What's Ahead in 2008
JIM PUPLAVA: Well, here we are at the beginning of the year, and as we always do at the beginning of the year, people are looking for predictions, and especially with all of the volatility and unpredictability of the markets. But just like the polls in the United States, which seem to be missing out on things, it’s getting more difficult to predict.
Joining us on the program this year is Dr. Marc Faber, he’s the editor of The Gloom, Boom & Doom Report.
And Marc, I want to start out with something you said in your January newsletter, and you quote Lao Tzu, the 6th Century Chinese poet, where he said: Those who have knowledge don’t predict; those who predict don’t have knowledge. Isn’t this going to be one of those difficult years to predict where the markets are going? It just seems like there are too many crosscurrents this year.
MARC FABER: I don’t think that it is all that difficult to predict markets, but we have to understand that you can’t give a target for, say, the Dow Jones because you essentially have a manipulated market. Manipulated by the Federal Reserve, in the sense that if the Fed cuts interest rates to say zero percent or one percent, as they’ve done after 2001, then stock prices can be supported. But obviously a cut of interest rates at this stage of the cycle where we clearly have inflationary pressure would obviously increase the rate of inflation and probably weaken the dollar further – certainly against a hard asset such as gold and other precious metals. So let’s say someone said the Dow will go up to, oh, I don’t know, double. Say for argument’s sake, from 13,000 to 26,000. We would have to measure that increase –this doubling of the Dow Jones – in a hard currency such as either a foreign currency or in gold. And if the Dow doubles because of money printing by the Fed to 26,000, it wouldn’t mean necessarily that economic conditions improved, but it would mean maybe that inflation picked up dramatically and that the gold price goes up three times. [2:52]
JIM: You also quote Peter Bernstein the economist and strategist and he said that:
The current scene bears no resemblance to a typical economic peak or to conditions usually preceding a slowdown in business activity. Those kinds of conditions feature excesses in the business sector. But the business sector at the present time has a relatively clean bill of health. There are no signs of the usual boom in capital spending that leads to a cyclical top and leaves an overhang of capacity.
I’d like to get your thoughts on the current condition of business. Is this the one saving grace that we have in the US economy right now?
MARC: I think that it is difficult to say that we don’t have, let’s say, excesses in capital spending because we live in a globalized world. In other words, capital spending may not have been excessive in the United States – although I could argue that home building is some kind of capital investment; the whole commercial real estate market is some kind of capital investment. And what we have is we have excesses in capital spending in other countries such as in China and in other emerging economies. So basically, the US has outsourced largely it’s production, and that’s where the excesses in capital spending are occurring.
Moreover, in a business cycle you just don’t only look at capital spending. I think the biggest excess was in consumption in the United States, where consumption as a percent of the economy has increased from around 60% in 1980 to now over 70%. So in an economy where you essentially have maladjustments as a result of easy monetary policies the excesses do not necessarily have to be in capital spending. The excesses can be in asset markets, such as the housing market, in stocks, in commodities and they can be in consumption. [5:04]
JIM: Let’s talk about consumption, because the big question everybody has here –and there is such an emphasis in the US economy on consumption – and that’s the US consumer. And we’ve got a situation now where you know they can’t take out money out of their mortgages like they used to and use them as an ATM machine. We’ve seen a bit of a slowdown in the fourth quarter with consumer spending. Do you think this is the time that the US consumer finally goes on hold. I mean, they’ve been counting the US consumer out for years and decades, but it’s like the Energizer Bunny: They keep on spending.
MARC: Yes, I agree that there has been a lot of let’s say apprehension about the ability of the consumer in the US to continue to consume, but I think the important question here is the Federal Reserve and also the Treasury have encouraged, in the US, consumption. And does consumption lead to the creation of wealth? Or if you have a table full of food and you just eat the whole food away does it lead to a reduction of wealth? That is really the issue here. And I think that in the US the excessive consumption which was driven by asset markets, in other words by increasing asset prices – stocks until 2000, and after that by the real estate market – have essentially led to an economy that is starved [of] savings and starved of capital spending and characterized by excessive consumption which is on evidence from the growing trade and current account deficits. And now the goldilocks apostles they will always say, “well, the trade and current account deficits do not matter.” But they do matter in the sense that there has been a huge transfer of wealth to foreign countries, and now foreign countries have these sovereign funds which they invest globally; and there has been a huge creation of wealth, in particular in the resource-producing countries; and also there has been extended US dollar weakness. And so the current account deficit and the excessive consumption does matter to some extent for the well-being of the US. [7:33]
JIM: One thing that we’re starting to hear in the US, we’ve heard it from Hank Paulson and the President in December (we’ve seen it recently – the White House convened last Friday), they’re talking about some kind of stimulus package coming out from Washington. Whether it’s going to help people that are under duress right now because of mortgage resets – but some kind of fiscal spending program – who knows? Maybe we get some kind of helicopter drop. What about the US government combined with fiscal stimulus and monetary stimulus as it appears right now that the Fed is probably going to get more aggressive in its rate cutting.
MARC: Yes. I’m sure that they will implement a stimulus package, but I think the stimulus package will be an ill-fated attempt to revitalize the economy. If you look at the problem of the economy, it’s been excessive credit growth that came from easy monetary policies. And what they want to do now is essentially to implement another set of monetary policies and other measures to stimulate consumption, when consumption precisely has been the problem of the United States – the excessive consumption. And I think a stimulus package may be useful if it were directed at the stimulation of capital spending and at the encouragement of saving at the expense of consumption. And that can only lead to essentially a readjustment period in the economy. Readjustments – basically what the US needs is a recession. And only a recession can redress the excesses that have taken place. And if you superimpose another bubble on the existing bubble you create more maladjustments in the economy and more ill-fated measures that eventually lead to a total breakdown of the system. [9:42]
JIM: You know, unfortunately here in the US, whether you’re watching both parties – the Republicans or the Democrats – they’re talking about ways to increase consumption because they’re worried by a slowdown in consumer spending. And nobody in a presidential election year seems to want to take the pain to go through a recession and redress a lot of the imbalances or cleanse the system because of the imbalances we see right now – whether it’s mortgages, excess consumption and indebt[edness]. So in the end, could you see a scenario, Marc, something like this: In the first quarter we see economic weakness as we’ve been seeing, we see more write offs coming from the financial system (there’s talk about Citigroup maybe writing off $16 billion), also there’s going to be a slowdown in corporate earnings, and then we get a massive response from the Federal Reserve that temporarily probably stimulates the markets. So let’s say, in between, if you think of an Oreo cookie, a hard first quarter, a creamy filling in the second and third, and by the fourth quarter higher interest rates and inflation come back to bite us again.
MARC: Well, personally, I think that the US, if you measure economic statistics properly –and the government is lying blatantly – the US went into recession 3 months ago. And I’m saying the government is lying blatantly, because they take nominal GDP and then they fiddle around with inflation figures. I mean none of your listeners have an inflation rate of less than 5 to 6% per annum. You just can’t exclude food and energy prices and healthcare costs from the CPI, from the cost-of-living increases. So nominally the US economy may still be growing, but inflation adjusted –in other words, in real terms – we’re already in a recession. And most US households, except for the super rich, are today no better off than they were five or seven years ago. Their income gains have all been eaten up by cost increases by inflation.
Now, some people have benefited from asset inflation in the sense that their houses in which they live have appreciated in value but that has been precisely because of easy monetary policies and the debt growth that have now brought about problems.
And all I can say is that corporate profits in my opinion began to contract in the third quarter of last year and they will continue to contract, because corporations now –and this is important to understand – corporations are facing cost increases. So the margins are going to be squeezed. And whereas the valuation of the stock market is not unbelievably high in the sense that stocks are not selling at 50 to 80 times earnings like in Japan in 1989, if you exclude say the energy sector from the S&P which is selling at 12 times earnings or 10 times earnings, then the S&P valuation is over 20 times earnings. If you’re faced with declining earnings then basically the S&P is not a great bargain here. [13:14]
JIM: Let me just continue on that inflation theory, because what you are talking about in the fourth quarter the GDP deflator, if I recall, was falling from the second, third and fourth quarter last year; and I know in the third quarter the GDP deflator was the lowest since Eisenhower was president. So could you get statistically, and I’m just looking forward in an election year, maybe we get the lowest inflation rates since Calvin Coolidge was president. So in nominal terms as reported by the government we get this slow growth figure that they’re talking about – one to two percent – in those terms, we avoid a recession even though in real terms we are in one.
