Hanna Barry
24 minute read
12 Oct 2015
1:37 pm

US growth is weak, Fed will ease rates – Jim Rickards

Hanna Barry

Jim Rickards on the financial crises to come and why you should invest in gold.

Currency Wars author, Jim Rickards | Image: Wikimedia

HANNA BARRY: Jim Rickards is the author of New York Times bestsellers, Currency Wars and, more recently, The Death of Money. He has advised the Department of Defense, The US Intelligence Community and major hedge funds on global finance. He is in South Africa for the CFA South Africa Global Investment Conference taking place next week at Gibs in Johannesburg. Jim, it’s good to have you on the show, welcome, thanks for joining us, let’s start with looking at where we are at the moment in global markets. The world is highly uncertain, market and currency volatility are the order of the day and you think that in this context gold is really the only true money and we should return to the gold standard as a global economy, can you talk us through why that is?

JIM RICKARDS: Sure, Hanna, that’s a great question and I’ll come to gold but before we get to gold I’ll talk about the first part of your question which is the instability and uncertainty in global capital markets and currency markets and I think that’s exactly the case. I attribute a lot of that to the United States, to our central bank, the Federal Reserve, and to policies of the US Government, not to the entire monetary history of the 20th and early 21st century but up until 1971 the world did have a gold standard that worked fairly well. From the late 70s it was a muddle, it was a very unstable period, not unlike the kind we’re having right now, although the danger today is more deflation, the danger in the late 70s was inflation but they’re just different kinds of instability. Finally by about 1980 through the efforts of our Fed Chairman, Paul Volcker, and President Ronald Reagan we stabilised the dollar and then for a very long period, for about 30 years from 1980 to 2010 the world was not on a gold standard but it was on a kind of dollar standard, our trading partners and other central banks around the world could anchor to the dollar and feel that was a reliable…value. It was sometime referred to as the age of king dollar. That was all torn up in 2010 after the global financial crisis of 2008, early 2009. The United States set about cheapening the dollar, this was really the beginning of the currency wars and the view in the United States was, well, the entire world economy is in a depression and it’s a very unstable thing, the US is the largest economy in the world, if we go down we’ll take the rest of the world with us in terms of trade and finance, so we needed a cheap dollar to give the US a little boost. We got it in 2011, the dollar was close to an all-time low and, of course, that was when gold in dollar terms was close to an all-time high. Not really a surprise, the dollar price of gold tends to move inversely to the strength of the dollar, so a weak dollar means a high dollar price for gold and conversely a strong dollar means a low dollar price for gold. So in 2011 we had a very weak dollar. Well, since then we’ve seen the cheap Japanese yen in 2013, then the euro was cheapened in 2014 through negative interest rates and quantitative easing, so it brings us around where these different currencies have taken turn cheapening themselves to give their economies a boost. Of course the thing about currency wars is not every currency can cheapen against every other currency at the same time, that’s a mathematical impossibility, you have to take turns, in the 30s this was called Beggar-Thy-Neighbour, today no one wants to use those words but exactly the same thing is going on. But the blunder of the Federal Reserve was in 2014 the Federal Reserve decided that we could in effect afford a strong dollar, that the US economy is doing better, that they would soon be able to raise interest rates and that it was okay for the euro and the yen and other currencies to be lower. That turns out to be a historic blunder, the Fed was wrong about that, not surprisingly, their models are…their forecasting ability is dismal and it’s not just an opinion, you can go back and look at the Fed’s forecast for the last seven years, they’ve all been wrong by orders of magnitude. So the Fed has a terrible forecasting record but they took the view that the US economy was strong, we could afford a strong dollar, that turns out not to be the case. The US economy is very weak, not on very sound footing and the strong dollar has made things worse. So now we have capital outflows from emerging markets, including South Africa, where you see capital leaving South Africa and China and Brazil, Russia, South Asia, all around the world, coming to the United States in anticipation of higher interest rates, we see a stronger dollar, this has made the United States a magnate for all the deflation in the world. So we have capital outflows from emerging markets, collapsing emerging markets currencies, deflation in the United States, the weakening US economy, so the world economy is in very bad shape, mainly because of these forecasting, analytic and policy blunders of the Federal Reserve. We’ve seen the IMF at their annual meeting going on right now in Lima, Peru, in their world economic outlook they’ve said not in quite the blunt language I’m using but they’ve said we’re on the edge of an emerging markets crisis and the world is slowing down.

