In current distorted market, cash & bonds are no longer safe

Written by Saikat Neogi | Updated: Feb 28 2012, 06:28am hrs
With two decades of experience as an investment banker at various organisations like JP Morgan and Merrill Lynch, Detlev S Schlichters recent book, Paper Money Collapse, published by Wiley, tracks the history of paper money and shows how the current policy of accelerated money production to stimulate the economy is counter-productive. In an interview to FE's Saikat Neogi, Schlichter says that in a market economy, interest rates are vitally important to coordinate savings with investment. Excerpts:

Do you think gold is an essential self-defence asset. At current prices, do you see any major correction in gold

Gold is the self-defence asset in this crisis. Central banks around the world are printing ever-larger quantities of new fiat money in a desperate attempt to avoid defaults, deflation and credit contraction. This policy is counter-productive. Defaults, deflation and credit contraction are part of the process by which the economy gets back into balance, by which it cleanses itself of the distortions from the preceding credit boom. All that the present policy of zero-interest rates and quantitative easing can achieve is to sustain the imbalances in the economy a bit longer and, in the process, even add more imbalances to it, such as more debt and financial leverage. If not stopped soon, this policy must end in hyperinflation and currency catastrophe. But I dont see anybody who wants to stop it. Corrections in the gold price can never be excluded, but as long as the present policy is being pursued, the overall trend is up. Gold is not in a bubble. Instead, we are witnessing the re-monetisation of gold as concerns over fiat money grow. This will continue.

Do you think the excess liquidity in developed countries will drive prices of stocks in emerging markets and, also, global commodity prices

Not necessarily. Central banks in emerging market countries always have the option not to join in the money printing exercise. This would most probably cause the currencies of emerging market nations to appreciate in foreign exchange markets. It is the resulting domestic political pressure that causes emerging market central banks to run accommodative policies, too. At this stage, asset markets around the world are inflated as a result of decades of fiat money expansion and, more recently, aggressive central bank policy. In nominal terms, many asset markets may continue to stay at these elevated levels, but it will be difficult to achieve meaningful gains in real wealth with them.

Given the uncertainties in the stock markets, how should people look at accumulating their retirement corpus

Whatever wealth you have, the first goal must be not to lose it, or not see it being diminished by the desperate acts of policymakers. The present crisis is far from over and if you have maintained most of your wealth, by the end of it, you will have done really well. I see very few opportunities for real gain from investing in any of the standard asset classes. Since the last link to gold was severed in 1971, we have experienced an unprecedented period of global inflation. Money debasement the persistent destruction of the purchasing power of money has become official policy everywhere.

In most developed countries, since the early 1980s, this inflation was channelled to a considerable degree into asset markets: Stocks, bonds and real estate. We are now left with distorted asset markets and a massive debt load. Today, there are no bargains available. The worst assets are cash and bonds. They are historically deemed to be low-risk. This is no longer the case.

You have said all paper money systems have ended in failure. Does that mean that investing in bonds is a no-no

Absolutely. I worked for 19 years in the bond business, which I left in 2009 to write my book and, at present, I do not hold a single bond in my portfolio. Bond markets in the developed world are massively overvalued, in particular the major government bond markets. These sovereign borrowers are, without exception, on a slippery road to fiscal disaster. Over the past four decades of unrestricted fiat money creation, these governments have acquired the habit of constantly spending more money than they take in via taxation. The Western worlds model of the cradle-to-grave welfare state is completely unsustainable, but appeared sustainable thanks to easy money and cheap credit.

Nobody worried about the rising level of debt and the growth in unfunded liabilities. And whenever the credit boom seemed to falter, central banks printed even more money and lowered interest rates to keep the show going. Of course, it had to end at some point, and it did in 2007. But nobody knows how to shrink the state. As an investor in government bonds you will ultimately face inflation or sovereign default, probably both. On a long enough timeline, everywhere is a Greece.

What are the investment trends you see in the medium-and-long-term

The present sense of recovery is a mirage. We dont have free markets any more. Capitalism has largely been suspended. Markets are being manipulated through central bank purchases; banks are being propped up with unlimited funds at no cost; money injections are used to make unsustainable debt loads look sustainable; regulation is being used to force banks and pension funds to hold on to government debt. Time is running out. We will see more quantitative easing everywhere. Central bank balance sheets will continue to grow. So will the debt load of the worlds major governments. When people start demanding higher yields and start selling bonds, it will get interesting. When this will happen, nobody can say. The next five years will be very interesting. I am agnostic when it comes to equities, but I am very bearish on bonds. Measured in paper money, gold will continue to appreciate, in my view.