«I dare to say that we have not yet seen the most radical brainwaves of the mandarins running our central banks.»
The global financial markets are under severe stress. The postponed interest rate hike in the United States, the fast cooldown of the Chinese economy and the crash in the commodity complex are causing a great amount of unease among investors. Fear is growing that the world slips into recession. «Central bank policy is intended to paper over the cracks in the systems. Seven years after the outbreak of the financial crisis we’re paying for this with a lack of growth», says James Grant. The sharp thinking editor of the iconic Wall Street newsletter «Grant’s Interest Rate Observer» draws worrisome parallels between the command based central planning of the Chinese economy and the economic policies in the West. He also doubts that Fed Chair Janet Yellen is the right fit for the top job at the world’s most powerful central bank. Looking for protection he points to gold and shares of gold miners
Jim, since the fall of Lehman Brothers seven years have passed now. In what kind of world are investors living in today?
It seems longer ago, doesn’t it? Certain things have not changed. The first of those permanent things is the nature of human beings who operate in markets and their tendency to buy high and sell low. That is just as it was the day before Lehman failed and it’s just as it will be forever. What’s new and different is the larger than life presence of government in our markets, both with respect to regulation and with respect to the management and the production and the manipulation of money.
Are you referring to super low interest rates?
There is nothing so terribly new about very low interest rates. In the 19th century interest rates fell for most of the area from the end of the Napoleonic wars in 1815 to the turn of the 20th century. But something new under the sun might be very well the hyperactivity of our central banks.
But without their interventions we might be even worse off today.
We are living in the age of magical thinking. Governments through central banks have muscled down money market interest rates to zero and in some cases below zero. Not content with that, they have implemented what economists chose to call «the portfolio balance channel». That’s a very fancy phrase meaning higher stock prices in the interest of rising aggregate demand. That was the theory of the Bernanke Fed and it certainly was the theory of the Chinese communists who sponsored the fly away levitation of the Shanghai A-shares. So the world over – and this goes for Europe as well – central bankers have taken it upon themselves to sponsor great bull markets in the hopes of making people spend more because they will feel richer. That was the theory. But they neglected to think through the full consequences of these policies.
The slowdown in China is putting the financial markets under a lot of stress. How bad is the situation?
If I were a member of the ruling elite of the Chinese communist party I would say to myself: «Wait a second, we were just doing what the capitalist West was doing for the sake of economic recovery: Manipulating interest rates, administering asset prices through QE and inducing people through broad winks and nudges to taking risks and thereby seeding bull markets. When things went to smash in 2008 they didn’t arrest short sellers but they did threaten them as well. So what are we doing that’s different?» What China is doing different is that they’re doing it more ham handed. But aren’t there rather obvious analogies between old fashioned marxist central planning of the entire economy and our style of western central banking in which they seek to impose certain outcomes through the manipulation of prices?
Is China set for a hard landing?
I think China is very worrying. The macroeconomic data are largely made up and their methods are almost predestined to fail as the methods of command and control and suppression of the price mechanism are always predestined to fail. And then, on top of that, what’s scary is the reaction of the West: Instead of questioning those principles we talk about that the Chinese are just not as proficient in these techniques.
China was a main concern for the Federal Reserve not to raise interest rates at their recent meeting. Was this the right decision?
I was hoping that they would choose to act if only as a mercy to change the subject. I mean can we talk about something more interesting like the weather? Of course, it’s not just about one quarter of one percent of scarcely discernable monetary tightening. It’s about the idea of something in the way of a normal structure of interest rates in the time to come. But here it is again: Seven years after the fall of Lehman the biggest and supposedly most dynamic, most resilient economy in the world is still not strong enough to absorb that. That is the message from the Fed. So no wonder the markets are worried.
Usually stocks rally when the Fed stays easy. Not this time. Is Fed Chair Janet Yellen still on top of things?
Here is a a very revealing fact: According to the «Wall Street Journal» when Janet Yellen goes to the airport to catch a flight she arrives hours early. Now, what does that tell you about her personality type? She’s really, really anxious. I think this is a personality type that perhaps is better suited not for high command. If a difficult decision needs to be taken a person who’s so anxious or so much of an impulsive risk minimizer is perhaps not the best qualified to take sometimes a leap into the dark. But that’s what investing and the management of money is everything about: At one point you have to take a leap in the dark because you can’t know the future. So this says a lot about a person who manages the world’s reserve currency without thinking of making too much of it.
So far there are few signs of inflation however. If anything, economists are concerned about deflation.