HANNA BARRY: In that context you mentioned a lot of different things there that I’d like to pick up on, so let’s start with US growth, we have heard a lot about US growth and analysts, investors, various commentators, including media, make a pretty big deal of it, the Fed has tapered its bond buying programme, quantitative easing that is, unemployment is at an all-time low and the US economy does appear to be picking up from what we’re led to believe, you obviously don’t buy that?

JIM RICKARDS: Well, I don’t buy it but I rely on the data. There is an old saying that you are entitled to your opinions but you are not entitled to your own facts. So what I do is look at the facts. Now just to take the United States in 2015, our first quarter GDP was 0.6%, the second quarter granted was very strong, it was about 3.9%, although when you look behind the curve a little bit a lot of it was inventory accumulation I usually …substitute final sales. But take it as it is – 3.9%. We just finished the third quarter. We won’t have those official numbers until the end of October, but there is a very good real-time tracker put together by the Federal Reserve Bank of Atlanta, one of our regional Federal Reserve banks, that has a very good forecasting record. And it is estimating third-quarter growth of less than 1%. To take the three numbers together, 0.6, 3.9, 0.7, add them up and divide by three and what you get is a good estimate of annualised growth of about 1.8%. The Fed’s target is 2.5%. So, once again, the target is too high, the forecast is too high, the actual data appears to be about 1.8%, which is very weak growth, nowhere near US potential, nowhere near the Fed’s forecast. As far as employment is concerned, yes, the unemployment rate, the headline number again is 5.1%. But again, when you look behind the number, labour force participation in the United States is the part of the adult population actually working is the lowest it has been since 1977, almost an all-time low in that data series. We are creating jobs. What’s happening is that we are losing a job that makes $80 000 a year in the oil patch, and we are getting three bartenders making $25 000 a year. Now there is dignity in our work – not disparaging bartenders, bartenders are just fine – but three $25 000 jobs doesn’t replace one
$80 000 job in terms of aggregate demand, purchasing power and marginal propensity to consume. So what you have is that yes, we are creating jobs but not high-paying jobs. The demand is not there, real wages are not going up, labour force participation is low. And now you look at inflation which is sort of the third leg of the stool. The Fed has a 2% inflation target. They use an indicator PCE… that’s showing about 1.2% that’s going down. So looking at actual data, not the kind of happy talk you get on television and radio from a lot of analyst, who maybe have an interest in working for investment banks, but if you get away from the happy talk and look at the actual data, year to date it looks like growth is about 1.8%, inflation is 1.2% and real wages are going nowhere and job creation is weak. And so putting all that together, it’s nowhere near the Fed’s target. It’s much weaker than most people realise. If the Fed did raise interest rates now, which I don’t expect, by the way, I should make it clear that I think the Fed’s next move will not be tightening at all, it will be easing. We can talk more about that but if the Fed were to tighten it would cause an emerging markets meltdown compared to 1998.

HANNA BARRY: I did want to ask you about rates but we while we’re talking about the US Fed, what is the role of central banks in this current environment and how has that role changed and what perhaps should central banks be doing more of or be doing less of and with what tools?

