Central banks around the world seem to have only one solution for every problem that the various economies have been facing: print more money. And a large portion of this money has been used to prop up banks and financial institutions that would have otherwise fallen and shut shop by now. “It is unfortunate that nobody is allowed to default these days, because all these bailouts are only adding to the inflation menace and the ongoing money creation is confiscating the purchasing power of the public,” says Puru Saxena, the founder and CEO of Puru Saxena Wealth Management. Based out of Hong Kong, Saxena is also the editor and publisher of Money Matters, a monthly economic newsletter. In this interview he speaks to Vivek Kaul.
In a recent column of yours you said “the world’s stock and commodity markets are defying all logic and advancing in the face of adverse economic conditions”. Why has that been the case?
All asset prices are determined by the risk free rate of return and by suppressing interest rates near historical lows, central banks in the developed world have engineered this rally in risky assets. When it comes to investing, monetary policy trumps economic fundamentals and cheap credit triggers a rally in stocks and commodities. This is why, despite sluggish economic growth in the US, Wall Street has been rallying for over 3 years. Conversely, despite good economic growth in India, due to monetary tightening, Indian equities have underperformed over the past year!
Do you expect this trend to continue?
As long as the Federal Reserve keeps interest rates at historical lows, the uptrend on Wall Street is likely to continue. Of course, the bull market will be subject to periodic corrections, but the primary trend should remain up. In our view, the next bear market on Wall Street will arrive after several months of monetary tightening by the Federal Reserve and we are at least 3 years away from this scenario. After all, Mr. Bernanke has pledged to keep short term rates unchanged until at least December 2014, so there is clear visibility for another 2 and a half years.
In Europe, the attention seems to have shifted to Spain. I was reading somewhere that the assets of the three biggest banks of Spain are at $2.7trillion or around twice the size of the Spanish economy. And the banking sector in Spain seems to be in a pretty bad shape. How do you see that playing out?
Spain is in real trouble, but the politicians will probably not let it default. So, either the European Central Bank will bail out Spain or it will continue to provide cheap loans under its LTRO(long term financing operations) scheme. It is unfortunate that nobody is allowed to default these days, because all these bailouts are only adding to the inflation menace and the ongoing money creation is confiscating the purchasing power of the public. Already, the Federal Reserve and the ECB have provided trillions of dollars of loans to hundreds of banks and this trend should continue for the foreseeable future.
What are the other dangers that you see the European markets throwing up in the days to come?
Many European nations are essentially insolvent and they cannot repay their loans in today’s money. So, unless they are allowed to default, the central banks will probably continue to bail out all the distressed bondholders and banks. The truth is that the central banks do not want anybody to default because the losses will be catastrophic for the financial institutions; so they are shoving even more debt down the throats of these heavily indebted nations! It is easy for us to see that more debt cannot solve a debt crisis but this is the strategy the central banks have come up with and we all have to live with the consequences.
The European Central Bank seems to be going the Federal Reserve way. The Federal Reserve in 2008-2009 seemed to have been rescuing banks and companies, the ECB is rescuing countries? Aren’t some of these countries like Italy and Spain are too big to bail-out?
So far, nothing has been ‘too big to bail out’! Already, the ECB has extended over $1.4 trillion of loans under its LTRO scheme to several hundred banks and if need be, it will probably create more currency units to bail out its banking cronies. If the situation becomes desperate, then, we may even get fiscal integration within the Euro zone but we don’t think that the establishment will let the Euro fail.
In all this talk about Europe, attention seems to have shifted away from the problems in the United States, which is where it all started. How good or bad is the scene there?
Although the economy is struggling in the US; things are much worse in Europe. Fortunately, the US is in the enviable position of being able to print its own currency at will and this is a luxury which the distressed European nations do not have. Under a crisis scenario, the US can always create even more dollars out of thin air and repay its creditors, but this is something Greece, Italy and Spain cannot do! Moreover, despite having a federal debt to GDP ratio of over 100%, the US still controls the world’s reserve currency and this is a big advantage.
