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Home > Blogs > Anthony Harrington > Mauldin’s "Endgame" teaches politicians the basics, but are they listening?

Mauldin’s "Endgame" teaches politicians the basics, but are they listening?

Austerity measures | Mauldin’s Anthony Harrington

John Mauldin’s blog “Thoughts from the Frontline” is one of the best financial and economic commentaries around, not least because Mauldin is an avid and skilled collector and presenter of good analysis culled from wherever he can find it, with credit always duly bestowed. His latest book "Endgame: The End of the Debt SuperCycle and How It Changes Everything, written with Jonathan Tepper, is an absolute must read.

The basic thesis, that a 60-year cycle of easy government debt is in its endgame, with bond markets likely to call time at any moment on the current unsustainable Ponzi scheme of endless national debt issuance, is hard to dispute, unless one believes that excessive debt really can keep piling up forever. However, the book is far more than a terse one-line message of doom. It is a rich storehouse of critical charts and complex points made with stunning, and one would think, unignorable clarity.

One of the starker bits in the book is the simple formula that goes to the heart of the feasibility of current austerity measures in the UK and Europe. As Mauldin notes, this formula is not a theory, it is an accounting fact, and as he puts it, if the formula is wrong, then kiss goodbye to 500 years of double entry book-keeping. So it probably isn’t wrong...  The formula is:  C + G – T = 0 (zero). C here is the Domestic Private Sector Financial Balance, G is the Government Fiscal Balance, and T is the Current Account Balance, which means a country’s Trade Deficit or Trade Surplus.  You can play with all three elements, C, G or T, increasing one or decreasing the other, but the formula demands that they always sum to zero. If they don’t then you have entered an extremely unstable position where one or more of the terms are about to adjust dramatically to restore the balance.

What does this formula tell us? It tells us that if C is rising, because consumers are saving and deleveraging, and G is rising, because government is implementing austerity measures and cutting spending (decreasing spending improves the fiscal balance), then T has to be showing a corresponding positive balance that is increasing as fast as the other two. In plain English, the only way on this lovely green planet that the private sector (consumers and business) and government can both shrink their respective inputs into this equation is if the particular country to which we apply the formula is being enormously successful at winning export share away from countries who are already dominating the global export market. And that is a tough trick to pull off, since the big trade surplus countries have wage arbitrage and demographics on their side.

The reverse position, where C and G are negative and T is correspondingly negative is a rather apt description of how the developed world ran up a mountain of easy debt up to the crash in 2008, with easy consumer credit sucking in imports and creating a corresponding trade deficit. Note that the formula is morally neutral: it works if you’re bad, it works if you’re good.

What has happened so far in the UK, the US and Europe is that G has moved strongly negative to meet C gaining in positive value as consumers shrank their debt and saved more. In other words, private debt has become public debt. It also follows, as Mauldin points out, that you can’t run surpluses in both the private and the government sectors and have a trade deficit. For those who are scratching their heads at this, let C=1 and G=1. The formula tells us that T must be 2 (1+1-2 = 0). If T was a negative number, meaning that the country was running a trade deficit, then subtracting a minus number would turn it into a positive number by the rules of arithmetic, and the formula would yield a positive result, not zero.

The formula also makes it plain as day that if you want to turn a trade deficit into a trade surplus, to trade your way out of a grievous debt hole as a country, you can’t have consumers and government both in austerity mode (i.e. aiming to run surpluses). If two of the elements are positive, the third has to be negative. So if, as a matter of fact, your population is paying down debt, by choice, rather than spending, and if you want to trade your way out of trouble as a country, it is sheer accounting illiteracy for government to think that now’s the moment to implement deep spending cuts.

Mauldin quotes from Rob Parenteau’s The Richebacher Letter, published by Agora Financial to make the point with respect to Europe, where austerity is being most loudly supported and practiced as a cure to the present sovereign debt crisis:

"The underlying principle flows from the financial balance approach: the domestic private sector and the government sector cannot both deleverage at the same time unless a trade surplus can be achieved and sustained. Yet the whole world cannot run a trade surplus. More specific to the current predicament, we remain hard pressed to identify which nations or regions of the remainder of the world are prepared to become consistently large net importers of Europe’s tradable products. .... for the sake of the citizens in the peripheral eurozone nations now facing fiscal retrenchment, pray there is life on Mars that exclusively consumes olives, red wine and Guinness...”

It is such a neat formula to ponder. If government starts to monetise its debt, then its assets shrink, which makes G more negative, and the resulting inflation means that the trade deficit will grow, making T more negative as well.

