Merryn Somerset Webb talks to Bill Bonner about economic cycles, and the catastrophic credit crisis that will make 2008 look like a walk in the park.
• If you missed any of Merryn’s past interviews, you can see them all here.
Merryn: Hi, today I have with me Bill Bonner. Regular readers will know Bill from his ‘Last Word’ column in the back of the magazine, more of you probably get the ‘Daily Reckoning’ where you can read Bill’s musings every day. Bill is also a very well-known author. This is one of his books, but he’s written five, most of which have made it to the best-seller lists. Bill is also the founder of Bonner and Partners Family office.
Now, Bill. Some time ago, when the financial crisis first started, you and I were chatting, and I said to you, “Bill, what do you think is going to happen?” and you said, “First there will be deflation, then there’ll be inflation”.
Merryn: Now where are we in that cycle?
Bill: Well that cycle is a very long cycle, and I think what is most amazing about the world that we live in, the monetary world, is that the cycles are extremely long, because the financial system that we live in today was begun, as you know, in 1971. And paper money, historically, lasts for a couple of years before the system blows up. This one has been going on all that time; this is like 44 years. No hard-money buff, no gold fanatic would have anticipated a system that could have lasted so long. So that’s the main thing, is that we’re in a money system which itself is extremely long lived, and far more durable than we ever thought it was.
Merryn: So tell me what you think has made it so durable. I agree with you: people who believe in hard money would look at a fiat money system like this and go, “Well this can’t survive” – but it has. Why?
Once inflation starts, it’s very hard to stop. Inflation expectations rise. People start spending their money faster. And then it goes up even more.
Bill: Good question. I don’t know why. I think it’s luck really, because it started to come apart at the seams in the 1970s. It was 1971 it came in – nobody understood what was happening, and then the inflation rates started going up, and then the classical economists began to look at it and think, “Oh this is going to go bad”, and then everything seemed to be following the usual pattern: more and more inflation, more and more. And once inflation starts, by the way, at a certain pace, it’s very hard to stop, because people anticipate it. Inflation expectations rise and then people start spending their money faster and then it goes up even faster.
But what happened was, that Paul Volcker came in – he was appointed by Jimmy Carter – came into the Fed, and Paul Volcker is not an inflationary guy, and he’s not a political guy, and he’s not a Keynesian, and he saw that the only way the system could survive would be by killing inflation. At that time, the consumer price index in America was rising at about 13% per year, which is the all-time high.
Merryn: And of course it was more than that in the UK.
Bill: Yes. And at that point Volcker came in and Volcker said, “Well this is going to stop, and I’m going to stop it”, and he raised the inter-bank lending rate to 19% or maybe 21%, briefly. He got ahead of inflation, in other words. And people hated him. Back then there were several calls in Congress for him to be pulled out of there, and everybody pressured – Ronald Reagan had then become president – and Reagan was under a lot of pressure to get rid of Volcker.
But Reagan had the good sense to back Volcker, and Volcker stuck with it, and gradually he turned what was the beginning of an inflationary disaster into the top of a credit cycle, or an interest rate cycle, so that interest rates, from 20% could come down, and they came down virtually every year for the next 20 years. And we’re still – now it’s 30-something years on – and we’re still at the tail end of that cycle: of declining interest rates making money more and more easy so that now we’re down to zero, and in many countries below zero for the interest rates.
And that cycle has got to the bottom, I believe, or very close to the bottom. But it was that long decline in which inflation was coming at lower and lower rates. There was disinflation that whole time, so in fact money looked better all that time. And now cash, especially dollar cash, is very highly regarded.
Merryn: So you reckon we’re at the bottom, or near the bottom of that interest rate cycle.
Bill: That’s right.
Five years ago, if you’d told me that half the world would be in negative interest rates or something like that, I’d say, “Well that’ll last for about a week”
Merryn: Any timings on that?
Bill: Merryn, I wouldn’t want to mislead your viewers. No, nobody knows. But how long can you run at negative interest rates? Nobody knows, and that’s what we’re saying initially, that these cycles are longer than you expect. Five years ago, if you’d told me that half the world would be in negative interest rates or something like that, I’d say, “Well that’ll last for about a week”, but it really can last for quite a bit longer. And Japan has shown us how long these cycles can last.
I think it was Keynes who said, “There’s a lot of ruin in an economy”, and we’re finding out how much ruin there is in a rich economy. A poor economy couldn’t stand this for very long, but the West is rich, Japan is rich, and that wealth has now gradually, gradually been worn down in these kinds of financial cycles. It could take a long time.
Merryn: But I’m assuming that your view is that, over time, these very, very low interest rates, QE etc, will shift us from disinflation into inflation.
Bill: My feeling is that we have not seen the disinflationary crunch yet; that there will be a panic. All inflation leads to disinflationary or negative inflation, and all credit bubbles lead to credit bust.
