Marc & Louis ; für alle jene welche Zeit zum Lesen haben:

verfasst von Emerald, 03.01.2006, 08:57

-->Brave New World Or Bust
Louis-Vincent Gave and Marc Faber Face Off On
Outlook For '06 & Beyond
That’s GaveKal Research’s Louis-Vincent Gave and the one and only proprietor of the Gloom, Doom & Boom Report, Dr. Marc Faber, none-too-subtly caricatured up yonder debating the outlook for 2006 and beyond. The actual event was a telephonic and utterly civil affair conducted, after overcoming some technical difficulties, between Louis in Hong Kong, Marc, in Thailand, and w@w’s NJ office, late last Friday night.
The impetus, besides the impending turn of the calendar, was GaveKal’s recent book, “Our Brave New World,” penned by Louis, along with his father Charles Gave and Anatole Kaletsky, a refreshing and tightly argued manifesto about why the economic outlook just might be different this time. Why the debt-fueled U.S. consumption boom of the last decade hasn’t yet and won’t necessarily end in the oft-predicted tears. Marc, of course, is one of the most prominent and articulate strategists making the opposite case in his books, speeches and always erudite newsletter. What better way to probe their arguments than to bring the two together, sit back, and let the conversation fly? (Especially since I could scarcely get a word in edgewise!)
The winner? Anyone who “sits in” on Louis and Marc’s exchange.
KMW

I’m delighted to get the two of you together for some crystal ball gazing. In fact, the urge was irresistible, I have to admit, Marc, after seeing how Louis so shamelessly used you as a foil in “Our Brave New World.”
Louis: Hey, let me explain. That was simply a rhetorical device. I had to use someone, and Marc is no doubt the most eloquent of all the bearish strategists on the United States. Besides, I have known Marc personally, for years, through my father, while I haven’t had the pleasure of meeting probably the only other bear who is as prominent, Mr. Steve Roach. Anyway, while I don’t want to presume to speak for him, I would bet Marc and I probably agree on almost everything—apart from the long-term outlook for the U.S. economy. I follow Marc’s writings closely every month when I get my copy of his Gloom, Boom & Doom Report. And short term, cyclically, we probably both see the same things— higher interest rates, higher oil prices, slowing housing—all having an impact. And not for the better.

Marc? Have we lost you already?
Marc: No. I want to start by thanking you for giving us this opportunity to express our views and secondly by echoing Louis in saying I have very high respect for GaveKal Research. Usually, our views coincide. We have both been very positive on Japan, for instance, for two years already. In fact, they gave me an opportunity to write a positive piece for them on the Japanese market a year ago. So, if we have a disagreement today, it is certainly not out of disrespect for GaveKal. But on certain matters we have difficulty to agree, simply because we are looking at the economy from different perspectives.

And yours is?
Marc: The way I see the global economy, it is flooded with liquidity from the United States’ ultra-expansionist monetary policies. Although I concede that in the last 18 months, money supply growth has been decelerating, nevertheless short-term interest rates are still below the rate of inflation, and there still has been very strong credit growth. And I think we have to look more at credit growth than at money supply growth to assess liquidity in the U.S. My view is that this excessive liquidity has led to a decline in America’s competitiveness and a widening of the trade and current account deficits. That liquidity then flows into the world. And, while it is true that it has goosed growth rates around the world, it has also boosted inflation rates.

It has?
Marc: Well, the way the U.S. measures inflation is, in my opinion, wrong. Unlike GaveKal, I think we have both consumer price inflation and asset inflation. And whereas consumer price inflation, as measured by the increase in the prices of goods, has been acting very muted, there has been very high asset inflation and commodity inflation—and that is indisputable. Since households not only buy goods but also buy services and since a large component of their purchases are affected by commodities price inflation, their real incomes are actually declining. I am not talking about people who work in Wall Street and so always have rising real incomes in an inflationary environment. I am talking about the median household. So I think that the U.S. economy is actually in far worse shape than official statistics show.

Louis: Can I butt in?

Sure. Marc has a point about excess liquidity pouring into all sorts of asset classes—and inflating prices. Yet you’ve written that asset inflation is a silly and dangerous notion—
Louis: Exactly. Right here, Marc has hit it on the nailhead, more or less all the points on which we have important differences of opinion. At the forefront is this notion of “asset price inflation.” Actually, it was Charles [Gave] who just wrote a piece explaining why asset price inflation is potentially quite a dangerous notion. For starters, we have to recognize that the very reason capitalism exists is to have asset price increases. That is the point of capitalism, so we shouldn’t bemoan the fact that asset prices are increasing. Then, I guess the question becomes what is a reasonable rate of increase in asset prices? But here again we are skidding on very dangerous ice. Who is to tell the market what is reasonable and what is not? Now, Marc’s main point has been that there has been excessive liquidity growth in the system and that therefore we have had this excessive asset price inflation—excessive compared to what otherwise might have been the historical norm. But there, really deep down, is the crux of our divergence in opinion: We are not particularly fazed by the big price increases in assets.

You don’t think they’ve been driven up by the flood of liquidity?
Louis: No, we do recognize that they come from the massive growth in liquidity. But we ask ourselves, where does this growth in liquidity come from? Does it come from central banks who are being just too easy and falling asleep on the job? We don’t think so, because then the bond markets would have tanked. I mean, we do believe in the role of bond vigilantes, especially in today’s markets, where you have so many financial instruments, such as futures and TIPS and whatnot to hedge future inflation. If the central banks had been falling asleep on the job, we are confident that the markets would have reacted. It’s the old story: You can fool some people some of the time, but not all of the people all of the time. The market is all of the people all the time. Markets can be wrong for a little while, but they can’t be wrong for 5, 10, 15 years.

