US Best Outcome?

John Mauldin, in his latest Outside the Box newsletter, presents Gary Shilling’s investment strategies for 2011. Mr Shilling’s picks are based on this expectation:

In our view, the overarching reality that will dominate 2011 and, indeed, the next decade or so is financial deleveraging, as spelled out in our new book, The Age of Deleveraging: Investment strategies for a decade of slow growth and deflation, which was published in November 2010 by John Wiley & Sons.

Mr. Shilling provides 9 buy and sell recommendations for 2011, all of which are reasonable and consonant with his economic outlook. There is no reason to disagree with Mr. Shilling’s picks, if you grant his forecast for the economy. It you see an alternative future, then you would not want his recommendations, as I suspect he would be the first to admit.

It is Mr. Shilling’s overall economic forecast that troubles me. First, let me say that I have not read Shilling’s recent book where he presumably makes the case for “a decade of slow growth and deflation.” I suspect that his scenario is similar to other respected analysts like Mish (Mike Shedlock) who argue deflation rather than inflation. Second, let me say how uncomfortable it is disagreeing with these two gentlemen whose opinions and analysis I respect.

I just do not see how we can have a decade of slow growth and deflation. From an economic policy standpoint, it could and should happen. From a political standpoint I do not see it.  The conflict between good economics and politics is never won by economics.

It seems that Mr. Shilling has produced a normative forecast. By that, I mean he projected a future based on proper economic policies or “what should be.” There is no way to have a decade of slowdown and deflation with continued governmental involvement. The proper policy requires benign neglect on the part of the government — “Don’t just do something, stand there.”

This behavior runs counter to government behavior for the past century.

This stance is opposed to the non-stop interventionism that has occurred since 2008. Continued governmental involvement will end up in a slowdown, but not deflation.

The other way to view the economic crisis is from a positive context where the term positive is to be interpreted as “what is” (or “will be”) as opposed to  the normative “what should be.” Economists, like other social and physical scientists, often are guilty of viewing matters in terms of their particular fields. In focusing on their body of knowledge, they ignore what is generally the most important predictive element — the institutional settings within which decisions are made.

Mr. Shilling’s economics is correct. Government must stop trying to prevent the economy from making the adjustments required to regain balance and growth. Debt must be shed and the distortions built up over decades of government meddling and intervention must be reversed and liquidated. That process would be slow growth as indicated by Mr. Shilling. It also would enable recovery, eventually.

Where I differ is not on economics but on politics. Politicians cannot keep their hands off the economy. For almost a century every minor slowdown has been met with some government initiative to “correct” the “problem.” The advent of Keynesian economics sanctioned politicians to intervene in the economy as a necessary and patriotic act. According to Keynes, an economy without government involvement would not provide full employment.

Mr. Shilling’s forecast can only occur without government involvement. That has not been possible for the last 80 or more years. In my opinion, the only way that would be possible would be via the elimination of government or the lobotimization of most politicians.

What is going to create this change? Why would one expect politicians to exercise benign neglect in a crisis?

Mr. Shilling, in my opinion, has offered a prescriptive of the future based on proper economic policies. I do not believe that proper economic policies will be enacted (or bad ones not enacted).

My projection is not normative but positive. Sound economics is not possible in a political world. Thus, I expect more intervention in the form of jobs programs, other stimulus and Bernanke’s continued use of Quantitative Easing so as to vitiate Mr. Shilling’s projection.

The remedies will not work and will ultimately make matters worse. They are terrible economics, but they are good politics. They are “caring” and serve to possibly kick the can a bit further down the road.

When one views the future in this fashion, a long, slow adjustment of deflation and debt liquidation will not occur. The politicians will not allow it. Their actions will be to prevent an orderly economic correction and likely trigger a destruction of the value of the currency which will produce a inflationary or hyperinflationary depression.

Regardless of who is correct, we are in for some unpleasant times. You pays your money and you takes your chances.