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Dan Denning Editor's
Note: We have edited the interview in this transcription for
clarity and readability.
Dan, up until roughly about 2000, the United States was considered the primary engine of economic growth. Today, you have the US and China, but also India, so there are multiple engines of economic growth. How does this change the investment climate for US investors?
JIM: You write in your book and describe how England leapt to global economic prominence by a very simple formula: number one, they had economic freedoms, but basically they started with saving, they invested, they traded, this made them a global power. The US did much of the same at the beginning of the 19th Century. Now, it seems that formula is breaking down here in the US. Why, it’s starting to work in places like China and India. What’s going on here? DAN: I think there are 2 things going on, and actually, I think today if you look at the closing numbers in the stock market, and this is true of the year so far and the second quarter, today Gateway, John Deere, and Wal-Mart were all down. You had a tech company, an old industrial economy company, and a retail company all down, so those are all different parts of the American economy, and based on the performance of those three blue chips you didn’t get very encouraging news. That’s the stock side of it. But what I try to say in the Bull Hunter, and it sounds like a truism – and some people have accused me of stating something that’s obvious, but I don’t hear it that often – so what I try to repeat is that people don’t get rich spending more than they make, and nations don’t get rich by consuming more than they produce. In the last 50 years, in particularly in the last 10 years, that has basically been the American national economic motto, that you can consume your way to prosperity. But as I pointed out in the first chapter of the Bull Hunter, that’s not how we got rich, and that’s certainly not how Great Britain became an empire. They produced goods and services that the rest of the world needed, traded them and then accumulated profits, capital, and invested in new businesses. That’s pretty much basic economics and it was true of 2 of the world’s economic success stories. I don’t know why people think that it would be any different now. So, when we see China and India doing basically the same thing, it looks like they’ve remembered what we have appeared to have forgotten. [5:32] JIM: Yes, it’s amazing every time you hear economic thought coming out of Washington, or Wall Street they talk about consumption, debt’s not a problem, and they ignore, it seems, all the things that made us great – or any time consumer spending goes up above savings they think this is great for the economy. DAN: It’s a disaster and I’m glad you mentioned policy makers because I mentioned it in one of my last alerts to subscribers, that our policy makers are basically economically illiterate. And you can see that when they talk about 3.5% GDP growth, and say that it was encouraging because consumer spending was strong, and it’s encouraging because consumer spending is roughly 60, to almost three-quarters of GDP. I can’t imagine in what world it’s possibly true that people spending money they don’t have is positive. And the other aspect of it that they cited in the recent employment report, was that there were, I think, something like 40 thousand new retail jobs and new jobs in construction. So it was essentially the same mantra that American growth, if you can call it that, is solid because people are spending money they don’t have. This passes for conventional analysis in America today, and what I’ve tried to do in the newsletter, and I know what you try to do with your readers, is wake people up and say, “this isn’t growth, this is growing backwards, this is very bad for the country and it’s a mistake you shouldn’t make in your investment decisions.” [7:01] JIM: You know this formula that you talk about in England, that worked in the US, that is now working in Asia which, basically, there’s an economic school – the Austrian school of economics – that talks about when you make capital investments from savings, this is how you build wealth. And it’s amazing, Dan – but I think it’s very important – I think, as you talk about in your book, when you’re looking at places to invest, where the bull markets are going to be, they’re going to be in countries that are adopting these kinds of formulas. DAN: Yes, it’s seems like common sense, although I don’t get a lot of affirmative responses like the one you just offered, but it is really simple: on the one hand, these are countries that are producing goods, and selling them to the rest of the world; now, sometimes the firms that have relocated and are producing from China are American firms, so you might be able to invest in a US firm that’s making things in China. But really it comes down to this: that those people are saving money and what they’ve been doing with their money is they’ve been buying US bonds, and keeping interest rates down here so that Americans can buy homes, and don’t have to service their credit card debt at high interest rates. Eventually, they will be much more interested in investing their savings in their own economies, rather than sending their money back to the United States to keep interest rates low. When I put it that way to people I usually get a green light, and they say, “Yeah, it makes sense to me that China is probably more interested in its own domestic growth than in keeping American interest rates low.” So I think from an investment perspective, that leads you to the conclusion that the growth of the middle class in China and in India will be the new engine of global growth, and so we have to start looking for the companies that are satisfying this emerging new global marketplace. [8:47] JIM: Well, just as you can have rising economic growth in countries that expand like the US did in the 19th Century, and as we’re seeing in China, that also spells opportunities in terms of bull and bear markets. I wonder if we might discuss the different bull and bear markets today, for example, you could have a bear market in stocks – which if you look at US stocks since the year 2000 they haven’t done particularly well – and yet at the same time, you’ve got a break out in commodities and commodity-related stocks. DAN: Yes, and that’s a confusing thing for a lot of people, because a lot of people formulate their attitude towards markets in terms of whether there’s inflation or deflation, and it seems impossible to people that you could have