You’re not implying that all the liquidity sloshing around the world is a mirage, are you?
Louis: Not at all. We do have a lot of liquidity in our system. But we have to ask ourselves why? We think the reason is twofold. The first is that over the history of Western civilization, every 40 or 50 years, we were very good at wiping out capital. The First World War basically wiped out the entire capital base of Europe, which at the time was most of the industrial world. The Second World War wiped out the entire capital base of most of the world. Then the Cold War tied up a lot of capital in fairly unproductive use. But now, for almost 20 years, we haven’t had anything to really destroy capital. Sure, you could point to the Gulf War, etc. But in terms of cost, it is peanuts. You know, 1% of GDP, compared to what the Cold War or WWII cost, is nothing. So we haven’t wiped out capital for a long time. Now, people are inheriting a lot more capital. Not only that, you have a changed demographic structure in the West. People in my father’s generation came from large families. My father is one of five, my mother is one of five. Now, most people have one or two kids. The result is that those one or two kids inherit from their grandparents and from their parents. People in the Western world just have a lot more disposable capital, so much so that at 24 years old, people now buy their apartments. In my father’s generation, it was unheard of for a 24-year-old to buy an apartment. Today it is very common. Why? Because they have the deposit money. They also have much higher job stability.

That’s a key part of your argument in “Our Brave New World.” Perhaps you’d best explain.
Louis: Basically, the emergence of the platform company model has allowed U.S. companies to outsource manufacturing, the most volatile part of the production cycle, to the developing world. So if underlying economic activity comes in weaker than forecast, the platform companies in the West don’t have to slash labor and inventories. It is their suppliers that have to lay off workers etc., while the designers and marketing people and other service workers in the West find their services still in demand. Of course, the loss of industrial jobs in the West is very bad news for hard hats—and for politicians dependent on organized labor. But it has actually tended to tame economic volatility in the West. Put another way, with services gaining an ever-more-important piece of the economic pie, the variable of adjustment for Western economies is no longer employment or profits. It is imports. Which decreases the volatility in our economy, and has very important consequences. If people are more secure in their jobs, they feel more confident taking on big mortgages and basically leveraging their futures.

I’m not sure that really applies beyond a very Wall Street-centric segment of U.S. society.
Louis: I disagree. In the U.S. over the past 15 years, we have moved from something like 22% of people working in industry, what you would call fairly cyclical jobs, to only 12%—and that 12% is probably a pretty sticky number. But that is a great development because we know that industrial jobs are not as secure as service jobs. It is just the nature of the game. Industry is just a far more cyclical game. So we have written a lot on this new business model, the platform company, which is a lot less volatile. Take IKEA as an example. Let’s imagine their sales slow down in the U.S. this winter because gas bills are high and interest rates are high or whatever, and that IKEA somehow failed to forecast the slowdown. What are they going to? They are not going to fire the furniture designer in Sweden or the salesman in New Jersey. They are going to call the guy in Poland or the guy in Mexico who makes the stuff and say, “Last month we ordered 50,000 cupboards and this month we only need 20,000.” The adjustment will be taken in Poland or Mexico, not in either Sweden or the U.S. That leads me to this third point— I am touching a lot of themes here—which is that as the IKEAs and Apples and Dells, all the Western platform companies, basically move out of manufacturing, their need for capital is a lot less.

It is?
Louis: Let’s again take IKEA as an example. IKEA never went to the equities market. It never went to the bond market. Yet its stores are pretty much in every big city in the world. This is because when you have 20 designers in a warehouse in Stockholm and you are basically producing on your suppliers’ balance sheets, you don’t need much capital. That brings me back to all the excess liquidity in our system. What we have now are financial markets organized to take money from the rich Western saver and bring it to the rich Western companies. But increasingly the Western companies say, “Hey, thank you very much. But I don’t need it. I can finance myself from my own cash flows or I finance myself from my producers’ balance sheets. Companies like Wal-Mart, like Dell, don’t need the market’s capital. Frankly, the only reason these companies are listed is to give options to the managements. So now we have the West’s pool of capital looking for a home. It goes into housing, it goes into bonds, it goes into junk bonds, it goes into emerging markets. It goes wherever it can, to try to find a yield. That’s why liquidity is everywhere, and given the reality of this brave new world in which we live, it’s not going away anytime soon. But I don’t think it is anything we can bemoan.

You’d better take a breather, Louis. He’s thrown out lots of ideas for you to respond to, Marc.
Marc: Well, first of all, I do concede that there are some points on which I would agree with Louis. On the other hand, they are relatively irrelevant points. The main driver of global liquidity has been debt growth in the United States and I think it is indisputable that total credit market debt at the present time in the U.S. is growing at about four times the rate of nominal GDP growth. I hope we can all agree on that.

Louis: Well—

Marc: And why does debt grow so rapidly? Because of excessive liquidity creation, especially after 2000, by the U.S. Federal Reserve. Incidentally, the deterioration of the U.S. net asset balance accelerated very badly precisely after 2001, when its monetary policy leading to debt growth, and leading to asset inflation, actually came about. I think we can also agree about that.

Louis: I would say—

Marc: As for Louis’ other argument about demographics and such, they may have something to do with some liquidity growth— but these are really minor factors in the whole context.

Louis: On the excess liquidity growth story, there is no doubt that the Fed dumped money into the system in 2001, following both the tech bust and 9/11. But where are we today? Well, over the past six months, U.S. monetary base growth has been around 2% or 3%, i.e. lower than GDP growth. So liquidity conditions in the U.S. have been tight. Which has been reflected in the markets in that the U.S. dollar has been rising very strongly. Clearly, there have been fewer dollars to go around than there were a few months ago, since the dollar’s price has been going up. Then, you also have to look at the the bank lending side, because there are always two sides to the liquidity growth story. There are only two agents that can create money out of thin air. First, you have the central banks. The Fed, it is true, has been very active both in putting money into the system, and in taking it out, over the last five years. Frankly, the results speak for themselves. They have done a good job. The commercial banks are the only other guys who can create money out of thin air. What you find when you look at the commercial banks is that their lending to consumers over the past five-ten years has been growing at a very high pace and very steadily. What has been all over the place has been commercial bank lending to companies. Basically, it collapsed in the period 2001-2004. But it has been picking up quite strongly this year, which is probably why the Fed is being as aggressive as it is. Typically, what the Fed does is just the opposite of what the commercial banks do—which is also probably what a smart investor should do, by the way.

Commercial banks have a long and storied history of almost invariably being in the wrong place at the wrong time at market peaks.
Louis: They sure do.

