Mirror, Mirror on the Wall, When is the Next AIG to Fall?

0:00Well, our next speaker needs no introduction. I think he's speaking to a room full of big fans. His books include Tomorrow's Gold. He publishes a monthly newsletter entitled Gloom, Boom and Doom Report, which captures pretty much the views of everybody in this room. He's received his PhD in economics, magna cum laude, from the University of Zurich. He's worked around the world and a member of Barron's Roundtable. Today, mirror, mirror on the wall, when is the next AIG to fall?

0:48Mark Fahmer. Well, thank you very much for this very kind introduction and thank you very much for the kind invitation by the Mises Institute to ship me from Hong Kong to New York and back. Of course, I'm also grateful to you for giving me the opportunity to share some of my views with you today and I'm very happy to be in New York after all it's the city I started to work because after studying I didn't know what to do but already then Wall Street paid the highest salary so I took a job on Wall Street with White Weldon Company and then fortunately in 1973 they said to me Mark we want you to go to Asia and develop our business so I played hard to get and then they said Okay, what we'll do is we'll send you for three weeks to Asia and then you come back and tell us whether you want to go or whether you want to stay here in New York and in Europe.

1:55So I went for a day to Tokyo and a day to Hong Kong and for two weeks to Pattaya. Pattaya is the capital of sin in the world that has a very efficient and well-established service industry, in particular at night. So I said, yeah, I like it, so I stayed in Asia. That's That's the economic background I have. But I saw already then that Asia had some potential and so forth and obviously what has happened in the world over the last 40 years is really mind boggling just to consider that we didn't have Bloomberg machines, we didn't even have fax machines in the 1970s. Walmart had sales of 44 million and 24 stores and had just gone public in 1970 and the Microsoft, Dell, Cisco, Google of course didn't exist. Also in Asia we still had Mao Zedong in China, the Cultural Revolution and we were in the midst of the Vietnam War and you couldn't invest in India and in China, Indonesia didn't have a stock

3:07market and so forth and so on. So I would like to say is that basically when people If you come to me and tell me, Mark, you've been so lucky to go to Asia in 1973 when there were so many opportunities, I think today there are far more opportunities than there were at that time around the world as a result of the breakdown of the socialist and communist ideology that has integrated 3 billion people into the market economy and the capitalistic system. But this is not what I'm here to talk about. Basically, nine months ago Mr. Krugman felt that the best would be to have another bubble and that one could deal with the consequences of such a bubble at the later stage.

3:55The problem is that he already felt that way in 2001 and we know now what the consequences of that bubble were. In fact, what happened before 2001 and after is actually quite interesting from a monetary perspective. As you remember, in the late 1990s we had a capital spending boom that was driven by the TMT sector, technology, media, telecommunication, and it led to a rise of 48% per annum for the NASDAQ between 1997 and March 2000, and a doubling of the NASDAQ between August 1999 and March 2000, but Mr. Greenspan couldn't see a bubble.

4:46And then after March 2000, when the Nasdaq began to collapse, the Federal Reserve rightly or wrongly became very concerned about a deflationary recession. So, as you can see here, they slashed the Fed Fund rate starting January 3, 2001, from 6.5% by year end to 1.75% and then down to 1% and they left the Fed Fund rate at 1% until June 2001. June 2004, and thereafter it is correct that they increased the FED fund rate but in baby steps from 1% in June 2004 to 5.25% in August 2006 and then they left it there.

5:33But as I shall explain, there was never any monetary tightening occurring in this period. And then the Federal Reserve and the Treasury, which kept on telling us that there wasn't a housing bubble and that the subprime problem was well contained, suddenly and surprisingly realized in September 2007 that the subprime sector was not an isolated sector in the U.S. but that the whole U.S. economy was subprime. And then they slashed again the Fed Fund rate from 5.25% to, as you know, at 0% at the present time. But I want to emphasize that this type of monetary policy, already expansionary before Y2K, leading to Y2K because of a misjudgment of the Fed, and thereafter the slash in interest rates after 2001 here, led obviously to credit expanding at a very rapid pace and what a central bank cannot control when they drop their dollar bills into In the room is where the money will flow to, and 80% of the credit creation then flowed into the housing market, led to the housing bubble and allowed essentially households

6:57to refinance their mortgages and use their homes like an ATM and then go and spend that money. So there we have already the impact of easy monetary policies on economic and and Financial Volatility, which was felt before 2000, before March 2000 and thereafter in the housing industry. But I'd like to just focus on this period, September 18th, 2007, to the current time when the Fed slashed interest rates, because what then happened is actually quite interesting. And here I have to go back somewhat in history. Commodity prices, they move in very long-term cycles. As you know, they had kind of bottomed out, or the great Konratyev cycle had bottomed out in the 1940s.