MARC: Well, basically, that would be a form of stagflation. And I mean it’s very difficult to measure GDP in the first place, and what you have to look at is essentially standards-of-living increases in an economy. And I don’t think that there are many standards-of-living increases in the United States at the present time, nor for that matter in Western Europe. We have huge standard-of-living improvements in emerging economies where a middle class is being created and where even workers or farmers are doing better than say a couple of years ago. But my point is simply that the government is lying. And they will continue to lie because they don’t want to admit that they created an unbelievable economic mess. Nor will the Fed admit that their ill-conceived monetary policies led to the crisis that we have today in the financial markets. [15:01]
JIM: What about the theory that’s being bandied about, even though the US economy slows down as we are now seeing that –they call the decoupling theory – that the rest of the world (whether it’s Europe, Asia, emerging markets) will continue to be strong? So therefore, if you are let’s say a large cap international company where you get a good majority of your sales overseas – and a good example would be, for example, DuPont this week beat estimates. They get 60% of their business overseas and because of that business doing very well their earnings were higher than expected. Do you subscribe to the decoupling theory, or do you think a slowdown in the US will have some effect on Europe and the rest of the world?
MARC: Well, basically, we have to first of all distinguish between an economic decoupling and a financial decoupling. In other words, can some countries grow when the US is say in a no-growth mode or in a recession mode? I think that this is possible because if you look at basically the US economy over the last two hundred years, occasionally you had a recession in one state, say, Texas in the early 1980s (when the oil price started to go down), and you had expansion in another state like New England (which benefited from lower oil prices); or in the early 1990s, you had a recession in California but other states they were expanding. So in an economy which is very complex, where you have different regions and you have different sectors – industrial sectors and service sectors – it is conceivable that one sector is in recession and other sectors or other regions are not; that is entirely possible. But I would argue that over the last seven years we had an unprecedented global economic boom where essentially every country has been growing with the exception of Zimbabwe, because you have a money printer in Zimbabwe who essentially should be joined by Mr. Bernanke. He would fit very well with Mr. Mugabe in that country.
Now, what happens if the US no longer grows is that the trade and current account deficits of the US shrink. In other words, we had during the excessive consumption period 1998-2006, a current account deficit in the US that increased from 2% of GDP to over 7% of GDP, and at the end was supplying the world with $800 billion annually. And this river flows into the world through the American current account deficits, and essentially provided the world with the so-called excess liquidity and created booms in everything from art prices to commodities, stocks, bonds, real estate, what not. And once the US no longer has this growing current account deficit, but a shrinking current account deficit, you have essentially a relative illiquidity coming up in the world. It is not that it’s tight money, but the rate of growth of liquidity shrinks and it does have obviously an impact on the economies and on the asset markets. And it is conceivable that say the US goes into a recession, Europe goes into a recession and that China does not go into a recession but into a growth slowdown, say from 8 to 10% GDP growth down to 3 to 6% of GDP growth. But this decline in the growth rate is still very uncomfortable for China, as well as for India. So I’m not a great believer in this decoupling theory.
Moreover, I don’t believe that financial markets will be decoupled. In fact, I would argue: If you look at look at the last four years, 2002 to today, then emerging markets have been the big bubble. The US markets have not been a gigantic bubble in the sense that US equities, especially large cap stocks, are not terribly expensive by world standards because the dollar has gone down so much. And so the big bubble is probably in emerging markets; and these markets, obviously if the S&P goes down, will be hit very hard. And I would argue, if someone puts a gun to my head, and says, “Marc, you must buy stocks,” as much as I dislike saying this but I would probably rather buy US stocks today, than say some of the emerging markets that are selling at 30 to 50 times earnings. [20:08]
JIM: You bring up an interesting point about liquidity in the world which has a genesis in much of the US trade deficit. As we look around the globe today, Marc – I have a screen on my Bloomberg that has year-over-year money supply growth rates around the globe and what is surprising as I look at this table is to see double digit money supply growth around the globe out of 18 of the top 20 central banks. I think Europe reported last week it’s money supply is growing at over 12%, yet Trichet is talking about being tough on inflation. You know, the inflation rates that we’re seeing here in the United States, are they not global in nature? Are you finding that, for example, in China where you have the inflation rate going at 6 or 7%, that this is a global phenomenon?
MARC: Yes, I mean that’s the point. I mean when recently people were very negative about the US dollar and so forth – and of course, long term you cannot be optimistic about the US dollar – but the US dollar has declined quite substantially, especially against the euro in the last couple of years; and the Europeans are also good money printers. It’s not just Mr. Bernanke that is the chief money printer. The others are not much better either. So basically, you have this excess liquidity being created in order to support asset markets and so forth.
But the point about this excess liquidity is that an eternal boom is out of the question. So what the Fed and the other central banks can do is kind of stimulate, through easy monetary policies, credit growth; but the private sector if it becomes, say, risk adverse can withdraw liquidity and a) not lend and people can also refuse to borrow, and so the credit does not accelerate but actually contracts. And that leads to what I call a relative illiquidity (it’s not an absolute illiquidity, it’s a relative illiquidity) and that then has some negative implications on some asset markets. But to come back to the first question you raise about making predictions, I think the difficulty today is that under normal conditions, say under a gold standard, we would be in a massive deflationary recession at the present time. Now, the central banks are all intent to prevent that and they print money like crazy and throw liquidity at the system by cutting interest rates and taking extraordinary measures. And so the question arises: How did you measure really economic growth and how do you measure your wealth? Say, as I mentioned, if the Dow goes from here to 26,000 – it doubles in value – if at the same time the gold price goes up 5 times, you lost out by being in financial assets. And I think this is what has happened since year 2000. In year 2000, as you know, you could buy with one Dow Jones, 44 ounces of gold. And now you can buy less 15 ounces of gold.
Now, I’m not saying that gold cannot have a meaningful correction, but I think that the central banks have created actually a state which I would almost call a hyperinflation where asset prices go up very substantially and they don’t make you really richer. I mean say in 1980, there were six billionaires in the world, and today you have thousands of billionaires in the world, everywhere. And money – the value of money – the purchasing power of money has depreciated very considerably. And I’m not speaking here of the US, because I was recently in New York and I saw that the price level in New York is actually quite reasonable compared to, say, the price level in Europe and in other countries. But usually when you have a situation like the US that has achieved relatively low prices levels through currency devaluations – and the US has pursued a policy to lower the value of the dollar – what usually follows (and not every time – usually what follows) is high and accelerating inflation rates. And the US government of course they will understate inflation, but the pocketbook of the consumer will notice this increase in inflation and what you will then get is essentially prices going up and the standards of living of people going down – in other words, stagflation. [25:08]
JIM: Isn’t this one of the signals that gold is giving to the financial markets? When you look through this period of time where we have seen nominal increases in assets and stock markets around the globe, yet if you look at the summer of 2001 when gold was at 255, and here we’re looking at gold heading towards $900 – do you think this is what is being recognized around the globe, that everybody knows that money is dying, it’s losing its value so gold is becoming the ultimate currency to hold?
MARC: Basically, my view is this: Normally, the safest investments in a society is cash, deposited in a bank or in Treasury bills. But the Western democracies and governments in general have created over time an environment where actually cash is a disastrous investment because you’re losing out to inflation like in the 70s as a result of consumer price increases or in the last couple of years as a result of asset price increases. Now, I’m not suggesting that there cannot be times – three months, six months, one year – when cash does better than, say, stocks or better than real estate. Say, in the last nine months it was better to be in cash than in stocks that depreciated or in real estate that depreciated. But basically, if you print money like the Fed or other central banks do, the value of money – of paper money – goes down and then it’s reflected in an increase in the value of assets such as gold that cannot be multiplied at the same rate. I mean someone could say, “oh, the gold price has gone up a lot since 2001.” I can turn around and say: “No, the gold price is the same. It’s the dollar the dollar that has collapsed against the price of gold.” And why did the dollar collapse against the price of gold. You call up Mr. Greenspan and Mr. Bernanke and you ask them about it. Of course, they will never give an answer. Each time Ron Paul asks them a sensible question they just evade the question and they move on to something else because, as I explained, they are a bunch of liars. And actually, if there was a court for honest money, both Mr. Greenspan and Mr. Bernanke should be hanged. [27:44]
JIM: You know, it was interesting – you mentioned Congressman Ron Paul. The last time Bernanke was on Capitol Hill, he asked him about curing inflation with more inflation, and asked him about what was happening to the dollar. And Mr. Bernanke responded – which I was horrified – and he said, “well, actually if you live in the United States and you pay for things with dollars it really doesn’t affect you.”
