Posts Tagged ‘recession’

Marc Faber: Bernanke Policy Will “Destroy” U.S. Dollar

Monday, March 10th, 2008

Recently, Marc Faber was being interviewed in Chicago where he freely shared his thoughts. You can watch the interview at Bloomberg here. Below is the content of the interview as summarized and transcribed by us:

If the statistics were measured properly in the United States, the US would already be in a recession and would already be so in a couple of months.

See our article, How much can we trust the price indices (e.g. CPI)?.

If the US goes into recession, it will not be a total disaster for the rest of the world, except that in the rest of the world, we also have colossal bubbles [in asset prices].

Since the world is in a global boom from November 2001, then this will one day lead to a global bust.

It is very doubtful that the global financial market is de-coupled from the US because of the close linkages and connectivity. For example, if the US stock market goes down, the rest of the world’s stock market will be dragged down as well.

As Marc Faber acknowledged by psychologists’ study, a dosage of bust is more painful than the joy of an equal dosage of boom. In other words, the implication the coming bust will be more pronounced and painful than the euphoria of the preceding 75 months of boom.

In the US, they pursue essentially economic policies that targets consumption, which in my opinion is misguided. What they should pursue is economic policies that stimulates capital investments and capital formation.

We would agree with Marc Faber wholeheartedly, as we quoted Ludwig von Mises in The myth of financial asset ?investments? as savings. As the US began their aggressively loose monetary policy from September 17 2007 by cutting interest rates from 5.25% to 3%…

What is the result? I tell you what the result is! The stock market in September 17 by the S&P is down 10%, the US dollar is down 10%, gold and oil are up 40%. Well done Mr. Bernanke!

Will the stock market continue to fall? Marc Faber said that we have to ask Mr. Bernanke…

… because if he prints money- and I have to add here one point: had I been the professor who had judged his thesis for his PhD, I would not have let him pass. I would have told him actually, “Mr. Bernanke, I have one condition in which I let you pass, and this is you never join a central bank, because you are a destroyer of money as store-of-value function, of the function of money being a unit of account. The only central bank that I would allow you to go to is the one under Mr. Mugabe in Zimbabwe. And I tell you Mr Bernanke with his monetary policy, he will destroy the US dollar.

This is what we said before in Peering into the soul of Ben Bernanke.

As pointed out by the interviewer, the dollar was in decline before Mr. Bernanke took over. Does Bernanke need to ease monetary policy to ease the US economy from this “spunk?” As Bernanke studied about the Great Depression, his conclusion was that the lack of flexibility in the monetary policy that resulted in such a prolonged downturn. Marc Faber disagreed:

The Depression occurred not because the central bank was tied when the Depression occurred. But because it was far too easy in its monetary policy in the period leading to the Depression, from 1925 to 1929.

This is what we said before in What causes economic booms and busts?. As Marc Faber said, it is not only Bernanke is at fault. Greenspan is responsible too, with his loose monetary policies when he cut interest rates to 1% in September 2001 and keep it that way till 2004. That led to the “reckless lending” and “reckless credit growth,” which in turn led to the problems we have today.

Marc Faber said that if he is the central banker, he will raise interest rates much earlier to target asset and credit price bubble and would not have cut the Fed Fund Rate to 1% in 2001. This is because unlike the Fed, he would not base his monetary policy on core inflation (which excludes food and fuel) because all humans eat and uses energy. Now that the Fed had created a “gigantic” credit and asset bubble, which is deflating right now, it is very difficult to re-inflate the bubble because “we are in the process of de-leveraging” as the private sector is now tightening credit conditions, “not the Fed.”

According to Marc Faber’s latest Doom, Bloom and Gloom report, investing in the bond market (mainly Treasuries) is “financial suicide” because with such low yields, actual price inflation will result in negative real returns. Marc Faber believed that “at some stage, the corporate bond market will offer some value.” However, the 10-year and 30-year Treasury market is a “disaster waiting to happen.” As the Fed cuts the Fed Funds Rate to possibly zero, the Treasury market will “tank” at some point in time. Though he is not a US credit analyst, Marc Faber reckoned that in the junk bond area, there should be some good quality bonds from company that can survive and continues to pay interests. He continued,

The arguments for stocks is frequently that you take the earnings yield of the stock market and compare it with the bond yield and people compare it to Treasury bonds. I think you should take the earnings yield of equities and compare it with, say, a typical S&P company, and that is a yield that correspond to, say, a triple-B, and so, basically as of today, some bonds are more attractive than equity.

