Hera : Euro, M3

Interview: Jim Rogers on Currencies and Inflation

Ron Hera — Fri, 04 Jun 2010 19:26:00 GMT

The Hera Research Newsletter (HRN) is pleased to present the following exclusive interview with legendary international investor, best selling author, adventurer and family man Jim Rogers, Chairman of Rogers Holdings and founder of the Rogers International Commodity Index (RICI). Jim Rogers’ commentaries on economics and finance have been featured in Time, The Washington Post, The New York Times, Barron’s, Forbes, Fortune, The Wall Street Journal, The Financial Times and other major publications, and he appears regularly on television networks around the world.

After growing up in Demopolis, Alabama, and earning degrees from Yale and Oxford Universities, where he studied politics, philosophy and economics, Jim Rogers co-founded the Quantum Fund in 1970, which gained 4200% over a 10-year period, during which the S&P advanced approximately 47%. After retiring at age 37, he managed his own portfolio while serving as a guest professor of finance at the Columbia University Graduate School of Business and as the moderator of WCBS’ “The Dreyfus Roundtable” and host of the Financial News Network’s (FNN) “The Profit Motive with Jim Rogers.”

Between 1990 and 1992, Jim Rogers fulfilled his lifelong dream of motorcycling across six continents in a 150,000 kilometer journey that won him a place in the Guinness Book of World Records. He also undertook a Millennium Adventure in which he traveled around the world in 1101 days, passing through 116 countries and traversing more than 245,000 kilometers.

Jim Rogers’ English language books include Investment Biker: On the Road with Jim Rogers (1994), Adventure Capitalist: The Ultimate Road Trip (2003), Hot Commodities: How Anyone Can Invest Profitably in the World's Best Market (2007), A Bull in China (2008), and A Gift to My Children: A Father's Lessons for Life and Investing (2009).

Hera Research Newsletter (HRN): Thank you for speaking with us today. Let’s start with the world reserve currency. What do you think about the International Monetary Fund (IMF) replacing the US dollar as the world reserve currency with Special Drawing Rights (SDRs)?

Jim Rogers: The world didn’t have an IMF for a few thousand years. The IMF was founded after the Second World War to take care of any short-term currency needs that countries might have. It turned out pretty quickly that they didn’t have very many as the world recovered from the war, so the IMF found other things to do. They now have thousands of employees and have manufactured jobs for themselves. They’ve not had much success, if you look back over the past 60 years. Nearly everything they’ve done was wrong. Why do we need the IMF? It’s not 1945 anymore.

HRN: Rather than using a national currency as the world reserve currency, what about a global central bank?

Jim Rogers: That’s not what the IMF is, first of all, but even if they were, we certainly don’t need a central bank for the whole world. We never had one and the world got along pretty well for thousands of years without bureaucrats taking the world’s money. I’ve never added up how much the IMF has spent during the last 60 years but it must be a staggering amount, and for what good? I mean, we certainly haven’t gotten anything out of it. We haven’t gotten nearly as much for our money as they have spent.

HRN: So, you wouldn’t agree with using IMF SDRs as the world reserve currency?

Jim Rogers: I’m sure the world does need to replace the US dollar. I’m not the only one who knows that. The US dollar is a terribly, terribly flawed currency. The US is the largest debtor nation in the history of the world. Something has got to be done. We cannot continue with a currency which is so deeply flawed and something is going to have to be changed. Special Drawing Rights, I don’t know. It could work. I don’t know what’s going to work. Most people, however, want to have something in their hands that they think they can spend. A Special Drawing Right is pretty amorphous and, while some professors and some bankers may understand them, I suspect that most people in the world will not understand Special Drawing Rights and will not be terribly enthusiastic, if that’s what happens. So, I would suspect it wouldn’t last. You know, I cannot imagine that a Special Drawing Right, which has no real existence, could survive a crisis or two. Human beings just don’t think that way, I’m afraid.

HRN: Would you advocate a commodity-backed reserve currency instead?

Jim Rogers: Reserve currencies can be anything that you want. The problem with paper money is that it’s easy to debase and abuse. As I said, the US is the largest debtor nation in the history of the world. They keep printing the stuff. The UK, once upon a time, had the world reserve currency. They abused it mightily. Eventually the world just said “no, we’re not going to take sterling anymore” and rightly so. So, in my view, that’s the problem with paper money. Now, gold has its own problems too. Gold didn’t survive very long either as the world reserve currency since politicians kept changing the rules. Unfortunately, politicians know how to abuse and destroy. One can think of various and sundry solutions. My only worry is that, no matter what mankind has come up with in the past, politicians have always found a way to abuse it and debase it.