rising commodity prices, and falling stock prices. But I think that’s exactly the scenario we’re going to see, and probably not just stock prices, I think probably housing prices, or any asset whose value is increased because interest rates were low. Those things, housing prices and stock prices, I think that, especially in the housing market, that’s purely been a function of low interest rates. Whereas the demand for oil and copper and energy and even precious metals – we’re starting to see an increase in that demand – that’s being driven, 1) by the simple fact that they’re scarce resources, you can’t flip a switch and make more of them like you can with dollars; but they’re also being driven by the fact that there’s now these 3.2 billion people in the other part of the world that are competing for the same lifestyle that we have taken for granted here in the West for the last 30 or 40 years. So, asset prices that are driven by interest rates are going to fall as interest rates go up, and the commodity market that you mentioned, that’s being driven by fundamental economic demand. So, even if interest rates go up, that doesn’t mean we’re going to consume less oil, it might slow down economic growth, but the truth of the matter is that now, commodity prices are being driven by demand – increasing demand – and inadequate supply. So I think you get a recipe for rising commodity prices and falling asset prices in the US. [10:56] JIM: Let’s talk about bull markets, and what I want to talk about here is internationally, you can have, for example, if you look at the returns of stocks this year they’ve been particularly dismal in the US, but they’ve been pretty good when you look around, in Europe, and you look around in Asia, and other markets, so you can have a bull market, it doesn’t matter, it doesn’t have to be New York, it could be London, Tokyo or Bombay. DAN: That might be a new idea for many American investors too, that the world doesn’t revolve around American asset markets. It’s true that American assets are still extremely popular, and we saw that with the numbers that came out from the Treasury Department this week, that demand for US assets increased. Although, I will point out foreign central bank demand for Treasury bonds decreased to, I think, its lowest level in almost 21 months. But you’re absolutely right, that there’s an entire world of opportunity out there; that’s the upside of globalization; if the downside is that we’ve lost 3 million manufacturing jobs, the upside is that resource rich countries – even Canada to the North, I think that the Toronto exchange is up 16% – those economies are investable for US investors. So I think that once people see that you can go for resource rich economies, or economies with a better balance between saving and spending, or production and consumption, if you will, Americans will see that they don’t have to be locked in to US borders to profit. And the truth is most of the companies – or the way that you can profit from these international stories, like Malaysia, or Singapore – you can buy those companies on US exchanges, or you can buy exchange traded funds, which I talk about in the book. So there are real solutions to these opportunities; you don’t have to go and buy stocks in Timbuktu, you can buy them through your broker, but you can benefit from things that are going on in other parts of the world. [12:45] JIM: Let’s come back to the US for a moment, you’ve got a chapter in your book about the US; let’s talk about the 3‘d’s of the US, which are debt, deficits, and the dollar. DAN: You know, if people make it past that chapter, they typically enjoy the rest of the book, but it’s a little bit of tough love, I guess, at the beginning. I think the first step to successful investing in the next 10 or 20 years is recognizing that we have some fundamental structural problems in the American economy. The first of them is debt, and that’s both at the government level, but primarily at the personal level: there’s $9 trillion dollars in personal debt; $2 trillion dollars in revolving credit card debt; $7 trillion in mortgage debt. But beyond the numbers – because I think most of your listeners are familiar with the statistics behind it – it’s the idea. It’s the idea that you can get rich borrowing money to elevate your lifestyle. I think this is as much psychological as it is economic, but this will be particularly difficult for people as interest rates rise, not only servicing that debt, but in the housing market, it’s an entirely separate issue, we could talk about that all hour. But the debt I primarily mean is Federal debt and municipal government debt; that our governments, whether it’s at the local level or at the state level or at the Federal level, have essentially made promises that they can’t keep, so either taxes are going to have to rise in order to pay for prescription drug benefits, or just an increasing share of entitlements, or the government’s going to end up defaulting on its bonds. But either way, there was a lot of celebration this week because the Federal government announced the deficit – this year’s deficit – would be smaller than expected. I don’t think it’s anything to cheer about when your government’s running a $300 billion dollar annual deficit, even if it’s less than what they forecast. So that would be the second ‘d’. And the dollar, of course, is the third ‘d’, and maybe I’m particularly sensitive to that one, because I’ve just spent about 3 ½ years living overseas, and I’m planning on living overseas in Australia for another 3 years, and what that means is that the purchasing power of our currency is being ruined by our central bankers and our government. And so for me it meant that I woke up in London and my currency was worth half of what I could get in the United States; so just imagine walking in your coffee store, and paying double what you would normally pay for a cup of coffee. Most Americans don’t sense that yet because they haven’t seen inflation in the economy, but the CPI numbers came out today, I believe, and they showed inflation is increasing. I believe the official numbers misstate CPI, and I think, as you mentioned on your program last week, Jim, the Fed will probably have to lower rates early next year once they realize they [inaudible] the economy by raising them. They’re in a no win situation. That third ‘d’ is when the Fed begins to lower rates to try and spur economic growth, then we’ll start to see the true nature of the inflationary beast in the economy, and people are going to lose purchasing power. So the book tries to at least introduce people to those 3 