Rob Parenteau: The First Interview (transcript)
Transcript of Addison Wiggin’s first recorded interview with Rob Parenteau from April 2009.
Addison Wiggin: Hi, this is Addison Wiggin, executive producer of Agora Financial. I am talking with Rob Parenteau, the editor of The Richebächer Letter. I’d like to make a formal introduction, but before we do that, I’d like to make a few comments.
In August of 2006, I had the pleasure of spending a couple of months in France working directly with Dr. Kurt Richebächer on what he had hoped to be his opus for his lifetime of work. He believed that he had refuted the monetarist view of the Great Depression. He was working on a book to prove that.
If we were able to pull that book together, it would have been the first solid critique of the Bernanke Fed. Ben Bernanke, who is now chairman of the Federal Reserve, is one of the most noted devotees of Milton Friedman, the champion of the monetarist view of the Great Depression.
Unfortunately, Kurt became ill and subsequently died of lung cancer several months later, and we didn’t have a chance to finish that work. It put many of the projects we had going on hold.
Kurt was famous for having predicted many of the crises of the 1990s and into the 2000s. Most notably, of late he was wary of the housing bubble and its impact on the financial system in the United States.
When we had to put those projects on hold, it gave great pause to us at Agora Financial. We went on a massive search to find somebody who agreed with many of the ideas that Kurt had been expressing. That led us directly to Rob Parenteau.
Rob, if I could, I’d like to introduce you and maybe have you say a couple of words about yourself, your background, and what brought you to understanding Kurt’s method and his unique way of looking at the world.
Rob Parenteau: Thank you, Addison. I will start off with a quick review of my background and then go more into how I got involved with The Richebächer Letter.
To start at the very beginning, I grew up during the stagflationary ’70s. That was the time after the Bretton Woods monetary system had broken down. There was a real fear in the air that the whole social fabric was going to come unwound.
When I went to William’s College, I studied political economics, which is basically a double major of political science and economics. I wanted to understand what was going on around me, and what the possible solutions were.
Luckily, during the course of that education, I was exposed to the work of Hy Minsky, who had done a lot on financial instability, and other heterodox economists. When I left and joined RCM Capital in 1983, I basically felt like I had a living laboratory. The financial market’s George Soros says, “Like a living laboratory,” where I would have access to Wall Street research. I would be able to apply the macro I had learned, and also learn on the fly and see whether the ideas actually worked in the real world.
As I joined the firm, I came in as a portfolio assistant tracking the macro inputs, and over time, I worked my way up to the chief economist and investment strategist of the firm. In the late ’80s, I earned my chartered financial analyst designation on the way. Essentially, what I would do is apply the macro insights that I had to global portfolio asset allocation decisions and also U.S. equity sector selection.
AW: Maybe you could describe a little bit what RCM does.
RP: RCM is an institutional investment management firm. They have pension fund money, high net worth fund money and college endowment money that they invest. Along the way, they were purchased by Allianz, which is a large German insurance firm. They’re part of a larger family now of fund managers, which include PIMCO, Nicholas-Applegate and other investment manager firms.
AW: The ideas of Kurt Richebächer informed your work at RCM at the time in what way?
RP: In the late ’90s, I tried to make sense of why Japan was stuck in such a persistent deflationary quagmire. I realized along the way that I didn’t have a good idea of how money and credit growth affected the economy.
I ended up diving into the local business school library and digging up the old debates of the 1920s and 1930s between the Austrian school, and Keynes, and some of their contemporaries to try to figure out what a credit cycle view of the business cycle looked like, and what was the theory that would tell us about deflationary conditions and how they might play out?
What I found as I did that digging was that a lot of these insights had been lost to all but a handful of economists out there. By hook or by crook, I got lucky enough to get my hands on The Richebächer Letter in late 1997. What I was doing was trying to apply these insights to the tech and telecom bubble.
