When a California bond trading magician and a conservative Texas financial writer open general sessions at a financial conference by quoting Lenin and Marx, one might presume something is rotten in more places than the state of Denmark, where one-year government bonds recently boasted negative yields. But they are exactly whom online newsletter editor John Mauldin and DoubleLine Capital CEO Jeffrey Gundlach quoted at the third annual Innovative Alternative Strategies conference in Denver in late July.
Both of these two serious thinkers addressed a series of issues that have come to dominate the national dialogue, offering different perspectives on what is emerging as a general consensus that something is profoundly wrong. For starters, the average American male has seen his real income decline since 1973.
Though Marx died in 1883, he lived long enough to grow displeased with how many were interpreting his ideas. Explaining how frequently human events can turn in a direction very few expect, Gundlach quickly moved on to another discredited economic practitioner, Herbert Hoover. In his memoirs, the former president described the world's shock at the outbreak of World War I. After 50 years of peace, the "evil spirits" that erupted in 1914 caught many sophisticated observers, Hoover included, off guard.
Change and innovation can sometimes bring societal structure and property relations into conflict with each other, Gundlach said, adding he wouldn't be stunned if the current austerity policies being implemented in Spain, where youth unemployment exceeds 50%, and Greece ignited civil wars. While both keynoters devoted a major part of their talks to Europe, Gundlach noted that pockets of America are displaying the same symptoms as the continent across the Atlantic. Detroit has halted street repairs and is turning lights off in 60% of the city.
Exacerbating these issues is that both the U.S. and Europe have tried to maintain an unnatural level of stability "with guardrails of debt." Between 2002 and 2010, the financial markets bought into former vice president Dick Cheney's theory that "deficits don't matter," Gundlach argued. Then two years ago, markets decided that "it is a real problem."
Myriad sovereign debt crises may have jolted today's generation of investors, but both speakers maintained they were hardly new developments. Greece has spent nearly half the last 210 years in default or restructuring while Germany spent about 12% of the same period in a similar state.
Since the advent of the euro, Germany has embarked on "a solo journey to full employment," Gundlach declared. Producing a chart comparing 20 years of industrial production in Germany and Italy, one could see the two nations marching in lockstep until 2000, when German manufacturing took off while Italian production entered a period of secular decline. In retrospect, one reason the new currency was so beneficial to Germany was that the deutsche mark was undervalued at the euro's inception, while many other euro zone nation currencies were richly priced.
Meanwhile, scarcely a week goes by without some minor and major scandal-from Libor price fixing to HSBC's money laundering to Peregrine's and MF Global's disappearing client funds to JP Morgan's London whale-spawned from the financial business, Gundlach noted. Two days after he spoke, Knight Capital's new software program ran wild and the brokerage firm couldn't turn it off. U.S. investors and regulators simply yawn as they "collectively hold their hands over their ears," Gundlach argued.
The economy and financial markets aren't the only locus of social imbalances. Since 1960, the top 0.01% of the population have seen their effective tax rates fall by about 50%, while those taxpayers in the 40th through 80th percentiles saw their taxes rise slightly, Gundlach claimed.
"You could see a humongous tax increase in the next four years," he said, if the "Taxes Are Too Damn Low" Party gets its way against the "Spending Is Too Damn High" Party. "Stocks with huge embedded capital gains could get hammered at year end."
Rebounds from recessions have grown weaker and weaker since the U.S. embarked on its epic debt binge in the 1980s and "started borrowing and giving it to the rich guys," Gundlach contended, adding that borrowing and squandering might be a better term. "Property relations really aren't working. No wonder we can't get along."
In such an uncertain world, Gundlach believes investors can be successful if they can position their portfolios for several different scenarios. Those scenarios include inflation, deflation, continued anemic growth and a global financial crisis.
Lenin was only one of two leaders of the late Soviet Union to graduate from a university and Mauldin began his talk by citing his remark that there are "decades when nothing happens and weeks when decades happen." In 2001, for example, the euro enjoyed a successful debut within months of the September 11 attacks and China's admission to the World Trade Organization. All three events are still profoundly affecting our lives today.
Mauldin's focus was on the endgame of a 30-year debt super cycle and the resolution of the debt crisis and the chronic federal budget deficit in America. "If we [the U.S.] can get through the deficit crisis, we can still be the biggest, baddest dude on the block," he said.
In contrast, Europe is "screwed." Mauldin believes the continent faces nothing but downside. "We have a choice with potential upside," he contended.