The U.S. economy has yet to recover to the satisfaction of most Americans. The unemployment rate hovers at 9%, while the stock market fell precipitously, then rebounded, after Standard & Poors lowered the country's credit rating in August. Even as U.S. President Barack Obama tries to assure voters the economy will not slip into a recession again, his handling of economic matters fell to a 26% approval rating this week, according to a new Gallup poll.
With an upfront perspective on the economy is CNN's chief business correspondent and author Ali Velshi, host of Your Money and The Ali Velshi Show on CNN Radio. He has extensively reported on the global financial meltdown since 2008; the financial collapses of Fannie Mae, Freddie Mac, AIG and Lehman Brothers; the U.S. government's bailout plan; and the battle over the fate of the nation's big three automakers.
Velshi's first book, Gimme My Money Back: Your Guide to Beating the Financial Crisis, was released in January 2009. His upcoming book written with co-anchor Christine Romans, How to Speak Money, Becoming Fluent in the World's Most Important Language, comes out November 8.
He spoke with Arabic Knowledge at Wharton on the recent S&P downgrade, its implications on the global economy, the European debt crisis, the strength of the U.S. economy and on investment opportunities in a volatile market. The key to any American recovery, he says, is quickly figuring out how to preserve and support its middle class, and resolving political disputes on economic policy.
An edited transcript of the conversation follows.
Arabic Knowledge at Wharton: Why it is not worthwhile for dollar-pegged countries, particularly Gulf States that have oil, to start switching and lowering their dependency on the U.S. dollar?
Ali Velshi: When I speak to folks at PIMCO [Pacific Investment Management Company] or big bond dealers and I ask them why it is not worth going into other Triple A countries with a higher yield than U.S. bonds, they always point out that the currency risk in arbitrage becomes a whole separate business. Determining whether you get a little more yield in Canada or Australia than you do in the United States versus the currency risk is a separate business. It is the same thing with dollar-pegged countries. You are betting that something else is going to be a better peg; you are going to let your currency float and you are not quite sure how that is going to affect you in the end.
The dollar remains the reserve currency of the world, largely because it is the most liquid currency in the world and because most commodities are priced in U.S. dollars. So again, if you are pegged to the U.S. dollar and you are a commodity-based country, for instance an oil-based country, you have an arbitrage between your currency and your commodity. It is not likely that they are going to re-price any commodities into something other than U.S. dollars. While that gets talked about all the time, including the idea of pricing oil in a different currency, it is just not likely to happen any time soon.
If that were to happen, if oil, commodities, and precious metals were to start to trade in different currencies, then it might become worthwhile considering switching over from the dollar. That day may come, but it is certainly nowhere near, and until then the cost and the risk associated with de-pegging or switching to another currency as a reserve doesn't make a lot of sense.
Arabic Knowledge at Wharton: Why is the U.S.'s liquidity an advantage?
Velshi: Take all the countries in the world that have Triple A credit; all of their debt doesn't add up to total U.S. debt, which means that there just isn't the liquidity, there isn't the availability of debt to buy, and there aren't the availability of bonds. So certainly for individual investors, you may make the decision to invest in, say, Canadian bonds, or bonds of another Triple A-rated country. But if you are a larger investor or an institutional investor, there just isn't that liquidity to necessarily make that change, and clearly the events since the downgrade of the United States have indicated that institutional and professional investors still regard it as the safest, most stable and most liquid market, regardless of the downgrade.
Arabic Knowledge at Wharton: Overall, you seem optimistic about the U.S., but you express concern for banks and lending?
Velshi: I am optimistic for the U.S. for two reasons: One is that unlike Europe, where the debt problems are structural and very difficult to change with respect to paid leave, retirement, and tax collections, in the United States they are entirely political. While I don't anticipate a whole lot of cooperation out of this Congress, ultimately these problems can be solved. U.S. companies have a great footprint in emerging and developing nations, so they get the profit advantage of faster growing markets and the stable base in the United States. While we have issues in respect to debt, lending and credit, and they are not anywhere near as serious as they were in 2008, banks and financial institutions do have some exposure. We are not through with the mortgage crisis yet, we are not through with the commercial real estate issue, so I wouldn't back up the truck and load up on financials and pegs. Of course, if you are an active trader, those can be great plays. They are certainly very volatile. But generally speaking, I would be more interested in dividend paying, blue-chip companies, particularly those with big cash balances which don't need to have major asset acquisitions. For them this is a great environment. The next best thing is the [U.S. Federal Reserve Bank] has come out and said that interest rates are going to stay low until at least 2013, so even those companies that need to borrow in the United States are not in a bad position.
