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JIM PUPLAVA: Well, some are saying we live in a brave new world, a world in which companies don’t have to produce anything, anywhere, all they have to do is sell goods everywhere. Some would argue that research and development, or intellectual property is much more important than capital expenditures, or the ability to manufacture and make things. To discuss these issues, joining me on the FSN Roundtable this week is Dr. Marc Faber, he is editor of the Doom, Boom & Gloom Report; he’s also author of Tomorrow’s Gold. You wrote a piece, From Asset Inflation to Consumer Price Inflation. In all the economic models that you look at today, if you look at the BusinessWeek, even some of the Barron’s Roundtable, they expect continuous economic growth; that we are basically in a normal economic cycle, and basically once the Fed stops the party begins. I take it you don’t subscribe that this is a normal cycle.
JIM: You know, Marc, taking a look at the money supply as reflected in M3, which as many people are aware will not be reported after the third week in March, but if we look at the Greenspan Fed, where we had M3 at roughly about $3.5 trillion, as of the latest reported week it’s about $10.3 trillion, but because of this bear market in commodities where the cost of real goods came down in a bear market, and also because of the expansion of manufacturing globally which imported cheaper costs into the United States, the US has been very fortunate in that we were able to inflate the money supply, and yet at the same time the Fed was able to say we have no inflation. MARC: That I have to give the US credit for up to now, but the question is how will it be in the future? It’s been in a sweet spot in the sense that if you’re Argentina, or Thailand, or Indonesia, if you have a current account deficit you can essentially only borrow in foreign currencies because nobody will lend you in local currencies. And so when the currency starts to go down you have a problem because your income in, say, Thai baht, in Argentine Pesos, or Indonesian rupia, but your liabilities are in dollars. So, when you have a crisis of confidence you get into trouble, and they are automatic stabilizers to readjust the economy, in other words, the currency collapses nobody wants to lend you money, so you have to put your house in order. In the case of the US, we had until now and still today a dollar standard. And so the US can borrow in US dollars to make up for its current account deficits, and trade deficits, and they’ve been very fortunate in this respect, and the current account deficit leads to accumulation of foreign exchange reserves in Asia, which are then recycled back by some ignorant central banker into US Treasuries. And so this game has worked very well up to now, and I have to say wonderfully for the US up to now, but what they’ve been able to do is consume more than they produce, to decrease their savings rate, and live above their standard of living basically. And the Asians have been producing the goods and shipping the goods to the US, and since they produce it at much lower costs, the US has been able to import fax machines, PCs, shoes, and so forth, at basically falling prices, and that has worked until now wonderfully well. But the problem is it won’t last forever, because at some point the dollar standard will come under pressure where people will say, “we already have dollars, we don’t want more dollars, we want to diversify into another currency.” The question is, what other currency will there be that is better than the US dollar? [7:31] JIM: You know, Marc, in this last rate-raising cycle, we’ve seen some unusual things occur. We had the Fed beginning to raise interest rates in June of 2004, where the long term Treasury, or 10 year Treasury note, was at 4.8%. In this rate raising cycle, interest rates on the longer term actually came down; we saw energy prices go from the mid-20s to as high as $70; we’ve seen inflation pick up in the economy, yet the stock market has held up, the bond market has held up, the economy has held up. Is this because of this influx of all this foreign money that supports our trade deficit? What’s going on here? MARC: It’s partly the central bank buying of US Treasuries, and agency bonds, but partly the increase in short term rates, in other words, the Fed Funds rate, [went] from 1% to 4.5%, and actually today the CPI in headline was a disappointment, but the bond market didn’t go down, because the bond market likes the Fed to increase short term rates until it kills the economy. So, until the economy weakens significantly the bond market actually will rally, because it will perceive that short term interest rates, or the Fed Funds rate will be increased further. In other words, at the March meeting to 4.75%, and most likely again to 5%, and so forth and so on. The bond market actually likes the increase in short term rates, because it knows at some stage the economy will weaken, and then the Fed will cut interest rates once again. But I look at this as a fallacy in some sense, because I believe that the day that