(Interviewed by Louis James, Editor, International Speculator)

L: Doug Casey is busy this week, hosting a big bash at La Estancia de Cafayate in Argentina, so I’m speaking today with Vedran Vuk, a senior analyst here at Casey Research. Vedran, I know many of us here rely on your help, but I suspect that few of our readers will know your name. What exactly is it you do?

Vedran: I contribute to The Casey Report and also work closely with Dennis Miller on his new Casey publication, Miller’s Money Forever. I occasionally write the Friday Daily Dispatch and pitch in with general research whenever anyone on the team needs help.

L: Very good. You pretty much have your finger on the pulse of everything going on here at Casey Research and support all our different publications, so I’d like to get your take on the world today. But let’s back up and talk a little more about who you are. How did you end up on the Casey crew?

Vedran: I was going to school at Loyola University in New Orleans. Actually, several current and former Casey researchers are from Loyola, including Chris Wood, Jake Webber, and Robert Ross. One of my professors was Walter Block, who is a well-known Austrian economist. He happens to be a good friend of Doug Casey. Since Doug was speaking at a New Orleans Investment Conference a few years ago, he stopped by to talk at Loyola. Afterward, Walter took a few of his students out to meet Doug and have dinner with him. I didn’t start working for Casey Research immediately, but went into an economics Ph.D. program. I left that after almost two years because academia isn’t my thing. Academia is a careful game of university and department politics –you’re encouraged to publish papers that won’t ruffle anyone’s feathers. When you’re working in the financial markets in the private sector, you’re free to have any idea, and you can put your money behind them. If you’re right, you’ll be handsomely rewarded; and if you’re wrong, the market will have your head. That’s the sort of environment that drew me from a Ph.D. in economics to applying the ideas in real time. So I contacted Olivier, with whom I’d kept in touch since the dinner with Doug. I have the same outlook on economics as Doug, I have writing ability and analytical skills, and the Austrian economics background – it fit like a glove.

L: Note to the young readers I know we have: Casey Research is not hiring at present, but it can’t hurt to send a résumé in and as Vedran says, keep in touch.

Vedran, when you mentioned Louisiana, I of course thought of Walter Block. Are you a defender of the undefendable as Doug and Walter are? Or are these ideas too extreme for you?

Vedran: I’m definitely on board. Dr. Block made me very radical – well, my free-market ideas are radical according to some people. I’d say Block and I are on the same page. In a world where regulating every aspect of our lives and invading multiple countries is the norm, I’m more than happy to be as “radical” as possible.

L: It’s pretty funny. In everyday life, we consider ourselves radicals, then we join Casey Research and we’re just run of the mill. Hope that doesn’t mess with your head too much…

Vedran: [Chuckles] Yes, strange to be normal. But it’s good to be surrounded by people who understand my views. I’ve heard stories of people with an Austrian economic perspective who got jobs in big financial institutions like Goldman Sachs, and it drives them crazy because the people they work with don’t see the market as they do.

L: I can imagine. So you’ve been on the team for several years now – our general specialist, or special generalist. How does the world and the global economy look to you today?

Vedran: The way I see it, with the Fed pumping plenty of money into the system, the stock market is probably going to keep going up – until something completely derails it. In a way, the market has a date with destiny; there will eventually be a crash. They may pump too much money into the economy, to the point where it’s a bubble – and all bubbles have to burst.

Or we may see the alternative, in which things generally go pretty smoothly – let’s say for the next year or two – and then the Fed starts letting interest rates rise, as it has promised to do. I don’t know how it can raise interest rates and expect the market to keep booming.

If you have an Austrian, free-market view, the bubble scenario is clearly bad news, but even if you’re a more mainstream or Keynesian thinker, you have to realize that raising interest rates is like putting the brakes on the economy. That may make sense in an overheated economy, but not in one struggling to recover. That leaves us between the proverbial rock and hard place. It doesn’t matter what your school of economic thought, every day we’re moving closer and closer to some market correction. The end result is the same, although the reasons may differ.