We see no inflation in the supermarket but we have already seen a great deal of it on Wall Street. Also, what exactly is wrong with low inflation? Many accredited economists and central bankers want us to think that unless the rate of debasement of money is 2% or higher we’re all in danger of some catastrophic economic event. Says who? This is one of these moments in which I feel utterly isolated from mainstream financial and monetary thinking. I ask myself: Are we at Grant’s crazy or are they? I guess we’ll know more in twenty years.
So what’s next for the global financial markets?
The mispricing of biotech stocks or corn and soybeans is of no great consequence to financial markets at large. Interest rates are another matter. They are universal prices: They discount future cash flows, calibrate risks and define investment hurdle rates. So interest rates are the traffic signals of a market based economy. Ordinarily, some are amber, some are red and some are green. But since 2008 they have mainly been green.
You’re saying there’s an accident waiting to happen?
The central banks lifted off the stock market so that aggregate demand is going to rise. But they forgot to consider that aggregate supply is likely also to rise: Oil drillers will have it easier to find financing with which to drill the marginal well and to produce the marginal barrel of oil. This will weight on the market causing lower oil prices which will lead the central bankers in return to print still more money to save us from what they call «the risk of deflation». So it’s seemingly a never ending, circular process of so called stimulus leading to still more stimulus and unconventional ideas leading to radical ideas. I dare to say that we have not yet seen the most radical brainwaves of the mandarins running our entral banks.
What do you think this will look like?
They don’t keep those things as a secret. They talk quite openly about «direct monetary funding» which is what Milton Friedman had in mind when he coined the phrase “helicopter money”. So the next idea is just bypassing the banking system altogether and mailing out checks to the citizens.
Would something like that even work?
All this monetary stimulus does two things in a reciprocal way: It pushes failure into the future and brings consumption into the present. Providing marginal businesses with very cheap credit is inviting companies that have passed their useful days of their commercial lives to pretending some kind of an afterlife thanks to the subsidies from the central banks. But capitalism is inherently a dynamic system based on entrepreneurship and to new inventions. It’s a little bit like the forest for the trees: You need life but you also need death. Without death there is no room for a new generation and what you get is Japan: Standing timbers of ancient age, none of them too healthy. Quantitative easing and artificially low interest rates reduce the dynamics, the growth and the vibrancy of economic life.
Now the fear of corporate failures is growing. You can see that in the widening spreads in the junk bond market.
The junk bond market has been characterized by very loose protections to the creditors. Those protections have been mainly eviscerated or weakened during this cycle of very aggressive lending and borrowing. That’s why I think the recovery rates on junk bonds in default will be lower and the final permanent losses to capital will be higher this cycle. But this should not be confused with the apocalypse. This is how finance works. This is the cycle of psychology of bull markets and bear markets, of boom and bust: There is euphoria and that mellows to complacency and at length it ripens to apprehension and then to fear and finally to abject terror – and that’s when you buy!
So where do you see opportunities for investors right now? Emerging markets for instance have crashed already pretty hard.
We see the beginnings of opportunity in some of the emerging markets. Still, I don’t think this is the moment to get involved broadly. But at least some securities have been marked down to levels at which you can say: «Ok, that’s at least interesting». One of them is Sberbank. It’s a very good bank and it happens to be in Russia, a rather forbidding place at the moment. But Sberbank came through the 2008/09 experience with shining colors, its management is first rate and it has terrific scale. So altogether it’s a first rate bank now greatly under strain owned to the difficulties in Russia. But I think it will survive and do well. Another interesting stock is the Moscow Stock Exchange. Like Sberbank it’s well managed, cheap and a good business. There are also Avianca, an airline in Colombia and Grupo Nutresa, a midcap food distributor and processor which is called the Nestlé of Columbia.
Where else do you see opportunities?
This is a monetary moment. I think we are looking at the beginning of the world’s reappraisal of the words and deeds of central bankers like Janet Yellen and Mario Draghi. What we’re waiting for is a sufficient recognition of the monetary disorder. You see monetary disorder manifested in super low interest rates, in the mispricing of credit broadly and you see it in the escalation of radical monetary nastrums that are floating out of the various central banks and established temples of thought: Negative real rates, negative nominal rates and the idea of helicopter money. So you need some hedge against things not going according to the script and that makes gold and gold mining equities terrifically interesting now.
Are there any gold mining stocks you would recommend specifically?
Anything that the Canadian mining entrepreneur Pierre Lassonde is involved with, is interesting. He is a very unusual mining entrepreneur because he is a businessman first and and geologist second. He wants a return on investment rather than just digging a hole in the ground out of which comes gold. He is involved especially with Euro-Nevada and with a very low priced speculative mining company called Newgold. Barrick Gold is another stock that is an attractive speculation because it is highly encumbered and in the not so distant future it faces a debt drama. But the shares are priced for that and if gold goes higher they have huge potential.