Deflationary Bust or Government Profligacy and Money Printing
Marc Faber, 2012 Agora Financial Investment Symposium
“I am very grateful to be here in Canada. Every time I travel from the US to Canada, it feels like I am traveling from Hell to Heaven.” With this opening grapeshot, Marc Faber was off and running.
He thanked the crowd for coming out so early in the morning (a cool 8:50am local time) – just a few timezones later than Niall Ferguson’s 6am call out!
Faber, a renowned aficionado of nightlife around the globe, appeared quite spry this “early” morning, sharing that he came from a meeting with fellow economists that’s left him very depressed. To get his spirits up, he pulled out his favorite punching bag.
The Fed’s Expropriation
Faber pointed out that the Federal Reserve has reacted to every crisis from the past 50 years with injections of liquidity into the system.
Mexico in 1994 was the first big mistake he mentioned, noting there was opposition from members of the Fed on the move, but Goldman Sachs had a big position that was ultimately protected.
Leverage grew with the bailout of LTCM in 1998, and after the NASDAQ bubble.
“Mr. Greenspan always claimed he cannot identify bubbles, which is nonsense,” Faber interrupted himself, pointing out that an asset that doubles in price within a year is likely in bubble territory.
After the NASDAQ tanked, the Fed cut rates, then raised them very slowly during the 00’s, keeping them below the rate of inflation.
“The Fed was asleep and did not realize the whole system was subprime,” he continued. “The Fed’s current thinking is that negative interest rates are desirable.”
“If you drop dollar bills into this room, the money will not flow evenly into the room. It will flow unevenly into housing, the NASDAQ, rentals, and so on…” Faber said, resulting in massive misallocations of capital.
He described the Fed’s low interest rate policy as “An expropriation of savers, decent people. The cost of living is rising at 5% or more per annum.”
So why would anyone buy a Treasury bond at these levels?
He explained the justified thinking among some people is that if you buy Treasuries, you’re sure to get paid back (despite losing ~4% annually due to negative real interest rates), because the government can ultimately print money.
“They say I’d rather lose 4% per annum then give my money to a money manager and lose 30% per year.”
New York Times Driven Policy
The Fed inflated credit growth for 30 years and nobody paid attention.
If you have a credit boom and it goes into consumer growth, you only get the benefit at the moment. “It’s gone and useless,” Faber said.
If on the other hand it goes into capital infrastructure, there are multiplier effects (as China is doing today).
“The Fed – under the influence of the Keynsians…who write for the New York Times and such – created huge deficits and monetized them.”
Fiscal Grand Canyon
“By the way, the accounting of the government stinks. If it was a private company, the debt would be much larger with unfunded liabilities,” Faber critiqued, explaining further that debt would be a multiple of current reported $15 trillion levels
“This will lead not to a fiscal cliff, but to a fiscal Grand Canyon!”
Taxes as a percentage of GDP, he showed, are actually declining – from 18% in 1990, just above 14% today. Meanwhile government spending has risen north of 25% of GDP.
On cutting spending and entitlements, he mused: “The politicians know what to do – they just don’t know how to get re-elected if they do it.”
Not missing a beat, Faber addressed the growing wealth gap in America, highlighting a chart of the tanking net worth of the youngest 35-44 age group.
Click to enlarge.
“They have been indoctrinated by CNBC that the NASDAQ always goes up, that housing always goes up,” Faber outlined, describing how they lost money day trading the NASDAQ, they went to buy homes with little or no money down (because they had none), and got slammed there too.
Thank You Mr. Bernanke
“The greatest country in the world (US) consumed, while the second greatest country in the world, China, produced.” (He delivered “greatest country in the world” tongue-in-cheek, by the way).
He credited US money printing with lifting commodity prices out of a long bear market in 2001.
As an example, he recalled that when the Fed slashed interest rates in 2007, oil “went ballistic” up to $147. It was not demand driven, as the world was already in recession, but instead speculation. Then it dropped from $147 to $30 in 2008.
“Thank you Mr. Bernanke, what a great job you’ve done.”
Skeptical on China’s Dry Stimulus Powder
The Chinese have been relatively smart, Faber believes, they have bought things from Australia, Brazil, and other emerging countries. They didn’t buy things from the US because the US didn’t want to sell them what they wanted to buy – namely weapons.
Faber warned that no matter how bullish you are about commodities, though, at some point demand will flatten out.
Faber pointed out that Chinese commodity consumption must flatten out (chart via Agora Financial – click to enlarge).
The need for commodities is high when you industrialize, but this declines as you build out your service economy sector.
“Don’t believe statistics that are published by any government in the world,” he gently warned.
He believes there is a credit bubble in China at the moment, but does not know how it will deflate. In his opinion some sectors of Chinese economy are contracting at the moment, and some are barely growing.
While many in the financial media believe China will be able to stimulate their economy in the event of a slowdown, Faber is more skeptical, due to the nature of their economy.