I could see that Dr. Richebächer knew exactly how credit and asset bubbles were deeply intertwined. He understood the unsustainable balances that get built up on the back of these bubbles. He was very clear in his mind about how resources get misallocated to specific industries — what the Austrians call “malinvestment” — with these bubbles. He was also willing to dig and see how the economic and earnings reports were being systematically distorted.
I could not find very many people on Wall Street at the time that were willing to take those types of stances — publicly at least — and take those types of views. He did it in a very powerful and coherent fashion. What I found was a meeting of the minds in his work. It helped me position the firm through the tech and the telecom bubble, based on those insights.
AW: I remember that Kurt was very passionate about his work. At one time, we all met at Bill Bonner’s chateau at Ouzilly in France. Kurt showed up in a very sporty BMW. He was already, I believe, 81 years old. He kinda spun into the parking lot. He was showering other cars with stones.
When he gave his speech, he had a silver-tipped cane, and he would bang it on the stone floors of the chateau, and it would resonate. He would say very incendiary things like, “I will not go to the United States as long as there is a Bush in the White House.”
He was very passionate about his ideas. We asked him, in calmer moments, why he was that way. He said that the root of his analysis came from a very rigorous digging of the data itself. He didn’t necessarily listen to the media. He didn’t listen to the other analysts who were trying to apply Keynesian theory or Austrian theory or even Minskian theory. He was trying to figure out on his own what these imbalances represented and how they got created, and then how that would inform his own investments. He was mostly interested in his own investments. Then he would write about it in his letter because that helped clarify his ideas.
To what extent do you also dig into the data yourself in order to draw from history, draw from the data, and draw from the theory that you hear both in the popular media, but also among economists that you know?
RP: I think you’re exactly right. One of Kurt’s greatest gifts was that he had a very independent mind. He was not swayed by popular opinion or the fads and fashions that go back and forth in financial markets and in economy theory. He was not swayed by those. He went to make up his own mind, and he presented his views as clearly and passionately as he could.
I should mention that in the spring of last year when you were able to get his library shipped to Agora’s facility, I dove into a couple of boxes. I believe there were three boxes that you had shipped. It was two tons worth of books. This man was no lightweight when it came to doing his research.
I was surprised to find that many of the books in his collections were the same ones I had been rifling through in the mid-’90s as I was trying to figure out the Japanese deflation. This was a man who was not afraid to do his own original thinking and his own original research.
I think if you’re going to be investing in markets, you need to be able to make up your own mind about what’s going on out there. We know the brokerage houses are not reliable sources of information. We know the government data can be distorted. You need to keep a very clear head about these things. I’ve been around the data now for over 25 years. I pretty much know the ins and outs of this. I’ve been digging around in these corners of theory, which most people don’t even want to think about.
The Austrian school is out there. The Keynesian school is out there. But they’re very ideologically rigid, and they don’t like anybody trying to cross that fence. I think there are plenty of ways that Kurt showed that you can go back and dig out some of these original insights, put them together in a new way, and it gives you a very, very powerful lens through which to make sense of current events and anticipate what’s coming down the road.
AW: I’d like to ask you two questions based on what you’ve just said. We lost Kurt in 2006. Many of the things he had been predicting — we even look at the promotions we put out trying to get people to sign up for the letter from that time. When I read them, I get chills up my spine because he was so right on about what was happening with adjustable-rate mortgages, and mortgage-backed securities, and then what he called balance sheet recession among the banks, which was already under way in 2006.
What do you think he would say about what’s happening now? On top of that, what do you think — since we’re endeavoring to continue his work — what do you think is coming down the pike next?
RP: I believe if you look at his work, he was very clear in warning about the debt deflation risks once the housing bubble burst. By debt deflation, I mean a spiral of debt coming due, and bankruptcy spreading, and people losing jobs, and income slowing so that it becomes more and more difficult to pay off the debt. In that situation, you can have falling price levels. It looks like we got a taste of that in the fourth quarter last year.
While most people were still arguing that the subprime mortgage disruptions were just a tempest in the teapot, a small obscure corner of the mortgage market that was getting into trouble, and most investors were convinced that the housing recession would be a sideshow, and it wouldn’t beget an overall economic recession, never mind a global trade collapse.