One talk in the market seems to be that the Federal Reserve Chairman Ben Bernanke will initiate QE III given that Presidential elections are scheduled this year. Several Federal Reserve Chairmen have in the past have run easy money policies to help the incumbent US President who is running for the election again..
In our view, Mr. Bernanke will only initiate QE3 after a big dip in the CPI. Currently, the CPI is hovering around 2.7% and it is conceivable that QE3 will be announced when the CPI dips to around 1-1.5%. With the CPI close to 2.7%, we believe that Mr. Bernanke will find it difficult to unleash more stimulus.
You have maintained for a while that world’s developed nations are all bankrupt. In fact in a column last year you wrote “Let’s face it; many of the world’s ‘developed’ nations are insolvent and the writing is on the wall. Either these indebted states will default or they will try and inflate their currencies into oblivion.” How do you see this scenario playing out?
Given the developments of the past 3-4 years, it is clear that the policymakers do not want to see defaults. So, they have chosen the monetary inflation route and this is destroying the purchasing power of currencies all over the world. As a result of massive money creation, currencies are being debased and prices are rising all over the world. In fact, inflation is surging in most nations and people are struggling to make ends meet. In the US alone, the Federal Reserve has created trillions of dollars to bail out the banks and the ECB has also created and loaned out over US$1 trillion to hundreds of banks over the past six months! Never before in history have we witnessed such monetary inflation in so many nations and nobody really knows the consequences of this strategy.
“When the interest payments on US debt become painfully high, Mr. Bernanke will be called upon to unleash the hyperinflation genie.” This is something you wrote last year. When do you see this happening?
As long as foreigners are willing to invest in US Treasuries and demand for US government debt is high, hyperinflation will not occur. However, if one day, bondholders stop financing the US deficit and they stop buying US Treasuries, then Mr. Bernanke will have no other option but to use the printing press to purchase US Treasuries. Already, the Federal Reserve is a very large player in this market but if other investors flee this market, then out of desperation, we may experience hyperinflation in the US. Fortunately, there are no signs of that happening anytime soon as demand for US Treasuries is still strong.
Many pundits in the last few years have forecast the crash of the dollar. The biggest among them being Pimco’s Bill Gross. But that hasn’t happened. Every time there is a slight hint of some new trouble, money rushes into the dollar. How do you explain this?
In the global beauty contest, the US Dollar is being perceived as the least ugly candidate! This is why the US Dollar has not collapsed against major world currencies, although it has depreciated gradually over the past decade. If you review the world today, Europe is a mess and Japan is still struggling. So, apart from the US Dollar, we don’t really have very many choices! In the developing world, no nation wants a strong currency and countries such as China, India and Brazil are all engaged in competitive currency devaluations. Under this scenario, the US Dollar cannot really crash against other currencies because either they are equally bad or they are being held down on purpose.
What is your prognosis on gold?
Gold is in a multi-month consolidation phase and currently, it is trading under the 200-day moving average. So, in our clients’ portfolios, we do not have any exposure to gold at present. In our view, QE3 will be required to trigger the next big rally in gold and until then, prices are likely to drift lower. Furthermore, after 11 years of gains, investors should be mindful of the fact that gold is no longer cheap and the bull market is now in its mature phase. Thus, owners of gold should be very cautious and consider booking their profits on the first sign of trouble.
What about India? Which are the sectors and stocks you are positive about?
It appears as though India’s monetary cycle has peaked for now and further rate cuts should assist the Indian stock market. Usually, there is time lag between monetary easing and its effects on the economy, so in our view, the Indian stock market may not take off for another few months. Nonetheless, we remain optimistic about Indian stocks and continue to like those companies which earn high rates of return on shareholders’ equity.
(The article originally appeared in the Daily News and Analysis on May 21,2012. http://www.dnaindia.com/mumbai/interview_in-the-global-beauty-contest-the-dollar-is-the-least-ugly-candidate_1691544)
(Vivek Kaul is a writer and can be reached at [email protected] )