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Marks and Klarman: There’s No Free Lunch

Posted by Larry Doyle on August 8, 2013 9:01 AM |

What will future generations do with the massive tab that has been and continues to be run up under the guise of propping our economy?

That is not a rhetorical question.

Many individuals far wiser than I maintain that we will experience generational defaults as our children and children’s children determine that the bills being left to them are not worth paying or able to be paid. That day may not be all that far off. In fact, it has already come in selected municipalities in our nation with surely more to follow.

For more on this topic, I thank the regular reader who shared a fabulous read by Oaktree’s Chairman Howard Marks. Those with the time will appreciate the full memo. I welcome highlighting Marks’ concluding comments in which he shares the wisdom of The Baupost Group’s Seth Klarman as well:

A word about the long run: While conditions, confidence and asset prices all seem moderate today, meaning there’s nothing brilliant to say about the short-term outlook, the long term remains worrisome. Because the U.S. is still able to attract capital from abroad and print money, our financial problems aren’t pressing at the moment. But the combination of intractable deficit spending, unsustainable entitlement promises and a total dearth of responsible action in Washington certainly raises alarms regarding the future.

Since I see no reason to reinvent the wheel when someone I respect has said something better than I could, I’ll close with a few words from Seth Klarman. Seth doesn’t find much in the things he discusses to inspire confidence, and I agree:

There is no free lunch in economics: if governments could print or borrow money in astronomical amounts without any major adverse consequences, why wouldn’t they always do this, forever avoiding downturns while their countries bask in the sunshine of limitless prosperity?

Indeed it seems clear that prior misplaced confidence in the Fed contributed greatly to years of complacency that turned the 2008 downturn into a full-blown crisis. Of course there will be a price to pay for today’s policy excesses — an equal and opposite reaction. We just haven’t seen it yet.

Will it take the form of a collapse of the dollar and the end of dollar hegemony, high interest rates, failed auctions of U.S. government securities and runaway inflation, a wrenching and protracted downturn requiring exceptional sacrifice, or something else? We will find out soon enough.

In most sectors of the economy — government, individual but also corporate — the U.S. has borrowed heavily to live beyond its means; we have been consuming through easy credit what we otherwise would have had to wait to buy. In the words of Michael Lewis, “Leverage buys you a glimpse of a prosperity you haven’t really earned.”

Asset values are contingent, as Jim Grant once said. But debt is forever. Instead of cutting back on leverage and getting our house in order, government response to the crisis has been to shift unaffordable debt from individual balance sheets onto the national ledger, where every day we owe more than ever before. . . .

I believe it is possible that the average citizen understands our country’s fiscal situation better than many of our politicians or prominent economists. Most people seem to viscerally recognize that the absence of an immediate crisis does not mean we will not eventually face one.

They are wary of believing promises by those who failed to predict previous crises in housing and in highly leveraged financial institutions. They regard with skepticism those who don’t accept that we have a debt problem, or insist that inflation will remain under control. (Indeed, they know inflation is not well under control, for they know how far the purchasing power of a dollar has dropped when they go to the supermarket or service station.) They are pretty sure they are not getting reasonable value from the taxes they pay.

When an economist tells them that growing the nation’s debt over the past 12 years from $6 trillion to $16 trillion is not a problem, and that doubling it again will still not be a problem, this simply does not compute.

They know the trajectory we are on, and that the most successful country in the history of the world can go into decline if it becomes arrogant or complacent. When politicians claim that this tax increase or that spending cut will generate trillions over the next decade, they are properly skeptical over whether anyone can truly know what will happen next year, let alone a decade or more from now.

They are wary of grand bargains that kick in years down the road, knowing that the failure to make hard decisions is how we got into today’s mess. . . .

And when you tell the populace that we can all enjoy a free lunch of extremely low interest rates, massive Fed purchases of mounting treasury issuance, trillions of dollars of expansion in the Fed’s balance sheet, and huge deficits far into the future, they are highly skeptical not because they know precisely what will happen, but because they are sure that no one else — even, or perhaps especially, the policymakers — does either.

Navigate accordingly.

Larry Doyle

Please pre-order a copy of my book, In Bed with Wall Street: The Conspiracy Crippling Our Global Economy, that will be published by Palgrave Macmillan on January 7, 2014.

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I have no business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.


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