the Fed cuts interest rates the bond market will actually tumble, as well as the US dollar. So at that stage the Fed will be in a very difficult position, because if they ease, the bond market goes down, the dollar goes down, and at some point import price inflation will come into the system. JIM: You know, Marc, some would argue though, as some do, that if you take a look at the US trade deficit, if we take a look at many high-tech items from computers to other manufactured items, if the US company designs it, but outsources the manufacturing and on a $700 computer US companies make $240 of profit, and foreign producers or manufacturers who make the actual item only make $40 profit, actually the US trade deficit is overstated and that if you look at where most of the profit is made, this can go on for quite some time. MARC: Yes, I mean first of all I think that economists will always find a way to explain away problems. If a computer costs $700, and the US manufacturers make $200 that’s wonderful, but $500 are made somewhere else. And this $500 is not made necessarily as a net profit, but they lead to employment gains somewhere else; they lead to investment flows to somewhere else. And believe me, whenever you have manufacturing moving somewhere else and employment gains, and the whole capital spending taking place somewhere else –in the case of the US, mostly in Asia – then knowledge moves along with it, and value added moves along with it. And I mean there is also this whole issue about R&D spending being important, and capital spending not being important. Well the fact is that R&D is increasingly moving to Asia. I mean the view in the Western world, and it’s not typical of the US – and I’m accused of some anti-Americanism – but the typical view in Europe is, “we’re the smart Europeans, we’re the smart Swiss and Germans and Americans, and we will invent, and the stupid Asians will make the Nike shoes for us, and we’ll make the profits.” But that is not the way the world will work. On the contrary, eventually knowledge and all the inventions will be in Asia because it’s so much cheaper to carry out R&D in Asia, than in Europe or in the US. I’ve been in India just recently, and I talked to some people, they all say, “look, we get this and this many contracts from Europeans to outsource R&D to India, because it’s much cheaper to design a new car in India, than to do it in Europe.” I mean in Asia we have 3.6 billion people. Let’s say we have one genius per million people, then we have 3600 geniuses in Asia. [12:43] JIM: You know Marc, one thing that strikes me about this whole concept where you have increasingly a few manufacturing producers in Asia that produce most of the goods for US companies could you indeed in the future see a situation much as the iron ore, or commodity producers who use to have their prices dictated to them by the manufacturing companies in Japan, but they woke up one day, and said, “wait a minute, we are the largest producers of iron ore, if Japan needs our steel to produce cars, and so does China, we’re raising our prices, and if Japan doesn’t like the price increase, we’ll turn around and sell it to China.” Could that happen to the US? MARC: Well, actually you’re raising a very important point because I’ve noticed one trend around the world, and that’s why I’m a little bit cautious about investing in mining companies, or oil companies, rather than investing in the physical commodity. For example, I’d rather own physical gold than a gold mining company because I’m seeing around the world a trend where the resource producers suddenly see that they have something very valuable, and now suddenly there is a movement in every country among the people, who say, “well, we’ve given this resource wealth too cheaply away to the international mining companies, we should get more of the international mining companies’,” and so forth. And so you can see in Latin America, sentiment has turned very much against the US, against the multinational mining and oil companies. It’s also happening in Africa. And I’d like to introduce another element: whenever you have an increase in commodity prices, you have an increase in international tensions. Because why do commodity prices go up? They go up because there are shortages, and so people who depend on commodities, such as the US for oil, and by the way, China also depends on oil for its growth, and India depends on imported oil also for its growth, so tensions are increasing and eventually that drives commodity prices even higher. And I think that the same thing will happen one day with the producers of shoes and so forth: either they will launch their own brands and compete one day with the Nike’s of this world – and we have examples of Asians’ producing brands, and lots of brands, Samsung was nothing 20 years ago, today it’s one of the world’s leading brands; today Lenovo in China, which by the way acquired IBM’s PC division, they had the largest market share, and so forth and so on. And so, it would be wrong to think that we – the US and Europe – are so smart, we will only design and the others produce the goods. It’s not