"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Thursday, January 20, 2011

Barron's Roundtable Discussion: Notable Comments by Felix Zulauf, Bill Gross, and Marc Faber

In today's article I am posting comments made by three great investors:  Felix Zulauf, of Zulauf Asset Management, AG, Bill Gross, Co-CEO of the world's largest bond fund, PIMCO, and well known contrarian Marc Faber of Marc Faber, Ltd.

The full article is available online at Barron's.  Here is some commentary I found interesting:
Zulauf: There are two worlds—the industrialized world and the emerging world. The industrialized world continues to live in a fiction: that it can afford its current lifestyle by going further and further into debt. At some point, the bond markets will riot against that. The private-household sector, not only in the U.S. but in several industrialized countries, remains stretched financially and will continue to deleverage. The public sector is leveraging up, and thus will support the economy. The U.S. economy will muddle along, probably growing by 2.5% to 3% this year. Inflation isn't a problem yet in the industrialized world. 
The emerging world has experienced high levels of growth, but it is entering a period of rising inflation. How emerging economies handle that inflation will be the decisive factor for the industrialized world. If they decide to fight inflation with really restrictive monetary policies, we're in trouble. If they hike interest rates only a little to restrain growth, the cycle can be extended. But that means later on, perhaps in a year or two, they will have much higher inflation and will have to crunch it. The choice is between more growth in the short term and then a crunch, or a more serious bear market now. 

Gross: The developed world is coping with the excesses of the past 20 to 30 years. The deleveraging cycle isn't just a one-to-two-year thing. The proportions of the excess, and now the attempts to deal with it, have a number of consequences. For one, growth will be slower, and inflation will be lower. In the U.S., we're seeing unacceptably high levels of unemployment—not just the published 9.4%, but 16% to 17%. The question is, can a debt crisis be solved with more debt?
In Portugal, Greece, Ireland and Spain, which lack the ability to devalue their currencies, a debt crisis can't be solved with more debt. Japan appears to have done a good job so far, because its debt is 200% to 250% of GDP, much higher than here. The U.S. has the advantage of being a reserve currency, which means it can print its way out of this situation. But that requires a willing acceptance on the part of creditors that the money it is printing is of decent value. Current interest rates, including a federal-funds rate of only 0.25%, are unacceptably low. Real [inflation-adjusted] interest rates are negative. Printing your way out of this, or kicking the can, is possible for some countries, but the solution isn't to create paper. It is to create goods and services the rest of the world wants to have.
Zulauf: All other industrialized countries, almost without exception, have focused on cutting deficits. The U.S. alone hasn't addressed the problem. If you eliminate public-sector tax revenue and spending, the U.S. economy would have grown in only two of the past 10 years. Public deficits have been supporting this economy for the past decade. The country has been suffering from under-saving and under-investment. Markets would cooperate fully if the government decided to pursue large, multiyear investment programs financed by debt. That would create a future return, and jobs.
Bill Gross touches upon the political and economic power of corporations:
Gross: Corporations are probably at the peak of their domination. They dominate versus labor in terms of their ability to export jobs and production overseas. They dominate now in terms of Washington, given the Republican electoral victory and the Obama administration's moving toward the center. 
They even dominate with regard to the Supreme Court, as evidenced by the recent ruling removing limits on corporate donations to election campaigns. This is all good for the market, but not for Main Street in the long run.
Zulauf: You also have a tremendous social division. In the U.S., the top 20% of the population owns 93% of the financial assets. That tells you the average guy is in bad shape. He spends what he makes, and, at the end of the month, he's even. 
And now, for my favorite analyst of the three, Marc Faber. In my view, he gives a good dose of reality:
Marc, you have been very quiet. What are you worrying about? 
Faber: Have you got an hour? You are all wrong. You say you would do this or that if you were policymakers, but nobody says "I wouldn't do a thing. I would let the market correct itself." The crisis in the U.S. happened largely because of government intervention that began 25 years ago. The government continuously implemented policies to boost consumption, when everyone should know that an economy will grow in a sustainable way through the implementation of policies that foster capital formation—that is, spending on infrastructure, R&D, education and the acquisition of plant and equipment. By fostering more baseball games, more TV shows, more talk shows, you aren't going to create a vibrant, growing economy. 
The government didn't create more baseball games.
Faber: But it created policies to borrow more money. Through artificially low interest rates, it created a huge credit bubble, which led to a bubble in consumption, a symptom of which was the growth in the trade and current-account deficit from $150 billion in 1997 to more than $800 billion in 2006. Now it is around $600 billion, but if these policies continue it will remain at this level or grow.
So you're really saying it's the Fed's fault.
Faber: What I am saying is that Archie lives in a dream world. I admire you all but you are all dreamers. The Federal Reserve was founded in 1913. Before that, throughout the 19th century, the U.S. had strong per capita income growth in a deflationary environment.
It also had huge financial panics.
Faber: That refreshes the system. Worldwide, we have two economies. Rich people and resource producers are doing incredibly well. The ordinary people aren't doing all that well. In 1970 the U.S. controlled 28% of world manufacturing output and China had 4%. In 1990 the U.S. still had 22%, but Japan had come up in the ranks and China still had only 4%. Now the U.S. says it has 20%, and China, by its own account, has 19%. In the U.S., not much happened in the past 20 years. But in China, India, Vietnam, Russia and Brazil you can see huge progress. That said, I agree with Archie that U.S. stocks might outperform other stock markets—once in a century.
Faber: History has shown that giant countries on the way down are very dangerous because they are desperate. But this year the U.S. has stabilized and is going to grow modestly.
One more thing: Janet Yellen, vice chair of the Federal Reserve, said about a year ago that if it were possible to push interest rates into negative territory, she would vote for that. This is a very important statement because it implies that the Fed will keep real interest rates negative as far as the eye can see. Negative real rates amount to expropriation and destroy one function of money: to be a store of value and a unit of account. If you measure the stock market not in dollars but gold, it is down 80% since 1999. I no longer regard the U.S. dollar as a valid unit of account. People shouldn't value their wealth in dollars because one day, in dollars, everyone will be a billionaire.
Gross: I agree with Marc on many things, though not everything. I don't know if the U.S. has reached a desperate point, but it is employing instruments and vehicles and policies that smack of desperation. We are not looking at a default here, but at years of accelerating inflation, which basically robs investors and labor of their real wages and earnings. We are looking at a currency that almost certainly will depreciate relative to other, stronger currencies in developing countries that have lower levels of debt and higher growth potential. And, on the short end of the yield curve, we are looking at creditors receiving negative real interest rates for a long, long time. That, in effect, is a default. Ultimately creditors and investors are at the behest of a central bank and policymakers that will rob them of their money.
Faber: It is much easier for a government to print money and default in the way Bill just explained than to come out and say "we aren't going to pay half our debts." Also, one of the big debates these days is between the deflationists and the inflationists. The deflationists claim the Dow will drop to 1,000 or less and the economy will contract sharply, and therefore you should be in government bonds, not commodities, equities or real estate. But if China and India continue to grow and car makers do better, as Mario said, commodities will do OK.
In a deflationary environment, tax revenues go down and fiscal policy remains expansionary. Deficits stay high, and even increase. Interest rates on government debt go up, and the quality of that debt declines. In a disaster scenario, I would rather own equities than government bonds. Since I am ultra-bearish, my preferred assets are equities and hard assets: real estate, commodities, precious metals and collectibles.
Zulauf: In the late 1970s and early 1980s, Paul Volcker [then the chairman of the Federal Reserve] crunched inflation by applying very high real interest rates for several years. Now we are getting the same process, just in reverse. Just as it took several years for the market to see that Volcker's policies would lead to declines in inflation and interest rates, it will take several years for the market to realize the Fed's current policies are highly inflationary. They will lead to a debasing of the currency, which is happening to varying degrees in most of the industrialized countries.
Zulauf: At its 1980 peak of $850 an ounce, gold represented 3% of the market capitalization of global equities, bonds and money-market assets. Today it is 0.6%. The price has a long way to go.
At one point, Marc Faber makes this statement:
Faber: I'm very bearish about the ultimate outcome. 
So what does Marc Faber believe is the ultimate outcome? Well, I dug up this interview that I recall from the summer of 2009. I think it's important to review past opinions of analysts to see how accurate they are, not just in the short term, but in the long term as well. Is the world still proceeding in the direction that Marc Faber describes here?