Marc: I would agree it is true that money supply growth has been slowing down, and that actually in real terms the monetary base has been contracting recently. That is one of the reasons for the dollar’s strength. On the other hand, what has muted the effect of the Fed’s tightening has been the easing of lending standards because of competition. It is still extremely easy to borrow in the U.S. Credit availability may just be beginning to tighten now a little bit, as some lenders become a bit wary about lending against inflated asset prices. But in general, the tightening moves by the Fed have not had much of an impact. Partly because inflation has moved up along with interest rates. So even at a 4% [now 4.25%] Fed funds rate, in real terms—if you use a normal inflation rate and not what is published by the Bureau of Labor Statistics—the Fed funds rate is actually still negative. Secondly, because of the easing of lending standards, there is still plenty of money around. That is evidenced, actually, by the current account deficit. If liquidity were really tight, it would actually come down.

Louis: Marc’s point about the easiness of bank credit in the U.S. and about how every Joe up the street can get a loan is important. That is one of the very important changes of the past 10 years. The reality is that 10, 20, 30 years ago, basically only blue chip companies could borrow large sums. Now everybody and anybody can. Is this a bad development or is this a positive one? Our own belief is that this is the result of commercial banks now having at their fingertips a much wider scope of information than they used to have. They have better models to decide whether they want to take a risk. And when they take on a risk, they can very rapidly package it, put it off their balance sheet, pass it on to insurance companies, pension funds, etc. These are very positive developments. We have seen a financial revolution in the United States. There is no doubt about it. The question is whether this financial revolution is going to come to a screeching halt and end in tears. Is it going to prove a disaster? Is everything that we thought we learned, in fact, a mistake? Or is this financial revolution going to be exported around the world?

You clearly think it’s anything but a mistake.
Louis: What we are witnessing right now is this financial revolution being exported around the world. We are starting to see the birth of mortgage markets in India. We are starting to see the birth of things like car loans and mortgage markets in China. So we really are living in a sense in a brave new world. We have witnessed a financial revolution. The scope of information available has allowed banks to price risk, repackage risk, pass it on, in a much more efficient way. All these things the banks have been doing are now moving all across the world—and that is massively bullish.

Isn’t that awfully panglossian? American financial innovations like liars’ loans, no income verification mortgages and credit cards up the yin yang are not necessarily unalloyed blessings for humanity.
Marc: No, Louis has a very good point. We can see the efficiency of the U.S. financial system in pricing risk just looking at the income statements of Fannie Mae! That is enough to judge how efficient the banks and financial institutions have become in pricing risk! It is very clear to me that in an environment of asset inflation, it is easy to lend someone money against a home. It is easy to lend to someone who has never repaid a loan—simply because, if the house continues to appreciate, you get your capital back anyway. So it doesn’t matter, even if the borrower has no intention of repaying the loan. But if you have continuous asset inflation, you create an environment where people don’t save anymore. That is an important point. Look at the U.S. savings rate.

What savings rate? It’s negative.
Louis: It’s a meaningless number, though.

Marc: Okay, everything is “meaningless.” The savings rate is “meaningless.” The current discount account deficit is “meaningless.” But in my book of economics, the savings rate has some meaning, because if you want to grow, you have to put some capital aside for capital investment. And if that capital investment doesn’t take place, you don’t have sound economic growth. You have economic growth purely driven by asset inflation, which is driven by easy credit standards, which is driven by excessive monetary growth. So, for me, the savings rate has some meaning. Because if people have no savings when bad times hit, whether you are an IKEA or a Dell, macroeconomically, it has an impact.

Louis: We will be very happy to debate the meaningfulness of the current account deficit—and you and I have talked about this before, Marc—but the savings rate, as it is measured in the U.S., is truly a meaningless number. Because what you do to compute it is you take someone’s income and you take away all their spending. On top of that, you subtract their income taxes and their capital gains taxes. So, if you sold, say, some Coca-Cola stock that you have owned for a long time, you subtract those capital gains taxes from your income to come up with your “savings.” But you don’t include your capital gains in your “savings.” In a country where more and more people have a lot of capital and more and more income is coming from capital gains, or just from the income thrown off by capital, and not just from the income from work, then the savings rate is a meaningless number. The way that you know it is a fake number is that wherever you care to look, U.S. savings institutions—the Fidelity’s, the Alliance Capital’s, the Putnam’s, the Capital Research’s—always make up 40-50% of the daily volume in every stock market in the world. So if Americans do not save, how come they have the biggest savings industry in the world? Something doesn’t add up!

Marc: That is just because they have the biggest printing press in the world. So they have asset inflation. What your argument means is that these people have no savings as defined by me. But they have savings as defined by you, through capital gains—which means that the Federal Reserve will have to continue to see to it that the capital gains are there and hence that the Fed has to support the asset markets. Not only that, they have to see to it that the asset markets actually continue to go up—

Louis: They don’t have to support the asset markets because in the natural state of capitalism, asset prices go up. It is only when central banks decide to do something about “asset price inflation,” as they did in Japan, or as they now seem to be keen to do in Europe, that asset prices collapse. The natural state of capitalism is that asset prices do go up so —

But they also go down, especially after getting over-inflated. Rockefeller Center and all the Impressionist paintings in the world were vastly over-inflated in the late ’80s, when the Japanese bubble was at its peak.
Louis: Sure, but what I mean is that you don’t need to have a central bank that inflates asset prices for asset prices to go up. In the natural state of capitalism, asset prices go up. Today, as a case in point, the Fed is really not inflating asset prices, the Bank of Japan isn’t. You basically have all the central banks in the world providing zero percent money supply growth or close to it. Yet asset prices pretty much wherever you care to look are going up. Why? Because companies are becoming more and more efficient in their use of labor, companies are becoming more and more efficient in their use of capital, which is producing massive productivity gains all around the world. We have all these new factors coming in like the revolution in financial products. This is a natural state of capitalism. It is progress.

