The economy is in trouble, but Richard Duncan has a solution. The chief economist at Black Horse Asset Management has also worked at the World Bank and served as the global Head of Investment Strategy of ABN AMRO Asset Management; his new book is The Corruption of Capitalism. Jack Otter spoke with him about the state of the economy, what we can learn from Japan’s mistakes, and what investors should do to protect themselves.
Back in 2008, everyone knew we were in big trouble. But right now the perception is things are turning around … and soon the world will be back to normal. In your book, you say that perception is actually just a pipe dream.
That’s right. Everyone needs to understand that we are being supported by government life support.
For example, last year the U.S. economy shrank by 2 percent, but the budget deficit was 10 percent of GDP — so had it not been for this … budget deficit, the economy wouldn’t have shrunk by only 2 percent. It would have been minus 2, plus minus 10 or minus 12, plus a multiplier: The economy would have contracted by 15 percent, unemployment would have gone above 20 percent, [and] it would have been a complete replay of the Great Depression. And this year’s the same. This year we’re looking at 11 percent of GDP budget deficit.
So we’re on government life support. This could remain like this for a number of years because the private sector is broken.
So what you’re saying is hundreds of billions of dollars are flowing from the government into the economy, and if it were not for that, the economy would be in deep trouble.
That’s right. In fact, $1.6 trillion this year.
And that’s all borrowed money?
Will we ever pay it back?
They will probably never pay it back.
You clearly think deficits are a big problem; you despise them. Yet in your book, you say we can’t live without one.
I think there are three important lessons that policy makers should learn from Japan’s … post-bubble experience. Their bubble popped in 1990 — 20 years ago.
The first lesson is when a giant bubble pops, it’s necessary for the government to support the economy with massive budget deficits for far longer than anyone thinks. Even now, the Congressional Budget Office is projecting $10 trillion worth of budget deficits over the next 10 years.
Point No. 2, though is that these budget deficits are much easier to finance than people currently realize. Japan has 200 percent government-debt-to-GDP [ratio], but the 10-year bond yield in Japan is only 1.4 percent — meaning that it’s very cheap to finance that government debt.
And the third and most important lesson we need to learn from Japan’s experience is not to waste all this money … building bridges to nowhere the way they did, but to spend the money wisely. [We need] to restructure the American economy, to actually make it viable again — because right now the U.S. economy is not viable. And that’s because wages in the manufacturing sector here are 40 times higher than they are in most of the rest of the world, where they are $5 a day.
Wow. That’s an interesting point in your book. You talk about how that money should be spent — and you say the government should invest in three 21-century industries. Can you explain that?
This money is going to be spent one way or the other. It’s just a matter of whether it’s wasted, frittered away, and stolen by special interest groups, or if we actually spend it wisely, restructuring the economy. … Instead of spending $10 trillion … over the next 10 years, I propose $13 trillion, an extra $3 trillion. The government should pump $1 trillion into solar energy, $1 trillion into the genetic engineering and biotechnology, and $1 trillion into nanotechnology. This would give us an unassailable lead in the 21st-century industries, and lock in another American century.
That’s a nice vision. But in Washington there’s not a whole lot of appetite for extra spending. Of course, as you say, it still goes on, but: Politically, how much of that is viable and how do you make it happen?
Politically it is difficult, because there are many special interests who do not want to see these things occur. You can imagine there’d be a lot of opposition from oil companies to trillion-dollar investments in solar energy. But still, at the very least, I hope this book provides a real clear analysis of what has gone wrong — not sugar-coat it, but with looking at the situation with our eyes wide open — and offers some solutions as to how we can get out of this. … I hope it provokes a discussion and a debate as to how we really could get out of this crisis. And if someone comes up with a much easier solution, I’d certainly support it.
You write that the financial industry has become a menace to society. Can you explain what you mean by that?
Right now, the three largest U.S. banks control most of this country’s deposits. And at the same time, these same banks are speculating in the derivatives market at the rate of trillions of dollars a day. This is a recipe for catastrophe. They blew up in 2008, had to be rescued, and now they still have not been reformed. They should be broken up into small, very tightly regulated utilities. Instead of being too big to fail, they should be made too regulated to fail.
Now what about these side activities, this proprietary trading: Would you stop that, or just let other companies do that that don’t have a government back up?
Banks should be banks and lend money, and that’s all they should do. Speculators and investment banks should be allowed whatever they want to do with their own money or their investors’ money. They shouldn’t be rescued by the government, they shouldn’t be allowed to be too big to fail — and they shouldn’t be able to use people’s deposits to speculate with.
A commercial bank should be a bank; an investment bank should be an investment bank. We need a return to the Glass-Steagall era, which provided 70 years of financial sector stability.
As an investor, looking at this somewhat uncertain future, what should I do?
Every investor is different, of course. Someone with a billion-dollar portfolio needs to do something in a different way than one who has $100,000 to invest.
Let’s consider that [$100,000] person …
… If their portfolio is large enough.
It’s important to have a broadly diversified portfolio.
I think gold is the surest bet. I believe that gold is likely to go up 10 percent a year, on average, for the rest of our lives. There may be some years when it drops 30 percent. But on average, gold seems to be the surest bet.
Still, no one should put his or her eggs all in one basket — not even a golden basket. So … I would also have in my portfolio blue chip stocks with a high dividend yield, in this country and other countries.
Also, government bonds: U.S. government bonds and German government bonds.
Next, I would recommend … buying a residential building to rent out.
And finally, I would recommend debt — fixed-interest-rate debt to finance your residential building.
And that way you’d be very broadly diversified.
The reason why it’s so diversified is because we’re on government life support; no one can be certain what the government’s going to do. If they spend too much money, we’re going to get very high rates of inflation. That would be bad for bonds and stocks, butwould be very good for commodities. Meanwhile, your debt would evaporate — and you still would have rental income.
On the other hand, if the government spends too little, we’re going to have deflation. That would be bad for commodities but good for bonds — and you’ll still have your rental income. The rents might go down, but so will the price of everything else.
So because we can’t be too sure what the government is going to do — and because the government is driving this economy now —diversification is the only way to have proper insurance.
That’s a very interesting. One more question: REITs. Is that for somebody who can’t afford a residential building? Can you invest in real estate through other implements?
I think no two REITs are the same. You’d have to look into at them very carefully.
And it might not provide that benefit, if your debt’s going down and rents are going up.