If there ever was a time to read Endgame, it is now. The full title gives a stronger message about what the book addresses: Endgame: The End of the Debt Supercycle and How It Changes Everything by John Mauldin and Jonathan Tepper.
I have had this book for over a year, finished reading it all the way through shortly after receiving it and have returned to reread various sections several times since. It is a book that will keep coming off the book shelf for further review long after the first reading.
There is a strange sensation when reading this book for anyone who, like me, has read John Mauldin's weekly epistles to the multitudes for quite a number of years; it is like reading something written by a family member. There is a long-familiar style that permeates every page, even though the book has a skilled co-author in Jonathan Tepper.
Some of the arguments and discussions presented are in fact related to things that have appeared in weekly newsletters. And yet the book seems fresh and cogent on its own merit - definitely not a rehash of anything that came before.
This book is especially valuable this summer because it appears that the eurozone may finally make some definitive moves to resolve the political crisis, which ultimately is what they have. The debt and economic issues are merely symptoms of the underlying political mess. Mauldin and Tepper have written a guide book for the debt and economic burdens that must be resolved by the various portions of the eurozone and the rest of the EU (European Union) in Part Two of the book (A World Tour: Who Will Face Endgame First?), which is divided between the U.S. (Chapter Nine, 40 pages) and the rest of the world (Chapters Ten through Fifteen, 78 pages with 31 devoted to Europe).
Considering themes that run through the book, one would be "We should have known better." That idea is found in the introduction and repeatedly throughout the book, right up to Chapter Fifteen "Unintended Consequences" where the authors write (p. 287):
…many, if not all of the bubbles that have occurred since the Dutch Tulip Mania in the seventeenth century have been precipitated by a combination of financial liberalization and innovation.
The "should have known better" argument reappears throughout the book in different forms. Perhaps the best example is Chapter Five, "This Time is Different". This chapter is devoted to a discussion with the authors of the book with the same title (Carmen Reinhart and Kenneth Rogoff). This reviewer found the discussion created a metaphoric image: The blasé attitude of the dancers in the ballroom of an economic boom cruise ship remain oblivious to the fact that every once in a while that ship can be an HMS Titanic until they find themselves in salt water surrounded by ice floes.
The conclusion is obvious, we should have known better than to assume that no more disasters could affect us. Yet the authors leave a lingering doubt with this reader that they have the opinion we still may not "know better" and that past ignorance may still be a player in future events.
And the future events still have a long way to go to complete the drama entitled "The Endgame." Right at the start of Chapter One, the crisis of 2007-08 is labeled "Act I, The Beginning of the End," an act that consumed 60-years following the end of World War II.
If this book has one overriding positive quality, it provides a plain language summary of the majority of economic thinking regarding the debt bubble that has built up over the past decades. That quality will make this a very worthwhile book for the average man on the street. The authors stated (p. 181):
… we purposefully set out to write so simply that even a politician could understand the nature of our problems.
Unfortunately, this strength is also the book's greatest weakness; thinking outside the economic mainstream is not included to any great extent. That leaves some of the economic observations hanging in mid-air for this reviewer.
Origins of the Problem
Chapter One is an excellent outline of how we got where we are. It also presents a good summary outline of the various ways we may get out of the problem. A very important point is emphasized on p. 25 about the nature of the decline in household debt in the United States (emphasis from the book):
The extremely important point is this: for the most part, debts have not been extinguished, merely transferred. Debt is moving from consumer and household balance sheets to the government.
A clear consequence of reversing this debt transfer, or even stopping it from proceeding further, is that the Main Street economy would be further handicapped. The transfer of debt has created increased liquidity (or diminished the loss of liquidity) for those relieved of debt, and thus the broader macro economy is being supported. This relationship was not discussed in the book. This is probably okay after thinking about it, because it is parenthetical to the theme. But it is an example of some of the thoughts I would have liked to have seen discussed, perhaps as a sidebar or a footnote.
In one area, however, Mauldin and Tepper are very clear in this discussion: The problem is global and ultimately the solutions will be global, whether by design or the natural consequences of individual countries pursuing "beggar thy neighbor" policies (my words summarizing what they wrote, not actual words from the book).
Discussion of Money
One discussion this reader wished were included would have expanded on the stated view that the U.S. sovereign debt increases are either a repayment burden for the future or a giant Ponzi scheme. The authors do not further address the question of how money can be expanded to meet growing demand from increasing population numbers and economic growth.
There is a view becoming more widely discussed that increased sovereign debt is merely one mechanism for expanding the money supply to meet real economic need (but perhaps not the most efficient way of accomplishing that objective). The economic theories at play here distinguish government debt for countries with sovereign floating currencies (e.g. China, Japan, Australia, Canada and the U.S.) from private sector debt and sovereign debt for countries that use a currency they do not control (countries that peg to the dollar - or any other currency - and the eurozone).