Marc: Well, here I have to interject. I was just reading a report that I received recently by GaveKal Research, entitled, “Asset Inflation: A Pompous and Potentially Dangerous Notion,” in which the author writes, “Has anyone ever heard of anything as stupid as share price inflation?” Now, I do agree that asset prices can rise naturally. Say, if a town expands its population because of immigration and because of wealth creation, then obviously asset prices will go up. But it would seem to me that there is such a thing as excessive asset price inflation, just as there is normal asset price inflation that is due to, say, real GDP growth. And when there is excessive asset inflation, it will manifest itself in a loss of competitiveness and in a depreciation of the currency. But that depreciation does not necessarily have to come against other currencies, especially if the currency in question is a world currency, like the U.S. dollar. So maybe the U.S. dollar will not collapse against the euro, the yen, the renminbi. Maybe the dollar collapses against a currency whose supply isn’t growing as rapidly—and that would be gold.” In that respect, I have to say that since 2000 or 2001, everything in the U.S. has lost in value against the price of gold. In 2000, you needed 45 ounces of gold to buy one Dow Jones Industrial Average. Now, you only need 20 ounces. And I have to say there is asset inflation when prices go up in dollar terms but go down in gold terms.

Louis: Okay, let me respond about that sentence that upsets Marc, that it’s silly to talk about “equities price inflation.” The way that sentence finished in our report was, “Who talks about equities price inflation? We talk about equities bull markets, we talk about an equities bubbles and then we talk about equities corrections.” When you throw in the inflation word, it implies that it is, first of all, a policymaker’s fault, the government’s or the central bank’s, and that they should do something about it. So in using that term, “asset price inflation,” you are intrinsically making a judgment call—you are calling for intervention by the government. Now, relative to gold and the performance of U.S. stocks—and I know, Kate, that you have republished some of our research on this—we wrote a lot in the late 1990s about the dangers of indexing. About how indexing was just a stupid way of investing. Well, since then, you may have noticed that the big-cap indices, the S&P 500, the Dow Jones Industrial Average, have all been very disappointing—even compared to equally weighted indices.

Just as you predicted.
Louis: Look at the S&P500 against the Value Line. There’s been just a massive divergence. The Value Line is hitting all-time highs, so your median U.S. stock has not deflated against gold. Your big- cap average has. And the reason is that the mega large-cap stocks that were so overvalued in the late ’90s are just going nowhere. But the average U.S. stock has done fine. In fact, the average equity portfolio anywhere in the world has done very well. Meanwhile, your gold has truly underperformed most commodities. Then, I would just like to make two or three more points about gold. It has two functions: it is a currency and it is a commodity. Now, has gold been going up because it is a currency or because it is a commodity? Usually, when gold goes up because it is a currency, bond markets tank, TIPS go through the roof, all that kind of stuff. But we have not noticed any of that. What I personally believe is that gold is going up mostly you have the Middle East getting richer for obvious reasons, and the Middle East has always been a big client of gold. And you also have India and China, which likewise are traditionally very big clients of gold—buying gold quite profusely. Gold’s rise is just a commodity story, supply and demand. It is not so much a currency story now. Although you could ask, why are the Indians and the Chinese buying gold? Well, historically, a lot of people have bought gold because it was a way to protect themselves against their currency being debased by their government. Of course, in the U.S., you have many other ways to protect yourself. You can buy the T-bond futures; you buy the TIPS, all that. But if you are an Indian or a Chinese, the only option you basically have over the very long-term is to buy gold. That is what people in France had always done—when we had exchange controls in France, reportedly over a third of the world’s gold stock was in France. But when, in 1982, the French government let go of exchange controls, all of a sudden a big source of demand for gold disappeared and supply came out of the woodwork. As it appeared on the markets, gold prices tanked. I am recalling this because today a lot of the demand for gold is coming from India and China where a lot of people are parking their new riches in gold. As long as India and China maintain exchange controls and those countries get richer, that demand for gold will be sustained. The day, however, that it looks like the exchange controls will disappear is the day you want out of gold. In a sense, it is a Sword of Damocles hanging over the gold price.

Marc: Well, it is not just the gold price that has shot up and outperformed the S&P and even the Value Line, but all sorts of unweighted indices, and numerous other assets, as well. I think it is excess liquidity that creates an unease in some people about the value of money. Debasement of a currency can occur in many different ways. Through rising consumer prices. Now, as I mentioned earlier, I don’t think that we are in a consumer goods inflationary period, simply because it is true that the new goods producers (and, I have to add to that, in India, new providers of services, as well) are keeping both goods inflation and wage inflation low in the West. But a loss of the purchasing power of money can also be reflected in money buying fewer assets—as assets become grossly inflated. So we do have asset inflation, which simply reflects simply excessive liquidity created in the United States.

Louis: A lot of what we say in our book is that we are in an era of discontinuous CPI. We have a lot of sectors where prices are falling, 20-30% a year: Electronics, textiles. We are talking now on the phone, I don’t know, but you are probably paying 5-10 cents a minute to call Hong Kong and Thailand. Just 10 years ago, it would have cost you $1.50 a minute.

Alas, good old Verizon is sticking it to me a little worse than that—but the web-based conference call I attempted, had it worked, would have cost a mere fraction of even that.
Louis: My point is that what we have is a highly discontinuous CPI. There are a lot of prices that are falling—and falling very hard —and then there are other prices that are rising—and rising a fair amount, things like education and services and nice restaurant meals in New York and London and Paris. As we wrote in our book, “It has never been so expensive to be rich.” And as a friend wrote back to us, “But it has never been so cheap to be poor.” There is a lot of truth in that. Basically, if the prices of a lot of the stuff we need to consume go down, at the end of the day, we have more money in our pockets. But then that money will compete for all the other stuff that we want. Like houses and Impressionist paintings and first-class seats on Cathay Pacific and dinner reservations in London. But there are a finite number of nice restaurants in London or first-class seats on Cathay Pacific, so those guys get to name their prices—because people with high disposable incomes compete for their services. There is an important lesson in this. I believe, like Marc, that we have a deflationary pull on the economy, because of the manufacturing in China, because of the services coming out of India, etc. But there’s no changing that. Wages just aren’t going to rise by 100% in China overnight. Once you accept that reality, then if you try to keep a lid on house prices, education prices or on whatever, you end up with all prices going down—in outright deflation. So it is just part of this brave new world of ours that we have to get used to a discontinuous CPI. As investors, we just have to learn to live with it and invest with it. Because trying to put pressure on rising prices would be a disaster.

Marc: Well, I would like to say that you cannot state, per se, that deflation is bad. There are numerous economies that have had deflationary booms.

Louis: You don’t have to tell us, we know it better than anyone.

