Bill’s gotten more and more shrill over time, which is surprising for someone in his position, and in this commentary he points out the obvious facts that most people either choose to ignore or are ignorant about – our debt and entitlements situation is precarious and we won’t be able to grow our way out of it. There really are no easy choices left but the longer we wait to take action, the more difficult the choices.
Unless entitlements are substantially reformed, I am confident that this country will default on its debt; not in conventional ways, but by picking the pocket of savers via a combination of less observable, yet historically verifiable policies – inflation, currency devaluation and low to negative real interest rates.
Ferguson is an original thinker who is always provocative and well worth listening to. As Consuleo Mack puts it, he definitely has the gift of gab.
Financial Thought Leader Niall Ferguson discusses why the centuries long dominance of Western economic and political power is waning and what the United States needs to do prevent it from slipping even more.
In his recent book, "Civilization: The West and the Rest," Ferguson attributes the dominance of the West over the East to the following six "killer apps":
Ronald Reagan's former budget director, David Stockman, has been on a tear lately. Not burdened by partisan politics or crazy-eyed ideology, he tells it like he sees it, which makes for refreshingly honest commentary.
As such, the interview below with Reason TV is must-see TV.
Some of his main points:
1. We live in a Welfare-Warfare State, a state of affairs that is not sustainable
2. We need to Bush's reverse tax cuts for all Americans
3. We need to means-test entitlement programs
4. TARP was a bad idea - Hank Paulson was the most incompetent treasury secretary ever!
5. Bailouts don't work and they don't make sense
6. He believes in "narrow" banking - not every bank should be insured by the FDIC
7. The end of Bretton Woods and the Gold Standard unleashed a wave of speculation and volatility
8. We don't need to spend so much on defense. The Soviet Union was a house of cards, so Star Wars and the huge military buildup was not necessary
9. Wars should be funded on a pay-as-you-go basis (i.e. raise taxes). The last honest war president was Truman.
10. Social Security and Medicare are an inter-generational Ponzi scheme.
End of QE2 Too early to tell if there will be QE3 Regardless, we need to fund $2T deficits next year -- will need to raise $800B from Banks or the Fed. Resource Scarcity and Saudi Arabia Concerned about resource scarcity Started investing the middle east in 2006-07 One of the largest investors in Saudi Arabia
The country is not in any index and does not attract institutional money
Aramco may have over $1T in revenue in the near future Financial Firms
No stake in financial firms
Regulatory issue vs. a bottom up analysis issue
Banks should be not allowed to pay dividends
We are pretending things are stable and back to normal Recovery
We are "not recovering"
Housing prices are still falling
Mortgage Duration issue (low coupon) - will not be able to refi if rates rise so people will be stuck in houses for a long time
Fed is stuck with owning a lot of mortgages - the problem will get worse over time
On Friday, March 11, President of the New York Federal Reserve Bank, Bill Dudley (aka Clueless Billy) gave a speech at the Queens Chamber of Commerce. He tried to explain to the masses why inflation was not a threat and why core inflation (i.e. inflation after you remove everything that goes up) was actually quite tame:
"Today you can buy an iPad 2 that costs the same as an iPad 1 [did]. That is twice as powerful. You have to look at the prices of all things."
This lead to widespread derision from the audience. One audience member called the comment "tone deaf."
"I can't eat an iPad" was the classic response from another.
Federal Reserve Bank of Dallas President Richard Fisher is one of the few people working at the Fed who gets it:
“There’s lots of liquidity sloshing around the U.S. financial system,” Fisher said. “We are seeing signs of all the intoxication that typically takes place when we have the ambrosia of cheap and readily available capital.”
Unfortunately, the mad men are in charge and there's not much we can do to stop the train wreck that awaits us. Be prepared for the inevitable chorus of "it wasn't our fault" and "nobody could have seen this coming."
Dubai is the parable of what money makes when it has no purpose but its own multiplication and grandeur... Dubai is a place that doesn’t just know the price of everything and the value of nothing but makes everything worthless.
The workers, who make up roughly 71 percent of the population, have precious few rights here. They can’t become citizens, though some are the third generation of their family to be born here. They can be deported at any time. They have no redress. Many of the Asian laborers are owed back pay they aren’t likely to get. There are reams of anecdotal stories about the abuse of guest workers. I’m told about the Pakistani shop assistant who, picking up an Arab woman’s shopping bags, accidentally passed gas, got arrested, and was jailed.
"The Prophet is not someone with special visions, just someone blind to what others see"
Ben Bernanke
Helicopter Ben was completely fooled. He didn’t understand the risks of the system and thought we were in a great moderation. He couldn’t figure out why the crisis took place and what the solution should be.
The System
The world is so complex that we need more “reserves” (buffers/redundancy) against unpredictability which makes the world less forecastable. For robustness in the system we need a lot of redundancy and a low level of debt (this will result in significant belt tightening). In a society with less debt bankers can be supremely incompetent but can’t hurt the system as much.
Example: mother nature gave us two kidneys. The exact opposite is debt – instead of having two kidneys, we borrow one.
Obama Administration
When Obama came into power he appointed people who were part of the system who got us into these risks. He should have immediately tried to “cut the cancer” similar to what Cameron did in the UK. Instead they converted private debt to public debt. They punished savers and bailed out debtors.
