THE ECONOMIC TIMES - ETMarkets | November 03, 2016
In an interview with ET Now, Russell Napier, Strategist & Co-Founder, ERIC, gives his views on the dollar index.
ET Now: Let me first broadly start with what is going on with the world right now and before I ask you specific question, I just want to mark, right now there is a debate on what is happening to the dollar index, where the strength lies. So what is your view on the way how things are shaping up and especially the way how the trade setup is? I mean, emerging markets are outperforming and the dollar index now seems to be making a comeback.
Russell Napier: I think that is a great question. You are absolutely right. The market is not focussing on it enough. Two years ago, there were dollar bulls everywhere, that's kind of faded away now and people do not pay attention to it. I believe that it is a move which will continue. I believe it's one that it is very important and the crucial reason as to why that might be important is that the Federal Reserve might find it very difficult to stop a rise in the dollar. I believe it reflects a more than cyclical view, negative view on the euro and a more than cyclically negative view on the yen. And if we are in a world where people doubt the integrity of the Euro going forward and whether it can survive as a single currency bloc and they doubt whether the Central Bank of Japan would absolutely be able to control the supply of money given its new monetary target. This is not about an interest rate differential for the dollar which is what the market focuses on and why from day to day as interest rates in America going up, that is important for the dollar, this is much-much bigger than interest rate differentials. I think the comments of the Fed make it fairly clear that they are very-very nervous about a rising dollar, because historically in stopping that and they very rarely had paid any attention to the dollar but clearly in 1982 and 1998 when we had emerging market crisis, they really did something about the dollar by reducing interest rates. They are really very concerned as to how they will stop the dollar going up and just one final point on the dollar. It can get a momentum of its own because it is highly borrowed cross border and as it rises, the people who borrow cross border, borrow when dollars to finance investments are sort of forced to cover. You get forced buying of the dollar when it spikes upwards. That is not necessary for the United States of America but I think everybody knows how negative that can be particularly for emerging markets, particular for China and it is obviously not particularly positive for commodity prices. So I think we ignore the dollar rates and I think one of the right questions is if it continues how could the Fed stop it.
ET Now: At the top of everyone's mind is the impact of US elections on world markets. Should people care who wins? I mean is the Trump victory a surprise and will that make markets nervous?
Russell Napier: Yes, I think it is fair to say that Trump victory is not priced in but Trump victory is also unlikely. I think the important thing about these elections is not to look at the president but it is also to look at Congress. I mean we do have a president in United States trying to put policy in place in United States of America but it is incredibly difficult given the composition of the Congress. Now the question is will that change after this election? We should also be looking at those for the House of Representatives. And the current situation seems to be that the Republicans will control the House of Representatives when we have President Clinton and then the question is will the next president be able to affect policy and do what is necessary in the last president. I feel that when this election is over, we will realise that what we have is another president who still hidebound by the American Constitution and when this constitution was put in place to prevent America from having a monarch and having a king after the pretty short expel from North America. But sometimes you need monarch, sometimes you need a king, sometimes you need someone with pretty significant power to get things done. My feeling is that the next president will probably be President Clinton and she unfortunately will not have that power and also I feel even if it was Donald Trump, I think also given some of his policies particularly his fiscal policies we have significant reaction in Republican Party. So we need dramatic action somewhere in the world and I do not feel that whoever the president of United States is after this election will be powerful enough to make those decisions.
ET Now: So can the Fed hike rates into 2017 when the rest of the world actually in easing mode?
Russell Napier: Yes I think that is particularly good point to make. If the Fed was looking entirely at domestic economic conditions determining the correct level of normal interest rates, they would be significantly higher already. I really doubt that. So why on earth are they waiting? Because they are very concerned about things that are happening in the United States of America whether that is Brexit or whether it is Japanese monetary policy but I think it really is the reason that is holding them back. So in forecasting the Fed going forward, it is very hard for me to see how the rest of the world suddenly gets the great stability that would allow the Fed to ignore going on in the rest of the world. It is difficult to say given the structural conditions of the euro and structural condition of the European banks, the structural change in Japanese monetary policy why suddenly they get the belief in the great stability out there that can allow the dollar go higher. So I think they will continue to be cautious and I would not say this the more the dollar goes up, the more cautious they would be. So the next interest rate rise will it come, will it not come? Well I would forecast that if the dollar continues to rise all the way up to that position, that would actually hold the Fed back from making the decision. So it is a very rare scenario where the Fed cares so much about the dollar because historically they have not. While they see fragilities in the system, maybe even more so than the market does, and I have said this before and I think they do speak a lot, Christine Lagarde, the IMF and it think she is constantly pointing out some of the fragilities in the system that would be brought out into the open with the strong dollar.
ET Now: Will the pound and euro fall further? Will it be a soft Brexit like the 11th hour 59 minute?