MARC: He’s out of his mind. Go to Zimbabwe and ask the citizens there: If you pay in Zimbabwe dollars it affects you that the currency has collapsed? Of course it affects you.
JIM: There’s a situation I want to move on to in the financial markets. A lot of the risks that we’ve seen erupt last year, whether it was in February with intermediate lenders or August with the collateralized debt obligations, something that has not gotten much attention and I think could even be a bigger issue and that is credit default swaps, which are now estimated to be somewhere in the neighborhood of 45 trillion. I think there have been a lot of people, Marc, in the hedge fund community and the banking community during this period when we were inflating between 2003 and 2006, they were writing these credit default swaps on corporate bonds because it was almost like free money. Now, if the US economy has gone into a recession –even though we’re not saying it formally – when you go into a recession companies have greater difficulties making their earnings, earnings slow down, cash flow slows down. And what happens if you start getting a bunch of corporate bond defaults? I think this is an issue with these credit default swaps that nobody is looking at. A few people have talked about it; Bill Gross saying it could be somewhere in the neighborhood of $250 billion losses. This is another issues that could surface this year that could throw chaos into the markets.
MARC: Well, I think you’re touching on something very important. I think that over the last 25 years we had numerous financial innovations. And I have to say is, the Federal Reserve had the power to control the financial innovations but actually they encouraged it and led to the excesses we had recently. And I think that the problem that occurred in subprime lending is a symptom of a much wider problem, and that the subprime lending crisis infects obviously other credit markets and so forth and that it will spread like a bush fire through the economy, especially if an economy was essentially driven by excessive credit growth. I mean in the last seven years GDP increased by $4.2 trillion and total credit between 2000 and 2007 increased by $21.2 trillion. In other words, debt has been growing much faster than the nominal GDP.
And I think that now we are in a process of deleveraging – of credit contraction, basically – but the Fed and the Treasury will do everything to restimulate the credit growth that led to the problems in the first place. That’s why I’m arguing that the policies of Mr. Greenspan, of Mr. Bernanke and Mr. Hank Paulson are totally misguided. Totally. And I believe, you know, the financial stocks, every bull market I’ve seen since 1970 when I started to work was accompanied by strength in financial stocks. When you have weakness in financial stocks something is wrong. And therefore, I don’t believe that this bull market that we had since October 2002 to the Summer of 2007 that this will come back. I rather believe that we are in a period of high volatility like in the 70s, when the Dow moved up and down every year by 20%, and in 1982 the Dow was still no higher than we were in 1964. So I think we can have a lot of fluctuations here. And at times the Fed, through rate cuts, can manipulate equity prices higher and so forth. And at times we will have disappointing earnings, disappointing results. And I would suppose that we will have massive bankruptcies as well where financial firms become illiquid and insolvent and are forced to the wall. And so the market environment for financial assets is not going to be particularly good. [32:46]
JIM: Let’s talk about a couple of investment themes among this volatility that we’re seeing. A couple of things that stand out or strike me, Marc, is energy which has been on a roll – and I happen to subscribe to the peak oil theory. I mean we have not made any major discoveries, we’re not replacing what it is that we consume, we have more people consuming energy today. That is one theme that I can see. And along those lines and something similar – you cover this in your current newsletter – is you’ve got a little over 1% population growth in the world, the acreage for growing crops isn’t expanding. In fact, in certain areas like China it’s being turned into parking lots – like Joni Mitchell’s song – or buildings. What about the theme of energy, food and precious metals if you wanted to be in this market as a long term investor?
MARC: Yes, I think that’s a very good point. In general, I believe that you should be in assets that cannot be multiplied easily, such as commodities (whether it’s copper or zinc or nickel or oil or precious metals), or food items (wheat, corn, soybeans, sugar and so forth). But the commodity markets had a very big move and the price of oil has gone up essentially almost 10 times since 1998 from $12 a barrel to now close to $100 a barrel. And in an environment of slowing growth in the world, I would be somewhat careful of investing now in industrial commodities whose demand depends essentially on strong economic growth. So I would not be surprised to see – as has already happened in some commodities like nickel – that prices correct meaningfully. And all I can say to investors is I’m bullish about gold in the long run, but don’t buy anything –whether it’s a house or stocks or precious metals – if you are not prepared to ride through say a 20% correction, because we have higher volatility. We will get more corrections along the way up. I mean I remember the great bull market of the Taiwanese stock market, 1984 to 1990. The market went from an index of less than 500 to 12,500, but we had in 1987 a 50% correction, in 88 a 40% correction, in 89 a 30% correction until we reached a final peak. So investors have to get accustomed to higher volatility. And someone who cannot live with this volatility because he is leveraged, is going to be forced to the wall.
So my advice is to be prudent. And yes, I like energy. I think energy stocks are actually quite inexpensive. But if the oil price for one reason or another drops to say $70, then obviously energy stocks will be down. And all I notice is when I started to like commodities in the year 1999 to 2002, it was not a widely accepted investment theme. And today, the investment theme is much more well known, and there are many more speculators in the market place. So I’m still positive in the long run but cautious say for the next six months. And I would also add, as of today – you see, if I remember, well, in 1980, after 10 years of consumer price inflation in the US, everybody thought that consumer price inflation would continue forever. And what then happened after 1980 is that consumer price inflation slowed down and we had a period of disinflation. Today, if there is one consensus it is that paper money will become worthless and that asset prices will continue to go up. And I would still think that it’s not very likely that Robert Prechter is going to be right with his deflationary bias –with everything, with gold prices collapsing to the Dow going down and so forth – but I would still think that there is still a small probability that we could have actually a period of deflation in the near future, which then will lead the central banks to print money like crazy. But in this period of deflation that I would not rule out we would have big declines in asset markets – big declines. [38:09]
JIM: Let’s say we start to get deflation. I mean certainly we’re seeing falling housing prices in the US and other places of the world. Do you think that we get preemptive strikes and perhaps they just throw all caution to the wind? Like right now, the latest consensus is when the Fed meets January 30th it’s going to be 50 basis points; and there’s even talk within the markets that they don’t wait until January 30th if things begin to deteriorate. I know there’s a lag effect to all kinds of things, whether it’s raising interest rates or lowering interest rates. If this deflationary period that could possibly erupt, do you believe it would be short-lived?
MARC: Yeah, very good question. I am quite sure the Fed will cut by 50 basis points; and if not by 50 at least by 25. But as you know, in Japan they cut rates dramatically to essentially zero and we still had deflation. I mean we cut interest rates from 6.5% on the Fed funds rate in January 2001, to 1% in 2003, and yet the NASDAQ still went down. So whether interest rate cuts and even a stimulus package – fiscal package – will help much remains to be seen. We could be in an unusual situation where it doesn’t help much. It’s possible because the public or the household suddenly starts to save; in other words, the savings rate goes up and people become risk adverse. As I said, I don’t know how the world will look like in a year’s time. I’d rather be in gold than in the Dow Jones, whereby maybe for the next three months the Dow Jones could outperform gold for a while. But in general, it’s very, very difficult to make any kind of predictions that make sense simply because you don’t know how irresponsible Mr. Bernanke and Mr. Hank Paulson will be. We just don’t have any idea. As you say, they can do a lot of things to try to support the asset markets. And Mr. Bernanke has written and spoken about this: that you cannot identify bubbles but when they burst you should step in with extraordinary measures. We just don’t know how extraordinary his measures will be. I mean the best for Mr. Bernanke, the best extraordinary measure would be to resign and say: “We failed. We are incompetent.” [40:54]
JIM: But you know, Marc, if you take a look at his study of the Great Depression and people might recall the comment he made at Milton Friedman’s birthday where he said to Mr. Friedman: “You know, you were right, we made the mistake. We caused the Great Depression. I assure you, it will never happen again.” Basically saying, according to Mr. Bernanke’s view and study of the Great Depression, the reason we had it was the Fed didn’t print enough money. Had they been able to do so the Depression would never have occurred. So it almost gives you an insight in terms of his thinking, which is along the lines with Mr. Greenspan in the sense that anytime there’s a problem in the economy or the financial markets massive liquidity seems to be the response and answer.