7:54And then commodity prices had a rising tendency, and the rise then accelerated in the 1970s, With oil going from $3 a barrel to close to $50 a barrel on the spot market and gold from $35 to $850 in January 1980. After January 1980, commodity prices then were in a long-term bear market that lasted more than 20 years. And they bottomed out basically here in 1998 and again in 2001. In 2001, and then this is the price of oil, commodity prices started to rise, partly driven of course by the incremental demand from China and also partly driven by the fact that as prices had gone down for 20 years, hardly any new investments in new production facilities and capacities had been undertaken. So prices went up and then they peaked here in May 2006 Oil prices fluctuated sideways around the $70-$75 a barrel until September 18, 2007, when the Fed slashed interest rates, the CRB index and commodity prices went ballistic, oil from $78 to $147 in July 2008.

9:24But as you remember, officially the US economy had begun to recover in November 2001, but then officially also it went into recession in November 2007. In other words, there was a slowdown in global demand for commodities in the second half of 2007 already and certainly in the first half of 2008. So the only reason commodity prices went ballistic were the artificially low interest rates by the Federal Reserve that drove speculation. And the impact, and I always say, monetary policies have frequently unintended consequences.

10:12One of them was obviously that the crude oil outlays, the expenditure for oil in the US, in other words, what the consumer pays for oil, went up very strongly. They had reached a low here of around $75 billion annually in 1998. That was what the US spends on oil. Then they had risen to 500 billion dollars here in 2006. But when the Fed slashed interest rates to zero after September 18, 2007, the outlays doubled from 500 billion dollars to close to a trillion dollars. That was an additional tax on the consumer. I'm not saying this is the only reason that the consumer went into recession, but whereas the Fed tried to cushion the downturn with lower interest rates, the lower interest rates produced a tax increase in the order of $500 billion, which is quite substantial on a $14 trillion economy.

11:17So, all I'm suggesting is that monetary policies and any intervention by the government into the economic system can have numerous unintended and frequently unforeseen consequences. I mean, you're all familiar with total credit as a percent of GDP, but I have to show this figure once again for several reasons. First of all, Mr. Krugman published last September an article, 7,000 words, in the New York Times entitled, How did economists get it so wrong? The title should have been, How did I, Paul Krugman, get it so wrong? But the interesting part of the article he discusses, all the economic series, half a sentence is devoted to the Austrian School and Schumpeter in a rather negative way.

12:12in a rather negative way, but basically he doesn't mention in even one sentence the word excessive leverage or excessive credit growth. Then on January 3rd in Atlanta Mr. Bernanke has a speech on monetary policy and the housing bubble and Fred Sheehan later on can give you all the details and the quotations, Growth, but the point again in 8,000 words, not a single mention of excessive credit growth leading to monetary and economic instability. And I think it should be clear to anyone if you look at the figures of debt to GDP, the Great Depression was preceded by rapid credit It grows as a percent of the economy, but in 1929 debt, total debt to GDP was only 186 percent.

13:09It then went up in the depression because GDP collapsed. And as you can see, afterwards there was a period of deleveraging and even in the 50s we had essentially debt as a percent of the economy contracting. In other words, the economy was growing at a faster pace than debt. Also to be remembered when the U.S. went into the Second World War, debt to GDP was only 140%. After 1980, debt to GDP begins to expand at a rapid clip, especially after the appointment of Mr. Greenspan, another academic genius. And then, under Mr. Bernanke, it explodes on the upside. Between 2000 and 2007, total credit increases at five times the rate of nominal GDP growth, and is now at 379%.

14:04I have to stress that the difference between 29 and today is not only total credit as a percent of the economy being today much higher. In 29 we didn't have Social Security, we didn't have Medicare and Medicaid and the unfunded liabilities about which I shall talk in a second. So in my opinion, and this is important to understand in terms of your investment allocation, In my opinion, for as far as the eye can see, the Federal Reserve will never again implement tight monetary policies. They will print and print and print. And of course it will not always work. But the point is, they cannot really afford to have a debt deflation in a credit-addicted economy.

14:53So they're going to print and that will have implications on the value of different asset classes and of course also on the long-term value of paper money or the US dollar specifically. Now it is important to understand a little the philosophy behind US monetary policies. Mr. Greenspan and Mr. Bernanke, they claim they can't identify bubbles But 15 months ago Mr. Greenspan wrote an article in the Herald Tribune that Spain had a housing bubble and three months ago he wrote about Shanghai having a housing bubble. So in Shanghai and in Spain he could see it but not in the US. But never mind.

15:40So they say we can't identify bubbles, but if a bubble bursts, we can take extraordinary measures and drop dollar bills onto the United States, which they will not do. But in this room, I can print money by dropping bills onto you. Electronically, I can credit each account of yours with a million US dollars. So the government that is intent on printing money, they can print money, that should be very clear, especially if they don't care about credit growth and if they don't care about deficit. Let me remind you that again a week ago an economist at the University of Texas, James Galbraith, wrote in an interview, said that deficits don't matter. The very week the crisis happened in Greece. Well, with that kind of mentality, obviously, you will have eventually credit problems in the system.

