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Jean-Francois Nobert
Jean-Francois Nobert
Articles (14) 

An Interview With Gary Shilling, a Mastermind of Economics

Our second opportunity to learn from one the greatest minds in the field of economics

Gary Shilling is, without any doubt, one of the few economists to whom we should pay attention. It is amazing to realize just how right he has been repeatedly throughout his career. His crystal clear view of the present economic environment is also very impressive. When meeting with him, you quickly get a sense of his deep knowledge and humility. He is a great inspiration. For those who missed it, I highly recommend that you read the interview we did with him last year.

You started your firm in 1978, about 38 years ago. Looking back, what would you have done differently?

I would probably start earlier. I always had the desire to start my own firm, and by nature I am not cut out to work for other people as I am too independent. I think this is the reason I have had the success I have had, because I can say what I think. But what I found difficult is that in the financial service industry, most people are paid to be bullish. As you know, I was fired twice by Don Regan, who was the CEO of Merrill Lynch, for forecasting recessions. I was Merrill Lynch's first chief economist and in 1968 I had forecast the 1969-70 recession that occurred, but it was not being bullish on America, which was the Merrill Lynch slogan of the day. So Don Regan fired me, and I took my entire staff with me to another firm, which was later bought back by Merrill Lynch so I got fired again. The story on Wall Street is that I am the only guy who was fired twice by Don Regan. The reality is that most people on Wall Street are paid to be bullish and I am not the only one who was fired for having different views. Being right or wrong is not important so long as you are bullish. Most economists have lived through a number of bear markets and recessions but they have never forecast one, at least they never talked about it. Again, if I were to do it all over again, I repeat that I should have started earlier.

Previously, you told me about your successful bet on the Australian dollar, can you tell us a little more about that thesis?

The Australian dollar was simply a way to play the decline in growth in China. China basically grew because of globalization, which I think is the most significant world economic event of the last three decades, the shifting of production, mainly manufacturing, from developed countries to China. It did not change the overall demand for manufacturing goods, but it concentrated their production in China. Of course, the story is that Australia is the main big supplier of coal to China as well as iron ore and other minerals, so China is basically difficult to short, as they control their currency, they control their stock market. The only way you can really short China is through stocks in Hong Kong, which is not quite the same. So the Australian dollar was simply a way to short China, nothing against the Aussies. They are digging up the island continent and basically sending their minerals to China. That was pretty much the whole rationale there.

What are the fundamental things you pay attention to when looking for opportunities in currencies?

I think the reality in currencies is all about global economic growth. Countries are always looking for ways to increase their production, and if this does not happen domestically, then their approach is to increase exports, and the way to accomplish this is to make them cheaper through currencies. So there exists a global desire to devalue against the U.S. dollar, something we see in the commodity currencies: Canadian, Australian and New Zealand dollars. Other commodity currencies are the Brazilian real and Mexican peso. Then you have the euro currency and the Japanese yen, with those central banks are deliberately trying to trash their currencies. Again, because they want to increase exports. Then you have the so-called "me-too economies”: South Korea, Taiwan, other Asian currencies and elsewhere, who want to join the parade; that includes China. China really wants to devalue and have a weaker currency. This is difficult for China to accomplish, and it started a year ago. With the collapse in stocks in China, there was a tremendous outflow of money and they tried to accommodate that by loosening their foreign currency reserve, which was decreased from $4 trillion to $2.2 trillion, basically to accommodate people wanting to move their money out of China. They traded U.S. dollars for yuans. They would like to devalue their currency but they are afraid that if they do, it will create an even greater outflow of money. One of the things China has done is to link their currency to a basket of currencies, so they can say they are flowing with the other currencies and going along with the crowd. They are very opaque about this, and one is not quite sure what they are doing versus the U.S. dollar. I think in terms of currencies, the U.S. dollar is the best bet. Virtually everybody else is trying to make their currencies cheaper relative to it.

When we are looking into currencies, should we look at exports?

In a theoretical economic sense you look at exports but I do not think exports, per se, are that important. Many countries are simply trying to increase their exports, in term of the export import balance. It is a big determinant of currencies these days but I am not sure it is as important as delivered government policies. In the case of the commodity currencies, yes, I think it is true of the Brazilian real, Russian rouble, Canadian, Australian and New Zealand dollar. The weak commodity prices are very weak there. Regarding the yen and the euro, they are driven by central bank policies.

Any authors or books you could recommend for developing a better understanding of currencies and their markets?