MARC: Yes, that is correct and I’ve written about this. And I think that the entire analysis of the Great Depression, especially by Mr. Bernanke, is totally wrong. The causes of the Depression were not tight monetary policies by the Fed, but easy monetary policies by the Fed. And Paul Warburg, who was at that time a Fed member, later on commented about this; that the Fed should have pursued tighter monetary policies in the years leading to 1929. And I’d just like to mention one point: In 1929, the PE on the Dow Jones was just about 13 times earnings. We didn’t have a massive stock market bubble in terms of valuation, but what we had is an earnings bubble and half the earnings collapsed. And I think today we don’t have, you know, like 50 times earnings on the stock market like we had in Japan. But I think we have an earnings bubble and that the earnings will disappoint very badly. But I’m just convinced that in a democracy, especially in a country like the United States, the politicians will print money. And whether or not it will always help to support asset markets is very questionable.
The one thing I can assure you is that money printing doesn’t create wealth. That is important to understand. And at some point, as my friend Barry Bannister pointed out, you reach with credit growth the zero hour. In other words, you print money, credit grows, but the economy doesn’t respond. And I think we are already in that situation. And what the outcome will be, hyperinflation or deflation, that is the difficulty to judge. But I think personally as an investor, I would be positioned to some extent in gold because in a deflationary environment I happen to believe that gold would outperform other asset classes because things will get so bad that people will run into gold as a safe haven. And at the same time, I would hold essentially some cash and I would probably deleverage. In other words, I wouldn’t hold a lot of debt in the present environment. If there is hyperinflation, to hold a lot of debt is the right thing to do; but just in case we have deflation, like now in housing and now probably also in commercial properties (that is the next shoe to drop), that in such an environment you’re better off by not holding too many debts. [44:40]
JIM: I want to cover a point in your January newsletter and just let our listeners know, if you don’t subscribe to Marc’s newsletter you’re really missing out on some good thinking.
MARC: Well, it is very kind of you.
JIM: You had a gentleman who has written pieces for your newsletter in the past, his name is Michael O’Higgins, he’s author of Beating The Dow – a very sharp money manager, and I’m going to quote from your newsletter here, and he goes:
So where does one find value in today’s investment world? In my view, given that the main focus of the current US Federal Reserve board remains one of fighting deflation, investors should avoid bonds entirely and concentrate on investments that can protect them from a rising inflation rate i.e. stocks and commodities. With these two categories we have our portfolios equally invested among four investment themes: dogs of the Dow; dogs of the world; precious metals and mining; and energy.
What do you think of that?
MARC: Well, basically, I agree with Michael and I think that if you buy today at 10 years the US Treasury, or 30 year US Treasury, you’re flirting with disaster because they will only perform well in an environment of total deflation, given the low yields they provide at the present time. But as I said, the concept of inflation and deflation is very complex because you can have an economic system where some assets are inflating and some assets are deflating. Like in the US, say in the last 12 months, you would have been better off in US Treasuries than say in the housing market, which has declined in value. So in general, I of course agree with Michael to be in stocks in the long run and to be in precious metals and in energy in the long run and so forth. I’m not sure whether that is the right medicine for, say, the next three to six months. I mean I’m very cash rich here. I’m cash rich US dollars. I think the US dollar does not have a significant downside risk against the euro. In other words, if you put a gun on my head and said, “Marc, you have to choose one currency today, for the next three months: the euro or the US dollar,” I think I would choose the US dollar. Although, I’m very negative about the US dollar in the very long run. But just for the next three months I think the dollar will hold because the current account deficit is now shrinking, the trade deficit is no longer expanding and so forth and so on; and the dollar is relatively inexpensive vis a vis the euro. Would the question be: put all your money into US dollars cash, or put all of your money in gold? As of today, that would be a very tough question because the gold market in my opinion is now somewhat overbought and could undergo easily a 10 to 20% correction. [47:59]
JIM: I’m sensing, Marc, as we’ve had this discussion and also from reading your newsletter, that you’re very cautious at this point. The fact that you’re holding larger amounts of cash and in the dollar is that because of the amount of uncertainty? And what would cause you to move out of cash?
MARC: Well, I think that as an investor – and I’m not a mutual fund manager or hedge fund manager that needs to show performance every week or every month – I’m a believer that occasionally the markets create an unusual opportunity. The unusual opportunity of the last 10 years was really commodities in the years 1999 to 2001, and emerging economies following the Asian crisis. They provided a lifetime buying opportunity. Now that the whole world is captivated with investments, and buying this and selling that and moving here and moving there and performance, I sometimes feel I want to actually be on the sidelines and just give it some time until I make the next major bet. I mean I’m involved quite heavily in gold. Would I put now all my money tomorrow into gold? I doubt it. And I want to be diversified. And all I can say: investment opportunities arise again and again. I mean, I suppose if Citigroup went down to $5, I’d be tempted to look at it. I’m not particularly interested here at the 27 to $30 level, because the financial excesses we had that were built over the last 25 years will take time to kind of correct. And if you have a boom sector, say, like the oil sector in the 70s, afterwards for 20 years oil was unattractive and the drillers were unattractive. And so financial stocks, after a bubble burst in that sector may not provide the leadership in the future and may be unattractive for many, many years to come. But I’m convinced, like I wrote about in my last report about Cambodia, I think there are some countries in the world whether it’s Cambodia or Ukraine or Belarus or parts of China or parts of India, or parts of Russia that can have strong economic growth even in a weakening global environment and provide investors with unusual opportunities. [50:50]
JIM: Marc, you do a lot of traveling around the globe and I think that gives you a different perspective than let’s say some analyst that stays in his office all the time. As you have been traveling over the let’s say last 12 months, is there anything that stands out in your mind and things that you’ve observed?
MARC: Well, I mean people talk about the housing bubble in the United States and the downturn in housing prices in the US. What stands out to me –and I never experienced that before and I’ve been traveling extensively since the 1960s – is wherever you go you encounter boom conditions. And some boom conditions are bigger than others. Say three years ago there was a boom in Dubai. Two years ago the boom was a bit bigger; a year ago it was a bit larger; and now, it’s difficult to imagine how the boom could become bigger to what it is right now. And the same happens in many other countries. Everywhere you have essentially a forest of cranes building; and we have an unbelievable construction boom everywhere in the world. And my view is simply: If you have a synchronized global economic boom as we have had, then the consequence is one day a global synchronized bust, because in the past usually booms were concentrated in one sector, say oil in the 70s or NASDAQ, I mean technology in the late 1990s, or Japan (1985-1990). So that was just one sector of the global economy that was booming and the others weren’t. But now I can assure you: Everywhere you have a colossal boom; and I think this will give way to colossal bust. If it’s this year or next year, who knows? But I don’t want to be caught in this colossal bust. And if someone says, “oh, we can make a lot of money over the next 12 months until it happens,” then good luck to him. I just don’t want to be overly exposed to this boom at the time when, say, cyclically I can see that there is this relative illiquidity coming up and where it is difficult to build much on the existing boom. And besides from that, if you really have boom conditions, that doesn’t guarantee that equities go up. Sometimes you have strong economic conditions and stocks go down like in the Middle East in 2006, early 2007. We had boom conditions but stocks still dropped 50 percent. [53:41]
JIM: Well, you know, Marc, I think it’s in the next week or so you meet with the Barron’s roundtable group. I’m sure I think your views are going to be much, much different than the roundtable. They usually are. Do you expect optimism to be expressed there. I mean one of the standard things that we see today, slow growth, rising markets, even though earnings are going down, interest rates are going down, so we could see multiple expansions. What do you expect your group of peers to be saying?
MARC: Well, basically, the interview took place last Monday and the group by and large is bearish on the economy. But they are in denial about the stock market. They all think that stocks will be okay, but they are bearish on the economy. And that’s what I think is happening throughout essentially the money management establishment. People are kind of cautious on the economy. The economists predict, say, a soft landing and the analysts are essentially actually quite positive because they predict the S&P earnings to grow by 12 percent this year. And so there is this environment of what I would call self-delusion. And my view is that the markets won’t perform well. But equally, as I said, if someone said you must own stocks, I think the emerging stock markets today are more vulnerable than the Dow Jones. And so if I had to own stocks, probably I would be in the Dow Jones – whereby I’d prefer not to own any stocks. [55:15]
JIM: Well, Marc, I want to thank you for joining us on the Financial Sense Newshour. You’ve been very generous with your time. I know it’s late there in Thailand where you join us. If our listeners would like to find out more about your work –and by the way, my compliments, it’s probably one of the best written newsletters out there. It’s always full of interesting aspects or thoughts on investing – tell them how they could do so.
