Merryn Somerset Webb talks to Dylan Grice about Japan, America, gold, and the commodities boom.It isn’t often that there is standing room only at a presentation on the future of the Japanese economy. But that’s what I found when I arrived, admittedly a tad late, at the Edinburgh International Conference Centre to listen to Dylan Grice speak last week. And I didn’t even hear that much either. My choice was to hover in the doorway behind a quite fat and very tall man, or to retire for a coffee and talk to Dylan later. The coffee won and I met him in the press room when he finally escaped from his hordes of admirers.
So what makes Dylan capable of selling out a conference hall when he is, on the face of it at least, talking about one of the most trying subjects known to market strategists? I think I know the answer. You’ll know the old joke about how what we really need is a one-handed economist (to stop them constantly bleating on about ‘on the one hand this…’ and ‘on the other hand that…’). Well, Dylan is the man with just one hand. He has a series of good, well-backed and very strong opinions. And unless the circumstances change dramatically, he sticks to them.
Audiences like that (as do journalists). And they particularly like his opinions on Japan. Ask the average strategist what will happen in Japan and your eyes will glaze over long before your mind can process the technicalities and ifs and buts of the answer. Ask Dylan and he’ll tell you that it will end in a hideous bout of hyperinflation that will take the Nikkei from its current level of 9,662 to 40,000. The country is basically bankrupt, has awful demographics (too many old people, not enough workers), and already spends over 50% of tax revenue servicing its debt. So it is heading for a fiscal crisis, a money-printing binge and an endgame that comes with a currency collapse à la Israel in the 1980s.
Japan needs a depression
I ask when this will kick off. He doesn’t know – this kind of stuff isn’t predictable. His best guess? “Within the next five to ten years.” So is there a way that Japan can stop this happening? What would he do if he were in charge? He “would resign”. I tell him people aren’t allowed to say that when my recorder is on. No Somerset Webb interviewees are allowed to resign from the Federal Reserve, from the Bank of England, from the European Central Bank, from the Japanese government or for that matter from the International Monetary Fund.
Instead, when asked these tricky questions they have to pretend they are in said position as a benevolent dictator with a 50-year mandate. That works for Dylan. Under those circumstances he would note that Japan is an “undertaxed economy” and he would gradually raise taxes – first consumption tax and then property taxes. He’d phase it in over a number of years to minimise the pain. He would “effectively engineer a depression”.
Any way out that doesn’t involve a depression? No. And even if there were, Japan’s politicians would mess it up. They are, says Dylan, so dysfunctional that even just after the nuclear disaster they were “trying to score points off each other”. If you want to have even an outside chance of sorting out Japan, you need political consensus. But Japan is “light years” away from that. So while it is horrible to suggest something is inevitable, in Japan, hyperinflation, “the path of least resistance for all politicians”, probably is. “I just can’t see a way out.”
What about the rest of us with our shockingly awful debt levels? Japan, says Dylan, should be seen as a leading indicator. It was first into a “deleveraging, deflationary, demographic crisis”, so odds are it will be the first to see the endgame. But the rest of us are in trouble too. I point out that the US isn’t in the same demographic bind as Japan. Dylan agrees. But while America’s dependency ratio is technically lower, they “have the least efficient healthcare system in the world” and that means that the cost of their retirees is higher than the cost of most country’s retirees. The result? While they shouldn’t be as at risk of “fireworks” as the likes of Japan, their almost unbelievably expensive Medicare and Medicaid systems mean that they are.
Who is Dylan Grice?
Dylan Grice is a global strategist at Société Générale. He joined Société Générale in 2007. From 2003 to 2006 he was Dresdner Kleinwort’s director of proprietary trading and was responsible for running thematic strategies, including macro-thematic and ETF strategies involving cash-equity products.
Before that, he worked as a senior economist at Dresdner Kleinwort, which he joined in 1997. He holds an economics degree from Strathclyde University and an MSc degree in economics from the London School of Economics.
So what would Dylan do if he were in charge of the US? This he thinks is a more tractable problem: he would instantly raise the retirement age to “77 or 78 or 80 or something like that”, bringing us back to a time when retirement was supposed to be only a very brief break between work and death and the deficit back into line along the way.