L: When does the crunch hit?

Vedran: Hard to say, but at best, I think we may enjoy a year or two before things really go off the rails.

L: Can you clarify why higher interest rates are the kiss of death? After all, the economy has functioned when rates were higher before; why can’t it do so again?

Vedran: It definitely could do so again, but it’s the change, the increasing of rates that causes growing pains – getting from Point A to Point B. Once it gets to Point B, businesses will have adapted. I mean, we lived through the 1980s, with interest rates at very high levels. But right now, companies are basically able to borrow money for nothing, so changing to having to pay for borrowing is going to have a negative impact.

You also get asset pricing issues. Rising interest rates will hurt everything from bond portfolios to real estate. We’ve got a little bit of a recovery in real estate now; once rates start rising, the cost of buying real estate increases. All those banks that lend for real estate and still have mortgage-backed securities on the books are just getting back on their feet. When rates start to rise, they are going to get kicked into the dirt.

So again, once people adapt, it’s not a huge problem, but the transition will be killer. With the 10-year Treasuries at about 2% – which is essentially zero, given that the official inflation figure is at about the same rate – going to a more normal historical range, say, around 5%, will be a painful transition. There’s really nothing the Keynesians have to offer that can avoid this. Bernanke knows this, and that’s one reason he’s been keeping rates so low.

L: Doug says the government can’t allow rates to rise, or the interest on the national debt will balloon to where it consumes almost all of the government’s revenue, leaving nothing for the military and other things the government is supposed to do.

Vedran: The government’s debt situation will definitely go from bad to worse. I don’t know that it would lead to an immediate default, but it would be one more serious problem on top of many others. You have to keep in mind that this would hit at the same time as many obligatory increases in entitlement payments hit, and as more and more of the Baby Boomers retire and start needing more medical services. It’s a nasty situation, creating a powerful incentive to try to inflate away the debt.

L: Understood. Hm. So much for the US. What about abroad?

Vedran: One thing beneficial about what’s going on in Europe is that there’s been so much time to think about it. The EU has been openly in crisis for about five years now, so I’m wondering how many financial institutions have been able to unwind their exposure to the problems. I’m reminded of our own problems with mortgage-backed securities and the subprime mess. It’s not like everything was fine in 2004 and stayed that way until suddenly crashing in 2008. In 2007, everyone knew there was a problem, and that it was serious.

L: Everyone except Ben Bernanke.

Vedran: Yes. There was some discussion at the Fed, but people like Bernanke thought they could just raise rates a little to dampen speculation, and everything would be fine.

But back to Europe. I have to wonder how many of these problems have been unwound. I mean, if a country like Spain were to default tomorrow, of course it would be bad – but perhaps not as bad as it would have been a couple years ago, now that everyone has seen the writing on the wall for so long.

That’s the good news: there has been a lot of time to prepare. The bad news is that if a major country like Spain or Italy defaults, it will really hurt everyone – there’s just no sunshine in that scenario.

L: So if you had to guess, would you say that Europe has muddled through the worst of it, or would you guess there’s worse to come?

Vedran: Tough call. It’s hard to sit here and say that Europe is going to crash tomorrow or in the near future. What’s easier to say is that Europe is not going to boom tomorrow – nor in the near future. I can’t see, for instance, putting my money into European equities and betting that the clouds will part tomorrow, lifting the European markets and my shares.

As an investor, I have to recognize that I don’t know what will happen, but I also have to recognize that there’s very little imminent upside, while there is serious potential that things could go very wrong in the near term. If the upside were potentially huge and imminent, it might justify the risk – but that’s not the case.

L: So why go there?

Vedran: Exactly.

L: Okay then – what about China? Isn’t China going to save the global economy?