Arabic Knowledge at Wharton: Is there an expected ripple effect on federal, state and local government's ability to raise money? Is the public sector going to suffer more because of the downgrade in the private sector?
Velshi: Yes to all of those. Some municipalities have already been downgraded and they already have problems raising money. The cost of borrowing, if you are a government and you are associated in any way, even in a trickle-down way, with the federal government, it is definitely more expensive. We have seen specific examples of how that has become more expensive. So, yes, municipalities and states, they were hit in 2008 by the economic crisis, then they were hit by foreclosures, the lack of property taxes, lower business taxes, unemployment resulting in lower personal taxes and now they are getting hit by the debt squeeze. It is very difficult to be a municipality or a state right now, and politically it is even more difficult because a number of conservatives who were elected to governorships and took sweeping [cost-cutting] action are now seeing a bit of a revolt on that as well. So even the fiscal conservative answer hasn't worked so that remains to be seen but that is a very difficult situation.
Arabic Knowledge at Wharton: Did the recent dramatic stock market drop and bounce convince some people who thought that there wouldn't be a double recession that more economic pain is inevitably on the way?
Velshi: Here is my thesis at the moment: The economy is not broken, but it is bifurcated. If you have money and you have the ability to borrow, you will first of all likely never see rates as low as they are right now. So whether you are buying a house or car, or for business or school, if you have the ability, if you have the credit and the ability to borrow, life has really never been better for you. If I could afford to buy 10 houses across America right now with 20% down, I would do that right now, because if I regard them as long term investments, the interest rate alone, regardless of the appreciation of the asset, I'll win on that, number one. Number two, if you have cash and no need to borrow? Wow, you are in the best situation of all. So a small percentage of wealthy people in the world are going to get substantially richer from this financial situation. And by the way that has been the same story for the last two years.
The problem is the poor who have access to none of this. They can't take advantage of low borrowing rates, they couldn't get credit even they could take advantage of it. They are struggling to get a job and are substantially worse off as a result. So this economy is worse than a recession for them. The only bulwark was the middle class and it is becoming substantially harder for them too because job cuts moved right into the middle class. The people who are long-term unemployed in this country are not the long-term poor, they are becoming the working poor, or the unemployed middle class. They are not getting access to capital, they are not the people who are building businesses and they are feeling their small businesses under a great deal of pressure because of a lack of demand. When you squeeze out the middle class — we know how that looks. We know why there is a difference between developed countries and developing countries; a lot of that has to do with the weight and the ability to tax the middle class, and this is where America's larger problems lie. So it may not be a recession or a double dip in the classic sense, but we are definitely going to feel the effects of the fact that we do not have a middle class in a good position to pull the U.S. out of this slowing economy.
Arabic Knowledge at Wharton: How much gold would you buy at this point, then? Do you foresee that being a bigger bubble than the housing market?
Velshi: I am not at all convinced about the value of loading up on gold. Now that said, if you had always had gold in your portfolio — some advisors will tell you they have to have 5% of their investments held in precious metals, and some have for years advised to have 20% or 30%. Certainly if you were in that band and you were disciplined about that proportion of precious metals in your portfolio, you would have been selling off as it was going up all these years, while still keeping some, so you would be at no loss. That ultimately speaks loudly to your taste for diversification. So if you always had 5%, you would have made so much money on that 5% and you would have kept paring it down, that it wouldn't matter to you how much the price of gold is approaching. I'm always sceptical about backing up the truck and loading up on anything. If you think precious metals have a role, and it hasn't had a role in your portfolio, then put in 5%, if you feel really gutsy make it 10%. I certainly don't see any reason to be doing more than that. I see no reason in any economy to throw caution to the wind unless you are a rock star or you are about to marry one.
Arabic Knowledge at Wharton: So where should investors put their money at this point? Should they rethink their outlook on real estate or are there any sectors that are appealing at this point?
Velshi: There are two things going on. When Europe's problems happened, and when the U.S. downgrade was announced, you saw exits from almost every asset class, including gold, by the way. I think this speaks to making sure that your investments are at least in five different non-correlated asset classes. This is important. You have got to invest in non-correlated things because ever since 2008, the rules have been broken: Usually, when money comes out of one asset class it typically goes into another. When a recession ends, you see one asset class performing better than others. Those rules got broken in 2008. Unless you know what the new rules are, it would be better for you to be exposed to various non-correlating classes, so that you preserve your capital and at least have skin in the game, so that when something starts moving in the right direction, you are in it. I remind people that at this point, despite all of the problems that we've had in the stock markets, back when I wrote my book in the lows of 2009 and told people they should be reinvesting in the market that January, if you did, you are now up more than 60% in the U.S. equity markets. So there is a case for being invested and there is a case for being diversified. And if you are going to be cautious, even be effective and strategic in being cautious. The instinct for many investors is to really put it in the mattress or treasuries, but I don't think the average person needs to be that cautious.
