Doug Noland, senior portfolio manager with the Federated Prudent Bear Fund (symbol BEARX), has warned of the building credit bubble in regular writings since 1999. The fund is designed to rise as markets, and particular stocks, fall. We interviewed him in October to get his view on credit problems around the world.
KIPLINGER: We last spoke in the spring of 2008, and at that time you said the cracks of the credit bubble had started to show, and of course the bubble burst that fall. How do you see the situation now?
NOLAND: As we made clear back in ’08, we’ve been in a multi-decade credit bubble. My view has been that everyone thought ’08 was the bursting of the bubble, but ’08 was about the bursting of the mortgage-finance/Wall Street-finance credit bubble. But the greater bubble just kept growing.
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What is the greater bubble? The global government finance bubble. And the policy response to the 2008 crisis in the U.S. and all over the world further inflated that bubble.
So now the credit bubble is all about governments? Correct. After doubling the amount of mortgage credit in the U.S. in just over six years last decade, we’re going to double our federal debt in four, or less than four. And you can see the same trend in central bank balance sheets all over the world. It’s unprecedented. We’ve seen huge expansion of debt in Europe and Asia, and now Greece and Asia are suffering from a sovereign debt crisis.
Where in Asia specifically? It’s my view that the Chinese credit system is a historic bubble. The bank lending in China is unbelievable. And now we hear more and more that there’s significant lending outside the banking system that hadn’t been accounted for.
That’s interesting, because many people look at China and see just a real estate bubble. But you see something more. We already know there have been huge credit excesses at the state and local government level. I think we’ll find out down the road that there have been excesses in the corporate debt market. I wouldn’t be surprised to see the bubble continue to grow for a bit.
And Greece and Europe? I see a lot of parallels between Greece and its first crisis a year ago and our subprime mortgage problems starting to show in the spring of ’07. Those were the initial cracks in the bubble. The marginal borrower gets denied access to cheap finance, so systemic stress starts to rise. Then you have your initial policy response that really doesn’t address the underlying debt problem, and then you start this contagion.
Many folks are very complacent about this because we’ve seen so many debt crises over the years be resolved by aggressive policymaking in Washington and elsewhere. But this is a government debt crisis that won’t be resolved as easily as previous crises. It’s very difficult for politicians to rein in big deficits after your economy has become accustomed to them.
Do you think that just as these crises spread, so will austerity measures that we’ve seen threatened in Greece? Absolutely. That’s the unfolding theme. The markets are now keen to these structural and economic issues, and that’s what starts the contagion. We’ve seen it from Greece to Portugal to Ireland. Now it’s knocking on the door in Spain and Italy.
At the same time, since the epicenter of the crisis is in Europe, the U.S. Treasury market had a huge rally. The markets continue to accommodate unbelievable deficit spending out of Washington. That’s part of this worst-case scenario. We already should have interest rates rising right now and imposing some discipline. Instead we continue to accommodate. The markets will continue to buy the debt until for some reason they don’t like the debt any more.
How will that play out? We saw this in Greece. In November 2009, Greece borrowed two-year paper at 2%. The markets knew they were borrowing in excess but didn’t think it was a big problem. Six months later, that two-year borrowing cost to Greece had risen to 15% and they were hopelessly insolvent.
What’s an investor to do right now? There’s so much risk in the marketplace that investors are facing very tough decisions. On the one hand, if you just want to save your money and protect it, the Fed’s ensuring you get no return on your money because interest rates are so low. So our monetary policy is forcing many savers into investing in stocks or bonds to get a return. What we think of as investing today isn’t really investing because there’s no way to gauge the risk level in the marketplace. If you can’t gauge risk, it’s more speculation than it is investing. So the whole thing is rather messed up.
So how do you play defense? We still believe in a well-diversified portfolio. Hold a lot of money in a low-risk strategy and have some commodity exposure. But there’s no easy solution.
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