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An Interview with Richard Duncan on China, Europe, & QE3

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The following interview was published in THE EDGE SINGAPORE on May 30, 2011


Richard Duncan, author of the seminal The Dollar Crisis: Causes, Consequences, Cures, an international bestseller that predicted the recent global economic crisis with extraordinary accuracy, commands a lot of respect among Asian policymakers. Armed with a Master’s degree in international finance, the affable American economist is a veteran of the region.

He first arrived in Hong Kong in 1986 to take a job as an equity analyst and later worked as a financial sector specialist for the World Bank in Washington, DC and as a consultant for the International Monetary Fund in Thailand during the 1997 Asian financial crisis.

Bangkok-based Duncan is currently chief economist at Blackhorse Asset Management. His latest book, The Corruption of Capitalism: A Strategy to Rebalance the Global Economy and Restore Sustainable Growth, was published early last year.

He recently spoke to The Edge Singapore on the sidelines of an investors’ forum. The following are excerpts from the interview:

The Edge: The US Federal Reserve is about to end the latest round of quantitative easing, or QE2, next month. The markets are fairly nervous about what might happen next. What’s your take?

RD: When QE2 stops, the US economy will weaken again, the global economy will weaken, stock and bond prices will drop. So, interest rates will go up, commodity prices will drop. The US economy will start moving back towards a recession and, around the end of the year, we’ll have QE3 or another round of quantitative easing, and then everything will spike up again — equities, bonds, commodities, all sorts of assets.

The Edge: So, you are predicting another speculative bubble in commodities and other assets? Can the US afford it?

RD: Sure it can. It doesn’t cost anything to print money. Yes, I believe inflation will move higher. But, before we get there, when QE2 stops next month, we will probably see a significant correction in commodity prices that will be disinflationary. That will help alleviate inflationary pressures long before QE3 starts.

There are really three different kinds of inflation. The first, what the Fed looks at, is consumer price index, excluding food and energy. That’s been trending downwards for years because of globalisation. The marginal cost of labour has dropped 90% or 95%.

In the past, if you hired someone to produce car parts in Michigan, you might pay US$200 a day. You can hire someone in Chennai for about 5% of that. In China or Thailand, you’d pay a little bit more, but still far cheaper than Michigan. This represents an unprecedented collapse in the cost of labour.

Nothing like this has ever occurred in history. If it wasn’t for this — all the paper money that is being created by central bank easing — it would have created hyperinflation.

There is also asset price inflation like stocks or real estate. The whole purpose of QE2 was to create asset price inflation. The Fed wanted stock markets to go up, bond prices to be higher, so interest rates were lower and that worked out very well. Since QE2 started, stocks have surged 25% from where they were just before it was announced. That created a wealth effect supporting US consumption, driving the US economy and, with it, the global economy.

The real problem is the third kind of inflation or commodity price inflation, including food, which is now a serious global issue. You have two billion people who live on less than US$3 a day. As food prices rise, they become hungrier.

That’s what North African revolutions have been all about. Egyptians and Tunisians didn’t wake up one morning and decide they wanted more democracy. They woke up hungry because of food price inflation, which was a consequence of QE2.

The Edge: So, you see a global economy in turmoil?

RD: I believe that the global economy is a very sick patient that is being kept alive by life support primarily in the form of budget deficits. The US deficit has reached 10% of GDP, or US$1.4 trillion ($1.7 trillion). It looks like the US economy might still grow more than 2% this year, but if it weren’t for the 10% budget deficit, the growth rate might actually be minus 8% or far slower.

The budget deficit has kept the economy from collapsing and is being financed in large parts by quantitative easing of US$600 billion over seven months, or roughly US$3 billion a day. That’s new money that the Fed is creating from nothing and using it to buy Treasury bonds.

The Fed has been buying every new bond that the government has sold over the last few months, and that has kept bond prices higher and interest rates lower, which in turn has helped support the economy and forced the people who would normally buy those bonds to buy equities, which is why you have stock prices moving 25% higher and helping create a wealth effect that drives consumption.

The Edge: What about China — the new global engine of growth, which is buying raw materials from Australia, and components and materials from Asia?

RD: Where does China get the money to buy those goods? Who does China sell most of its goods to? Mainly, the US. Nearly 80% of the people in China still earn less than US$10 a day and that means they don’t have enough money to buy things like the iPhones they make in their factories.

The remaining 20% or so who have money to spend are earning money from companies that export to the US or because they have access to bank loans.