HRN: Do you think a return to the gold standard would constrain government abuse?

Jim Rogers: Well, it never has. The Romans had precious metals as their currency and do you know the term “debase”? The Roman politicians had the brilliant idea that if a coin was 100% pure precious metal, they could slip a little base metal in and, over a couple of hundred years, they went from 100% pure precious metal to almost 0%. That’s where the term “debase” comes from. So, we’ve tried it.

HRN: You mentioned that the US is the largest debtor nation in the history of the world. Do you think that will lead to high inflation or hyperinflation in the US?

Jim Rogers: Well, there will be inflation. First, you have to have inflation before you can have hyperinflation. I mean, we have inflation now. If you go to the shop, whether it’s groceries, or education or insurance or health care, prices are going up for everything. The government lies about it in the US. Some countries lie, many countries don’t: Australia, China, India and Norway. Many countries don’t lie about it and acknowledge that we have inflation. Others lie about it, the UK and the US, but if you go shopping you know prices are up.

HRN: Are you saying that the American Consumer Price Index (CPI) published by the US Bureau of Labor Statistics is a lie?

Jim Rogers: In my opinion, yes, of course it is. Have you looked at it? They’ve changed their accounting several times in the past few decades. When housing was 20% to 25% of the CPI and housing was going up, they didn’t count it, saying rents weren’t going up, and then when home prices started going down, they counted it. It’s the same with many things. It’s staggering some of the tortuous reasoning that the BLS has used over the past 25 or 30 years. When the price of gasoline goes up, they say it’s not really going up because it’s better gasoline, better quality, therefore you’re getting more for your money. I mean, it’s endless, the stuff that they say and for some reason people sit there, although more and more people are catching on, and accept what the government says. As I said, in other countries, they acknowledge that there’s inflation. I don’t know how there could be inflation in Australia and not in the US; how you can have inflation in Norway or India and not in the US, but the US says there’s no inflation.

HRN: An article in the Telegraph by Ambrose Evans-Pritchard reported this week that the US Federal Reserve’s M3 monetary aggregate is estimated to be contracting at an accelerating rate, in other words, deflation.

Jim Rogers: What’s going down in price in the US economy? I’d like to know where you shop. We know home prices are down. Oil prices are down to $73 per barrel, if you’re talking about a monthly or quarterly basis, or even an annual basis. I’m talking about what’s going on in the big picture. Where is the deflation in the US?

HRN: Some people believe a contraction of M3 indicates deflation.

Jim Rogers: Is M3 something you buy in a shop? M3 can lead to changes in the price structure, but M3 is not price inflation or deflation.

HRN: That’s a good point. Inflation is a concern in Europe and the Euro seems to be in trouble. Can the Euro survive?

Jim Rogers: I certainly expect the Euro to be around in 2012 or 2013, but whether it’ll be around in 2023, I don’t know. It’s becoming more and more a political currency. It wasn’t always. In the beginning, it wasn’t a political currency. It was designed to be a rock solid currency, but, since then, it’s become a political currency and most political agreements or political institutions don’t last. No currency union has ever lasted. It’s been tried before. I wish the Euro would survive. The world needs something to compete with the dollar. The Euro, on paper, makes enormous sense, but, unfortunately, the people who wrote that contract back in 1992 are all gone now and the new guys all want to buy votes. So, I would like to see the Euro survive, but, in reality, I don’t see how it can.

HRN: So, you expect more inflation in Europe?

Jim Rogers: Yes. Printing money has always led to inflation, eventually. When things go wrong, governments have always printed money, at least in the last few decades. That’s all they know and they will do it again. There will be times, obviously, when the printing presses slow down or even stop but when things get bad again they start over, and that’s all they know.

HRN: I’ve read that China is experiencing high inflation.

Jim Rogers: There is inflation in China. There are many places that are reporting inflation. It’s dumbfounding to me that many countries have inflation and the US doesn’t. That’s because some governments lie and some governments don’t.

HRN: It’s been widely reported that Chinese real estate is in a bubble. Do you think that’s true?

Jim Rogers: In urban, coastal real estate there certainly was a bubble. That’s not the whole of China. Have you ever looked at a map of China? Do you consider urban, coastal real estate the Chinese economy? Where’s the bubble? Other real estate in China has, for the most part, had very little movement.