problems, and then hopefully introduce them to some investment solutions. [15:53] JIM: You know it’s amazing, because when you look at the US, as a whole, let’s say the United States was a corporation. Dan, if you were to look at some company that consistently kept losing money and they kept losing more money each year, and their sales – they had to import more of their raw materials and kept running a large debt laden balance sheet – you would say, “that’s not a company I want to invest in.” And yet, when you take those same macro and financial ingredients and you look at the US, you know, Washington and Wall Street basically ignore them, and as, I believe, many investors do. DAN: You’re exactly right. Most investors do. I remember about 2 years ago, I was in London visiting a relatively well known commentator on the bond market – and I won’t mention him, but I talked to him afterwards, and we had arranged to meet – and I said, “When do you think the credit rating on the 30-year bond, or long term US debt might be lowered.” And he said, “That’ll never happen, the US government will never default on its bond obligations.” And I said, “Why is that impossible, if you look at the balance sheet of the US government and the way it’s run, it’s a credit risk, and shouldn’t it be priced as a credit risk, shouldn’t it have to pay more to borrow?” And he said, “Well, that would mean the end of the dollar, and that would mean the end of the world economy where the 30-year bond was the safest investment in the world.” And I said, “Exactly! Those things are ending.” But that’s an awful lot to chew on for people who aren’t familiar with the ideas. But fundamentally, as you point out Jim, that’s absolutely the story in America today: that our balance sheet dictates our government is a credit risk, the bonds should fall in price, that will drive interest rates up and it’s not good news for the dollar either. It’s not good news, but I would rather be the bearer of bad news while there’s still time for people to do something about it, than pretend that it’s not a problem. [17:53] JIM: You make the case in your book about the dangers of this, because I’ve seen some people who are on the bear side, and they’re talking about debt, they’re talking about deflation, they’re talking about assets coming down, but then they’re also talking about how the dollar holds up which doesn’t make sense because if the US economy was to go into a recession, if interest rates were to rise that means the government’s deficit would get much, much larger because tax revenues would go down, at the same time expenses would go up, so that means we’re going to have to either finance more of that or we’re going to have to monetize part of that. I don’t see, given the present economic course that we’re embarked on, Dan, how we can have anything but problems for the dollar for the future. DAN: I don’t either. It’s funny you mention it because I think where we are at macroeconomically is that there was a very tepid recovery following the recession in 2001: the recovery didn’t benefit average wages; it didn’t tremendously benefit employment; it didn’t benefit the stock market; house prices benefited because interest rates were low, so that’s where most of the inflation went; and the dollar recovered somewhat against the euro after its big decline against the euro. But I think you’re right. One of my colleagues, Addison Wiggin, who also wrote a book of his own a few years ago with my publisher, Bill Bonner, he’s just published a book called the Demise of the Dollar, which tries to explain, or show to Americans how this is all but unavoidable, and if you wanted to – most people don’t want to, because it’s a pretty boring subject, but if you wanted to go back and – study the history of currencies, and in recent history, the history of central banks, they almost always, without exception, when confronted with the tremendous amount of debt in the economy, take the easy way out. And the easy way out is to print more money, and try and inflate away the debt. So, people who think the currency can retain its value when the central bank is so irresponsible as Alan Greenspan has been, I think are kidding themselves. And I’ve heard all sorts of arguments about why deflation is more likely than inflation but frankly, I don’t buy any of them, because they don’t take into account the central bank always does the same thing when confronted with this amount of debt, and that should lead to inflation and a fall in the dollar. [20:18] JIM: Given the fact that you see a fall in the dollar, and I agree with you 100%, let’s talk about how do you hedge, because you talk about that in your book? DAN: The nice thing for investors is 10 years ago, or even 5 years ago maybe, if you were concerned about that, then it would be very difficult to hedge by either putting your money into a different currency, or trying to get into a different asset class. I think two things are going to happen that are on the side of individual investors during this upcoming dollar crash. The first is, the dollar will not fall exclusively against other currencies, it’s going to fall against hard assets, in fact I think all currencies – all paper currencies – will fall against hard assets. We’ve already seen that, really, with oil prices: oil’s gone from $67, even with a strong dollar right now, and gold of course is doing fairly well right now, so those are the two chief hard assets, against which the dollar is going to fall, but a basket of commodities wouldn’t be a bad bet. I think for individual investors, if you don’t already own physical bullion, or numismatics – which are a little trickier because they have a premium on them because they are collectibles – those are 2 ways you can own physical gold, which has always been the best antidote against a weak paper currency. I do believe you can profit by owning gold equities, even though they’re still stocks. In a stock market correction, or in a crash, gold stock is still a stock, but I think if you own a company like Newmont Mining, whose main product is gold, I think that’s also another way of hedging against the fall in the dollar. And then I think, if you’re a speculator, if you have a taste for risk, you could just bet against interest rates through exchange traded funds, through options on exchange traded funds; bond prices have to come down as interest rates go up, so you could buy put options on TLT or IEF which are proxies for the US government; that’s really for speculators though. I mention it in the book because I think it’s a new tool, but the basic tool is to try and diversify your assets a