To be honest, I extracted most of the bearish views found in the interview, which I mostly agree with.  Other analysts disagree, and I recommend a full reading of the interview HERE to see their opinions.  At the end of the interview the analysts discuss what they own, or will buy this year.


Dave Narby said...

I loved their subtitle

"The big picture might look scary, but the stock market is heading higher, say the members of the 2011 Barron's Roundtable. In the first of three installments, our panelists share their big-picture views. "

They should have had the Mogambo Guru write it instead ("We're Freaking Doomed!").

Misthos said...

That's a good one. I always get a kick out of reading the Mogambo Guru.

Marc Faber however, is one of the few out there that can go on and describe horrific scenarios, and yet be invited back to speak again. That's rare in mainstream media. And what makes me laugh is how he smiles when he describes these apocalyptic scenarios! The guy's got charm; few can pull that off.

As for the stock market rallies, I'll admit, I was overly pessimistic in early 2009, yet Faber correctly called the bottom. I never realized how powerful double-entry book keeping is. The Fed just needs to make an entry on its balance sheet, and voila - somehow, somewhere in the system, the money flows to the US stock market.

Main Street? - well, they're shit out of luck.

But big picture, long term? Mogambo is right... "WE'RE FREAKING DOOMED!!!!"

OKL said...

just love the shenanigans we're playing; everyone's printing money to buy each other's debt and keep the USD low... sort of like getting into an orgy.

sometimes i wonder if im the one that's mad.

Misthos said...

Welcome OKL!

No you're not mad, the world's gone mad and few realize it.

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