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September 21, 2011; The Final Days of the Keynesian Utopia: An Interview with Hunter Lewis


The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, as promised, we talked about looking at Keynes again, even though it is an ugly picture. We have as our guest today Hunter Lewis.

David: Kevin, I think the importance is this: We see experiments over, and over, and over again, with bailouts, both here in the U.S., and in Europe, and around the world, and they are predicated on the same things – basically, Keynesian economics. We are now into the third round of bailouts for Greece. The first didn’t work, the second didn’t work, and the third – of course it will work. At least that is the belief, and we do the same thing over and over again, believing, not that the method was wrong, but that we were only wrong by degrees. We should have done more of the same. We didn’t do enough of it. We didn’t spend enough. Billions weren’t enough, we needed hundreds of billions. Hundreds of billions weren’t enough, we needed trillions. Trillions weren’t enough, and this is the same kind of insanity that led to the Havensteinian nightmare, if you will…

Kevin: Back in the early 1920s.

David: Exactly. Dr. Rudolf Havenstein was a very smart man, a national icon in Germany, and he had the full support of the academics of the day, saying, “If things are getting more expensive, just print more money, and that way it will be more affordable,” and everyone loved the idea, and no one questioned some basic assumptions. I think that is what I love about now turning back and saying, “Let’s pause, let’s think about this. We need to reassess the way we view economics.”

This is a dismal science. Nobody particularly likes economics, but listen, your life is being predetermined for you by economic, fiscal, monetary policies, not only here in the United States, but around the world, where there is collaboration, and everyone is agreeing that we should do the same thing. This is the definition of insanity, Kevin, in which you do something, it doesn’t work, and yet you do it again, and again, and again. I want to explore that a little bit with Hunter Lewis today.

Kevin: David, it defies common sense, and that is the thing that Keynes was known for, defying common sense. Last night I was grilling steaks on the grill and we were talking to my son. He doesn’t live here, he is up in college in Boulder, and he said, “Who do you interview tomorrow?” I said, “Hunter Lewis. He wrote the book, Where Keynes Went Wrong.” Then I started to say, “Okay, here is what Keynes believed,” and he cut me off, and he said, “Dad, I know what Keynes believed – spend more.”

David: It is interesting. I think it is becoming more common knowledge that the guy was a bit of a quack. He agreed with Sylvio Gesell’s idea that you print money with an expiration date on it. In other words, you don’t save it. If you own it, you need to get out there and get it moving.

Kevin: Penalized for saving, basically.

David: He loved progressive taxation where you take more from the wealthy and redistribute it to those who have to, or will, spend every bit of it, rather than save and invest. He loved the idea of setting interest rates at zero and keeping them there permanently.

Kevin: How in the world would anybody retire? I don’t understand. If you set interest rates at zero, what is your CD going to do for you?

David: It is the issue of price controls, central planning, government monopolies, the role of the state being bigger and bigger because they are better and better, in his mind, and you do see shades of a world view that puts the state in control of everything. In fact, that was a part of Keynes’s ideals, not just in economics, but in politics. If you go back to Plato’s Republic, you find that Plato really fancied the philosopher king as the person who should be making all the decisions, and you couldn’t trust the hoi polloi, the average voter. “Well, just what do they really know? And really, things should be centralized around one person.”

Ironically, you find this figure, the philosopher king, being at the center of the universe. Keynes was no different. He created a structure of thought which propelled him to the very top. Basically, it should be central planning, and I am your consigliere. I am your advisor. I am the philosopher king from behind the scenes who is dictating, not only political issues, but economic, as well.

Kevin: David, with that in mind, when we have taken economics classes in the past, we have had these ISLM curves, and we have had a lot of different equations. It becomes so amazingly complicated, when in reality, really, all that is being taught is that you need to make sure that you don’t spend more than you make, and you spend productively what you spend. I would just say, when you had us read this book a couple of years ago, Where Keynes Went Wrong, the entire office, and then we discussed it, it was a way of condensing voluminous material on Keynes, and I wouldn’t encourage anybody to just go sit down and read all of Keynes’s material. Not only does it not make sense, but it is unnecessarily complicated so that the person actually is intended not to understand what he is reading. But this book, Where Keynes Went Wrong, is a great summary of Keynes, and why it doesn’t make sense, and then what does make sense, wouldn’t you say?

