“Extreme Money: Masters of the Universe and The Cult of Risk,” offers expertise and insight from best-selling author Satyajit Das.
John Nyaradi: Hi everyone, I’m John Nyaradi, publisher of Wall Street Sector Selector, a financial media site specializing in exchange traded funds and global markets and economic analysis. Today, I’m really pleased to welcome our special guest, Satyajit Das. Das, welcome to Wall Street Sector Selector.
Satyajit Das: Happy to be with you.
John Nyaradi: Das is an internationally respected financial expert. He has more than 30 years of experience with firms like Citigroup and Merrill Lynch, is the bestselling author of “Traders, Guns and Money” and was featured in the 2010 Oscar-winning documentary “Inside Job.”
Das has a new book out called “Extreme Money: Masters of the Universe and the Cult of Risk.” Today we’re going to talk about that book, what he sees ahead for investors and the global economy, and how we as retail investors can navigate today’s dangerous waters.
Das, let’s just start with the title, “Extreme Money.” It’s really a catchy title. Give us an overview of extreme money.
Satyajit Das: Well, I think you have to look at money as it used to be, which was a means of exchange and a claim on real goods and services. But somehow, somewhere along the line, we lost track of that, and we converted money into something quite extraordinary where money gradually became more and more removed from the real economy and became things like collateral obligations, or CDOs, and CDO squared and CDO cubes, with people issuing debts, which were basically buying other debts, which were basically buying other debts, and the whole thing became something so abstract, the whole thing was about leverage and creating different types of risks, so extreme money is a catchall for this process which has brought us to this rather disastrous point in financial and economic history.
John Nyaradi: You have some wonderful phrases and subtitles and one I particularly enjoyed was the Doomsday Death Machine. Can you explore that a little bit?
Satyajit Das: The Doomsday Death Machine was my way to show how debt became an overarching process, and I think the level of debt in the world is now quite extraordinary. You’ve got to remember two very simple rules. Rule number one is that if you’re borrowing, you have to find the asset on the other side of the balance sheet, as it were. Where did that debt go? And as long as what you bought with it or invested, it has value and that value exceeds the value of the debt, well, you tick one box.
The second box that you need to tick is basically that the income that the asset provides is sufficient to pay the interest of the debt and ultimately pay back the capital. Now, if you consume with that, it depends on what you consume. Like if I go and get an education, which enables me to earn more income to pay back the student loan that’s great, but if I use it to basically go on a holiday where there is really at the end no productive income to me, the debt becomes problematic.
And what we did was, we forgot those two rules absolutely, totally, entirely. And I think that fundamental Doomsday Death Machine was forgetting that rule, and the world now has more debt than it can afford.
So now you have to deal with the fundamental problem that this debt is unserviceable, cannot be repaid, and we’ve got to write it down. The problem is when we write it down, somebody, somewhere, who’s lent the money, who saved that money, is going to take a loss, and in this case, the savers of the world are going to take massive losses, and that’s why I call it the Doomsday Debt Machine. It’s like a gigantic Ponzi machine, really.
And the second element of the debt machine is it artificially creates value because that flood of money pushes up all the assets in terms of values, and we’re going to go through a massive, massive reset of asset values around the world because most of that was inflated, in my view. Prices are also going to have to adjust because they were based on the assumption that this infinite, almost constant tide of liquidity would be there, but we’re now going into a world where that liquidity is shrinking, and that’s what I meant by the Doomsday Debt Machine.
John Nyaradi: You talk about cracks in the structure and a great reset.
Satyajit Das: There’s an interesting diagram in the book. There’s a small box, which is the real economy. Then I add leverage and put a big box around the little box, and suddenly, the economy appears bigger, and I’m saying well, that leverage box is now deflating slowly, and when it deflates, you still have the real economy, but obviously, the economy overall will look smaller.
And that process that I’m talking about is the reset, and the reset is a very, very complicated process because I don’t think certainly in the economic history I’ve read and studied, there is any precedent for this type of process. We had the Lehman moment, the AIG moment, the banks having to be bailed out moment. We’re now having the global sovereign moment. We’re going to have a series of these dislocations, and it’s part of the process of the entire financial system resetting, what I always referred to as we went from real engineering to financial engineering, and we’re now going a full 360 degrees back to exactly where we started, to real engineering.
We’re going to go back to that real economy. Unfortunately, what that means is, having accelerated all this consumption and accelerated all this economic growth, we’re now going to go back to mean which basically means we’re going to be in a very prolonged period of low growth.
It’s about the fact that everybody’s realised we’re not going to grow 4% to 5% for a very prolonged period of time, and growth is going to be much slower, and secondly, and this is the most important issue, that the policy makers really are not at all powerful superheroes. In fact, they have very limited powers, and most of the limited ammunition they have has been spent.
And I think this is symptomatic of the fact that there’s a kind of a desperation on the part of policy makers because you don’t win elections promising people, you know, a recession, and that’s what all the politicians and policy makers around the world are now confronting. That’s a very, very difficult choice. So I think we are in a place where it’s uncharted territory. We are Lewis and Clark in the Wild West going “Oops, did I make a wrong turn here some way?”
