Michael Campbell: I just love this chance to Martin Murenbeeld, Chief Economist of Dundee Wealth because of course there is so much drama that is impacting directly the investment markets, Greece, Italy, Spain and the bond rates etc. . What does that mean to investors and why should we care about these stories?
Martin Murenbeeld: Oh gosh! The big issue is if Europe goes into a very significant recession, or heaven forbid a mild depression, we are going to have ramifications right around the world. Certainly companies in Canada and the United States that have an exposure or are selling into Europe are all going to be affected. You also have the bank side, the exposure of the US banks to Europe is not very high when you compare it with the exposure of European banks to Greece and Italy but there will still be linkages there and there will also be some very minor linkages between the Canadian banks and the European financial sector. Bottom line, nobody will really escape an implosion in Europe.
Michael:Let me just say I have not been this pessimistic in quite a while. In terms of societal dislocation, a lot of disruption and I think its going to be with us for a while. I don’t see a way out of the Italian problem that doesn’t spell some pretty negative consequences, some worse than others, and I’ve looked at their numbers. Can you manage the dislocation or is it just sort of jump all over us?
Martin: Well yes, the solutions that are being presented are sort of coming down to two, and probably the second one is not a solution. The first one as you are probably aware the French have began to insist that the European central bank should step into the market in massive amounts to buy Italian debt, Greek debt, French debt, Spanish dept and so forth to keep those interest rates down some what because as you know, the higher the interest rates get for those countries, the more it taxes and the government fiscal position and a larger amount of money in the budget ends up debt servicing and it gets to the point where the the countries cannot support it.
Michael: It’s a pretty straight forward thing. Nobody wants to lend those countries any money. I mean the major private clientele around the world would think you are nuts if you said, ‘Hey I got an idea. Let’s go buy some government debt out of Italy or Spain. Nobody who has a choice wants to lend these people money so hence, they’ve got to go to other bodies like the International Monetary Fund, the European central bank or some other entity, hey just simply won’t get private investors interested at this point.
Martin: Well that what the rise in interest rates is all about, the higher the interest rates go the hope is of course the more it encourages the private sector invest, but you’re absolutely right the private sector is balking. I overheard somebody saying on business network the other day, the fellow said ‘you know I think Italy will make it’ and then pause ‘but not with my money.’ That’s the situation we are in. Somebody has got to buy the debt otherwise interest rates just keep rising and rising and rising. Greece is already putting a haircut on the debt it owes and at some point Italy will say ‘listen, we cannot pay these interest rates, we cannot pay the debt.’ It comes down to somebody having to buy debt, if it isn’t the private sector its going to be the ECB which is what the French proposal is. The Germans are aghast to this proposal, they do not want the ECB to go in and buy debt from these various governments so if we follow the German model which is the model we are currently on, I have almost no doubt at all that we are going to have a breakup of the Euro.
Michael: One of the things I love about your research is you always put out probability scenarios of which way we are going. If the euro breaks up and it’s a sudden shift, you know how fast it can overcome us like bottom line is that if the European central bank doesn’t want to lend any money and individual investors don’t want to lend any money then you get the Greece like situation that is not doable. So with the euro, what would it look like and what are some of the scenarios if the euro just can’t keep going the way it is.
Martin: Well there are different ways that the euro could split up. My preferred way, lets start with the nicest way, is where the northern European countries, the triple A rated countries, the countries that don’t have these massive debts, the countries that can service their debts they leave the euro. Not that Greece leaves, but the Germans and the Dutch leave. And the reason for that is what is left is what we call the Latin block or the Southern European block and that block retains the euro. So that Southern Block keeps all the debts of those countries, denominated in euros which they by in a large owe to the northern half of Europe.
Okay now obviously what will happen when the northern half breaks away, they will have their own currency, will call it the Deutsche mark or the North Euro it doesn’t matter and that currency is going to rise against the southern euro. But from an accounting point of view, everything kind of stays the same, the debts that Italy owes to the German banks and so forth and to the French banks will all remain denominated in euros. A German Bank operating under the north Euro block now, will obviously get paid back in Euros which will be less than north Euros, so they loose but they are going to loose anyways.
At this point and time, the northern countries are going to loose big time no matter what happens, that’s the nicest way. The worst way things will break up is that you get some kind of a rogue withdrawal of Greece and possibly even Spain and Italy and that will then immediately shock the system. You and I will do exactly like the fellow I just quoted, we are not going to lend any money to anybody over there because we don’t know where the rot will go. Remember after Lehman went under general electric had trouble rolling over its short term paper and you wonder what the heck is general electric got to do with Lehman? But the point is, you and I will not be lending and that then spells a disaster.