I must admit that I struggle with the detail of an accounting formula that does not have time as one of its parameters and presents us with an eternal present. If consumers are saving, in most economic theories that equates to more investment in capital goods, according to Ludwig von Mises, which means that T should rise as well, but with an almighty lag of anything from eight months to a handful of years. How long does it take a new generation of the machines that make machines to get into the production cycle and to start generating consumer products? Again, anything from several months to several years depending on norms of the various industrial sectors.

Anyway, this is just one nugget from a book that is rich in nuggets. It won’t make you happy, since, as Mauldin says, most economies are now faced with picking from a range of unpleasant to highly unpleasant choices, with no good options available. But at least "Endgame" will leave you with a clearly articulated grasp of how we got ourselves into this mess.

Further reading on austerity measures and stimulus:

Tags: austerity , debt supercycle , demographics , fiscal balance , John Mauldin , stimulus , wage arbitrage
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  1. u289744 says:
    Sun Mar 27 02:30:53 BST 2011

    Mr. Harrington, I'm not sure I understand the following assertion you make: "The formula also makes it plain as day that if you want to turn a trade deficit into a trade surplus, to trade your way out of a grievous debt hole as a country, you can’t have consumers and government both in austerity mode (i.e. aiming to run surpluses)." Per C + G - T = 0 (with a positive 'T' consistent with a trade surplus), isn't it true that having both consumers and government in austerity mode (e.g. both running a surplus ) is one way to ensure a trade surplus? You then go on to say, "If two of the elements are positive, the third has to be negative." You seem to be contradicting your point earlier in your commentary referencing the simple mathematical identity. If C and G are both positive, must not T be positive as well? In other words, if T isn't also positive, the equation doesn't balance.
  2. rob-parenteau says:
    Sat Mar 26 17:15:51 GMT 2011


    Very helpful translation of the points John raised in his book with respect to how the various sector financial balances have to be considered in an interactive fashion when we talk about major changes in fiscal policy. There is just one section you may want to clarify:

    "So if, as a matter of fact, your population is paying down debt, by choice, rather than spending, and if you want to trade your way out of trouble as a country, it is sheer accounting illiteracy for government to think that now’s the moment to implement deep spending cuts."

    It is possible to have a domestic private sector running a financial surplus (spending less than it is earning, or equivalently, saving more than it is investing), and a government running a fiscal surplus, while the current account (or trade) balance is in surplus. You can see in your version of the sector financial balance identity, if C and G are positive, then T must also be positive, as the accounting indentity is C + G - T = 0.

    I think what you may be trying to say is that if the domestic private sector is attempting to run a net saving position in order say to pay down private debt, and policy makers decide it is time to increase the government fiscal balance (say, reduce a fiscal deficit), they better be aware at the same time they need a plausible way to increase their trade balance in an offsetting fashion.

    Otherwise, the hike in taxes and the reduction in government expenditures willl merely drain cash flow from the domestic private sector and either thwart their attempt to run a positive financial balance, or lead to lower income levels, or more likley, some combination of the two. This of course reduces the ability of domestic firms and businesses to service existing private debt loads and reduce private debt outstanding.

    By the way, you can see how this is also relevant to Allan Meltzer's criticism of Paul Krugman that you also have posted recently on your excellent website. It is possible to have the economy grow when fiscal policy is restrictive as long as, at the same time, you have an improving trade balance or a domestic private sector willing and able to reduce its financial balance (net save less, or deficit spend more).

    In the case of Margaret Thatcher's success in reducing the fiscal deficit, all the improvement in the trade balance was over by 1981, and it deteriorated dramatically until the end of her administration. Growth was possible because the domestic private sector was willing and able to reduce its net saving position and adopt and increasing deficit spending path of its own. The consequence was a build up of private debt in the Lawson boom, which eventually came home to roost in the 1990-2 bust.

    So Allen Meltzer is technically correct, naive Keynesians are being far too dogmatic when they assert economic growth is impossible while the fiscal balance is rising. But he also needs to acknowledge that growth can only be possible during a fiscal consolidation if at the same time, the trade balance can improve, or the domestic private sector can raise its spending out of its income flows, in a sufficiently offsetting fashion. In the latter case, he must also recognize this can often involve heavy reliance on private credit growth and asset price bubbles, and so can end in tears with episodes of financial instability, as we have seen time and again over the past three decades.

    Simply put, as laudable as the goals of fiscal consolidation may be, we are foolish to remain blind to the impliciations for the financial balances of the remaining sectors of the economy. Plausible paths forward have to recognize and work with the interactions between the fiscal balance, the trade balance, and the domestic private sector financial balance. We need a more coherent and consistent stock/flow approach to macroeconomics. Thank you for helping to communicate that to your audience.


    Rob Parenteau, CFA

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