I think Kurt’s work stands on its own suggesting that there were much larger risks in the housing bubble than most people appreciated. He knew there would be widespread defaults and delinquencies in the mortgage loans. He knew this would force the households to try and rebuild their savings rate. He knew that would clobber profits. He knew that would disrupt the export-led economies abroad. He had identified ahead of time all the intricate connections to the housing bubble.
If anything, I think he might have been surprised at the speed of the collapse of some of the large investment banks. He might not have anticipated the size of the policy response, which I know both of us sit here with our jaws dropping daily as we see these things come into being. I think if you look back through the last three years of his work, he would probably say today, “I tried to warn you. And now is the time you’re going to have to pay the piper.” I think there’s plenty of evidence that he had it all lined up. He saw what was coming.
As I look at the situation today, there’s no doubt in my mind that this is the sharpest recession the United States has had — if not the entire global economy has had — since the Great Depression. We’ve seen almost $13 trillion worth of wealth wiped out in the last few quarters. This is a tremendous shock to household portfolios. Companies have buckled down into survival mode.
When I look at the dataflow, what I find is maybe we’re two-thirds of the way through the financial sector deleveraging, meaning the hedge funds have deleveraged and some of the shadow banking system, the carpet has rolled up and they’re gone. They’re out of business.
Maybe we’re two-thirds of the way through the household sector rebalancing their finances. In other words, I can see the household sector now saving more money. They’re spending less than they’re earning. This is something we haven’t seen in a long time. The household savings rate is near 5% now.
We’re probably only halfway through the profit margin compression. I think we’ve only just begun the household balance sheet repair. They’ve only just started to pay down debt, which is the first time they’ve ever done that in a postwar period.
I also think that Asia has been hung out to dry here. These are the export-dependent economies I was speaking about before. Their production structures — their production capacity — is geared for the global consumer, and the global consumer is on the mat. They’ve either got to find a way to feed their own demand, possibly through tax cuts, or they’ve got to mothball some of this capacity. Some of them are trying to use competitive currency devaluations to get out of it. But they’re fighting for a shrinking global pie. In other words, the export market share may be improved, but the global trade pie is definitely shrinking here.
I think we face some enormous challenges here. I think this is a very serious sequence of events. I think Kurt’s work was dead on in basically trying to warn people that this is not just some sideshow in the housing market. There are many things that will fall through if the housing bubble bursts.
AW: To clarify that, the boom that everybody has been watching in China, in India, and even Brazil to some extent, that boom was dependent on Anglo-Saxon consumption, which was a bubble in itself. It was dependent on easy credit and a continuation of spending beyond household need.
RP: That’s absolutely right. If you look at these economies, they were running trade surpluses that were driving their growth, and the trade deficits were most apparent in the U.S., the U.K., Australia and a few other places. Where credit booms had been allowed to run, housing values had gone through the roof. People had learned how to use their homes as ATM machines. They were spending more than they were earning.
You put that movie into reverse, and what do you get? You have a bunch of countries that were depending on exports to carry their production that no longer have that channel for growth. We see things like China now implementing its own dramatic fiscal stimulus, building railroads left and right in order to try to keep people employed in the economy, and keep political stability in the nation.
AW: What of domestic demand in China and in the local Asian markets? Is that developing?
RP: I think when we consider the amount of years that they’ve been building up the manufacturing production structures or to feed Western consumers, this is a very large challenge that they face. China is enough of a top-down-oriented economy — in other words, there are still remnants of the old central planning — that they may be able to pull it off. If any country has the political necessity to pull it off, certainly it is China because of the political stability questions.
They may be able to go down this route, but it seems the fiscal stimulus route is not very common, nor very familiar in Asia. They are headed down this route, but the reality is the production capacity they have domestically is well in excess of their own domestic demand. This is going to have to be resolved one way or another.
AW: Let’s talk about the policy response from the United States then. Because the idea is that since households are now saving at a rate that they haven’t been doing in years, and since corporations are cut off from the credit spigot and can’t borrow and spend, the idea is that government is the only entity that can borrow at will and spend in order to make up the deficit that’s created by people not consuming any more.