16:36Now, okay, the Fed says we can't control credit bubbles, but each time a credit bubble bursts, we can essentially, or we can't control asset bubbles, but we can take extraordinary measures. and this they've actually actively done essentially for the last 20 years the SNL crisis, the tequila crisis, LTCM, the bailout of LTCM by the way was a huge mistake because it gave a green signal to Wall Street leverage up there is a Greenspan put and after 2006 when Mr. Bernanke became Fed Chairman people said yeah there's a Bernanke put as well with a higher striking price so this is This is essentially what has happened and the Federal Reserve then also says, oh we target core inflation.

17:23Core inflation for any economist is a very incomplete measure of inflation because it doesn't include food and energy. Now looking at the dining room today, I think that most people eat and that most people need money for transportation, Maybe the Federal Reserve employees don't. So all I'm suggesting is that the Fed essentially targets a very narrow measure of inflation. Now, they had a very fortunate condition for the last 25 years in their monetary policy, which I'd like to summarize as follows. I mentioned earlier on that commodity prices had bottomed out in the 1940s and thereafter had a rising trend until 1980.

18:17Thereafter commodities were in a bear market until 1998-2001 when they bottomed out. Now, interest rates within the Kondratiev wave follow the commodity cycle very closely, and I have to stress the Kondratiev is not a business cycle, it is a price cycle. So when commodity prices go up, interest rates go up, as happened here between the 1940s and 1981, thereafter they went down. In the 1940s, interest rates on long-term treasuries, the 10 years note, had bottomed out at less than 2%. There were still 2% in 1949, 4% in 1960, 6% in 1970, and then they went to a surprisingly high 15.84% on September 21, 1981.

19:151981. That was a landmark high for interest rates and thereafter as commodity prices went down interest rates also came down. And this is now the big question. We have been in the bull market in 1981 and here is the low so far, December 18th, 2008 and now as you know Interest rates backed up again from the 10 years which bottomed out at 2.08% and the 30 years at 2.53% we went up on the 10 years to close to 4% and recently interest rates have backed down again somewhat. Now this is the big question, the deflationists will maintain that interest rates here will go down back to below 2% again on the 10 years and that the 30 years will go back down to say two and a half percent and the inflation is like myself we believe that after this long term down cycle in interest rates we are somewhere here in a major low area for interest rates and that from here onwards will go up and in my view will go up very substantially because I remember when I joined Wall Street in 1970

20:40There were actually the original Dr. Doom, who was Henry Kaufman of Salomon Brothers at that time, and he was called Dr. Doom because he was forecasting higher interest rates and bonds to go down in price. And there was even a Dr. Tess Alvordtchenilower, he was at First Boston, and he also predicted interest rates to go up, but I can assure you, in 1970, nobody dreamt that interest rates could go up here from 6% on the 10 years to 15.84%, nobody. And so I think the likelihood that at some point interest rates will be much higher for reasons of the increasing federal deficit is very high, this possibility.

21:32Now, that will have an impact obviously on asset inflation because as long as interest rates fell here in this period, 1980 to 2008, when a bubble burst and you printed money didn't lead necessarily right away to inflation, that may be different going forward, it could lead to rising inflation and rising interest rates. I'd also like to mention that even if we were successful in implementing hard money, we could still have bubbles. Say, in this room it would imply hard money, that the supply and the quantity of money is limited. Say, we would have a gold standard, but if someone discovered a major mining deposit over here, Here say like in California at the middle of the 19th century, then money would flow from the back of the room and people would flow from the back of the room to take advantage of this new found profit opportunity there and therefore, prices over there would have a rising tendency, there would be a bubble like railroads or canals, but because the money would come out of the back of the room, there would be deflation at the back of the room.

22:51So, if you look at the bubbles of the last 200 years, usually they were concentrated in one region of the world, or in one sector of the economy, like the TMT sector bubble in 2000. It wasn't the stock market bubble, because shipping stocks were depressed, oil stocks were depressed, mining companies were depressed, all the old economy stocks were depressed. It was just the NASDAQ and technology media telecommunication stocks that were in cuckoo land. So also Japan, 89, we didn't have a commodities bubble, we didn't have a US stock market bubble at that time. All I'm saying, bubbles can occur even under constant money or sound money. But the lifetime achievement of Mr. Greenspan and Mr. Bernanke is really that they created a bubble in everything.

23:45I mean, if you look at 2002 to 2007, everything went up. Stocks went up, commodities went up, surprisingly also bond prices went up, in other words, interest rates continued to go down. and art prices went up, real estate prices and this globally, everywhere in the world it happened and there was only one asset class that went down here 2002 to 2007 and that was the US dollar then 2008 something very interesting happens, the US dollar is strong and everything collapses and then we come to major turning points and again this is a big question for investors October 28, 2008, the Chinese stock market bottoms out, the resource sector stocks and several industrial commodities bottom out in December 2008, the dollar peaks out at the end of February 2009, and the stock market bottoms out 666 on the S&P on March 6, 2009, and from there onwards, all asset prices go up again, but the dollar is again weak until recently.