little bit. Precious metals and hard assets – even on the equities side – I think are the best way to do that. [22:30] JIM: Speaking of exchange traded funds, you spent quite a bit of time in your book, explain what they are, and how they fit in a portfolio and are a good strategy to profit from them. DAN: What they are is they’re sort of a more nimble, more precise version of mutual funds. So rather than owning the S&P 500 – which you actually can do through an exchange traded fund – they carve the stock market up into smaller pieces, whether it’s by sector or geography, or asset class. And the reason that’s good for investors, as you mentioned at the top of the interview, the Dow hasn’t gone anywhere in almost 4 years. In fact, I checked this morning and the high for the year this year was 10,940, the last time the Dow was that high was June 2001, so 4 years is a long time to wait for people who have immediate investment needs, whether it’s retirement or you’re trying to help your children get through school. So what exchange traded funds do is they take you out of investing in the market, and put you in specific sectors, or asset classes. So one example right now would be energy stocks, which have been the big drivers of the S&P performance and the S&P earnings; you can buy a basket of energy stocks; so rather than buying the S&P 500, you can buy XLE, and that’s the ticker symbol for about 20 different oil and energy stocks that make up the S&P energy sector. So what you’re doing is buying where the bull market is, you’re not buying the S&P. That wasn’t entirely possible 5 years ago. So that’s just one example. Another example would be a country like Malaysia, and this is an example of geographic diversification. I didn’t get to Malaysia on my trip to Asia last year, but everywhere I went people were talking about it. It’s currency is basically pegged to the Chinese currency, so as the Chinese currency strengthens, the Malaysian currency strengthens, so it’s peripherally a China play. But it’s got a very balanced economy: it leads the world in exports of rubber and rice; it’s a big trading partner with China and India; but it’s got much better transparency in its publicly traded companies and those publicly traded companies trade in the United States. So if you were looking for a little international diversification, Malaysia would be a great place, and you can buy the top 10 or 15 companies in Malaysia through EWM, which is an exchange traded fund that baskets together those top Malaysian companies in one stock. So how people fit these into their portfolios is a question obviously of what their individual investment goals are. What I’ve written about in the Bull Hunter, and what I recommend in my newsletter, is that people use them as ways to diversify outside of US stocks, and secondly, to specify the sectors they really want to own, because for example I would not want to own retail stocks right now in the United States, but I wouldn’t mind owning Chevron, Texaco, and Exxon-Mobil. So ETFs make it possible for you to slice the market into smaller pieces. I think right now there are maybe 200 of them and they have about $300 billion in assets and the mutual fund industry still has $7 trillion. So it’s very early in the game, but I think that ETFs will be to the next 20 years, what mutual funds were to the last 20 years. [25:53] JIM: One thing that you talk about in your book, and sometimes this escapes investors, and all of a sudden we wake up as we did on 9/11 and we find a geopolitical event that changed a lot of things. Dan, we live in a more dangerous world today. I mean you just have to take a look at my son who just went to London the day after the attack – he’s on a student tour – and he’s heading over to Egypt and there’s an attack over there. And so we’ve got a lot more geopolitical risk today. What do investors need to know, and I guess given these exogenous type of events, what are their options for a more dangerous world today? DAN: That’s an interesting question, Jim, because I was in London for a year and a half and moved out on July 2nd, so I was there basically 5 days before all that started to happen, and I was fortunate to have left before that happened. And when I thought about it, what I wrote is that one of two things seem to happen. One, either financial markets are very good at pricing in geopolitical risk because they didn’t move at all, and that might be a sign of the times, that the world is now used to these types of things happening and it shouldn’t be too disruptive to financial markets. However, I would qualify that by saying that what happened in London, and what happened in Egypt and what happens in Iraq almost everyday, and what may happen in American cities, God forbid, it will be a lot worse, if and when, there’s an attack that uses a weapon of mass destruction. And in my opinion, that’s nearly inevitable, whether it happens next week or next year or next decade, this seems to be the trend of the way things are going geopolitically in the world we live in. And in that case, I think that’s the strongest case you could make for owning hard assets, and by that of course I mean mostly precious metals and gold: that any kind of paper asset, or any derivative –anything that derives its value from another asset – is not going to do well in the kind of financial crisis where liquidity dries up. So unfortunately, I think that people have to recognize that that’s a possibility and if you were going to hedge against it, or at least set aside some of your wealth in case liquidity dried up, gold would be the best answer there. I hope I’m wrong about those things, but you know the world has changed so much in the last 4 years that it seems to me more and more likely that sudden geopolitical events will be very disruptive to financial markets. I think they’ll recover more quickly, but if you’re tied up exclusively in stocks during a liquidity crisis it’s a really bad position to be in. So at the very least, people ought to consider lowering their portion of stocks they have in their portfolio. [28:36] JIM: Even though we are talking about this, and this may be uncomfortable for many investors to hear, but you know, you have people like Warren Buffett, who runs a very successful insurance company – Berkshire Hathaway – and he’s had to address this issue and has talked about the topic of WMDs as a very distinct possibility. So I think, as we turn on the TV, as we did on the events of 9/11, and more recently in London and Egypt, or even Spain, these things are becoming more frequent. That’s the one thing that you can say: it’s definitely