Richard Duncan: The market’s next tipping point is almost here

“‘The Fed knows credit must expand, or we have a depression. And today, debt levels are so high that a depression would be catastrophic. The disaster would be worldwide, not just in the U.S. And people would die.” –Richard Duncan in The Crux

Welcome back to the Stansberry Radio Interview Series.

As you know, every Saturday, the Stansberry Radio Network brings you the most valuable ideas from the most intriguing guests from all of our shows.

This week, Porter Stansberry interviews best-selling author and global economist Richard Duncan.

Richard is the chief economist at Blackhorse Asset Management in Singapore and the publisher of the quarterly video newsletter Macro Watch. (He’s graciously offered a 50% discount to our readers. Just use the promo code “Stansberry.”)

Porter says Richard is one of the smartest guys in the world about the ongoing debt crisis… “He’s exactly the guy that you’d want to talk to understand how all this is going to end up, where is all the money going to go, and how are we ever going to repay any of the sovereign debts that we have outstanding.”

In the following interview, Richard explains what he sees as the next important tipping point in the markets… And that if we want to make money, we have to anticipate it. To get his prediction, read on…


David Newman
Senior Producer
The Stansberry Radio Network


Originally aired on the Stansberry Radio Network, June 19, 2014

Porter Stansberry: Joining us today on Stansberry Radio is Richard Duncan. Richard is the author of three books on the global economic crisis. The first was The Dollar Crisis: Causes, Consequences, and Cures [2003], and that explained why a worldwide economic calamity was inevitable given the flaws in the post-Bretton Woods international monetary system. It was an international best-seller.

The next book Richard wrote, The Corruption of Capitalism [2009], described the long series of U.S. policy mistakes responsible for the 2008 crisis. It also outlined the policies necessary to permanently resolve the problems.

His latest book focuses specifically on the role that credit creation has played in this disaster. The title is The New Depression: The Breakdown of the Paper Money Economy [2012].

Richard, welcome to Stansberry Radio.

Richard Duncan: Porter, thank you very much for having me on.

Stansberry: I’m glad we have you on the show this week because there has been a very significant change in global liquidity. I’ve seen it watching emerging markets. And Richard, you watch the Fed and you watch credit and liquidity better than anybody I know. So, can you tell us what’s going on? What’s changing in the markets?

Duncan: Well, I think we’re just at a very important tipping point now between the second quarter and the third quarter. In the second quarter, there’s been a tremendous amount of excess liquidity. I’ll explain that in just a second, but the excess liquidity I believe is the reason that the stock market’s at an all-time record high and that bond prices have been moving higher and pushing the bond yields down on the ten-year government bond. It went down to 2.4 percent a couple of weeks ago, shocking almost everyone and confusing almost everyone as well.

But I think this can all be explained by excess liquidity. What I mean by that is in the old days, we used to talk about “crowding out.” Back when there was only a limited amount of money – when gold was money – if the government borrowed a lot of money it would push up interest rates and crowd out the private sector. But what we’re seeing at the moment is exactly the opposite of that.

You could call it “crowding in” because the Fed, even though it has started to taper quantitative easing, in the second quarter it’s still going to create $145 billion and pump it into the financial markets. Meanwhile, because Americans pay taxes in the second quarter, the government won’t have any budget deficit whatsoever in the second quarter. In fact, they’re going to have a very big budget surplus. So you have the Fed pumping in almost $150 billion, and the government’s not borrowing anything. In fact, it’s probably going to take a surplus and pay down its old debt. So this is creating a big liquidity surge that’s now driving asset prices up.

But all of this changes in the third quarter. In the third quarter the Fed will only print $85 billion, and then the government will be back borrowing again because they’ll have a big budget deficit to finance in the third quarter. So this excess liquidity that we’ve been enjoying not just in the second quarter, by the way, but for many years, it’s going to evaporate in the third quarter.

I believe that when it does, interest rates will start moving up again on the ten-year government bond. That will make property prices start to drop. The stock market will sell off. The net worth that has been rising rapidly thanks to quantitative easing will go into reverse. Consumption will weaken, and the U.S. economy will start moving back toward recession. When it does, I believe the Fed is going to jump in again with another round of quantitative easing to push everything back up again.

Stansberry: I just wonder, what would precious metals prices do if there was a sharp selloff in the stock market, a sharp decline in bond prices, a spike in bond yields, and the Fed came in and said, “Okay, we’re going to go from quantitative easing at the peak of $85 billion a month, and now we’re going to make it $100 billion a month, because we’ve got to – there was a sharp selloff, and we have to completely stop the fear in the markets”?