None that I can think of at the moment, as currency markets are now divorced from the normal determinant. For example, one of the things that has periodically received a lot of attention is purchasing power parity, the idea that a Big Mac costs about the same in the U.K., France, Canada, China or wherever. The idea is that ideally the currency should adjust to bring the prices into balance, but unfortunately this is not the case because currencies are so politically driven that I do not have any book I would recommend.

Starting from the beginning with currencies, it is all about global economic growth, and as long as growth is slow and we are now in the age of deleveraging, working off the excess of the 1980s and 1990s we will have a great desire to devalue. Of course, to the extent that everybody devalues, they can offset each other.

What are your biggest concerns at the present time?

The political landscape, we have many unusual politicians who have received lots of attention. You have Justin Trudeau, the Prime Minister in Canada, Marine Le Pen of the Front National in France, Jeremy Corbyn, leader of the U.K. Labour party, there is the far left and right in Germany and France, and of course in the U.S. So we had virtually no growth in real inflated adjusted income for most people in Europe and North America for over 10 years. People are reacting and saying they have to blame somebody and the mainstream politician gets the complaints. In the 1976 movie "Network," there is a guy who yelled, "I’m mad as Hell and I’m not going to take it anymore". I think this is where a lot of voters are today in Europe and North America. I think the result is probably going to be a big push toward fiscal policy stimulus, as monetary policy is not working that well anymore. In the U.S. there are two areas where this might be detected, one is infrastructure, we certainly need a lot of work on roads and bridges, railroads, etc., and most Democrats and Republicans could agree on that. The other one is defense spending, and this would be more favorable if the Republicans controlled both the Senate and the White House. You also have Japan being much more militaristic, and of course Russia invaded Ukraine. We detect some frustration going on there, and we will see how it plays out. Could Marine Le Pen become president of France? It’s possible! And, of course, the U.S. will be very interesting, and I will look at our current election very closely. I think that even if a more mainstream politician gets elected in the U.S., it may well be that Congress and that new president may want to do something to stimulate the economy because the voters are not very happy.

Do you think new fiscal policy would be the right thing to do?

Certainly in the case of the U.S., we can use the infrastructure improvement. There is a lot of slack in the economy, the labor market still has a lot of it, industrial operating rates are still very low. So yes, there is plenty of room, and the only question is always whether or not the money will be efficiently spent. That is the problem with government programs: they are very well-intentioned but very often they are not efficient in terms of their spending; they do not have a bottom line.

How would you change that?

I think that I would favor investing in the infrastructures: construction companies, suppliers of raw materials, basic industries, and if the investment is big enough, it could revive the U.S. economy sooner than it otherwise would. If not, we are still working off the excess of our indebtedness built up in the 1980s and 1990s, and there is no indication that this deleveraging process is over, and it probably has to run for a couple more years. Infrastructure investment could revive the overall economy. Even if there is a will, nothing will happen before the new president and Congress get elected. By the time you get this all geared up, you are two or three years down the road, but with market anticipation, so you can detect this anticipation faster than the actual spending.

Do you think the worst for China has yet to come, or has it already passed?

China had benefited from this globalization, the movement of industrial production to an emerging economy. China has the biggest economy and the most obvious one, we talked about this earlier in the case of Australia. That globalization process is pretty well completed. If you look at U.S. manufacturing as a percentage of GDP, it was 50% of GDP in the late 1800s. About 20 years ago, it was 20% and now it is 12%. I think the great shift of manufacturing to China is over. We are at an irreducible minimum, so that sort of growth in China is over. The other thing that created growth in China came from massive infrastructure spending and they created a lot of ghost cities, excess in infrastructure and huge debt to finance it. So that process is pretty well over now. Now what China is faced with is shifting its economy from one driven by exports and infrastructure to a consumer economy and it requires some reorientation, a process that takes a lot of time. In China, this shift is still in its very early stages. From the standpoint of globalization’s effect on the rest of the world, it is pretty much over and the shock that people had over China when they saw the increase of commodity imports, well that is pretty well over too. It is pretty much like Japan. Everybody thought that Japan would take over the world in the 1980s and then they had a housing collapse, followed by a stock market collapse in the early 1990s, and then for the last 20 years, nothing. I think China is going to be the same, it is not going to go away, but as the major focus of attention on the global stage I think it’s pretty much over.

Economists point towards financial instruments as exacerbating the fragility of the finance sector. While often innovative, many financial products allow higher risk-taking, are likely to have unrealistic valuations and are difficult to regulate. Many call for better regulations. Do you think this is possible given the inter-connectivity and complexity of global financial markets?