these types of events are in an up trend. DAN: I think – to put it into trader’s terms – the great book by Nassim Taleb, Fooled by Randomness, I think he put it into precisely the way that helps investors understand it: you should not confuse the frequency of an event with the magnitude of an event. In other words, it doesn’t have to happen 9 times out of 10 in order for you to worry about preparing for it. If the magnitude of something happening is so large that it would destroy a huge portion of your wealth, or at least endanger a large portion of your wealth, then it’s a problem that you have to take seriously, and the magnitude of the kind of events like that, or a housing market crash, or a spike in US interest rates, or China invading Taiwan, these are all unpleasant things to talk about, and in some senses it’s speculation as to whether they may happen, but it’s not prudent for investors to not at least consider those, and then look in some small way how they might be able to prepare for them. And I know when I read Warren Buffet, he mentioned it in a note to his investors that Berkshire Hathaway, and I think his insurance company, would now be able to withstand the destruction of an entire American city. I thought, what has the world come to, when that is just a normal news item in the newspaper. But that’s the fact of the matter these days. So, if Warren Buffet is taking it seriously, then obviously as you said, individual investors should do so as well. [30:38] JIM: Let’s move on to something else you talk about in your book, and that’s money migration. What is it? And discuss if you can, briefly, the 5 elements. DAN: Well, in a nutshell the money migration is an explanation how – what we’ve talked about here – the US economy has some large structural problems: the chief one is people think getting rich means spending money, and in the meantime you have a lot of people – 3 billion people – in the other part of the world who are just getting a taste of rising standards of living; they’re also competing for the same resources that we have really had to ourselves, and primarily that’s oil, but it’s also lumber and base metals and even agricultural commodities. And then there’s also a demographic element to it, that there are a lot of people in Europe, where I spent the last 3 years, and even here in the States, who will expect to be able to retire comfortably in the next twenty years on a government pension. And you have this at a time when Western economies are trying to compete with Eastern economies, and they’re having difficulty doing it because of the labor advantage in the East. So essentially, you have aging countries in the West, who have a huge retirement bill coming due, and have been borrowing money from the rest of the world, and now are competing for resources with the world, and then this other group of people on the other side of the planet, who are competing for the same resources and are probably not interested in funding the retirement of Americans and Europeans. So, – that’s probably not a nutshell – but in a nutshell, it means that the East is going to get rich, the way the West got rich 200 years ago, and the best investment opportunities are going to be in the East. [32:25] JIM: Let’s talk about some of the specific investments that you think may do well, and I want to talk about gold, mining, and energy, and how that fits in the portfolio, and perhaps another area which is water. DAN: Yes, water, I’d love to talk about that. I’ll mention the 3 companies that I profile in the Bull Hunter are roughly in those 3 categories: energy, mining and agriculture. The first one is Korea Electric Power, which is not a traditional energy company, it’s not an oil or a gas company, but it’s located in South Korea, it trades in New York, it’s helping the Chinese build pebble-bed reactors in time for the 2008 Olympics. The electricity infrastructure needs in Asia are tremendous – and I’m not even talking about the fact that they are going to increase their consumption of oil from 20 million barrels to 40 million barrels – they just have raw infrastructure needs that will have to be met before \Asia\ can reach its full potential as a producer of economic goods. So Korea Electric Power is not only an excellent company for that, but at the time I wrote about it, it was selling at a tremendous value. It was just the kind of stock that Graham and David Dodd would like. I think it’s a little more expensive now than when I first wrote about it, but I think as a long term investment in the energy needs of Asia it’s excellent. BHP Billlington is the Australian mining giant I recommended in the book. It’s obviously known for producing iron ore to China – China’s now the world’s largest steel producer, most of that is for domestic consumption, although they may start exporting some, if their production ramps up – but BHP is a diversified mining company; it’s from a commodity producing country; it’s got a lot going for it, so I recommended that; and it was also a very good value for investors who weren’t paying 50 times earnings, I think it was 17 times earnings at the time. It may be a little more expensive now but not much more. And the third company is a US company that has a lot of agricultural assets in Latin America, particularly in soy beans. It’s one of the things I noticed when I went over to India and China, there’s thousands and thousands of stories you could tell about that region, but I chose to focus on the most immediate demands. And if economies need oil as a form of energy, people need energy too in the form of calories, and soy oil is one of the chief cooking components over there. The company is Bunge, and the ticker symbol is BG. They exports soy beans to China and all over the world, so it’s also a value investment, but it’s a well run company: it’s well managed; the cash flow is good; it’s obviously in a business that’s growing; it has a durable competitive advantage because it owns the land – the arable land that it farms and sells from. So, those 3 companies, food with Bunge, Korea Electric Power, and BHP Billlington, to me those are the three most direct ways – or 3 easiest ways – to invest in what’s going on in Asia. It’s funny you mentioned water because I’m in Colorado right now, and I’m from here originally. My brother lives in a part that was not populated 20 years ago when I grew up, it’s a little town called Superior, which is now full of clapboard houses and you can actually see Rocky Flats, the old plutonium processing plant, from here. Water is a huge issue in the West, here in the United States and there aren’t a lot