To what extent is shadow banking an endemic issue for the international financial system?

FABER: I have argued for many years that because of easy monetary policies, we had rapid credit growth in the Western world and also in other countries, whereby, after the Asian crisis, there was some de-leveraging in Asia. But in general, if you look at the world, say compared to the 1950s, 1960s, and even the 1970s, it is very clear that financial markets, official and less official, have grown disproportionately to the real economy. In other words, you have say, a global GDP of $60tr or whatever it is and you have financial markets that turn $60tr around in a week or less. I believe that one day this financial bubble will have to adjust on the downside. Either it will adjust on the downside because we have an inflationary burst or because we have a collapse of the system. We do not know exactly how the end game will be played. But in general, I cannot see how the derivatives market will continue to exist for the next 5,000 years. It has got to end one day and when it ends one day, either through war or through a financial collapse, it will be very painful.

Do you see a disconnect between asset markets and economic realities in the global economy?

FABER: I do not necessarily see a disconnect, but we have to distinguish an economy that is essentially balanced and an economy that is imbalanced. If you print money and you have artificially low interest rates, such as we had repeatedly since the 1990s, you create excessive credit growth, you create new financial instruments, and you distort market pricing. The printing of money by Mr. Bernanke, and we now have a Fed fund rate of 0% in July 2013 when the ‘economic recovery’ in the US began in June 2009. So we are 4 years into an economic expansion and we still have 0% interest rates. We also have a stock market that bottomed out in 2009, and now in July 2013, we have a 4 year bull market during which the S&P was up 140% or more. If I look at asset markets, let’s say you have $100m, you can put it in the bank and the bank hardly pays you any interest. Your costs for holding the money in the bank or the charges the bank will levy on you are higher than the interest rates you will get. So the 0% interest rate forces you, and that also applies to pension funds, the insurance industry, and corporations, to find something to do with the money that will earn a slight return. Nobody can deny that the cost of living has gone up over the past couple of years. It is more costly to buy energy today, to pay for electricity, to pay for food, and so forth and so on. So money in the bank loses purchasing power inflation adjusted. So people, because of these 0% interest rates, went and bought high-yield bonds, they bought emerging market stocks, they bought gold, they bought commodities, real estate, and so forth and so on. But they do not buy it all at the same time and in the same proportion. So this money printing then creates increases in asset prices in some sectors of the economy because people are also influenced by psychology. So everybody bought NASDAQ from 1997 to 2000 because they thought that it will go up forever, then it collapses. Then they buy US homes, and that market also collapses. Then in 2008, they buy commodities, and it collapses. Over the last few years, we have had a huge inflow into high yield bonds and emerging market bonds and emerging market securities, and I think there we have equal distortions. If you print money in the US, because we have an international system, the money printed in the US does not necessarily have to stimulate the US economy and create inflation in the US. It can stimulate the Chinese economy, the Vietnamese economy or any other economy and create inflation in those countries.

Has Fed economic stimulus been in any way effective?

FABER: It is interesting that the money that has been printed essentially has not flown into the pockets of the workers or the middle class. We have precise statistics about who benefited from the money printing. Asset inflation has benefited a maximum of 3% or 4% of the population. It has benefited less than 1% meaningfully because if you look at real estate prices last year in the Hamptons, they were up 35% to record highs. Sandy Weill bought a condo in New York in 2007 for $43m at the peak and he sold it for $88m last August. Steve Cohen, a hedge fund manager, bought a condo for $24m on the East side and he is now putting it on the market for $115m. That price has gone up, the Mayfair economy or the luxury economy has gone up. But if you look at Las Vegas, or anywhere in the US that is not high end, it has recovered somewhat, but it is still way below the peak. But we also see this say in Asia. Recently I was in Bangkok and I have never seen such a big Ducati agent in the world. A Ducati is an expensive toy by Thai income standards. Driving around Thailand, you see a large number of Bentleys and Maseratis and Ferraris and BMWs and the works. These are expensive cars in this country because there is a 100% import duty on these cars. Whereby I think a lot of well to do people did not pay the import duty.

What impact has Fed monetary policy had on inflation in emerging markets?

FABER: If you look at monetary policies in the US, I think the cost of living increases in the US are much higher than what the Bureau of Labor Statistics publish because in the CPI they exclude food and energy. Also, a CPI is a basket of goods and services, so maybe you have 100 items and then it changes depending on how they are each weighted as well. So they underweight things that have gone up a lot in cost like education and healthcare and insurance premiums. If you would weight it properly, I would suppose that most people’s costs of living are rising at more than 5% per annum and that is true also here in Asia. But the biggest impact on inflation has not been on the US. We had very high inflation in Asia over the last 10 years. If you want to buy land in Thailand in some areas, land prices are up 5 times in three years. Similarly in India real estate prices have gone up a lot. Now for the people that own the land, to an extent they benefit. But the people who come out of universities and need to buy the land, how can they afford it and build a house. So it creates an unfavorable social climate. I would not go as far to say Mr. Bernanke is responsible for the social unrest we had in Libya, Tunisia, Egypt, Turkey and so forth. But very clearly, when you have an increase in wealth inequality, and as I said earlier, the money printing has not really helped the real economy, it has helped asset prices and people that had assets before and the financial circle, then you have a kind of tension rising in society. You may say Gadhafi was not a like-able character, but the influence by foreign nations on him came after the unrest in Tunisia and about the same time the unrest started in Egypt. These are not so much religious issues or issues against a leader per say, but discontent in the population among the people – the middle classes, the students, and the workers. This is because they have not progressed much. I can see it here in Thailand. Wages are up and the government has increased minimum wage whereby most people probably do not care about the minimum wage, but the fact of life is that the cost of living of these people has gone up a lot. So they have to pay more for food. Do not forget that if you earn a million dollars a year, what you spend on food is maybe 1% or 2%, but if you earn $1000 dollars a year, then you spend probably 50% to 60% of your income on food. So when food prices go up, it hurts you much more than the well to do people.

Will the US retain reserve currency status?

FABER: I think that’s an issue. I am not convinced that someone in the US really sits and thinks, “What if we lose reserve currency status?” Clearly the US has a huge advantage in the sense that they can print money. Let’s say they go to war in Afghanistan, they actually do not pay for it, they just print the money. They go to war in Iraq, for now, they do not pay for it. The government prints money, creates large deficits, and the Fed buys this. It will have unintended consequences in the future, but for now it is OK. Other countries cannot do that. If you are a member of the EU, let’s say you are Greece or Spain, you cannot do that. If you wanted to do that you would have to leave the EU. In emerging economies if you print money, then the currency collapses and then you have import inflation. So the US has an advantage from the US dollar being a reserve currency. My view is that the dollar will stay as the reserve currency for a while, but I mentioned that in my view that eventually the financial system will collapse and we will move towards a new kind of arrangement with, most likely, the backing of some precious metals for currencies or with automatic stabilizers so that you have countries that are forced to essentially have a contraction if they have trade deficits and an expansion if they have trade surpluses to balance the trade surpluses and deficits. Today we have a huge imbalance in the world with the US having huge deficits externally and the rest of the world with surpluses.