Baltimore – (Today’s Financial News): The following was taken from Bill Bonner’s appearance on a Special Edition of TFN’s Smart Trading Action Alert with TFN president, J. Christoph Amberger. These two well-respected economic observers delve into the U.S. economy in 2008. (Watch the video.)
J. Christoph Amberger: Stock markets around the world have set a series of new highs in 2007. Shanghai, Bombay, Hong Kong, Germany, all have set all-time records, in some cases, doubling their valuations in less than a year. Even the Dow Jones Industrial Average hit an all-time high earlier this year.
But few escaped serious, if temporary, setbacks throughout the year. The United States subprime loan prices ripped through international markets, highlighting that the U.S. consumer remains the keystone of the global economic boom.
Where are we headed in 2008? My guest today is William Bonner, founder and president of Agora, Inc., and author of The Financial Reckoning Day, Empire of Debt and just released Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics.
Bill, you just concluded a world tour. Tell me, what are your impressions of where the world is headed, where is the U.S. economy in 2008 headed? Give me an idea of what you have seen and observed over the last couple of months?
Bill Bonner: The truth is, Christoph, I didn’t really see that much. I went to about four continents in about two weeks. But what was most impressive to me was India, and the India story has always been in the shadow of China. China gets the headlines because it’s growing at 10 percent a year, and there’s skyscrapers going up all over China.
India has been a kind of secondary news story. It’s a harder story to understand because they don’t have such state involvement. Their government policy is not leading the way. In fact, the Indians say that they’re growing in spite of the government.
J. Christoph Amberger: Current economic strength would be a very strong argument against a global slowdown or indeed a recession. Why do you think the current outlook of economists, and especially newsletter editors, has been so bearish of late?
Bill Bonner: Well there’s a little bit of exaggeration in the current trends. Obviously, there is a crisis in the U.S. originated by sub-prime mortgages that has translated into more volatility and basically locked up certain parts of the current markets creating a credit crunch, but we’ve seen these crises in the past around the world and the capacity of both the administration and central banks to deal with this crisis and resolve it, especially in an economy as flexible and developed as the U.S., leaves me with very little doubt that we’ll basically come out of this situation very, very well and quite quickly.
J. Christoph Amberger: What do you think are the key factors to continued economic growth?
Bill Bonner: Well basically to start with, the U.S. is a very flexible and open economy and basically we’ve seen the dollar sell off. The dollar sell-off is equivalent to a monetary easing and that is very stimulative of the economy as exports start increasing dramatically and imports contract creating a lot of economic activity domestically. At the same time, with a weak dollar it attracts a massive amount of capital from abroad as the U.S. being a very large economy becomes very attractive for the rest of the world to invest in, and that again is very stimulative.
Thirdly, the Fed continues to drop interest rates. That again is very stimulative of economic activity and those three are very powerful reasons why the U.S. will go through a very mild deceleration and reacceleration in the second half of next year. To add some fuel to this fire, next year is a presidential election year, which traditionally has been very stimulative of both the economy and the stock market.
J. Christoph Amberger: So in other words, the recent volatility of the markets also creates an opportunity, doesn’t it, for investors?
Bill Bonner: That’s exactly right. In fact, I was just chatting with some other of my colleagues in the editing profession where we were seeing this volatility in the U.S. as an incredible buying opportunity. So whenever we see pullbacks in the U.S. we see it as opportunities to go in and pick value, pick basically the proverbial baby that has been thrown out with the bathwater.
J. Christoph Amberger: So tell me about what risk factors you feel could derail this kind of bullish outlook.
Bill Bonner: Basically, the major risk over here is that you have some sort of blowup that goes out of control. For example, I’d say the major blowup would be a deflationary spiral like Japan fell into and it cost them 10 years of growth and major asset deflation, but the advantage that we have is number one, we’ve seen what happened in Japan, number two, the Fed is ahead of the curve in controlling and in being very alert at preventing that deflationary spiral. Therefore, it is my strong belief that the Fed will continue easing rates to prevent the U.S. from falling into that deflationary spiral that’s so damaging to the banking system.
J. Christoph Amberger: So where are you recommending your readers to look right now?
Bill Bonner: Well basically, I’m favoring those benchmark financial institutions like Citicorp where already the wheels have started to turn in order to recapitalize and resolve the problems and make them once more lean and mean profitable moneymaking machines.
Other areas of interest for me in the U.S. would be multi-national companies that invest in the global scenario and have competitive advantages… companies like Coca Cola, Pepsi, exporters like Boeing, 3M, and U.S. industrials, as well. A weak dollar favors U.S. industrials and obviously the areas of growth around the world. China, Brazil, and Russia I’m not that interested because of the political situation amassing too much power. It’s not to my liking.