“If you reflate consumption, it’s not a favorable development, but you at least restimulate demand. But if you reflate on top of capital spending, you just have additional unused capacity.”
Oil and War
While he’s cautious on the commodity sector, he believes oil demand will continue to go up because per capita consumption is very low, especially in China and India.
“Also if you look at the Middle East – this is going to go up in flames,” he said, dropping his first prediction of military confrontation – making this an official Faber talk.
Unlike the US – which can source oil from Canada, Mexica, West Africa, etc – China sources 95% of its oil from the Middle East. This is a security issue, if you happen to be running a country with 1.3 billion people, and you are relying on oil being shipped from the Middle East to China.
These ships are also very vulnerable due to tensions around the South China Sea (instigated by the US, he added).
“I am quite optimistic about Asia in the long run. But war, of course, would change everything.”
Holding all money in cash would be very dangerous, he warned. He predicted that while the Republican say they will kick out Mr. Bernanke, if the S&P drops 300 points, they will say, “Please print money!”
His fiscal policy outlook for the entire world, “Including the Chinese who invented paper, will be to print money.”
You have two choices for an investment strategy, he believes:
- “If you are a smart trader, and you know the NASDAQ will peak out in 2000, you sell it and buy gold then, and sell gold as its peak in September 2011, and then you move into bonds and sell those when…” he mocked.
- He instead prefers diversifying among different asset classes.
His big four, as usual: Equities, Cash and Bonds, Real Estate, and Gold.
Look Out Hotlanta, Scottsdale Club Scenes
Faber admitted that US real estate is extremely cheap (agreeing with BCA’s Martin Barnes).
“I can tell you, you can buy a house for less money in Atlanta and Phoenix (where he was earlier in the year) than you can in Thailand.”
“Paradoxically, monetary inflation creates great opportunities to invest in distressed assets.” Bubbles make things unaffordable, but as the bubble deflates it overshoots to the downside.
US real estate, if he were a US citizen, would be an asset class he would look at (though he is not interested himself for various reasons).
He cited rising rentals – in San Francisco, rental prices are up 15% in the past year, and up 9% across the board in the US.
“People get kicked out of their homes, and then they have to pay rent. This is monetary policy,” he sarcastically concluded.
Investment Picks: “Please Shoot”
“We could easily have a trading range for the next few years,” Faber said in reference to stocks. “The monetization will be there in my view.”
Equities have underperformed commodities since 2000, and he does not believe equities are terribly overvalued right now.
“If someone puts a gun to my heads and says you must buy Johnson & Johnson or Treauries…I may say: ‘Please shoot.’
“Otherwise I might take the shares.”
He conceded that given the choice to buy and hold something for the next 10 years – for example Johnson & Johnson, Procter & Gamble, Merck…or US Treasuries…he would probably go into stocks. He also noted that a significant percentage of US stocks have a dividend yield higher than the 10-year Treasury
“I would have some stocks because bonds could be dangerous, cash could be dangerous.”
He pointed out that US stocks recently reached a huge non-confirmation high – a high on the S&P that was not confirmed by transports or European stocks.
He believes European stocks are now cheap, and has started to buy some stocks in Italy and Portugal, as markets there are “essentially at or below their March 2009 lows.”
Finally he addressed why he’s “not overly bearish on equities in an environment of money printing”, using the example of the Mexicon peso and stock market in the 1980s. The peso lost 98% of its value, but the stock market compensated accordingly, so “at least you kept your purchasing power.”
(He also outlined an interesting case study on when to purchase stocks during hyperinflation, using 1920s Germany as the example, in his book Tomorrow’s Gold. He found that you’d have done quite well buying stocks when hyperinflation was at its worst, as the market overcompensated when things looked bleakest, but quickly recovered when hyperinflation went from terrible to just plain bad).
I Will Never Sell My Gold
Faber dismissed concerns of a gold bubble, saying that nobody really owns it yet.
When the NASDAQ peaked in 2000, and oil stocks peaked in 1980, there was widespread ownership. Today that’s not the case with gold, he said, describing current sentiment as “rather negative”
So what’s the broader solution to this mess?
“Fire half the government, and reduce government spending by 50%. It will still be too large.” Faber’s point being that in the Western world, public spending is completely choking off the private sector.
“The Krugman model in its entirety would be the socialist/communist model. Let’s keep the politicians asleep, because every time they do something, it’s the wrong thing.”
“As long as I live, I will never sell my gold,” he declared as his grand finale rant reached a crescendo – pausing on his final slide, a political cartoon of President Barack Obama.
“Especially as long as I see people like that.”
Dr. Marc Faber publishes a widely read monthly investment newsletter, The Gloom Boom & Doom Report, which highlights unusual investment opportunities, and is the author of several books, including Tomorrow’s Gold: Asia’s Age of Discovery, which was first published in 2002.