Stimulus packages “fragilize” the system further.
Bailouts
Two moral problems with bailouts:
1.Innocent pays for the mistakes of the wrong doers
2.Transferred debt and risk to future generations
Europe
Europe has less debt than the U.S. and thus is more robust. They also understood problem of too much debt early on.
Globalization
Not against globalization, but we need to understand that globalization reduces predictability and results in more winner take all effects – overspecialization (leading to lower inventory and more volatility) and fragility. As a result, globalization can destabilizing. It is not a panacea.
Overall Metaphor
In Korea in October 2009: someone from the IMF showed economic projections for 2010 through 2015. Taleb challenged him to show his projections for 2007 and 2008 that were made in the early 2000s. His main point: You should be as wrong as you want without affecting other people” i.e. the “expert problems” shouldn’t be allowed to hurt society.
An interview with Barron's New Bond King, who discusses the high yield and muni markets.
High Yield Market (Appears at the 2 minute mark)
“Priced to perfection market” with high volatility that will experience defaults.
Currently yielding 6.75% and priced for low defaults (currently under 1%, no defaults in January). The average default rate is 4% per year. The loss adjusted yield looks more like long term treasuries at 4.50/4.75.
Volatility of HY is like a 20 year treasury with 12 standard deviation, so don't compare to basket of Treasuries with a std deviation of 5. That spread vs. 20 year treasuries is only 225 bps.
Would rather buy long duration Ginnie Maes where he can get 6% with government guarantee.
The market is not about to collapse. Will give a decent recent right now but won't outperform treasuries. We may not see defaults till 2013. 2009 and 2010 issuance was not good quality and it will take 3-4 years for defaults. Why did issuers take out low yielding bank debt for higher yielding bonds? Because of rollover risk (bank debt is short term).
Starting to see garbage issuance again - cov-lite. Never buy PIKs. Head for the hills when PIK issuance takes off.
People hungry for high yield. Not a fan of dedicating money to HY portfolio. Manager is forced to keep investing in the asset class regardless of valuations when fund inflows are strong.
Economy
Economy will be on a low growth trend line for a long time
Muni Market
The market has “bad fundamentals” and is “badly owned” - people buy because of a technical benefit - tax benefit - but not fundamental analysis. Similar to subprime – a Triple A market that had never traded below par.
Muni market is headed lower but agnostic on whether it will crash. Expects at least a 15-20% drop in muni market. When markets start to fall, muni bond holders will sell out of fear.
What he likes
Long term govvies. Rate rise is overblown against a weak economy.
Equity Market
If deflation wins, we will see the S&P go down to the 500 level.
An extremely rare interview with one of the savviest investors out there. Some notes from the interview:
Independent Thinking
Independent thinking and creativity are essential ingredients for making money in the markets. Ego reaction to making mistake is one of the biggest impediments to successful investing. Defends his company's culture.
The Dollar
The dollar is likely to lose its reserve currency status gradually over the next 10 years. The dollar accounts for 2/3 of world's reserves and will probably go to 50% of reserves. He expects big currency adjustments over the next couple of years (see below).
Emerging Markets
The world is divided between the debtor developed world (US, Europe, Japan - 47% of world GDP) and the booming emerging world (53% of world GDP). They are tied via currency links which leads to inappropriate monetary policies (and bubbles) since interest rates are also linked. He expects a seismic shift (in 2012) since developing will not be able to tolerate accelerated inflation and will have to adjust their currencies upward.
Per Capita income in China is 1/10 of the United States, but that is not borne out by their actual productivity difference. He would diversify into Emerging Market currencies.
US Equities
Relatively cheap and should benefit from currency depreciation. Most currency devaluations are beneficial for equities.
On the other hand, portfolios are concentrated in developed market stock and bonds. Investors should diversify into other assets, such as gold.
Gold
Most sovereign wealth funds and investors are underweight gold. Gold was and is money and should be a part of people's portfolios. Gold is a good store of wealth
The role of the Fed
The Federal Reserve prevented a serious depression.
The Deleveraging Cycle
De-leveraging events are rare. Dalio describes how the process of accumulating debt (leveraging cycle) works and how it eventually results in a bubble (financial assets cannot service debt). Eventually need to sell asset and cut expenses. The government needs to run deficits to make up for this contraction in private spending. That was 2009. 2010 and 2011 are transition years. Slack in the economy allowed increases deficits without inflationary pressures. You need the ability to print money to work your way out of a deleveraging cycle.
Rate of growth going forward will be limited to real income growth of 2% a year since we can't use debt to fuel growth. This will be with us a long time.
Inflation
Dalio expects inflation pressures in 2012. Long-term, there is a serious debt problem and paying down debt with real dollars or restructuring can have extremely ugly social consequences. This is a self-reinforcing negative cycle.
Best path is an orderly spreading out of the problem (aka inflation) -- don't need a high inflation rate for this to happen. This is very likely to be orderly. There are historical precedents for government inflating their way out of debt.
2011 and beyond
Should be a good year for equities. Sweet spot of the cycle. Late 2012 should be more challenging because of currency adjustments and competition with countries with strong economies for commodities. 2013 expects greater tightness of monetary policy and more trade-off between inflation and growth.
States and Munis
He would not hold munis but is not an expert on the area. Not comfortable giving an opinion.