Vedran: It’s interesting – people take such divergent views on China, even among free-market thinkers. Some people, like Jim Rogers, see China as the next great market – the best place for investors to be in the world for decades to come. I respect Jim Rogers very much, but there’s another view, that despite some pro-market policies, China is still a very managed economy lacking transparency and the free market’s corrective mechanisms. The famous Chinese ghost cities are emblematic of this problem.

This is very confusing to many investors. It’s in the nature of the Chinese economy, some aspects of which are indeed very free and some aspects of which are under total government command and control.

Two things are clear to me. First, China’s blistering pace of growth has slackened, and that graph has to continue leveling off. It can’t maintain 10% growth forever. The other thing is that the command aspects of the economy are a hindrance to China’s ability to become the market paradise of the 21st century – there are huge, government-induced distortions in the Chinese economy that have yet to be unwound.

We’ve learned something very important from China, and that’s how much an economy can grow after freedom is increased even just a little. But that doesn’t guarantee sunny days for the century ahead.

L: Maybe it’s another example of Pareto’s Law – the 80/20 rule. The country got huge benefits from making a few changes, but to really go all the way would take much deeper and more thorough reform. It would have to adopt the kind of market institutions and mechanisms that are completely at odds with the desire of the central committee to continue controlling the economy. The infrastructure takes time to build and a cultural shift to make work – the country just doesn’t have that yet.

Vedran: I agree, and see the same thing in other emerging economies. India and Brazil are great examples of the same issue. Both countries have been growing pretty well, but I think it would be wrong to say that Brazil or India is a real free market. They have, however, opened up enough compared to what they had before, and are seeing a lot of growth as a consequence.

L: The wonders of a low starting point. Percentage increases can be spectacular.

Vedran: Yes. At some point, much more change is needed in order to keep growth going.

L: That’s a good point. It’s not just about how free the market is, but about how stable growth is and hence the ability to lift more people out of poverty.

Vedran: Exactly.

L: Hm. Well then, is there a ray of hope for today’s economic order out there anywhere? Or do you agree with Doug that the Greater Depression has started, and it’s got to get worse before it can get better?

Vedran: We’re on an inevitable path to meet up with doom, considering our growing debt and ever-expanding government. My only ray of hope has to do with timing – that maybe this isn’t the recession that pushes us over the cliff, but rather some other one, perhaps a decade or more down the road. But the downside here is that this point of view only buys time. It doesn’t make the problems go away. My other ray of hope is that once a truly enormous crash happens, we’ll finally get our game together quickly rather than spending twenty years in a Greater Depression. One can hope, but your chances on the lowest-probability horse at the racetrack are probably better.

L: So where does one invest today?

Vedran: I think you have to be extremely selective about what you invest in. In Miller’s Money Forever, for example, a lot of the investments we’re looking at are bigger, defensive investments – things that don’t fluctuate much with the market. Things like consumer staples and pharmaceuticals – people are going to eat, and they’ll need their meds regardless of what the economy is doing.

L: People can cut back on going to the movies, but not their diabetes pills.

Vedran: Right. That limits the downside, but these same companies will surge with the rest of the market if continued quantitative easing forces a lot of newly printed dollars into stocks. In contrast, consider something like Bank of America. If the market keeps rising for the next couple years, that stock will probably be a winner – but I really wouldn’t want to own the shares if there’s another crash.

We want to take advantage of what’s going on in the market, but also stay very defensive as well. Hedging with gold, as you recommend, is another thing we’re doing as well in Money Forever. And we also have trailing 20% stop losses with our picks, to limit the downside. While the market is going up, we’re taking advantage of it, but we’re not taking our eyes off the risks for even a second, by choosing more defensive picks and using the stop losses.

L: Sounds good. And this has been a good look at some of the thinking that goes on here at Casey Research – a conversation around our virtual office water cooler. Thanks for your time and insight.

Vedran: Thanks for inviting me – it’s been fun.

L: All right then, until another time.