by Tom Tragett
Posted 22nd December 2016
On a recent trip to Berlin I met with best-selling author of Currency Wars, Jim Rickards.
Away from the conference we were both there to attend, we took some time to sit down and talk about the state of the markets right now.
Below is a transcript of our discussion. I hope you find it interesting.
And if you’re interested in reading Jim’s new book, The Road to Ruin, you can find out how to get a copy here.
Tom Tragett: Jim, given that we are now potentially entering the new world order of anti-globalisation in economy, the death of economic liberalism; do you feel this is now the wrong time for the UK to be divorcing itself from Europe and looking for wider trade agreements beyond European shores?
Jim Rickards: No, I thought the UK was never a good fit with the European Union. There were two ways for the UK to do it. One was join the European Union and also adopt the Euro.
That would make a certain amount of sense because then the UK would have the implicit support of the European Monetary Union’s ten thousand tonnes of gold.
Another path would be to leave the EU, stick with the pound but buy gold. Unfortunately, the UK seems to be on the middle path of leaving the EU, not having the Euro, but not having gold either.
So, it leaves the UK a little bit isolated; but I think if they were to actually conduct a looser monetary policy, print sterling, buy gold, build up their gold reserves, then that would leave them in a very stronger position and a good position to negotiate separate individual trade agreements.
TT: Well, following on from that question, I know that we both share the view that sterling’s headed a lot lower…
TT: And obviously we’ve been in that opinion for some time. But you know, beyond that sort of outlook scenario, do you see anything on the horizon that could potentially derail that outlook?
JR: No. Look, in the short run, things evolve… and the Bank of England talks a good game about raising interest rates; but you know the problem is since a long time there has been a story of continuous sterling devaluation. Major devaluations in 1931, 1944, 1967, 1991. Time and again, the solution for the UK has been to devalue sterling.
I see no reason to think that will change. They’ve sold most of their gold, so they have some gold but not very much relative to the size of their economy. So this is really the only card they had to play.
And interest rates are close to the Euro. They could cut rates a little bit, but they’ve really got to devalue the pound to stimulate the economy. It’s all they have.
TT: Okay. Switching to the other side of the pond. We’re here in Berlin ahead of the final Fed decision of the year in 2016. Do you see anything in terms of Fed being behind the curve? And in this current sort of policy stance… and do you think there’s an argument for more aggressive rate hikes from next year?
JR: Well, the Fed is always behind the curve. I mean, even in a normal environment; and what we’re in is far from normal… but in a normal environment the way that the Fed works is… you know, they watch the economy, the economy gets hotter and hotter, it grows… you know, labour markets get tight, capacity constraints get tight, inflation takes off and the Fed says, oh, we need to raise rates.
And then they do. But they’re usually behind the curve.
And then they keep raising rates and the economy cools down and unemployment goes up and they go, oh shoot, we need to cut rates.
So they’re always behind the curve. That’s typical. But this… we’re in a much more extreme and precarious situation. What happened was the Fed missed an entire interest rate cycle. They should have raised rates. I said it in 2009, but even if you were to say, well maybe 2010, 2011; there was a period… 2010, 2011, and 2012 when the economy was strong enough to bear some interest rates hikes…
There was no liquidity crisis then, there was plenty of money around. The Fed instead wanted to experiment with what they call quantitative easing or QE. This would go down in history as one of the great monetary blunders of all time. But that still has to play out. So they should have got interest rates up to around, say, 3%, maybe 2.5% by let’s say, the end of 2012.
If they had done that, they would be in a position to cut rates today to fend off a recession. Instead we’re eight years into an expansion, 8 plus years; one of the longest expansions in US economic history.
We have to be closer to a recession than not.
And so when you do, how are you going to cut interest rates to get the US out of a recession if interest rates are already close to zero?
The Fed is in a desperate race to raise interest rates so they can cut them. I say this is like hitting yourself in the head with a hammer because it feels good when it stops.
Frankly, the US economy is fundamentally weak. The so called Trump reflation trade will not play out as people expect because our Debt to GDP ratio is already too high, over a 100%. $20 Trillion in debt. We’re not going to be able to spend as much as Trump would like.
So, when the reality check comes, the reflation trade does not work as expected; and you know, the Fed is on this tightening path, it’s going to slow the US economy, maybe even throw the US economy into a recession.
How will the Fed then cut rates if they’re not that high to begin with? So this is… they’ve painted themselves into a corner, there’s no good way out. They raise rates enough to cut them: they’ll probably cause the recession they’re trying to prevent.
None of this adds up.
TT: Yes. I guess you can say that. They’re moving the car forward so they can reverse it back again.
JR: Right, exactly.
TT: You know, beyond the reflation trade, the latest move in oil prices as a result of this latest OPEC agreement, and finally they’ve agreed to do something. Do you see anything on the horizon that domestically-wise in the US that could actually add to the inflation situation then?
JR: No, actually no, I see the trends adding to deflation. And the reason I say that: if you look at Trump’s appointments, Tillerson for secretary of state, he’s not the secretary of energy, but he’s an oil man. Rick Perry, former Governor of Texas, he’s our new secretary of energy. This policy will be what we call, drill baby, drill.
And Trump has said this, that they’re going to open up a new oil exploration offshore. Oil and natural gas in the United States. Connect natural gas pipelines to Canada. You know, invigorate the shale industry. Export abroad.
So everything, all the cards are kind of lined up to increase US energy production and increase US exports. Probably some deals with Russia. So all this will be very deflationary. And you know, the OPEC agreement; sure it’s fine in the short run, but they have a long history of cheating.
So I would view this expanded energy production as perhaps turning the oil price around. And deflationary. Not right away and not in the short run, but over the course of 2017.
So, you know, higher interest rates. A strong dollar, more energy production. Technology demographics. These things are all fundamentally deflationary. Against that, you’re trying to get inflation with policy helicopter money, but we may be at the outer limits of that, with the Fed having a $4 billion balance sheet and the US with $20 Trillion in debt. And eight years into expansion. How much reflation can you really get?
TT: Well, actually, following on from the comments about the dollar there, you know, obviously ahead of this Fed decision the dollar has elevated already. We’re at 1.05 against the Euro, and given that… you know, it’s… a decade low. Against the all time low, which we both know was $0.82. Do you feel there’s a situation that could develop this side of the pond in Europe that could deteriorate it to such a degree that we could actually start to revisit those lows again?
JR: I don’t think so. I don’t think the Euro will go down to that level. By the way, I was vacationing in France when it was $0.80 and it was a delight…
You could go out to dinner, have a four-course meal and wine and deserts and it wasn’t even $100. So, I had no problem with that.
But look, today, the Euro could get a little weaker, might test parity; but the problem is the Euro doesn’t get weaker in isolation. A weaker Euro means a stronger dollar, that’s all there is. It’s a cross rate.
So my question is how much stronger can the dollar get before the US economy hits a brick wall because of deflation. Again, emerging markets, denominated debt crisis, how are the… you know, Turkey, Indonesia, and Malaysia… their own currencies don’t produce enough dollars to pay it all. I understand these are short term trends, but honestly they don’t add up in the long run.
TT: Okay then. Maybe we’ll see what Yellen has to say about all this tonight.
TT: Thanks very much, Jim.
ED NOTE: That night the Fed raised rates as expected. The next morning I took some time out to talk about my thoughts on the matter.
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