going to be that way. [16:08] JIM: And when that changes, when producers say, “look, we’re the largest maker of boxes, let’s say for computer for companies such as Dell, does that profit relationship as we discussed earlier, where the American companies may make $240 on making the computer, the manufacturers only make 40, then does that equation reverse itself? MARC: Well, by the way, I’m not so sure about that statistic, because if we make the computers in Asia, first of all, everybody will understate his profit because nobody wants to pay any tax in Asia, so that is one consideration. Secondly, in my opinion, on the $500 that they sell to, say Dell, and Dell makes the $200, on those $500 in my opinion, their profit is about as large – all the manufacturers combined, in other words, the component makers, and so forth – as Dell’s profit. That would be my impression. And by the way, if you look at corporate profits in the US, then since 1999 domestic manufacturing has been down, the only corporate profits in the US that have expanded are financial profits – I mean the financial sector – and overseas earnings; in other words, subsidiaries that are located overseas. The subsidiaries that are located overseas make money. I suppose the local manufacturers that make the products also make money. If we were in this wonderful, brave new world, as described by some people, and America makes all the profits and the stupid Asians work in the sweat of their factories, and don’t make any money, how is it that in China per capita incomes in real terms – in other words, inflation adjusted – have doubled every ten years, for the last 25 years, and that the standards of living in Asia by and large –I’m not saying for everybody, but by and large – has improved dramatically? Whereas I being a Swiss, I can say in good conscience that for the last 30 years in Switzerland the standard of living has not improved for the typical household. And we have statistics in the US which show that since 1999 real median household income is down by 4%, and in Michigan it is down by 15%, and in Illinois by 12%. So please explain to me, if the US makes so much profit, how is it that the typical household has falling real income, and in Asia we have a doubling of household income, of personal income, every 10 years? How is it? [19:10] JIM: Well, that one just doesn’t add up. MARC: It doesn’t add up. JIM: Marc, one of the issues that is being bandied about in the financial world is as the US economy slows down, because of rising interest rates we’ll get back into this disinflationary environment. And the one thing that we have seen repeatedly is anytime the US economy slows down, anytime the US has a financial crisis – whether it’s the Peso crisis in 94, Asia’s crisis, Long Term Capital Management, or the events of 9/11, and the recession of 2001 – money growth accelerates. And with that money growth we eventually get a recovery even though the quality of that recovery seems to get poorer and poorer each time. Now, we’re going through another slowdown, the Fed is raising interest rates, a lot of people are talking about deflation – deflating the asset bubble in real estate, real estate prices will come down, maybe the stock market will come down – but are we at risk now that we have rising commodity prices coming from Asia, global demand for energy that this time around what we get is inflation, not deflation? MARC: Yes, I think we have to distinguish between the period 1980-2000 and the last 5 years, because if you look at the stock market crash in 87, the S&L crisis in 99, the Tequila crisis in 94, the Asian crisis in 97, LTCM and Russia in 98 – it all occurred at the time of falling commodity prices. And so, if you printed money at that time, it didn’t flow into hard assets, or commodity prices, but now we’re in a different situation in as far as commodity prices have been rising. So the next time the Fed – and I have no doubt that if the stock market drops 10%, and if the housing market drops 10%, Mr. Bernanke will not cut interest rates in baby-steps the way they have been increasing, but he’ll cut them at half a percent at a time, or even 1% at a time, or even 2% at a time to prevent asset deflation causing economic damage. In that situation, I think the dollar could really take a hard hit. As I said before, we’ll have to define a ‘hard hit’ against what? But I suspect that when the Fed prints money the next time, no matter how weak the economy is, that inflation will be a problem still. [22:08] JIM: You know the one fortunate thing that the US has had is being the world’s reserve currency. One of the most important commodities in the world is oil. MARC: Yes, precisely. JIM: And the US is fortunate that we can price oil in terms of dollars, so if the price of oil goes up other people that import oil need more dollars to pay for that oil. What happens to the US, Marc, in a time when you’ve got tremendous competition globally for resources, you’ve got stronger economic growth in Asia which requires energy, if suddenly OPEC decides that may be part of the way they price oil is in a basket of currencies, not just