of water stocks unfortunately for people to invest in, but I think fundamentally, and this might sound crazy to people, but the availability of water for irrigation or for just potable drinking water, is going to start becoming an issue to the development, not just of cities in China but probably to the sustainability of cities like Phoenix, Las Vegas, Los Angeles and even some cities here on the front range in Colorado. [36:15] JIM: Well, you know, you can’t talk about the 21st Century investing without discussing China. What makes China so great an opportunity for investors? DAN: It’s several things. First, it is the world’s workshop now. Many of the world’s manufactured goods come from China, and even if wages there doubled in the next 5 years they would still be an order of magnitude cheaper than anywhere in the West. They’ll lose some of that advantage to their competitors in Asia, but the things we used to make in the United States are now being made in China. And if we think that that’s over, I think it’s just beginning: whether it’s multinationals who manufacture there, or Chinese companies who start using their $700 billion of dollar reserves to buy US assets, like we saw CNOOC try to do with Unocal, you have to pay attention to Chinese companies, their cash flow, and their potential market. And I think that’s the second thing – is that in a nation of 1.2 billion people, they have a very small middle class as a percentage of the population, but numerically it’s still 200 million people who have an elevated standard of living. Those people are going to drive the growth of the world economy in their consumption of material goods. They’re younger on average than we are in the United States and Europe, and they have higher savings. So, they’ll have more money to spend, whether it’s on luxury goods, or travel, or just on automobiles and microwaves. But it will be the engine of global growth, both on a production basis and on a consumption basis, in the next century, in the same way the US was in the last century. [37:48] JIM: When you talk about China, one thing that has struck me, is most people don’t realize how much they own of our Treasury debt – not just Treasury debt but Agency debt – and one thing that we’ve seen the Chinese do over the last probably year and a half is they’re shopping globally to secure natural resources. So they’re turning those dollars into hard assets so to speak. Shouldn’t investors be doing some of the same things that the Chinese are doing? DAN: Absolutely. I wrote about that in one of the chapters of the book. It’s essentially a war-chest, with an expiration date. The Chinese have traded with the United States and have accumulated huge dollar reserves, and they see the writing on the wall. They know they’ve been lending money to a government that is a credit risk. So they’re going to want to spend that money before their dollars lose their value, and I think what you saw with the CNOOC bid for Unocal was really just the leading edge of that effort to trade paper assets for hard assets. And behind all of it, is just the strategic reality: they are competing for resources with us, and with Canada, and with Europe, and with Mexico, and with Brazil. So that is the driver of asset prices in my opinion, it’s not ‘is Google selling at a reasonable multiple’, it’s ‘does China have adequate oil reserves, or adequate food supply, or adequate access to iron and steel’. That’s what’s driving their acquisition of global assets, and it’s what’s driving the competition with the United States and Europe. So for investors, the situation really isn’t that different – you don’t have to act like a government, but what you do realize is that this asset class, commodities, is in a secular bull market because the world is now competing for scarce resources: whether it’s at a corporate level or at a government policy level, that is the chief driver of demand for hard assets. [39:41] JIM: What are some of the risks in your opinion to China’s future? DAN: Well, one, really. I think that ironically 95% of China is the same ethnic group – they’re Han – so it’s not an empire in the same way the Soviet Union was an empire, so it won’t fall apart for those reasons, but I do believe that it’s likely within 5 years, perhaps less, that the communists in Beijing take all the stolen money they’ve squirreled away in the last few years and leave for Zurich or Paris, or wherever deposed communist dictators go. And the reason I think that will be the case is that markets work better than governments, and it is an impossible task for a central government to manage the growth of the economy the way the Chinese are trying to do it. So far, they’ve done a laudable job of preventing a financial collapse because their banking standards are so low, but I think the chief problem is that you have about 500 million people who still operate in sustainable agriculture, they don’t work in factories and their standard of living hasn’t improved. We’ve already seen in the last 6 months that the bulk of the political strife in China is economic: it’s becoming a nation of coastal haves, and rural have-nots. I don’t think the central government can control that because it can’t suddenly make 500 million people richer by changing where foreign direct investment goes. So I think, as has always happened, market forces overtake central planners, and lead to economic dissent, as well as lead to some political dissent. I don’t think economic liberty and political liberty are that inseparable – well, I think they are inseparable, I think you can’t have one without soon wanting the other, you know the horse’s out of the barn so to speak, and so far the Chinese have gotten a free ride with their repression of various minorities and political dissent. But I think that that will spin out of control. So that’s the chief risk for investing in China, is that it’s growth will be disrupted by political upheaval, or as political upheaval becomes a bigger problem the Chinese will invade Taiwan to distract the domestic population. That’s all possible and if it happens it’s not good for asset markets, but what I recommended in the Bull Hunter is that the companies that I recommended are going to benefit whatever happens in China; if China remains placid they’ll do even better; but the fundamental driver behind their bottom line is the global demand for resources. So you’re not completely China-proof, but you’re reasonably safe. [42:15] JIM: Let’s talk about another engine of growth and that’s India. DAN: I went to India and I didn’t spend long there, but the Indians describe themselves as 10 years