Over the past 4 to 5 years, US stock market has underperformed other markets, e.g. the emerging market and the commodity market. However, today, the emerging market is far more vulnerable (e.g. China and India market could easily fall by 30% to 40%). With the money printer in the Fed (Ben Bernanke), the deflation will more likely lead to the US dollar decline than an actual asset price deflation. Thus, relative to the Euro and gold, the US stock market is going down.

Some may argue that given the commodity market has risen so much since 2001, would it be too late to join in the bull market? Marc Faber disagreed with that argument. When the commodity market bottomed and rallied in the 1990s/2000s (note that not all bottomed at the same time), they were at the lowest level, inflation adjusted, in the 200-year history of capitalism. For example, gold was at around $250 when it fell from a high of around $850 in 1980 (which Marc Faber admitted is too high). But in the last gold bull market in the 1970s, gold rose 25 times from $35 to $850. The current gold bull market of several years rose only 4 times. Among the commodity markets, sugar is the cheapest commodity in real terms.

When asked, “Are we going to see a major US bank fail?”

“I hope so.”

“You hope so????”

Marc Faber saw that this is the only way to “introduce discipline” into the US financial system. By continuously bailing out banks, the Fed introduces moral hazard that “perpetuates the mistakes” that the Fed has already done. When asked, which major bank is more likely to fail, Marc Faber had no opinion because that depends on the banks’ derivative exposures, which is the next time bomb to explode. The ‘derivatives’ that he mentioned does not include the structured products (e.g. SIV, CDOs, etc). This will be the next major financial issue in the next 3 to 6 months. Marc Faber believed that we will not see the bottom of the stock market until we see stocks like Google falling 50% from their highs, hopefully more. In a bear market, one sector (e.g. home building) will fall first and then the goldilocks crowd will reassure the market that everything is fine. Then the next sector will fall, followed by next. And so, the bear market has to mature, like “good cheese and wine.”

What cause booms and busts? Introduction to the Austrian Business Cycle Theory

Tuesday, February 6th, 2007

What causes the business cycle of booms and busts? According to popular belief, the business cycle is due to the collective mood of the consumers, which drives investments and spending. That is why Wall Street is so fixated on the readings of consumer confidence. Central banks, on the other hand, hope that by adjusting a lever called the ?interest rates?, fluctuations of the economic cycle can be smoothed through the resulting influence on investments and spending. Hence, it may seem that the Fed?s policy of ultra-loose monetary policy (of exceptionally low interest rates) several years ago not only prevented a recession, but created further economic growth.

But according to the Austrian School of thought, the control of interest rates is the very action that creates the business cycle. Thus, the Fed did not avert a recession several years ago. Instead, they merely defer it. Worse still, the extent of the coming recession is proportional to the excess of the prior artificially induced boom. By deferring a necessary recession and engineering a synthetic economic boom, the Fed is setting the stage of an even more severe recession down the track.

Before we introduce the Austrian Business Cycle Theory, let us ask a thought-provoking question: If we generally let market forces set the price of things (e.g. stocks, consumer goods, bonds, real estates, etc), then why is it that the price of money (interest rates) should not be chosen by the market? Does the central bank know better than the market to set the ?right? price of money?

Now, here comes the introduction to the Austrian Business Cycle Theory to explain the phenomena of booms and busts. For this, we will use a metaphor from this book, Economics for Real People:

Imagine that you are a bus driver, at the edge of a desert, about to take a busload of passengers across it. You have left all gas stations behind. Your destination is a town on the other side of the wasteland before you. You are faced with a trade-off: the faster you try to reach the town, the less the passengers can use the air-conditioning to alleviate the desert heat. Both higher speeds and higher air-conditioning settings will use up the gas more quickly. And since, in our luxurious bus, each passenger has his own temperature control for his seat, you, the driver, cannot control the total amount of air conditioning used on the trip.

In order to make your decision, you look at your fuel gauge and determine how much gas you have. You tell the passengers that they must now make a trade-off between comfort on the way and speed travelled, as the more air-conditioning they choose to use; the faster the bus will consume fuel. Then you collect statements from the passengers on what temperature they will keep their seat. You perform some calculations on mileage, speed, and fuel consumption, and pick the fastest speed at which you can travel, given the amount of gas you have and the passengers? statements about their use of the air-conditioning.

The passengers had to decide whether to cross the desert in greater comfort but arrive later at their final destination, or in less comfort but with an earlier arrival. The science of economics has little to say about the combination that they picked, other than that it seemed preferable to them at that moment of choice.