Michael: With all the uncertainty that’s in Europe about who can pay their debts, whose going to do it, if they can resolve it. Do you see this as a scenario though that could be very positive for gold or for the US dollar as examples.
Martin: I think generally speaking yes. I mean it will be, at the moment as we speak you know that the gold market has been a little bit rocky because you know there is always the other things at play in the gold market. Suppose we go into recession or God forbid a mild depression in Europe that’s going to shock the international economy and so the international economy gets dragged down a little bit so that’s the other side. That could pull gold down a little, down somewhat. But you know if the world goes in that direction then there is no doubt in my mind that within relatively short order you are going to see a significant amount of fiscal and monetary stimulus certainly in the United states. In Canada too, I mean the bank of Canada has said a number of times it stands ready to put liquidity in the system if and when its needed. However it happens in Europe, whatever currencies are working in Europe the central banks behind those currencies will also be printing to curtail the negative drag in economic activity and all of that will be very, very beneficial for gold. In fact I could see gold breaking the $2,000 barrier in that sort of a scenario.
Michael: I could see a scenario where major pools of capital that don’t have a lot of choices to move to go the the US Dollar, or the Yen, especially on the short term.
Martin: Yes absolutely, I mean there has been some attempts for money to move into the Yen, and you saw the bank of Japan did. They basically said hey we don’t want the Yen to go up and they started intervening heavily. The same thing was happening to the Swiss Franc which probably if you are sitting in Europe that would be your first move. You’d move your Euros over to Switzerland and you probably wouldn’t keep it in Euro’s because you are not entirely sure that there is going to be a Euro a year from now. So you convert them to Swiss francs. and the Swiss franc was going crazy against the Euro so the Swiss national bank has come into the market and said “hey enough is enough” and it’s time to suppress the Swiss franc. So you are right in that regard that large money you know will move to the US dollar.
We are also getting reports that there is quite a bit European buying of high priced property in London. I mean basically money is moving to where it can go, where the markets can absorb it and its driving the prices of those things up and that includes the US dollar. You know I’m gold friendly but frankly if you want absolute safety, you buy US treasury bill. That’s the only thing that I can guarantee you are going to get exactly your full amount of money back. You put a $100 in US treasury bills you are going to get a $100 back.
Michael: If money is going to be flooding in to the US and Canada does this mean that interest rates will stay low in our neck of the woods for quite a while?
Martin: Oh absolutely yes there is no doubt in my mind and for several reasons. First off the fed is more or less promised that they are not going to raise interest rates before the middle of 2013. I don’t see the bank of Canada raising interest rates in fact there is a reasonable probability the bank will be lowering interest rates a little bit. Interest rates here are going to stay low. If I were to think outside the box a little bit on this one you could conceivably come up with a scenario where by the Chinese are encouraged to support European paper.
So let’s say the Chinese start to buy Italian debt because they have, 3.2 trillion in reserves right so they could do that, but then the question is where does that money come from because it isn’t sitting around, its invested. So then the Chinese would have to sell off US treasuries to go and buy Italian paper, but those are very low probability sort of scenarios.
Michael: Low probability but it’s a reminder for investors that one of the reasons we have such huge volatility today is because of these major pools of capital and what if they move. It’s a level of uncertainty because I agree with you it’s a low probability that the Chinese decide to bail out the Italians but it is possible and they sure aren’t going to be phoning me or any other analysts before they make the move.
Martin It will be an announcement and that will change the whole ball game.
Michael: Lets go to back to volatility, as an investor we are sitting trying to determine if its a buy day, a sell day, you know there such major moves.
Martin: You know for an economist it’s a great time. On Monday my left hand is right and on Tuesday my right hand is right, I mean it can get better. I can have whatever scenario and I’m likely to be right one or the other day, it’s that kind of a crazy world at the moment.
Michael: But tough for an investor.
Martin: Its very, very difficult for an investor so you play this very safely. I encourage investors to have some gold exposure because at the end of the day no matter how this all unfolds there will be loose money printing, in other words central banks buying government debt. That’s what we call money printing. There will be some of that going on and gold is very sensitive to that. So I’d want investors to have some gold in the portfolio, Obviously we have some products at Dynamic that we think we are interesting but you know don’t want to make a plug for that. that, I think Other stuff that I like are very good companies that are good dividends payers.
Michael: That’s great advice and I think again people want it to be simple but its not, its complex. I’s uncertain out there. So I think your money has got to reflect that, that’s something I’m always saying Martin, is when uncertainty raises I’m worried about preserving my capital. Also I couldn’t agree more with you if you got some high quality companies that pay off some dividends.
Martin Murenbeeld chief economist of Dundee Wealth Management always terrific to talk to you.