JIM: Marc, I want to thank you so much for joining us on the program. I want to wish you a happy, prosperous and healthy new year.
MARC: Well, thank you very much for having me.
Joining us on the program this year is Dr. Marc Faber, he’s the editor of The Gloom, Boom & Doom Report.
And Marc, I want to start out with something you said in your January newsletter, and you quote Lao Tzu, the 6th Century Chinese poet, where he said: Those who have knowledge don’t predict; those who predict don’t have knowledge. Isn’t this going to be one of those difficult years to predict where the markets are going? It just seems like there are too many crosscurrents this year.
MARC FABER: I don’t think that it is all that difficult to predict markets, but we have to understand that you can’t give a target for, say, the Dow Jones because you essentially have a manipulated market. Manipulated by the Federal Reserve, in the sense that if the Fed cuts interest rates to say zero percent or one percent, as they’ve done after 2001, then stock prices can be supported. But obviously a cut of interest rates at this stage of the cycle where we clearly have inflationary pressure would obviously increase the rate of inflation and probably weaken the dollar further – certainly against a hard asset such as gold and other precious metals. So let’s say someone said the Dow will go up to, oh, I don’t know, double. Say for argument’s sake, from 13,000 to 26,000. We would have to measure that increase –this doubling of the Dow Jones – in a hard currency such as either a foreign currency or in gold. And if the Dow doubles because of money printing by the Fed to 26,000, it wouldn’t mean necessarily that economic conditions improved, but it would mean maybe that inflation picked up dramatically and that the gold price goes up three times. [2:52]
JIM: You also quote Peter Bernstein the economist and strategist and he said that:
The current scene bears no resemblance to a typical economic peak or to conditions usually preceding a slowdown in business activity. Those kinds of conditions feature excesses in the business sector. But the business sector at the present time has a relatively clean bill of health. There are no signs of the usual boom in capital spending that leads to a cyclical top and leaves an overhang of capacity.
I’d like to get your thoughts on the current condition of business. Is this the one saving grace that we have in the US economy right now?
MARC: I think that it is difficult to say that we don’t have, let’s say, excesses in capital spending because we live in a globalized world. In other words, capital spending may not have been excessive in the United States – although I could argue that home building is some kind of capital investment; the whole commercial real estate market is some kind of capital investment. And what we have is we have excesses in capital spending in other countries such as in China and in other emerging economies. So basically, the US has outsourced largely it’s production, and that’s where the excesses in capital spending are occurring.
Moreover, in a business cycle you just don’t only look at capital spending. I think the biggest excess was in consumption in the United States, where consumption as a percent of the economy has increased from around 60% in 1980 to now over 70%. So in an economy where you essentially have maladjustments as a result of easy monetary policies the excesses do not necessarily have to be in capital spending. The excesses can be in asset markets, such as the housing market, in stocks, in commodities and they can be in consumption. [5:04]
JIM: Let’s talk about consumption, because the big question everybody has here –and there is such an emphasis in the US economy on consumption – and that’s the US consumer. And we’ve got a situation now where you know they can’t take out money out of their mortgages like they used to and use them as an ATM machine. We’ve seen a bit of a slowdown in the fourth quarter with consumer spending. Do you think this is the time that the US consumer finally goes on hold. I mean, they’ve been counting the US consumer out for years and decades, but it’s like the Energizer Bunny: They keep on spending.
MARC: Yes, I agree that there has been a lot of let’s say apprehension about the ability of the consumer in the US to continue to consume, but I think the important question here is the Federal Reserve and also the Treasury have encouraged, in the US, consumption. And does consumption lead to the creation of wealth? Or if you have a table full of food and you just eat the whole food away does it lead to a reduction of wealth? That is really the issue here. And I think that in the US the excessive consumption which was driven by asset markets, in other words by increasing asset prices – stocks until 2000, and after that by the real estate market – have essentially led to an economy that is starved [of] savings and starved of capital spending and characterized by excessive consumption which is on evidence from the growing trade and current account deficits. And now the goldilocks apostles they will always say, “well, the trade and current account deficits do not matter.” But they do matter in the sense that there has been a huge transfer of wealth to foreign countries, and now foreign countries have these sovereign funds which they invest globally; and there has been a huge creation of wealth, in particular in the resource-producing countries; and also there has been extended US dollar weakness. And so the current account deficit and the excessive consumption does matter to some extent for the well-being of the US. [7:33]
JIM: One thing that we’re starting to hear in the US, we’ve heard it from Hank Paulson and the President in December (we’ve seen it recently – the White House convened last Friday), they’re talking about some kind of stimulus package coming out from Washington. Whether it’s going to help people that are under duress right now because of mortgage resets – but some kind of fiscal spending program – who knows? Maybe we get some kind of helicopter drop. What about the US government combined with fiscal stimulus and monetary stimulus as it appears right now that the Fed is probably going to get more aggressive in its rate cutting.
MARC: Yes. I’m sure that they will implement a stimulus package, but I think the stimulus package will be an ill-fated attempt to revitalize the economy. If you look at the problem of the economy, it’s been excessive credit growth that came from easy monetary policies. And what they want to do now is essentially to implement another set of monetary policies and other measures to stimulate consumption, when consumption precisely has been the problem of the United States – the excessive consumption. And I think a stimulus package may be useful if it were directed at the stimulation of capital spending and at the encouragement of saving at the expense of consumption. And that can only lead to essentially a readjustment period in the economy. Readjustments – basically what the US needs is a recession. And only a recession can redress the excesses that have taken place. And if you superimpose another bubble on the existing bubble you create more maladjustments in the economy and more ill-fated measures that eventually lead to a total breakdown of the system. [9:42]
JIM: You know, unfortunately here in the US, whether you’re watching both parties – the Republicans or the Democrats – they’re talking about ways to increase consumption because they’re worried by a slowdown in consumer spending. And nobody in a presidential election year seems to want to take the pain to go through a recession and redress a lot of the imbalances or cleanse the system because of the imbalances we see right now – whether it’s mortgages, excess consumption and indebt[edness]. So in the end, could you see a scenario, Marc, something like this: In the first quarter we see economic weakness as we’ve been seeing, we see more write offs coming from the financial system (there’s talk about Citigroup maybe writing off $16 billion), also there’s going to be a slowdown in corporate earnings, and then we get a massive response from the Federal Reserve that temporarily probably stimulates the markets. So let’s say, in between, if you think of an Oreo cookie, a hard first quarter, a creamy filling in the second and third, and by the fourth quarter higher interest rates and inflation come back to bite us again.
MARC: Well, personally, I think that the US, if you measure economic statistics properly –and the government is lying blatantly – the US went into recession 3 months ago. And I’m saying the government is lying blatantly, because they take nominal GDP and then they fiddle around with inflation figures. I mean none of your listeners have an inflation rate of less than 5 to 6% per annum. You just can’t exclude food and energy prices and healthcare costs from the CPI, from the cost-of-living increases. So nominally the US economy may still be growing, but inflation adjusted –in other words, in real terms – we’re already in a recession. And most US households, except for the super rich, are today no better off than they were five or seven years ago. Their income gains have all been eaten up by cost increases by inflation.
Now, some people have benefited from asset inflation in the sense that their houses in which they live have appreciated in value but that has been precisely because of easy monetary policies and the debt growth that have now brought about problems.
And all I can say is that corporate profits in my opinion began to contract in the third quarter of last year and they will continue to contract, because corporations now –and this is important to understand – corporations are facing cost increases. So the margins are going to be squeezed. And whereas the valuation of the stock market is not unbelievably high in the sense that stocks are not selling at 50 to 80 times earnings like in Japan in 1989, if you exclude say the energy sector from the S&P which is selling at 12 times earnings or 10 times earnings, then the S&P valuation is over 20 times earnings. If you’re faced with declining earnings then basically the S&P is not a great bargain here. [13:14]
JIM: Let me just continue on that inflation theory, because what you are talking about in the fourth quarter the GDP deflator, if I recall, was falling from the second, third and fourth quarter last year; and I know in the third quarter the GDP deflator was the lowest since Eisenhower was president. So could you get statistically, and I’m just looking forward in an election year, maybe we get the lowest inflation rates since Calvin Coolidge was president. So in nominal terms as reported by the government we get this slow growth figure that they’re talking about – one to two percent – in those terms, we avoid a recession even though in real terms we are in one.