India is going to accelerate their banking industry so it looks like a tremendous opportunity. And in China I’m expecting some slowdown because already the Chinese are overheating their economy and they’re seeing some signs of inflation. The second wave of profits that I’ll see in China are not so much the companies that export into the U.S. but companies that grow domestically because of the mammoth growth and purchasing power that the Chinese are experiencing and are going to continue to experience over the next 5-10 years.
J. Christoph Amberger: Its five-year plans and everything.
Bill Bonner: Yes, they had all that. They had all that under the Gandhi years. They were very pro-Moscow for a long, long time. But now we’re finding that in India, they’re growing in a very decentralized, very uncontrolled way with lots of obstacles because things don’t work in India. You can’t take anything for granted, and yet they do. They’re growing at 9 percent per year.
So we’re looking at companies there now that are growing. This fund manager I was talking to said that he thought that he could safely find companies growing at 20 percent per year because they’re getting 9 percent staying up with the economy; they’re getting another 6 percent in inflation. He says by choosing them carefully, he believes that he can come up with companies that will grow at 20 percent per year for the next five to ten years.
J. Christoph Amberger: That certainly sounds good. I know we had Karim Rahemtulla here on the show earlier this week who made a similar prediction.
Now, where do you see the U.S. consumer and all his easy credits and the loose credit cards and, of course, U.S. fiscal and monetary policy figuring in the global equation? The U.S. consumer has, in the past, driven so much of the economic boom in China and Hong Kong. Is the U.S. consumer going to fuel the next round in India or if not, who is it going to be?
Bill Bonner: Well, I think we’re coming to the end of that long-running story. It began back in 1980 or so. It began, actually, when Paul Volcker got a grip on inflation rates in U.S., and since then, inflation rates have come down. And when inflation rates come down and when interest rates come down, people have more credit, and when they have more credit, they can buy more stuff.
And so name of the game for the last 20 years, 25 years, has been China, and to a lesser extent, India because India is not such an exporter to the U.S. China and Southeast Asia and Japan are export-led economies. They’ve been selling stuff to Americans, and Americans have been paying for this stuff with money they didn’t really have.
Now, anybody could see that this was going to be a problem, and it is a problem – a big, big problem. And so what I expect is in the next few years we’re going to see the dénouement, the unraveling of this fabric. We’re going to see the problems resolved, and that resolution is going to be difficult. It’s going to be painful for a lot of people.
You know, even today, Americans represent something like 1/20th of the world’s population. They are consuming 1 out of 5 consumer products in the world. Every five consumer dollars is spent by Americans. And there’s no way that you can make the transition… which everybody’s talking about …how Asia is going to grow without American buyers because they have so much domestic demand. Well, it’s true. They have almost unlimited domestic demand.
J. Christoph Amberger: In theory.
Bill Bonner: In theory. But the economy is now set up to produce stuff for Americans not stuff for Asians. And that transition is going to be a very, very difficult transition.
J. Christoph Amberger: I see a similar difficulty arising in Europe if you look at Germany’s export numbers. Germany is one of the top export countries in the world, plus they have the European demographics working against themselves. We have the one-child policy in China, which imposes natural restrictions on growth and expansion, even though there’s plenty of internal potential growth to be had.
Now, with the importance of U.S. spending and U.S. credit, easy credit, do you foresee a global financial crisis if that easy credit dries up?
Bill Bonner: Oh, absolutely. I think that what we’re seeing is a global financial crisis. It hasn’t developed into a global financial crisis yet, but it seems inevitable.
J. Christoph Amberger: Rehearsal dinner?
Bill Bonner: We’re getting to that point. We started with the – I use the metaphor of a tide going out. The tide has been coming in for many, many, many years. We’ve seen rising levels of asset prices that have risen up on this tide of credit and liquidity and dollars.
And now we’re seeing that at the margins, it’s like the tide going out. Well, it first goes out in those little marginal, marshy areas, and that was the subprime area. The subprime house buyer, now he’s finding himself a little high and dry. He’s got to pay that mortgage, the mortgage cost is going up and he doesn’t have the money to do it.
I could give you a long, long story about why he doesn’t have the money to do because of that economy; the basic economic formula of the United States, was not a good one. And what we were doing was really a consumption-led growth, meaning that consumers had to spend more and more money in order for the economy in 2008 to rise. But consumers can’t spend more and more money forever. You can only spend more and more money if you actually make more and more money, but in America, consumers were not making more money.
In fact, what they were doing is going deeper and deeper and deeper and deeper into debt, so that we’ve reached the end where consumers now can’t go any further into debt. And the more interesting, the lending industry doesn’t want to lend them any more money because now they’re seeing losses. They’re seeing losses because when the marginal borrower who borrowed money to buy a house, he can’t pay the money back.
