessive stimulus programs from other troubled economies around the globe. 

EQ: What was your opinion of Chairman Bernanke's recent comments to ensure the market that the tapering is still further down the road?

Mauldin: Everybody knows that the Fed, at some point, is going to have to begin to reduce the bond purchases. In fact, they know that the Fed will have to even raise interest rates too. We don’t live in a normal situation right now. Many observers are saying that the reason why we’re having a good market is because the Fed is injecting money. That’s probably true, so they’re afraid that when the money injection stops, then the good times stop. So they’re just terribly sensitive to that concept.

Anything, even a small hint that they’re going to take away even a few cups of the punch bowl, let alone the entire thing, just sends traders and momentum players into a panic. They all know that the exit is coming, and they don’t want to be left at the back of the auditorium when everybody’s rushing for the exits.

EQ: Now that the Fed has acknowledged the market's hypersensitivity to its actions and comments regarding the QE program, does this change the dynamic at all going forward?

Mauldin: It might, but we now have a very distorted situation where the Federal Reserve is setting policy to try to stabilize the equity markets. That’s not their mandate. Their mandate is inflation and, arguably, unemployment. Somehow that got morphed into them being responsible for equity prices. So what they did was they engineered, through low rates and financial repression, the lowest risk premiums in history.

We’ve seen a little backing off recently, but the point we’re at right now is still the lowest point in history. The Fed can’t reduce risk premiums much more than they’ve already done. We’ve gone about as far down the risk curve as you can go. By trying to fight instability, the Fed has actually created a very unstable situation.

EQ: Has the inability of the rest of the government to manage the national budget and get the economy back on track essentially put more stress on the Fed and given the central bank more power it should have with regards to how the system should work?

Mauldin: Absolutely, and you’ll see Bernanke constantly giving lip service to the fact that government has to be willing to deal with deficits and bring it back into a manageable number. It has to be lower than the growth rate of GDP, which it’s not. We haven’t handled the entitlement programs well, and Congress is just willingly borrowing. But what they had this year is a couple of one-off situations. We get big checks from Fannie Mae (FNMA) and Freddie Mac (FMCC). We also got a rather large increase in taxes that came from everybody moving as much of their expected income from 2013 into the 2012 tax year to capture the lower rate. So it’s artificially made the deficit look like it’s dropping and going away.

That effect will go away by the end of the year, and deficits will start rising again. It will be in a political year in 2014, and nothing will have happened. The longer we go without dealing with the deficit, then the more difficult it’s going to become.

Now we don’t have to deal with it all at once, but we have to put ourselves on a glide path to a deficit that’s sustainable where our debt-to-GDP doesn’t grow. Once we get to that place, then we’re fine. It’s doable today, but it’s going to require wholesale changes in the entitlement program, but everybody’s just scared of doing that.

EQ: You’ve been a proponent in spreading out that pain to deal with the problem instead of consistently putting it off and eventually having to tackle it all at once.

Mauldin: Well, do you want to be Greece? They put it off, and kept putting off all their reforms, just like how Japan put off their reforms. Now they have to deal with it in a very draconian manner. In essence, Japan is going to have to reduce the value of their currency by 50 percent over the next five years. That’s a beggar-thy-own nation type of policy. It’s going to create problems for countries that compete directly with Japan, like South Korea, Germany, and so forth. It’s really going to create problems for the Japanese people because their buying power has been reduced.

EQ: Looking at Japan, you said that it will unleash the most significant currency war since 1930 and essentially attempt to export deflation. How would that destabilize the US economy if they were successful?

Mauldin: I don’t know if it destabilizes it. Everybody wants to grow their way out of their crisis. Everybody wants to have a positive trade balance. But world trade is a zero-sum game. There has to be buyers and sellers, and Japan is saying that they want to be the big seller. They want the surpluses. That, by definition, is going to reduce everybody else’s surplus. It all has consequences.