There is no question that financial markets have been excessive. The only justification for finance is to grease the wheels of industry, to provide the financing. If you did not have finance, you would have had a borrower economy, which is very inefficient. But what has happened in recent years, and particularly with slow economic growth, is that finance really took over and it is an end in itself, and we have got tremendous financial excess, a lot of which got wiped out in the financial crisis. But not all of it, particularly in the U.S. The bailout of banks and others left a lot of it intact and I am not sure more regulation is the answer because if you increase the regulation of the banks, the money moves to the shadow banks, the hedge funds, private equity, and I am not sure that is a very healthy situation because then you do not really know what is happening out there, the degree of leverage, with very little regulations in those areas. However, that is probably going to continue because the responses of regulators in the U.S. to the big banks bailed out was to break them up in order to reduce their size to the point that they are not too big to fail. But the banks pushed back on that, so the regulators, in effect, said OK, you do not want to be broken up so we will regulate you to the point you would like to be broken up. And that is what they are doing, and they have relieved them from different profitable activities like proprietary trading, derivative origination and trading. And they were pushed back to lending, basically taking deposits and lending the money out with a spread with a very flat yield curve for long term rates in relation to short term rates, which is not a very profitable business so it has put the banks in trouble. This resulted in further regulations, further increased capital requirements on the banks. I do not think this changed it to a zero risk profile, but it certainly pushed the action elsewhere.

Would you recommend more regulation in the shadow banks?

It probably makes sense from a theoretical standpoint, but if you did that, it would probably be so disruptive and result in a tremendous reduction in finance entirely, to the detriment of the economy. I think there is probably a case to be made for trying to control this.

And finally, to which moments in history should we look if we want to move past these cycles of financial crises?

The biggest concern that I have now is that people are trying to jam the current economic and financial situation into some kind of a regular cyclical pattern. We experienced fairly regular cycles early in the post-World War II period that ran through the 1950s, '60s, '70s and even the '80s, but then when you started to see all the leveraging up that took place in the financial sector and U.S. consumer area and other sectors in the 1980s and the '90s. Then it was of course followed by the financial crisis, great recession, very slow growth. I think it created a very different environment.

So to me the problem is that people are looking for a simplistic kind of answer, they are looking for something like a cyclical pattern and where are we in that cycle, so as to know what to predict next. I do not think we are in anything like the typical post-World War II cycle. I think the greatest mistake that a lot of younger people make in particular, is that they are looking backward nostalgically to that era, assuming it must be the same cyclical pattern as the 1950s and 60s, enabling us to follow the script and see where we go from there. But I do not think that is the case. I think we are working off this massive leveraging, we still have this overblown financial sector, and we still have slow global growth. And we know strong growth covers a multitude of sins. Really, when you have strong growth you can make a lot of mistakes! But when you have slow growth, it does not take much to fall into a recession. You look at the emerging economies in Africa, for example, who earlier had strong commodity prices and a lot of money coming in, but they did not use that money to restructure and diversify their economy, resulting in these countries now being in terrible financial shape. I think this means we are in a different era, and I do not think it is anything comparable to what we saw earlier.

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Rating: 4.8/5 (12 votes)



Newyorkpapi premium member - 3 years ago


Jean-Francois Nobert
Jean-Francois Nobert premium member - 3 years ago

Yes i agree with you, the problem is that they are rare, Mr. Shilling is quite exceptional!

Asawhneyy - 3 years ago    Report SPAM

He did not offer anything new---the same standard talk --I guess every body has to sell something to be independent.

Buffet is the only Picaso in investments--

Jean-Francois Nobert
Jean-Francois Nobert premium member - 3 years ago

Mr. Buffett is indeed one of the best investor of all time, no doubt about it, but a single man alone can't know it all. If you think Picasso is the only great artist it's a personnal choice but certainly worth to have a look at his approach. So if you want to become a great artist of investing and business such as Picasso was for art. I think Picasso would say he found great value to learn from others such as: Edvard Munch, Henri de Toulouse-Lautrec, Jean-Auguste Dominique Ingres, Diego Velazquez, Francisco Goya, and Rembrandt van Rijn. And probably much more!

So the question ia about you, do you want to become the next Picasso or enjoy watching his painting? If you want to be a great artist of investing there is tremendous value to learn from Mr.Shilling who has adviced both Prem Watsa (Trades, Portfolio) an John Paulson (Trades, Portfolio). Both of them both forecast the last financial crisis while Warren Buffett (Trades, Portfolio) didn't so. Without any doubt Mr.Shilling is one of the greatest mind of economic worth to learn from if you want to become a great businessman and investor.

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