Marc: Well, seemingly not, because you argue so strenuously against deflation.

Louis: But if you try to push down asset prices, Marc, then you do what the Bank of Japan did—and you end up in a deflationary bust, not a deflationary boom.

Marc: No, the only time you really have a problem with deflation is when total credit market debt is very high and so, when deflation hits, your debts stay at an elevated level. Your debts don’t go down, but your asset prices come down. Then, you have a problem. That is why I argue that the U.S., having created this asset inflation over the last 20 years or so as a result of expansionary monetary policies and excessive credit growth, cannot afford deflation. They have to keep printing money. The biggest worry for Mr. Bernanke is that, actually, asset prices will go down, say, by 10% or more. That the housing market declines by 10%, that the stock market would go down by 10%. At that time, for sure, the money printing presses will be turned back on and rates cut, but the end result will be a deflationary bust—not a boom—because they’ve created beforehand this huge asset inflation as a result of the excessive credit expansion.

Louis: I have to admit, Marc, I am not sure I am following you 100%. On the one hand, I think that by using terms like asset price inflation, etc., you are calling on policymakers to do something about the rise in house prices or the rise in equity prices in the U.S. On the other, you seem to be saying that if and when the policymakers do something, that will create a deflationary bust. Now, on that second score, I fully agree with you. If and when they target asset prices, it is going to create a deflationary bust. No doubt about it. The thing is about central bankers and policymakers is that politicians cannot create wealth. Central bankers cannot create wealth. They can very well destroy it, but they sure as hell can’t create it. If anything, that’s the lesson of Japan over the past 15 years. Now, what we have seen in the U.S. in the past 15 years, of course, has been a massive creation of wealth. How can we explain this creation of wealth? We tend to believe that it is due to a more efficient use of capital, a more efficient use of labor, a revolution in financial products. A revolution in the sharing of information and technology. Frankly, what we think we are witnessing is what Alvin Toffler talked about in “The Third Wave.” We are witnessing an economy moving from being a Second Wave economy to being a Third Wave economy and that is obviously great news. So I am not quite sure what the problem is in your eyes. Is it that central bankers should target asset prices, or that they are about to? Or what is causing your concern?

Marc: I do not think that central bankers should target asset prices. They should target credit expansion. But when I say they should not target asset prices, I mean on the downside as well as on the upside. They should let asset prices decline without intervening in the free market by, for instance, dropping interest rates artificially low, below the rate of inflation. If you accept that the central bank shouldn’t target asset inflation then you should also accept that the central bank lets asset prices go down. But it seems to me that the U.S. Federal Reserve accepts that asset prices go up and actually encourages the asset price inflation. But the moment asset prices are about to adjust on the downside, they intervene. Which creates a highly unstable and unbalanced U.S. economy.

Louis: I’ve got two problems with that. The first is that intrinsically you believe that central banks can do something about asset prices. I think the history of Japan shows that they can’t. Again, you can fool the markets for six months, but you can’t fool the markets for very long periods of time. Japan dumped all of the liquidity you could want into the system and asset prices—take something like Tokyo real estate—are still pretty much at their lows. Policymakers in general can create the conditions for wealth creation. They can remove the conditions for wealth creation. They can’t create wealth out of thin air. I think you and I agree that central banks and policymakers shouldn’t target asset prices whether on the up side or the down side. At least, that is what I am hearing from you. But what I also hear from you is that central banks instead should target credit creation and make sure that credit creation doesn’t get out of hand. On that score, it is very much a part of the central bank handbook (except the ECB’s) that central banks have two mandates. First and foremost, they have to control consumer price inflation. Secondly, they have to control the commercial banks; make sure that they don’t get too excited at the top and too bearish at the bottom. To be very honest, when I look at the Fed, they have done a great job. Look how the Fed has been putting money into the system and taking it out. They have been leaning against what the commercial banks have been doing for the past 20 years now. Whenever commercial banks have gotten excited, they would take money out of the system. Whenever commercial banks got too bearish, they would push money back into the system. A central banks’ role is to do the opposite of what the commercial banks do, and the Fed, in that, has been very successful.

Marc: Over the last 20 years, I do not notice a meaningful wealth improvement or standard of living improvement in the Western world. But I have noticed meaningful standard of living improvements in Eastern Europe, in the former Soviet Union, in central Asia and in Asia. So I think that wealth creation has to do with something other than central banking. It has to do with people making capital investments—which come about as a result of foregoing consumption and investing in new processes, in research and development, in the construction of factories, and in the creation of net capital investment. Yet that is precisely what is lacking in Western Europe and, in particular, in the United States. So your huge wealth creation, in my opinion, is largely an illusion, and not a real wealth creation.

Louis: That is another big divergence between us. Of course, there is no doubt that many people in Asia and especially in Eastern Europe are far better off today than they were 20 years ago. Anything has to be better than Communist tyranny. On that we agree. We are obviously also convinced, as you are, that there is a lot of opportunity in Asia for growth. That is why we moved our head office from London to Hong Kong. But there is an argument between us about whether there has been an increase in wealth creation in the Western world. Compared with 20 years ago, I would say there definitely has been. You now have a lot more young people who own their flats and as such, as I said. They are more financially secure. That’s got to be an improvement.

Isn’t that more reflective of a more liberal attitude toward using leverage than of wealth?
Louis: Yes. But it is normal for young people to be leveraged. When you start off in life, you have a mortgage. You have a car loan and you have education loans or whatever. Then, when you are 45, you don’t have any more that leverage. That is just the normal way the cycle goes. The U.S. is a young economy. I think there is this sort of Calvinist attitude, especially among a lot of journalists, if you don’t mind me saying that, Kate, who consider leverage a bad thing. But leverage that you can handle because you have a nice paying job and it is a stable job and you are going to have it for 20 years—what is wrong with that? After all, you have to live somewhere. In the U.S., mostly for fiscal reasons, owning makes a lot more sense than renting. Why should you be paying somebody else’s mortgage when you can be building capital instead?