MARC: Well, basically, that would be a form of stagflation. And I mean it’s very difficult to measure GDP in the first place, and what you have to look at is essentially standards-of-living increases in an economy. And I don’t think that there are many standards-of-living increases in the United States at the present time, nor for that matter in Western Europe. We have huge standard-of-living improvements in emerging economies where a middle class is being created and where even workers or farmers are doing better than say a couple of years ago. But my point is simply that the government is lying. And they will continue to lie because they don’t want to admit that they created an unbelievable economic mess. Nor will the Fed admit that their ill-conceived monetary policies led to the crisis that we have today in the financial markets. [15:01]
JIM: What about the theory that’s being bandied about, even though the US economy slows down as we are now seeing that –they call the decoupling theory – that the rest of the world (whether it’s Europe, Asia, emerging markets) will continue to be strong? So therefore, if you are let’s say a large cap international company where you get a good majority of your sales overseas – and a good example would be, for example, DuPont this week beat estimates. They get 60% of their business overseas and because of that business doing very well their earnings were higher than expected. Do you subscribe to the decoupling theory, or do you think a slowdown in the US will have some effect on Europe and the rest of the world?
MARC: Well, basically, we have to first of all distinguish between an economic decoupling and a financial decoupling. In other words, can some countries grow when the US is say in a no-growth mode or in a recession mode? I think that this is possible because if you look at basically the US economy over the last two hundred years, occasionally you had a recession in one state, say, Texas in the early 1980s (when the oil price started to go down), and you had expansion in another state like New England (which benefited from lower oil prices); or in the early 1990s, you had a recession in California but other states they were expanding. So in an economy which is very complex, where you have different regions and you have different sectors – industrial sectors and service sectors – it is conceivable that one sector is in recession and other sectors or other regions are not; that is entirely possible. But I would argue that over the last seven years we had an unprecedented global economic boom where essentially every country has been growing with the exception of Zimbabwe, because you have a money printer in Zimbabwe who essentially should be joined by Mr. Bernanke. He would fit very well with Mr. Mugabe in that country.
Now, what happens if the US no longer grows is that the trade and current account deficits of the US shrink. In other words, we had during the excessive consumption period 1998-2006, a current account deficit in the US that increased from 2% of GDP to over 7% of GDP, and at the end was supplying the world with $800 billion annually. And this river flows into the world through the American current account deficits, and essentially provided the world with the so-called excess liquidity and created booms in everything from art prices to commodities, stocks, bonds, real estate, what not. And once the US no longer has this growing current account deficit, but a shrinking current account deficit, you have essentially a relative illiquidity coming up in the world. It is not that it’s tight money, but the rate of growth of liquidity shrinks and it does have obviously an impact on the economies and on the asset markets. And it is conceivable that say the US goes into a recession, Europe goes into a recession and that China does not go into a recession but into a growth slowdown, say from 8 to 10% GDP growth down to 3 to 6% of GDP growth. But this decline in the growth rate is still very uncomfortable for China, as well as for India. So I’m not a great believer in this decoupling theory.
Moreover, I don’t believe that financial markets will be decoupled. In fact, I would argue: If you look at look at the last four years, 2002 to today, then emerging markets have been the big bubble. The US markets have not been a gigantic bubble in the sense that US equities, especially large cap stocks, are not terribly expensive by world standards because the dollar has gone down so much. And so the big bubble is probably in emerging markets; and these markets, obviously if the S&P goes down, will be hit very hard. And I would argue, if someone puts a gun to my head, and says, “Marc, you must buy stocks,” as much as I dislike saying this but I would probably rather buy US stocks today, than say some of the emerging markets that are selling at 30 to 50 times earnings. [20:08]
JIM: You bring up an interesting point about liquidity in the world which has a genesis in much of the US trade deficit. As we look around the globe today, Marc – I have a screen on my Bloomberg that has year-over-year money supply growth rates around the globe and what is surprising as I look at this table is to see double digit money supply growth around the globe out of 18 of the top 20 central banks. I think Europe reported last week it’s money supply is growing at over 12%, yet Trichet is talking about being tough on inflation. You know, the inflation rates that we’re seeing here in the United States, are they not global in nature? Are you finding that, for example, in China where you have the inflation rate going at 6 or 7%, that this is a global phenomenon?
MARC: Yes, I mean that’s the point. I mean when recently people were very negative about the US dollar and so forth – and of course, long term you cannot be optimistic about the US dollar – but the US dollar has declined quite substantially, especially against the euro in the last couple of years; and the Europeans are also good money printers. It’s not just Mr. Bernanke that is the chief money printer. The others are not much better either. So basically, you have this excess liquidity being created in order to support asset markets and so forth.
But the point about this excess liquidity is that an eternal boom is out of the question. So what the Fed and the other central banks can do is kind of stimulate, through easy monetary policies, credit growth; but the private sector if it becomes, say, risk adverse can withdraw liquidity and a) not lend and people can also refuse to borrow, and so the credit does not accelerate but actually contracts. And that leads to what I call a relative illiquidity (it’s not an absolute illiquidity, it’s a relative illiquidity) and that then has some negative implications on some asset markets. But to come back to the first question you raise about making predictions, I think the difficulty today is that under normal conditions, say under a gold standard, we would be in a massive deflationary recession at the present time. Now, the central banks are all intent to prevent that and they print money like crazy and throw liquidity at the system by cutting interest rates and taking extraordinary measures. And so the question arises: How did you measure really economic growth and how do you measure your wealth? Say, as I mentioned, if the Dow goes from here to 26,000 – it doubles in value – if at the same time the gold price goes up 5 times, you lost out by being in financial assets. And I think this is what has happened since year 2000. In year 2000, as you know, you could buy with one Dow Jones, 44 ounces of gold. And now you can buy less 15 ounces of gold.
Now, I’m not saying that gold cannot have a meaningful correction, but I think that the central banks have created actually a state which I would almost call a hyperinflation where asset prices go up very substantially and they don’t make you really richer. I mean say in 1980, there were six billionaires in the world, and today you have thousands of billionaires in the world, everywhere. And money – the value of money – the purchasing power of money has depreciated very considerably. And I’m not speaking here of the US, because I was recently in New York and I saw that the price level in New York is actually quite reasonable compared to, say, the price level in Europe and in other countries. But usually when you have a situation like the US that has achieved relatively low prices levels through currency devaluations – and the US has pursued a policy to lower the value of the dollar – what usually follows (and not every time – usually what follows) is high and accelerating inflation rates. And the US government of course they will understate inflation, but the pocketbook of the consumer will notice this increase in inflation and what you will then get is essentially prices going up and the standards of living of people going down – in other words, stagflation. [25:08]
JIM: Isn’t this one of the signals that gold is giving to the financial markets? When you look through this period of time where we have seen nominal increases in assets and stock markets around the globe, yet if you look at the summer of 2001 when gold was at 255, and here we’re looking at gold heading towards $900 – do you think this is what is being recognized around the globe, that everybody knows that money is dying, it’s losing its value so gold is becoming the ultimate currency to hold?
MARC: Basically, my view is this: Normally, the safest investments in a society is cash, deposited in a bank or in Treasury bills. But the Western democracies and governments in general have created over time an environment where actually cash is a disastrous investment because you’re losing out to inflation like in the 70s as a result of consumer price increases or in the last couple of years as a result of asset price increases. Now, I’m not suggesting that there cannot be times – three months, six months, one year – when cash does better than, say, stocks or better than real estate. Say, in the last nine months it was better to be in cash than in stocks that depreciated or in real estate that depreciated. But basically, if you print money like the Fed or other central banks do, the value of money – of paper money – goes down and then it’s reflected in an increase in the value of assets such as gold that cannot be multiplied at the same rate. I mean someone could say, “oh, the gold price has gone up a lot since 2001.” I can turn around and say: “No, the gold price is the same. It’s the dollar the dollar that has collapsed against the price of gold.” And why did the dollar collapse against the price of gold. You call up Mr. Greenspan and Mr. Bernanke and you ask them about it. Of course, they will never give an answer. Each time Ron Paul asks them a sensible question they just evade the question and they move on to something else because, as I explained, they are a bunch of liars. And actually, if there was a court for honest money, both Mr. Greenspan and Mr. Bernanke should be hanged. [27:44]
JIM: You know, it was interesting – you mentioned Congressman Ron Paul. The last time Bernanke was on Capitol Hill, he asked him about curing inflation with more inflation, and asked him about what was happening to the dollar. And Mr. Bernanke responded – which I was horrified – and he said, “well, actually if you live in the United States and you pay for things with dollars it really doesn’t affect you.”
