Transcript

You're listening to Ask the Expert on Sprott Money News.

Hello again everyone, and welcome back to the February edition of Ask the Expert here on Sprott Money News. I'm your host Craig Hemke, and with me on the line today is Grant Williams. Grant is internationally known as a newsletter writer and speaker at many investment conferences around the world. His newsletter, Things that Make you Go Hmmm..., is one of the most widely read that you'll find anywhere. He's also one of the founders of Real Vision Television, and online and on demand finance channel that showcases the brightest minds in finance. I encourage everyone to check that out as well. Grant, thank you very much for spending some time with us here at Sprott Money News.

Grant: Craig, it's a great pleasure. Thanks so much for having me.

Craig: If you could, just take a second and in your own words I guess describe your own background and what you're doing for a living today.

Grant: Well, I've been in financial markets now for, I hate to admit it, over 30 years. During that time I started off my first job in the markets was in the Japanese equity markets in the mid '80s when those markets were going crazy. I had an up close and personal view of a huge bubble in real estate and equities in Tokyo. [inaudible 00:01:22] bubble, the Japanese real estate bubble officially burst. That was a real baptism of fire for me. From there I ended up in the US when the NASDAQ bubble burst. I was in Hong Kong for SARS. I was in Australia for the GFC. I'm in Singapore now, so it might make sense to keep an eye on Singapore. Something bad is probably going to happen now that I'm living there.

Craig: Waiting for the next shoe to drop, Grant?

Grant: Yeah, it seems that way. Trouble seems to follow me around.

Craig: I tell you what, let's just dive right in, my friend. For regular listeners of the Ask the Expert program, we've submitted or at least asked for a question to be submitted from Sprott Money customers around the world. We let them know who the expert's going to be, and they send us questions. I like to then turn around and pass them on to you. The very first one has to deal with your long term macroeconomic view, Grant. In that sense, do you think that the global central banks are beginning to lose control of the markets?

Grant: It's such a great question. I think it's arguably the single most important question that people have to really have an opinion on right now.

We've seen since 2009 when markets bottomed what optically looks like a recovery. It's been touted as such by central bankers and politicians all around the world. As I said optically things have bounced, nominally they've bounced, but beneath the surface the news isn't so good. That's a lot of what I try and do when I write is point out the things that perhaps people should be paying a little closer attention to in order to try and flesh out the whole picture.

Since '09 the overriding narrative has been one of central bank control of markets and the markets dancing to the tune the central bankers have been playing. That has come mainly in the form of repeated stimulus. There's been this concerted effort by central banks for four or five years where they were all on the same page. They were all trying to levitate markets higher. That was done through first of all the slashing of interest rates, then when we reached zero what's been described as the printing of money. It's a little bit more complex than that. We will at some point I think get to the very simple stage of literally printing money.

That's all been predicated upon the markets having faith in the central banks, faith in what they've been telling the markets and faith in the fact that they will be there with a backstop should things not work out. That's given people the latitude and the confidence to buy assets and take them higher. For the longest time I've been saying that the one Achilles heel in this is this whole idea of market confidence in central banks. At some point I've been worried that that confidence is going to disappear.

Essentially if you look beneath the surface, there's been no real recovery. Things are not better than they were. They're certainly not back to where they were before the crisis. When you throw amongst the central banks about $12 trillion, you've ended up with the weakest economic recovery in history. If people start to question that the central banks are in control and they are being effective and they are engineering a genuine recovery, all it takes is people to start questioning that narrative.

Once they do that, as investors they then have to try and invest accordingly. If you believe that the central banks aren't in control and you believe that what they're doing is not going to have the outcome they're promising you then you have to invest accordingly. That means what we've seen in recent weeks and months and that's going to cash just to be on the safe side. The problem then becomes one of liquidity.

As I've written about and spoken about in the past, in a rising market liquidity is essentially endless. There is always stock for sale at a price. If a market's rising, it may be 10% higher but someone will offer you stock at a price. People have forgotten over the last seven years that in falling markets sometimes there is no bid. When you establish that and you are reminded of that fact it's too late.

I worry that if markets do start to believe that the Federal Reserve particularly along with the ECB, Bank of England, and Bank of Japan who are probably the closest to being up against the wall, once markets realize this and there's any kind of coordinated move for the exits you are going to see what we've seen in the first couple of months of this year magnified to a degree which central banks won't be able to cope with because they are out of bullets. We could see some very extreme measures which is why we now find ourselves staring down the barrel of a negative interest rate environment and talk about the [inaudible 00:06:28] of cash.