The authors clearly understand the differences between sovereign currencies and non-sovereign. See, for example, p. 216, where they discuss the shortcomings of the euro as currently implemented. They conclude:
Europe has almost none of these [requirements for an optimal currency area]. Very bluntly, this means it [eurozone] is not a good currency area.
However, for some readers the significance of that statement may be lost without considerably more hand-holding than the authors provide.
Inflation and Deflation
The authors suggest that for major economic powers the future is a fairly sharp contrast of two possible outcomes (p. 294):
The future in many parts of the world - the United States, the United Kingdom, Europe and Japan - is fairly binary. Either the forces of deleveraging will lead to long, crushing deflation, or the policy responses will succeed in leading to devaluations and inflation.
They are more specific on p. 295:
Where do we stand on the issue of deflation versus inflation? We think we'll have both. Deflation first, and then inflation.
Mauldin and Tepper discuss both the deflationary cycle and the inflationary cycle in the end game. In fact, simply by page count, Chapter Seven "The Elements of Deflation" covers 24 pages and is 1/3 longer than Chapter Eight "Inflation and Hyperinflation" (18 pages). By the "dropping of the thesis down the stairwell technique" the discussion of deflation wins hands down.
Both chapters are well worth reading and the stairwell test should not be the readers' only test of value.
The discussion of hyperinflation draws heavily on the work of Peter Bernholz "Monetary Regimes and Inflation". The authors state (p. 170):
Digging yourself deeper in an inflationary situation is what economists call the Tanzi effect, after the economist who discovered it.
The actual statement by Bernholtz (which the authors do not reference at the point they make the above statement) is far more nuanced than the quote above indicates. From Bernholtz (p. 84) with emphasis added by the reviewer:
There is, however, one other possible explanation, namely that the budget deficits were caused by inflation. And in fact, there is empirical evidence that budget deficits are increased because of high inflation (the so-called Tanzi (1977) effect, which had, however, already been stated by Bresciani-Turroni (1937, p. 66 ff.). Since government expenditures lag its tax and other revenues, the purchasing power of these revenues is diminished until they are spent, and this the more the higher the rate of inflation. As a consequence the real budget deficit grows, if the amount of real expenditures is maintained.
In other words, Bernholtz suggests that inflation increases government deficits and not the reverse. Recognizing this would bring one to an entirely different set of possible solutions than are suggested by many, including Mauldin and Tepper. At the very least, discussion should center on treating the disease (inflation) first rather than simply addressing the symptom (government deficits). It is perhaps not completely fair to bring this up in this review, since these thoughts are not ones that are found in the main stream of economic thinking which is what the authors are reporting.
But, of course, dealing with inflation is something we have to get to after avoiding the deflation trap. That is a continuing battle, as cited by Joe Wiesenthal at Business Insider:
The problems of Spain, Italy, and Greece are often pointed to as being somehow bleeding-edge, canaries in the coal mine that serve as warnings to other governments of what might happen if they don't get their acts together. But the real story today is just the opposite. The world is experiencing whatever the reverse of a sovereign debt crisis is, as borrowing costs for government are plummeting EVERYWHERE.
And that ongoing deflation risk has been summarized by the observation of Warren Mosler:
We so fear becoming Greece that we risk becoming Japan.
The Eurozone Crisis
The authors discuss how the modern euro functions in a manner analogous to a gold standard. This creates the addition of internal stresses on local (national economies) because the adjustments available through exchange rate arbitrage are not available.
The discussion of the eurozone and the larger EU are as good a plain language discussion as I have read. (This comprises almost 15% of the book, Chapters Ten, Eleven and Thirteen.) They correctly include the monetary accounting balance sheet identities for nations (p. 227) - and this is done in a way that anyone can quickly understand. They also have a thorough but brief discussion of the "Latvian Austerity Miracle" (p. 243-44) which has recently been touted by some as a "proof that austerity works" and criticized by others. In material written almost two years ago the authors got a summary of the facts correct, long before the situation was being so widely discussed.
Alternative Economic Thinking
Mention of the work of Minsky's students and similar thinkers like Randy Wray, Warren Mosler, Steve Keen and Bill Mitchell would have added some further depth to the discussion of how to manage the debt super cycle end game. In fairness to the authors, though, I expect they did not intend to write a book on monetary theory, so I am willing to let them wrestle in a future work with how potential changes in monetary system management might affect the economy and investors.
However, hopes were raised early on that there might be some of this discussion coming in this book when they wrote (p. 17):
Stability leads to instability, and success breeds its own undoing.
This statement reflects on what would be a summation of Minsky's life work. But there was no direct follow-through later in the book, which was a disappointment for this reviewer.