David: I would, and Kevin, I think this is one of the things that gets to the heart of it for me, and I think for our listeners, too. The fact that Keynes did not take a look ahead, he was not concerned about the future, he did not care about future generations. It was not in his equation at all. Everything was about the present moment, and that is reflected in his own life, it is reflected in his personal decisions, it is reflected in his orientation to an economics which is driven by success today, irrespective of what happens tomorrow.

Kevin: Like the cavaliers. “Eat, drink, and be merry, for tomorrow you may die.”

David: And he justified it by saying, “In the end, we’re all dead.” So by putting that finality out there, he concentrated on the here and now, so much so, Kevin, that he betrayed future generations. I think that is what we have to be cognizant of, as thinkers, as actors, in the marketplace today. We cannot afford to betray future generations as our current body politic has done, and will continue to do, to the degree that it continues to hold Keynesian ideas in its stock of beliefs. And this is why Hunter Lewis is joining us today.

David: Joining us again today is Hunter Lewis, and the discussion is Keynes, his book, Where Keynes Went Wrong. I have gone through the book, yet again, and this is a book that we read in the office, nearly two years ago, and benefited from immensely. It is on the shelves of every person in the office and we had some in-depth discussions, not only about what Keynes said, but just how confusing, at times, it can be, and almost incoherent, except the man was truly brilliant, and that was how he got away with saying what he did. No one really wanted to challenge him.

What Hunter Lewis has done in his book, Where Keynes Went Wrong, is to parse out some of the things said, and what has been misconstrued, what has been put into place as policy, and assumed to be good economic theory. I couldn’t recommend the book more highly. You can either get it in hardback or paperback. Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles and Busts.

Thank you for joining us, Hunter.

Hunter Lewis: It’s a pleasure.

David: In some respects, Keynesian economic theories were simply a justification for his own personal choices and ethical leanings, really, as a rejection of 19th century social conventions or values, what was conventional morality at the time, including things like thrift, savings, maybe even an orientation to the future, the 19th Century certainly had that, predicated on traditional family structures, and again, savings for future investment. He really had a focus on the here and now, maximizing the present, whether it was present pleasure, or present economic stimulus. Maybe you can look at where we are today. We had this conversation, to some degree, two years ago. Has anything changed in the last two years in terms of the government pursuing a more or less Keynesian solution to the current economic malaise?

Hunter: Not only has our government not changed, but every government in the world is continuing to follow the same Keynesian policies, and of course, they haven’t worked, they aren’t working, but we just keep doing more of the same.

David: We find ourselves looking at the classic phrase, “A spoonful of sugar helps the medicine go down. In this case, that simple shot of sugar helps the system feel better, although it doesn’t necessarily bring health. The criticism of Keynes, and this is a self-reflective criticism by practicing Keynesian economists, seems to be that 2008 rolled around, and we gave it a spoonful. Now, we have found that we needed a cupful. Now we need a wheel barrowful. Now we need a dump truck-full. The only criticism seems to be that we didn’t do enough, and there doesn’t seem to be a preceding criticism of, “Does this actually work?” Maybe you can comment on that.

Hunter: First of all, back in 2009 when we were coming out of the crash, in the first interview I had about the book with the BBC, they said, “Are you proposing to take the patient off life support?” And I said, “That’s the wrong way to look at it. It’s not life support, it’s just more alcohol for the alcoholic, or it’s more heroin for the drug addict. Then of course, you need more and more of that to keep an addict from being in withdrawal, but it doesn’t help the problem, it just makes it worse, and that’s essentially what has been going on.

Moreover, the most interesting thing to me is that as time has passed and these solutions have not solved anything, but, in fact, they’ve made it worse. None of the Keynesian economists who were propounding, “Let’s have more stimulus,” are providing any justification for it, on a theoretical basis, or an evidence basis. They just take it for granted. In every article you will read, even the recent one by Robert Shiller, in which he said, “It’s undeniable that we need more stimulus now.” He doesn’t explain why it’s undeniable, because the truth is, there is no logic and there is no evidence for it.

David: One of the things you point out in your book, Hunter, is that that actually was the force of argument that Keynes used, himself. It was stated so emphatically that there really wasn’t evidence that was provided, and he got away with it. In his General Theory, it’s not as if he built a case, he just stated emphatically, “Thus so,” and everyone went along with it. That has been, I think, one of the particularly insightful things about your book is that, really, it is just a statement, there is nothing there that supports it.