JIM RICKARDS: It’s a great question, they should probably be doing less of everything. I’ve actually been in markets long enough and I remember a time not all that long ago when your typical American or citizens around the world could not tell you the name of the chairman of the Federal Reserve, when they made policy changes they did not announce them, market watchers could infer a policy change from actual activity in the market place but they did nothing to announce it. They really played a behind-the-scenes role, simply easing or tightening in small increments at the margin to try to avoid inflation or give the economy a little boost. Today that’s all changed, first of all the US Central Bank has what they call a dual mandate, most central banks around the world have a single mandate, which is price stability, they are just supposed to maintain the value of the currency and stable prices. The US has a dual mandate, which is price stability and job creation or maximum employment, given the economic conditions but it boils down to job creation. But once you tell a central bank that they’re in charge of creating jobs you’ve turned them into central planners. By the way, the Fed has no ability to create jobs, the Fed does not create jobs, jobs are created by entrepreneurs, business people, capital committers, that’s how you create jobs. But the Fed has got it in their head because they’re all sort of big brain, PhD economists without much connection to the real world that they can somehow mystically create jobs. So they’ve become central planners for the economy. Now given the role of the US dollar, as the leading reserve currency worldwide, when you have our central bank manipulating the currency to try to manipulate the economy to create jobs, indirectly they are manipulating the entire global economy because countries from South Africa to China have to decide do we want to peg to the dollar, do we want to cheapen, do we want to fight the currency wars but you cannot get out of the system, at least not very easily, unless you’re North Korea or something like that. So the point being that they’re manipulating the global economy, they don’t have the ability or the learning really to do it, they’re doing a poor job of it, they have obsolete models, bad forecasting and they’ve just created one bubble after another and they’re in the process of creating new bubbles. The most dangerous bubble in the world today, by the way, is emerging market dollar-denominated debt because US interest rates have been so low for so long that companies, corporations throughout the world have borrowed in US dollars for low interest rates in the expectation that the dollar would not get a lot stronger. Well, indeed, it has got a lot stronger, making the real value of that debt higher, which will lead to a massive…. This $9trn problem, as estimated by the Bank for International Settlements, what the IMF was referring to in their statements this week. So you have another bubble, it’s not US housing, this time it’s emerging markets dollar-denominated debt, so this looks like 1997 all over again. We’re on the verge of one or more financial crises in the next two years, much worse than 2008 because of these blunders by the Federal Reserve.

HANNA BARRY: Is this why you think the Fed needs to ease rates, you mentioned easing versus tightening?

JIM RICKARDS: Yes, the US economy is slowing down, the Chinese made the mistake of pegging to the US dollar, so the Fed has been tightening for the past two years. China pegged their currency to the dollar, well, when you peg your currency to another currency, if they tighten you have to tighten to maintain the peg. So the Fed has been tightening for two years, this led to tightening in China because of the transmission mechanism of the exchange rate, this is what the currency wars are all about, the one aspect of it. So the US has slowed down, China has slowed down. I find the talk about US raising rates nonsense, why would you raise rates when your economy is slowing down, this is typically a time to ease. Now people say the Fed cannot ease because they’re already at zero, they’ve been at zero interest rates since 2008, which is true, they cannot lower interest rates but there are five ways the Fed could ease. The first would be what we call helicopter money, which is just running fiscal deficit and then monetising the debt by money printing, the second would be a new round of QE, quantitative easing, so call it QE4, the third would be that we join the currency wars and cheapen the dollar, which would make other currencies stronger, so that’s a form of ease. The fourth way of doing it is reinstating forward guidance, which is just really tightening and easing by using words rather than using interest rates, so they would give markets some words to indicate that they’re not raising rates any time soon. The fifth way to do it would be negative interest rates. So you do have five policy tools to ease, my expectation is that they’ll start with forward guidance and then maybe do some kind of QE or more likely probably get back to currency wars. So I would look for forward guidance and a cheaper dollar in 2016 but the Fed is going to have to do one of these things or else the US economy will go into a recession and take the world with it.

HANNA BARRY: We will get to that in a second, what does that mean if the dollar collapses. Let’s talk about China though, you did mention it a couple times, the recent devaluation of the yuan caused major turmoil in markets across the globe, how important is China’s economic growth for the rest of the world and what did that market collapse indicate?

