Demand is slowing. Recession is coming. Central bankers won’t be able to prevent it. Currency wars will intensify. Share prices will be devastated – it will be a downturn that will be remembered in 100 years.
When Crispin Odey made his gloomy views known it caught the market’s attention – not only because of his apocalyptic tone. He is one of London’s most experienced (and highly paid) hedge fund managers. His record of calling big turns in markets is not perfect but his recent form is good: he anticipated the credit crunch and rode the post-2009 bull market.
When we meet in the Mayfair office of Odey Asset Management, which looks after £9bn of assets, he takes the story back to 1994. He recalls a “prescient” interview that Sir James Goldsmith, the billionaire financier, gave on American television.
“1994 is when we were all slathering about the idea of a world economy, and what it is going to do as we open up,” says Odey.
“And Goldsmith basically says: ‘Hey, be careful about this because it is fine to have trade between peoples who have the same lifestyles and cost structures and everything else. But, actually, if you encourage companies to relocate and put their factories in the cheapest place and sell to the most expensive, you in the end destroy the communities that you come from. And there will come a point where the productivity gains from the cheapest also decline, at which point you have a real problem on your hands’ – And we are kind of there.”
China – one of those lands of cheap labour – is faltering and its growth will slow to 3%, thinks Odey, a comedown from recent norms of 7% to 10%. One problem is that China can’t create growth easily by the old means of expanding lending. The country already accounts for $26tn of loans, a quarter of lending in the world, and its banks are constrained by the shrinking current account surplus. Lending is also becoming inefficient: it now takes $4 of loans to generate a dollar of growth in China, reckons Odey.
China is also losing its competitive edge as minimum wages rise at 15% a year. Such increases are needed to keep housing more or less affordable for workers arriving in the big cities, Odey argues. “If you stop the 15% you have two and a half years of excess housing stock … and you probably also have revolution because people now expect that wages grow by 15%.”
From China, Odey moves on to its suppliers of raw materials – coal, metals, iron ore, oil. “The interesting bit then becomes: does the west spend the benefits of the [lower] oil price as fast as the producers feel the effects and cut their spending?” he says.
Most investors assume so; Odey is not so sure. But he definitely thinks central banks won’t be able to offset the deflationary hit. Cheaper oil is worth 2% of the global economy but that doesn’t match the impact that cuts in interest rates had in 2008-09.
“What worked in the Anglo-Saxon world is that we could cut rates from 6% to zero in an emergency,” he says, thereby dramatically reducing the interest on people’s mortgages.
“This time round, the trouble is we believe these guys [central bankers] can conjure anything from anything,” he says. “But interest rates are zero anyway.”
There is, he concedes, evidence of a spending pick-up in Europe – but only at the expense of the savings rate. And, in the UK, the “absolutely horrible” figure is a stubborn 5% current account deficit.
The investment moral, he concludes, is that pressure on corporate profits will be downwards: “My cry is that it all goes back to Jimmy Goldsmith. Effectively, we have a lot of deflation in the system. It is the peak of the profits cycle because companies have relocated but productivity [gains] in their factories from here [are] zero at the bottom end – and going down. So, in a strange way, we have enjoyed all the benefits of world trade but we look like we might be about to harvest some of the pain.”
For 60 years, he says, recessions were short because lending expanded quickly afterwards: “A guy not only got a new job, but he took out a loan and had a family. Once you got that recovery, it really ignited.” This time, even the US has seen negligible credit expansion, despite growth in employment and wages. The result will be much shorter economic cycles, as in Japan in the last 20 years, and investors “start to realise they haven’t got a clue whether the cycle will turn up or turn down the next day.”
The stock market, he argues, is full of “refugees”, driven to invest there by low interest rates. But how real are the yields they chase? He recounts how a City broker rang him recently to pitch the delights of Vodafone’s shares – European operations picking up a bit, data traffic being monetised, “and a 5% dividend while you wait”.
Odey’s take was, hold on a minute, Vodafone shares are priced at 69 times the company’s earnings, which means profits must increase by 300% for the dividend to be paid from earned profits. Big oil producers are the same, he says: they pay their dividends by increasing debt.
“They can do it for a while. But you slightly say, this is a Ponzi scheme. And the only reason you would say this is not a Ponzi scheme would be if you thought profits were about to go up by 300%,” he says. “But that’s quite a big ‘if’ after a six-year bull market.”
Currency markets, Odey says provocatively, are the last “honest” market because they are where lenders and borrowers meet. The temptation now will be “every man for himself”, putting strain on a system where world trade has risen to 32% of global output from 12% in Goldsmith’s day. In his last letter to investors, Odey predicted capital controls in Russia and the Australian dollar tumbling – the country is a big commodity producer. China, he adds, will have to let the renminbi float.
There is also a sense, Odey continues, that politics are moving faster than markets – as in Greece, where he sympathises with a country that no longer sees the point of continuing the “charade” of adding unpaid interest to an unpayable debt obligation.
“It’s Leviticus. It’s the whole idea of jubilee,” he says. “Jubilee was every 50 years in Israel. All debts were written off because otherwise the financial economy strangled the real economy. God got it right.”
His 2009 optimism was based on the idea that low interest rates would buy time. He thought a high oil price might help by encouraging investment – airlines would order more efficient planes, for instance.
If economic activity does not pick up, he predicts another round of debt default. He is particularly depressed by Europe because it has written off only 6.5% of loans, whereas experience suggests 11%-12% is required. “We said ‘Let’s put interest rates to zero and hope incomes will grow.’ Now we might be going to the solution which says ‘Actually, we’ve really got to write these loans down,’” he says. At that point, a way out appears, thinks Odey – “take advantage of these very low rates and build things that people really want.”
Dramatic as Odey’s warnings were, reactions have largely been dismissive. Consensus opinion still expects a slow but sure global recovery, supported by cheap energy and low interest rates.
“Timing is impossible, it’s a mug’s game,” admits Odey. But he says the same was true in 2006: “What you knew then was that there was going to have to be a crisis because the only thing that would solve the problem of people borrowing at 8% to invest in property yielding 3% was if interest rates went down to zero.” That implied a shock to the system. “When you didn’t quite know.”
Today, he emphasises three core factors. First, China: “I can’t see how it gets better.” Second, the number of countries entering the “sick bay” – Brazil, Australia, South Africa, Latin America, Mexico, Canada, the eurozone and Russia. Third, the overwhelming faith in central banks to create financial weather: “We will have to test that particular claim before we can put in place alternative solutions to the world we are in.”
Odey ends with a last historical footnote: “At the moment, everyone’s view is ‘hey, why are you so bearish? You know [Mark] Carney [governor of the Bank of England] is in charge, he can magic anything.’ But why was the Wizard of Oz written in the 1930s?”
This article was written by Nils Pratley, for theguardian.com on Friday 20th February 2015 15.45 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010