Gary Shilling, author of The Age of Deleveraging and editor of the investment newsletter Insight, thinks the world is facing another 6 to 8 years of deleveraging with a "high probability of panic deflation" that will push 10-year Treasuries to 1% and oil eventually back to down to $10 or $20 a barrel.
Here is an abbreviated version of his recent interview with Financial Sense, which aired Friday on our podcast (see Dr. Gary Shilling: The End of Growth – Deleveraging Continues Globally).
Financial Sense: How much longer do you expect the age of deleveraging to continue?
Shilling: If you simply look at the rate in which the deleveraging has taken place so far, it could actually take another 6 or 8 years. Now that's just putting a ruler on trend. I think, for example, consumer debt in this country—household debts from credit cards, student loans, auto loans (almost anything that's legal) in relation to assets to after-tax income, which is normally how you look at it—the norm was 65% debt-to-income. In the early '80s it took off to 130% and it's now down to 104% so it's a long way from the norm and, as I say, if you just project where we are it could take another 6 or 8 years.
You once stated that 10-year Treasuries would reach as low as 1%. Do you still believe that and what will be the driver?
I certainly do and there are several factors. One is that Treasuries have a tremendous safe-haven appeal. Foreigners, when times are tough, go to Treasuries... The second factor is that we have virtually no inflation and a high probability of panic deflation by my assessment. And the third interesting factor is Treasury yields, as low as they are, are much higher than those of almost every other developed country. You look now and Germany is negative; Japan, they're negative. So, for European investors, they basically can invest in Treasuries and pick up a yield spread and if the dollar rallies, as I think it will, they get a double whammy because they get more yen or more euros when they convert that back into their own currency.
Half of Federal Reserve board members are forecasting only one rate hike this year now when most thought we would see four rate hikes in 2016. Where do you think rates are headed—higher or, given how things are playing out currently, lower to try and ease financial conditions?
Yeah, I've been on record—I said in our Insight newsletter early in the year that I thought the next move of the Fed would be to cut rates not to increase them. They seemed to increase rates 25 basis points—a quarter of a point—last December I think because they've been crying wolf so long their credibility was disappearing. They've been talking about a stronger economy...and, as a result, they've been forecasting that they would raise rates. I mean if you go back a couple of months they in effect said they were going to raise rates four times this year and now it looks like they may raise once or maybe not at all...
But now they look around, labor markets are certainly weak. The latest numbers for last month were extremely low with 38,000 payroll employment—that's a long way from the 200,000 average, which is none to great to begin with and the unemployment rate dropped from 5% to 4.7% but that was only because people dropped out of the labor force—they gave up and quit looking for jobs...so we've got a situation now where labor markets are weak and inflation is low, if not going into deflation, and then the Fed is now paying a lot more attention to the rest of the world...you've got a lot of factors that I think are convincing the Fed that they are, if anything, not going to raise them.
Do you still believe oil is going to fall back down to $20 or even $10?
Yes, definitely, and the reason is because OPEC is a cartel. Cartels exist to keep prices above equilibrium—that's the only reason for that—and that encourages cheating; somebody in or out of the cartel wants more than their share and so the leader of the cartel's job is to cut its own production to accommodate the cheaters. Well, the Saudis—the leader of the OPEC cartel—decided that they were not going to go along with that and that they were going to basically encourage OPEC to not increase production—not to cut—and to play a game of chicken. They thought they could outlast others and when you're in a price war, the cost of meeting budgets isn't the number that counts... It's the point where free cash flow disappears and that in the Permian Basin in Texas is $10 to $20 a barrel and it's even less in the Persian Gulf.
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