the dollar? MARC: I don’t assign this a great importance because let’s say, you price oil in dollars, theoretically, if you’re an oil producer – whether you’re Venezuela, Iran, or OPEC, or Russia – you can hedge your dollar into euros, or the day you get your dollar you can convert them into euros. So, to price them off us in a different currency in my opinion will not have a meaningful impact. But obviously, the big difference between say the 1970s, and today, is that in the 1970s the US imported maybe 20% of its oil requirements, and today they import 60% of their oil requirements. So rising oil prices, or oil prices around this level, $50 to $60, is an additional problem for the US in terms of a trade deficit, because the US is running a trade deficit with OPEC on the order of about $100 billion. You have to give the Chinese credit –coming back to the manufacturers in Asia – compared with the wisdom in the US, China has a trade deficit with OPEC of $4 billion. They’re just very good at selling their garbage – whether it’s wheat, or toys, or electronics, or whatever it is – to the Middle East. And so, I think that regardless of whether oil prices will be priced in dollars or in another currency it will be a problem for the US as long as the oil price doesn’t go down meaningfully, because it adds to the import bill, and it adds to the growing current account deficit, and it kind of weakens the dollar. And it weakens the dollar not necessarily against another paper currency, but it has weakened the dollar very significantly against a basket of commodities, against the CRB, against gold. People say the gold price has doubled since 2001, from $255 to now $550, or whatever it is; I would say the price of gold is always the same price, it’s the price of the dollar that has been cut in half. The dollar has gone down by 50% against an ounce of gold. And if Mr. Bernanke prints money, whenever that will be, and he will do that, that I can guarantee, because he is a deflation fighter, and so he will print money, so the dollar will just tumble even more against gold. And eventually it will also be reflected in the stock market going down against gold which it has begun to do since 2001. Since 2001, the Dow Jones is down 50% against gold. So, of course, the US can print money, but eventually people will go to – in my opinion – a gold standard, because people will start to distrust the dollar. And the purpose of having money is to facilitate exchanges, so that I don’t have to buy meat by exchanging milk for the meat; or I don’t go to the cobbler bringing him my farm products to exchange them for a pair of shoes. With money you can do transactions, so it facilitates trade. But the second and more important quality of paper money should be as a store of value but if money depreciates against a basket of goods, so you lose money through consumer price inflations, but in the last few years money has depreciated against a basket of assets, whether it’s a Picasso painting, or real estate, or commodities, or equities. So, in other words, people don’t trust cash anymore because the return on cash is so low, compared to assets, and I think this will lead to very high inflation at some point and to a total distrust in the function of storing value in cash. [27:10] JIM: And in one of your recent newsletters in the Gloom, Boom, & Doom Report you talked about a roadmap to ruin, and phase 1 of this was the Fed would raise interest rates attempting to reign in inflation. Phase 2 begins as the economy weakens, the Fed begins to reverse course, they cut rates, they ease massively, commodity prices remain firm, we now could have a possibility of a dollar crisis, which leads to higher interest rates and the combination of a falling dollar, rising interest rates, rising commodities leads to inflation, and stagflation in the US economy. Where are we in terms of that phase two? MARC: Well, interestingly enough, although the Fed has increased short term rates from let’s say 1%, 18 months ago, to now 4 ½ %, it has had no impact on the economy. The economy’s still humming along, and expanding, if you measured the economy by consumption. And my view about this is that inflation, along with the increase in the Fed Funds rate, has been rising. So, in other words, today if you borrow money the house price is still basically rising faster than your borrowing costs, and the stock market is still rising faster than your borrowing costs, and so forth. So it hasn’t yet really hurt the economy meaningfully. So, it is possible that the Fed has to increase interest rates actually more than is expected by the market place, and at some stage the economy weakens quite considerably, then immediately they cut rates like crazy but it may not stimulate employment gains in the US in manufacturing and capital spending, when it can just go into inflation, into price increases. [29:10] JIM: You know, one thing that we have seen and this was written on Contrary Investor, you’ve also touched upon it in your newsletter, if we take monetary growth and its effect on GDP, in the 50s it took roughly $1.80 of debt to get $1 of GDP, in the 70s