week we survey the economic landscape that the new president will
inherit. It is a polite understatement to say that he will be getting a
serious mess. In reality, the US goes to the polls this next Tuesday to
elect a Janitor-in-Chief. He will face a task that rivals that of
Hercules in cleaning out the Stygian stables (legendary huge stables
that had not been mucked out for ten years). However, there are no
convenient rivers at hand for a probable President Obama to redirect
that will quickly be able to clean out the mess left in the stables of
our economy. This will indeed be an Herculean task and one that will
take most of the first term of the next administration. So, let's look
at what will face the next president. It should make for an
interesting, even if not optimistic, letter.
But first, a quick
commercial. My friend Steve Blumenthal at CMG wanted me to remind you
that there are money managers who have been able to create value in
these markets. If you are wondering where to turn to in this rather
difficult environment (to say the least!), I suggest you go to his
website, register, and then let them show you what a blend of active
managers that are on his platform would have done over the past few
months and years. These are primarily managers who will trade a managed
account (using various proprietary styles) in your name and are quite
liquid. And if you are an advisor or broker and would like to see the
managers on his platform and how you can access them for you clients,
sign up and let Steve and his team know you are in the business. The
link is http://www.cmgfunds.net/public/mauldin_questionnaire.asp.
is the firm to which I refer investors who typically have a net worth
of less than $2 million. If you are an accredited investor with a
higher net worth and would like to see what a portfolio of alternative
investments, including hedge funds and actively managed commodity
funds, has done this year, I suggest you go to www.accreditedinvestor.ws
and my partners at Altegris Investments in the US (and Absolute Return
Partners in London and Europe) will be glad to talk with you. And if
you are a registered investment advisor or broker in the US, you should
seriously consider signing up and talking with the team at Altegris.
Some of the solutions they have might be ideal for your clients. (In
this regard, I am president and a registered representative of
Millennium Wave Securities, LLC, member FINRA. Please note that past
performance is not indicative of future results and pay special
attention to all the risk disclosures at the websites and at the end of
this letter.) And now to the letter.
Electing the Janitor-in-Chief
normally do not get into politics in this letter, as my beat is
economics and investing. But this election has large economic
implications. Even though I am a long-time Republican, I can still read
polls. And it looks like Obama will be our next president. (I have
already paid off my bets made last year, for what it's worth.)
let's look at what will be the main problem facing the new president.
George Bush came into office with the country already in recession.
Over time the economy recovered, albeit somewhat slowly. As I have
demonstrated numerous times, the recovery was fueled by Mortgage Equity
Withdrawals. Over 2% and sometimes over 3% of GDP growth in 2002-2006
was the result of rising housing prices, allowing consumers to borrow
against their homes and spend on whatever they chose.
I have used the chart below on a lot of occasions, but as it is central to today's letter. Let's review it.
red bars show how the economy would look without that borrowing power.
George Bush would most likely have been a one-term president, as the
economy would have been in a serious recession for two years, followed
by a very slow recovery of less than a 1% growth in GDP in 2003-04.
Unemployment would have been dismally high. The slogan would have been
"It's the Economy, Stupid" all over again. That was what beat his
father in 1992 and would likely have done it to the son in 2004.
the nation was in fact growing at over 4%, and 9/11 was not so distant
a memory. The focus was on the War on Terror, and Bush won a close
But that is not the situation today. The economy is
in recession. Over one million jobs have been lost in the last 12
months. The preliminary number came out today for third-quarter GDP and
it was down by 0.3%, the first negative quarter since the last
recession. As it is the preliminary number, and does not really have
much data from September, it is likely that future revisions will see
the number be even worse. 1% is not out of the question.
fourth quarter that we are in will again be negative, and even worse
than the third quarter. Bush came in with a recession that started in
the waning months of the Clinton administration, and he will leave his
successor with a much deeper recession and a consumer that is on the
Let's review this table from a few weeks ago. To
understand the real economic problem facing the new administration, you
have to understand this table. These are not normal problems that a
likely President Obama will be facing. The above chart stopped at 2006.
James Kennedy recently updated the data. Notice below how net MEWs have
fallen precipitously in 2008, down 95% from three years ago. On this
data alone, GDP should be off by 3% this year. No wonder we are in
negative economic territory.