JIM RICKARDS: It’s very important, China is about 13% of global GDP, so if you slow China down by a third – it’s still growing, I’m not talking about recession in China – but if Chinese growth goes from say 7% to 3.5%, somewhere around there, that’s a 30% slowdown of 13% of global GDP. So that takes about three points off global GDP. Global GDP is only 3.1% to begin with, according to IMF estimates. So you’re talking about China by itself taking global GDP growth to zero. That’s a global recession. That’s a very serious matter but this is partly because the US Federal Reserve has again tightened monetary policy and China went along with it, so both federal banks blundered, the Fed by tightening and China by pegging to the dollar, so they slowdown as well. Now there are many other problems in China, they have a credit bubble, they have asset bubbles in stock and real estate, which has started to deflate, those bubbles have started to pop, they have a non-competitive exchange rate, when you look at their trading partners like Vietnam and Korea and Taiwan and Japan, they are either partners or competitors, their exchange rate is non-competitive. So they have a credit bubble, asset bubbles and a slowdown all at the same time. So I’m not placing all the blame at the Federal Reserve but they certainly contributed to it. China and the US are the two largest economies in the world, together they are over 30% of global GDP, if you take those two economies and slow them down you are going to slow down the entire world and that’s what’s happening.

HANNA BARRY: Could we see China’s yuan renminbi becoming another reserve currency and can we have multiple reserve currencies?

JIM RICKARDS: It is possible to have multiple reserve currencies, the last time it happened was in the 1920s, 1930s when you had the US dollar and sterling but there was gold standard at the time, so maybe you had multiple reserve currencies but there was an anchor to the system which was gold. Now even today there are multiple reserve currencies, the dollar is the leading reserve currency, about 60% of global reserves but then in the other 40% you have significant amounts of euros, Japanese yen, sterling to some extent. So the Chinese yuan is coming along but the yuan will not be a true global reserve currency any time soon, they may be included in the basket that backs up the IMF world money, what they call the SPR, it’s a form of printed world money coming from the IMF and they have a basket five currencies they use to calculate the value. So they may include the Chinese yuan in that basket next year and that carries some prestige with it but the difference between a reserve currency and a trade currency the yuan can be a trade currency, so if South Africa is conducting trade with China, which they are, South African exporters can agree to be paid in Chinese yuan and that yuan might be useful for buying Chinese exports, manufactured goods or clothing or whatever the case may be. That’s a trade currency but to be a reserve currency you need a bond market, you need something to invest in. If I run a large trade surplus in a currency, you can’t stick the money under a mattress, you need to go out and buy some bonds to hold those reserves. Well, there is no Chinese bond market to speak of and they’re very far away from it because it’s a communist society so they don’t have a rule of law, they don’t have derivative, futures and options you can use for hedging purposes, they don’t have a good payment system, they don’t have all the things you need to run a bond market to be a reserve currency. The Europeans do and sterling and Japan and the United States do but China does not, so they are far from being a reserve currency but they will grow as a trading currency that’s true. The question is what happens the next time there’s a global financial crisis? We know what happened the last time, which is the Federal Reserve printed, swopped and guaranteed tens of trillions of dollars to reliquify the world and prop up global markets but when it happens again their ability to do that we probably be constrained because they’ve never – having expanded the balance sheet in 2008 – they’ve taken those steps to reduce the balance sheet. So what are they going to do, they went from about $1trn to $4trn, they printed $3trn, are they going to print another $3trn or $6trn, what is the outer limit of their printing ability? Well, they’re probably close to it and so to reliquify the world who is going to print the money? Well, that’s going to have to come from the IMF, they’re going to have to print trillions of dollars of SDRs, which will be highly inflationary and that’s really the intent. At some point my estimate is that investors around the world will lose confidence in all this money printing, they’ll lose confidence in the ability of central banks and the IMF and the G20 to maintain a sound system and that’s when we’ll see the rise of gold.

HANNA BARRY: That’s when gold comes in and you do say that investors should invest, as far as I know, 20% each in gold, land and hedge funds or private equity, 10% in fine art and the rest in cash, around 30%. But if you weren’t invested in equities let’s say over the past five years you would have missed out on quite a nice bull market. Do you expect that not to continue going forward?