I heartily agree. But there is an increasingly large segment of the U.S. population that is more heavily leveraged at 45 and maybe even at 65 than they were at 25—
Louis: That’s my second point, about improvements in living situations. It used to be that 65 was old. But 65 is young now. I remember my grandfather. At 65, he was an old man. My father now at 65 is on a different continent every week; he is knocking on doors, he is going out four nights a week. He is living a full life. He never stops. Part of the reason he can do that is, of course, that he’s traveling around in much more comfort than was possible in the old days. There have been massive improvements in the Western World, no doubt about it.

And in the East, when you’re flying first-class on Cathay Pacific.
Marc: Sure, for some people there have been improvements. Just consider that today there are some 300 billionaires in the U.S. and that in 1980 there were just eight. But this is very polarized. You are talking about the massive improvement in the standard of living of the rich—of 1% of the population. By contrast, for the typical household—and this is something you’ve even published from time to time yourself—real wages have been declining. So the vast majority of people, not just in the U.S. but also in Western Europe, are not living meaningfully better than they did 20 years ago. And if they do live better—if—it is only because Asians now produce goods that are more affordable. But in general, I would say that the standard of living in the Western World has stagnated. Whereas, by comparison, when I think of Hong Kong and Singapore, Taiwan, South Korea—25 years ago, how poor they were. But how well-to-do they have become in the meantime. Then I look today at China and India and other countries in Central Asia and at how wealthy they will become over time, because of their high savings rates. Relative to that, I don’t see how someone can be very optimistic about the Western World. Nor do I see how everyone in the Western World is going to thrive by designing furniture for IKEA and computers for Dell. Especially because, in time, all those designs will be made and sold in Asia, as well.

Louis: Nobody is going to argue that the standard of living hasn’t gone up massively in Singapore and Korea and almost all of Asia, obviously. It is a great development. But as we are all aware here, the economic pie is not a fixed pie. It has grown immensely. So sure, the growth rate, from a much smaller base, in Korea and Taiwan has been faster in the last 20 years. But that doesn’t mean that the standard of living has had to go down commensurately in either the U.S. or Europe. Marc, you live in Thailand and I was actually in Phuket, Thailand last weekend. One of the things that is very striking in Phuket now is the number of Scandinavian, German, Austrian, French and Swiss tourists there who would not be considered upper class or even upper middle class, for that matter. There were a lot of tourists there who 20 years ago would have spent their holidays in Brighton or on Lake Balaton in Hungary.

Sure, the tour operators must be offering tremendous deals to lure people back after the tsunami.
Louis: My point is that judging if life is better or not is a tough call. But your average middle class American now can travel to Paris if he wants to, which would have been unthinkable 20 years ago. You now have TVs with 100 channels. You have DVDs, you have a much better car. If you are just judging the quality of life based on material goods, the average American family now has a lot more than they did 20 years ago. One of the ways that you know the average American family is doing very well in this new environment is that tax receipts are at an all-time record—and as Mark Twain once said, you tax poor people because there are more of them. It is not the rich who pay those taxes.

Marc: I want to return to an earlier point you made. You said that if there were really excessive monetary growth in the world, the bond markets already would have tanked. My response is that all the evidence is not in yet. We still have to wait. Normally, there is a close correlation between commodities prices and interest rates. As an example, between 1940 and 1980, commodities prices (especially in the 1970s) rose sharply and interest rates went up. As an example, between 1960 and 1980, the yield on long-term Treasuries rose from 4% to over 15% and then commodities prices started to decline after 1980 and interest rates started to go down after 1981—until 1999, 2001. Then, commodity prices took off and actually interest rates continued to decline. So you have had hugely diverging performance between commodities prices, say, from 2001 to today, and bond yields. I think this diverging performance will be closed at some time. Either the bond market is right and we are in a non-inflationary environment and commodities prices will collapse. Or, the commodities markets are correct and we are in an inflationary environment—defined as a loss of purchasing power of paper money—and interest rates will go up substantially. That is something to consider.
Secondly, if you look at interest rates and nominal GDP growth over the last 50 years, I note two phases: 1960 to 1980, when long bond yields were always below the rate of nominal GDP growth. Then from 1982 to recently, 2001, when the bond yield was always above nominal GDP growth. Now, between 1960 and 1980, when the long bond yield was below nominal GDP growth, you had a phase of accelerating inflation. Then, after 1980 when the long bond yield was above nominal GDP growth, you had a phase of disinflation that would have been deflationary if the monetary authorities hadn’t embarked on a huge money printing exercise. But now, most recently, interest rates have fallen below nominal GDP growth—which I think will eventually filter through in higher inflation rates. So I believe that the bond market may be massively wrong at the present time to only yield what it yields. I think that the worst investment an investor could make would be to actually buy a U.S. 30-year Treasury bond, yielding less than 5%, and to hold it. I am not talking about the next 10 minutes or the next three months. But someone who buys and holds a 30- year U.S. Treasury yielding less than 5%—is going to lose all his money.

Louis: That is a very important issue. We ourselves—for many of the reasons that Marc highlighted—were fairly bearish on Treasuries, and bullish on European bonds, basically until March of this year. Then we reversed our recommendation, in March-April. One of the reasons is because of something that our old friend Hunt Taylor, who used to be a trader in the Chicago pits, always tells me. “You have to pay the most attention to market moves that seem to make no sense, because those are the moves that contain the most information. They will make sense to you later on, but only at prices that are very different from today’s.” Well, I think a lot of people have been looking at the bond market and scratching their heads. As we said in the introduction to our book, markets can be totally wrong for six months or a year—but after that, you have to go back and check your premises. And yes, ask what could be different this time. What is different in this cycle than in other cycles? When it comes to the divergence between commodities and bond market, the easy answer is that the CPI just hasn’t gone up. In the old days, when commodity prices went up, the CPI would shortly follow. This time around, it hasn’t happened. Why?

You tell us.
Louis: Well, frankly, if we had had this conversation two years ago and I had told you that oil would run up to $70, copper would be up four times, the Baltic Freight Rate Index would be up four times and U.S. inflation would be at 3% and bond yields at 4.5%, you would have laughed hard and called me an idiot.

And yet, look where we are.
Louis: Exactly. I would have done the same and yet that is the reality we live in today—one no one thought possible two years ago. I think the reason for the big divergence this cycle has been the emergence of China and India. Now, I might be wrong. But this is obviously something very new, so you have to find new explanations. And it is tough, because you can’t check it back against history. But when you talk commodities, at the end of the day, as Marc pointed out in his book, “Tomorrow’s Gold,” you are really talking about the new demand from China. And the interesting thing about that demand, when you look at it, is the state of Chinese manufacturing today.