MARC: He’s out of his mind. Go to Zimbabwe and ask the citizens there: If you pay in Zimbabwe dollars it affects you that the currency has collapsed? Of course it affects you.
JIM: There’s a situation I want to move on to in the financial markets. A lot of the risks that we’ve seen erupt last year, whether it was in February with intermediate lenders or August with the collateralized debt obligations, something that has not gotten much attention and I think could even be a bigger issue and that is credit default swaps, which are now estimated to be somewhere in the neighborhood of 45 trillion. I think there have been a lot of people, Marc, in the hedge fund community and the banking community during this period when we were inflating between 2003 and 2006, they were writing these credit default swaps on corporate bonds because it was almost like free money. Now, if the US economy has gone into a recession –even though we’re not saying it formally – when you go into a recession companies have greater difficulties making their earnings, earnings slow down, cash flow slows down. And what happens if you start getting a bunch of corporate bond defaults? I think this is an issue with these credit default swaps that nobody is looking at. A few people have talked about it; Bill Gross saying it could be somewhere in the neighborhood of $250 billion losses. This is another issues that could surface this year that could throw chaos into the markets.
MARC: Well, I think you’re touching on something very important. I think that over the last 25 years we had numerous financial innovations. And I have to say is, the Federal Reserve had the power to control the financial innovations but actually they encouraged it and led to the excesses we had recently. And I think that the problem that occurred in subprime lending is a symptom of a much wider problem, and that the subprime lending crisis infects obviously other credit markets and so forth and that it will spread like a bush fire through the economy, especially if an economy was essentially driven by excessive credit growth. I mean in the last seven years GDP increased by $4.2 trillion and total credit between 2000 and 2007 increased by $21.2 trillion. In other words, debt has been growing much faster than the nominal GDP.
And I think that now we are in a process of deleveraging – of credit contraction, basically – but the Fed and the Treasury will do everything to restimulate the credit growth that led to the problems in the first place. That’s why I’m arguing that the policies of Mr. Greenspan, of Mr. Bernanke and Mr. Hank Paulson are totally misguided. Totally. And I believe, you know, the financial stocks, every bull market I’ve seen since 1970 when I started to work was accompanied by strength in financial stocks. When you have weakness in financial stocks something is wrong. And therefore, I don’t believe that this bull market that we had since October 2002 to the Summer of 2007 that this will come back. I rather believe that we are in a period of high volatility like in the 70s, when the Dow moved up and down every year by 20%, and in 1982 the Dow was still no higher than we were in 1964. So I think we can have a lot of fluctuations here. And at times the Fed, through rate cuts, can manipulate equity prices higher and so forth. And at times we will have disappointing earnings, disappointing results. And I would suppose that we will have massive bankruptcies as well where financial firms become illiquid and insolvent and are forced to the wall. And so the market environment for financial assets is not going to be particularly good. [32:46]
JIM: Let’s talk about a couple of investment themes among this volatility that we’re seeing. A couple of things that stand out or strike me, Marc, is energy which has been on a roll – and I happen to subscribe to the peak oil theory. I mean we have not made any major discoveries, we’re not replacing what it is that we consume, we have more people consuming energy today. That is one theme that I can see. And along those lines and something similar – you cover this in your current newsletter – is you’ve got a little over 1% population growth in the world, the acreage for growing crops isn’t expanding. In fact, in certain areas like China it’s being turned into parking lots – like Joni Mitchell’s song – or buildings. What about the theme of energy, food and precious metals if you wanted to be in this market as a long term investor?
MARC: Yes, I think that’s a very good point. In general, I believe that you should be in assets that cannot be multiplied easily, such as commodities (whether it’s copper or zinc or nickel or oil or precious metals), or food items (wheat, corn, soybeans, sugar and so forth). But the commodity markets had a very big move and the price of oil has gone up essentially almost 10 times since 1998 from $12 a barrel to now close to $100 a barrel. And in an environment of slowing growth in the world, I would be somewhat careful of investing now in industrial commodities whose demand depends essentially on strong economic growth. So I would not be surprised to see – as has already happened in some commodities like nickel – that prices correct meaningfully. And all I can say to investors is I’m bullish about gold in the long run, but don’t buy anything –whether it’s a house or stocks or precious metals – if you are not prepared to ride through say a 20% correction, because we have higher volatility. We will get more corrections along the way up. I mean I remember the great bull market of the Taiwanese stock market, 1984 to 1990. The market went from an index of less than 500 to 12,500, but we had in 1987 a 50% correction, in 88 a 40% correction, in 89 a 30% correction until we reached a final peak. So investors have to get accustomed to higher volatility. And someone who cannot live with this volatility because he is leveraged, is going to be forced to the wall.
So my advice is to be prudent. And yes, I like energy. I think energy stocks are actually quite inexpensive. But if the oil price for one reason or another drops to say $70, then obviously energy stocks will be down. And all I notice is when I started to like commodities in the year 1999 to 2002, it was not a widely accepted investment theme. And today, the investment theme is much more well known, and there are many more speculators in the market place. So I’m still positive in the long run but cautious say for the next six months. And I would also add, as of today – you see, if I remember, well, in 1980, after 10 years of consumer price inflation in the US, everybody thought that consumer price inflation would continue forever. And what then happened after 1980 is that consumer price inflation slowed down and we had a period of disinflation. Today, if there is one consensus it is that paper money will become worthless and that asset prices will continue to go up. And I would still think that it’s not very likely that Robert Prechter is going to be right with his deflationary bias –with everything, with gold prices collapsing to the Dow going down and so forth – but I would still think that there is still a small probability that we could have actually a period of deflation in the near future, which then will lead the central banks to print money like crazy. But in this period of deflation that I would not rule out we would have big declines in asset markets – big declines. [38:09]
JIM: Let’s say we start to get deflation. I mean certainly we’re seeing falling housing prices in the US and other places of the world. Do you think that we get preemptive strikes and perhaps they just throw all caution to the wind? Like right now, the latest consensus is when the Fed meets January 30th it’s going to be 50 basis points; and there’s even talk within the markets that they don’t wait until January 30th if things begin to deteriorate. I know there’s a lag effect to all kinds of things, whether it’s raising interest rates or lowering interest rates. If this deflationary period that could possibly erupt, do you believe it would be short-lived?
MARC: Yeah, very good question. I am quite sure the Fed will cut by 50 basis points; and if not by 50 at least by 25. But as you know, in Japan they cut rates dramatically to essentially zero and we still had deflation. I mean we cut interest rates from 6.5% on the Fed funds rate in January 2001, to 1% in 2003, and yet the NASDAQ still went down. So whether interest rate cuts and even a stimulus package – fiscal package – will help much remains to be seen. We could be in an unusual situation where it doesn’t help much. It’s possible because the public or the household suddenly starts to save; in other words, the savings rate goes up and people become risk adverse. As I said, I don’t know how the world will look like in a year’s time. I’d rather be in gold than in the Dow Jones, whereby maybe for the next three months the Dow Jones could outperform gold for a while. But in general, it’s very, very difficult to make any kind of predictions that make sense simply because you don’t know how irresponsible Mr. Bernanke and Mr. Hank Paulson will be. We just don’t have any idea. As you say, they can do a lot of things to try to support the asset markets. And Mr. Bernanke has written and spoken about this: that you cannot identify bubbles but when they burst you should step in with extraordinary measures. We just don’t know how extraordinary his measures will be. I mean the best for Mr. Bernanke, the best extraordinary measure would be to resign and say: “We failed. We are incompetent.” [40:54]
JIM: But you know, Marc, if you take a look at his study of the Great Depression and people might recall the comment he made at Milton Friedman’s birthday where he said to Mr. Friedman: “You know, you were right, we made the mistake. We caused the Great Depression. I assure you, it will never happen again.” Basically saying, according to Mr. Bernanke’s view and study of the Great Depression, the reason we had it was the Fed didn’t print enough money. Had they been able to do so the Depression would never have occurred. So it almost gives you an insight in terms of his thinking, which is along the lines with Mr. Greenspan in the sense that anytime there’s a problem in the economy or the financial markets massive liquidity seems to be the response and answer.