Maybe we can look at some of the things that you and I would share in common a criticism of, but maybe the listener doesn’t know just what it is that gets under my skin, and I think perhaps yours, as well. Ideas like the rate of interest, set by the market. We are used to that. We look at the bond market as market practitioners, and see that people judge credit risk, people judge ability to pay. People judge all of these things, and give you, basically, a market grade. How do you fare in the pecking order? A junk bond may be 10-12%, and someone who is considered to be a good credit risk is maybe 2, or 3 or 4%. So there is that grading in the marketplace. As far as Keynes was concerned, the rate of interest, if it is set by the market, is always too high, with the ultimate target being zero. Why would Keynes target a zero interest rate policy – which frankly, sounds very familiar today – why would he target that as a perpetual ideal?

Hunter: This goes absolutely to the heart of what is wrong today. We have a market system which is based on prices and profit, and yet, the government keeps interfering with the price system, and it is the price system that tells everybody in the market what they need to do. So they are really shutting off the flow of information that is essential to prosperity.

When you have high unemployment, that tells you that there is something wrong with the price system, that there are prices that are not in the right relationship to each other, and yet, the government keeps messing up the biggest, most important prices of all, one of which is interest rates. The system really can’t function if the information that the market is providing in the form of the interest rate, is not available.

And of course, it makes no sense at all, as Keynes advocated, to keep driving interest rates down to zero and hold them there. That is essentially giving away money. And of course, we are giving away money, today. The Federal Reserve provides newly printed money to Wall Street, to firms like Goldman-Sachs. They are getting virtually free money, and of course, they make a lot of money with that money, themselves. So then we have this problem of crony capitalism that goes along with it – all these people who are getting rich off these government policies which are not helping the economy as a whole.

David: You raise an interesting point. The market system is dependent on an information feed, and prices tell you what is happening, whether it is healthy or unhealthy, and for governments to step in and play with the price system, via interest rates, is distorting the information feed, and it confuses investors. It also, with a zero interest rate policy, disincentivizes savers. That is also at the heart of Keynes, is it not? That you really don’t want there to be a saving, or using the 19th Century language, a rentier class?

Hunter: That’s right. He basically suggested that the government could print new money. That money would flow into the economy in the form of debt, and that would take the place of savings, but there is just no evidence for that at all, there is no logic behind that. In fact, if you want a good economy, what you need is savings, and you need then to invest those savings, and you need to invest those savings in a wise way.

Of course, Keynes completely ignores the issue of how you are investing. For him, not only is any investment equivalent to any other investment, but spending is equivalent to investment. It just doesn’t make any sense at all. If you want to restore the economy, you have to save, you have to invest, and above all, you must invest wisely.

David: And he went even further to say, whatever means necessary to use up those savings. You bring this out in your book. He argued that natural disasters, earthquakes, even wars, were a way to increase wealth by using up savings. I have to scratch my head on that one – the more you use up savings, even if it is for something like what just happened in Japan – that is productive? That is a move toward an increase of wealth for the Japanese? Help me understand that.

Hunter: It’s a complete logical fallacy, because the idea is that after the disaster, the Japanese have to spend a lot of money, and that will help the economy, but what that ignores is that they then can’t spend the same money on something else which would have been more productive. Obviously, just restoring what they had before is not the best investment they could make. The best investment they could make would be something new and productive. It’s illogical. It’s just a logical mistake on Keynes’ part, and yet, he made lots of logical mistakes.

David: It sounds awfully like the broken window fallacy.

Hunter: It is the broken window fallacy, which Henry Hazlitt wrote about a long time ago, back in the 1950s. Here we have the world’s governments basing their policies on Keynesian economic theory that just makes no sense.

David: We oftentimes discuss, here in the office, Thomas Kuhn’s book, The Structure of Scientific Revolutions, and the idea that there is no real evolution, but there is revolution within a theory of ideas, a theoretical framework. Whether we are talking about a scientific framework, or an economic framework, or even something relating to literary theory or philosophy, there tends to be a textbook community, a group of people who have agreed what is acceptable and true knowledge, and the educational system then perpetuates what is “real” or “true” or “reliable” information. Up until the point where you have problems that cannot be solved by the prevailing paradigm, people just accept it as common knowledge.

It seems we’ve done that with Keynesianism. Keynesianism is economics, largely, and as you said earlier, it is not just the U.S. government, it’s not just the Fed and Treasury, but if you go to any central bank or fiscal or monetary authority around the world, they have the same bias because, largely, they have studied at similar universities, and share that same textbook knowledge.