25:02Then after November 25, 2009, the dollar begins to strengthen, the euro peaked out at 151 at that time, November 25, 2009, dollar starts to strengthen and it's then followed by renewed weakness in asset markets recently. So this is a very important relationship to understand, weak U.S. dollar is a symptom of expanding global liquidity and a strong U.S. dollar is a symptom of tightening global liquidity, not necessarily induced by Federal Reserve and other central banks' action, but by the marketplace. Now, the Federal Reserve, of course, they love to see these asset prices go up. That's what they want to engineer.

25:49The problem is, this time around, that unlike previous recessions post-Second World War, like 1973, 1974, 1981, 1982 and 1990, when home prices dipped briefly because of California, this time around home prices went down significantly. Of course, the Treasury and the Fed will say, oh, the problem is home prices went down. But I want to tell you something. After 1997 in Hong Kong, home prices went down by 70%, 7-0. None of the major developers went bankrupt. Very few households went into foreclosure. Why? Why? Because the difference is the level of debts that is in the system. Here in the U.S. in the 1950s, homeowner's equity was still 80%.

26:41If someone bought the house for a million, it didn't exist at that time, but say for $100,000, then he had $80,000 equity and in the 1974, 1982 recession, it was still 70% homeowner's equity. Now we drop to something like 40%. That is the problem, the leverage in the system. But that escapes the attention of the Federal Reserve. Now, I mentioned earlier on when the Federal Reserve increased the interest rates from 1% in June 2004 in baby steps to 5.25%, that there was never any monetary tightening occurring.

27:26The reason I mention that is if you look here at credit growth in the system, in the June 2004 quarter it was running at 7% annually. Then as they increased interest rates, credit growth accelerated from an annual rate of 7% to an annual rate of 18% as they were moving up interest rates. But, I mean, you have to ask yourself what they were smoking at the Federal Reserve, because, I mean, they couldn't see that this accelerating credit growth, as interest rates were going up, would not be sustainable, when actually a lot of private sector economists, some of who are even here today, like David Tice and others, pointed out that this was, of course, unsustainable and lead to a major bust, Now the private sector, post 2007, acted rationally. The banks tightened lending standards and individuals tightened their belts and spent a little bit less money and so the savings rate went up and credit growth slowed down and on the private sector it turned negative.

28:45But obviously, in a credit-addicted economy, a slowdown in credit growth is of course poison. That the Federal Reserve knows. So what has happened over the last two years is this. The private sector contracts now, decreases its credit growth and contracts it. Private credit growth is at the present time negative. Government, on the other hand, increases credit growth through fiscal deficits and monetization and then you end up with a situation that leads to the kind of economic volatility we have. 2008, the private credit growth contraction exceeds the government credit growth expansion so asset markets tumble.

29:36March 2009, the credit growth by the government begins to exceed the credit growth contraction by the private sector and asset prices go ballistic with stock markets around the world going up between 80 and 120% and some individual stocks going up five times. And then recently the private credit growth contraction exceeds again the credit growth expansion by the government and asset markets run into some indigestion period. The question is when will they again print money and when will government credit again exceed private credit growth contraction?

30:22I think it will happen but some people disagree with me. But in any event, what I'd like to really emphasize, for us to make any forecast how the world will look like in three or five years, beyond saying it's going to be a roller coaster ride is impossible. We don't know. That is for sure. But it will be a roller coaster. Number two, we have to rethink what is a safe asset. Here you have essentially liquidity as a percent of market capitalization. Now as you know under normal conditions, normal conditions meaning a non-inflationary environment, people will essentially regard cash or investments in treasury bills as the safest.

31:14Then longer-term government bonds, then corporate bonds of different qualities, and then equities, more volatile, then growth stocks and more speculative stocks without any dividends, even more speculative. Commodities are probably the most volatile because they have no cash flow. But in an environment such as we have today, and let me explain to you what I mean by that, Mr. Gregory Mankiew, of course an economist at Harvard, but he represents very well the views of the Federal Reserve, in particular the views of Ms. Janet Yelton, who is now the vice-chairman at the Fed. He says, and he wrote an article in the Wall Street Journal a year ago, the problem is that people are saving money instead of spending it, and we have to get these bastards to spend it again and to essentially get the economy going.

32:16So, how do we do that? He says, well, the easiest way is to introduce negative interest rates. So, in other words, all of you, you go to the bank, you deposit $100,000. In a year's time, you only get back $90,000. Well, he says, well, the problem with that is people will take that money out of the banking system and cash it into bank notes and put the bank notes under the mattress. The selection of the bed will be very important in this case, but in any event he says, well, if they do that, we have a remedy. We can have a lottery once a year and declare, say, 10% of all banknotes to be invalid. So if you have bad luck and you sleep on the wrong bed, maybe you lose all your money, but on average people would lose 10% of their banknotes that would be declared worthless.

33:10The problem in implementing that is that people will then take the money and convert it into foreign currencies or into gold and silver. The easiest solution is to just create inflation of 6% per annum. That is the frame of the mind of the Federal Reserve. And I can assure you, as far as the eye can see, the Federal Reserve will keep interest rates at zero, precisely zero. And by zero I mean 0% in real terms. They could be at 5%, but if inflation is 10%, you'll still have interest rates at minus 5% in real terms. And if interest rates like in Zimbabwe are at the thousand percent and inflation is at the million percent, then they're still highly negative in real terms.

