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Faber: How investors can beat hyper-inflation
By Dan Slater | 24 September 2007
Commentator Marc Faber says investors could benefit from sky-high asset prices as the US stokes inflation.
In a typically bearish appraisal, author of the Gloom Boom and Doom Report Marc Faber advised investors on the last day of the CLSA Hong Kong forum on Friday to stock up on physical gold and rural real estate ahead of possible global conflicts and US stagflation (inflation without growth, last seen in the 1970s.)
Faber sees the US as a consumption giant unable or unwilling to make capital investments, with third-world infrastructure, and a tendency to binge on consumer goods actually produced by other people. He estimates the US GDP has shrunk from a 32% share of the world's GDP in 2000 to just 28% this year. He believes the rise of the Asian block is inexorable, and points out that in emerging markets, oil consumption is already greater than that of the G7 group of countries. The sale of semiconductor chips is also four times as great in Asia as that of semiconductor chips in the US.
Faber believes the conditions for a period of higher interest rates, low growth and high inflation are now with us, rooted in recent US policy.
Thus, he sees US GDP growth for the past several years as being based on consumer debt rather than savings and manufacturing prowess (as in Asia). He estimates total US credit market debt to be around 330% of GDP. The US current account deficit, which has swollen to 7% of GDP in 2007, compared to 2% in 1998, is also a reflection of America’s preference for consumption over production. That deficit has had the effect of pumping $800 billion of liquidity into the world economy, fuelling asset prices worldwide, and increasing the risk of a synchronised economic crash.
In the wake of the subprime fiasco, US growth is now under pressure, with the American consumer currently finding it difficult to maintain his dizzying levels of spending. Faber estimates that credit growth needs to accelerate just to maintain current growth levels. “But with the current account deficit no longer widening, and the market (rather than the Fed) imposing tighter lending standards, it’s hard to see where the growth will come from.”
In addition, he warns that credit problems in the financial sector will be repeated in the market for securitising credit cards and car loans.
Faber sees the US debt problem as beginning back in 2000, as the Y2K appeared to threaten a global information technology crisis. Interest rates were slashed from 6.5% to just 1%. Faber says that the economy had begun to recover by November 2001 – but that rates stayed rock bottom until June 2004. This created a massive liquidity-led growth spurt. “The low interest rates and current account deficit lead to an asset bubble not just in the US, but worldwide, and in all asset classes.”
Faber reckons the Fed under current and former chairman Ben Bernanke and Alan Greenspan has demonstrated breathtaking intellectual dishonesty. “When asset prices are going up, they appear to believe there is no reason to interfere. They only interfere when asset prices are going down. That’s a massively asymmetrical approach to the problem.”
An unchecked consumption credit binge can only lead to one thing: inflation, he points out. Faber takes issue with the US government’s definition of inflation, which he says greatly underestimates the problem. Core inflation conveniently does not include energy and food price rises. Faber reckons grocery prices have increased 6%, for example. But the Fed claims that 6% more groceries have been sold, which Faber believes unlikely. “It’s hard to be exact, but I estimate that for the people in this room inflation is running at between at 5%-10%."
And that is set to increase, given that the US consumer can no longer pick up the slack. The preferred solution will therefore be to print money, thereby injecting liquidity into the economy. As the supply of paper rises, the greenback’s value will sink.
Faber is cynical even about the interest rate hikes that lead to the 6.25% Fed fund rate before the most recent cut. “You had an expansion in money supply which easily made up for the higher rates.”
Faber reckons that the Fed has no stomach for a tight monetary policy because they have allowed things to become so bad that the real estate market and stock market would collapse, leading to a massive recession. In other words, the Fed should have acted far earlier. The effect of the weaker dollar will inevitably be to increase US inflation, since imports will become more expensive. Add raw material inflation caused by the China boom (especially oil, facing diminishing production), and a second driver for inflation joins the mix.
A likely solution for Faber is that the US retreats behind a wall or protectionism and capital controls. This would be devastating for international investors, whose money will be prevented from leaving. Faber therefore advises them to stay well clear. “In any case, the return on US assets has been inferior to the return on most foreign assets.”
Faber believes a sudden, massive devaluation of the dollar is unlikely. But foreign investors should worry given they hold 44% of all outstanding T-bonds. In passing, he knocked the claim that an appreciating Chinese currency would help solve the problem of the US current account deficit. “The yen was at 350 to the dollar in 1971. Now it’s at 114. And there is still a huge trade surplus with the US.”
In previous years, Faber has been willing to expound on his theories of the decline of the US ‘superpower’ – the ironic quotation marks are his. However, this year he confined himself to telling investors how they could ride out the storm of paper caused by the non-stop churning of Ben Bernanke’s printing presses.
His thesis is simple. As the Fed reneges on its traditional duty of domestic price stability, Faber reckons the US central bank is becoming ever more a standard bearer for Wall Street and for key indices such as the Dow and the S&P500.
If they ever look like falling, the Fed will simply accelerate the operations of the printing presses. When too much money is chasing too few assets, prices rise. However, in real terms, there is little point in buying US assets, points out Faber, who estimates that in Euro terms US growth has been anaemic, if not negative, since the late 1990s. “Investors have to look for assets which cannot multiply as fast as the pace at which the Fed prints money,” he says.
Consequently, gold is a great bet, along with other precious metals. Faber recommends actually holding physical gold in gold-friendly countries such as Hong Kong, India and Switzerland. He counsels against holding gold in the US for fear that it might be nationalised by the government. He is still bullish on other commodities in the face of global shortages and booming Asian economies. He’s also bullish, as it were, on war. “Rising commodity prices often trigger wars – which in turn cause commodity prices to go ballistic.”
One thing seemed to be clear from Faber’s speech. If things continue along the current trajectory, the argument that Western financial and information technology expertise is a substitute for Asian R&D, a high savings rate and engineering expertise will have been comprehensively discredited.
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