We’ve got one major player in the world. If Argentina decides to destroy its currency—which currently it’s doing as an inadvertent result of their incompetence toward internal money management—the rest of the world just usually shrugs it off because Argentina doesn’t export anything that’s going to change world prices. They’ve actually done it like seven times in the last 100 years. They export soybeans and wine. There’s a world price for that stuff. It doesn’t hurt U.S. farmers that much. It might allow the Argentines to have a little better profit margin, but it’s not enough to change the world.

Machine tools, cars, consumer electronics, that doesn’t hurt the U.S. that much. We do compete with machine tools, but so does Germany. So Japan is more of a problem for an economy like South Korea. My personal view is that from the U.S. standpoint, we probably should ignore Japan and take advantage of the cheap exports. We won’t do that, however, because we’ll start having corporations that are competing directly with Japan complaining to their Congressmen. We’re already seeing people in Congress associating with labor unions writing letters to the Treasury and all the yen has done is go back to 100 versus the dollar. It was 120 about five years ago.

The Japanese can rationally say that 120 should be the normal price and everyone would probably calm down. Nobody was writing to their Congressmen when the yen was at 120 or griping when it was at 75, so 100 isn’t necessarily out of the ordinary.

But when the yen gets to 150, then that’s a different story. Keep in mind this would be a five-to-seven year move. It’s not a one-time, linear move. It will be gradual. It may go to 140, then back to 110, and people will say that the market is changing. The Wall Street Journal called me two months ago when the yen had dropped from 99 back to 93 or so, and they asked me what I thought about it. Well, it had jumped too far too fast and it corrected. Now it’s back to 100. It’ll get to 110, then fall back, but then get to 120 and back down. It’s not going to be a one-way march.

That said, over time, the Japanese have to monetize the biggest portion of their government debt. It has to go onto the balance sheet of the Bank of Japan. That’s truly the only way they survive. They have to accumulate it slowly to prevent it from distorting everything, and then get the bulk of the Japanese government bonds off the books of their banks. That way, their banks won’t have their capital destroyed when interest rates finally rise.

They’re in a delicate dance. It’s very possible that the Japanese can pull this off. It’s also very likely that the wheels come off in the middle of it all. From an academic standpoint, it’s probably the most interesting economic experiment in history.

EQ: You recently wrote about lessons we could and should learn from Cyprus. It seems like a common theme in most economic collapses isn't it?

Mauldin: Cyprus is like every country in the world; it’s just very, very small. They really started to believe their own press releases. They had decades of stability, and they somehow believed that too much debt in their banks would not produce a crisis. They believed the European Union would bail their banks out—because that’s what they had done for Ireland and Spain—they were just truly shocked when it didn’t happen. The reality is that the European central bank—like the other central banks around the world—are making the rules up as they go along.

Just look at what our central bank has done in five or six years. Who knew they would create all these different types of programs. Nobody in 2006 would have ever said that it’s possible that we’re going to get TARP and take over Fannie and Freddie, and AIG ($AIG), and that we’re going to write $10 billion checks to Goldman Sachs (GS) . That just didn’t occur to anybody because it was a seemingly impossible situation, but it happened. So what I think we have to recognize is we’re coming to an end of a period of massive increase in leverage and debt, serious government intervention and messing around with the markets, and that’s going to produce a period of instability.

EQ: Could these major government rescue programs potentially be helpful by setting precedence in dealing with major market meltdowns?

Mauldin: Bankers are going to try to reduce the pain and reduce the instability as much as possible, but if it’s to the extent that it prevents Congress and politicians everywhere from dealing with the real problem, which is deficits and debt, then that’s not good. We’re enabling. We shouldn’t be in this situation in the first place.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


Symbol Name Price Change % Volume
GS The Goldman Sachs Group Inc. 223.53 1.06 0.48 1,787,060 Trade
AIG American International Group Inc. New 63.55 0.43 0.68 8,817,060 Trade
INAAL Viver Inc S/Gdr 144A n/a n/a n/a 0


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