Craig: Well, that's a perfect...Oh, I'm getting some feedback actually, Grant. That's a perfect segue for the second question that was sent in. It has to deal with negative interest rate policy. You're talking about bullets and what might be the next one in the chamber for the central banks to fire at the world. The second question deals with that. As negative interest rates proliferate around the globe, what is the likelihood that this phenomenon will spread to the US and Canada?

Grant: Well, look. As I said earlier, I was living in Japan when the wheels started to fall off. That was 25 years ago. Japan has slowly and steadily moved to a place where it didn't want to go. Everybody all along has assumed that that was just Japan and it's not something to be really worried about because the US isn't Japan and Europe isn't Japan. I was reading a piece literally today by Stephanie Pomboy of MacroMavens who is absolutely brilliant in her analysis. She pointed out that when the Nikkei bubble burst in 1990, 12% of the Japanese population was 65 or older. When the same thing happened, the housing bubble burst in the US, 12.4% of the population was over 65.

The comparisons between Japan and the US are terrifying. If you look at where the JGBs are now, you have 10 year JGBs have a negative yield. The Japanese central bank has [inaudible 00:08:02] $484 billion to borrow money in the last six months or so. People think that can't happen in the US, but unfortunately the path that all these guys are on is identical.

People need to be able to comprehend outcomes that they just haven't given any credence to to this point. My friend and partner in Real Vision Raoul Pal was on CNBC talking about the chances of the US 10 year rate trading at 50 basis points. The anchor was absolutely gobsmacked. She couldn't believe that he was actually saying it.

You look at Japan, you look at Germany, both of those countries are in that position now. There really is no reason why the US doesn't end up there. They're going down the same path. They're pursuing the same policies. This belief that the US is immune to the kind of problems that Japan faces and the problem Europe faces because it's the US is just not a smart way to think.

They might avoid it. I'm struggling to find a sensible course of events that will avoid it for the US. To rule things out, to rule out extreme events simply because it's the US I think is a foolish thing to do. To me the US is heading towards negative rates just like everybody else is. Whether they get there or not is to be seen, but you have to factor that into your thinking as a possibility and a very real possibility.

Craig: The third question, Grant, is similar to that last one. We're trying to assess global impacts and how they might affect back in the US and in Canada. One of the big stories so far in 2016 has been the meltdown of some of the European banks. A lot of that is due to negative interest rates, but it's also due to what appears to be significant commodity derivative exposure. The third question is there are potential derivative issues at Deutsche Bank and Credit Suisse. Do you think there are any US or Canadian banks that have that same exposure?

Grant: That's another good question. Look, banking I think we all know is the second oldest profession in the world. The banks' business models are all the same. These guys used to make money on interest rate spreads. That's been taken away from them. Now they can't borrow and lend with a spread and make a nice safe profit. That's just not there anymore for them. As we move further into negative interest rate environments, that gets more [inaudible 00:10:30]. If you look at the chart of the European banking sector and the Japanese banking sector, two regions that have negative interest rates, you'll see that those banking stocks are down 30-plus percent in the last year or so.

That's where the US is heading as they move towards that. The US banking sector's only down I think 12 or 13 percent in that time. These guys have the same business models. For every derivative that's outstanding on Deutsche Bank's balance sheet you better believe there is a similar position on JP Morgan's balance sheet, on Citigroup's balance sheet. It's not just the US obviously - UBS, Credit Suisse and some of the Asian ones. If you look at HSBC, if you look at Standard Chartered, I don't have the numbers but I am certainly not naïve enough to think that these banks do not have their own significant derivatives exposures. It just so happens that the Deutsche Bank number is so extreme. It's about the same size as global GDP notionally. That is the one making all the headlines.

Whether these banks have similarly outsized positions, the defense against it is that it's not gross exposure that matters but it's net exposure. As someone pointed out very succinctly and very clearly recently, you only need one failure in the custody chain and suddenly gross exposure is all that matters. That's the danger.

Deutsche Bank you can see what's happened to the share price recently. It's under enormous pressure. It's way too big to bail out. It's also impossible to let that thing fail. That's a decision I suspect that people may have to make at some point in the near future.

