Monday, November 14, 2016

Interview with Guru Focus - Part 2 Final

What are your biggest concerns at the present time?

The political landscape, we have many unusual politicians who have received lots of attention. You have Justin Trudeau, the Prime Minister in Canada, Marine Le Pen of the Front National in France, Jeremy Corbyn, leader of the U.K. Labour party, there is the far left and right in Germany and France, and of course in the U.S. So we had virtually no growth in real inflated adjusted income for most people in Europe and North America for over 10 years. People are reacting and saying they have to blame somebody and the mainstream politician gets the complaints. In the 1976 movie "Network," there is a guy who yelled, "I’m mad as Hell and I’m not going to take it anymore". I think this is where a lot of voters are today in Europe and North America. I think the result is probably going to be a big push toward fiscal policy stimulus, as monetary policy is not working that well anymore. In the U.S. there are two areas where this might be detected, one is infrastructure, we certainly need a lot of work on roads and bridges, railroads, etc., and most Democrats and Republicans could agree on that. The other one is defense spending, and this would be more favorable if the Republicans controlled both the Senate and the White House. You also have Japan being much more militaristic, and of course Russia invaded Ukraine. We detect some frustration going on there, and we will see how it plays out. Could Marine Le Pen become president of France? It’s possible! And, of course, the U.S. will be very interesting, and I will look at our current election very closely. I think that even if a more mainstream politician gets elected in the U.S., it may well be that Congress and that new president may want to do something to stimulate the economy because the voters are not very happy.

Do you think new fiscal policy would be the right thing to do?

Certainly in the case of the U.S., we can use the infrastructure improvement. There is a lot of slack in the economy, the labor market still has a lot of it, industrial operating rates are still very low. So yes, there is plenty of room, and the only question is always whether or not the money will be efficiently spent. That is the problem with government programs: they are very well-intentioned but very often they are not efficient in terms of their spending; they do not have a bottom line.

How would you change that?

I think that I would favor investing in the infrastructures: construction companies, suppliers of raw materials, basic industries, and if the investment is big enough, it could revive the U.S. economy sooner than it otherwise would. If not, we are still working off the excess of our indebtedness built up in the 1980s and 1990s, and there is no indication that this deleveraging process is over, and it probably has to run for a couple more years. Infrastructure investment could revive the overall economy. Even if there is a will, nothing will happen before the new president and Congress get elected. By the time you get this all geared up, you are two or three years down the road, but with market anticipation, so you can detect this anticipation faster than the actual spending.

Do you think the worst for China has yet to come, or has it already passed?

China had benefited from this globalization, the movement of industrial production to an emerging economy. China has the biggest economy and the most obvious one, we talked about this earlier in the case of Australia. That globalization process is pretty well completed. If you look at U.S. manufacturing as a percentage of GDP, it was 50% of GDP in the late 1800s. About 20 years ago, it was 20% and now it is 12%. I think the great shift of manufacturing to China is over. We are at an irreducible minimum, so that sort of growth in China is over. The other thing that created growth in China came from massive infrastructure spending and they created a lot of ghost cities, excess in infrastructure and huge debt to finance it. So that process is pretty well over now. Now what China is faced with is shifting its economy from one driven by exports and infrastructure to a consumer economy and it requires some reorientation, a process that takes a lot of time. In China, this shift is still in its very early stages. From the standpoint of globalization’s effect on the rest of the world, it is pretty much over and the shock that people had over China when they saw the increase of commodity imports, well that is pretty well over too. It is pretty much like Japan. Everybody thought that Japan would take over the world in the 1980s and then they had a housing collapse, followed by a stock market collapse in the early 1990s, and then for the last 20 years, nothing. I think China is going to be the same, it is not going to go away, but as the major focus of attention on the global stage I think it’s pretty much over.

Economists point towards financial instruments as exacerbating the fragility of the finance sector. While often innovative, many financial products allow higher risk-taking, are likely to have unrealistic valuations and are difficult to regulate. Many call for better regulations. Do you think this is possible given the inter-connectivity and complexity of global financial markets?

There is no question that financial markets have been excessive. The only justification for finance is to grease the wheels of industry, to provide the financing. If you did not have finance, you would have had a borrower economy, which is very inefficient. But what has happened in recent years, and particularly with slow economic growth, is that finance really took over and it is an end in itself, and we have got tremendous financial excess, a lot of which got wiped out in the financial crisis. But not all of it, particularly in the U.S. The bailout of banks and others left a lot of it intact and I am not sure more regulation is the answer because if you increase the regulation of the banks, the money moves to the shadow banks, the hedge funds, private equity, and I am not sure that is a very healthy situation because then you do not really know what is happening out there, the degree of leverage, with very little regulations in those areas. However, that is probably going to continue because the responses of regulators in the U.S. to the big banks bailed out was to break them up in order to reduce their size to the point that they are not too big to fail. But the banks pushed back on that, so the regulators, in effect, said OK, you do not want to be broken up so we will regulate you to the point you would like to be broken up. And that is what they are doing, and they have relieved them from different profitable activities like proprietary trading, derivative origination and trading. And they were pushed back to lending, basically taking deposits and lending the money out with a spread with a very flat yield curve for long term rates in relation to short term rates, which is not a very profitable business so it has put the banks in trouble. This resulted in further regulations, further increased capital requirements on the banks. I do not think this changed it to a zero risk profile, but it certainly pushed the action elsewhere.

Would you recommend more regulation in the shadow banks?

It probably makes sense from a theoretical standpoint, but if you did that, it would probably be so disruptive and result in a tremendous reduction in finance entirely, to the detriment of the economy. I think there is probably a case to be made for trying to control this.

And finally, to which moments in history should we look if we want to move past these cycles of financial crises?

The biggest concern that I have now is that people are trying to jam the current economic and financial situation into some kind of a regular cyclical pattern. We experienced fairly regular cycles early in the post-World War II period that ran through the 1950s, '60s, '70s and even the '80s, but then when you started to see all the leveraging up that took place in the financial sector and U.S. consumer area and other sectors in the 1980s and the '90s. Then it was of course followed by the financial crisis, great recession, very slow growth. I think it created a very different environment.

So to me the problem is that people are looking for a simplistic kind of answer, they are looking for something like a cyclical pattern and where are we in that cycle, so as to know what to predict next. I do not think we are in anything like the typical post-World War II cycle. I think the greatest mistake that a lot of younger people make in particular, is that they are looking backward nostalgically to that era, assuming it must be the same cyclical pattern as the 1950s and 60s, enabling us to follow the script and see where we go from there. But I do not think that is the case. I think we are working off this massive leveraging, we still have this overblown financial sector, and we still have slow global growth. And we know strong growth covers a multitude of sins. Really, when you have strong growth you can make a lot of mistakes! But when you have slow growth, it does not take much to fall into a recession. You look at the emerging economies in Africa, for example, who earlier had strong commodity prices and a lot of money coming in, but they did not use that money to restructure and diversify their economy, resulting in these countries now being in terrible financial shape. I think this means we are in a different era, and I do not think it is anything comparable to what we saw earlier.