Arabic Knowledge at Wharton: In a recent debate you had with your colleague Richard Quest, you said the U.S.'s debt problem could be solved in 24 hours unlike Europe's problem. How will Europe's debt problems impact the U.S.?
Velshi: Yes. I absolutely believe that the U.S. debt problem, not the U.S. debt, is not knowing where the light is at the end of the tunnel, and that can be solved inside of 24 hours. The U.S.'s problem is political more than it is anything else. It is a matter of making choices, whereas the European problem exists for very structural reasons, including retirement age, the degree to which social services are provided, how taxation is not collected and the degree to which they have not standardized their work day, their vacations, and their paid leave. It is much more structural and not everybody is on board with how exactly you are supposed to fix that, and clearly voters themselves are not on board with that, which is why are seeing rioting. The European problem is substantially more serious than the U.S.'s problem. Now that said, we have traditionally depended on Europe, which collectively is as big an economy as the United States, to help the U.S. out in terms of demand, and I am truly worried that you are going to see a collapse of demand on the European side because of how serious their problems are right now. So I completely stand by the fact that the U.S.'s problems can be fixed in a day, but I also stand by the fact that that I don't think they will be fixed by the deadline for the Congressional 'super committee.' [The bipartisan committee created under the debt ceiling deal, charged with finding at least US$1.2 trillion in deficit savings by the end of November.] They may pass but they will not be as effective as they can be.
Arabic Knowledge at Wharton: You speak of the importance of the American middle class, what can be done to improve their condition?
Velshi: It is very important to preserve and maintain the middle class. This is your strongest tax base. We know that low-income earners don't contribute a great deal to the tax base and we know that high-income earners pay tax at a lower marginal and absolute rate. You want a middle class that earns well, feels prosperous, consumes and pays tax. This is where we are feeling the biggest hit right now. The things that have to be done are twofold: The American middle class is home to a class of entrepreneurs and so we have to incentivize them to invest and do things that create jobs and value in the United States. At the same time, we have to be very careful with what happens to their taxation. This is a group of people in the United States who are very sensitive to taxation increases, and if their taxes go up they will spend less in the economy, and will be less likely to do things that are expansionary. Ultimately the main entry point into the middle class in the United States is through work. We are losing a lot of jobs in the middle class and are not building them back with enough speed. So that is one of the main problems that we have got to deal with.
Arabic Knowledge at Wharton: There is debate as to whether or not the S&P downgrade is the result of the fiscal policy pursued by the White House.
Velshi: It is important to remember a couple of things. One is President Barack Obama put forward suggestions with respect to deficit reduction that were substantially further reaching than the one he finally agreed on. Certainly much further than what a lot of Democrats were interested in. The difference between what he put forward, which would have cut US$4 trillion from the deficit, instead of this one which is under US$3 trillion, is that he has included revenue increases, tax increases. The cutting of certain loopholes and credits was simply not acceptable to a number of fiscal conservatives, including those who are beholden to a group called 'Americans for Tax Reform' run by [Republican activist] Grover Norquist. They have pledged to do nothing that ever involves approving a tax increase. The President wanted to go further and had his deal been approved, indications for S&P and Moody's, certainly from S&P, is that US$4 trillion would have been the point at which they would probably not downgraded the United States' credit rating. That said, I don't know what the ultimate long-term effect of a downgrade is going to be anyway. It has not substantially increased lending rates, bond yields. It certainly riled markets and it has created an environment of uncertainty, but ultimately it may not end up being all that important.
Arabic Knowledge at Wharton: What are your thoughts on billionaire Warren Buffett, who owns the rating agency Moody's, being very vocal about not agreeing with S&P's downgrade?
Velshi: If he could give it a 'Quadruple A' rating, he would. More importantly, the part Warren Buffett talks about that I think is more relevant to most people is [that] 'the lower stocks go, the more I buy.' He is of the school of thought that stocks are undervalued at this point on a price-earnings (P/E) basis. There are some questions about the P/E — we are not at historic lows but we are certainly at lows for a number of stock. The bottom-line is for value investors — not for growth investors — keep in mind there is a big distinction. If you are a value investor, this could be a very good market for you.