Russell Napier: So the answer to that is yes that I expect both those currencies to be weak relative to a dollar. I am a citizen of the United Kingdom, I live in the United Kingdom and themystery to me has been why sterling has been so high for many years given the size of our current account deficit. It has been hard to justify why it has been so high so just looking at our current account deficit one would expect it to be a lower exchange rate anyway and there has some downsides in terms of inflation which we are seeing but many upsides in terms of competitiveness. When we last spoke it was just after the Brexit vote and I said that the Brexit would probably be a side issue in a long term history of Europe and finance because it is probably the foothills on a much bigger issue that is coming along here which is political disagreement within the Eurozone. So we have the referendum the people of Britain voted to leave European Union why is that a side issue because we are not in the Europe but we held people now in the euro itself getting to seriously debate their long term commitment to the European Union. Now once that begins most people particularly British Economist and British financiers long forecast that the Euro would not survive but they focussed on Economics and they focussed on finance and they were wrong. But when we begin to get a political disagreement and that is where we are and that is what Brexit has triggered and I think it was coming anyway but it is sort of encourage people who are fairly silent on this issue within Europe not within the United Kingdom to be more vociferous. The market is focussing on that and believe me the downside for the euro is really very-very large indeed if we have been to talk about an insoluble currency union which can in fact end and come to an end and of course I do not know to what extent this is getting a coverage in India but the move by the Hungarians, the Poles, the Czech’s and the Slovak’s what they call that the counter revolution which is getting some support from people like Marine Le Pen and the Nicolas Sarkozy and alternative for Deutschland that ultimately because it ends the move towards greater fiscal integration, threatens the long run survivability of the euro.
ET Now: So emerging markets will continue to rally and India will continue to do better within EMs is that your view as well?
Russell Napier: Yes, I mean we discussed India at many times in the past and I will remain negative in the short run and all emerging markets because of the strength of the dollar and because there are these fragilities that you've picked out some countries that have them it is hard to see those countries getting into trouble and it is hard to see capital flows continuing to by all the emerging markets regardless even though they genuinely have those fundamentals. I have just written a report focusing on the key issue for the long term investor which has debt levels across the world and in the developed world and the emerging world and we can say this about India it stands apart as being one of the best countries for having low levels of debt relative to its GDP whether that is in a public sector, whether that is in a private sector, also it is debt to GDP is at a level which has historically been unmanageable level for most emerging markets and why is that so important because when you get a very high level of debt in the economy it really narrows down government policy to some things that are very negative for investors and it is hard to think of a positive way for investors of shifting just these incredibly high burdens of debt and GDP. We find effectively in the develop world and we come to India and they really do not exist. This is a perfectly manageable level of debt for India. Anyways this is a huge question in a long run it is evident already that the developed world wants to sort this problem by controlling markets, by manipulating prices and thats what India did from Independence all the way up to 1991 and India is on a different path now. One of the most fascinating things for India is will it maintain that different path when the west turns backwards and you know I have always been optimistic in the India in the long run but if it can avoid this policy mistake and continue to open up to market forces and prices than a future for India is actually even better than it used to be not because it is doing things faster and better but because the west is really going in a different direction and for investors in particular in a very bad direction and India has an option and opportunity doing something different whether the politician stake is a different question but at least our option exist and actually quite exciting.
ET Now: Is there a trade in gold, precious metals, because you are making a case that uncertainty and volatility is back?
Russell Napier: Yes. I am pretty negative about the world in terms of growth in the stock markets and I believe that dollar will go up. Normally that would not be a scenario in which you would be buying gold. Strong dollars not good for gold and falling inflation good for gold, so why would I be positive on gold anyway in that scenario, well I think we saw it very early in this year from the January to February we actually had a scenario where the dollar was somewhat strong and the gold prices going up anyway. If you get into a scenario where effectively centrals bankers feeling that you should expect the governments to get more active I think the least likely thing is if we get another turndown in growth in the west that they stop and this time the government’s will join in. Now as I suggested in answering the last question there is lot of control involved in government intervention and if the control which is ultimately good for gold than more the government wishes to control capital and investment and credit which is a power for the West is running down rapidly and more people would prefer an asset like gold which is not impossible for government to control but it is clearly significantly more different for the government. So the interesting thing about gold at this juncture is you should buy it whether you are deflationist or whether you are inflationist.
ET Now: I cannot help but ask you what has been the experience like with Flame University Students out here in India?
Russell Napier: Well the most important figure in finance is to ask a right questions because it is a multifaceted business with many different disciplines and actually it is incredibly difficult to ask right questions I think many people notice famous quote from Einstein where he said he was given a problem to solve he would spend one hour to solve it, he would spend 55 minutes trying to work out what the right question was and then finding the answer would be easy. I too learn how to ask the right questions I think reading financial history and studying financial history is useful and clearly going to the right sort of business school is also useful. So I would what can you say I do not really have to tell Indian people that education is the key but it is an education which teaches you the right questions because in our business there are really very few right answers. Don't struggle to get the right answer, struggle to get a better answer. But frankly if you ask the wrong questions it doesn't matter if you get the right answer.
ET Now: The tie-up at Flame comes at an interesting time. Tell us more
Russell Napier: Its a very auspicious time for us as well to be involved with FLAME. FLAME is effectively like the Columbia Business School of India. And what a great partnership we have. The reason we are involved with FLAME is we have similar approaches in that we are both charities and we have similar approaches to financial education.
There is more to financial education than numbers and supply and demand and we believe by teaching financial history, we're effectively teaching a little bit of sociology, a little bit of philosophy, a little bit of accountancy, a little bit of economics.
We think that financial history gives us a more rounded approach to investment and obviously FLAME which also teaches liberal arts, takes a similar approach to education. That helps us with the course that my charity runs, the practical history of financial markets. Perhaps even more importantly, FLAME has actually established a library in Poona, and that is the world's second library of mistakes. So we are absolutely delighted that FLAME has partnered with us and we hope to work together and collaborate together to bring back an old approach to investment which believes that there's more to life than an equation.