The US’ slipping into a crisis doesn’t make those 20% Chinese any richer. Indeed, it makes them poorer because those businesses that export won’t be as profitable as before. Did you know that Chinese bank loans expanded 60% over the last two years? When the US slipped into recession and started buying less from China, it almost burst China’s bubble. The Chinese government responded by prodding the banks to lend more.

Can you imagine what would happen to any economy if bank loans grew 60% over two years? It’s like China has been drinking a gallon of Red Bull. It’s so stimulating that it’s shaken China and given it severe heart palpations. It’s only going to lead to a greater property bubble, more and more unnecessary capacity to produce goods that no one wants to buy, and then a crash.

The Edge: Couldn’t China just put off that moment of truth with more stimulus and hope that, in time, the US economy will recover and everyone is busy emptying the shelves at Walmart?

RD: It would be nice if that happened, but the US’ problem is mainly structural. The US economy is no longer viable the way it is structured. The reason it is not viable is that it is fast de-industrialising and losing all of the manufacturing jobs. The reason it is losing manufacturing jobs is that wages in China, India or Vietnam are 90% lower.

Wages in China could double but they’d still be 80% lower than in the US. The Chinese currency might appreciate 20%, but that still wouldn’t change anything. The service economy mostly financial services, real estate, etc — isn’t creating enough jobs. Actually, it just blew up and had to be bailed out by the government. And, some of the other service sectors were only profitable so long as Americans were borrowing in a big way. The US has innovative companies like Google and Facebook but, unfortunately, they don’t seem to employ many people.

The Edge: So, what should President Obama or the Congress do now? Is there a way out or just a steady deterioration from here on?

RD: The US has two choices. The government can spend less and the US will collapse into a depression, from where it will be all downhill, or just spend more wisely. The US needs to spend in a way that actually restructures the economy and restore its economic viability. It looks like the US government will have a US$10 trillion budget deficit over the next 10 years.

If we spend US$1 trillion on solar energy, US$1 trillion on genetic engineering and biotechnology and US$1 trillion on nanotechnology, it will give the US an unassailable lead in these future technologies. We will then be producing things that people couldn’t buy from anywhere else. Like the cure for cancer. We would be able sell our cure for cancer in exchange for Chinese tennis shoes and the trade will then balance.

A trillion dollars into solar technology will mean an America with free, limitless energy. That will immediately cut our trade deficit by 40%. On top of that, we would cut our budget deficit by US$200 billion because we wouldn’t have to defend the Middle East oil that we need. On top of that, the government could tax domestically generated electricity and bring down the deficit even further.

As soon as we start selling that cancer vaccine, it won’t be long before we pay our national debt. We need a strategy to go forward boldly with investment projects designed to solve our problems rather than sit back resigned to fact that there is no hope except cutting spending, which I believe is a road to disaster.

President Obama, in his State of the Union address, said: “This our Sputnik Moment” — meaning that we have to invest in new industry or be overtaken by our rivals, just as Russia forced us to rethink our space strategy with its launch of the Sputnik in the 1950s.

The Edge: And what should China do?

RD: China should agree to a global agreement on increasing industrial wages by US$1 a year every year. We need a global minimum wage so that wages go from US$5 a day this year to US$6 a day next year, tripling to US$15 a day in 10 years. That, in turn, will greatly expand the purchasing power of a billion people at the bottom of the Chinese pyramid, who would be able to afford the sneakers or the iPods they make.

It took 150 years after the industrial revolution before industrial workers in the West could afford to buy the things they were making. When Henry Ford increased wages to US$5 a day in 1915, everyone thought he was insane. Only because wages went up did you have in the US the base of a consumer-based industrial society. If wages had remained low, the West would not have developed to the stage where it is now and Americans wouldn’t be able to afford Chinese-made goods in Walmarts.

The Edge: What’s your take on the sovereign debt crisis in Europe? Will the eurozone break up, with weaker economies such as Greece, Ireland and Portugal dropping out?

RD: I don’t think the eurozone will break up, though it is not impossible that a country like Greece might drop out. Over the long run, we will see some of the weaker economies gradually bailed out by European taxpayers and the European Central Bank.

The Edge: What should Southeast Asian policymakers worry about?

RD: All asset-price bubbles end up in busts, and that destroys banking systems. Southeast Asian banks came out unscathed in the global financial crisis but, if property prices in Singapore, Hong Kong and China keep going up, mark my words, there will be a banking crisis. Just because Asian banks withstood the last crisis doesn’t mean they will withstand the next one.

The Edge: Anything else policymakers in Singapore should worry about?