Is that enough? The stimulus package of the Obama administration and the unanimous economist view in the United States, is that enough to get the United States out of recession and address the issue of overproduction in the Asian economies?
RP: As you mentioned, there are two ways out of this when you have a private sector where spending is slowing on the consumer side and corporations are buckling down into a survival mode.
One way out is through the trade balance. You can try to reduce your trade deficit and go into a trade surplus. That is occurring in the United States. The trade balance has improved about 2% of GDP. It may improve another 2% of GDP this year. But that’s not enough.
It’s also hard to turn your trade balance around when the rest of the world is basically in a very deep recession as well. So that’s not going to get us out of it. The fiscal balance going deeper into deficit means the private sector is getting income flows from the government side of things. That buys time for them to basically build their savings rate and repair their balance sheets along the way.
What we have is the private sector deleveraging, lowering their debt, and the public sector re-leveraging and increasing its debt as you have government deficit spending taking place.
Does this get you a solid foundation for the next wave of growth? I think Dr. Richebächer’s view was informed enough by the Austrian school that he would say that you have to consider restructuring the production facilities within the United States and setting up new industries that will help you grow into the next decade.
We know we need to work on energy independence. We know there’s plenty of room for people to begin exploring alternative energy sources. There are ways we can make our electricity transmission grid more efficient through smart grid technologies and so forth. These are things that need to be explored and opened up in order to create the next wave of production within the United States.
To that extent, the fiscal policy isn’t really addressing that. It’s just a stopgap measure with respect to transfer payments, to households, or to state and local governments. It’s not solving that lack of productive capacity in the United States which will be needed to drive growth in the future.
Kurt’s view was always first and foremost that long-run sustainable growth has to be driven by capital spending and by investment spending. I don’t see enough of a component beyond the infrastructure capabilities that are put into place with this fiscal stimulus to get us to that next leg of growth. My concern would be on the other side of this we get this type of jobless recovery environment that we’ve seen before because we really haven’t dealt with the underlying disequilibria of the production structure in the United States economy.
AW: In that environment, what can individual investors do? Many of the people who may be listening to this conversation would either be advising their own clients on how to structure their investments, protect their portfolios or even, in some cases, take advantage of arbitrage opportunities that arise, or they might be individual investors themselves, people with a pile of money that they want to figure out what to do with.
What can you advise either of those sets of people, either advisors or individuals, who are trying to make very difficult decisions about what could be characterized as uncharted territory — something that Kurt saw fairly clearly, but most people alive today have not had to deal with these types of situations?
RP: There’s no question that this is one of the most challenging investment environments I’ve ever seen and perhaps most people have ever seen — the mid-1970s being one other possible time when things were this extreme. I think you can come to some clear conclusions, but you need to be willing to think outside the box. That’s exactly what Dr. Richebächer was capable of doing.
One of the things that strike us along this path of massive policy response is that central banks around the world are racing to a zero nominal policy rate. The fed fund rate is virtually indistinguishable from zero. The Bank of England is headed there. The Bank of Japan has been there for some time.
We have policy rate manipulation going on here. At the same time, we have more and more overt manipulation in the money market, and the government and mortgage bond rate to the extent that we saw earlier this week the Fed offering to expand its balance sheet to $3 trillion from what is already close to $2 trillion in order to engage in what they call this quantitative easing.
I think more and more professional investors are realizing the system is getting flooded with excess liquidity, and they will begin to question more and more the nature of fiat currencies.
As they do so, even though we may have in the very near term a price-deflation risk, I believe more and more investors will want to hedge against the possible explosion of central bank balance sheets and the eventual emergence of inflation.
That’s not this month. That’s not next month. But you can see by the way they’re progressing that central banks are basically taking a whatever-it-takes attitude toward trying to break the freeze in the credit systems. As they do that, they’re likely to put too much money into the system.