I’ve been expecting a huge move in gold and silver for years, and we haven’t seen it despite the round after round of quantitative easing. I think that there is a big move coming because I just can’t understand how all this debt is going to get paid.

Richard, when you look at the numbers in the United States, and you can correct me if I’m wrong, the tab now on the federal debt is approaching $20 trillion. If you put that on a real taxpayer basis, it comes down to about a million dollars per taxpayer and that doesn’t compute.

What’s the long-run endgame? There could be, as you suggest, a liquidity crisis later this year, and of course the Fed would print more money and the Treasury will borrow still more money. But how does this all get resolved? How does the world go from being awash in paper money and credit to being a place of sound money and sound debts?

Duncan: Porter, here’s my experience. I’ve been in the investment industry for more than 25 years now, and I had a very formative experience. I was in Thailand during the early 1990s watching the Thai economy blow into a great economic bubble. It was clear that this bubble was growing and becoming very destabilizing, but I could see that many years before the bubble actually popped. So had I been very, very bearish on the Thai economy. I was bearish, and I was wrong.

What I learned from that is that you can see bad things happening at some point in the future, but if you want to be practical about it and make money, well, you have to think what’s going to happen next month and next quarter and next year, not five  or 10 or 25 years from now.

So those obligations that you mentioned that put the U.S. government debt at $20 trillion, well, that’s certainly true if you’re looking out 30 years and counting all the pension obligations. But the situation we’re facing right now is the government’s current debt is roughly the same size as the economy, about 100 percent of GDP, and the U.S. GDP is $17 trillion. So we’ve got about 100 percent debt to GDP, and there’s nothing in the near term that would stop the government from being able to issue more debt if it wants to.

Now in the past, again, it was much more difficult because there was only a limited amount of money. Gold was money, and the dollars were pegged to gold. But once we broke the link between dollars and gold, it made it even easier for the government to increase its level of debt because the Fed can simply print money now and buy government bonds, which is what has been happening since this crisis started in 2008. In the past, that wouldn’t have been possible because all of the paper money creation led to very high rates of inflation. That would been completely destabilizing and unacceptable.

But something else has changed. Now we have globalization, and globalization is extremely deflationary. That’s because it’s driving down wages radically. You no longer have to hire someone in Michigan and pay that person $200.00 a day to build a car. You can hire someone in India and pay that person $5.00 a day to build your car. So this represents a 95 percent drop in the cost of your next worker.

This extreme deflationary pressure is completely offsetting all of the inflationary pressure caused by the Fed’s fiat money creation. It’s creating a kind of nirvana-type moment where it is possible – as we have seen over the last five years – for our government to borrow and spend trillions of dollars it doesn’t have and to finance that with paper money creation on a trillion-dollar scale without creating high rates of inflation in the short-term. Being practical about it, there is nothing to stop this from continuing for the foreseeable future, and by that I mean probably the next five to ten years… and perhaps even longer.

If you look at Japan, for instance, Japan’s crisis started 25 years ago, and Japan has taken its government debt from 60 percent of GDP all the way up to 250 percent of GDP. That’s how they’ve stayed out of depression for 25 years, by massive government borrowing and spending to stimulate the economy and keep the bubble there inflated. Very likely, we’re going to do the same thing. So I don’t think this is going to end within the foreseeable future, and if we want to be practical about it and make money, what we have to do is anticipate what the government is going to do next.

Here is what I think they will do…

Once this liquidity starts drying up in the third and fourth quarter and asset prices correct, then the Fed’s going to have to jump in with another round of quantitative easing, “QE4.” We number these 1, 2, 3, and 4 because they keep happening again and again. When QE1 ended, the economy got weak and the stock market went down. Then we got QE2, and the same thing after QE2. I expect the same thing after QE3, and if I’m right, this is really going to take the market by surprise… no one seems to be focusing on that possibility at the moment.

Answering your earlier question, I do think it will push precious metal prices considerably higher when the announcement of QE4 is released.

Stansberry: I think it would be absolutely shocking to the market, and I think the repercussions in the precious metals market would be massive.

Richard, I agree with everything you said. To me what seems to be the most destabilizing thing is the difference between wages and asset prices. You’re right – globalization has led to a sharp decline in wage opportunity in America. There’s a reason why something like 40 percent of able-bodied men are not working today, and that’s in part because of the large social safety net and in part because wages are not compelling enough to entice people to work. I’m talking about the dependency ratio. I’m sure you know those statistics.

But what I’m curious about is, do you think that the unintended consequence of these Fed policies is that asset prices continue to be inflated while wages continue to be depressed, and that is causing a real big spike in what they call the wealth gap?

Duncan: Yes, I think that is right, but there’s no other obvious way that policymakers can keep driving the economy and preventing it from collapsing into a new depression.