it stayed roughly about the same - $1.70. But beginning in the 80s, 90s and this new century: in the 80s it took almost $2.90 for every dollar of GDP; in the 90s that figure rose to over $3; and in this new century now it’s taking almost $4.50 of debt to get $1 of GDP. So, if the Fed begins another reflation cycle, if the economy weakens its seems to me that it’s going to take an ever increasing amount of debt to get any growth out of GDP because monetary policy is becoming less effective, you get less bang for the buck in the economy. MARC: Yes, of course, you don’t need to be a rocket scientist to understand that printing of money does not lead to wealth, otherwise Zimbabwe would be the richest country on Earth; and the whole Latin American Continent would be the richest continent on Earth, because these Latin American countries, by and large over the last 50 to 100 years, have had a tendency to print a lot of money. What money printing does is it increases the price level in your economy, it may not increase the price level in real terms; in other words, if you’re Mexico, Argentina or Brazil in the 80s, by printing money their stock markets in local currency terms, their property markets in local currency terms, tended to go up strongly, but the deflation occurred through the collapse of the currency. Now, I’m not sure that the dollar will collapse against the euro, the yen, and against the Chinese RMB, and against the Brazilian Real and so forth, that may not be the case, so although it could happen, but I think the dollar is doomed, and the Dow Jones is doomed against the price of precious metals. [31:34] JIM: If we look at this roadmap to ruin that you have been describing in phase 2 at some point the Fed will have to start cutting interest rates, and inflating massively. Let’s go to phase 3 of your scenario, roadmap to ruin. In this case, you have a massive Fed assault to revitalize growth with extraordinary measures, perhaps this is where we get a lot of helicopter money, and we got a glimpse of that by the way after the hurricanes in New Orleans, where these debit cards were given to individuals with $2,000 worth of purchasing power. What happens in phase 3 and how does that play out in your mind? MARC: Well, actually, the Fed Chairman, now Mr. Ben Bernanke, he’s got one thing wrong. The US cannot drop money from helicopters because all the helicopters are in Iraq, so he’ll have to take some other measures to drop some money onto the US. But the point is, if you want to print money you can print money. In theory you can buy the whole government bond market; you can buy the entire stock market. The Fed can do that, these are the extraordinary measures he’s talking about. The ultimate would be to send a check to every household for a million dollars, that is money printing in extreme form, but it doesn’t necessarily lead to more employment gains. What the ultra-expansionary monetary policy of Mr. Greenspan which were implemented in 2001will lead to are more consumption, production, and investment activities in Asia and other countries. [I] would add here, that the US has the talent to have a trade deficit with every region of the world. There is not one region where they have a trade surplus. That tells you a little bit about the competitiveness of a country. If you measure competitiveness by market share of a country compared to total world exports then the US has been going down, whereas other countries have been going up. And so I think that this policy of printing money at the end will not lead to anything in terms of stimulating the economy, but it will lead to hyperinflating in the system. Eventually then the system breaks down. It can go for quite some time, but my feeling is if you look at the US dollar, and these are not statistics that I have invented, but it is a fact that the US dollar since the introduction of the Federal Reserve in 1913 has lost 92% of its purchasing power; and this is purchasing power as measured by the consumer price index published by the government. Probably, it’s lost even more than that. But let’s say it took roughly 100 years to lose 90% of your purchasing power, and by the way in Europe we have also lost purchasing power, so it’s not only endemic to the US, it’s just in the nature of paper money. But now, I don’t think it will take another hundred years to lose another 92% of the dollar’s purchasing power. I think it will do it in 10 years. [35:03] JIM: Under those circumstances where the Fed begins to inflate, the dollar begins to decline, could you see in the United States something similar to what we saw in Germany during the early 20s, where with inflation you start to see nominal increases in assets such as, let’s say, the stock market, but deflation in terms of gold in terms of purchasing power? MARC: Yes, as you remember, interestingly enough in 99, just essentially between six months and one year before the stock market started to go down, James Glasser published a book Dow 36,000, someone else published a book Dow 40,000, and someone else published a book Dow 100,000. That may all happen, that’s possible the Dow goes to 