Greatest Moral Hazard, Says Paul McCulley, Is Austerity Here And Now (Mauldin)

Greatest Moral Hazard, Says Paul McCulley, Is Austerity Here And Now

via John Mauldin, Outside the Box

October 3, 2011

The last Thoughts from the Frontline featured an interview of me by Kate Welling. I promised another interview she did with my friend Paul McCulley, who (warning) is a consummate Keynesian. For him (paraphrasing closely), prescribing austerity for the US is like putting an anexoric patient on a diet. While Paul and I are very good friends, we do not agree on what to do about the current morass. But this is Outside the Box, and the point is to have views that I don’t agree with. And Paul is nothing if not an articulate proponent of the neo-Keynesian view. The original publication of his interview in Kate’s letter drew some very pointed comments. Right up the OTB’s alley.

Kate Welling is simply the best at doing interviews and teasing out controversy, but her work is hard to for the average person to access, as it is now just for institutional clients. I have convinced her to break out of her shell and offer it to the retail world. She is working on the “details,” such as price, etc., but in the meantime you can go to and click on How to Subscribe (Individual Investors) and put in your email address and she will get the information back to you. I assume she will offer a free sample or so. Check it out.

And in the interview, Paul talks about what his new “gig” will be after PIMCO. He is working with David Kotok to launch the Global Interdependence Center Global Society of Fellows, a most worthy group and effort, which I heartily applaud. The GIC encourages the expansion of global dialogue and free trade in order to improve cooperation and understanding among nation states, with the goal of reducing international conflicts and improving worldwide living standards. You can learn more at

Tonight I am in Geneva and was hosted by Lord Alex Bridport, founder of one of the largest bond brokerage firms in Europe (if not the largest). I will report back Friday. It is an interesting time to be in the markets. OK, one tidbit. He confirmed that banks (and not just in Europe) are really as bad as they look. And with that note, have a good week!

Your going to be 62 in a few hours analyst,

John Mauldin, Editor
Outside the Box
Greatest Moral Hazard, Says Paul McCulley, Is Austerity Here And Now

Is Paul McCulleyfeeling liberated by his retirement from Pimco? A mere glance at the accompanying likeness, drawn from a snapshot I took of him at “Kamp Kotok” (Cumberland Advisors’ annual Maine economic conference and fishing party) in early August says it all. Not that Paul has ever been one to hide his light — or his views — under a bushel basket. But his new life style clearly agrees with him. What just as clearly does NOT agree with the economic realm’s leading disciple of Hyman Minskyare the incessant calls for fiscal austerity filling the airwaves. It’s precisely the wrong response to the liquidity trap in which the economy is ensnared. Or, as Paul might, but didn’t say, “Moral hazard be damned, the anorexic economy needs to be fed.” Keep reading for what Paul DID tell me during an afternoon chat that was even better than the fishing.


How are you adjusting to all of your newfound leisure time in “retirement” — when you’re not fishing, that is?

Well, I’ve actually been doing quite a lot of fishing — but my retirement was no spur of the moment thing, either. It’s not like I was unprepared to make adjustments.

I knew you had been planning it for quite a while; had set up your foundation —

There was a lot of strategic planning involved — I say that in a positive way, not in a wonkish one — about what my life would be after PIMCO — not that I wasn’t ecstatic there. But I spent a good chunk of my life anticipating that my next stage would be in Washington, as a Fed

governor. I came close, but that didn’t happen. Anyway, I’m pursuing a very satisfying life now. I’m still very engaged intellectually. I’ve been a supporter, via my foundation, of the Global Interdependence Center for a number of years. I am good friends with David Kotok, the Chairman and CIO of Cumberland Advisors, and Bill Dunkelberg, the Chief Economist of The National Federation of Independent Business, who head the GIC. We sat down last year and developed a new wing, if you will, of the GIC called the Global Society of Fellows. I am the first fellow, my foundation has funded the endowment, and we’re excited about doing new things there.

I want to hear all about that. But first, let’s talk about what’s happening in this crazy economy. You started saying we’re in a liquidity trap some time ago. Where are we in that process?

I like how you ask the question as, “where are we in this liquidity trap” because that allows me to fine tune the diagnosis. Most of the marketplace, and the policy makers even more so, are still debating the diagnosis: Are we, or are we not, in a liquidity trap? To me, it’s absolutely critical that this diagnosis is made correctly. Because if you conclude that you’re in a liquidity trap — and I do unambiguously embrace that conclusion — it has profound implications for the right set of policies. It also has profound implications for how markets will discount the policies. What this means is that policy is not a matter of a large menu, encompassing, “Well, we might know we’re in a liquidity trap and we also might not be in one, therefore we’ll do –

A little of this and a little of that—

Right. There are clear-cut things that you do if you’re in a liquidity trap. A liquidity trap is simply defined as when the private sector is in a deleveraging mode, or a de-risking mode, or an increasing savings mode — all of which you can also call deleveraging phenomena — because of enduring negative animal spirits caused by legacy issues associated with bubbles. In that scenario, the animal spirits of the private sector are not going to be revived by a reduction in interest rates because there is no demand. It’s not the price of credit driving the deleveraging. It’s “I took on too much debt during the bubble. I have negative equity in my home. I don’t care what the price of credit is, I already have too much outstanding. I am paying down credit!” That can be entirely rational for an individual household. It can be rational for an individual firm. It can be rational for an individual country. However, in the aggregate, it begets the paradox of thrift. What is rational at the microlevel is irrational for the community, or at the macro level, and I’m amazed that this is not assumed as a given description of what we’ve got going on right now. The paradox of thrift and the liquidity trap are fellow travelers that are functionally intertwined.

Could it be that people are confused because of all the attention paid to the liquidity the Fed has pumped into the system via quantitative easing — even though most of that only flowed into the most speculative and unproductive pockets in Wall Street?

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