Fears about inflation and hyperinflation could create another economic downturn, bigger than the one the world went through, Hugh Hendry, chief investment officer at hedge fund Eclectica, told CNBC Tuesday.
Dollar and Euro
The stock markets are due for a correction after having risen dramatically this year, but this is not likely to come in the summer and another rally is possible, Hendry, who said he was remaining risk-adverse this year, told "Squawk Box Europe."
"We have a huge intellectual conviction… that this is a more profound downturn that we're experiencing and markets will be under pressure," Hendry said.
"People get more get more concerned about government debt… and it sows the seeds of its own destruction," Hendry said. "We're actually tightening the screw, we make monetary policy tighter and tighter."
Long-term yields on government bonds have been rising, as investors fear central banks, especially in the US and the UK, will have to absorb excess liquidity from the system and raise interest rates to fend off inflation once an economic recovery takes hold.
"I think this paranoia today that inflation is happening today I think it puts in place a motion for a decline in the economy," Hendry said. "I think they're not printing enough money… with regards to the wealth destruction that has been happening over the past 18 months."
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"We raised interest rates and actually we killed the golden goose," he added.
Stock Market Correction
A correction in the stock market is likely, but it will not come over the summer, and the S&P 500 index may even hit 1,000 before the downturn, according to Hendry, who admitted he is not stepping in to catch the tail of the rally.
"It's kind of fun watching it from the sidelines, I must say I'm not participating," he said. "My flower opens in the winter, not in the summer."
There is a tight correlation between the oil price and the Chinese currency, the yuan, with oil prices rising as the yuan was strengthening, Hendry said. This is because Chinese speculators had borrowed in dollars as the yuan firmed, and all that liquidity was thrown into the oil market last year.
"The one non-confirmation in the world is that, since July, the Chinese currency has done nothing, it was flat vis-à-vis the dollar," he added.
Hendry said he still prefers conventional government bonds, and admitted they were the cause his fund was 3 to 4 percent down on the year. But, he added, government bonds were down 20 percent – although he doesn't think they will end the year like this.
China and other countries with a current account surplus are not as safe as they seem at first glance, because their economies are still hugely dependent on exports to the US, which is still "down on its luck," he said.
"If that's the case, the last place you want to be is the surplus countries," Hendry said.