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Outside the Box is a free weekly economic e-letter by best-selling author and renowned fnancial expert,

John Mauldin. You can learn more and get your free subscription by visiting www.mauldineconomics.com
1
Hoisington Investment Management Quarterly Review and Outlook,
Second Quarter 2014
JOHN MAULDIN | July 15, 2014
Tis weeks Outside the Box is from an old friend to regular readers. Its time for our Quarterly Review &
Outlook from Lacy Hunt of Hoisington Investment Management, who leads of this month with a helpful
explanation of the relationship between the US GDP growth rate and 30-year treasury yields. Tats an
important relationship, because long-term interest rates above nominal GDP growth (as they are now)
tend to retard economic activity and vice versa.
Te author adds that the average four-quarter growth rate of real GDP during the present recovery is 1.8%,
well below the 4.2% average in all of the previous post-war expansions; and despite six years of federal
defcits totaling $6.27 trillion and another $3.63 trillion in quantitative easing by the Fed, the growth rate
of the economy continues to erode.
So what gives? Were simply too indebted, says Lacy; and too much of the debt is nonproductive. (Total US
public and private debt rose to 349.3% of GDP in the frst quarter, up from 343.7% in the third quarter of
2013.) And as Hyman Minsky and Charles Kindleberger showed us, higher levels of debt slow economic
growth when the debt is unbalanced toward the type of borrowing that doesnt create an income stream
sufcient to repay principal and interest.
And its not just the US. Lacy notes that the worlds largest economies have a higher total debt-to-GDP
ratio today than at the onset of the Great Recession in 2008, and foreign households are living farther
above their means than they were six years ago.
Simply put, the developed (and much of the developing) world is fast approaching the end of a 60-year-
long debt supercycle, as I (hope I) conclusively demonstrated in Endgame and reafrmed in Code Red.
Hoisington Investment Management Company (www.Hoisingtonmgt.com) is a registered investment
advisor specializing in fxed-income portfolios for large institutional clients. Located in Austin, Texas, the
frm has over $5 billion under management and is the sub-adviser of the Wasatch-Hoisington US Treasury
Fund (WHOSX).
Some readers may have noticed that there was no Toughts from the Frontline in their inboxes this
weekend. As has happened only once or twice in the last 14 years, I found myself in an intellectual cul-de-
sac, and there was not enough time to back out. Knowing that I was going to be involved in a fascinating
conference over the weekend, I had planned to do a rather simple analysis of a new book on how GDP
is constructed. But as I got deeper into thinking about the topic and doing more research, I remembered
something I read 20 years ago about the misleading nature of GDP, and I realized that a simple analysis
just wouldnt cut it.
Outside the Box is a free weekly economic e-letter by best-selling author and renowned fnancial expert,
John Mauldin. You can learn more and get your free subscription by visiting www.mauldineconomics.com
2
Rather than write something that wouldve been inadequate and unsatisfying, I decided to just put it of
till next week. Your time and attention are quite valuable, and I try not to waste them. But there will be no
excuses this weekend.
Te conference I attended was organized by Great Point Partners, a hedge fund and private equity frm
focusing on medical and biotechnology. I really had not seen the program until I arrived and did not
realize what a powerful lineup of industry leaders would be presenting on some of the latest technologies
and research. Te opportunity was too good to pass up, as it is so rare that any of us get to sit down with
people who are responsible for the science we all read about.
I had breakfast with a small group of 11 readers/investors one morning and learned a lot by asking them
what their favorite investing passion was. Although everyone had concerns, they all had areas in which
they were quite bullish. I fnd that everywhere I go. It was interesting, in that they all expected me to be far
more negative about things than I am. I guess when you write about macroeconomics as much as I do, and
theres as much wrong with it as there is, you kind of end up being labeled as a Gloomy Gus. I am actually
quite optimistic about the long-term future of humanity, but Ill admit there will be a few bumps along the
way. Given how many bumps there have already been, just in my own lifetime, and given that we seem to
have gotten through them, I cant help but be optimistic that well get through the next round.
It was a fascinating weekend, made all the more so by my very gracious hosts, Jef Jay and David Kroin,
Managing Directors of Great Point. Tey and their staf made sure I could enjoy my time on Nantucket
Island. It was my frst visit to the area, and I hope it wont be the last.