RD: Derivatives. There is no reason Singapore should try to be a global hub for derivatives. Warren Buffett was right when he said derivatives are financial weapons of mass destruction. Singapore and other emerging financial centres should be wary of derivatives and the damage unfettered use of derivatives could do.


  1. So, the assumption here is that there will be a break between QE2 and QE3 (couple of months). The impact on asset classes is obvious: all will drop. I wonder however how precious metals (bullion) will fare; I think more and more people smell a rat and realize the endgame, so gold and silver (to a lesser extent) could hold value pretty well.

    If there is a disinflationary period (between QE2 and QE3), it will help soften China’s inflation problem. So those who bet that China’s bubble will burst shortly could get disappointed (e.g. Jim Chanos & Co). It will take many more months or even years.

  2. The markets are getting harder to predict. Usually if the dollar was going down against the Euro the Dow would get a nice boost but now the dow is falling and so is the dollar. Gold meanwhile is still moving upwards. I’m starting to believe that people are finally waking up to the fact that Gold isn’t a commodity or an investment, but rather money and thus when things are going south Gold is the true safe haven in lieu of the U.S. dollar.

  3. Warren Buffet said derivatives are financial weapons of mass destruction. Warren is now investing in derivatives. If you read Forbes report this year and Warren documentary by BBC on the youtube. The question is why is Warren investing in derivatives? Is Warren doing this as astute investor or is he trying to buy back is country from financial destruction?

    Thank you Duncan. I hope American will wake up and do what is neccessary to save the world.

  4. I believe you are RIGHT ON with the idea: “If we spend US$1 trillion on solar energy, US$1 trillion on genetic engineering and biotechnology and US$1 trillion on nanotechnology, it will give the US an unassailable lead in these future technologies” !!!

    common sense not being that common, in the meantime we need to shore up our portfolios – I guess the QE2/QE3 Interim is a good time to buy low… bullion seems to be holding it’s own though.

    How long is QE3 and what is the post QE3 scenario? I guess this will denter around the 2011 Presidential Elections to pump up the economy for a re-election bid… Thoughts & insight welcome

    1. The US can spend trillions on solar, biotech and nano, and they may even come up with some nice discoveries. However, China, India and other countries can copy these ideas (e.g. industrial sabotage, etc. – see how the Soviet Union developed the nuclear bomb) and with 1/10th of the costs the US spent they can develop their own industry and compete with the US.

      Gold and gold stocks would be an obvious choice for the qe2 and qe3 interim. Energy and agriculture could be interesting too, depending how much they deflate after qe2.

      It will be interesting to see what form and name qe3 will take, and when it will happen. And when these become more clear/predictable, I hope Mr. Duncan will give us his views on the investment implications asap, before the market prices in the news quickly, which was the case when qe2 was announced/mentioned in late August 2010.

  5. DUNCAN: “We will then be producing things that people couldn’t buy from anywhere else. Like the cure for cancer. We would be able sell our cure for cancer in exchange for Chinese tennis shoes and the trade will then balance….As soon as we start selling that cancer vaccine, it won’t be long before we pay our national debt.”

    RESPONSE: What is to preclude China from pirating our cancer drugs the way they have pirated every other product we’ve produced in the last 15 years?

    Let’s remember folks, US R&D created the television in the late 40s…and the technology quickly found its way to Japan. Today, there are no US manufacturers of TVs.

    Same goes for VCRs in the late 70s…and every other technological advance we’ve come up with in the last 60 years. But Mr Duncan seems to believe that this time out with cancer drugs, somehow things will be different.


  6. A bit surprisingly, as early as in mid July, Bernanke already expressed his intention to implement a new round of money printing in case the economy starts going down again. This helped to keep commodity and asset prices high, because market participants are confident that Bernanke will not let asset prices fall. And the gold market is also sniffing that qe3 is on the way, even though one would have expected some consolidation or even decrease because of the end of qe2.

    The fact that Bernanke made this statement so early means that the economy is in such a bad shape that we will not have to wait for qe3 until the fourth quarter this year. At least the program announcement will be made pretty soon (end of August??) and then markets and commodities will take off again and by the time the program actually starts the markets will have priced it in already.

    Actually, I was hoping that all asset classes would ease a bit in July and August and then buy some stuff, but apparently Bernanke’s comment has ruined my plan.

    Btw, the size of the new round of money printing will have to be gigantic. If the official GDP grew only by 1.5% in H1 this year despite qe2, then to reach a higher growth rate they will have to come up with something big. And if we calculate with the actual rate of inflation (and not the official one), then the GDP might have decreased in H1.

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