Once you start looking at those banks and you look at someone like JP Morgan for example, it's not an awful lot different to Deutsche Bank. The only differences I guess are in the regulatory regimes, the policing of these banks. Whilst the US may be slightly better than Europe, it's certainly not a safe jurisdiction. It's not something that I particularly would want to take as a risk on my own books. I think all the banks are in a similar boat.

Craig: Understood. To that end, then, I guess that's another good segue to the next question, Grant. We've talked about negative interest rates. There's this seeming war on cash as we get more and more trial balloons on almost a daily basis of eliminating hard currency just to really focus folks on keeping their, I guess we'll call it money, in the bank and nowhere else. To that end if this begins continues to play out, how concerned are you about the institution of global capital controls?

Grant: Oh, look, I think they're here. I think they're here to stay for the next little while. Unfortunately, they're complex things. Until you reach a tipping point in the number of people who understand what's being done to them, these things tend to stay entrenched for a while.

When you talk about trial balloons, you can't open a newspaper without talking about the banning of the 500 euro note or the 1000 Swiss franc note or the $100 bill. It's very simple to understand why this is being floated. The narrative is that it's exclusively drug dealers and terrorists that use $100 bills or 500 euro notes or 1000 franc notes. It's a great narrative to say this is why we're doing it because bad people use them.

If you look at the US currency in circulation, there's about $1.4 trillion in circulation. About $1.2 trillion of that is $100 bills. If you ban the $100 bill, instantly you're essentially banning cash.

If you think about the end to this, if you outlaw cash altogether and people just have essentially digital bank accounts, you can take rates negative 10 percent, negative 15 percent. There's nothing anybody can do about it. You can't have your money elsewhere. It's a digital entry somewhere. People who are taking cash out of the bank and putting it in a safe at home or they're moving into gold as an alternative store of wealth are doing very sensible things.

Ultimately you are fighting an organization in terms of governments and central banks that do have the power to force you down blind alleys, who do have the power to confiscate wealth. Unfortunately, and this is the key thing to understand, they have a very real need to do that in terms of the outstanding debt that they all find themselves under. If you give someone a need and the means to sate that need at the expense of other people, generally speaking they're going to do it. People have to understand that right now they're in a very confrontational relationship with governments and central banks. They have to try and stay ahead of this. As I said before, that involves countenancing the kind of outcomes that people don't like to think about.

Craig: Yeah. To that end, Grant, it definitely augurs for the physical possession of gold and silver for any one of a number of reasons. You've got to store it someplace. You can hold some of it yourself. If you've got it inside, you've got to hold it someplace. A lot of folks think about storing it outside of their country outside of their own personal jurisdiction. The fifth question is what do you see are the pros and cons of storing precious metal in jurisdictions such as Singapore or the Cayman Islands. Do you feel that any one place is safer than the next or a better alternative than the next?

Grant: That's a great question. We don't know. The problem is it's hard to really think through what could happen here. Once you get into an environment where extreme outcomes start to become the norm, it gets very, very difficult to protect yourself against all the various things that could potentially happen.

As far as gold goes, I've been a gold bull for a long, long time now. The last four years have been a bad time to be a gold bull depending on why you were owning it. For the people that bought it at 1900 thinking they were going to sell it at 2000, gold could be any asset. It's nothing to do with gold. You bought the wrong share at the wrong time. You bought Cisco right before it went down. You bought Lucent Technology. It's nothing to do with gold.

Owning gold as an insurance policy, owning gold as a diversification of wealth is a whole different kettle of fish. I think if you are going to own it, if you do the mental work required to understand the need to own gold then the next kind of fork in the road is how do I own it. Do I own it through the GLDTF? Do it own it by gold miners? Do I own physical gold?

Most people, having done the work and understanding I really should own some gold, they then realize that to do it the right way is, as is often the case, is to do it the hard way which is to buy physical gold and work out where to hold it, how to buy it, and how to store it. That's a little bit too much work for some people.

To understand you need to own it and then buy a piece of paper that doesn't give you possession of it is just a foolish thing to do. I think if you're going to own gold you do need to own it physically. You do need to own it outside the banking system. If your gold is in a bank vault and we end up with a bank holiday, as we've had more times than people care to understand over the years, then you're not going to have access to that gold and the chances are some of it will be confiscated from you.

