You cannot spend your way out of a fiscal crisis. The current path is simply unsustainable.

~ John Mauldin, Between Dire and Disastrous

Update #1: Thanks to David at Health Business Blog for including this post in the Cavalcade of Risk: Just When You Thought It Was Safe to Go Back in the Water edition.

Update #2: This post was also included in the Carnival of Financial Planning #132 at The Smarter Wallet. Thanks!

When I wrote about 10 Reasons to Be Cautious Right Now, I borrowed liberally from John Mauldin. He is the economic thinker and author whose weekly newsletter Thoughts from the Frontline has been required reading for me for years now. I’m going to quote him quite a bit here as well since I happen to share a lot of his views.

He’s way more knowledgeable on this stuff than I, so his opinions lend more credence to my forecast. Having said that, everything I’m about to write reflects one view of how the economy might unfold over the next decade or so. There are other opinions out there and I encourage you to seek them out and think about where you stand.

Balance & the Change Imperative

One of my earliest posts, Balance Is a Journey, examined the prevalence of balance in all areas of life from science and nature to investing and economics. A core principle of this blog is something I called The Change Imperative. It basically states that if something is out of balance, change is required.

In October of 2009 John Mauldin wrote, in a newsletter entitled Another Finger of Instability, “There is a truism that goes a little like, ‘if something can’t happen, then it won’t'”. He was referring to the unsustainable nature of the mounting U.S. deficits, predicting that the U.S. “won’t have a trillion-dollar deficit in ten years. Why? Because it can’t happen. The market will simply not allow it.” We can flaunt the laws of balance for some period of time, but in the end, everything reverts to the mean.

For decades, imbalances in the global economy have grown more severe. I’m going to concentrate on one imbalance in particular as I think it’s the one that’s going to precipitate a huge mean reversion in the form of global deleveraging. Regular readers already know that I’m referring to debt. There is too much leverage in the system at all levels: consumer, corporate, and sovereign. In This Time Is Different, Mauldin hits on the incontrovertible truth that makes some type of reckoning inevitable:

“You cannot keep borrowing past your income, whether as a family or a government and not go bankrupt.”

The more out of balance things become, the sharper the correction when mean reversion comes calling. Right now, a very corpulent mass of debt has the global teeter totter lodged in the mud. Imagine what will happen when it inevitably breaks loose? I wouldn’t want to be on either end when that happens. So when will it happen? No one knows, but it will. Citing data from Reinhart and Rogoff’s much-discussed book This Time is DifferentMauldin explains:

“The point is that complacency almost always ends suddenly.  . . . There is no way to know when it will happen. There is no magic debt level, no magic drop in currencies, no percentage level of fiscal deficits, no single point where we can say ‘This is it.’ It is different in different crises.”

Forecast for the Next Decade

With all of the evidence above on the radar screen, it’s not surprising that my forecast isn’t all that sunny. As the title of this post indicates, I think we’re in for some stormy weather. At some points, things will look like they are improving. Those periods may only indicate that we are either in the eye of the storm, or simply waiting for the next one to thunder ashore. Use those times to shore up your defenses.

I believe that the 2010s will be characterized by a series of rolling debt crises that flare up and fizzle out, causing higher volatility in all global asset classes. There will be a persistent sense of unease punctuated by sudden downdrafts and equally unpredictable bounce-backs. Those familiar with market jargon will recognize what I’ve just described as a secular bear market. I think this one will have sharper claws than some of those we’ve experienced in the past.

What Should You Do?

You’re probably thinking, “Thanks a lot 2 Cents. What am I supposed to do with this fun forecast?” No one, least of all me, is qualified to give blanket advice that fits everyone. My intention here is the same as a meteorologist’s. I just want people to be aware of the conditions and dress accordingly. That simply means that it’s prudent to reduce risk in this environment. There are a few ways to go about that:

• Get Serious about the 10 Steps to Fiscal Fitness: Get your financial house in order so that you are not wiped out in the event that a storm surge hits your area. If the storm misses you, you’ll be in better shape anyway.
• Re-Evaluate Your Risk Tolerance: Look at where your money is invested. Will it be able to weather a storm? If you’re concerned, you can raise your cash allocation to a level that makes you more comfortable.
• Aim for Debt-Free: Obviously, clearing all of your debt isn’t going to happen overnight. But if you keep working at it, you will get there. Just because our government leaders are paying for debt with more debt, that doesn’t mean you have to follow suit. Control what you can.

I’ve used so many metaphors in this post beyond the weather/storm thing that I might as well go for broke and throw in a few more to close. Fans of The Princess Bridemight recognize a parallel between the on-and-off crises I’ve described and the flame spurts. I really think we may be headed into the fire swamp. Watch out for that “popping sound”. Let’s hope the flame spurts are the only problem. I don’t want to see any R.O.U.S.’s or lightning sand! (Non-fans can just disregard this metaphor. On to the next . . . )

The economy is out of balance. How long it will remain that way is anyone’s guess. One thing that is certain though, is that everything will revert back to the mean, the teeter totter will pop back up, the pendulum will swing the other way, and the music will stop. The moral of the metaphor overkill is that you need to be careful where you’re standing when it happens. Here’s hoping we all get a chair.

What do you think of this forecast? Have I misread the radar, or are you stocking up on umbrellas and plywood?