And we’re going to have to work our way out and the only guide we have is what happened in Japan where they had, not exactly the same problem, but there were some symptoms, which are similar, and as we know in Japan, it’s taken a very, very long time to basically try to work your way out of that, but basically, they haven’t really to a large extent ever recovered the economic drive and impetus of say, the 1970s and 1980s.
John Nyaradi: Obviously we’re in dangerous times and we have a rough road ahead; what should individuals do?
Satyajit Das: Well it’s pretty tough, and I think most people are now coming to the realisation that once sovereign debt becomes very risky, which is now what’s happening, then you know, in the Martha and the Vandellas song, you remember the old song “Nowhere to Run, Nowhere to Hide?” And that’s basically where we are and so you need to think about your investment portfolios in a different way.
Will Rogers, the very famous American comedian, once said that he was interested in the return of his capital more than he was interested in the return on his capital. So first thing investors have to do is look at things which are going to hold their value longer term, which obviously, traditionally has meant things like bonds and fixed income. The income is going to be far more important than the capital gains.
The other interesting thing is you can throw traditional methods of asset allocation out the window because the moment the market’s correlation is so close to one to one, it just becomes meaningless to try to do asset allocations. You’re going to have to be much, much more active. You’re going to have to basically look at the world as it evolves and try to get ahead of it as much as you can, but the key asset here is volatility.
During periods like this when you get a huge, huge dysfunctional change – and that’s what we have, a massive plate move in terms of tectonic plates – what you have is enormous volatility, and you need to capture into that volatility, and one strategy that certain people use is to have the bulk of their portfolio in capital secure things like government bonds, and basically play the volatility by buying out of money options in puts and calls which give you exposure to large moves. So you have no view on direction. You just have a view that the world is going to be a scary and uncertain volatile place, and that type of strategy is one way to think about it.
I used to joke with people that if it was a Botox economy, the first thing you need to work out is how much Botox do they have, and secondly, where are they going to inject it? So if they’re going to inject it near the eyebrows, I want to be long eyebrows. If they’re going to inject it near lips, I want to be long lips.
And so it’s about almost anticipating the actual way governments are going to react. I think the days of stocks for the long run and if I just, you know, buy and hold, is going to be extremely difficult and I’ll give you a very good parallel. The Nikkei is down right about 75% from end of 1989 in nominal terms, about 85% in real terms, but there are moments in time when you could have made a 100% in the Nikkei because it doubled from year to year, and it is that opportunism that’s going to become very important. That’s very difficult for individual investors because just mentally they don’t really think in that way, and those are some of the challenges that individual investors are going to face, and it is going to be a very challenging, a very difficult period for everybody.
John Nyaradi: I always like to end these conversations by asking if there’s anything else you’d like to add, just one thing that’s really on your mind right now that maybe keeps you up at night that people should watch out for as we go into the 4th Quarter of 2011?
Satyajit Das: I think the major thing is how people will react to the social side and the political side of this, and let me illustrate what I mean by that. You’re now seeing in Europe, in places like Greece and in Spain, essentially the starts of what I would call social disorder. These are people who are very middle class, who have had reasonable jobs, reasonable prospects with the future who are now being disenfranchised. Now you can argue whether they’re protesting for the right reason or the wrong reason. That doesn’t matter anymore. They’re protesting. And I really worry about what that means for social order because we all live, as we know, on a very thin crust of the earth, and every once in a while, it opens up and plunges us into fiery depths below.
And that social order that we actually have is fairly fragile, and I don’t know how these pressures from the economic and financial sphere are going to affect that. If we have vast scale social disorder driven by poverty and driven by social disenfranchisement, I worry deeply about what this means.
And the second dimension of this is what it does to the political spectrum. We are seeing the rise of extreme parties. We see very, very divergent views in Europe, and in the United States, we’ve seen almost a Balkanization of both the main parties, the Republicans and Democrats, the most obvious example being the Tea Party, and these people have quite extreme agendas.
Now, if you actually look through their agendas, there are things in it which actually are a response to some of the economic pressures and financial pressures that have emerged, and what does that mean to the governability of countries?
So we have these geopolitical things which in the financial sphere, we don’t often engage with, but they’re out there, and sometimes, they’re related to what we do in the economic and financial sphere, sometimes, they’re not. And those are some of the issues that I muse over and try to work out how those things could essentially change the course of economic and financial history.
John Nyaradi: Well folks, unfortunately time and space allow us to just scratch the surface of this fascinating book, “Extreme Money,” written by bestselling author Styajit Das who’s an internationally respected expert in finance, bestselling author, and featured in the 2010 Oscar-winning documentary “Inside Job.” You really owe it to yourself to read this unique work in great detail because it is a fascinating look at all this we’re going through right now. The book has gotten rave reviews from Nouriel Roubini, The Financial Times, Bloomberg and Barry Ritholtz and it’s already a business bestseller and deservedly so. I would like to add my humble endorsement to say this book is a terrific way to learn about our new world and what’s happened, how we got here, and where we’re going.
To learn more about Das’s book and his work, just follow the link at the end of this interview and that will take you to his page at amazon.com where you can learn more about his work. Das, it has been wonderful chatting with you today. Thanks for joining us. I know we’re all looking forward to talking with you again soon.
Satyajit Das: Thank you for having me and it would be a delight to continue our conversation at a future date.
(Recorded interview, edited for length and clarity)