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John Mauldin


This is the November 16, 2018 edition of Mauldin's weekly opus - Thoughts from the Front Line


Reviewer comments:

In this issue Mauldin quotes extensively from investment whizz Ray Dalio and recommends his book, Principles for Navigating Big Debt Crises. Mauldin includes a link in his report for individuals to obtain a PDF version of Dalio's book, but it did not function for me, so I have not yet read the book, but base comments here on Mauldin's extracts. He writes that "Ray gives us a brilliant tour de force examination of how debt crises arise and what you can do when one strikes." He has been writing for months that a 'debt crisis' will occur, sooner or later.
Both Mauldin and Dalio persist in describing debt and too much debt as a 'debt crisis'. I believe the entire conceptual basis on which the economist and financial wizards base this discussion is mistaken.
But actually debt is the entry in a ledger book that is created by credit. The problem is that government and the banking system has given out too much credit. Today the 96%+ of the national money supply is credit and foreign banks have done the same to the money supply of the world countries. The result is that for every dollar that the Treasury and its agent the FED would reduce the federal debt that would reduce the nations money supply by several dollars. My further comments will be included with quotes from this Mauldin report.


Know Thyself:

Mauldin here gives a brief account of Dalio's success as a fund manager. He believes Dalio's success is due to being highly 'empirical'. For the book, he has studied 48 previous 'debt crises' and drawn conclusions from this. But such examination may not reveal reality if it is based on a fundamental misunderstanding.


Lending allows Spending:

Mauldin begins by noting that he and Dalio recognize that 'debt' can be either 'good' or 'bad' depending on how it is used. Well, I turn that around and claim that it is 'credit' that is either good or bad depending on how it is used, because it is credit giving that is the active process, while debt is the accounting passive counterpart. People do not seek 'debt' but do seek 'credit'. And lenders do not issue debt, they issue credit. Lending allows for much more than spending - throughout history it has been crucial for allowing investment.
But Mauldin then quotes Dalio "To put these complicated matters into very simple terms, you create a cycle virtually any time you borrow money. Buying something you can't afford (out of your capital or cash) means spending more than you make."
I do not believe in the ancient concept of cycles, but let that go, but waves could be a better analogy. Again, borrowing capital is the essential prerequisite for expanding investment and merchandizing. And of course Dalio knows that because his business relies on borrowing and investing capital.
But he continues: "you are borrowing from your future self. Essentially, you are creating a time in the future in which you will need to spend less than you make so you can pay it back."

This explanation of the situation itself creates a problem. Because it emphasizes spending less when it should be stressing making more. This generates the political-financial mantra to enforce austerity on a country - spend less - consume less - rather than work harder and produce more.

He continues: "The pattern of borrowing, spending more than you make, and then having to spend less than you make very quickly resembles a cycle". Well, lets think of a wave. But, indeed, spending (consuming) less rather than creating (producing) more does create a curve down that may resemble a cycle (although it does not return to the initial point). While producing more would result in a new wave up.

Dalio then discusses the game of Monopoly and describes how the rules make it an analogy to our current economic situation in which the desire for property versus for cash or reverse depends on the situation. Then he describes new situations and results that would come from various changes in the rules.
In high school I used to spend entire weekends playing Monopoly over and over and experimenting with making different changes of the variables in the rules to see what the changes in results would be. Some cause dramatic changes in the behavior of the players.
And changes in financial rules over the past 40 years or more in the U.S. and world economy have resulted in significant changes (see list below for some references on this.)

Dalio continues:" "In other words debt actually creates its own cycles. Lending (especially) from institutions that can create money under a fractional reserve banking system) allows spending that spawns more spending, which eventually must reverse into contraction that spawns more contraction. "

This is an excellent description of the financial problem today. But it does not identify the real resulting problems. First, exchange in the private market place is based on sellers and buyers exchanging real (existing) goods and services or extending existing capital (credit) with the expectation that real created (production) capital will be returned to cancel the debt. And rulers do not produce goods but exchange real goods and services created by the private sector for either currency they manufacture or credit instruments which earn interest and are often also promises to return the capital. Both are then largely exchanged in payment of taxes which cancels the debt. But now and recent times governments issue credit to consumers who do not produce or produce too little to ever create production to exchange to cancel the debt. Moreover, the government established financial intermediate system issues that credit to banks that are authorized to use it as the reserve on which to create even more credit both to producers for investment and to nonproductive consumers who will never cancel the debt.
The result is not a financial cycle but a series of increasing rising waves in which more and more credit is issued without offsetting increased production.

Dalio depicts this in graphical form in which he divides his time 'cycle' into phases (the graph does not show a cycle but a wave_). He divides the time into phases - 1 borrowers are using credit to finance new production - stage 2 which is a bubble during which people presume the economic expansion will continue up. Stage 3 is the 'top' when financial institutions and regulators believe conditions are becoming adverse so curtail further expansion of credit which 'moderates' expansion. Stage 4 'happens when growth slows' and business and families curtail spending (consuming). Stage 5 is 'when businesses and families reduce spending to pay their debt. Stage 6 begins a new expansion.


Wealth Gap
Mauldin comments that the above account depicts the time sequence and that Dalio believes we are in the late stages. He then shifts to discuss the social - political situation and potential outcome. This is about the relative ownership of the 'assets' created during the financial expansion phases. The adverse 'side effect' is that 'higher asset prices accrue to asset owners, which most people are not." True, study of Forbes' annual listing of the 400 most wealthy individuals in the U.S. shows that most of them hold paper assets or assets acquired as a result of manipulating 'other people's money' via financial transactions, such as in hedge funds. He addresses the 'wealth gap' between rich and poor and divides the population into a 'top 40% live in a different world than the bottom 60%".
He writes "Already, huge federal deficits will therefore keep growing just as the Federal Reserve both raises rates and reduces its balance sheet assets." This raises the question - just what are these Federal Reserve 'assets'. They are paper - financial instruments which the government itself created either directly or indirectly through the banking system's fractional reserve process. Reducing them reduces the money supply.


A Beautiful Deleveraging:

Mauldin quotes Dalio's concept of a 'Beautiful Deleveraging" This concept is described in terms of four alternatives policies and processes. 1 austerity- spending less - that means consuming less and I commented about that above
2 debt defaults, restructuring - a favorite policy of governments that have debt including in foreign currency
3. Central bank 'printing money' and making purchases" - well that is what the government- banking system is already doing.
4 Transfers of money and credit (of course credit IS money, but many don't understand that) from those who have more than they 'need' to those who have less' - Well, this is what the 'welfare state' is all about and what the governments are already doing through the tax system and subsidies. And this is part of what creates the problem. When the government gives more money (credit) to people who did not produce an equivalent amount but simply consume, the result is prices rise.


IRA Magic

This is an interesting diversion. Here Mauldin describes an investment policy that he notes others use. It is to place one's entire financial assets into a Roth IRA. - including everything -one's business, real estate, as well as investments. Thus, everything expands with capital gains non taxable.



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Jeffrey Friedman - Engineering the Financial Crisis

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Philip Coggan - Paper Promises: Debt, Money and the New World Order

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Peter Wallison - Hidden in Plain Sight: What Really Caused the World's Worst Financial Crisis and Why it Could Happen Again - Ecounter Books

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Charles W. Calomiris - Stephen H. Haber - Fragile by Design: The Political Origins of Banking Crises and Scarce Credit - Princeton Univ. Press

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George Selgin - Floored! - CATO Institute

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Peter Bernholz - Monetary Regimes and Inflation - Edward Elgar, Cheltenham, U.K.


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