Here is an interview with the man who wrote the Power of Gold. We may have to wait another 5-7 years before the dollar really starts to loose value.
thestreet.com
Thses are some of his comments
Brett D. Fromson: An incipient flight from the dollar.
Peter L. Bernstein: Yes, if there were flight from the
dollar, what would this do to us? Why should we be
worried about it?
Only within the last couple of weeks or at least within
the last month, [Federal Reserve Chairman Alan]
Greenspan himself said this is something that could
happen eventually, and that we have to be concerned
about. And he's the guy with his hand on the trigger, so
it's going to be his job to try to take care of it. It's a very
different kind of crisis from the kind he's used to dealing
with.
Why should we care? A weak currency is inflationary.
Otherwise, it really doesn't matter a hell of a lot, but it
means that instead the pound is now $1.40, that
instead of an Englishman wanting to import something
from the U.S. ... Then he'd get $2 for his pound. So that
one pound would be $2 worth of stuff instead of $1.40
worth of stuff. Then we'd see our exports going up, and
we'd have to pay $2 for a pound's worth of English
merchandise. To go over there to have dinner in London
is expensive enough now, but it would be that much --
50% -- more expensive than it is now.
So, we would be exporting more, and we'd have less
import competition. And the consequences would be
inflationary. The only way to prevent this is to raise
interest rates sky high, and that certainly makes the
stock market go down and the bond market go down.
Brett D. Fromson: And the real economy?
Peter L. Bernstein: And then this hits the real
economy. And that's really the classical medicine, you
see. Then the real economy gets weaker and we don't
import so much. Because we're now importing about
$30 billion more than we're exporting. That would
change.
Brett D. Fromson: Are you concerned about the dollar
flight question in the near term?
Peter L. Bernstein: Near term, no. I have a basic
philosophy -- I guess because I'm a child of the '30s --
that anything can happen. And that economic
conditions change and that good times develop
maladjustments and lead to bad times. Bad times can
lead to readjustments that lead to better times and this
is how the world works, and there's absolutely no
reason to believe that's ever going to change. So, while
I'm not concerned about this near term, all the
necessary ingredients are there for something of that
nature to occur.
Brett D. Fromson: Meaning a dollar crisis?
Peter L. Bernstein: Meaning a dollar crisis.
Brett D. Fromson: How important is the federal budget
in a currency crisis?
Peter L. Bernstein: In every case where a country's
got into currency trouble, the fiscal position is in
trouble. They were running into or moving toward the
red.
"But if the surplus begins to shrink, that
could be a problem, and there are a lot of
reasons to think that it may."
Brett D. Fromson: That was a necessary
precondition?
Peter L. Bernstein: To get the gold flowing back in,
they had to get their fiscal house in order. This was
before the bankers in other countries would lend to you.
You had to take these steps and this is really the awful
crises of the early 1930s, when Britain got into trouble.
In 1931, with millions of people unemployed, raising
their interest rates, the gold still kept going out of
Britain. Then we did the same thing, raised taxes and
interest rates in 1931 -- banks failing, prices falling,
unemployment going up, but we had to protect the
gold. To some extent, although we don't have the gold
standard anymore, we would face the same kind of
danger if the dollar were to become very weak.
Brett D. Fromson: Explain that.
Peter L. Bernstein: There would be a run on the dollar,
as I said before. I think that as long as the budget is in
surplus to this extraordinary amount, the crisis might
not occur or might be much more muted because the
U.S. would still look like a stable place. But if the
surplus begins to shrink, that could be a problem, and
there are a lot of reasons to think that it may.
You've just got to read the daily paper ... these budget
projections are based on very fragile kind of substance,
any one of which could easily be wrong. That takes
away a very important prop under the dollar. I think we
could survive weakness in the dollar if the surplus was
strong, and we could see the surplus diminish if all the
other factors stayed in place, but all of the necessary
ingredients for a dollar crisis are there. I'm not sitting
here and predicting it, but in painting scenarios, which
is I think the only rational way you can do it as a
forecast, you need to look at all the different
possibilities. It sure as hell belongs in there.