34:00And when this happens, when interest rates are negative in real terms, what is the worst investment? Cash is of course a bad investment, becomes a very risky investment, except for brief periods of time like 2008 and the last two and a half weeks. In general, cash becomes a bad investment. The second worst investment is of course long-term government bonds, because if interest rates are negative in real terms for a sustainable period of time, you can be sure that inflation accelerates at some point in future. On the other hand, equities are an avenue to preserve wealth. They are very volatile, but essentially they are less risky than probably cash and government bonds. Of course, then you also have precious metals.

34:51But it's important to understand that this is the view of the Federal Reserve to keep essentially interest rates at zero for an extended period of time. of Time. And they'll cheat the public, they may increase at some point the interest rate, but the cost of living increases at that time will be much higher than the level of interest rate. In fact, actually a condition that has existed since 2000. The cost of living increases were much higher than the interest rates up to this very day. Now I have to also mention one point. You may have noticed that I'm slightly critical about US monetary policies but again they have had an unintended and very favorable consequence but not favorable for the US. Let me explain. Here you have the US trade deficit and as you can see the trade deficit of the US widened somewhat in the 1990s but not by much. I also Also I have to mention here at this stage that the Chinese pegged their currency against

36:01the US dollar in 1994 at one US dollar equals 8.28 RMBs and that for the first 10 years actually not much happened in terms of imbalance with China over the first six years. But here After 1998 obviously something changes. The expansionary monetary policies ahead of Y2K and especially after 2001 that created the credit bubble, lifted home prices, allowed the refinancing boom, homes to be used like an ATM and the consumer to take money out of the Homes and go and spend it. But because of economic policies in the US that are not particularly capital spending friendly, the capital spending didn't occur in the US nor the industrial production. So you have spending in the US and industrial production elsewhere.

37:06And so the trade deficit goes up and the current account deficit also goes up from annually $150 billion here in 1998 to over $800 billion annually in 2006-2009. It's contracted recently somewhat but not by much. Now, the U.S. consumed, over-consumed, all the statistics show that consumption in the U.S. went way above trend line. This was met by industrial production Production overseas, in particular in China, and that drove industrial production in China and it also drove obviously employment, capital spending and the exports then flowed to the United States.

37:55But what I want to emphasize is that monetary policies in the U.S. have been a catastrophe for the U.S. itself because they didn't lead to industrial production growth and capital spending over the next 10 years or employment gains. There are less people employed in the U.S. today than 10 years ago, but it led to a boom in emerging economies. And because of the Chinese incremental demand to meet the demand from the United States for its consumption, the crude oil outlays and this does not only apply to crude oil but also to other commodities went up. Now we have to think 1980 to 2001 commodity prices go down. So the resource producers of the world produce and sell is going down in price.

38:43So, the buying is still going up in price because we had this inflation but not deflation. So, we call that a worsening terms of trade. After 2001, the outlays in the world for crude oil and also iron ore, copper and agriculture commodities go up substantially because price increases and demand increase. And so the world, instead of spending just 500 billion dollars as in 1998 for crude oil, now suddenly spends in the summer of 2008 4 trillion dollars. You have to see what change that meant for the resource producers of Latin America, Africa, Central Asia, the Middle East and Australasia.

39:29That was a huge bonanza, and so these countries went out and could buy consumer goods, expand their capacities and bought capital goods, and we had a global boom. And this has meant, I'm not saying that US monetary policy were only responsible for a shift in the balance of economic power in the world, But they certainly accelerated it. For the first time ever you have car sales in emerging economies exceeding car sales in the US, Europe and Japan. And car sales in China exceed now US car sales substantially. They may be subsidized, they are correct, but you can see the trend is clearly up and here the trend is at best flat and here they were also subsidized by the way.

40:18And also importantly, the oil consumption in emerging economies for the first time exceeds oil consumption in the developed world, here, and also the oil consumption in emerging economies is still growing, whereas in the developed world it is contracting. I'm only mentioning this because I think in the Western world people still look at emerging economies as being their poor cousins. Yeah, it is true that the GDP per capita of India and Vietnam is $1,000 per annum and that we in the Western world have GDP per capita, I don't know, $40,000.

41:04But, because 80% of the world's population lives in emerging economies, in aggregate the demand is of course huge. In 2009 they sold 120 million new mobile phone subscriptions and mobile phones. These are markets that are not yet saturated and growing very rapidly. And here, just as another example, semiconductor sales in Asia, ex Japan, so as Asia without Japan, are larger than semiconductor sales in the US, Europe and Japan combined. All I want to tell you, yesterday I was sitting next to someone at dinner, he said he's never invested overseas, I can't believe this.

