Michael Pento is the president of Pento Portfolio Strategies, which provides calculated advice and research for individual and institutional clients. A well-established specialist in the Austrian School of economics, Pento is a regular guest on CNBC, Bloomberg, FOX Business News and other national media outlets. His market analysis can also be read in most major financial publications, including the Wall Street Journal. He also acts as a financial columnist for Forbes, contributor to thestreet.com and is a blogger at the Huffington Post. His book, The Coming Bond Market Collapse: How to Survive the Demise of the U.S. Debt Market, was published by Wiley in April of this year.
Opportunist: In your book you warn investors to prepare for ‘fireworks’ in the bond, currency and equity markets around the world. What inspired you to write this book?
Michael Pento: I got tired of watching the average middle class investor get destroyed during the dot com bubble in the late 1990s and then again in 2006 when they suffered catastrophic losses by buying houses with nothing down and were encouraged by the government and private banks to take on way too much debt. Speaking tangentially, I don’t think the average American understands how markets cease to work when the government intervenes and so when the Fed tells them home prices cannot fall they believe that. The government encouraged homeowners to take out negative amortization mortgages. If I can save investors from getting destroyed in bond funds or save somebody’s retirement I think I will have been very beneficial to their well-being.
On the day in late April when my book was released, the yield on a Ten-Year Note was 1.5 percent. An epic bubble is being built up in bonds and the bursting of that asset bubble will be exponentially worse than when the real estate bubble burst.
Opportunist: What makes you draw that conclusion?
Michael Pento: The U.S. government bailed out the banking system by taking on trillions of dollars of sovereign debt, so much so in fact that the national debt is now equal to700 percent of government’s revenue. That amounts to $17 trillion in debt outstanding or $54 trillion in aggregate debt if you include public and private sector debts. The only other time in the history of this country that we have seen a national debt of this proportion was during World War II. All of these things are records, so the bursting of the bond bubble is going to occur. There is no reason why a nation has a 10-year note anywhere near 2.9 percent as it is today where we peak. It should be much closer to 7 percent, which by the way is the average going back to 1971. Commercial banks that own all of this sovereign debt will have capital taken away from them. The bond bubble by quantitative easing is going to result in the collapse of incipient asset bubbles known as equities and real estate. We could be looking for real disaster around 2016. Inflation and currency risks and credit risks associated with owning U.S. treasuries are going to dramatically increase going out in the next few years and are likely to cause the collapse of our bond market. We are already starting to see that.
Opportunist: Speaking of asset bubbles, you recently wrote in one of your columns that the economy has become ‘addicted’ to the Fed’s level of credit creation and its ability to create asset bubbles. Why do you think that is?
Michael Pento: Well, in the late 1970s and early 1980s we had asset bubbles in commodities as well as a huge problem with inflation created by then-Federal Reserve Chairman Arthur Burns. His successor, after G. William Miller, Paul Volcker, came in and vanquished runaway inflation and helped to usher in the 1980s prosperity. I don’t like the amount of debt incurred in the middle and latter part of the 1980s, but it was inarguably a prosperous decade. Anyway, we had the same problem at the height of the credit bubble in 2006 and 2007. And we tried to fix it with a dramatically increased money supply, inflated asset prices and a tremendous level of debt. In 2007 the Fed decided it was not going to raise interest rates but lower them to 0 percent instead and leave them there for 7 years, which is how long it will be—at minimum—that we will have had 0 percent interest rates. We ended up printing $3 trillion into our monetary base, which stood at $800 billion before and is now at $3.6 trillion. However, both things cannot be true. You cannot crush inflation by taking a Paul Volckeresque kind of approach and also vanquish inflation by taking a Bernankesque approach. I cannot say the Fed is not doing more of the same thing that initially brought on the problem. We have seen a massive increase in debt and that’s why we are in a lot of trouble. What conditions have we solved since the credit crisis? We cannot say that we have solved the problems of debt, the problems of low interest rates or of money-printing. The only problem we solved was taking the cost of money down so people have a lower debt service condition. We have greatly expanded all our other problems, and this will lead to the inevitable increase in interest rates and reveal insolvency that we have as a nation. I believe we will see violent swings between inflation and deflation going forward.
Opportunist: You have also been outspoken in your disapproval of the Federal Reserve’s stance on inflation and what it is doing to the middle class.
Michael Pento: Yes I have. Can you imagine that the so-called protectors of our currency, the very ones placed in stewardship of our currency with the purchasing power thereof, have gone on record to say the rate of its decline is not quite fast enough? That is egregiously and flagrantly bad. How could someone unelected—an appointed entity—tell you, the middle class, that the value of your dollar is too strong and needs to be depreciated against the asset classes you need to survive, such as food, energy and shelter? The Federal Reserve is out there bemoaning the fact that inflation isn’t high enough—‘below our targets,’ they say—and yet we look around and see the stock market is up 150 percent in the last few years. According to the Commerce Dept. and the National Association of Realtors, home prices are rising again at double digits—the same rate at which they were rising in 2006 when the progenitor of the bubble, the credit crisis, eventually led to widespread mortgage defaults. For the first time in history, we are seeing all three of these bubbles concurrently: equities, real estate and bonds. I am very concerned that whatever method the U.S. uses to try to normalize interest rates, whether through the Federal Reserve or the free market, will reveal how stressed the nation’s balance sheet really is.
Opportunist: Do you believe the housing market will continue its positive path of recovery, or will we see another downturn?