In 2005 there was almost $595
billion in mortgage extractions that went into some kind of consumer
spending. Remember, according to the graph above, that translated into
a 3% rise in GDP. In 2007, MEWs were down to $470 billion, for a boost
of 2% to GDP.
second quarter of 2008 saw an anemic $9.5 billion. At that run rate, we
could see a drop-off of well over 90% from 2005! Now, think what the
second quarter would have been without the federal stimulus program of
$150 billion. It might have looked and felt like this quarter!
the economic data which came out today, consumer spending was down
3.1%. You have to go back to the intense and deep recession of 1980 to
find a worse number. And we are just in the middle innings of what is
likely to become a much worse recession.
Can't Borrow on Your Home? Whip out the Credit Card!
did American consumers cut back on borrowing? Not if they had a credit
card! Total loans from commercial banks to consumers grew by $89
billion for the 12 months ending in September. $61 billion of that was
credit card debt, and the amount in recent weeks has exploded. Let's
look at this analysis from my favorite slicer and dicer of numbers,
data-wizard Greg Weldon (www.weldononline.com). Going with a Halloween theme:
MORE 'telling' is the LOPSIDED degree to which Credit Card balance
growth is 'contributing' to total growth in Consumer Loans, a sign of
intensifying 'stress' on consumers, amid accelerating job loss, home
price deflation, and equity-market paper wealth devaluation.
"Even the raging Frankenstein stops to note the shockingly UGLY data details:
Banks, Outstanding Credit Card Balances ... SOARED by an eye-opening +
$7.1 billion in the WEEK ending October 15th, representing a +1.9%
single-week rate of expansion ... or ... nearly ONE-HUNDRED PERCENT
"Even more 'telling' is the 'read' acquired by contemplating the following pair of data FACTS:
* Credit Card Loans, 10 months Sep07-thru-Jul-08 ... up + $29.1 billion
* Credit Card Loans, 10 weeks Aug-08-to-mid-Oct-08 ... up + $32.3 billion
other words, Commercial Bank 'exposure' via the total amount of Credit
Card 'loans' outstanding has risen MORE in the last ten WEEKS, than it
did in the previous ten MONTHS COMBINED !!!
growth in the last ten-weeks, $32.3 billion, or about $600 million per
'shopping day' since the beginning of August ... represents nominal
growth of + 9.3% ... or ... + 48.3% annualized over the last ten weeks.
to American Express, delinquencies on credit payments rose to 4.1% of
all credit outstanding in the 3Q, up from 2.5% in 3Q of 2007, with Bank
of America's rate rising even more steeply, to 5.9% in the quarter.
"Moreover, the 'pool' of loans deemed 'uncollectable' rose to a high 6.7% in the 3Q, soaring from 3.6% last September."[Emphasis mine.]
consumer spending there is has been fueled in part by credit card. Greg
notes this uncomfortable piece of data: the second largest
"merchant-vendor" for credit card use is now McDonalds. This suggests
that many consumers are in serious distress when they need to get their
$4 Big Mac and fries with a credit card.
This is the problem
facing the economy next year. Credit card growth like we have seen in
the last few months has never been sustained at such a level, and is
unlikely to be this time either. This is especially true as credit card
delinquencies have been rising, as noted above.
administration is going to be faced with a retrenching consumer, which
will likely push the economy even deeper into recession. This will of
course result in higher unemployment. In the first year of the next
president's term, he is likely to see another one million people lose
their jobs, pushing unemployment to almost 8%.
in his regular letter, notes the rising levels of the DURATION of
unemployment. It is now over 9 months, close to 38 weeks. As the
recession deepens, this means a lot of people will stop receiving
unemployment benefits. Oh, and of course, unemployment is not good for
consumer spending. And it will put even more pressure on homeowners
behind on their mortgages. And unemployed people do not pay taxes,
widening the deficit.
If you thought the recovery under Bush was
the "jobless recovery," wait until you see the next version without the
benefit of profligate consumer borrowing and spending.
Deficits as High as an Elephant's Eye
in a sadly bipartisan way, aided and abetted by a Bush administration
that simply did not use its veto power, has given the next president
deep and growing deficits. Official projections are close to $500
billion. In a recession that will reduce tax revenues and increase
costs due to rising unemployment? Can you say $600 billion? $700
billion? Add in the costs of bailing out various entities and it could
be much higher. Is a Democratic Congress likely to pass another huge
economic stimulus program? Add another $150 billion.
are likely to continue to slide. Consumers already shell-shocked by
falling home values will face even more pain. Already, one in five
homeowners owe more than the value of their mortgages. That number will
rise. Aging boomers and retirees who thought they would be able to sell
their home as part of their retirement plan now have seen that nest egg
cut by a considerable amount.