36,000, but in my opinion if the Dow goes to 36,000 then an ounce of gold will go to say $3,600, or maybe it will go to $10,000. In other words, you produce nominal gains in the stock market but against gold it continues to deflate. So, I feel the deflation in the US will not occur in the nominal level of prices as some deflationists such as Robert Prechter whose view I admire, but he basically will be right one day that there will be deflation, even in nominal prices when the stabilization crisis hits, he will be right. But before that happens, if you print money – and believe me, if you read the speeches of Mr. Bernanke, he will print money – and it’s in the interests of the Wall Street establishment to print money, because the more money that’s printed the more investment banks make, and the more the rich people benefit because in an asset inflation environment wealth becomes very concentrated, and the wealth inequality increases. So, it’s in the interest of the ruling class to actually inflate because they can benefit from inflation, whereas the middle class, and the workers, and the typical household benefits to a much lesser extent. And some people even have no benefit at all, as is evidenced by the fall in real income for the median household since 1999. [37:39] JIM: Marc, you refer to something that’s taking place right now. I have a friend who works for a major financial institution, and at the end of the year last year his employer granted cost of living raises to the employees. So he got a 3 ½ % pay raise in December. But as he told me, after he paid his Social Security taxes, 25% income tax for Federal, and 9.3% State income taxes, after taxes he got a 2% increase in purchasing power of his salary, but he said that didn’t keep pace with what he had to pay for groceries, what he had to pay for gas to get to work, what he had to pay for his medical premiums. So, in essence, this is already taking place with American workers, where their wages are failing to keep up with the true purchasing power of inflation, or the devaluation of the dollar. They’re falling further behind, and in many senses, are supplementing that shortfall with debt. MARC: Yes, of course, but it’s not only in the US, I’m not picking on the US, it is happening in Western Europe as well. Let’s say in Switzerland, the average worker or middle class employee gets a salary increase of say between 1% and 3%, and the cost of living for these people is of course going up much more 1% to 3% - just look at energy prices. [39:13] JIM: Where does this ultimately lead. When we’re in phase 3, you refer to the dollar starts to fall and could head into a crisis; as people start to exit the dollar that brings down the dollar even more, that means because the US is so dependent on foreign made goods, the price of just about everything starts to go up. In this scenario you see foreign exchange controls imposed in the US, and possibly gold ownership is declared illegal. MARC: One of the consequences of this scenario is that for the typical household the standard of living will go down eventually. It’s happened already for a lot of people. And the second consequence is that wealth becomes very concentrated in the hands of a few people who are obviously very powerful because in a democracy the people who have the money basically have more power to bring their people into the government, as so forth. It creates a very unpleasant social environment, and what it eventually does is it impoverishes the majority to enrich the minority. At that stage you can get social upheaval, and you can of course get situations where the minority is then like a money aristocracy, and things to the detriment of the majority [may happen], such as in future there may be some very costly expeditions overseas military expeditions, or they’ll blame it on the minority. I mean it’s difficult to tell what the ultimate outcome is, but I would say that in Western society the probability of having at some point a major crisis where people will have to tighten their belts very considerably whether that occurs in a deflationary environment, or as I believe rather in a very high inflationary environment where salaries just don’t go up as much as the cost of living and so people don’t have the money, then at the same time as inflation picks up interest rates go up, and people can’t meet their interest payments and are bankrupt and so forth. All this leads at the end to a major crisis, and in that situation when things get really bad of course after the rich people have moved their assets overseas, then they declare foreign exchange controls. [41:55] JIM: That’s something we have seen repeatedly in countries that have incurred large trade deficits, whether it’s been Argentina or other countries, that there is a currency crisis, the government in order to stem the fall in the currency will impose capital controls, and more or less keep the people trapped in the country. There’s a good likelihood given the size of US deficits, given the amount of money that is held overseas of US assets that we experience the same thing. In your opinion what will be the signs