Last night I had dinner with Art Cashin, Barry Ritholtz, Jack Rivkin, and Dan Greenhaus. It was a raucous,
intellectually enlivening evening, and our conversation ranged from macroeconomics to our favorite new
technologies. Jack Rivkin is involved with Idealab, and one of his favorites is that he sees the eventual end
of Amazon as 3-D printing becomes more available. Given how Bezos has adapted over the years, Im not
so sure. Jack and Barry will join me in Maine in a few weeks, where we will again join the debate about bull
and bear markets.
Now lets go to Lacy and think about the intersection of velocity and money supply and what it says about
future growth potential. I have two full days of meetings with my partners and others here in New York
before I return to Dallas, and then I get to stay home for a few weeks. Tere are lots of new plans in the
works. And lots of reading to do between meetings. Have a great week!
Your hoping to be able to stay optimistic analyst,

John Mauldin, Editor
Outside the Box
Outside the Box is a free weekly economic e-letter by best-selling author and renowned fnancial expert,
John Mauldin. You can learn more and get your free subscription by visiting www.mauldineconomics.com
3
Hoisington Investment Management Quarterly Review and Outlook, Second Quarter
2014
Treasury Bonds Undervalued
Tirty-year treasury bonds appear to be undervalued based on the tepid growth rate of the U.S. economy.
Te past four quarters have recorded a nominal top-line GDP expansion of only 2.9%, while the bond
yield remains close to 3.4%. Knut Wicksell (1851-1926) noted that the natural rate of interest, a level that
does not tend to slow or accelerate economic activity, should approximate the growth rate of nominal GDP.
Interest rates higher than the top-line growth rate of the economy, which is the case today, would mean
that resources from the income stream of the economy would be required to pay for the higher rate of
interest, thus slowing the economy. Wicksell preferred to use, not a risk free rate of interest such as thirty-
year treasury bonds, but a business rate of interest such as BAA corporates.
As chart one attests, interest rates below nominal GDP growth helps to accelerate economic activity and
vice versa. Currently the higher interest rates are retarding economic growth, suggesting the next move in
interest rates is lower.
Outside the Box is a free weekly economic e-letter by best-selling author and renowned fnancial expert,
John Mauldin. You can learn more and get your free subscription by visiting www.mauldineconomics.com
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To put the 2.9% change in nominal GDP over the past four quarters in perspective, it is below the entry
point of any post-war recession. Even adjusting for infation the average four-quarter growth rate in real
GDP for this recovery is 1.8%, well below the 4.2% average in all of the previous post-war expansions.
Fishers Equation of Exchange
Slow nominal growth is not surprising to those who recall the American economist Irving Fishers
(1867-1947) equation of exchange that was formulated in 1911. Fisher stated that nominal GDP is equal
to money (M) times its turnover or velocity (V), i.e., GDP=M*V. Twelve months ago money (M) was
expanding about 7%, and velocity (V) was declining at about a 4% annual rate. If you assume that those
trends would remain in place then nominal GDP should have expanded at about 3% over the ensuing
twelve months, which is exactly what occurred. Projecting further into 2014, the evidence of a continual
lackluster expansion is clear. At the end of June money was expanding at slightly above a 6% annual rate,
while velocity has been declining around 3%. Tus, Fishers formula suggests that another twelve months
of a 3% nominal growth rate is more likely than not. With infation widely expected to rise in the 1.5%
to 2.0% range, arithmetic suggests that real GDP in 2014 will expand between 1.0% and 1.5% versus the
average output level of 2013. Tis rate of expansion will translate into a year-over-year growth rate of
around 1% by the fourth quarter of 2014. Tis is akin to pre-recessionary conditions.
An Alternative View of Debt
Te perplexing fact is that the growth rate of the economy continues to erode despite six years of
cumulative defcits totaling $6.27 trillion and the Federal Reserves quantitative easing policy which
added net $3.63 trillion of treasury and agency securities to their portfolio. Many would assume that such
stimulus would be associated with a booming economic environment, not a slowing one.
Readers of our letters are familiar with our long-standing assessment that the cause of slower growth is the
overly indebted economy with too much non-productive debt. Rather than repairing its balance sheet by
reducing debt, the U.S. economy is starting to increase its leverage. Total debt rose to 349.3% of GDP in the
frst quarter, up from 343.7% in the third quarter of 2013.