behind China. I think that they may be a little further behind China than that, and the chief reason is that there is a tremendous amount of red tape left over from the socialist era after the Indians made friends with the Soviets in the 50s. In practical terms, it’s just hard to be a foreigner and invest money in India. But the story there will be domestic growth: they also have a fairly high savings rate; and they have tremendous local infrastructure needs; tremendous service needs; they’re going to continue to benefit from getting a lot of the white-collar jobs that are moving offshore from the United States. But practically speaking, there aren’t as many good options for individual investing in India’s story as there are in China. And so, what I recommended in the book, is just to wait till the capital markets there sort themselves out. They need to make some regulatory changes to make it easier for foreign investors to own Indian shares, or for Indian companies to get foreign capital; until that happens I would tell people it’s probably a bridge too far in terms of foreign investment. There are probably some mutual funds that do it, but frankly I wasn’t interested in owning a lot of Indian stocks; I want to own the ones that are growing because the middle class is growing there, but those companies just aren’t listed yet on Western markets. So, I’ve got my eye on it but right now, to me, it’s not the best place to be. [43:46] JIM: Talk about who Dr. Chet Richards is and Colonel John Boyd. Explain who they are and how investors can profit from these men's’ wisdom. DAN: Well, that’s a great question. Chet Richards is a man I met right before I left for my trip – and when I say my trip, I was gone for about 4 months to India, China, Thailand, Australia, and I think that’s it, there might have been one other, or two places there – but Chet had written a book called Certain to Win, and his work was based on the work of a retired air force colonel named John Boyd, and John Boyd was famous for what he called the Boyd cycle, and in military terms the Boyd cycle was, “observe, orient, decide and act,” they called it an OODA loop, and Chet knew John Boyd, and it was basically a description of how to operate in any environment where there was abundant information and you had to react quickly to a changing world. That’s obviously a description of how our military operates now in Iraq. It’s got a technological advantage so it observes, orients, decides and acts, and it’s called the ‘decision cycle’; you try to make your decisions more quickly than your competitors. When you apply it to the business world as Chet did – he applied it to the Toyota business model, or to Southwest Airlines – and so what he was doing was he was applying that methodology to what it would take for a business to be successful in a globalized world: it would have to observe the changing conditions of globalization; orient itself to the regulations and procedures it would have to adopt to operate; decide the best corporate strategy and then execute that strategy quickly; and the key thing is doing it all relatively quickly ahead of your competitors. When I studied it, I said that is pretty much what you and I do everyday as investors: we try to observe what’s going on in the world; figure out what it means; decide what to do and then do it. So, in one of the chapters of the Bull Hunter, I describe how to apply that methodology to your investment decisions. And really, it’s probably something people do intuitively, but it is a useful way for understanding what it’s going to take. You really can’t make one plan and stick to it for 20 years. I think you have to be more adept at monitoring what’s going on with geopolitical events, with interest rates, with currencies, which is the work that I know you try to do with your group, and it’s also the work I try and do at Strategic Investment. [46:13] JIM: Explain, Dan, the simple rule of three, and give an example of how it might work in looking at an emerging market. DAN: I know a lot of people think that investing in emerging markets means doing something strange and exotic, so what I try to say is just keep it simple. Most countries that are just starting to hit their stride economically have very few strong, public companies anyway, so if you can limit it to 3 companies then it’s going to make your job easier. And generally there are probably only 3 or 5 companies anyway that are worth looking at. So the ‘rule of three’ means look for the most solid bank in a country; the most solid, maybe a telecom stock or a media stock; and then maybe something that’s unique to that country, whether it’s in Brazil it might be an iron ore company, or Australia it might be a mining company. But generally what I suggested is that if you’re dipping your toe into buying an ADR, or a stock that’s based in a foreign country then confine yourself to companies that are in well known industries which a growing economy will need; whether it’s infrastructure or financial services or telecommunications or health care; just pick simple needs the way Peter Lynch used to describe when he walked into the store and he understood what was going on. I think that’s what people need to do with emerging markets. And one example I would use, I think is BHP Billington in Australia. Australia might not be described as – by a lot of people – as an emerging market, but if you were a little disconcerted about buying a stock based in another country, BHP is a great example: it’s the second largest mining company in the world; it’s in an industry which is very easy to understand; and it has clients all over the world. So, it doesn’t completely eliminate the risk of investing in foreign stocks, but it’s a way to start measuring how much risk you are really taking. And that’s really the issue there: don’t take any more risk than you have to; don’t buy on a local market, a thinly traded stock you know nothing about. It’s completely unnecessary to do so, so stick with the major blue chips that have international markets and are listed on US exchanges. [48:21] JIM: In the last chapter of your book, you wrote a chapter on your vision of the future. I wonder if you might share some of that, and I thought it was rather unique, as you went around the world you wrote about these things, identifying bull markets, then you sort of said, “this is what it may look like, let’s say, 50 years from now.” DAN: Yes, it was a sort of ‘China, 2050’ and it was a description of China that has become the world’s manufacturer, and chief driver of global growth, both from consumption and its rising middle class, where