Thursday 20th July 2017

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The Prospects For Economic Recovery

Part III of an Interview with Marshall Auerback

By Kevin Michael Grace

Marshall Auerback is Director of and Corporate Spokesperson for Pinetree Capital Ltd, a Toronto-headquartered diversified investment, financial advisory and merchant banking firm focused on investing in early stage micro and small-cap resource companies. Pinetree, which has a market cap of $475 million, is invested primarily in Uranium and Coal, Oil & Gas, Precious Metals, Potash, Lithium and Rare Earths and Base Metals. Mr Auerback was previously an advisor to a number of fund management organizations, such as PIMCO, the world’s largest bond fund management group, RAB Capital and David W. Tice & Associates. He has a BA from Queen’s University and a law degree from Corpus Christi College, Oxford.

Part III of an Interview with Marshall Auerback

Q: The EU has a monetary union but not a fiscal union. I always thought this a non-starter, but it’s only recently the chickens have come home to roost. What do you think is going to happen?

A: I wrote a paper on this. It basically said this is a monetary-fiscal halfway house, and it can’t work. You either go the full nine yards and have a United States of Europe, or you just break it up and go back to various national currencies. The crisis is increasingly pushing these countries in the direction of more federalization and the establishment of a European-wide bond market. That’s a proposal that’s been made by the European Central Bank, even though it’s opposed by the Germans. That would give the EU a quasi-federal fiscal function. When the ECB buys bonds in the secondary market it is in a sense doing this, so we are gradually moving in that direction.

Q: There’s a rising feeling in Germany that they cannot serve endlessly as an ATM machine for the PIGS [Portugal, Ireland, Italy, Greece, Spain].

A: What the Germans fail to realize that they’re in the same position. I’ve called the euro the roach motel, and Germany is in the penthouse suite. They have a slightly stronger balance sheet than the PIGS, but they’ve all ceded their fiscal sovereignty because they’ve joined a supranational currency union. So if the periphery starts to implode, that’s going to affect Germany’s ability to export to those countries. Their current account will come under pressure; their growth will slow; their budget deficits will rise; and they will experience many of the same problems of the outlying countries.

Q: There was an alternative for Ireland—they could have left the euro.

A: They could do that. Or they could choose the Iceland solution. They could say, sorry, we can’t afford to back up our banking system anymore, so the bond holders are going to have to take a haircut. Iceland effectively guaranteed deposits for Icelanders, but they didn’t extend it beyond that. They devalued the kroner by about 75%, and now they’re growing again, and unemployment is back down to 7%. The Irish are chasing their tails. They keep cutting their budget deficits and trying to cut spending, which aggravates an intensely deflationary spiral which is causing GDP to collapse, which causes their budget deficits to rise even further.

Part III of an Interview with Marshall Auerback

Q: Is there a way out for Europe?

A: Hopefully, they’ll come to their senses and work out some sort of restructuring along the lines of what you had in Uruguay or New York City in the 1970s. You say, we’re going to extend maturities out 20 years and pay a non-punitive interest rate.

Q: How bad will the European fallout be?

A: If the crisis is restricted to, say, Portugal, Ireland and Greece, then it’s not really much of a problem. If it starts to spread to Spain, then it will spread to Italy and could ultimately spread to France. Then it could get very, very serious in terms of impacting global growth. But with Greece, you’re talking about a place with a GDP not much bigger than Chicago. If the ECB backstops the bonds in the way they’ve been doing, they can thereby ensure the overall solvency of the European monetary union.

Q: It has become a maxim that bad news in Europe is good news for America. But don’t we all live in a global economy?

A: You’re right. It’s good for America only to the extent that if the euro weakens, the dollar strengthens, which allegedly gives the Federal Reserve or the US Treasury more leeway to reflate. If the European crisis becomes serious enough, it affects everyone. When Lehman went bust, it affected everyone because the credit channels are quite interconnected globally.

Q: Do you see the Canadian and US economies diverging?

A: They already are diverging, but this is a matter of degree. At the end of the day for better or worse we will live and die with the US economy. If the US were to double dip, which I don’t think is likely right now, but if it did, then it would clearly impact Canada. Australia is booming right now, but that’s because it has essentially become China’s coal mine. So Australia is leveraged to China in much the same way—maybe not to the same degree—as Canada is to the US.

Currency devaluation is a soft way outMarshall Auerback

Q: The Australian boom has occurred despite a soaring dollar, yet we still see the argument that Canada cannot afford dollar parity with the US.

A: The argument is that a heavily export-dependent economy must remain competitive by keeping its currency weaker, but of course if everyone does this, it impoverishes everyone. The Germans, for example, have learned how to export with a much stronger currency. Currency devaluation is a soft way out that enables you to resist the harder decisions which would improve productivity or profitability through other means. In a full-employment economy—and Canada’s not there yet—why would you want to export everything anyway? It seems to me the objective is to get the output consumed domestically.

Q: Economic recovery is so dependent on China, but there are serious questions about China. I recently wrote a story about rare earths, and in the course of my research discovered there are major rare-earth bootleg operations in China. What does this say about the power of the central government there?

A: If you go to Chinese provinces, you find that the Communist Party exerts relatively little centralized control. That’s the problem with their credit system as well. The other problem is you’ve got these guys in the Army that run these little operations and are a law unto themselves. In China, we are not dealing with a classic liberal democracy, which is governed by the rule of law, and that is another risk we have to be aware of in the long term.

Read Part I of interview

Read Part II of interview

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