The point with Kuhn was, really, you get to the point where there are too many problems that can’t be solved by the existing paradigm, and then something replaces it. Do you see that as a possibility? And is the replacement a better one, or a worse one, given what we have in the social milieu today?

Hunter: Yes, there are, in effect, intellectual bubbles, just as there are economic bubbles, and Keynesianism is an intellectual bubble which is underlying the economic bubbles that we have had and that have gotten us into trouble. These things are very hard to change, but they do change, and an idea gets bigger and bigger and bigger, but eventually it does explode, the change comes very rapidly, and then it’s all put behind.

Some people have observed that there is a process in which these ideas change. First of all, an idea is ridiculed: Anti-Keynesianism, in recent decades, has been ridiculed. Then it is ignored – it is getting around, but you don’t want to give it any publicity: The major media today, in general, tries to ignore anti-Keynesian ideas. Then it is fought ferociously. Then, at the end of the process, everybody who fought it says, “Oh, I knew that all along.” That is the typical way that these ideas change. But, eventually, they do change, and they change dramatically. I have no doubt that Keynesianism is on its last legs, but in the meantime, billions of people are suffering as a result.

David: Yes, there is real human suffering, which is far more important than something that is, perhaps, catastrophic to one’s portfolio. Tying in something that you mentioned in your book, negative real rates, this is a chief consideration for everyone, and a consequence of that manipulation of interest rates, keeping them too low, too long.

Negative real rates – there are some practical considerations. You quote Peter Fisher, former Undersecretary of the U.S. Treasury, and New York Federal Reserve Bank. It is not as if officials at the U.S. Treasury or Fed are unaware of these issues, but he says capitalism is premised on the idea that capital is a scarce commodity and we are going to ration it with a price mechanism. When you make short-term funds available essentially free, with negative real rates, and you say rates lower than inflation have happened, for example, between 2001 and 2004, crazy things start to happen.

This is where we are today. We have negative real rates of return. There are different ways of constructing the inflation number – the models in the 1980s, the models in the 1990s, the way we count it today. Today it is less than 3%. If it was counted by the old model in 1990, it would be over 6. If it was counted by the Volker view of inflation, it would be double digit today. We have deeply negative rates, and it forces major misallocation of capital. Maybe you can talk about the consequences of being in a negative real rate environment and the bubbles that are perpetuated. Really, what was set forth in 2008 is the seed of a future problem. Would you agree with that?

Hunter: Yes, absolutely. But first, I want to stress the point you just made, which is that the way the government calculates inflation and unemployment today has changed a lot over time. Some of the biggest changes came during the Clinton administration. If we calculated unemployment the way we did in the 1930s, we would have depression levels showing right now, a lot more than what they are saying, and we would certainly have more inflation showing, as well.

We do have an environment of both inflation and unemployment and that, again, is just the result of these bubbles that have been blown up since the mid 1990s, and they have been blown up, just as you said, by holding interest rates too low, printing way too much money, in an effort to keep interest rates down. A combination of too much money and too low of an interest rate just creates a bubble. Meanwhile, again, the Keynesian economists – and that means most economists – say, “Oh, bubbles are just natural. Bubbles are just part of the market system.” If that is true, why is it we have had nothing but bubbles since the mid 1990s, and we didn’t have bubbles before that for decades? Again, it is just nonsensical to say that these kinds of bubbles are normal, when they are so evidently abnormal, and they are the source of our problems.

David: The business cycle is something that Keynes was not particularly fond of – abolish slumps, and instead, seek to maintain a perpetual quasi-boom, to paraphrase him. There was, in the 19th Century, a period, let’s say between 5 and 10 years, where it was more or less two steps forward, one step back, and a regular, if you want to call it, mini-boom and mini-bust cycle. Nothing deeply catastrophic, but surely painful to those who were on the wrong side of an investment, and those messes got cleaned up pretty quickly, again, in a two steps forward, one step back process. Keynes’s response was, “No – perpetual bliss.” And wasn’t his view really that of a utopian?

Hunter: Absolutely. As in any other utopian thinking, it just doesn’t make sense. It doesn’t recognize reality. The truth is that mild recessions are the price you pay for avoiding deep recession. When you try to eliminate mild recessions, as Alan Greenspan did, and Bernanke did, all you do is create the kinds of problems we have today.