the children learn English and maybe, we might see American students or students from Europe go over and become nannies, and teach Chinese schoolchildren English, but where the fundamental focus of the world’s economy has shifted to the East, because the West got old, and the West got lazy, or the West got complacent, and thought that our economic advantage was eternal and that we didn’t have to work anymore, we didn’t have to save anymore, or that we didn’t have to be prudent with our investments. And in some senses, you know, people are disappointed by that, because the question I get the most is, “what can we do to reverse what’s going on in America; what policies do we have to adopt; what can the government do?” And I think that’s the wrong question: the government generally doesn’t do the right thing – and I’m apolitical in that respect – what I mean is that policy makers will either raise spending, or raise taxes; we wouldn’t be in this situation if that hadn’t been what was going on. So the main thing I try and encourage to do in the book is – probably the most patriotic thing you can do is – to save your capital, accumulate capital, make good investments, understand what’s going on in the world; that is the American way; the American way is not to ask what can the government do to save our bacon; the American thing to do – the patriotic thing to do – is to save your own bacon, whether the government does it or not. And I think if people started doing that, we might have fewer political problems. But it doesn’t mean that it’s the decline and fall of America, and I don’t subscribe to the theory that America is in a sort of late decadent Roman phase, although there are parts of the country where that seems familiar to me, but what I do think is that the economic values of the country aren’t competitive anymore and there are other places in the world that are more competitive because their economic values are more sensible – and they’re sensible because they took them from us; it worked here, we’ve just stopped doing it. So I’ve tried to remind people what those values are and how to reincorporate them in their investment strategy, and hopefully for them and their families that’ll provide them a measure of safety in the years ahead. [51:04] JIM: You know, it’s amazing how history – I think it was Mark Twain, who said, “history doesn’t repeat, but perhaps it rhymes” – but prior to the age of discovery in the 15th century, China was a more developed civilization than if you were to look at Europe at that time, and then the West took off over the last 500 years, and now it looks like it’s reversing again. DAN: Yes, it will be fascinating. I will say that having lived in London and being an American, one of the huge advantages we have is that we have 300 years of experience in the West of operating capital markets: insurance companies; stock markets; exchanges. And that’s what they don’t have in China and India. They have no experience in doing those things. Now, whether or not that’s a handicap to them, that remains to be seen, but you know, Denmark and Holland and England and France and the United States, we didn’t get rich by being complacent about our national position, we did it by trading with the rest of the world and accumulating capital. And it just doesn’t seem like most people either understand that, or believe that it’s necessary anymore, but as you said, I think that the circle has turned – the wheel has turned – and that money migration, that process of people getting rich by doing the things that it takes to get rich, by working hard and saving and investing, that has taken hold in Asia, and taken hold with considerable force. The great thing is, because of the capital markets, you and I can profit from it. The sad thing is, it might mean there are a lot of Americans who are caught by surprise. But my goal in the book is not to save America as a nation, but to try and help people profit from what I think is going to happen. [52:46] JIM: Dan, if there is one thing that if an investor was to pick up your book and read it and walk away with one thought, what would that be? DAN: Well, my publisher might disagree with me but I would say primarily the book is a warning first, and then an opportunity second. The warning is don’t take the US dollar at face value; that there will come a day when, if you haven’t done it already, that you will wish you had your wealth tied up in some other form. In the last hundred years, it has happened twice – it happened in Great Britain in 1931; it happened in Germany after World War I – that a currency everyone thought was stable, and a perpetual store of value, completely fell apart, and everybody who had their wealth tied up in that currency saw it vanish in a matter of months. That’s a very stark possibility, but the reason it’s one to take seriously is that it seems to happen every time a government mismanages the currency; our government has done so, and people who don’t take the threat of the dollar inflating into nothing seriously, I think will deeply, deeply regret it. [53:56] JIM: And then I guess a final thought – you’ve started and run 2 successful investment newsletters – as an investor, personally, in your own experience, what is the most important thing you’ve learned? DAN: I think the most important thing is – I think there are two: The first obviously is what your goals are, and not to get greedy; and I think the counter side of that is to be conscious of risk and what is an appropriate risk for you, whether that’s based on your age, or your income, or geopolitical risk. The Bull Market in NASDAQ, which I benefited from as investor and as a publisher from 1997 to 2000, was an exception, it is not the rule, that’s a bubble, that’s a mania, and I believe we’re seeing the same thing in housing. So be conscious of what assets have more risk than others. Any stock has risk, but right now hard assets and gold stocks, precious metals – things that have tangible value – to me have less risk because the demand for them is what’s driving their growth, not just low interest rates, and not just a dream that you can get rich trading stocks. So I’d say be conscious of the risk out there and let that influence your decisions about what assets to own. [55:11] JIM: Dan, I want to thank you so much for joining us on the Financial Sense Newshour. Good luck to your new endeavor in Australia. And the name of the book, folks, is The Bull Hunter: Tracking Today’s Hottest Investments by Dan Denning. Dan, all the best! DAN: Thanks a lot, Jim. I appreciate you having me. 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