41:49Nowadays, everyone should have at least 50% of his assets outside the developed world. I'm not saying that you have to rush and place your orders with Goldman Sachs to be executed on Monday morning. But I'm saying that in terms of the world, we live in a different world where emerging economies as a percent of the world are now at least 50% or more. In goods market, in many goods market, much more. It is true that the US consumer is still the largest consumer in the world. But let me tell you something about statistics. When you measure consumption in the western world, about 60% of consumption or 70% are service related.

42:35is related. If we just look at the goods markets, cars and mobile phones and TV sets and so forth, then of course in countries like China with 1.3 billion people, you have much larger goods markets than in the US with 330 million people, should be clear. Same for India. Plus, in the western world, the consumer is over leveraged, over 100% household debt to GDP. In a country like Vietnam where only 10% of the people have a bank account, how much leverage do you think there is? There's no credit card. When people buy a house, they go and pay with gold coins or gold bars. So this is a different situation. We have unsaturated markets and we have favorable demographics. The other point I'd like to make about all the deflationist The point of this talk is, if you look at the growth of international reserves from $1 trillion here in 1995 to now $8.5 trillion, that is a symptom of inflation.

43:42It is a clear symptom that there is an excess liquidity in the system. And when the German finance minister says the markets are out of control, I have to say the central banks are out of control In terms of printing money and letting credit growth occur. That is out of control. The markets are not out of control. And by the way, the central banks never say markets are out of control when they go up. They only say when they are going down. So I mean something is wrong in their attitude. Now I have to accelerate this because we are running late. Basically, as I mentioned, I think that all of you have to allocate a larger portion of your assets I'm not saying that you have to do it tomorrow, because I think that we have a lot of social issues that are still impending and a lot of problems will still occur, but in general that would be my idea to shift assets gradually overseas and also to have the custody of assets overseas.

44:51One day you won't be able to get your money out of the jurisdiction you're in. That should be very clear. I'm not only talking about the U.S. there. In Asia, and I'm not talking here about performances of stocks, I think what will drive economic growth is basically a low level of urbanization. In India, there's still 700 million people living in the countryside. In China, urbanization has picked up a lot. A lot is about 20 million people moving to cities every year. That requires the construction of new cities, the infrastructure, the transportation equipment and so forth and so on. So that leads to some inherent economic growth. I'm not saying that stocks will go up because of that, but I think we'll have some growth in Asia longer term.

45:42The other point I'd like to make about this shift in the balance of economic power, it's remarkable how fast it has occurred. If you look at economic history, say the 19th century, the deindustrialization of India and colonialism, at that time it took still four months until You can build a construction of the Suez Canal to send news or people or goods from London to Asia. Now you can do it overnight and you have instant communication and so forth. So one of the consequences is obviously that the industrialization and the shift in the balance of power can occur at a much faster pace.

46:31Just as an example here, you have steel production in China as a percent of world's steel production. From 10% in 1990 to 44% at the present time. Aluminum from 10% in year 2000 to 33% today in 10 years time from 10% to 33%. This in economic history has never happened before and this leads to increased obviously economic and financial volatility and also of course to tensions around the world. Now, I have to return back to the view that the whole world depends on the U.S. consumer.

47:16Here, you have exports of China to the developed countries. They went down as a percent of total exports from 48% down to 38%, Whereas exports from China to emerging economies have gone from 42% here to 48%, but they exclude Eastern European exports and so forth. So if you added those to it, then the exports from China to the emerging world would be 60% of total exports. So yes, the U.S. is still a very large market, but it's not growing anymore. Whereas here the growth to emerging markets is very strong and the world's economic system is now much more China and emerging economy centric than it was before when it was very US centric.

48:11Now, in terms of commodities, China will obviously not stop buying iron ore and copper and oil because on a percentage, on a per capita basis they have very little and their per capita consumption including India is very small, in China two barrels per annum, per capita in India is 0.8 barrels compared to 17 here in Japan and South Korea, So I think it's fair to say that the demand in China and India and the rest of Asia will continue to go up and in the meantime, expenditures on oil explorations have gone up substantially but production is flat and also the marginal cost of getting new oil has been up, it's now around $70 and whereas geologists will debate whether we have peak oil or not peak oil Everybody agrees on one thing, the world consumes more oil, then they add new reserves annually, so essentially the oil reserves, the proven reserves are going down.

49:20And so I believe that over time prices will rather go up. And this is something to also consider. I mean, if someone had shown me the picture of a burning Bangkok a year ago, I would have said, I don't believe it. But it happened sometimes, political events and regulatory changes and social conditions can have a huge impact on asset markets and all I want to say is in the 70s the US was still over 70% oil self-sufficient and now it imports over 75% of its oil requirements And in the case of China, here you have the reserves going down, the production is flat, and here the demand is up, after 1994 they became oil importers.

50:11And so the US and the Chinese are here in the Middle East, obviously because of oil, and you have to see for China, this is a top priority. The U.S. has a huge strategic advantage in the sense that the U.S. can source oil. First of all, they have access to two seas, the Atlantic and the Pacific Ocean, and they can source oil from Canada and from Mexico and Venezuela and Ecuador and from the west coast of Africa and from the North Sea and the Middle East. The Chinese, the Japanese, the Koreans, the Taiwanese, they source essentially all the oil, 95% here from the Middle East, they come here through the Strait of Malacca, and then up here the Vietnamese coast, past the southern tip of Taiwan, and then to Japan and the northern ports of China and Korea.