The stock market crash has reduced
global wealth by over $16 trillion dollars. A lot of that has been in
US retirement accounts. Consumers are going to start to see the need to
save once again, which of course reduces consumer spending. There are
going to be calls to rescue the consumer and 401k plans.
about this. Broad stock indexes are about where they were almost 11
years ago. If you take inflation into account, you have lost
considerable buying power. What cost $1,000 in 1997 today costs $1287.
Put another way, the inflation-adjusted S&P 500 is 764 instead of
the actual 968 at which it closed today. An entire generation is
beginning to learn that "stocks for the long run" means a lot longer
than most of them thought it meant.
Let's sum it up. Here is
what faces President Obama. The economy is in a recession that is
getting worse by the day. This is the first consumer-led recession in
27 years. Unemployment is rising and the time between jobs is probably
over ten months by the time he takes office. The US deficit is likely
to be soaring above $500 billion. Consumers are retrenching, hit by the
double whammy of falling home prices and seriously lower stock values
and retirement savings.
You will not have the luck of George Bush
to have consumers borrow $500 billion a year from their homes and
resort to a negative savings rate. Banks will be cutting back on
consumer lending, and consumers will be cutting back on spending and
increasing their savings. The economy is unlikely to begin even a slow
recovery until later in 2009, without serious and continuous large
deficit-busting stimulus packages. Even then, the recovery is going to
be prolonged, because the causes of the recession are the bursting of
the twin bubbles of the housing and credit markets. These problems
cannot be solved in a short amount of time. It will be several years
into your administration before the housing market recovers, and the
credit markets will be on life support for some time.
The Fed has
run up its balance sheet by over a trillion dollars. Interest rates
have been cut to less than 1%. There is no cavalry coming from the Fed
to save the economy with more rate cuts.
What are your options?
You have made promises to various constituencies. One is a tax cut for
95% of Americans. The problem is that 47% of Americans do not pay
taxes, so what you are really talking about it a massive expansion of
welfare. But if you use that tax increase on the "rich" to pay for your
"tax cuts" to other Americans, you have no money to pay for other
programs, let alone get anywhere close to a balanced budget.
of course, as each year passes there is less net Social Security income
to the government. If you use your tax increase to fund more expenses
today, you will not have that to fund Social Security in 2017 when the
program goes into a cash-flow deficit. Or, taxes will really have to
rise later in the decade. But then again, that will be another
How do you offer the increased medical
programs you propose if you use the tax increase for tax cuts for 95%
of Americans (read - welfare for 50%) without really busting the
budget? Or any of the $600 billion in programs that you want to see?
your serious economic advisors are going to point out (at least in
private) that raising taxes on the 5% of wealthiest Americans is eerily
similar to what Herbert Hoover did in his administration, along with
legislation to restrict free trade and increase tariffs, which you have
also advocated. Look where that got him and the country.
those "rich" you are targeting are actually small businesses that
account for 50-75% (depending on how you measure growth) of the net new
job growth in the US. When you tax them, you limit their ability to
grow their businesses. Further, you reduce their ability to consume at
a time when consumer spending is already negative.
Reduced consumer spending will be reducing corporate profits and thus corporate tax revenues. Just when you need more revenues.
tax hike in 2010 of the magnitude you currently propose, in a weak
economy, is almost guaranteed to create a double-dip recession. That
will not be good for your mid-term elections. Given that the recovery
from a second recession is likely to be long and drawn out, it would
also make it difficult to get re-elected, as the economy would be the
first and foremost issue.
Both Obama and McCain have said they
are the candidate for change. And the large majority of the country
believes we are headed in the wrong direction and need change. But I am
reminded of a quote attributed to Lord Palmerston, a former prime
minister of England (in the mid 1800s). Queen Victoria was talking of
the need for change in order to help the country. He is reported to
have said, "Change, change, all this talk about change. Aren't things
quite bad enough already?"
We are going to get change. I just hope it is not too much and the wrong kind of change.
