We’re reflating a bust bubble

“There is never a good time to die. Nor is there a good time for a crash or a slump. Still, death happens. Be prepared. Say something nice to your mother. Offer a bum a drink. And buy gold.”William Bonner & Addison Wiggin in Empire of Debt - The Rise of an Epic Financial Crisis.

Bonner and Wiggin gave that advice in the last paragraph of their book. But two years before that, in 2004, the authors wrote another tome: Financial Reckoning Day: Surviving the Soft Depression of the 21st Century, in which they said that the trade of the decade is to sell stocks on rallies and buy gold on dips.

“We started advocating it when it was trading at $253 ounce,” says Addison Wiggin, one of the authors of these New York Times bestsellers. He is the executive publisher of Agora Financial, an economic forecasting and financial research firm based in Baltimore, US, and the editorial director of Agora’s flagship publication The Daily
Reckoning.

Wiggin is also the executive producer and co-writer of the highly acclaimed documentary I.O.U.S.A, which was shortlisted for the 2009 Academy Awards.
In an interview with DNA, Wiggin tells us why the yellow metal still rules. Excerpts:

In your book Empire of Debt, you equate the United States to a Roman Empire. Why?
We used the word “empires” even though US is a constitutional democracy. The US has risen to the level of influence of the empires of the past; militarily we cover 120 countries around the world with troops, culturally, movies from Hollywood are all over the place, economically we have interests in just about every country on the planet and politically anytime any of our leaders show up in a country, security is all over the place.
We have entered a phase of our history where we count on that influence and we abuse it, in the same way as the empires of the past abused their authority around the world. The impact of the (George W) Bush administration and the wars they were conducting is getting us into more trouble than we can afford. And there is the debt part of the empire, where we are having to borrow from the around the world in order to continue to keep up appearances, as they say.

“Great empires look for ways to destroy themselves.” How is that happening with the US?
We have run out of enemies so we will have to figure out a way to destroy ourselves. We are collapsing under our own weight. Another way of phrasing it is that we are sort of victims of our own success. We have gotten used to getting our way for a long enough period of time. But you know, all things rise and all things fall. And I think that is natural for nations as well.

After the Second World War, the dollar became the reserve currency of the world, which took the coalescence of power in Washington and distributed it globally. We are still looking at the end of that era now. The question is, how are we going to wean ourselves off the dollar as the standard currency or the reserve currency of the world because so many countries India, China, South Korea and Japan hold massive amounts of dollars, and pretty much universally? Even Americans agree that it is not a good idea to hold them anymore. But there is no alternative (TINA) yet. The rise of the empire has been an interesting story, but like all empires, we have outlived our utility to most of the people that we do business with.

All the dollars that are being printed, where do you see that going?
Every dollar that is printed cheapens the ones before it. Even in normal times, the Fed’s target is 2% inflation rate, which means that the dollar loses value by 2% per year. But with all the printing that is going on, you can expect inflation down the road to be much more aggressive. The interesting tension is that they are fighting against the deflationary cycle, a credit bust, which requires all this cash to be poured in. So we don’t see inflation on the horizon just yet, but that will be the interesting story to be done.

Everyone is holding dollars and they are going to get less valuable. The big question is, what is going to be the alternative?

Just last week, when rumours floated that oil will be priced in alternate basket of currencies, the dollar got hit by a point-and-a-half that day. Just like that. So if an alternative arises, when most countries aren’t prepared for it, we could just see massive inflation overnight, and there would be a run on the dollar. It will be a difficult situation for everyone, since so many people around the world hold dollars and have priced their assets in dollars.

Why this bias against the US dollar? Almost every country is busy printing currency? Why our bias against it?
Mostly because all our assets are in dollars. It makes for a tenuous situation. It seems like a reckless recipe of policy decisions and the dollar will ultimately be the one that will take the biggest hit. Personally, that offends me.

You visualise any catastrophic event that will cause the dollar to go on a free fall or will it happen over a period of time?
History shows that when you move from one currency to another as the reserve currency of the world, like when the pound shifted to the dollar, it took two world wars and a great depression to make that happen. They don’t generally happen in a smooth fashion.

There is a unified effort to move away from the dollar as a reserve currency, but no clear alternative has presented itself. To me the catastrophic event would be an alternative that people pile into and just shed the dollar. But we don’t see anything like that right now.

So everybody is in, sort of, the same bucket, saying, what are we going to do now? What happens to countries like China, Japan or the oil producing countries that have all that dollars that they hold?
In a way, it looks like short-term speculation. They are holding on to the dollar while the dollar is what it is, but they are looking for viable alternatives. Historically, US treasuries and the dollar have been a fairly safe investment. It was interesting that during the credit crisis last year in September, interest rates were negative for some time, and people would rather have the government hold their money and lose a little bit on it than lose all their money in the stock market.

The dollar rallied phenomenally as a lot of cash got repatriated. Lot of people got scared and pulled their money back from overseas, and so the dollar rallied. That event shocked us a little because of the severity with which both the dollar and treasuries reasserted themselves as flight-to-safety trades. In that sense, it;s smart for China, India and South Korea etc to hold treasuries and dollar-based assets, they continue to be the safest on a speculative level, despite the fundamentals.

Recently there has been news of China buying gold?
We keep hearing rumours that they are accumulating behind the scenes. They may or may not be. They wouldn’t want to announce if they were, because if everyone knew that they are buying gold, then that itself would be an alternative. That’s why you see gold hovering around all-time high.