51:07So, the Chinese are highly vulnerable to an interruption of oil supplies here from the Middle East, whereas the U.S. is less vulnerable, and it's a priority for the Chinese to essentially become oil and other resources sufficient in terms of having secure supplies for the future. So they are building a pipeline here from Myanmar. Of course the American embargo of Myanmar helps the Chinese. And they also have built a pipeline or financed a pipeline in Russia to their border. And they have built a pipeline here into Central Asia, Kazakhstan and for gas to Turkmenistan.

51:54But the point I really like to make is the Chinese, yes, they have access to the East and South China Sea here, but they're surrounded by American military and naval bases and the US has 11 aircraft carriers, the Chinese don't have one, whereby the Chinese have very efficient submarines that can probably sink them all. This is new world techniques, but essentially it should be clear that it's not in the interest of the Chinese to have American bases here, because then they are really encircled with the American bases here in the Pacific. So I think that tensions will go up. The Russians, by the way, have no interest to have American bases here, The Chinese have a long border here with Central Asia, with Kazakhstan, Kyrgyzstan, Tajikistan, even a small border with Afghanistan, Pakistan, and I think eventually it will come to war.

52:59In wartimes you want to own commodities, physical, of course not paper money and derivatives at UBS and Citigroup. and physical, because during war times, when prices go up, tensions increase, prices then go ballistic, Napoleonic War, Civil War, then World War I and then Vietnam. So this is something to consider. The other thing to consider is obviously how will the next war look like. For the last 5,000 years of human history, cities offered safety. I think now the countryside will offer safety. You have to have a house in the middle of nowhere, nobody will drop a bomb on you.

53:46Whereas in the cities they'll poison the water, switch off the electricity, the internet, your credit card, you won't even get home. Do you have quarantines? Because you will be infected and the others don't want to be infected. So if I were you, I would all buy a house in the countryside, far away from any place. The last observation I'd like to make is obviously, I can't, it's a tremendous economic sophism to believe that you can print your way into prosperity. If printing of money and debt growth would lead to prosperity, then Zimbabwe would be by far theividest country, run by Robert Mugabe, the economic mentor of Ben Bernanke.

54:45The other point I mentioned to you earlier when I talked about debt to GDP are the unfunded liabilities. Over the last 10 years, actually the big deficit were the unfunded liabilities that went up. And so the government debt with Fannie Mae and Freddie Mac and General Motors and so forth and the unfunded liability is more like 600% of GDP. There you add the 250% of GDP private credit, then you get something like 800% debt to GDP. I tell you, sovereign credits in the Western world are all bankrupt.

55:31But before they officially go bankrupt and can't pay, they're going to print money and massively so. That should be very clear because that's the easiest way politically to postpone the hour of truth. You postpone the problem to the next president or to the next party or whatever it is, and that, I think, should be very clear. Some people say, oh, they can't print money. As I said, you can send a check to people. to people, you can essentially, when people say, deficits don't matter, I actually wonder, why do people actually have taxes, they shouldn't pay any tax at all, you just finance everything through deficits, it's much simpler, makes everybody much happier. So, I mean, sometimes, I have to say, when I look at the economists in academia, I'm sure they're all very intelligent and that they studied the textbooks, except the wrong ones, and B, they're totally inconsistent in their views. Now, the one thing I want to reiterate about an environment where you

56:44In the late 70s we had a boom in Latin America which came about as a result of rapid credit growth. Credit came to Latin America via the OPEC surpluses that were channeled through American banks into Latin America. And then, after 1980, when the oil price no longer went up, Latin America had a credit crisis, the so-called petrodollar crisis. And the Latin American governments reacted like the U.S. government in the last two years. They created large fiscal deficits and they printed money. So what then happened is this.

57:30The currency, and here I take the example of Mexico. The currency of Mexico collapsed between 79 and 87 by 95 percent. So if you were unlucky and you bought Mexican pesos here, or you were Mexican and you held Mexican pesos here, then obviously you lost 95 percent of your value compared to at the time the US dollar was a strong currency. Now, what was the best way to actually survive this period of rapid currency depreciation? Now, here you have three tables. This is the Mexican stock market in local currency, in other words, in peso terms.

58:16This is the Mexican stock market in dollar terms and this is the performance of the Mexican fund, which is run by a fund manager. Now, in local currency, to make things simple, the Mexican market went as the currency tumbled here. There's an adjustment in stock prices on the upside. If I print money, everything in this room will go up. Some things will go up more than others, but the currency goes down. So as the currency went down, stocks in nominal terms or local terms went up. When we went up, the index from 1000 here in 79 to a peak of 343,000 in 87, then we had the crash in 87, global crash, then we ended up here at 139,000.

