The man who called the last stock crash is already blaming the Fed for the next
By Anora Mahmudova Published: Nov 20, 2014 5:06 p.m. ET
S&P has gained more than 10% since the QE taper was announced An earlier version of this story incorrectly identified Peter Schiff as a hedge-fund manager. The story has now been corrected.
NEW YORK (MarketWatch) — The investment adviser who accurately predicted the crash of 2008 is once again sounding the alarm.
This time around, Peter Schiff, the chief executive officer of Euro Pacific Capital who memorably predicted the collapse of the housing market in 2008 and the global financial crisis of 2010, is speaking out against the Federal Reserve, which, he claims, has inflated the prices of stocks and bonds with its ultraloose, unconventional monetary policies.
“The recession the Fed is fighting is the cure,” Schiff said in an interview with MarketWatch. Schiff espouses the view that a good, old-fashioned recession may be exactly the catharsis the markets require, in the wake of a fleet of quantitative-easing measures that have merely buoyed stock values temporarily.
Schiff was right about the housing market’s myriad flaws in 2006, but his predictions about the fall of the dollar, hyperinflation, the collapse of the U.S. economy, and global economic decoupling remain unfulfilled.
Contrary to his theory, the dollar has strengthened against other currencies as the rest of the world — most notably Europe — has seen faltering growth.
Here’s a montage of some of Schiff’s more prescient moments in and around 2006 — just a year before the real-estate implosion tore a gaping hole in the global economy — being mocked by a string of pundits:
Schiff has been one of the most vocal bears and Fed critics. Here he is at the Vancouver Resource Investment Conference last year:
His book: “The Real Crash: America’s Coming Bankruptcy — How to Save Yourself and Your Country,” was published two years ago.
Schiff’s been prophesying economic armageddon for a while now. And, as the old saying goes, even a broken watch is right twice a day.
To be sure, Schiff isn’t alone in his criticism of the Fed. Guys like Jeremy Grantham, co-founder and chief investment strategist of Grantham Mayo van Otterloo, said in a quarterly newsletter released on Monday that the stock market is headed in the right direction for a crash.
Opponents of the central bank’s easy-money policies, like Schiff, over the years have warned that the billions of dollars’ worth of liquidity injected into the financial system would eventually create inflation. They also warned that stock prices — inflated by the liquidity — would fall dramatically once the program ended.
But besides a brief October scare, U.S. stocks have been on a monster tear, notching new records on a regular basis. On Tuesday, the S&P 500 SPX, +0.20% registered its 43rd record close for 2014, closing at 2,051, while inflation has been trending dangerously lower.
That sensational and rapid run-up may alone be sufficient reason to harbor concerns about what’s fueling the market’s run. A super-low-interest-rate environment has forced investors into a stock-hungry frenzy. Where else are investors going to go for yield?
Bulls argue that there have been clear signals the U.S. market is on much healthier footing than the rest of the global economies, notably Europe and Asia. Confidence in the U.S. market has resulted in the dollar rising about 11 percent since early May against a basket of rival currencies.
Schiff points to gold as his safe harbor investment. His theory is that the dollar will plunge, and gold will skyrocket, once the market realizes stocks are overheated.
“Gold prices will go ballistic, once people realize that the dollar is overvalued,” Schiff said, forecasting that the value of the currency will fall by 90%.
It’s entirely possible gold could get pricey. What is difficult to imagine is the depreciation of the dollar, or a jump in inflation on the scale Schiff envisions.
Schiff believes that the dollar will tank because of too much Fed intervention. He predicts it will begin QE4 at the first sign of serious weakness in the stock market or the economy, which would lead to a loss of confidence in the Fed and, by association, the greenback.
The S&P 500‘s correlation with the Fed’s balance sheet is presented as evidence of impending doom.
Ethan Harris, a global economist at Bank of America Merrill Lynch, has a problem with Schiff’s view and the assumptions tied to the Fed balance sheet chart often used to support the idea of the tenuousness of the market:
“Implicitly, this chart assumes that the markets are not forward looking and it is the implementation of QE that drives the stock market: when the Fed buys, the market booms and when it stops, the market swoons.”
Harris thinks this relationship is a classic case of spurious correlation: anything that trended higher over the last five years has a 90%-plus correlation with the Fed’s balance sheet.
He further comments that QE is far from over, as the Fed is not going to shrink its balance sheet for a very long time.
Asked about the risks of inflation, Harris dismissed it. “People confuse bank reserves with money. Until banks start lending their reserves, those funds are not going to enter the economy. And even when they start lending, there is no automatic link and the process is gradual.”
Investors are still voting with their wallets, however. Gold prices fell more than 28% last year and are slightly down this year. This chart shows the ratio of gold to the S&P 500. The current ratio indicates that investors are confident about the U.S. dollar and the stock market. Compare this period’s levels with the heady levels of 2000, when stocks were clearly in bubble territory.
Yahoo Finance, Federal Reserve History lacks precedence for what happens when the Fed keeps rates at near zero for so long and holds trillions of dollars on its balance sheet. So some serious rockiness is a given.
However, Schiff paints an apocalyptic picture. While stock markets can and will at some point correct, and maybe even crash, hyperinflation in the U.S. is unlikely.
The Fed knows exactly how to fight inflation, it’s the deflation that leaves the Fed and other central bankers grasping at straws. At this point, the Fed would welcome 2%+ inflation, to ensure the economy is growing and has positive momentum.
In the world of currencies, it’s a zero-sum game. The dollar rises or falls against another currency. For it to devalue by 90%, other currencies would have to strengthen by an equal amount.
For that to happen, another economy would have to step up and serve as the reserve currency of the world, as the U.S does now.
It’s important to note that Schiff was right about the last crash but wrong about the impact on U.S. currencies. They rallied as the rest of global economy buckled.
And right now, his feelings about the dollar couldn’t be further from the reality. The dollar continues to reach new multiyear highs against its major rivals, and most analysts expect it to strengthen through 2015.