Owning it in a third party vault outside the banking system, when you talk about owning it offshore, we've seen in the US back in 1933 with Executive Order 6102 FDR made it illegal to own gold in the US. There is precedent there to have to turn your gold in. I think it would be a much harder thing to do today. Still relatively speaking it's a very small percentage of US citizens who own gold so it doesn't play too badly to confiscate it.

If you try to do that kind of thing in Asia where almost everybody owns some gold...It may only be one coin, but families in Asia grow up with gold being passed down through the generations. For a government somewhere like China or Singapore or Korea or Vietnam to try and confiscate gold, they would unleash all kinds of trouble that they really don't want a part of. To me owning gold somewhere in Asia makes an awful lot of sense. Singapore and Hong Kong are probably the two most sensible places. Storage facilities are springing up all over Asia, and I think for very good reason.

My position on this is probably rather too well documented given the performance of the price in the last few years. I think everybody should own some gold but be very thoughtful about how and where they own it.

Craig: Yeah. That's tremendous advice. Grant, as the final question, let's just kind of speculate and look over the horizon a little bit. I always tell my readers that tomorrow is not going to be like yesterday. You've really got to be forward thinking in this environment.

The last question that was sent in had to do with I guess the eventual replacement or whether there will be something to run parallel to the dollar which has been the global reserve currency now for 70 some odd years. The specific question was wondering if you see maybe something out of the Shanghai Cooperation Organization working with something like the Eurasian Economic Union perhaps, having them cooperate in some way to introduce some type of new gold backed currency or whether that's just a direction we're headed. Do you think that is ultimately an alternative that will be presented here in the 21st century?

Grant: What an audience. What a fantastic set of questions.

Yeah, look, it's funny. Monetary regimes have come and gone throughout history. We happen to have lived through a period, as you said, of 70 years of very stable monetary regime with the dollar being a global reserve currency. Anytime you get a period of time of that length where the status quo is very, very solid, people have a hard time imagining a change to that. If you had been around right after World War Two in 1950 and we were having a talk about the dollar no longer being the global reserve currency, well it only had been for about 5 years. It wouldn't have been a big thing for people to get their heads around. Now, it's almost impossible for most people to get their heads around.

Every single fiat currency in history has failed. I'm English. The Brits had the global reserve currency with the pound. The Spaniards have had it. Even Portugal, who now are one of the most indebted countries in the world, had the global reserve currency at one point. Ultimately the dollar will be supplanted. There's no two ways about it.

When you're at or close to the point where that might happen, it just seems like a bridge too far. I think what you're talking about here in terms of a gold backed currency, again, people struggle because we've had essentially 45 years with no gold backing and a lot longer without pure gold backing. People think it won't ever happen again.

Gold has been a part of the monetary system for six or seven thousand years and it will be again. Whether it's a hard gold peg, it would be hard to see how that would work. Having a currency that has some form of backing in precious metal to me personally, having sat and thought about this for more hours than I care to remember, that's not a huge stretch at all.

Any drive towards that will necessarily come out of Asia. It'll come out of China. It'll come out of maybe India. It will be a group of countries in that part of the world that get together to do this. My own belief is that the Chinese when the time is right will move to a gold backed yuan. I think we're a little way off from that unless things really start to fall apart.

Again, it's one of those extreme outcomes that you don't have to necessarily act on right now, but you need to have a plan. You need to have a plan for all these things what you would do if these things happen, because they happen very, very quickly. If you let them happen while you're trying to figure out what to do, it's going to be too late.

Craig: Excellent advice. Grant, as we begin to wrap up, please tell everybody again where they can find your work on the Internet.

Grant: Sure. My letter, Things that Make You Go Hmmm..., I write that twice a month. You can find out more about that at the website which is www.ttmygh.com That's Things that Make You Go Hmmm... dot com. Real Vision Television, which is a project that I started about 15 months ago with my partner Raoul Pal, is an online financial video service which showcases as many of the really smart financial minds that we can find. We sit down with them for in depth conversations that really give them a chance to explain their thinking. We've been delighted with the feedback to that. You can find out more about that at www.realvisiontv.com.

Craig: It's tremendous. I wish you the best of luck in those ventures, Grant. Thank you so much for spending some time. It's been a real pleasure to visit with you.

Grant: Oh, Craig, likewise. It's been a thrill. Thank you so much.

Craig: From all of us here at Sprott Money News, thanks for listening to this month's Ask the Expert.