LOF: You’re right, there is a tremendous amount of money that is not being employed in the economy, and it’s all part of the same problem. And that problem is that the banks don’t have any confidence, companies don’t have any confidence, outside investors don’t have any confidence. Everybody is frightened, and everybody is trying to protect themselves. That is not an environment that produces growth.
DAVID: So they are leaving the money on deposit at the Fed because they’re not sure about their capital needs? What if the Fed were to go back to paying them nothing on their excess reserves, or actually start charging them to keep the money parked at the Fed? Wouldn’t that help push that money back out into the economy?
LOF: All these potential decisions by the Fed have consequences that neither they nor anybody else can anticipate. What you’re suggesting might work out, but I don’t think anybody knows. I don’t pretend in any way to have opinions as to what the Fed should or should not do. It’s not something I study. It’s not something I understand, particularly.
Instead, I try to approach these sort of things as a businessman or as an investor. And as a businessman and as an investor, I look around and see a lot of uncertainty, I see real potential for crisis. And when I see that, I just want to hunker down in some way, and that attitude influences every decision I make.
As I’ve mentioned before, since 2007 I’ve changed the way I think about things. As a result, for the last four years I’ve been working to position myself and my family in a way that I believe is more sensible. Becoming far more cautious could be the right thing to do or it could be wrong, but however you look at it, when you extrapolate that shift in attitude across millions of investors and business owners and even bankers who have been acting much the same way, it is not a positive for the economy. I guess that wasn’t a specific answer to your question, but…
DAVID: No, it makes sense that this widespread reaction to uncertainty is a fundamental force in today’s economy and investment markets. Any thoughts on interest rates? It seems odd that the US government could have record levels of debt and continue to run record deficits and yet interest rates bump along at record lows. Does that make sense to you?
LOF: Actually, it has made sense to me. I have felt for some time that the people, including Bill Gross, who I think is great, who have been saying that interest rates and inflation are heading higher, although probably right in the long term, were not going to be right in the short term, and that the short term has a ways to go. Specifically, I have felt for some time that interest rates were headed lower, and I continue to believe that we could easily see 1.5% on the 10-year Treasury and somewhere in the 2s for the 30-year.
My rationale is that there are such tremendous headwinds preventing the economy from growing in any significant way, and it will probably be contracting, and those conditions are not going to produce rising interest rates. Quite the opposite. The headwinds are all the things that we’ve talked about, plus you’ve got this dramatic entitlement problem in our country and in Europe that is only going to grow more problematic.
If you go back in history and look at the ability of a democratically elected government to take things away from people who vote, the record is pretty clear. Predictably, if you’ve given people something significant, and then you try to take it away and they vote, the politicians will be voted out. So whether it’s right or it’s wrong, the populace in general will not stand for it, so therefore the politicians will avoid taking the hard measures that could actually help solve the problem.
Historically the only way to resolve the sort of problems we’re facing is through growth, and if you don’t get growth, then the policy makers will continue to debase the currency.
Ultimately that will happen, but in the period of time that I can foresee, which is the next three or four years, I don’t see much of a chance that interest rates will go up. I think there is a very, very strong downward pressure on interest rates that will continue for a while.
DAVID: Obviously, the uncertainty will keep people looking for those safe harbors, and Treasuries are still considered safe harbors. The other thing that sort of strikes me as a factor now is the dismal shape of the Eurozone. I have to imagine that there is an awful lot of money currently in the Eurozone that would like to get out of there and is starting to move out. Of course, US Treasuries are one of the few instruments that can actually handle any kind of real volume, so that will probably help keep rates down as well.
LOF: Absolutely. I think that’s absolutely true.
DAVID: You seem to be expecting short-term deflation, longer-term inflation, would that be a good way to describe it?
LOF: It’s pretty hard to create a scenario where you don’t have inflation in the long run, but what the long run is, is another question, and the long run could be quite a ways out.
Let me add that I am more positive about the future than I may otherwise sound. I think that the American economy, in particular, has resilience that is pretty impressive, and that ultimately we are going to get through this. But I think it’s going to be a very, very long period of time before that happens; it could easily be five to ten years.
When we do come through it, I think the economy will have a vibrancy that people won’t expect, but it’s going to be a while, and at that point, I think we’re going to have to deal with some serious inflationary pressures.
DAVID: Given the obligations and the entitlements and the current level of debt and no end in sight to the trillion-dollar-plus deficits, it seems to me that this is not going to end without some sort of default, either overt or covert in terms of inflation. If for no other reason than that these obligations can’t be met. Would you agree with that?
LOF: Yes, I don’t think they can be met. I think it’s impossible. I think they have to be restructured in some way. You’ve got to restructure the whole entitlement system, and politically you can’t do that right now.
I recently had a conversation with the economist at a major bank, and I asked him what he thought. I said, “What do you think the chances are of another crisis of the magnitude or greater that we had in 2008 and 2009, and if that crisis occurs, when would it occur?”
He said he thought that there was a real chance of that happening, and if it happened, it would probably happen sometime after the election in 2012 when the markets realize that even in a new administration, these problems will not be dealt with.
In his view, once the markets understood that, we are likely to see a very, very bad crisis. Then, just maybe, at that point will the political process make the necessary adjustments. But I think that even that’s questionable.
DAVID: I just finished an article for John Mauldin’s newsletter, in which I looked back at all the times the US monetary system was in danger of failing and had to be fixed.
As it’s been 40 years since the last major do-over of the monetary system – when Nixon closed the gold window – most people think of the monetary system as being fixed in stone, and the notion of it stumbling doesn’t even come up in the average conversation. But in reality, it has been restructured numerous times since the Civil War.
In our view, the current fiat system is not going to make it to the other end of this crisis intact, but will have to be remade in some way that anchors money to commodities, with gold at the core.
How do you and your friends in high finance view gold these days? Do they still view it as a barbarous relic, as they did a few years ago? Are they starting to buy it for their portfolios? Personally?
LOF: I think that more and more of what you might call respectable opinion puts gold in a different category than they would have five years ago. You hear an increasing number of serious commentators, people like Byron Wien, for example, talking about having a 5% position in gold, and you never would have heard that five years ago.
Back then, favorable opinions on gold would have been seen as far out. Today having a significant gold holding is more and more in tune with respectable opinion than it ever was. The mainstream guys are also thinking in terms of things like TIPS and in terms of holding other currencies.
In other words, they’re investing in things that they never would have thought of doing before this crisis, but gold in particular. And not so much as a commodity but as a currency. That’s been my view for some time, but now I am hearing that same view on a much broader basis.
DAVID: So I take it you have been buying gold personally?
LOF: I have.
DAVID: Starting when, more or less?