Hmm, I say, it’s lucky that in the world we have created for the purpose of the interview, he can’t be voted out. The point, says Dylan, is that solving the US’s problem shouldn’t really be that hard. “You raise the retirement age and you restructure the healthcare system.” It isn’t that there isn’t a solution. Just that the US is a “vipers’ nest of vested interests”, so there isn’t one that can be implemented.”
Central banks should be scrapped
What else would he do? “Get rid of the Fed.” Dylan would dump central banks completely and go for free banking instead (see a conversation I had with Jim Rogers on the same subject). There’d be no gold standard, “no anything standard” and no Ben Bernankes knocking around fixing the cost of capital.
Why? Because, says Dylan, how can central bankers possibly know what the cost of capital should be? Look back over the last 20 years. “How do we know that this massive debt bubble was not caused by them getting it wrong?” Maybe 2% inflation wasn’t the right level. “Maybe it’s 0%, maybe –2%.” We are always being told to trust the market, “to allow the market signal to work its magic” when it comes to everything from wages to the price of electricity. But when it comes to interest rates we are told that without central bankers “the economy wouldn’t be able to behave itself”.
But that’s just “nonsense”. It may be the case that “the market is not perfect”, but “it’s probably better than anything else” for figuring out the price of capital as well as the price of labour. “And it has got to be better than guys like Bernanke and Mervyn King.”
So does he rate King as badly as Bernanke (who he can no longer “take seriously”)? He does. King has shown every sign of not just being “completely wrong”, but “being a deeply flawed individual” who won’t accept that he is wrong. See what I mean about the one hand?
Gold isn’t in bubble territory yet
I ask Dylan if – given that he thinks anyone should be able to introduce their own currency – he thinks central banks should be abolished and, as he owns (and keeps hidden) physical gold and silver, he considers himself to be a gold bug. He does not. Instead he claims to “view it as a currency” just like the other ones he holds (the Singapore dollar and the Norwegian krone). He also notes that he isn’t in the business of holding gold forever and he thinks he could bring himself to sell into mania when it comes. A real gold bug couldn’t. I bet he hasn’t buried his krone in his garden, though.
Does he think there is a danger that gold is near mania territory now? No. With long-term inflation expectations in the US hovering around 2.5%, it is hard to make the bubble case. If they go higher, gold will “explode”. And odds are, they will. His fear of inflation isn’t just about public-sector insolvency. It’s about emerging markets too. Look at per capita use of anything from oil to zinc in China and you’ll see that it is still far from international norms. As it moves towards them we might find that the demand for commodities we see today is just the beginning of a huge shift.
You’d think that would mean that we should be stocking up on commodities. But this is not the case at all. Suppose this really is the “mother of all bull markets”, says Dylan, and you’d invested in a commodities index ten years ago. The truth is, it wouldn’t have done you much good – you’d have made about 4% a year over the decade. The best way to back the rise in commodities demand isn’t necessarily to buy physical assets. It might work, but it is “really high risk”. Instead, “bet on human ingenuity” – by buying cheap mining stocks where you can find them. That way, if we really are in a commodity supercycle and the resource companies find better and cheaper ways to produce more, “you are going to make a killing”. If it isn’t, “you just bought some cheap stocks. That’s OK too.”
Hedged Japan funds
If Japan does end up with hyperinflation, that’ll send stocks soaring and the yen plunging. So to take advantage, sterling investors would have to hedge against the collapsing yen. As we noted back in March, a number of funds offer sterling-hedged options. Dalton Strategic Partners has a sterling-hedged version of its Melchior Japan Advantage (tel: 020-7367 5400) fund. The annual management fee is 1.5%, and there’s a 15% performance fee. Launched in 2007, the unhedged version of the fund has returned 3% over the past three years, against a 37% fall in the Topix.
Jo Hambro Japan Fund (0845-450 1972) issued a sterling-hedged version in April 2010. Manager Scott McGlashan focuses on small and medium-sized Japanese firms, where he believes there are many undervalued opportunities. He typically holds 40 to 60 companies. The unhedged version of the fund is down 13% over five years, against a 45% fall in the Topix. The annual fee is 1.25% and there is a 15% performance fee.
GLG’s Japan CoreAlpha (020-7016 7000) fund was launched in 1999 and a sterling-hedged share class, GLG Japan CoreAlpha Equity, was brought out last year. Managed by Stephen Harker and Neil Edwards, the unhedged version of the fund is up 9.7% over five years, compared to a 45% fall in the Topix index. The annual fee is 1.5%.