HRN: Do you think China’s economic growth is sustainable?

Jim Rogers: Is it sustainable, yes; every quarter, every year, of course not. You know, in the United States in the 19^th century, we had 15 depressions, a horrible civil war, no human rights, massacres in the streets and very little rule of law, and yet, out of that, we had a pretty successful 20^th century. China is going to have many, many problems as they rise. I don’t know what and I don’t know when, but I know it’s going to happen. I don’t see any other country on the horizon that is going to have, long term, a sustainable, good future in the 21^st century.

HRN: You’ve talked about inflation, pointed out problems with the US dollar and the Euro, and described the rise of China. How can citizens of Western countries protect their wealth?

Jim Rogers: Historically, the best way is to own commodities. Throughout history, the way you protect yourself when currencies are being debased is that you own real goods. Whether that’s silver or cotton or natural gas or whatever it happens to be, you own something that’s a real good. As the value of money is debased, some things will maintain their value and some will even increase.

HRN: Investors seem to be turning to gold as a way to preserve their wealth.

Jim Rogers: Gold has been, historically, a good way to preserve wealth, but so have other things as well. I own gold. Gold is making all-time highs. It certainly has been a way to preserve wealth in the last decade. Whether there are better things in the next decade or not, and I suspect that there will be better things, I do own gold.

HRN: You mentioned silver as a way to preserve wealth but gold seems to be in the spotlight.

Jim Rogers: Let’s put it this way, silver is about 70% below its all-time high. Gold is making all-time highs. Often, one is better off investing in things that are down 70%, rather than things that are making all-time highs.

HRN: Thank you for being so generous with your valuable time.

Jim Rogers: Thank you very much. Contact me any time.

After Words

Jim Rogers doesn’t mince words. When a person as remarkably successful and accomplished as Jim Rogers, and having long experience, states that the official statistics produced by government economists and views expressed in mainstream financial news outlets are incorrect, or disingenuous, one must take pause. Objectively speaking, for a majority of investors, views that are at odds with those of Jim Rogers are probably wrong.

According to Jim Rogers, the US dollar is deeply flawed because the US is the biggest debtor nation in the history of the world and, although an alternative currency is needed, the Euro will not survive in the long run because it has become political and IMF SDRs will probably not last as a reserve currency in the face of significant global economic crises. Long-term trends point to inflation and to the sustainability of China’s economic growth, as well as to China’s ascent as a world power. As prices inevitably, eventually rise due to inflation, real goods stand out as a time tested way to preserve wealth and to profit from changing economic conditions. In simple terms, currencies can be printed but real things cannot.

The Ultimate Bubble and the Mother of All Carry Trades

Ron Hera — Sun, 31 Jan 2010 15:14:00 GMT

Among the many opinions expressed by billionaire investor George Soros over the course of the 2010 World Economic Forum in Davos, Switzerland was his statement on January 28 in an interview with Maria Bartiromo, host of CNBC's Closing Bell, that "When interest rates are low we have conditions for asset bubbles to develop, and they are developing at the moment. The ultimate asset bubble is gold." New York spot gold closed at $1085.40 down $1.80, but the price of gold is not as much about gold as it is about the value of currencies, particularly the US dollar.

Since new currency is created through lending activity, very low or 0% US interest rates and government deficit spending are fueling a US dollar carry trade and monetary inflation in the US dollar resulting in rising asset prices and global speculation. According to Zhu Min, deputy governor of the People’s Bank of China, “[The US dollar carry trade] is a massive issue; estimates are that it is $1.5 trillion, which is much bigger than Japan’s carry trade.” The close relationship of global commodity prices, particularly the gold price, to the value of the US dollar can be seen by comparing the changing value of the US Dollar Index to an inverted US dollar spot gold price chart.

^{Chart courtesy of}^{StockCharts.com}

The inverted gold price chart follows the USDX closely and while the fluctuations are not strictly proportional the overall trends as well as the peaks and troughs generally correspond, thus the asset price bubbles noted by Mr. Soros are reflections in asset prices of both the US dollar carry trade (the effective value of the US dollar) and, ultimately, of the long-term devaluation of the US dollar, thus the value of the US dollar in real terms.

^{Chart courtesy of}^{StockCharts.com}

An “ultimate bubble” in gold could be an offspring of the mother of all carry trades, but its magnitude would depend not only on the effective value and rate of change in value of the US dollar while the carry trade is booming, but also on the actual, eventual value of the US dollar (in real terms) after the carry trade has come to an end. Although the value of the US dollar will certainly recover to some degree when the carry trade ends, it will remain significantly lower in value for other reasons.

