John Mauldin: This Time Is Different

I have quoted at length in past letters from Ken Rogoff and Carmen Reinhart’s masterful work, This Time is Different. While the market may have been surprised by such a low jobs number, it is PRECISELY what is typical following a credit crisis, as they demonstrate in their book.

And now the Fed is done with QE2 (except that they will take the mortgage roll-off from their portfolio and use it to buy treasuries), and the fiscal authorities are going to put the brakes on government spending, or at least slow things down.

Everything is very fluid, but the headlines in today’s Wall Street Journal suggest a deal on the order of $4 trillion in on the table. I assume it will be back-loaded, but it is a start. But assume that the first year sees real spending cuts of $200 billion. That is a reduction of 1.5% in GDP. It’s that pesky old equation I keep using:

GDP = C (total consumption) + I (Investments) + G (government Spending) + net exports Now, the literature suggests that the effect on the economy from a reduction in G should be over within about 4 quarters, on average. But then we reduce “G” again the next year. Maybe not by as much overall, but at least by another $50-100 billion. This is going to put a real headwind in the face of economic growth for years, but we simply have to do it or we become Greece.

The economy will already be slowing down. A recession in 2012 is a real possibility if there is any type of shock coming from Europe, and what will happen there is anyone’s guess. I think most European leaders are basing their thinking more on hope than on reality. When Greece defaults there will be a domino effect; you can count on it. And you could actually see a banking crisis before we get actual sovereign defaults.

Gentle reader, you need to understand that the market does not get it. Neither in Europe nor in the US. When someone says the market has already priced in a default, go back and ask them how well the market priced in a crisis in the spring of 2008. The market doesn’t know jack.

I got a lot of internet buzz from a throwaway line in an interview on CNBC in London. I said that if the market knew what Bernanke and the leadership of the central banks talked about after their third glass of wine, the market would wet its pants. That is not to suggest I don’t think Bernanke or Trichet can hold their liquor. It means that they get the problem more than they let on in public and are simply trying to stem as much damage as they can.

Banking crises are followed by credit crises by 2-3 years. It is getting close to that time. We need 3-3.5% GDP growth in the US to really make a dent in jobs. We are not going to get it. There is nothing we can do other than Muddle Through as best we can. Prepare accordingly.

Read the full report PDF.