I would suggest a worthwhile future focus on how and why the end game for many sovereigns is not resulting in soaring interest rates. As pointed out in the quote earlier from Joe Wiesenthal at Business Insider, while Spain, Italy and Greece struggle with Draconian interest rate burdens, in most parts of the world interest rates have plummeted. Perhaps further analysis could address whether the Bernholtz interpretation of historical data (discussed above) has a corollary which reflects on the cause and effect relationships between government deficits and deflation. Yes, as already mentioned, the authors did say deflation first and then inflation, but that overview leaves an infinite number of possible paths open.
Another area of research that I wish had been included is the work of Steve Keen which has concluded that:
(1) the real problem with the debt bubble is with private debt rather than public debt; and
(2) that economic growth is empirically related to the second derivative of debt vs. time (i.e., the acceleration of debt) more than it is to the first derivative (growth of debt).
The implication of this research is that all that is needed to increase economic growth when private debt is contracting (negative first derivative with respect to time) is a decrease in the magnitude of the negative rate of contraction (positive second derivative). This is in contrast to driving as fast as possible to the end of debt contraction, which is a popular position among so-called austerians.
Again I may be opening doors into complicated areas that would have doubled the length of the book and removed much of the mass audience that the authors hope to reach. How many people would consider reading a 700-800 page book on the credit crisis? I dare say Mauldin and Tepper might reduce potential book sales by well more than half if they had doubled the length of their book. The purpose of the book is, of course, to start educating a wider public audience, more than to sharpen the understanding of a few.
However, that doesn't stop me from wishing that the book did just mention some of the new economic thinking that is outside the neoclassical mainstream.
A Few Boo-Boos
As much as I like this book and recommend it, there are a few things that I think miss the mark. Some are comments made in passing and others concepts the authors developed in at least a little detail. A few examples:
p. 60: The authors argue that stimulating consumption in a balance sheet recession is useless yet they never discuss whether stimulating private balance sheets would be a good or bad idea.
p. 111: Government debt is compared to mortgage debt, a bad analogy since no mortgagor can legally coin or print money.
p. 122: The authors state that government debt and spending do not increase productivity. This is not really true in all cases and that is not recognized in the book. To be true we would have to accept that government built infrastructure (highways, airports, etc.) do not increase productivity. And what about the government expenditures to start the internet? The internet is probably one of the greatest productivity improvement vehicles of all time, with the interstate highway system not too far down that same list.
p. 131: The authors indicate that monetizing the debt of a monetarily sovereign country (i.e. creating more money to cover growing economic needs) results in inflation. The fact that this is a theory accepted by a large majority of economists does not make it true. There are economists who argue that no such result (inflation) is a given with proper monetary and fiscal policy management. This possibility is not mentioned in the book.
p. 148: The authors repeat a statement that is found in almost every basic economic textbook: "Government debt crowds out savings and investments." The fact that this fallacious statement is repeated by so many textbook authors still does not make it true. This is demonstrated in a recent article by German economist Dirk Ehnts, entitled "The Picture That Quashes 50 Years of Economic Malarky", which contains the following graph:
click to enlarge image
There is a clear correlation with increases in government debt corresponding to increases in private investment and vice versa. The accounting system for money balances called Modern Monetary Theory has at its core the accounting relationship showing increases in public debt correspond directly to increases in private savings. The authors do discuss money velocity relationships (p. 140-144), but that discussion does not cover the explosive increase in both public debt and private investment since the peak in the velocity of money in 1997.
Now, a reality check is in order. The authors were not attempting an economic textbook; they were not producing their own economic research. Their purpose was to report on the thinking prevailing in the world within the political and economic community. The authors are reporting on the situation in the world and what the predominant thinking is regarding that situation. A reader, such as this reviewer, who tries to focus on what is not known, will find what I have called a "few boo-boos" in this book. But these do not detract from the superb job the authors have done in summarizing mainstream economic thinking.
Do not avoid this book because it does not analyze the shortcomings of neoclassical theory. That was not the authors' objective.
Advice for Investors
Mauldin and Tepper discuss at several points in the book, but mostly in Chapter Fifteen and the Epilogue, what all this means for investors. Their comments are probably more general than some investors would prefer, but they do make sound suggestions of sectors to remain on the investor radar screen: biotech, telecommunications, electronic technology, energy technology and emerging markets. They also give quite specific asset class recommendations for investing in a deflationary environment and another set for an inflationary environment.
This book is highly recommended as a plain language dissertation on the nature of the global debt bubble and some of the resolutions that may obtain. It does not give a prescription for how the crisis will be worked out; but it does outline some of the paths that may be followed. The authors go out of their way to be non-judgmental and discuss the need for political decisions to be made, not just economic choices.
This is a book that can be understood by those who are quite unschooled in the world of political economy and how the financial world works. At the same time it is a worthwhile reading for those who are much more knowledgeable in the arcane intricacies of economic theory and national/global government politics. There are some technical details that are not quite correctly presented in this reviewer's opinion and others that are very correct and at the same time presented succinctly, a difficult task for the subject.
And, as I stated at the beginning, if there ever was a time to read Endgame, it is now.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.