But even in the past, when you had deep recessions, or even depressions, they didn’t last long. The market cured them in fairly short order. The early 1920s depression is a good example of that. The government did nothing and it was over in about 14 months. Contrast that to the Great Depression, or the kind of problems we have had since, where it just goes on, and on, and on, because the medicine the government applies actually just makes the patient worse. It provides temporary relief, but then it doesn’t solve the problem and makes it worse in the long run, or even in the short run.

David: You are talking about Harding, and his response, essentially, to Herbert Hoover. Hoover suggested they pump tons of money into the system in a very Keynesian fashion. Harding said, “Go fly a kite,” and he cut the budget significantly. If I recall, he cut spending almost in half, and we went from a 12% rate of unemployment, to 2%, by 1923 – 2% and change. A very different response, and it was, as you mentioned, a deep recession. It just didn’t last that long, because a different solution was offered by the Harding administration.

Hunter: Right. And there is more recent evidence of that sort, when the East Asian economy got into trouble in the late 1990s, they did not have the resources to apply Keynesian policies, they acted more like Harding and they got over it very quickly. They had a very strong rebound in no time at all, and that is in contrast to the countries that have practiced Keynesian responses, where they don’t get a rebound. They don’t fix the problem, they just make it worse.

David: Is it going to be a surprise to the average man in the street, or woman in the street, who comes to terms with this bankrupt ideology – will it come as a surprise to them just how nonsensical it was to believe in it? And how Ph.D.’s, very, very bright men, have held to these views, which are utterly nonsensical, and very against common sense? I go back to the Redbook article that was from 1934, in which John Maynard Keynes wrote in answer to the question, “Can America spend its way into recovery?” He answered, “Why, obviously, the very behavior that would make a man poor, could make a nation wealthy.” Is it going to pass muster with the voting public that politicians of both stripes, that academics, that Wall Street geniuses, to some degree, rely on Keynes as an intellectual pillar?

Hunter: Keynes was always the smartest kid in the class. He always had his hand up, and he was always telling the teacher, “No, everything you are saying is wrong.” He loved to provide what seemed to be a paradox. If too much debt causes a crash, load on more debt. It’s okay to grow debt faster than income, indefinitely. If debt becomes too burdensome, just cut interest rates. If low interest rates are causing bubbles, just lower them further. He was a specialist in these kinds of paradoxes.

And it is generally thought today that economics shows us that it is an area, it is a discipline, where common sense is actually wrong. But that in itself is wrong. Real economics, which is completely violated by Keynesianism, does reflect common sense. That’s what you need, you need common sense. You cannot violate common sense and expect to do anything for the poverty in the world, or to help the middle class. You have to have common sense policies. And it is just incredible that brilliant people, like Robert Shiller, a Yale professor and greatly respected, just keep clinging to these views, even though there is no logic, and no evidence offered to support them. They are just completely assumed.

David: In recent weeks we have talked about the Fed getting very aggressive in providing liquidity to Europe. It is just within recent days that they have done that, that they are providing ample liquidity through currency swaps and short-term lending via the EC in a coordinated effort with the ECB, the Swiss National Bank, the Japanese. We are re-liquefying the system yet again, and the amazing thing is that the markets love it. The markets absolutely love it. Are the markets really that bright, that they should be saying, “Hey, this is fantastic?” To me, it looks like the smile on the face of the dope addict who just took another hit, and “Boy, isn’t this grand?” Am I seeing this accurately?

Hunter: When we talk about the market, in this case, we are really talking about Wall Street, and Citi and people like that, and as I alluded to earlier, Wall Street has gotten rich off of all these bubbles. Wall Street gets rich off the printing of the money, and keeping interest rates low. They love this kind of thing, and they are only concerned with how much money they make in the next quarter, or the next year, and they are certainly not concerned with the long term. So it is not surprising that the stock market goes up when these fallacious policies are pursued even more intensely.

In terms of Europe, one of the big factors is that the European Central Bank operates under rules in which, if there is any default of the bonds that they hold, they have to sell them immediately, or not count them as capital. So the European Central Bank is faced with technical bankruptcy unless they just completely refinance, if Greece defaults. Just for that reason alone, they are doing everything possible to avoid the default. What a default actually is, is just a recognition that there is way too much debt, it cannot be repaid. That is called reality. That is called common sense. And throwing more money, more money, and more money, after bad, is not common sense.