in your scenario that this is where we’re heading into? What should people be looking out for to protect themselves? MARC: I have to say the crucial distinction between Argentina and the US is when crisis hit Argentina they had a problem because their income was in local currency, and there liabilities were mostly in dollars – in other words, the dollar against the Argentine peso is a stable currency and the peso goes down and of course they try to stem the outflow – the selling of pesos and the buying of dollars – and so occasionally foreign exchange controls are introduced. In the case of the US, and Mr. Bernanke has said it very clearly, we have the printing press, that’s why a buyer of US Treasuries has to worry about lots of things, but he never has to worry about getting his interest on the Treasury, and he never has to worry about repayment, because Mr. Bernanke can print more dollars to pay all the outstanding bonds that foreigners own. That’s not a problem for the US on the existing debt, but when the US moves into monetizing very heavily then foreigners will have second thoughts about buying dollars just to get repaid on what they’ve already lent to the US. That’s why I’m saying in the end the dollar will weaken. Now will it tumble against the euro, or the yen – that will depend on how much money the euro zone, and Japan prints, and they haven’t been much better in the US. They’ve also printed money; they’ve been slightly better but they’ve also printed, so that’s why I think that eventually the purchasing power of the dollar and other paper currencies will lose value against hard assets. I happen to think that in the US you have a housing bubble in some parts of the country, let’s say on the coast in California, San Francisco, San Diego, Los Angeles, in Florida, and New England, and parts of Washington State, Seattle and so forth, but in principle I think that people who have dollars in cash may be better off by owning some real estate than by keeping money in cash, because eventually the cash value of the dollar with people like Bernanke at the central bank at the Federal Reserve will probably lose more in the long term than real estate. I would just not go and borrow heavily against real estate, I would buy in the US because I think that interest rates will one day surprise on the upside. [45:29] JIM: Turning this to investment conclusions which you talked about in your February newsletter. You wrote there is a limited supply of precious metals, oil and other commodities. In contrast, over time, when you look at other markets which are glutted and where the supply can be increased at discretion, basically paper money will depreciate compared to markets where the supply is limited. So, given the fact that we are headed down the road towards inflation, and maybe even hyperinflation, how should investors best position themselves to weather this upcoming storm. MARC: In principle, I think that we all don’t know what the future will hold, but in principle I would say first of all I would say if I look at the world over the last say 50 years, the US reached probably kind of the peak power economic and also political, and military power, probably around 1990. I’m saying this because at that time the Soviet Union was in disarray. Basically the Soviet Union collapsed not because of Mr. Reagan’s Star Wars program, but it collapsed because the oil price collapsed. And it’s interesting that the Soviet Union collapsed when the oil price after 1985 collapsed, and also the Russian financial crisis occurred in 98 after the oil price collapsed between 96 and 98. So, in other words, the correlation between falling commodity prices, and countries that produce commodities being essentially forced to the wall – that also occurred with Latin America. But now with commodity prices going up the balance of power that shifted between 1980 and 2000 as commodity prices went down to the United States, Western Europe (industrialized countries), now, with commodity prices going up the balance of power is shifting to the resource producers. Suddenly, you have characters like Hugo Chavez, or Ahmadinejad, or Mr. Putin who are powerful people are very powerful people because they control the resources. And in my opinion the US basically as a society has lost ground over the last 10 to 15 years, not because it went downhill, that isn’t the case, but because others have caught up very quickly, have been growing very rapidly and have become very powerful nations, such as China – Russia is a powerful nation today, because it controls so many resources. And so I would argue that the US is essentially in a relative decline vis a vis other nations. And I can see this very clearly because I went to Asia in 1973, and in 1973 Asia was dirt poor. Today, I’m not saying that Asia is rich, but a lot of cities, and lots of countries have become relatively rich like Taiwan, Singapore, Hong Kong, South Korea, Japan, anyway. Now, you already have 30 billionaires in India; in China, you have about 16 billionaires, 300,000 millionaires in China. Nobody in China would have dreamt that they would be this relatively well