So we have this huge credit bubble: there’s $200trn worth of debt in the world, according to the latest McKinsey numbers, and the world has never seen anything like that.
All of our theory, all of our experience tells us that when you have that much credit, that much debt in a society, you’re going to have one hell of a bust up. You’re going to have defaults, because when you start lending at zero rates or under zero rates, people are taking money and they’re doing funny things with it, because their signals are all distorted so they’re buying things that don’t make sense, they’re investing money where they can’t possibly pay off. They’re borrowing money and then consuming it, so they’re not building the kind of capital that you would need to repay debt. So all of these bad investments, malinvestments and so on, they’ve got to go bad in some way. And that happens in a credit crisis when prices go down and there are defaults.
Merryn: So the real financial crisis is not behind us, it’s still ahead of us.
Bill: Oh yes, we’re just getting there. The question is how long it’ll take to get there and what shape it takes. Now, back when this started, 1970s, anybody, any serious economist looking at it would say, “Well, we’re going to print more money and inflation rates are gradually going to go up”.
Well that didn’t happen, and even now, most analysts look at it and say, “Well, sooner or later it’s going to go up because the central banks have bought all these bonds, they have all this money stock. The base money is much, much bigger, and eventually that’s got to express itself in consumer prices”, but I don’t think that’s what happens. I think when the central banks buy government debt, and perhaps other debt too, it is effectively disappeared. It vanishes; it never does anything.
Merryn: Well maybe this is a good thing? Disappearing debt.
Bill: Well, a lot of people think it is a good thing, but it can’t be a good thing. You can’t actually…
Merryn: …just because it’s dishonest somehow?
Bill: Just because it’s dishonest and impossible.
Merryn: It’s morally wrong.
Bill: Yes, you can’t really create wealth that way, but you can try.
And well, the next credit crisis will be much, much worse because there’s much more debt there and because the tricks that were used to stop the last credit crisis have already been used. Last time, when the credit crisis hit in 2008-2009, they dropped the rates to zero. The rates are already zero, they’re below zero in many cases, so they can’t do that trick again.
Merryn: Well we don’t know that. No one has ever yet experimented with taking rates properly negative. There’s an assumption that zero band is as far as it gets or minus a couple of basis points is as far as it gets, but this is a new environment, it could go a lot lower.
Bill: It could go much lower than zero. You know, I haven’t fully thought that through. And you may be right about it, but there’s got to be some lower bound for interest rates.
Merryn: Well Bill, this all sounds horrible.
Bill: Well it’s not horrible. It’s not horrible, this is just the way things work in nature. And nature does not permit anything to go too far out of whack: it brings things back in to whack in way that are sometimes painful in the short run, but everybody’s better off as a result.
There’s going to be a run on cash. Real cash, I mean – dollars. Everybody should keep a stock of cash.
Merryn: And quite unpredictable. Now, given this, how is one supposed to invest? Historically you always suggested to people that they buy and hold gold as insurance against unexpected events. But in deflationary or disinflationary environments is that still a valid strategy?
Bill: It’s still a valid strategy for an investment portfolio, but you need a personal portfolio too, and in America – I don’t know about here, but in America – I’m anticipating that there’s going to be a run on cash, that people are going to want real cash. But real cash I mean dollars.
Merryn: You mean actual notess?
Bill: Pieces of paper, because the whole economy works on credit. In a deflationary credit collapse, the credit stops. People will want cash because the credit won’t be worth anything because their banks will be going bankrupt. Everybody will doubt that the credit card is any good, so people won’t take credit and when you go into a gas station and buy gasoline they’ll say, “Cash only”. And who’s got cash? Almost nobody, because cash has been replaced by credit.
Merryn: Are you telling me that you keep, in your house, large trunks of cash? And where is that house?
Bill: I’m not telling you that. I’m not saying that, but I should do that. I mean everybody should keep a stock of cash for that short period, and it will probably be short, between the time when the credit crisis hits, people desperately need cash, and then the government will supply the cash that they desperately need and desperately want. But it won’t happen overnight; it will take a while to get that machinery up and running.
Merryn: A little gap in the middle where we can use the cash that you’re hiding in your basement.
Bill: The gap in the middle will be very painful for people. Really it’s the old Gresham’s Law, that bad money drives out good money. And so in America this credit has driven out even the cash. The cash has driven out gold and then credit has driven out cash, so now, not many people have cash. And you go around to anybody and ask them to look at their wallet, and they’ve got a few dollars, that’s all, because they expect to live on credit.
And when that credit crisis hits, when credit disappears, when the machinery of credit – they’ll go to the ATM machine, to the cashpoint, and there will be no cash in that machine because somebody else has taken it out and hoarded it. People hoarding pieces of paper because that’s what you do in a credit crisis.
Merryn: And with negative interest rates as well, you’re more likely to hoard cash aren’t you?
Bill: Yes, you’re much more likely to hoard cash so the velocity of money is going to decline to zero, people are going to hoard every bit of cash they can, and the credit cards won’t work.