How so?
Louis: Today in China you have 300 car manufacturers, 300,000 ball bearing manufacturers. Yet we know that in 10 years’ time, there can only be, at most, 10 Chinese car manufacturers and maybe 5 ball bearing manufacturers. What does this mean? The CEOs of all of these companies obviously want to be one of the very few who survive. And how do they get to be one? In China, it is not by being profitable. It is not by producing the best car. It is by being the biggest. Having the most workers. So whenever they can get any capital, from commercial banks, from the government, from foreign investors, they add capacity. Why? So that when the cycle rolls over, they will be employing 250,000 people and be the first to get emergency aid from the government or whatever.

So the name of the game in China is to truly get too big to fail.
Louis: Right. But what happens when every single manufacturer is using a too-big-to-fail business model? They start competing with each other for commodities. They start competing with each other for labor and you see prices going up. They start competing with each other for time on the electricity grid, for time on the transportation grid. Before you know it, you have massive overcapacity everywhere. All of their costs are going up and they can’t pass those costs onto anybody, which kills profit margins. Which is why, today, Chinese stocks are at 8-year lows, despite the massive boom that we see in China. It is a very perverse cycle. I will just give you just one story. About six months ago, I went to listen to a management presentation from a Chinese electronics company to investors in Hong Kong. They said, “Well, we missed our earnings target. We missed our sales target.” But then they said—and very proudly, “But we made our capital spending target.” At which point, the equity investors in the room were crying bloody murder. But this management was extremely proud that they were getting bigger, so they could survive a downturn. My point is that as long as this is going on, you can have higher commodities prices that don’t get passed on to the consumer. As long as the Chinese producers eat the higher costs, you could continue to see a divergence between commodities prices and the bond markets. That, again, is why it is different this time.

Marc: Again, you make a very important point, namely that excessive credit creation leads to huge misallocations of resources. In some places, it leads to asset inflation and in others, to a huge capital spending boom. And you are correct, today in China, we have a huge cap-ex boom that is not particularly profitable. But it is not such a disaster, either, macroeconomically. At least, at the end of the day, they will still have the factories and the infrastructure they are building. And as for the Chinese individuals who are employed by these firms, they will have acquired knowledge and skills and employment. Now, there’s no question that out of the 300 or so car makers, only a few will survive. Sure, it will be the larger ones, based on the too-big-to-fail-model. But that, the Chinese learned from the Americans. You just have to look at General Motors to realize that!

Louis: That the U.S. has no business anymore being in auto production is a fact I think we can all agree on.

Marc: Actually, some people are very successful building cars in the U.S. today—the Japanese. But they have a different cost structure than the U.S. industry. Which leads me to a point again about the standards of living. The problem isn’t only in consumer prices and goods inflation, but in services costs, such as health care. Correct me if I am wrong, but health care costs in the Western world have been growing at least at 10% per annum. You may argue that you are living longer, so it’s worth paying 10% per annum more. But I am not sure this is a valid argument because old age is not particularly pleasant.

Nor is it for sissies.
Marc: Anyway, there are some costs that have risen a lot in the Western world—and also elsewhere. In Hong Kong, we have a lot of inflation, as you must know, Louis.

Louis: Boy, do I.

Marc: So you can talk about core inflation at 3%, which is the number published by the BLS that you see in headlines. But I think real inflation is actually much higher. My estimate is that inflation in the West is running around 5%-6% per annum. And my cost of living, and probably yours and your father’s are rising at an even higher rate, because as you pointed out, it’s becoming very expensive to fly first-class.

Louis: There is no doubt about it. That is one of the points we make in “Our Brave New World.” It is has never been so expensive to be rich. Anatole [Kaletsky] wrote a very tongue-in-cheek chapter about the discontinuous CPI that we talked about earlier. How the trouble is that all the things that rich people want—the houses in the Hamptons and in Vail—are all finite goods, so stuff that you can’t mass produce gets bid up to astronomical levels. But you made a very important point earlier, which I think is right on the money. It is that when central banks ease, in the old days that would basically trigger a new consumption wave and then lead to higher inflation. But today, we’ve found that when central banks ease, it not only triggers new consumption, but it also creates massive new supply. So in the U.S. we’ve actually seen a whole new supply of housing and a massive construction boom. But we’ve also seen a massive new supply of manufacturing capacity in China. In essence, you get into cycle where, as the Fed eases, you get what people believe to be all this new consumption. And part of it is final consumption. But another part is actually just capital spending, which is going to turn around and generate more supply in a couple of years. That’s the phase we’ve been in for the past couple of years—and why commodities prices have gone up so much. You have had a big increase in supply, thanks to the low interest rate environment and also a big increase in consumption, likewise thanks to the low interest rate environment. But looking ahead at the next two years, we are going to have is all this new capacity coming onstream in an environment in which consumption is possibly going to slow. Which, cyclically, makes for a much tougher environment.

Which speaks volumes about why, for all your “structural” bullishness, you’re not terribly optimistic about the near-term economic or markets environment.
Louis: That’s right. Unlike Marc, I tend to believe that in this environment a cyclical downturn is pretty likely in the next year. And so 4.5% long T-bond yields, or even better, say, 6.2% bond yields in Thailand, might not be that ugly.

Marc: I actually think the long bonds are probably okay for the next three months or so. But I am quite convinced that the eventual outcome of the present asset inflation will be more asset inflation and more depreciation of paper money against hard assets. So eventually, in our lifetimes, interest rates will be substantially higher than they are now. Either that, or, interest rates at least will be higher than the rate of inflation. Which then will have a negative impact on some of the asset markets that have become grossly inflated, like the U.S. housing market.

Louis: I just have to interject here. That term, “asset price inflation” really grates on us, as you can tell from the report you quoted earlier, Marc. I think we have to be more precise in our language. What we should say is an “equity bull market” or “bond bull market” or an “equity or bond bubble” or a “housing bubble.” So let’s characterize it that way. Then, okay, let’s say that we admit we are in a housing bubble. So when the housing bubble bursts, housing prices fall 30% or 40% and it is a nightmare scenario, etc. To me, it seems that bonds are a pretty good hedge against that. If that happens, I can’t see bond yields going up. Likewise, if we are in an equity bubble and if equities fall 40% or 50%, again, I can’t see bond prices really collapsing.