It's more of a likelihood, but I think if you're talking
about a five- to seven-year time span, I think the
probabilities are good.
Brett D. Fromson: What do the Europeans get out of
the current dollar strength? We don't hear them
complaining too much.
Peter L. Bernstein: If you can't sell at home, sell
abroad. You can still do business. And the weak
currency helps that. And I guess they'd be in worse
trouble in some ways if they didn't have the export
markets.
Brett D. Fromson: Has the dollar replaced gold? And
can any currency ever replace gold in its role as the
means of exchange?
Peter L. Bernstein: The dollar has replaced gold
vis-a-vis the rest of the world because it's the standard
that every other currency is expressed in terms of
dollars. The ultimate reserves that other countries hold
are dollars. They pay their obligations in dollars. Huge
amounts of world trade are denominated in dollars even
between country A and country B, where the U.S.
doesn't even come into it.
So that, in this instance, the dollar is playing the role of
gold. But the dollar is also the currency of the United
States of America and its value is subject to what
happens in the U.S. economy. Gold stood outside the
system. It was a stateless currency. It therefore played
a different role from the dollar.
The dollar plays the same role as gold in all of the rest
of the world at this moment, because the dollar is
perceived to be as good as gold. But the gold standard
was a rigidly enforced system of exchange rates that
didn't vary, and where speculating against a change in
exchange rates would be a losing proposition. I don't
think we'll ever go back to such an arrangement. It puts
each country in too much of a corset. You crucify the
world on a cross of any standard. Each country gives
up a certain amount of domestic freedom.
Brett D. Fromson: Let's look at the euro. One of the
reasons it appears to be so weak is obviously that the
fundamental economy in Europe is not as strong as the
U.S. economy. But another problem they have is that
the European Community is perceived to be weak as
a political entity, and they have essentially created a
common currency without a common government.
Peter L. Bernstein: So they don't have credibility. This
is the big word. What the gold standard really conveyed
was credibility -- credibility that a country would not let
inflation run away, that its currency would continue to
have purchasing power. This was the promise that the
gold standard conveyed because the gold would begin
to leave if they weren't behaving. But that was a world in
which you could create unemployment without creating
a revolution. Today's world is much more difficult. This
is why I think that going back to that kind of
arrangement is very unlikely; the corset is too tight.
Brett D. Fromson: Which currency today seems most
vulnerable to you?
Peter L. Bernstein: I think the most vulnerable
currency is the dollar because we have this tremendous
deficit in our current account.
But, except for us, there aren't any major currencies
that are exposed. The more we buy abroad, the more
other currencies accumulate dollars and therefore seem
to have plenty of reserves to take care of them if there
were a run on their currency.
The only country that is exposed to that kind of crisis is
ourselves. Because we have some reserves of foreign
currency but not an awful lot, relative to the magnitude
of what our foreign liabilities are. But if there were
reasons to move out of the dollar, then there would be a
lot at stake, and the speculators would be right out
there bidding and it would not be stable. It would be
very destabilizing.
"I think the most vulnerable currency is
the dollar because we have this
tremendous deficit in our current account."
Brett D. Fromson: Just paint very quickly what that
might look like.
Peter L. Bernstein: The pound is now costing $1.40
for Americans and it might cost $2. You'd get maybe
50 yen for a dollar instead of what you're getting now. It
would make the purchasing power of dollars in terms of
foreigners go down. But more importantly, it would be
an attack on the capital market.
Brett D. Fromson: In the United States?
Peter L. Bernstein: In the United States. Foreigners
would begin to liquidate their assets.
Brett D. Fromson: Stocks and bonds.
Peter L. Bernstein: Yes. And there's no reason why
an American sitting by and seeing a foreigner selling
wouldn't join in, because the consequences of holding
might be bad. So it would be real bad, it would be the
mother of all crises. Certainly it could be the worst
since 1974 because the dollar is so overowned in the
rest of the world today.