What will happen to all the debt that the US has accumulated?
My feeling is that they won’t be able to repay. In some way it’s in US’s interest to have a cheaper dollar because that is the only way they can even pretend that they are going to pay back.

The number that we follow is $67 trillion, but those are promises, it’s not a debt yet, they are the unfunded liabilities of the government. What is going to happen is that huge number will be erased by some sort of accounting trick in future.

We are already approaching $12 trillion on debt alone that we have to service. We have to pay interest on that debt as it is. The Congress is incapable of dealing with this. It is ruled by committee and they won’t move till forced to and one of the things that will push them is the potential downgrade of US debt by the rating agencies, which is kind of a joke in itself.

I read this in the Financial Times that in January 2008, there were 12 companies in the world with AAA ratings and there were 64,000 derivative instruments with AAA ratings. The real threat of the US debt being downgraded from triple AAA is zero because the rating agencies just won’t do it. But the quality of that debt is degrading rapidly. One of the ways in which they will default on those promises is by printing more and more dollars until they can pay off at least the national debt.

What is your take on the current ‘recovery’?
This is a classic sucker’s rally. The government stimulus, the monetary easing, they are working their way through the system. Like the US gross domestic product is supposed to have risen by 2.8% or something in the third quarter, but in that number, they include government spending. So it’s a victory for Ben Bernanke and the Federal Reserve, because the numbers look better. But it is not real economic growth, it is government spending. 

Consumers are still wondering. In September, they backed off a little bit. The savings rate dropped a little bit to below 3%. Consumer credit rose again, which, probably, is a reaction to this recovery noise as well. Our line is that people can’t spend more than they earn forever. And they can’t spend their way to wealth. That seems to be the model that the government is trying to recreate.

The effect of the entire stimulus and the monetary easing is more speculation in stocks around the world. The Sensex is up. People are all excited here in India too. The rising stock market, even if the economy is not looking so good, draws more and more people to the market, until the market gets overvalued and sells off again.

The Dow Jones re-crossed 10,000 recently. What does that tell us?
It is not surprising that the Dow went over 10,000; there is a lot of money being pumped into the system trying to combat a deflationary credit bust. The money goes into the system, people are reading the cues, there is no enterprise, real economy is not producing, consumers aren’t sure what to do, corporations are trying to figure out their own balance sheets, so the only place where people can speculate now is the stock market. The (US) housing market is dead.

People are piling back into stocks and they are borrowing money at cheap rates, speculating. It is not surprising that Dow is over 10,000. It’s a speculation again. It’s a reflation of the bubble that we just withdrew. It is like people have collective amnesia and they don’t remember.

What about the fact that dollar seems to have replaced yen as a carry trade currency?
It is a new development —- as long as interest rates are low in the US. It’s short-term speculation.

Would you say that all money being printed by the US government is going into speculation all over the world?
Yes. I think that is absolutely true. The concerted effort to reflate the bubble isn’t just a US phenomenon. It’s the case with most of the nations —- dropping rates and printing money.

Till when do you see this continuing?
At Daily Reckoning, we have been focusing heavily on balance-sheet recession. Goldman (laughs as he utters the name) Sachs just reported $3.1 billion in profit in the third quarter.  But this time last year they were nearly broke. You could see another episode of balance-sheet recession among the banks. But probably what is going to happen is you are just going to see speculators in the market thinking that it is a real recovery. The rise of the stock market around the world is going to reach a stage where people are going to start selling because they will lose confidence.

Just looking at historical trends. These rallies, once they begin to sell off, often find new lows. Japan’s lost decade of the 1990s had many rallies —- I think they were five rallies which were either above 30% or 50%. And each time the market fell, it reached new lows. In 2006, they were at a 27-year low.

Which is the next big bubble waiting to burst? And why? Or would you say there are lots of bubbles?
There is a danger of the next bubble being in gold and commodities ago. We just had a bust about fifteen months again. Gold is attracting a lot of attention and people who don’t really talk about investing in gold are acting like it’s the next big thing.
It could possibly come in the Asian stock markets too. They have a very strong sentiment in Asia — that it’s a new Asian century, and these economies, having gone through trouble in the 1990s,  are better prepared to deal with the crisis that we just went through; they are going to lead the way through recovery. A good story like that would attract attention. I don’t think there is a clear bubble on the horizon, but it could be any of these.

You have been a big gold bull for a long time now…We started advocating it when it was trading at $253 ounce. So is the price too much? Is that what you are asking?
Yes... I don’t think so, until a lot of these tensions these trends work itself out. Gold is serving its rightful role as the anti-dollar. It’s a hedge against collapse and that’s the way the market is trading it right now.

Any targets?
 I have gone on record to say I think it will hit around $2,500 an ounce.
You had said in Financial Day Reckoning that buying gold on dips and selling stocks on rallies would be the trade of the decade.

What is the trade of the next decade?
 That’s funny. I just updated that book and I was looking at that chapter and everything that we were saying when we first wrote the book still applies. The trade of the decade was a successful trade. Actually, we still have a year to close before the decade is over, but it was the right trade to make. But all of the reasons that we gave for the trade are still in place.

So what I ended up doing was updating the data, renewing the same argument and I put a parenthesis around an s at the end of it. It is now the trade of the decade(s). I think gold is still a good buy and stocks are still not driven by fundamentals, they are driven by speculation at the moment.