US Dollar Devaluation

In the above mentioned interview, Mr. Soros went on to say that "Some countries, like the US and European countries have plenty of room to increase their deficits; [although] the political resistance to doing so increases the chances of a double dip [recession] in the [global] economy in 2011 and after that." Since further monetary inflation as a consequence of government deficit spending may be necessary to maintain economic stimulus measures and financial system life support, Mr. Soros anticipates further devaluation of the US dollar. Devaluation of the US dollar will have both beneficial and harmful effects on the US economy.

Devaluation of the US dollar will reduce the value of debts in real terms, reducing the overall debt to GDP ratio of the US economy, and stimulate nominal GDP growth as domestic prices and wages (at different rates) adjust to the altered value of the US dollar, while at the same time helping to create conditions where US banks can resume lending to consumers and small businesses. Unfortunately, currency devaluation also has deleterious effects, such as higher prices, a loss in the value of savings and a reduction in the real value of wages. There is also a risk of uncontrolled domestic price inflation (although prices can be held in check without raising interest rates by curtailing the flow of money and credit to consumers and small businesses).

^{Chart courtesy of}^{Karl Denninger}

In addition to reducing the US debt to GDP ratio, devaluation of the US dollar will lessen the risk of higher interest rates resulting in greater deficit spending by the US government as a consequence of increased debt service ($145.4 billion in fiscal 2009) since it will allow the US federal government’s tax receipts to grow faster than the increase in debt service resulting from higher interest rates.

Currently projected US federal government borrowing (or, alternatively, quantitative easing) will maintain downward pressure on the value of the US dollar through the year 2019. According to the US Office of Management and Budget’s (OMB) baseline projection of current policy, federal deficits will total between $7 and $9 trillion for fiscal 2010 through fiscal 2019 and the US public debt will grow from $12.3 trillion to more than $16 trillion in 2019. Other estimates indicate that US federal government debt will exceed $18 trillion in 2019, setting aside the net present value of unfunded federal liabilities based on Generally Accepted Accounting Principles (GAAP). According to David M. Walker, former Comptroller General of the United States from 1998 to 2008 and current President and CEO of the Peter G. Peterson Foundation, current federal liabilities and unfunded obligations total approximately $63 trillion. As a result, further devaluation of the US dollar is inevitable.

Disparate US Dollar Values

Curiously, the US dollar has two different and diverging values, one within the US financial system and another in the broad US economy. As a result of the US financial system rescue, which included purchases of various assets from banks at book value by the US Treasury and Federal Reserve, the US monetary base has expanded roughly 150% since the beginning of the global financial crisis in 2008, but the newly created currency has not filtered into the broad US economy where, in contrast, deflationary pressures persist.

^{Chart courtesy of}^{Federal Reserve Bank of St. Louis}

Although it is not apparent in the broad US economy, the value of the US dollar has been dramatically altered and its devaluation cannot be isolated indefinitely within the financial system independent of the broad US economy. The counterbalancing, but much smaller, contraction of the broad US money supply, as measured by the M3 monetary aggregate, also cannot continue indefinitely.

^{Chart courtesy of}^{Shadow Government Statistics}

At some point, the two disparate values of the US dollar (that found within the financial system versus that found in the broad US economy) will be reconciled and, unless current policies are reversed, the outcome will be a substantially less valuable US dollar. The consequences of the eventual reconciliation will certainly include price inflation in the US, higher US dollar prices for commodities that are subject to global demand, such as oil and gold, as well as higher nominal values for US dollar denominated assets. However, the potential unintended consequences of a falling US dollar include high domestic price inflation, a further reduction in international demand for US debt or a collapse in demand, a disruptive decline in trade, i.e., US imports, or in the worst case, rejection of the US dollar as the world reserve currency or a hyperinflationary collapse of the US dollar.

Is Gold in an Asset Price Bubble?

Diversification for the purposes of risk mitigation and wealth preservation is a rational response to unstable market conditions and is not comparable to a market mania, like the dot-com bubble. Similarly, a long-term shift in asset allocation favoring one general category of assets over another based on fundamentals, while it may result in rising prices, does not by itself describe an asset price bubble.