Stansberry: I think it’s a very interesting idea, and I wonder how destabilizing that could be politically.

Duncan: Well, potentially very destabilizing. They say now that the richest 400 families have as much wealth as the bottom 50 percent of the entire U.S. population.

Stansberry: [Laughs] That doesn’t seem very stable in a democracy.

Duncan: No. Well, we’ve had a democracy now for 230-plus years. That doesn’t mean we’re going to always have a democracy.

Stansberry: There’s one other question I really had for you. Looking at Japan as an example, you said their sovereign debts are outrageous. Even so, their currency remains as solid as the dollar or the euro. The big three currencies still today are the yen, the euro, and the dollar.

The Japanese were able to keep their economy mostly out of recession for the last 25 years, mostly, but they weren’t able to revive their stock market with their actions. Meanwhile, in the United States, we’ve not only got the economy out of recession by massive amounts of stimulus, but we have seen the stock markets go to new all-time highs. How did we pull that off?

Duncan: Well, to begin with, the U.S. has had a very big bubble, but it wasn’t as big as the Japanese bubble. In the late ’80s, the first time I visited Tokyo on a business trip, the stock market peaked at 39,000. They were all trading on 100 times P/E multiples plus, and the property market was out of control. People had to take out 90-year mortgages to be able to afford a tiny little flat – three-generation mortgages. As everyone knows, the gardens around the imperial palace in Tokyo were said to be more valuable than all of California. They had just such an extraordinarily large bubble.

Stansberry: I remember all that. So the Japanese stocks peaked at around 100 times earnings, and the S&P didn’t really peak much about 40 times earnings or so back in 2000.

Duncan: Right, and the property prices were never as out of control here as there.

Stansberry: So here’s an interesting question. Do you think it is possible that we just simply haven’t seen the top of our bubble yet?

Duncan: Well… there has to be some connection between how high asset prices can go and the income of the public. If the ratio of wealth to income becomes too out of line, in other words, if asset prices inflate too much relative to the income of the public, then the people simply don’t earn enough money to pay the interest on the debt that they have used to finance the inflated asset prices.

Here is a problem…

I look at the ratio of household sector net worth to personal disposable income. In other words, wealth to income. Now, going back to 1950, this has averaged something like 525 percent over all of those years. But during the NASDAQ bubble, it went up all the way to 616 percent. Then that popped, and it went back to its normal level. Then during the property bubble of 2005, ‘6, and ‘7, it went up all the way to 660 percent. Then of course that popped, and it went back to its normal range.

Now it’s all the way back up to 640, quite near an all-time high, and that suggests that asset prices are moving too much out of line relative to income. So there does to be some limit as to how much longer perhaps the Fed will be able to continue driving economic growth by inflating asset prices by printing money.

Stansberry: That is a very interesting statistic. I had never heard that analysis, but it does make great intuitive sense. I’ll have to go back to the FRED [Federal Reserve Economic Data] database and rebuild that analysis for myself.

Duncan: Yes, that’s where I get it… from the Fed’s flow of funds data.

Stansberry: Yeah, very interesting. I’ll get to work on that. Richard, I want to thank you very much for coming on the program. Folks, I want to again endorse Richard’s quarterly video newsletter. It’s Richard says if you will use the coupon code “Stansberry,” he’ll give you 50 percent off a subscription to his newsletter.

Also, be sure to check out his books. The most recent is called The New Depression: The Breakdown of the Paper Money Economy.

Richard, thanks for being a guest on Stansberry Radio, and I hope you’ll come back and talk to us at some point after the third or fourth quarter, and we can see if your liquidity trap arguments come true.

Duncan: Well, great. Porter, thank you for having me on, and I look forward to the next time.

Stansberry: Very good. Have a great day.

Duncan: Thank you. You too.

Crux note: Richard says one of the hallmarks of a bubble economy is when asset prices rise faster than wages. In a recent edition of the S&A Digest, Porter tested how well this ratio predicted recent U.S. bubbles. He and his team built a chart that measured the last 20 years of U.S. household net worth (assets) versus disposable income (wages). Here’s what it revealed:

This ratio peaked in 1999 and stocks blew up in early 2000. This ratio peaked in 2007, and stocks blew up in 2008. The ratio is now almost to the same point it was in 2007, and it’s higher than it was in 1999. But it hasn’t “rolled over yet.” This tells me that while assets (like stocks, bonds, and real estate) have gotten far too expensive relative to wages in the U.S., they could still go higher before the stock market crashes again.”

To learn more, listen to Richard’s 2013 interview on Stansberry Radio here.

You can also sign up to be a free Stansberry Radio subscriber here, and you’ll get Porter’s podcasts e-mailed to you each week.

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