Can You Count to 41?
my international readers, it is likely that Obama will be the next
president. The real thing to watch on election night is how many
Republican senators there will be at the end of the evening. Under the
rather curious rules of the US Senate, 41 Senators (out of 100) can
block any given legislation. Things, including polls, are quite
volatile this election. It is possible the Republicans will lose as
many as 9 senators, giving them only 40. If such a thing transpires,
and there is a real possibility it might, the changes we will see will
be epochal in nature.
You have only to look at the legislation
the House of Representatives passed this last session, only to have it
blocked in the Senate, to see what would soon become the law of the
land. Let's just say trial lawyers, unions, and far-left liberals will
be happy. Those who believe in free trade and lower taxes will not. And
it will not be change that can be "fixed" if Republicans ever get back
to power. It is unlikely that we will see the day when Republicans will
have the necessary 60 Senators to change things back any time soon.
deserve to have lost control of the House and Senate, as well as the
presidency. They got power and then went on a spending binge, letting
deficits get out of control. Shame on them! I just hope we can keep 41
Senators, to have some check on things. We will see if my countrymen
And maybe we can learn from this near-death experience and
get it right the next time. But we are going to pay a price the next
four years in terms of liberal activist judges who will be around for
decades, a real setback to free trade and lower taxes. The Republic
will survive, as it always has. But it should not have come to this.
Chairs, Moving, and Tony Bennett
Tuesday I went to hear Tony Bennett. He is 82. He still has it. It was
one of the more magical music moments of my life. He put down the
microphone at one point, and with a smooth Les Paul guitar backing him
up, began to sing "Fly Me to the Moon," in the rather large new
Meyerson Symphony Hall in Dallas. The hush in the room was amazing, as
everyone wanted to hear this old favorite. I wondered if he could do it
in such a large hall, but he did. Just Tony, no microphone and a soft
guitar. It was magic. If he comes to a place near you (he is in New
York, New Jersey, and Vegas next month), drop what you are doing and go.
are making plans to move. I will move to a new home in Dallas (leased)
the weekend after Thanksgiving, and then we will move the office into
it in the middle of December. Rather ambitious while trying to write a
book as well. But I look forward to the 5-second commute.
and I are doing about 15 interviews a week with millionaires from all
around the world as part of the research for our new book, Tiffani
asked me to let those of you who have asked to be interviewed to have a
little patience if she has not gotten back to you. We had so many more
volunteers than we ever imagined would come forth. As we plan a series
of books, we will be doing interviews (though not at this pace) for
several years, so it is our intention to get to as many of you as
We have had almost 17,000 people take the survey (25%
from outside the US). We hope to get 20,000. The survey is quite
thought-provoking and takes about ten minutes to complete. If you
haven't taken it yet and want to participate in this research (and we
want everyone to take it, as you don't have to be a millionaire - if
you are reading this, you can take it), please visit: http://survey.frontlinethoughts.com/index.php?sid=12431&lang=en
one of those surveys, I was reminded about my recommendation of the
Health Chair. The interviewee had bought one, and he agreed with me
that it was one of the best investments he had made. I know it has
really helped my back, given how much time I spend in front of a
computer. Lots of people responded to my recommendation last year and
got the chair, and the accolades are still coming in. Freddy V from
Switzerland wrote the designer the following letter, which says it all.
"... recently I had to do some truly tedious work on the compy.
I sat for days and consequently for long stretches of hours on my new
chair. After a few hours my back started with familiar symptoms of pain
coming from the muscles. What did I do? I simply moved the back
supporters into different positions and wowie, the pain disappeared
without me noticing first. I never had to pause, to interrupt my work.
I sat for hours and hours and could do the job without being bothered
by any kind of tiredness or pain. Am I a fan of your health chair, this
is simply outstanding and unbelievable! Congratulations from my side
and a huge thank you for making this possible. I will stay grateful for
a long time. I only hope this chair is surviving me, it will be the
most precious thing my heirs have to fight about. Unless the other two
kids opt for one too... Freddy."
You can read more about the chair by going to: http://www.thehealthchair.com/jmep.html. Your back will thank you.
Have a great week. Let's hope Tuesday is not as scary as it could be.
Your hoping we can count to 41 next Tuesday analyst,
Copyright 2008 John Mauldin. All Rights Reserved
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