Marc: But what is the likelihood of Mr. Bernanke letting the housing market or the stock market drop like that?

Louis: So your bearishness on bonds is predicated on the view that, should things start falling apart, the Fed would step in and just dump money in the system. At which point you want to be short bonds. Our feeling is that if and when we get to that point, then we can make that call. Now is too early. As I look at it, over the next six to 12 months, the most likely outcome is that all this new supply comes onstream in China from all this capital spending that’s been going on, and we probably see a big drop in demand for commodities from China. Which is pretty bullish for bonds, in our view. It’s also pretty bullish, incidentally, for U.S. companies who source stuff in China, because everything made there is going to be much, much cheaper in 2006.

Marc: I can see a trader buying bonds for the next 10 minutes or the next three months as a trade, because the bond market is somewhat oversold, whereas the stock market is grossly overvalued right now. But to buy a Treasury now with the view to hold it for 30 years, is a recipe to lose money.

Louis: But Marc, nobody apart from insurance companies wants to hold for 30 years anymore.

Marc: That may be, but I buy “assets” to hold them for life. I don’t buy assets as a trade. If I want to trade, I can buy S&P futures or short the S&P futures. I can do anything. But if I am talking about an investment, the long T-bond here is a disastrous investment. You are buying it in a structurally weak currency, in a country that has a highly questionable government and you are buying it in an environment where you have a central bank whose future chairman has said that deflation has to be avoided at any cost. This future Fed chairman is not concerned about the prices of cell phones and fax machines coming down because China produces them more cheaply. He’s concerned about asset deflation. So I don’t believe that the housing market will collapse dramatically. Instead, what will eventually happen is that interest rates will move above the rate of housing price inflation and so the housing market will go up less than, say, short term interest rates,or go up less than the depreciation of the U.S. dollar against hard assets, such as gold.

Louis: The main question in front of us is are we moving away from the disinflationary/deflationary environment that has held sway in the West basically since the fall of the Berlin Wall, and into a more inflationary world? I would argue that we are not. The structural forces that have moved us towards disinflation—namely, faster sharing of information, technology, globalization, demographics—all of these trends are, if anything, accelerating. And central banks are really just bit players in all this.

You’d better watch out, Louis. That’s not exactly how they’re accustomed to being described.
Louis: But it’s true. All they can do is mess things up. If you listen to Mr. Greenspan’s speeches, he is the first to admit that a lot of the things that have happened in the U.S. have been very much beyond anything he has done. Hey, he admitted there’s a new paradigm.

At least he has led mostly by following the bond market.
Louis: Which is exactly what he should have done. A central banker should really do two things: Follow the long end of the bond market to see what he should be doing, and do the opposite of whatever the commercial banks are doing, as I said. With those two rules, you really can’t mess up as an investor or as a central banker.

Now the question is, will the new fellow follow suit?
Louis: On that note, I would say that Anatole spends a lot of time with the people at the Fed, and one thing is clear. It is not going to move from being a Greenspan Fed to being a Bernanke Fed overnight. Not only does Greenspan definitely have a strong and dominant personality, but he has been running the Fed for a very long time. So all through the organization, his footprints are very visible. He has put together the research groups and policy teams that feed stuff to the board. It will take a while for Greenspan’s footprints to be wiped off and replaced with Bernanke’s. It is going to remain a Greenspan Fed for quite a while. The head may change but the body will be the same.

Marc, want to wrap up your outlook for ’06?
Marc: Well, I am always open to new ideas and to any “Brave New Worlds.” But my attitude is that the future will tell. How the U.S. will stand relative to the rest of the world, we will see in a few years’ time. We will see, too, if current account deficits do or do not matter really. Those are the big questions. We will see in the future whether the West’s loss of competitiveness, not just in the goods produced by industry but in increasingly services (as a percentage of GDP in the U.S. the trade surplus in services has actually begun to decline) will have a negative impact in the long run on living standards in the U.S. and in the West—and perhaps a continuing positive impact on living standards here in Asia. GaveKal and I agree in favoring emerging markets assets. Where we disagree is on their brilliant outlook for the U.S. But if GaveKal is indeed right and we are in a continuing disinflationary environment, it would be totally unrealistic to expect, as I gather they do, that U.S. corporate profits will continue to expand at double-digits forever. Because in the long run, corporate profits expand at approximately the same rate as nominal GDP growth. That should be clear to everyone. That is a relationship that is very well-established. I also want to point out that in the U.S., corporate profits have increased very sharply because of financial profits and because of profits of overseas subsidiaries. But they haven’t increased much at all in the non-financial sectors in the U.S. And financial gains are highly dependent on asset inflation.

Louis: Marc makes a very good point, again. There is no way that corporate profits, over a very long term cycle, can rise faster than nominal GDP. And that is true on a global basis as well. That has always been the rule. But, part of the brave new world we live in is that we have China growing GDP at 10% or 12% or 13% nominal while corporate profits are falling in China by 5% a year. Does this mean that corporate profits elsewhere have to rise much faster to absorb part of this profitless GDP growth China is experiencing? That is one of the issues we deal with in our latest book and it is also one of the big problems with a U.S. current account deficit. Because if you have somebody in the world that produces goods for no profits, that messes everything up. Inherent in the current account is the assumption that basically profit margins are the same everywhere. Now, if you calculated the current account on profits, and not on sales, it’s likely the current account in the U.S. would be massively positive, not negative as is today the case. And, of course, what really matters for the global system that we live in is not sales, it is profits. So I am not sure how meaningful the current account is as a measure—and there have been some articles recently, one even from the Fed, indicating that people are starting to come around to that view. Which brings me to the thought with which I’d like to conclude:
The very first economists in the world were the physiocrats, in the late 18th Century. They were French and being French myself, maybe I am particularly sensitive to not reproducing their errors. When they looked at the industry burgeoning all around them

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• Marc & Louis ; für alle jene welche Zeit zum Lesen haben: - Emerald, 03.01.2006, 08:57