"Dishonest Money" and Its Consequences

Talking to investors, Marc Faber points his finger.

In the opening speech at the fifth annual Structured Products fair, the legendary investment guru Marc Faber judges the American financial policy and analyzes China’s influence on the commodity market. Faber expects the U.S. debt to double within 10 years. He advises individual investors to split their portfolios into four quarters. One should completely forget about government bonds.

Faber is “nevertheless the expert during difficult stock-market times,” says the moderator about his presentation: Marc Faber, world-renowned Swiss investor and investment expert, especially known as publisher of the monthly stock letter “The Gloom Boom & Doom Report.”

The difficult stock-market times have driven the interested observers in masses into the panorama room of the congress building. Faber is used to such rushes for his presentations, but he “hurts” as a contrary investor. He looks at his audience skeptically. The best investments are mostly found where the objects of investment are ignored by the large masses.

Fatal American debt policy

Faber’s presentation has the title “The Causes and Investment Implications of ‘Dishonest Money.’” The investment guru devotes himself specifically to the American debt policy, which obviously strengthens the volubility of the markets beyond the frame of the normal business cycle.

This shows itself, says Faber, by the short-time measures undertaken by the U.S. Federal Reserve during the last few years, which have a negative, long-term effect. Not only the mortgage sector but the whole American financial system has been “subprime.” When policy experts finally realized this in 2007, U.S. interest rates were set close to zero in no time, a similar reaction to when the technology bubble burst at the beginning of the decade.

Faber explains that, as an investor, one is currently confronted with “de facto” negative interest rates. But it is not that bad. After all, Faber quotes a finance manager who says it would be better to lose 5 percent on bonds than 20 percent on active assets management. In reality, the existing regime punishes the individual saver but forces investors to invest and speculate which caused a sharp rise in commodity prices, Faber explains further.

Who will lose?

Now the question has to be asked: Who will lose? Will it be the commodity investors or those owning government bonds? Faber’s simple answer: Probably both. Low interest rates, especially in the U.S., promote a considerable hike in total debt (i.e. the government debt, compound with enterprise and common households) in relation to the Gross Domestic Product (GDP). The rise of 379 percent in recent years makes even the 1920s pale in comparison (1929 saw an approximate 140 percent rise). The total debt grew five times faster than the economy itself. It seems clear that this trend cannot continue. Quite apart from that, the 379 percent rise does not include the government’s social security responsibilities.

Faber does not see a long-term solution for the Western world other than keeping the money-printing machine going in order to escape bankruptcy. A curbing of expenses, especially social security expenses, is unlikely. At any rate, the big problem with democracy is that the politicians who cut social security don’t get re-elected. Faber figures that the U.S. debt will double to $30 trillion in the next 10 years.

Inflated commodity prices

Faber further points out that the low interest rate environment and freshly printed money led to a massive inflation of commodity prices. This cyclical trend and its tendency was seen in the price of oil, which had already peaked at $147. The current monetary policy, the rising commodity cost and the lowering of wages are widening the income gap and will consequently lead to social tensions.

Faber does not hold back on his criticism of the Fed. Ben Bernanke and Alan Greenspan are said to have decided to let it rain money over the U.S. “from the helicopter,” in order to weaken the bursting of the bubble and to supervise the creation of a new bubble as a result. The only question would be: Where? The Fed could not control this. Aside from that, American money was flowing mostly into consumerism. While other countries, especially emerging markets, invested their money, the U.S. real estate bubble allowed American households to live way beyond their means through re-financing of their own homes.

The West was wrong

Investment activity has shifted to emerging markets, mainly to China. That is where the use of commodities grew enormously, not only through investment, but also through higher wages. Faber illustrates his thesis as follows: “If you double the income of a Swiss who earns one million per year, he/she will not eat significantly more or use the car more. At most, he will use more cocaine.” If a Vietnamese person suddenly earns 1,000 francs more per year, first of all, he/she would purchase a motorcycle.

Above all, such effects drove the energy consumption of the emerging markets up, so that they have overtaken that of the Western world for the first time. The West was wrong in believing it would benefit significantly by the rise of the emerging markets. It has been shown that the emerging markets would again obtain goods chiefly from other emerging markets. Faber sees the heavyweight in the world economy today to be China and other emerging markets.

Four-Quarter-Split without government bonds

How can investors benefit from these developments? Faber is skeptical where a strong engagement toward China is concerned. Even there they reacted to the crises with an expansive monetary policy, which led to an asset bubble. The question is only whether it is going to burst now or three years from now. In any case, the consequences for the commodity markets will be enormous. In the long term, the investment expert is clearly expecting higher oil prices than at present.

For the private investor he recommends a Four-Quarter-Split of the portfolio: 25 percent in cash and corporate bonds, 25 percent stock, 25 percent real estate and 25 percent precious metals. Faber advises to stay away completely from government bonds. This even includes the securely established German bonds where one would have lost all his money three times in the last hundred years: During the hyper-inflation in the 1920s as well as during the two world wars. Siemens enterprise stock obviously did much better in the same time frame.

“There will be war”

At the end of his presentation, Faber touches on the geopolitical issues and flashes the prophecy of doom for which he is well known. He throws the remark at the audience that the Middle East would burst into flames. The reason: 95 percent of Chinese crude oil consumption is covered by sources in the Near East. The Chinese would overthrow the U.S. in the short or long term with their efforts to protect these sources.

This can also be seen by the activities of both superpowers in the Indian sub-continent: While Washington is increasingly looking for ties with India, China is pursuing ever closer ties with Pakistan. There will be war, explains Faber, but surely not tomorrow: “Therefore, you can calmly go home!”