On Saturday, I had the good fortune to attend a Stanford University alumni event in London (the only European date in a four-year, 20-city world tour by President John Hennessy and distinguished faculty, called Leading Matters). It is not only a way for Stanford to reconnect with alumni, but also a great opportunity for alumni and their guests to hear about multidisciplinary research from faculty members on topics ranging from personalized DNA-based medicine to ecosystems sustainability and energy policy.
The most successful session by far, though, was one where academia and practice came together: Business School Dean Bob Joss (whom I am a great fan of – see a short article here) started off a discussion with alumni Jerker Johansson, CEO of UBS Investment Bank, and Bill Browder, founder and CEO of Hermitage Capital Management.
Now, I’m going to focus on what Bill Browder said. It is very much of a Black Swan scenario – yes, blacker than it’s been so far. Not that I’m giving you such a big scoop: first, because Browder has already gone on the record as fundamentally bearish (see here); second, because in a couple of weeks’ time you will be able to listen to the whole session on iTunes (the meritorious organizers of the event are making recordings and notes public – see for example the Los Angeles sessions from last January here); third, because he’s probably going to give much the same speech at the London campus of the University of Chicago next week. It was Browder’s talk that generated the most heated debate at the cocktail reception and dinner that followed, and I did take some notes, so I thought I’d share them with you.
Browder made four – admittedly extremist, but in his view quite solid – predictions for how the crisis will play out in the rest of 2009.
- Commercial banks will start “gating” their deposits (i.e., introducing restrictions on how much a depositor is allowed to redeem), probably in the European Union.
Rationale: the entire banking system still has a precariusly low level of capitalization, and government guarantees are no longer credible – a country like Ireland, with €7bn in offical reserves, cannot possibly make good on €400bn of guaranteed deposits. If 10% of depositors decide to pull their money out, Ireland needs to come up with €40bn in cash, and by the time the ECB has scheduled a meeting to see if they can help out the Irish, the whole Irish banking system is insolvent. That’s why the last resorts for banks – or for governments, really – will be to tell you that you cannot take out more than, say, a thousand euros per week. Can’t happen? It’s already happened – in Russia, Argentina, Latvia, Ukraine. Sooner or later, it is happening somewhere in the EU.
- The price of long-term US government bonds will crash.
Rationale: 10-yr and 30-yr Treasury yields are unrealistically low. The US is facing the biggest budget deficit in its history: even if you argue that the US is not just like any other borrower (which Browder doesn’t believe, by the way), bond prices cannot defy gravity indefinitely. Who will buy enough bonds to finance a $2 trillion deficit? Nobody. Even if buyers can be found for bonds covering half of it, for the other half the Fed’s going to have to print money. And you don’t want to be caught holding bonds with a single-digit nominal return when the Fed prints enough money to generate double-digit inflation. (By the way, an interesting side effect may be that other countries can’t issue bonds at all, because issuing by the US Treasury is crowding out everybody else).
- There will be a number of sovereign defaults, including in the EU.
Rationale: follows from the above. Current risk premiums already imply a probability of defaulting within the next 5 years between 10 and 20% for the usual suspects: Ireland, Greece, Poland, Italy. The probability that at least one of them defaults, even if we don’t know which one, is pretty high. Again, it’s happened before (Russia, Argentina, etc.)
- The price of gold will go up.
Rationale: it’s the only thing that governments cannot print.
The best question from a rather traumatized audience was: “What has to happen for you to be wrong?”
Browder replied that, for his argument to be wrong, asset prices have to stop falling. If we’ve bottomed out today, then the predictions above are wrong. However, note that, no matter how much they commit in relief programs and stimulus packages, governments have never been able to stop asset prices from falling.
Recommendations for the retail investor? Put 90% in Treasuries with extremely short maturities (2 weeks to a month) or, if you have access to it, buy commercial paper by the likes of Microsoft, Johnson & Johnson, and Philip Morris. Put the other 10% in gold. And sit tight.
The only bright spot in Browder’s argument was: the Euro is not going to fall apart. Stress on the Euro is coming from the likes of Ireland and Portugal, not from the healthier countries. The people with the biggest problem have the biggest incentive to stay in the Euro, because doing otherwise would be disastrous for them (as far as Italy goes, I’ve believed for months that without it we’d all be in the streets, banging pots and pans, Argentinian-style). Conceivably, France and Germany could decide they’d be better off getting out of the Euro and leaving the rest of the Euro countries to fend for themselves: yet their political commitment to the Euro is too big. It took 40-50 years to make the Euro, it won’t get unmade in the short run.
And on that happy note, my dear readers, let me remind you that the next Leading Matters is scheduled in San Francisco on May 9 and, given the proximity to the University, promises to be packed with interesting speakers, although it won’t be featuring Bill Browder, I believe. Still, if you have any friends who’ve been to Stanford, get yourself invited and you’ll have a great time fulfilling your intellectual curiosity. And wishing you were back in school, maybe!