So that reverberates all through the financial system, all the way up to Wall Street, into Wall Street’s lenders, to Wall Street’s investors. And people who were multibillion investors, very, very sophisticated investors, put their money into these derivative contracts. And then you go back the other way, and you find that the whole thing rested on the ability of some guy who was a bagger at Wal-Mart, and this guy couldn’t pay the mortgage on his house. So this is not a very good situation.
J. Christoph Amberger: A certain ironic situation that the capitalists of the world are going to be not only the cause of the crisis but also are going to pay the bill, literally.
Bill Bonner: Yeah, it is a funny situation. As a capitalist – the most sophisticated capitalist, we saw Citigroup. Here they are, and these guys know better than anybody what’s going on. They were packaging this debt. They were on both sides. They were packaging the debt. They knew what was in it.
They would have it rated by Fitches and Moodies. They’d have these mathematicians doing elaborate formulae to try to figure out what it was worth. And in the end, they should have known, and they did know that it really wasn’t very good stuff. And yet, they bought it and held it in their own accounts.
J. Christoph Amberger: Now, considering that consumption, especially Western and American consumption, place such a crucial role in this credit consumption growth triangle, what will that do to commodities resources? We’ve had the China growing, creating its own demand, mainly export driven, for oil, for energy, for metals, for gold, for all kinds of things. If the crucial element of consumption is eliminated or greatly reduced…?
Bill Bonner: This is a very, very good question. What we’re seeing is that the end-user, the American consumer, is losing his ability to consume. So now we go back up the supply chain, and you find that all of the sudden you don’t need so many ships bringing in stuff. Those ships don’t need to burn so much oil. You go to China and you find the factories there, they don’t quite need that much factory space, and they don’t quite need that much copper and iron ore and all those other things.
So what you’d expect is a deflation of the whole chain of commodities, and that is, in fact, what I expect. But we are living in funny, funny times, and those times, people are beginning to talk now about stagflation. And in stagflation, you get this phenomenon where you have an economy that’s really kind of melting down. It’s slowing down. It’s sluggish. It’s hard to develop any real growth.
But at the same time, you have rising prices, and you have that because the monetary officials are fighting the slowdown. And we’ve seen it before, but not for a very long time. And we’re seeing it now where we’re seeing the Bernanke Fed, for example, cutting rates. And we’re going to see that worldwide. They’re all going to cut rates in order to try and stop this process of deflation of an economy that’s melting down, of credit that’s imploding.
And so they’re going to be printing more and more money, and this money is going to go out there, and that money is going to have to find something to attach itself to. And it’s going to attach itself to things that they can’t make more of easily. And so you’re going to find this funny situation in which the price of oil probably will continue to go up. Because even though we’re seeing less and less demand for it, we have – it’s calibrated in dollars – principally dollars – although there are going to be a lot more dollars around.
But it doesn’t happen – we’ve never had this exact set of circumstances before so it’s very hard to predict what will happen. What I see is this titanic struggle developing between the forces of deflation, on the one hand, where you’ve gotten to the end of an economic expansion. You’ve gotten to the end of a credit expansion. Now, you expect to go down.
And in the downside, typically, prices fall because people have less and less money. You imagine what happens when the stock market goes down 10 percent. That erases about $1.5 trillion of wealth that people thought they had.
Look at the housing market. The housing market, so far, is down about 10 percent. Ten percent of U.S. housing market represents $2 trillion in wealth – fictional wealth, but wealth people thought they had. And the guy who runs the index on that, he’s expecting prices to go down 30 percent. Thirty percent, that’s $6 trillion – more than $6 trillion in wealth that will evaporate; it’ll disappear.
That is deflation. It’s old-fashioned deflation, classic deflation. And when that happens, there’s less and less money chasing the same amount of consumer goods, and you have prices falling.
On the other hand, you have this other phenomenon going on where the central banks are all committed to a policy of inflation, and they are putting out as much money as they possibly can. They’re fighting. And Bernanke did his work; most of his major work was done on the Japan experience of 1989 to 2007, which was, fundamentally, a deflationary experience.
So Bernanke has gone on record saying he won’t let that happen. He will do everything possible to avoid it, even to the extent, he says, of dropping money out of helicopters in order to get it into private hands. Now, that’s a – I like to describe it as a titanic battle. We’re going to see which way it goes. I know which way it’ll go. It’ll go in favor of deflation first and inflation second because that’s the way it works.
J. Christoph Amberger: Now, if you’re looking at this kind of balance of deflation and inflation, which is, of course, negative for the creation of wealth and expansion or even maintenance of wealth of the individual consumer, my impression would be that a major global event or even a national event could easily disrupt this precarious balance that we’re having here.
My personal opinion is that we will be seeing just an event like that in China, probably at around 2009, maybe March 2009, past the China Olympics – the Beijing Olympics when the true amount of public expenditure for the Olympics plus the incredible amount of bad debt that the Chinese have accumulated becomes public.