Michael Pento: I think the housing market is up depending on which measure you look at. It has seen double-digit gains year over year, and that’s not the nature of bubbles. They don’t heal that quickly. About 95 percent of all mortgages are underwritten by the government now, and the government secures these loans and is now in the habit of issuing mortgages for 3.5 percent down. There is no private market for mortgage backed securities because everything is engendered by the government. When interest rates rise, investors will get out of purchasing new and existing homes. Following the Great Recession, about 30 percent of real estate sales have been cash purchases. When interest rates rise again that will be part of the next crisis but not the nucleus. Sovereign debt and the U.S. fixed income market will be the core of the next crisis, but I believe another leg down in real estate prices is on the horizon.
Opportunist: The U.S. Bureau of Labor Statistics reported that the unemployment rate fell to 7.3 percent in August, but skeptics say we are becoming a nation of part-time workers. What should the Obama Administration and Congress be doing to encourage hiring and facilitate job creation?
Michael Pento: None of their stimulus packages are the answer. They are nonsensical if you ask me. I believe we should adopt a much fairer tax code or go to a consumption tax of, say, 10 percent on discretionary items. In other words, food, clothing, and shelter would be exempt from taxes but everything else you consume would be taxed at 10 percent. And we should abolish every other tax there is, including the payroll tax and the income tax. We also need to adopt a balanced budget amendment. The nation needs to come up with $120 trillion over the next 75-year projection period if we are going to make good on our promises to Social Security and Medicare—that’s how long the actuarial tables go out for Social Security and Medicare Trustees. The economy only generates $2.5 trillion in revenue every year, so we have to be honest with the American people and let them know if we cannot make good on the promise. I also recommend strengthening our currency, keeping interest rates low and stable and abolishing the Dept. of Education and allowing the education system to operate in the free market instead. Those are just a few things that we should do right away to help the long-term sustainability and viability of this nation.
Opportunist: Are you in favor of a return to the Gold Standard for the U.S. dollar?
Michael Pento: I am very much in favor of going back to gold and even taking it one step further and adopting a 100 percent fractional reserve system—it’s not enough to just increase the monetary base by 1.5 percent per annum, but it is enough to make sure banks using the fractional reserve don’t blow up the money supply superfluously from the monetary base. A soaring dollar is one of the best things we could ever experience. Everybody would want to own dollars and investors around the world would come to this nation with their capital and we would create and guarantee that the U.S. dollar would be the world’s reserve currency for decades. I am not at all concerned about the dollar hurting our manufacturing sector or increasing our trade deficit because the deflation associated with a strong dollar would offset any increases in the currency.
Opportunist: How will the conflict in Syria affect the markets?
Michael Pento: There was a report released recently on real median incomes that revealed wages have dropped 6 percent since December 2007, after adjusting for inflation. If you have a condition where consumer incomes are already falling—and that does not simply mean they haven’t increased, but that they have actually fallen—and you add something like the Syria crisis, which has already brought West Texas crude oil up to $110 a barrel by the way, it doesn’t look good. Any aggression toward Syria by the United States could spill over into other countries such as Iran and Saudi Arabia and potentially cause a sustainable increase in oil prices. That would put more pressure on the consumer who cannot handle more pressure, but a sustained increase in oil prices is just one of three main concerns that I have heading into the end of this year.
Opportunist: What are your other concerns?
Michael Pento: The last time we had fiscal gridlock was in 2011 and the Dow Jones Industrial Average lost 2,000 points in a month. This time around we have a continuing resolution that must be passed in a matter of weeks. There is an Oct. 1 deadline for funding the government and by the middle of October Congress must agree to raise the debt ceiling. The last time this occurred it didn’t fair well for the markets. The Federal Reserve clearly has bipolar syndrome, depending on who you talk to and which day it is. The Fed may taper its bond-buying in September or it might increase QE. But the market is already taking interest rates higher. I think the Ten-Year Note can go to 4 percent by the first quarter of 2014 and, if so, the economy will be in another recession. Those are my three big worries: oil prices, fiscal gridlock and how high interest rates may go. Of those three, the level of long-term interest rates and how high they rise poses the biggest threat to the economy.
Opportunist: Who influenced your career?
Michael Pento: That’s a big pie to swallow. Austrian economics in general. I could name names but there are too many to mention. I give credit to the founding fathers of this nation, who probably wouldn’t recognize our state of affairs today. I always like to thank God as well for everything that he has blessed me with.
I became licensed after graduating from Rowan University in 1991 and went to work in the discount brokerage end of the business. I also worked on the floor of the New York Stock Exchange and with specialist firms who traded Disney and Textron. I started my own money management business in 1996, but I think the most salient point of my career was when I started writing about the coming collapse of the housing market in 2005. I was one of the lonely voices warning about the asset bubble and spillover effects on the economy. That’s when things really took off.
Opportunist: What do you find most rewarding about your work?
Michael Pento: My ability to be able to speak independently without an agenda, to analyze data and spit out my conclusion based on an independent and autonomous thought process.
Opportunist: Which industry sectors do you believe hold the most promise for investors?
Michael Pento: I see the most potential in shorting the bond market, and there are easy ways the average investor can do that. I also recommend owning precious metals as an insurance policy. The common misperception is that the credit crisis is over and that the United States can just unwind its fiscal and monetary stimuli with impunity, but that is blatantly and patently false and that is where your opportunities lie. Many times I am going against the mainstream financial media and Wall Street in general, but being a contrarian like that allows me to have great opportunities for myself and my investors.
Leslie Stone is an award-winning writer/editor with more than two decades of experience covering business, finance and lifestyle issues for newspapers, magazines and online publications. Originally from Virginia, she currently resides in Florida. Follow her on Twitter at @les7989
Pento Portfolio Strategies - http://www.pentoport.com
The Huffington Post - www.huffingtonpost.com/michael-pento/
Books by Michael Pento - http://www.amazon.com/Michael-Pento/e/B00BFX3184