Brett D. Fromson: How might the Fed cope?
Peter L. Bernstein: Greenspan's experience and skill
and his ability to put his finger in the dike at moments
of crisis has created liquidity when there was a liquidity
crisis.
This would be the opposite kind of a problem, in that
creating more dollars would only make the situation
worse. And the only answer is to push interest rates
up, not down. And that's very painful medicine.
It's really a scary possibility. This could be a moment
when gold suddenly regains its luster, because maybe
the euro and the yen don't look like the answer to
everything, and so there's a reversion, in a really scary
time, to more primitive kinds of things.
Brett D. Fromson: How so? Because gold represents
some kind of absolute value at a time of panic?
Peter L. Bernstein: If you visualize something like this
in the very complex financial system we have today,
which is a world of derivatives, all of which have a huge
amount of counterparty risk attached to them, gold is
something for which there isn't any counterparty. That's
it.
In that kind of crisis we'd see the price of gold way up
again. I'm sure there would be some reversion back to
that, because it would look like the only thing that
people would be willing to take if they began to lose
confidence in the value of paper money.
Brett D. Fromson: Final question. You're not only an
economist, but for many, many years you were an
investment manager. What would you say about where
money should be invested today? How do you position
yourself now so that you don't get wiped out in a panic
seven years hence, but you don't forego the
appreciation in, say, U.S. equities in the meantime?
Peter L. Bernstein: I have a very simple answer to
that. And it's a stuffy, old-fashioned answer, but it's
delivered with great conviction. Diversification is very
important. We do not know the future, and
diversification is the only rational way to deal with the
future.
The theme of the book is that greed gets you nowhere.
So, 100% of anything is a terrible, terrible mistake. If
I'm 60% in equities, and the market keeps going up, I'm
not going to make as much as the guy who has 100%
in equities. But I'm going to do all right.
But if it's wrong to be in equities, I'm also going to be a
survivor. And I don't know whether it's right or wrong,
but I don't have to maximize -- maximizing is taking
very big risks. I don't know, if I were 25 years old I
suppose I would take a different view, but for people
who are accumulating for their retirement, which is kind
of the big motivation today for being in the market aside
from having fun, and it is a lot of fun, surviving is just as
important as seeing it grow. If you don't know which
way the cat is going to jump and you're 60% in
equities, you'll get richer. You'll come out OK.
Brett D. Fromson: And the other 40%?
Peter L. Bernstein: The other 40%? Look, I'm not
picking 60% as a number, but less than 100%. I just
don't buy the 100% theory at all. I read one just the
other day I shouldn't mention -- the PaineWebber one.
It's very well done, but it's pure extrapolation of the past
into the future. You can have something that looks
perfect and it's not durable.
Cash is the ideal hedge against this kind of crisis that
we're talking about. Because when interest rates go up,
Treasury bills are what really serve you best. If you
have a hedge against an extreme outcome like 10% in
bonds or 5% in gold, and the worst happens, these
things pay off big.
Brett D. Fromson: And gold?
Peter L. Bernstein: In 1980, the value of all the gold in
the world, the monetary gold in the world, was more
than the value of the New York Stock Exchange. So if
you had taken just a small position in gold in the 1960s
and the early 1970s, it would have exploded into an
enormous amount when everything was hitting the fan,
so you don't have to have a big position as a hedge
against an extreme outcome like that for it to pay off.
So I think I would have small positions in bonds and
maybe gold stocks. But cash is the primary hedge
against the stock market. It also has a cost. The return
is low. But in an inflationary period, it's a wonderful
thing to hold because you're rolling it over as money
market fund rates just go up. But I would not be 100%
in stocks. This is the main thing. What you do with the
rest, you fiddle around, but I would not be 100% in
stocks for anybody under any circumstances, ever.
Brett D. Fromson: Peter, thank you very much.
Peter L. Bernstein: Thank you.
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