off compared to 25 years ago. I mean this is almost an economic miracle. That was partly due to the easy monetary policies of the US, that have led to the trade deficit of the US, and the trade surpluses in Asia, and the huge investment flows into China and other Asian countries. Now people talk about China, but India is also coming up in many respects, and also Vietnam. The competition for the US and Western Europe will only intensify. And in my opinion the end game will be that, let’s say, investors in order to protect themselves they have to have more assets outside the US than they currently have. Because if you look at the world stock market capitalization, over 50% is still the US, and say Asia including Japan is about 13%, so if you go to a traditional money manager and say, “I’m a global citizen, will you put 50% or more in the US, and only 13% in Asia.” I would say it should be the reverse. You should have 13% of your assets in America, 50% in Asia, and of course, some in gold and other commodities. Now, commodity prices can have big fluctuations, and we have had a bull market now since 2001, I’m bearish near term about commodities, I think the correction has started, and some commodities like Aluminum, Zinc and Tin have already corrected meaningfully – in the case of Zinc it’s down more than 15% from its recent peak, so a correction has gotten underway. And it may go on further. The peak was I think in 76, and 78 the price of gold went down by almost 50%, and afterwards it still went up 8 times. So we can have a meaningful correction in commodity prices and it still goes up much more than say the Dow Jones over the next couple of years. [51:12] JIM: Marc, if you were talking to a group of investors, say a final thought, if you were to give them one piece of advice right now, given the scenarios we have discussed, what would that be. MARC: Don’t trust the government. JIM: Don’t believe the inflation numbers, huh!? Or the value of the paper. MARC: I think it’s not just the inflation numbers, I think there is the belief in the world that dictatorships and kingdoms are bad, and that democracy is great. I’m not so sure about this. I’m of course in favor of a democratic system where people can vote and so forth, eventually power corrupts, no matter where and how it was acquired. Power is a very destructive kind of an element in social sciences, and I would be very, very careful if I had a lot of money in one country – not to keep all the money in that country. And it’s not of any use if you’re a US citizen, or a Swiss citizen, to buy foreign securities with your money in that country. What you have to do is physically move your money somewhere else, and have accounts in different jurisdictions, that is the important point. Because if you were say in Germany, and you had all your money in German banks, and then Hitler came, and you owned foreign securities, it wasn’t very useful to you if you were on the blacklist or when these problems occurred, but if you had accounts somewhere else then you were in a better position. All I’m saying is today we’re world citizens, we don’t know and maybe I’m wrong and the US will be the richest and most powerful nation in 20 to 30 years time – I doubt it, but maybe that is the case – but then you’re not missing out too much by having an account in Singapore, in Switzerland – or I don’t know where, in England – and you can still buy US securities from that account. But I would advise people to diversify the location from where they hold assets because, you know, we’ve seen Refco – lot’s of people still don’t know if they will get all their money back which they had at Refco, maybe they’ll get it, maybe not, but they are at the mercy at the present time of lawyers. It’s an unpleasant situation to be in. So my advice is A, you have to diversify your assets whether it’s stocks, bonds, commodities, real estate; B, you have to diversify the location from where you hold your assets. You shouldn’t hold all of your assets within the jurisdiction of the US. You should move some somewhere else. And now it’s still possible; it’s been becoming more difficult, I have to say that, but it’s still possible. One day it may be impossible. [54:11] JIM: Well, Marc, I want to thank you for joining us here on the Financial Sense Newshour, you are joining us from Thailand where it’s late, but why don’t you give out your website. I receive your newsletter, The Gloom, Boom, and Doom Report and I have to say it is one of the most thought-provoking newsletter which I receive. And I’d highly recommend it. MARC: Very kind of you. JIM: If someone wants to get some original thought and take a look at the world from a global view, your newsletter is one of the best sources. So, give out your website as we close, Marc. MARC: Yes, it’s www.gloomboomdoom.com. JIM: Well, Marc, you’re a gentleman and a scholar, and it’s always a pleasure to have you on the program. Thanks so much, I wish you a good evening. MARC: It is my pleasure, and thank you very much for having me on the program. FSN Guest Expert Page: Dr. Marc Faber ©
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