59:04So from start 1979 to the end here in 1988, we were up 139 times in local currency terms. In dollar terms, the situation looked different because, as I mentioned, the currency collapsed here completely. What then happened in dollar terms is this. Depending whether you were lucky or unlucky in the first year of 1979 to buy Mexican stocks, You bought them at the high of 70 or at the low of 48 or 45 here and then they went up to 220 in 87 and then closed at 62 here. So essentially in stocks your purchasing power was more or less maintained. You didn't lose, you didn't really make any money but you didn't lose any money.

59:56Cash holders, of course, they got slaughtered and bondholders in local currencies also because the interest rates never really adjusted sufficiently on the upside. So in an environment of money printing, as I mentioned before, cash and bonds are not very desirable, stocks are not perfect, but still they kind of keep the purchasing power alive. Secondly, and this is important to understand, especially if you are, say, interested in gold, by the way, I'd be interested in this room. How many of you own physical gold and not just a few gold coins inherited by your great grandfather? Gold. Gold. Yeah, this is, I mean, a reasonably high percentage, very bearish people in this room, but I can assure you, normally at conferences, if say three to five percent of the audience owns any gold, that's about the maximum, and most people not a meaningful position, but anyway, I'm mentioning this because in an environment of money printing, and as we have, I mentioned the high volatility monetary The following is important to understand. Here, 1979 to 1984, the currency collapses at a faster rate than the stock market goes up.

1:01:27And the result was that therefore as the currency collapses more, then stocks go up in nominal terms or in local currency terms, that in dollar terms your market went down here from a peak of 1779 down to 5 in dollar terms in 8283. By the way, this is very well described in The Economics of Inflation by Bresciano Turroni. I think it's also on the website of the Mises Institute, finally. So, in this period of time, you didn't want to be in Mexican stocks. You wanted to be in US dollars or whatever other assets in the world. But once the currency depreciation had exceeded for an extended period of time the appreciation of stocks, stocks became incredibly undervalued here in the 84, 82, 83 period.

1:02:26At that time you should have moved back from dollars into Mexican stocks and then ridden the Mexican stock market rally from 5 to 220 because after 83 stocks went up more than the currency depreciation. In other words, you can't be too dogmatic today. You have to shift your assets from time to time. I'd like to also mention, I hope this is very clear, at times the currency depreciation exceeds the appreciation of local company stocks in local currency. You don't want to be in that market, but at times the stock market in local currency in any country will go up more than the currency depreciation, than you want to be in those markets.

1:03:17I'd just like to mention Mexican stocks started at 10 and then it ended at 7 and it went down in the meantime to 1.72. It underperformed everything because it's run by fund managers. Now, I mean, I'm not overly bearish on stocks. I'm very bearish about everything. I think you're better off in stocks long term for the next 10 years than in cash. We had a negative return over the last 10 years, usually there after you have some kind of positive return of, I don't know, 7 to 8% per annum. The Asian markets are unusual in the sense that the Nikkei was in March 2009 at a 30 years low, same level then in 81.

1:04:05If the S&P went to the 81 level we would be at 120. South Korea, Taiwan were at 20 year lows. If the S&P was at 20 year low we would be at 300. So I think that in Asia we had very low valuations and in the case of Japan we have essentially bond yields, I mean stock yields higher than bond yields. So I think that some Asian markets from a longer term perspective are reasonably attractive. As I said, you should have a piece of land in the countryside. Agricultural commodities are now very depressed. They are probably the most attractive commodities longer term. And as always, I would continue to accumulate some gold.

1:04:50I don't think that gold will always go up and that meaningful corrections cannot occur, but we have to distinguish between smart guys who know how to trade and buy at the low and sell at the high, like Goldman Sachs that had a profit in every single trading day in the first quarter of this year. This year simple people like me prefer to just hold some gold because I'm mindful the central bankers are going to print money no matter they have no other option and when it doesn't help the economy will tank and the people that advance the argument of output gap, I tell them why don't you go to Zimbabwe and you look at the output gap in Zimbabwe and tell me whether output gap and inflation is not compatible? Yeah, sure. I mean, particularly weak economies will have high inflation because in strong economies you don't need to print money. That is the difference. You don't need to have a fiscal deficit. So these are some

1:05:59investment themes. Healthcare, we have very low healthcare expenditures in Asia as a percent of the population, about 1% of what they are or will be in the United States. Then gold and silver bonds, I think they may rally for three months, that have no problem, but I think after 20 years bull market in bonds, I think that the bull market is pretty much at its end or has, as I believe, ended on December 18, 2008 and that from here onwards will have higher interest rates. Banks in Asia are relatively safe because they didn't buy a lot of CDOs and so forth. They didn't understand them. And the traffic was too heavy for the Lehman salesmen to get to the banks. I think the final crisis will happen and you know you can just postpone a crisis but eventually you have a major crisis and I really believe If 2008 the financial system went bust, next train station will be when governments will go bust, and I think in the western world they'll all go bust.

1:07:10Before they go bust, they'll print money, and they go to war, so everything will be, and all of us will be doomed. Thank you for your attention.

1:07:31www.fieggen.com