JIM RICKARDS: Yes, exactly, as you know, the economy is nearing recession around the world with stocks appearing to be in bubbles, with a lot of…being propped up by the central banks and central banks reaching the outer limit of their ability to continue to prop up markets, on a going forward basis I would certainly recommend a portfolio of hard assets, the percentages, yes, I have made those references from time to time, I think the percentages can be flexible but you should have some goal in your portfolio. I think fine art is a very good asset category, it’s not easily accessible to everyone, cash…portfolio, and I would make the point that investors need to protect against inflation if you have this massive printing of special drawing rights but they also need to protect against deflation because of the central bank blunders. If I told you we were either going to have inflation or deflation you would know exactly what to do but when I say that we’re in danger of having both or one and the other in sequence then the investor really needs to be prepared for both. So good inflation protection would be gold, land, fine art, some of the things you mentioned. Good deflation protection would be high quality government bonds and cash. So I think investors really need a diversified portfolio of both of those things to withstand either extreme outcome.

HANNA BARRY: What does all of this mean, these currency wars, global financial market instability, potential crises, perhaps we are experiencing one already, what does it mean for an emerging market such as South Africa?

JIM RICKARDS: Emerging markets are extremely vulnerable for some of the reasons that we’ve been discussing, which is given the role of the dollar and given the role of global capital flows, so if you’re South Africa you could be pursuing good policies and have some growth, and then suddenly the US dollar is cheaper and then dollar-based investors flood into South Africa, they want to buy the rand, they want to invest in the local stock markets, they want to invest in companies and all that, which feels good, that’s a nice compliment. It feels good if you’re South African but then suddenly, just like that, the Fed talks about raising interest rates and the economy slows down and all the money goes out again and people sell the stocks, they sell the real estate, they sell the rand and get back to dollars to cover the short position. So it’s almost like a tide but an extreme tide, so the money flows in and then the money flows out. If you had a stable monetary system that wouldn’t happen, what would happen is people would pick investments based on fundamentals, they would not pick investments based on cross trades and carry trades that are verging currency wars. But we do have a world of leverage and currency wars and so we have all this hot money sloshing around the world but it’s very destabilising. Again, the South African rand has varied between as strong as eight and as weak as 12 to the dollar in the past couple of years and we expect that to continue. Now it’s a little bit weak but what if the Fed, as I expect, wakes up and sees that the US economy is weaker than they expected and they decide to get back into the currency wars and cheapen the dollar and the rand gets stronger. Again, it could be South Africa but the same analysis applies to China and India and Brazil and a lot of the other countries around the world. This is not a stable system and one of these days, probably sooner than later, this volatility will cause an unexpected collapse…and then the contagion will spread very quickly and we’ll be back to a global financial crisis of the kind that we saw in 2008.

HANNA BARRY: Tied to that is that need to perhaps build in some resilience and perhaps here is a secret for emerging markets, you have called for a diminishing of the role of finance and an empowering of the role of commerce. Briefly, what does that look like?

JIM RICKARDS: Well, it looks like the history of the world prior to very recently. What I mean by that is what is the purpose of finance? The purpose of finance is to facilitate commerce. So commerce is trade, it’s entrepreneurship, it’s export, import, it’s building business, it’s creating jobs, it’s hiring people, it’s innovation, technology, education, it’s all the things you want in your economy. Now there is a role for finance in facilitating that in the form of short-term finance, in discounting bills, in capital raising and that’s a perfectly fine traditional role and that’s the role finance played until recent decades. The problem today is that finance has become end in itself because of derivatives, because of greed, because of leverage, because of technology, people pursue finance not to help commerce but to extract profits in almost a parasitic way from the larger body of society and in the process of doing so they create instability, they create leverage, they create hidden risks that the regulators and, indeed, the financiers themselves have…the capacity to discern. So we get these bubbles and crises time and again, we’ve seen them in 1994 in Mexico, 1998 in Russia, 2000 in the dotcom, 2007 in US mortgages and then today we can see clearly bubbles in emerging markets dollar-denominated debt and elsewhere. So my recommendation is that finance needs to be more heavily regulated and returned to a traditional function as a facilitator of commerce, rather than a parasitic or extractive end in itself.

HANNA BARRY: Jim Rickards is the author of New York Times bestselling books,Currency Wars and The Death of Money.

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