It is possible to cast an increase in debt in positive terms since it suggests that banks and other fnancial
intermediaries are now confdent and are lowering credit standards for automobiles, home equity, credit
cards and other types of loans. Indeed, the economy gets a temporary boost when participants become
more indebted. Tis conclusion was the essence of the pioneering work by Eugen von Bhm-Bawerk
(1851-1914) and Irving Fisher which stated that debt is an increase in current spending (economic
expansion) followed by a decline in future spending (economic contraction).
In concert with this view, but pinpointing the negative aspect of debt, contemporary economic research
has corroborated the views of Hyman Minsky (1919-1996) and Charles Kindleberger (1910-2003) that
debt slows economic growth at higher levels when it is skewed toward the type of borrowing that will not
create an income stream sufcient to repay principal and interest.
Scholarly studies using very sophisticated analytical procedures conducted in the U.S. and abroad
document the deleterious efects of high debt ratios. However, the use of a balance sheet measure can be
criticized in two ways. First, income plays a secondary role, and second, debt ratios are not an integral part
of Keynesian economic theory.
Outside the Box is a free weekly economic e-letter by best-selling author and renowned fnancial expert,
John Mauldin. You can learn more and get your free subscription by visiting www.mauldineconomics.com
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We address these two objections by connecting the personal saving rate (PSR) which is at the core of
Keynesian economic analysis, and the private debt to GDP ratio that emerges from non-Keynesian
approaches. Our research indicates that both the Non-Keynesian private debt to GDP ratios, as well as
the Keynesian PSR, yield equivalent analytical conclusions.
The Personal Saving Rate (PSR) and the Private Debt Linkage
Te PSR and the private debt to GDP ratio should be negatively correlated over time. When the PSR
rises, consumer income exceeds outlays and taxes. Tis means that the consumer has the funds to either
acquire assets or pay down debt, thus closely linking the balance sheet and income statement. When the
PSR (income statement measure) rises, savings (balance sheet measure) increases unless debt (also a
balance sheet measure) declines, thus the gap between the Keynesian income statement focus and the non-
Keynesian debt ratio focus is bridged.
Te PSR and private debt to GDP ratio are, indeed, negatively correlated (Chart 2). Te correlation should
not, however, be perfect since the corporate sector is included in the private debt to GDP ratio while the
PSR measures just the household sector. We used the total private sector debt ratio because the household
data was not available in the years leading up to the Great Depression.
Outside the Box is a free weekly economic e-letter by best-selling author and renowned fnancial expert,
John Mauldin. You can learn more and get your free subscription by visiting www.mauldineconomics.com
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Te most important conceptual point concerning the divergence of these two series relates to the matter of
the forgiveness of debt by the fnancial sector, which will lower the private debt to GDP ratio but will not
raise the PSR. Te private debt to GDP ratio fell sharply from the end of the recession in mid-2009 until
the fourth quarter of 2013, temporarily converging with a decline in the saving rate. As such, much of the
perceived improvement in the consumer sectors fnancial condition occurred from the eforts of others.
Te private debt to GDP ratio in the frst quarter of 2014 stood at 275.4%, a drop of 52.5 percentage points
below the peak during the recession. Te PSR in the latest month was only 1.7 percentage points higher
than in the worst month of the recession. Importantly, both measures now point in the direction of higher
leverage, with the PSR showing a more signifcant deterioration. From the recession high of 8.1%, the PSR
dropped to 4.8% in April 2014.
Historical Record
Te most recently available PSR is at low levels relative to the past 114 years and well below the long-term
historical average of 8.5% (Chart 3). Te PSR averaged 9.4% during the frst year of all 22 recessions from
1900 to the present. However this latest reading of 4.8% is about the same as in the frst year of the Great
Depression and slightly below the 5% reading in the frst year of the Great Recession.