MARC: Yes, that is correct and I’ve written about this. And I think that the entire analysis of the Great Depression, especially by Mr. Bernanke, is totally wrong. The causes of the Depression were not tight monetary policies by the Fed, but easy monetary policies by the Fed. And Paul Warburg, who was at that time a Fed member, later on commented about this; that the Fed should have pursued tighter monetary policies in the years leading to 1929. And I’d just like to mention one point: In 1929, the PE on the Dow Jones was just about 13 times earnings. We didn’t have a massive stock market bubble in terms of valuation, but what we had is an earnings bubble and half the earnings collapsed. And I think today we don’t have, you know, like 50 times earnings on the stock market like we had in Japan. But I think we have an earnings bubble and that the earnings will disappoint very badly. But I’m just convinced that in a democracy, especially in a country like the United States, the politicians will print money. And whether or not it will always help to support asset markets is very questionable.
The one thing I can assure you is that money printing doesn’t create wealth. That is important to understand. And at some point, as my friend Barry Bannister pointed out, you reach with credit growth the zero hour. In other words, you print money, credit grows, but the economy doesn’t respond. And I think we are already in that situation. And what the outcome will be, hyperinflation or deflation, that is the difficulty to judge. But I think personally as an investor, I would be positioned to some extent in gold because in a deflationary environment I happen to believe that gold would outperform other asset classes because things will get so bad that people will run into gold as a safe haven. And at the same time, I would hold essentially some cash and I would probably deleverage. In other words, I wouldn’t hold a lot of debt in the present environment. If there is hyperinflation, to hold a lot of debt is the right thing to do; but just in case we have deflation, like now in housing and now probably also in commercial properties (that is the next shoe to drop), that in such an environment you’re better off by not holding too many debts. [44:40]
JIM: I want to cover a point in your January newsletter and just let our listeners know, if you don’t subscribe to Marc’s newsletter you’re really missing out on some good thinking.
MARC: Well, it is very kind of you.
JIM: You had a gentleman who has written pieces for your newsletter in the past, his name is Michael O’Higgins, he’s author of Beating The Dow – a very sharp money manager, and I’m going to quote from your newsletter here, and he goes:
So where does one find value in today’s investment world? In my view, given that the main focus of the current US Federal Reserve board remains one of fighting deflation, investors should avoid bonds entirely and concentrate on investments that can protect them from a rising inflation rate i.e. stocks and commodities. With these two categories we have our portfolios equally invested among four investment themes: dogs of the Dow; dogs of the world; precious metals and mining; and energy.
What do you think of that?
MARC: Well, basically, I agree with Michael and I think that if you buy today at 10 years the US Treasury, or 30 year US Treasury, you’re flirting with disaster because they will only perform well in an environment of total deflation, given the low yields they provide at the present time. But as I said, the concept of inflation and deflation is very complex because you can have an economic system where some assets are inflating and some assets are deflating. Like in the US, say in the last 12 months, you would have been better off in US Treasuries than say in the housing market, which has declined in value. So in general, I of course agree with Michael to be in stocks in the long run and to be in precious metals and in energy in the long run and so forth. I’m not sure whether that is the right medicine for, say, the next three to six months. I mean I’m very cash rich here. I’m cash rich US dollars. I think the US dollar does not have a significant downside risk against the euro. In other words, if you put a gun on my head and said, “Marc, you have to choose one currency today, for the next three months: the euro or the US dollar,” I think I would choose the US dollar. Although, I’m very negative about the US dollar in the very long run. But just for the next three months I think the dollar will hold because the current account deficit is now shrinking, the trade deficit is no longer expanding and so forth and so on; and the dollar is relatively inexpensive vis a vis the euro. Would the question be: put all your money into US dollars cash, or put all of your money in gold? As of today, that would be a very tough question because the gold market in my opinion is now somewhat overbought and could undergo easily a 10 to 20% correction. [47:59]
JIM: I’m sensing, Marc, as we’ve had this discussion and also from reading your newsletter, that you’re very cautious at this point. The fact that you’re holding larger amounts of cash and in the dollar is that because of the amount of uncertainty? And what would cause you to move out of cash?
MARC: Well, I think that as an investor – and I’m not a mutual fund manager or hedge fund manager that needs to show performance every week or every month – I’m a believer that occasionally the markets create an unusual opportunity. The unusual opportunity of the last 10 years was really commodities in the years 1999 to 2001, and emerging economies following the Asian crisis. They provided a lifetime buying opportunity. Now that the whole world is captivated with investments, and buying this and selling that and moving here and moving there and performance, I sometimes feel I want to actually be on the sidelines and just give it some time until I make the next major bet. I mean I’m involved quite heavily in gold. Would I put now all my money tomorrow into gold? I doubt it. And I want to be diversified. And all I can say: investment opportunities arise again and again. I mean, I suppose if Citigroup went down to $5, I’d be tempted to look at it. I’m not particularly interested here at the 27 to $30 level, because the financial excesses we had that were built over the last 25 years will take time to kind of correct. And if you have a boom sector, say, like the oil sector in the 70s, afterwards for 20 years oil was unattractive and the drillers were unattractive. And so financial stocks, after a bubble burst in that sector may not provide the leadership in the future and may be unattractive for many, many years to come. But I’m convinced, like I wrote about in my last report about Cambodia, I think there are some countries in the world whether it’s Cambodia or Ukraine or Belarus or parts of China or parts of India, or parts of Russia that can have strong economic growth even in a weakening global environment and provide investors with unusual opportunities. [50:50]
JIM: Marc, you do a lot of traveling around the globe and I think that gives you a different perspective than let’s say some analyst that stays in his office all the time. As you have been traveling over the let’s say last 12 months, is there anything that stands out in your mind and things that you’ve observed?
MARC: Well, I mean people talk about the housing bubble in the United States and the downturn in housing prices in the US. What stands out to me –and I never experienced that before and I’ve been traveling extensively since the 1960s – is wherever you go you encounter boom conditions. And some boom conditions are bigger than others. Say three years ago there was a boom in Dubai. Two years ago the boom was a bit bigger; a year ago it was a bit larger; and now, it’s difficult to imagine how the boom could become bigger to what it is right now. And the same happens in many other countries. Everywhere you have essentially a forest of cranes building; and we have an unbelievable construction boom everywhere in the world. And my view is simply: If you have a synchronized global economic boom as we have had, then the consequence is one day a global synchronized bust, because in the past usually booms were concentrated in one sector, say oil in the 70s or NASDAQ, I mean technology in the late 1990s, or Japan (1985-1990). So that was just one sector of the global economy that was booming and the others weren’t. But now I can assure you: Everywhere you have a colossal boom; and I think this will give way to colossal bust. If it’s this year or next year, who knows? But I don’t want to be caught in this colossal bust. And if someone says, “oh, we can make a lot of money over the next 12 months until it happens,” then good luck to him. I just don’t want to be overly exposed to this boom at the time when, say, cyclically I can see that there is this relative illiquidity coming up and where it is difficult to build much on the existing boom. And besides from that, if you really have boom conditions, that doesn’t guarantee that equities go up. Sometimes you have strong economic conditions and stocks go down like in the Middle East in 2006, early 2007. We had boom conditions but stocks still dropped 50 percent. [53:41]
JIM: Well, you know, Marc, I think it’s in the next week or so you meet with the Barron’s roundtable group. I’m sure I think your views are going to be much, much different than the roundtable. They usually are. Do you expect optimism to be expressed there. I mean one of the standard things that we see today, slow growth, rising markets, even though earnings are going down, interest rates are going down, so we could see multiple expansions. What do you expect your group of peers to be saying?
MARC: Well, basically, the interview took place last Monday and the group by and large is bearish on the economy. But they are in denial about the stock market. They all think that stocks will be okay, but they are bearish on the economy. And that’s what I think is happening throughout essentially the money management establishment. People are kind of cautious on the economy. The economists predict, say, a soft landing and the analysts are essentially actually quite positive because they predict the S&P earnings to grow by 12 percent this year. And so there is this environment of what I would call self-delusion. And my view is that the markets won’t perform well. But equally, as I said, if someone said you must own stocks, I think the emerging stock markets today are more vulnerable than the Dow Jones. And so if I had to own stocks, probably I would be in the Dow Jones – whereby I’d prefer not to own any stocks. [55:15]
JIM: Well, Marc, I want to thank you for joining us on the Financial Sense Newshour. You’ve been very generous with your time. I know it’s late there in Thailand where you join us. If our listeners would like to find out more about your work –and by the way, my compliments, it’s probably one of the best written newsletters out there. It’s always full of interesting aspects or thoughts on investing – tell them how they could do so.
JIM: Marc, I want to thank you so much for joining us on the program. I want to wish you a happy, prosperous and healthy new year.
MARC: Well, thank you very much for having me.
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