Epoch Times: Mr. Rickards, what happened last year with the so-called taper, the Fed’s monetary tightening by reducing bond purchases?
James Rickards: I had expected all summer 2013 that the Fed would not taper in September but most market participants and analysts were sure that they would.
When they did not taper that was not a surprise. But then in December I thought the Fed might not taper and of course they did.
In both cases, I was taking the Fed at their word. It’s not that I had a crystal ball. The Fed said repeatedly they had certain economic targets in mind with regard to growth, unemployment, inflation, and other metrics and I did not see those targets being satisfied. So my view was they would not taper.
Epoch Times: Why did they do it then?
Mr. Rickards: My inference was they must have had another reason, since their own indications and their own words said that they should not taper. What else were they concerned about?
I think it was a couple of things. I think it was Ben Bernanke trying to tie up his legacy with a bow. Having been the father of quantitative easing Bernanke wanted to show the way out, show the exit strategy and also tie Janet Yellen’s hands a little bit. Because Janet Yellen is much more of a dove and less likely to start the taper.
So he was boxing her in a little bit. Of course that’s done and they tapered again in January. Janet Yellen faces a serious dilemma, which is that the Fed has tapered into weakness.
Epoch Times: Why is that a problem?
Mr. Rickards: Because they started tapering without satisfying their own growth and inflation criteria. The danger now is that they cause a recession.
In fact I think a recession in the United States in 2014 is even likely. My expectation is there will be one more round of taper in the March meeting of the FOMC [Federal Open Market Committee] where they will probably taper another $10 billion.
But by June it will become very apparent that the economy is stalling out, the stock market is going down. They risk a stock market collapse. I think they will stop by pausing the taper.
They won’t increase asset purchases but they’ll stop the decrease; what I call the Yellen Pause. But the market expects more tapering, so if they just pause that will be a form of monetary easing relative to expectations. Maybe later in the year they’ll increase asset purchases.
Epoch Times: How can the Fed do this?
Mr. Rickards: Of course, the thing about Quantitative Easing 3 (QE3), which is different from QE2 , is that the Fed has given itself degrees of freedom to change the amount, change the direction of asset purchases versus tapering. They are not locked into a set program with respect to time and amount as they were with QE2.
Epoch Times: What are the effects of the taper?
Mr. Rickards: It’s very apparent. It starts out in emerging markets, because one of the big drivers of investment in emerging markets is the kind of carry trade.
Investors will borrow dollars then convert them into some emerging market currency, whether it’s Indian rupees or South African rand or Chinese yuan or Brazilian reals, and use that to buy global stocks and bonds. They do it on a leveraged basis and in the past that has produced very high returns.
The problem is if you expect U.S. interest rates to go up, and tapering is not the same as increasing rates but it is a form of tightening, and it is the beginning of that process, you want to unwind that trade very quickly.
The reverse is: You have to dump the emerging markets stocks, get paid in emerging markets currency, convert the currency back to dollars, pay off your dollar debt and go to cash, go to the sidelines.