If we have something like this where the system itself, the machinery of manufacturing and distributions, may be affected by short-term drying up of easy credit in China. Not necessarily at the hand of the Feds, but the Bank of China cracking down on loose-lending policy within the common list nomenclature. We could see a drying up of easy credit there or shrinkage of manufacturing, shrinkage of actual demand for resource and commodities.
Now, my concern has been the accumulation of physical resources by which hedge funds, investment funds, pension funds, who have sidelined large quantities of metal, of oil, of actual physical supplies, in part, to artificially keep the price as high up as possible. We’ve seen, in recent months, any kind of disruption in the profit producing of investment funds can lead to the immediate recall of principle investment in those funds.
How do you see the element of that speculation that has been building up for the last seven years? Is there a particular danger that could implode the speculative bubble on the commodities side as well? And do you consider that a real danger?
Bill Bonner: Well, I think the whole thing is a danger, and I think you’re right. I see too that it wouldn’t take much to send China off the edge. China is the accident waiting to happen. It’s the 1929 economy. It’s the Wall Street of 2007 or maybe 2008. It’s the go-go economy.
You go to Shanghai today and you get the same sort of energy and same sort of enthusiasm that you got in New York City in 1927 and 1928. That manufacturing capacity, that capacity that’s been added in China is real. They can make things, and they can sell them at a profit; it’s not phony. But it’s all built upon a base which is – has big holes, big weaknesses in it. One of them we’ve talked about already. It’s the U.S. consumer as the ultimate end-user of this process, and that guy doesn’t have the money to continue buying.
But the other part you’ve also mentioned is the banking system in China is just horrible. It’s a banking system organized and run by communists. What do communists know about banking? Take bankers in the West, even the best of them…
J. Christoph Amberger: They don’t know what they’re doing.
Bill Bonner: Yeah, they don’t know what they’re doing either. Now, imagine some communist banker. He’s going to make even bigger mistakes. Only a few years ago these people were wearing those funny little suits and walking around in steps.
Now, you’re going to see big, big problems in China – big, big problems. And certainly, that 1929 economy, when China blows up, the world blows up. It’s just too big an engine right now. I saw a chart recently showing a China consumption, not of consumer items because China doesn’t consume, but of resources as leading the world. You take out the coal and the iron ore and all those kinds of things, and that’s where all that stuff is going.
So yes, I mean, when China blows, the whole world blows, and it’s going to be something to see. But I don’t think you need – we don’t know what exactly – it could be a terrorist incident; it could be any kind of thing. If you look back at 1929, you ask yourself, “What was it that set off the stock market collapse and the Great Depression; what event?”
Well, economists differ about it. According to some, it was some small bank in Austria that collapsed. Well, it’s like the wings of a butterfly somewhere in Shenzhen province start flapping; next thing you know you’ve got a worldwide financial crisis.
So you don’t know. But I think what we’re seeing now is the beginnings of it right here in America. We’re seeing where this process by which the average person’s spending power is going down; his view of the future is changing rapidly. He doesn’t think he’s going to make money on it his house anymore. He doesn’t think, necessarily, he’s going to be able to retire on that house. That view is slowly grinding, grinding down. And we’re going to see a decline in that person’s ability and his desire to spend money.
And that process – this year, last figures I saw, was something like 300,000 houses have been foreclosed. Well, next year there’s supposed to be something like 1 million houses foreclosed on. One million houses foreclosed and put back in the market. You’re going to see some big changes and a lot of people who are going to be really pressed pretty hard. And when that happens, you can look around for an event, a trigger event, but who knows what that will be.
I don’t think you need a trigger event. What happens is these things build up, and the maybe something in the news, some remark made by Bernanke where some hedge fund fails. It could be anything; it could be China. I think China is where you’re going to see the most spectacular fireworks because China has led the world in growth. But the process, I think, is inevitable no matter what happens.
J. Christoph Amberger: So what is the best country to ride out this coming financial crisis?
Bill Bonner: Christoph, I wish I knew. It depends on what you’re trying to do. If you want to put your money somewhere, so far, to me, Japan and India both look good. Japan for the obvious reason that it’s been going down for a long time, and it hasn’t recovered. It’s, fundamentally, a very strong economy. The people have a lot of savings. The yen is low and probably rising. And the market is low.
J. Christoph Amberger: I don’t think Japan has anything to do with that.
Bill Bonner: No. But the values you get in Japan today are pretty good values, and the economy is fundamentally very strong with a great trade surplus. They have all the basics going for them. Fundamentals are good.
And if you want growth, I would certainly look at India. India is not as exposed; it’s not as vulnerable as China. It’s not the big story. And India is hard to deal with. Certainly you don’t go into India easily, but once you get into India, if you could get in, you could expect growth to be fairly decent for a very, very long time.
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