Merryn: OK, so in our personal portfolios, ie our basements, we should hold a lot of cash.
Bill: You should hold a lot of cash.
Merryn: In our investment portfolios we’re holding a little gold. What else are we going to hold in an environment like this?
Bill: You hold cheap stocks.
Hold cheap stocks – there are very cheap stocks right now in Russia and in Greece. Inexpensive equities go up in price, and expensive equities go down in price. I don’t think that’s going to change any time soon.
Merryn: Where are we going to find these cheap stocks?
Bill: Well there are very cheap stocks right now in Russia and in Greece – and I’m looking in those areas myself, of course. And everybody should. The world doesn’t change in that respect. Inexpensive equities go up in price, and expensive equities tend to go down in price and there’s been a lot of study of this over many, many years. I don’t think that’s going to change any time soon.
That’s not to say there won’t be all kinds of crises and interruptions and problems in the meantime, but generally you’re better off over the long run holding a balanced portfolio of stocks. Mostly cheap stocks.
Merryn: Sound advice Bill. Now, you are also a great fan of investing in real estate, right?
Bill: I’m a great fan of real estate, I like real estate. But real estate’s a lot of work. As a portfolio item it’s hard to tell people to invest in real estate. It depends on where you are: real estate’s very local, it’s very particular. And London – I doubt if real estate in London’s a good buy. I don’t know the rest of England. But in America for example, there are still very good real estate deals. Many fewer now than there were five years ago, but there are still deals where you can buy an apartment building and you can get a decent return on your money.
And then it’s, is there going to be a credit crisis? Yes. Are people going to have a hard time paying their rent? Probably, but they’re going to need a place to live and you’ll have the place to live and you’ll get through the financial crisis with your wealth intact.
Merryn: OK, and anywhere else one might look at real estate other than America? Greece, perhaps? Might be a good place to pick up and island or two?
Bill: I don’t know, but there may be. Those markets are kind of stuff: they don’t react very well. That’s what’s nice about America, because the financial markets, including the real estate market, tend to be very quick moving. And when you have a crash you have a real crash and you can go in and buy things.
In Europe it’s been less so. In France, for example, property should have fallen a lot but it hasn’t.
All kinds of things are going to happen and I don’t think bonds are worth the risk. I personally would stay away from the bond market.
Merryn: Now, we should talk about bonds briefly, before we finish. And I’m guessing, from what you said earlier about your view on rates, that you wouldn’t be a great investor in the bond markets at the moment, in any area?
Bill: Well, I would not because I regard it as too risky. I do think they’re going to go up. I think they’re going to go up because I don’t think we’ve finished with this deflationary trend. And in that final crisis a person probably will find bond market, as you say, interest rates dropping even more negative.
But bonds depend upon people who pay their interest, and in a real credit crisis, then everybody starts to look across the street to see whether the person who owes them money has the money to pay you, and you begin to doubt it and then the people, the institutions who are supposed to be paying interest fail. There are defaults.
So there are all kinds of things that are probably going to happen and I don’t think they’re worth the risk, so I personally would stay away from the bond market.
Merryn: OK, thank you. Now, one last question and I’m particularly interested in your answer to this one. If you ruled the world – maybe you should – how would you sort out the global financial situation?
Bill: Well, if it were possible to sort it out, it would be very simple to sort out: you would let it sort itself out by letting markets function, really.
Markets are perfectly capable, and by the way only markets are capable, of determining a good asset from a bad asset, a good credit from a bad credit. Only markets can do that, and that’s why we have markets. They never know but they always discover what things are worth. We call it ‘price discovery’. What’s something worth? It’s worth whatever you can get in a market situation.
And right now we have markets all over the world which are all distorted by all these crazy things that the central banks are doing: lending money at zero. There’s no market in the world that can survive credit at zero.
Merryn: So basically you’d abolish the central banks?
Bill: I’d abolish the central banks and I’d abolish their currency too. The paper currencies, all that stuff.
Merryn: Okay, no more central banks.
Bill: No more currency.
Merryn: No more currencies; we’re back to a gold standard here? Or are we going to use shells?
Bill: Well, people would figure it out themselves, like bitcoin. It’s a perfectly acceptable kind of money; so is gold, and so could anything be. But that would be for the free market to decide. It wouldn’t be up to me to decide what people should use as a medium of exchange.
Merryn: You’re not going to be very good at being in charge of the world if you won’t make rules.
Bill: That’s the thing though: there’s a lot of thinking been done on this subject – some of it by me. And the more that you are in charge of the world, the less well the world will work.
Merryn: OK, well thank you very much Bill.
Bill: Thank you, pleasure.
Merryn: If you would like to hear more from Bill, Bill will be speaking at our next MoneyWeek conference. And better still, if you’d like to spend a lot of time with Bill, Bill will be joining us on the MoneyWeek cruise in October and so will I, so look out for more information on that.