CONSUELO MACK: How is this going to be resolved? What impact is this going to have on us as investors on the markets?
ROGER LOWENSTEIN: Of course we can’t know, but the period that comes to mind, the scariest comparison, is the 1970s when the dollar lost 20-30% of its value to other currencies, lost more in the United States to the terrible inflation we suffered. At the same time we had that stagflation, meaning we had a stagnant economy and inflation. We had both terrors. You get asked, by the way, sometimes now- what should we fear more now, inflation or deflation? Which tells you that we are really worried on both sides. The thing that pulled people through the best in the ‘70s, and I won’t say that they made out terrific, but equities hold their own against inflation because if you’re selling a lemonade stand and the currency depreciates, you can raise the price of lemonade. Obviously if you have a long-term bond and you’re getting paid in dollars, they buy fewer lemonades each year if the currency depreciates. The first thing I would say is stay away from long-term bonds.
CONSUELO MACK: Starting now.
ROGER LOWENSTEIN: Starting yesterday.
CONSUELO MACK: The Fed. You just mentioned the fact that people are worried about both deflation and inflation. Right now the Federal Reserve seems to be much more worried about deflation. Correct?
ROGER LOWENSTEIN: That’s right and I’m not saying they’re wrong. The Fed’s first worry can’t be your portfolio over the next 10 years. It has to be avoiding or averting a recession or depression. We have had really zero growth over the last two years-plus combined. And history says, if you go back to the real Depression in the ‘30s, they thought they had it licked in ‘36. They tightened up again and the Depression came back in all its glory and horror in 1937-38. So Bernanke knows if he errs, he’s got to err on the side of making sure the economy recovers. That’s probably right, but does it mean we are running the risk of inflation down the road? Of course it does.
CONSUELO MACK: Because one of the seeds of the financial crisis that you covered extremely well in your most recent book, The End of Wall Street,
was the fact that interest rates were kept so low for so long, which just encouraged people to do more borrowing and resulted in the credit bubbles that we had. Interest rates are still extremely low and it looks like they are going to continue to be kept low for an even more extended period than anyone anticipated. Is this setting us up for yet another problem?
ROGER LOWENSTEIN: Well, it could be because as you say, those interest rates were low in 2002, ‘03 and ‘04 because we had had a recession, the dot com collapse, all of that, Enron in ‘01. They wanted to make sure that we got over that problem and the low interest rates fed into this one. I think something for investors to think about, as well as for the Fed to think about, is that in this world, this interconnected global world, the excesses don’t necessarily come via price inflation. In fact, given the amount of global trade, it’s hard for there be price inflation because if you run a toy store, if you’re Toys R Us, it’s hard to jack up prices when there is competition from China, Indonesia and so on. What happens, though, that cheap credit fuels money in from overseas and we get asset bubbles. It was the Chinese, Japanese, others lending us, lending American investors and American banks who lent to investors, the money for that mortgage bubble that we saw.
So investors have to watch out not just for old-fashioned, if I can call it that, price inflation, but for asset bubbles, which we’re seeing that if interest rates stay low for an extended period of time, bankers start saying, oh, I could do LBOs because money is so cheap. Individuals start taking out dicey loans because the marginal costs of their mortgage and private equity loans are cheap. So I think we really have to worry in this world as much about asset bubbles in a low-interest-rate world as we do about price inflation.
CONSUELO MACK: Roger, the same risk management models that really failed dismally in the financial crisis that we have just come through are still in existence. Aren’t they still a major problem for financial planning and for investors going forward?