A long goal position through this period, even though near-term prices may be falling, seems to us to be the appropriate response to central banks that are on the run printing money as quickly as they can.
Another possible trade here, we believe, is to short the Asian equities. Again, this is tied back to the story about the manufacturing production capacity being there. It’s simply too large for a world where the consumer has got to spend within its income flows, cannot rely on serial asset bubbles — that sequential asset bubble after asset bubble — in order to continue to go deeper into debt and buy more than they’re producing.
We know the news flow out of the Asian region is of a Depression scale. There’s production and export drops that are large, double-digit drops, the type of thing we didn’t see before the 1930s. It’s worse than the ’97 and ’98 crisis.
If the debt-financed consumption binge is down for the count, as we think it is in the Anglo-American nations, then the Asian region is stuck with a lot of excess capacity. They will take some time to rationalize that and to find a way to revive their own domestic demand to take up some of the slack. A short Asian equity position should also help you through a period where we’ve got enormous transitions going on in the global economy.
AW: Earlier this week we heard the first words from the President of China expressing concern about U.S. Treasuries. That’s a public statement by a very high official in China for the first time saying maybe holding our wealth — the wealth they’ve built up over 20 years of trade — is not necessarily well preserved in U.S. Treasuries.
That’s the first time we’ve heard it. There have been murmurs from finance ministers and party officials, and even from other countries like South Korea and India. This seems like a hallmark moment. Two days later, the Fed came out and made their announcement that they were going to buy $300 billion worth of Treasuries. Is there an interplay between Washington and Beijing that we need to be aware of?
RP: Yes, there’s a very large danger here. If the Fed goes all the way down the playbook that it has described in the past it’s willing to use in periods of deflation, that they will be willing to take steps that will lead to dollar depreciation. If you’re holding U.S. dollar-denominated assets and you’re a foreign investor, that immediately eats into your returns and eats away your capital gains. I believe the Chinese messages are not-so-subtle threats that this will not be tolerated on their end.
In that case, you could have a variety, not just Asian, but also European investors saying, “I want out. I don’t want exposure to Treasuries because I can see the Fed is in a position to flood the system with liquidity. Eventually, that will either spoil the dollar, or lead to inflation, or both.” That’s been a risk all along here, but you’re hearing more and more people begin to wonder whether the U.S. dollar should continue to be the reserve currency of the world.
In that situation, it places the Fed in a very difficult position. As you’ve stated, now what they’ve come out and offered to do is buy $300 billion of U.S. Treasuries for their own portfolio. If you think about it, in essence what they’re doing is trying to create the perception that there’s a floor on Treasury bond prices, that there’s a ceiling on Treasury bond yields that they’re willing to commit to keeping. In that case, they’re setting themselves up to be the sole buyer of last resort in Treasuries because people will want to take advantage of that price guarantee and sell to the Fed if they’re concerned about currency or inflation risk.
So, you’re right. There is more and more concern abroad that their Treasure holdings will be basically burned up in either an inflationary wave through the United States, or through the weakness in the U.S. dollar. It puts the Fed into really tough position.
AW: The immediate response of the currency markets was to knock the dollar index down by three to five points over the course of the next week, which was the largest drop since the index was created in 1971. There’s an obvious concern out there. That also, I might add, offers some interesting trades in the currency market. That’s the continuing tension we’re going to be looking at in The Richebächer Letter.
As we endeavor to found and expand The Richebächer Society, I’d like to welcome you, Rob, and thank you for taking an interest in Kurt’s work.
I hope we can work together to build the kind of clarity that Kurt had about these kind of big ideas as they work their way through the global economy, but then also be able to translate them to actionable advice for individuals who either may or may not understand what’s happening, or they have to make real decisions about what they’re going to do with their own money, and how they’re going to protect their families, and/or pay for tuition, and healthcare and retirement. Those are some of the very important big decisions that we need to make.
Thank you very much, Rob. We’ll be speaking again soon.
RP: Thank you, Addison. I also appreciate the opportunity to extend Kurt’s work. I think this is very important work, and I think it’s well worth the effort.
