Imagine you are in a space ship hurtling toward a black hole. You might try to turn the ship around and fire the engines full force. The problem is that the blast from your engines only adds mass to the black hole, making its gravitational pull even harder. What do you do? Fire the engines harder to try to hit escape velocity?
That may sound like a silly analogy for our ecnonomy, and it is definitely far from complete. But as the brilliant John Mauldin discusses in his “Thoughts From the Frontline”, the black hole of debt is posing some very unusual economic problems. This “singularity” is, simply put, a place where the normal equations that describe the universe of economics no longer apply. What can we do when everything we know no longer works?
With that analogy in your head, consider that the life of the creation of debt “singularities” is likely one of the strongest driving forces of the long “supercycles” or K-Waves. These are the patterns of “secular”, or long lasting bull and bear markets that come together in one big cycle lasting 50-70 years.
Mauldin cites one of his favorite economists:
Hyman Minsky, one of the greatest economists of the last century, saw debt in three forms: hedge, speculative, and Ponzi. Roughly speaking, to Minsky, hedge financing occurred when the profits from purchased assets were used to pay back the loan, speculative finance occurred when profits from the asset simply maintained the debt service and the loan had to be rolled over, and Ponzi finance required the selling of the asset at an ever higher price in order to make a profit.
The process of moving through business cycles appears to followers of this analysis to be an increasing appetite for debt. “Hedge” debt is taken out even by cautious entrepreneurs in difficult times, but may appear to have lower returns than speculation. As investors gradually stop worrying about debt they eagerly chase return, moving gradually into something like a big Ponzi scam.
That’s when the black hole forms. That’s when the rules break down in a singularity.
Back to the spaceship struggling to break out. Anything that increases debt only adds to the problem, making it necessary for us to have even higher velocity to escape. In this analogy, economic growth is the velocity that will get us away, but it has to be done carefully. Debt that is clearly an investment, or a “Hedge” in Minsky’s terms, is very different from the other kinds of debt.
Then again the best shot we have is to somehow deflect ourselves around the black hole and “slingshot” to safety. Mauldin thinks it’s still possible, and so do I – but it will be difficult.
The US still has the chance to pursue what I call the “glide path” option. We can reduce the deficit slowly, by say 1% a year, while aggressively pursuing organic growth policies such as unleashing the energy and biotechnology sectors, providing certainty to small businesses about government healthcare policies, reducing the regulatory burden on small businesses and encouraging new business startups, creating a competitive corporate tax environment (a much lower corporate tax with no deductions for anything, including oil-depletion allowances), implementing a pro-growth tax policy, etc.
I hope we can forgive Mauldin for sounding a bit like a politician here, but there’s a good chance that what we need to do is this simple. And listening to the debate between Presidential candidates right now tells me that there is very broad agreement. So why doesn’t it happen?
Once again, we are stuck arguing about the hard part, which is serious deficit reduction, before we get to the stuff we generally agree on. Focusing for a moment on what we have in common is almost certainly going to be where we have to go from here.
Back to the spaceship. Imagine the crew arguing among themselves and fighting to grab the controls, breaking down any chain of command and fighting each other rather than the problem. You know what will happen to that group no matter what. Even if escape is unlikely in the best situation, we know that such a crew is definitely dead.