An asset price bubble, such as the Dutch tulip mania of the 1630s, is an irrational and economically unsustainable investment trend that holds sway over investors only temporarily and that inevitably collapses violently. Asset price bubbles end when a tipping point is reached where the awareness of and tolerance for escalating risk exceed irrational exuberance producing a panic. So long as the great majority of market participants discount risk, individual participants may rely on the irrational exuberance of others. In contrast, rational confidence does not depend on a majority of market participants behaving irrationally and is based instead on sound fundamentals.

The view that rising global commodity prices, fundamentally, are asset price bubbles in various stages of formation unreasonably discounts the risks associated with financial institutions, governments and currencies. If we are to learn anything from Iceland, the Baltic states, Dubai, and Greece it is that if irrational exuberance exists in the financial markets today it is exactly confidence that is not based on sound fundamentals in financial institutions, governments and currencies.

In the 1980 asset price bubble, gold rose from an inflation adjusted low using constant 2009 dollars of $392.57 per Troy ounce on August 31, 1976 ($104 1976 dollars) to its January 21, 1980 peak of what would have been $2,358.04 in 2009 dollars ($850 1980 dollars), a gain using constant 2009 dollars of more than 500% in 4 years. The 1980 asset price bubble in gold violently collapsed in same year, returning to 1979 levels by 1982.

^{Chart courtesy of}^{Bianco Research, L.L.C.}

On April 4, 2001, the gold price would have been $315.78 in constant 2009 dollars, the lowest value since 1970 adjusted for inflation. From that point, the gold price rose from a nominal low of $255.95 on April 4, 2001 to a nominal high of $1,212.50 on December 2, 2009 (London PM fix), a gain of roughly 375% over approximately 10 years (284% using constant 2009 dollars).

^{Chart courtesy of}^{Kitco Metals Inc.}

Over the past decade, the US dollar has declined from its 2002 high by roughly 33% compared to other major currencies and approximately 40% from is 2000 high compared to the Euro. At the same time, most of the currencies in the major indices have been debased alongside the US dollar since 2008 for the same reasons, thus the value of the US dollar in real terms is not apparent from the index alone.

^{Chart courtesy of}^{Federal Reserve Bank of St. Louis}

The alternate US Dollar Indices published by Shadow Government Statistics (SGS) suggest that the Federal Reserve’s trade weighted exchange index of major currencies, which includes the Euro zone, Canada, Japan, the United Kingdom, Switzerland, Australia, and Sweden, may be an optimistic formulation.

^{Chart courtesy of}^{Shadow Government Statistics}

The decline of a national currency, particularly that of a nation with a large trade deficit, is first apparent in international trade while domestic prices do not at first fully reflect the devaluation of the currency. As a result, the prices of commodities that are subject to global demand tend to rise before the general increase in domestic prices that results from currency devaluation, thus the prices of commodities such as gold would be expected to rise faster than domestic measures such as the US Consumer Price Index (CPI).

^{Chart courtesy of}^{Federal Reserve Bank of St. Louis}

The alternate CPI measure provided by SGS may represent a more accurate method of estimating the US dollar prices of commodities that are subject to global demand. The SGS alternate data show accelerating price inflation over the past decade leading up to the global financial crisis in 2008.

^{Chart courtesy of}^{Shadow Government Statistics}

If the SGS alternate CPI data are applied to the gold price it is apparent why Shadow Government Statistics’ John Williams stated in an interview with Bloomberg reporter Pham-Duy Nguyen that if the same methodology of measuring inflation were used today as in 1980, the 1980 gold price would be equivalent to $7,150.

^{Chart courtesy of}^FGMR

While gold certainly has enjoyed tremendous gains over the past decade, including the effect on the gold price of central bank gold demand, the current gold price, following on the heels of an unprecedented global financial crisis, has little in common with the 1980 asset price bubble. The current gold price reflects a rational diversification into hard assets for the purposes of risk mitigation and wealth preservation and can be explained in terms of monetary inflation and associated loss in the value of the US dollar independent of the US dollar carry trade. The continuing devaluation of the US dollar will result in a further rise in the prices of commodities that are subject to global demand, thus the gold price will continue to rise also.

Mr. Soros is certainly correct in that low interest rates contribute to the formation of asset price bubbles, but neither the value of the US dollar or the price of gold depend only on interest rates or on the US dollar carry trade. The view that a gold price over $1000 per Troy ounce represents the “ultimate bubble” ignores the ongoing devaluation of the US dollar, discounts risks associated with the stability of financial institutions, governments and currencies, and does not reflect confidence consistent with sound fundamentals.