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.
Epoch Times: What is the effect on U.S. stocks?
Mr. Rickards: That’s the unwind of the carry trade, money in money out, risk on, risk off, whatever you want to call it, it’s the same dynamic.
That’s playing out with a vengeance in emerging markets as we see: Brazil, South Africa, Turkey, India, and others.
What that is doing in the short run, it is causing those other countries to raise interest rates to defend their currencies. We have seen interest rate increases in Turkey and South Africa; I think we will see them elsewhere in the near future.
That will tend to slow growth. If that slows growth and if there are fewer capital inflows, then those countries have less capacity to buy U.S. exports and China is slowing down for reasons of its own.
All of this feeds into a global weakening, global slowdown, global deflation, and that’s one of the reasons why U.S. stocks are correcting.
Now, we also have a lot of volatility—down 300 points one day, up 200 points the next day. It’s what I call nondirectional volatility. It doesn’t represent a bear market, it doesn’t represent a rally, what it represents is confusion.
This is not surprising because the Fed itself is confused and uncertain of what it is doing. The Fed doesn’t really understand what it is doing. Because they are manipulating markets, the whole world is somewhat confused.
Epoch Times: So you expect a lot more volatility for 2014?
Mr. Rickards: Correct. 2014 will look more like 2011 or the first half of 2012. If you recall in 2011/2012, the driver of the volatility was not emerging markets, it was the euro crisis.
One day [German Chancellor] Angela Merkel would be fighting with the Greek finance minister and markets would go down, the next day, they would kiss and make up and the markets would go up.
What you had was just this volatility driven by this risk on risk off again vis-à-vis Europe. Now Europe is stabilized but we are seeing the same thing in emerging markets.
It all comes back to the Fed and what economists call regime uncertainty. So I think we’ll have that kind of volatility in the first half, but by the second half the U.S. weakness will be apparent, the Fed may back off the tightening, and then emerging markets may rally.
Epoch Times: So will U.S. equities?
Mr. Rickards: Yes, because there is nothing U.S. stocks don’t like about free money, so the more free money the Fed creates the more the stock market likes it.
And by the way: The reason we call it QE3 is because we had QE2 and QE1. And remember what happened: Everyone said the tapering started in December of 2013, but actually, when QE1 ended that was a 100 percent taper and when QE2 ended, that was a 100 percent taper.
It merely wasn’t gradual; it was all at once. Both of these programs tapered to zero and they both failed. They had to come back for more, leading up to QE3. We have two data points and what they tell us is: Tapering fails. So I would expect it will fail again.
James Rickards is the author of the national bestseller “Currency Wars.” He is a portfolio manager at West Shore Group and an adviser on international economics and financial threats to the Department of Defense and the U.S. intelligence community.
The interview has been edited for brevity and clarity.
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