However, also imagine that, before you began your calculations, someone had sneaked up to the bus and replaced the passengers? real choices with a fake set that chose a higher temperature, in other words, one that makes it seem they will use less fuel than they really will. You will make your choice on travel speed as if the passengers will tolerate an average temperature of, say, 80 degrees, whereas in reality they will demand to have the bus cooled to an average of 70 degrees. Obviously, your calculations will prove to be incorrect, and the trip will not come out as you had planned. The trip will begin with you driving as if you have more resources available than you really do. It will end with you phoning for help, when the sputtering of your engine reveals the deception.

Stay tuned for the explanation of this metaphor!

Divergent sentiment

Friday, October 13th, 2006

Today, we looked at and saw something quite amusing. One set of headlines cheered in jubilation: ?Earnings driving the Dow? and ?Michael Farr says investors ‘are thinking positive’.? Another headline wallowed in worry: ?Manufacturers see gloom ahead.?

Is the US economy slowing down and threatening to roll over into recession? Remember, it was not long ago that the fall in manufacturing index prompted the stock market sentiment to turn negative. Now, the market merely shrugged off this report. The housing boom had already collapsed and threatened to cut down US consumer spending, which made up 70% of the US economy.

On the other hand, is the US economy going to power ahead as what the stock market is feeling it would right now? Perhaps the rebound in consumer confidence and the fall in oil prices will help the economy get into a perfect ?soft-landing??

Now, let?s get back to the basics. Make no mistake: the US economy is indeed slowing. The question is, whether this slowdown will result in a ?soft-landing? or recession (or worse still, a depression). Currently, the US economy is at an inflection point. The stock market seems to believe that after this inflection point, the US economy will not get too bad, maybe even mounting ahead. The bond market, on the other hand, believes the opposite. Who is right?

We believe that neither is right. As what we heard from Marc Faber?s (a famous contrarian investor) recent presentation, you can make the Dow Jones climb as high as you want as long as you print enough money. When excess money is being printed, company earnings will definitely grow in nominal terms, which will propel stock prices even higher. But that doesn?t mean that the economy?s production has increased. In other words, real GDP growth will not necessarily grow as much as the growth in money supply. Put it simply, the Dow Jones will rise merely due to inflation.

So, the stock market is wrong, not because the stock prices rise due to economic growth. They rise due to monetary inflation (printing of money). To illustrate this point further, over the past several years, the Dow Jones might be higher in nominal terms, but in real (inflation-adjusted) term, it had fallen.

The bond market is wrong, not because interest rates will be cut due to a recession. On the contrary, this coming recession will be accompanied by excess monetary inflation, which means nominal interest rates have to rise.

But be note that – the above-mentioned scenario will take time to work out. It will not happen overnight. Therefore, time is on your side as you fortify your financial well-being from the coming storm. In the meantime, expect more volatility.

Strange rally

Monday, October 9th, 2006

Recently, the US stock market had been in a rally mood. Currently, with the North Korean nuclear tests just completed, we are not sure how the rally mood will turn out. But we smelled something very fishy about this recent rally. The economic news had not been good (and the good news wasn’t good enough), and the risk of a recession in the US economy is something that we believe is quite likely to happen. The US Federal Reserve chairman himself had warned of a substantial correction in the US housing market. Even the bond market believes that a recession is on its way.

Yet the stock market was incredibly optimistic. It?s simply beyond our belief.

We are getting out while we can.

Huge rally fueled by positive US consumer sentiment for September 2006

Wednesday, September 27th, 2006

This morning, we heard news of a strong rally in the US stock market overnight, triggered by much better than expected US consumer sentiment report for the month of September. Apparently, this improvement is due to the falling of oil prices, which will certainly translate to cheaper petrol at the bowsers. As of right now, the Aussie market, along with the rest of the Asian markets, is following suit- the All Ordinaries index is shooting up by almost 2 percent. Meanwhile, on the negative side, US home builder, Lennar, lowered its fourth-quarter outlook, due to the faster than anticipated pullback of the US housing market.

We look in amazement at the market?s rapid turnaround in mood. It wasn?t long ago that the market was fretting over worries of a recession in the US economy. It can?t seem to make up its mind in deciding whether to believe that the US economy is heading for recession or not.

As for us, cautious as we often are, we feel that today?s rally in the Aussie market may be short-lived. It looks to us that the market is over-reacting, given that in the context of so many bad news (including the ?good? news), this good news (the consumer sentiment report) is just only good for the month of September only. We prefer to base our tentative conclusions more on the trend (which is trending down for the US economy) than on individual isolated outcome (which is up for the consumer sentiment in September). Particularly vulnerable, are the stocks in which their businesses are related to the US housing market- US median home sales price fell for the first time in 11 years.