Outside the Box is a free weekly economic e-letter by best-selling author and renowned fnancial expert,
John Mauldin. You can learn more and get your free subscription by visiting www.mauldineconomics.com
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In Dr. Martha Olneys (University of California, Berkeley and author of Buy Now, Pay Later) terminology,
when the PSR falls households are buying now but will need to pay later. Contrarily, if the PSR rises
households are improving their future purchasing power. A review of the historical record leads to two
additional empirical conclusions. First, the trend in the PSR matters. A decline in the PSR when it has
been falling for a prolonged period of time is more signifcant than a decline afer it has risen. Second, the
signifcance of any quarterly or annual PSR should be judged in terms of its long- term average.
For example, multi-year declines occurred as the economy approached both the Great Recession of 2008
and the Great Depression of 1929. In 1925 the PSR was 9.2%, but by 1929 it had declined by almost half to
4.7%. Te PSR ofered an equal, and possibly even better, signal as to the excesses of the 1920s than did the
private debt to GDP ratio. Both the level of PSR and the trend of its direction are signifcant meaningful
inputs.
John Maynard Keynes (1883-1946) correctly argued that the severity of the Great Depression was due
to under-consumption or over-saving. What Keynes failed to note was that the under-consumption of
the 1930s was due to over-spending in the second half of the 1920s. In other words, once circumstances
have allowed the under-saving event to occur, the net result will be a long period of economic under-
performance.
Keynes, along with his most famous American supporter, Alvin Hansen (1887-1975), argued that the U.S.
economy would face something he termed an under-employment equilibrium. Tey believed the U.S.
economy would return to the Great Depression afer World War II ended unless the federal government
ran large budget defcits to ofset weakness in consumer spending. Te PSR averaged 23% from 1942
through 1946, and the excessive indebtedness of the 1920s was reversed. Consumers had accumulated
savings and were in a position to fuel the post WWII boom. Te economy enjoyed great prosperity even
though the budget defcit was virtually eliminated. Te concerns about the under-employment equilibrium
were entirely wrong. In Keynes defense, the PSR statistics cited above were not known at the time but have
been painstakingly created by archival scholars since then.
Implications for 2014-2015
In previous letters we have shown that the largest economies in the world have a higher total debt to GDP
today than at the time of the Great Recession in 2008. PSRs also indicate that foreign households are living
further above their means than six years ago. According to the OECD, Japans PSR for 2014 will be 0.6%,
virtually unchanged from 2008. Te OECD fgure is likely to turn out to be very optimistic as the full
efects of the April 2014 VAT increase takes efect, and a negative PSR for the year should not be ruled out.
In addition, Japans PSR is considerably below that of the U.S. Te Eurozone PSR as a whole is estimated at
7.9%, down 1.5 percentage points from 2008. Tus, in aggregate, the U.S., Japan and Europe are all trying
to solve an under-saving problem by creating more under-saving. History indicates this is not a viable path
to recovery. [reference: Atif Mian and Amir Suf,. House of Debt, University of Chicago Press 2014]
Japan confrms the experience in the United States because their PSR has declined from over 20% in the
fnancial meltdown year of 1989 to todays near zero level. Japan, unlike the U.S. in the 1940s, has moved
further away from fnancial stability. Despite numerous monetary and fscal policy maneuvers that were
described as extremely powerful, the end result was that they have not been successful.
Outside the Box is a free weekly economic e-letter by best-selling author and renowned fnancial expert,
John Mauldin. You can learn more and get your free subscription by visiting www.mauldineconomics.com
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U.S. Yields Versus Global Bond Yields
Table one compares ten-year and thirty-year government bond yields in the U.S. and ten major foreign
economies. Higher U.S. government bond yields refect that domestic economic growth has been
considerably better than in Europe and Japan, which in turn, mirrors that the U.S. is less indebted.
However, the U.S. is now taking on more leverage, indicating that our growth prospects are likely to follow
the path of Europe and Japan.
With U.S. rates higher than those of major foreign markets, investors are provided with an additional
reason to look favorably on increased investments in the long end of the U.S. treasury market.
Additionally, with nominal growth slowing in response to low saving and higher debt we expect that over
the next several years U.S. thirty-year bond yields could decline into the range of 1.7% to 2.3%, which is
where the thirty-year yields in the Japanese and German economies, respectively, currently stand.
Van R. Hoisington
Lacy H. Hunt, Ph.D.
Outside the Box is a free weekly economic e-letter by best-selling author and renowned fnancial expert,
John Mauldin. You can learn more and get your free subscription by visiting www.mauldineconomics.com
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