David: I did a radio interview here in the last day, and the gentleman in Houston said, in a somewhat unrefined manner, “I look at gold as my stupid politician insurance.” I was thinking to myself, “You know, I might have said it differently, but we are really talking about insurance against Keynesian economic policies when we look at a money substitute like gold. Combine negative real rates of return, combine poor policy and the fact that this is really ideologically driven, and there really is a commitment to the ideal. Someone wrote a thesis, they have staked their professional career and reputation on it, there is ego involved, and no one is going to recommend a different course until we have actually gone off the cliff. Is there a reason to assume a different investment thesis at this point, that, really, insurance is unnecessary? Or should we still prioritize insurance in the equation, perhaps not against stupid politicians, but ideas that are bankrupt, themselves?

Hunter: No, I think insurance is even more important. Every day that passes, it just gets more important. There are different scenarios of where we go from here. We could head into a major depression, or deflation, or we could head into a major consumer price inflation, or a combination of the two, but protecting yourself against both is extremely important. In the old days, you could protect yourself against depression by owning bonds, and the longer the bonds, the higher quality, the better, but that doesn’t work right now because the chances of inflation are so great, that could destroy the value of bonds. So the only things you can really rely on now are cash as a deflation hedge, gold as somewhat of a deflation hedge, and gold also is also a great inflation hedge, so gold is really the prime asset. And the irony about gold is that the trouble of holding gold is that you don’t earn any income on it. That would normally make it seem disadvantageous to do so, but because the politicians are holding interest rates so low and refusing any kind of return to the saver, it makes the lack of income return on gold seem not so bad.

David: That is the issue of negative real rates, and going back to Gibson’s paradox and the Summers-Barsky thesis: Low-to-negative rates drive investor interest into something that represents almost a sideline position. “If there is too much risk and no reward, then just count me out until I can look at productive assets with a keener eye to benefit.” Again, we go back to our original point. This is a market system, based on prices and profits, and if profits are taken out of the equation, then people look to opt out, so to some degree, gold is an opt out.

Hunter: I just want to add that Keynesians, of course, say that if you buy gold you are hoarding, if you just keep a savings account, you are hoarding – you are not investing, you are a hurting the economy. But actually, you are helping the economy, because you are keeping capital available for future investment when the opportunity finally arises to make a good, sound investment.

David: It seems, though, if people look at the price of the insurance – you have credit default swaps, for instance, an insurance against default, against a particular underlying asset. Let’s take Greek paper, as an example. It is trading at records of 3 million dollars for every 10 million dollars of underlying paper, or over 3000 basis points, and that is even with the new ECB and U.S. interventions. That insurance seems expensive, and yet, it also seemed expensive at 2000 basis points, it seemed expensive at 1000 basis points, it seemed expensive relative to other types of insurance at 500 basis points. The argument is being laid similarly against gold. It was expensive at $900, it was expensive at $1200, it was expensive at $1500. This insurance continues to get more expensive. At what point does it just not make sense to buy the insurance, because it is just flat too expensive?

Hunter: Again, the Keynesian argument would be that gold is in a bubble, that it is going to burst, and every time gold retreats a bit, you read, “Ah, the gold bubble is bursting.” But I don’t think it is a bubble at all. I think it is still just insurance, and it is still sensible insurance at this price, and that it has potential to go up a lot more because, unfortunately, politicians are not going to change what they are doing anytime soon.

David: With the existing stock of thinkers, we probably won’t see remonetization of gold, but with a different stock of thinkers and policy makers, do you see the potential for a partial remonetization?

Hunter: Yes, I think that there is a great potential. In fact, I am sure that is what will happen, eventually, and it might come sooner than people think, because as the monetary system breaks down, they are going to have to find a new monetary system, on short notice. Monetary systems do tend to break down every 40, 50, 60 years. And when they do, they are doubtless going to bring gold back. The danger is that they will bring gold back in an inadequate way. People talk about the gold standard being a problem in the Depression. Well, we didn’t really have a gold standard then. And you can have a phony gold standard, as we did after World War II. But what you really need is a true gold standard, of the sort that existed before World War I, before the Federal Reserve was created. But it is less likely that they will do that.

David: It seems that it is less likely because it limits government spending, and certainly, the gold exchange standard, as a quasi-gold standard, that you just mentioned, allowed for greater flexibility, so to say, and freed politicians to spend wantonly. You are suggesting bringing it back in part might now be enough, going back to the old gold standard, circa 1860 to 1914, or what the Brits had from 1717 forward, with the exception of wars here and there. What is the political context that would legitimize a full return to the gold standard?

Hunter: I think the present monetary system will collapse, and when it does, they will bring back a so-called gold standard, but it will be something more like Bretton Woods, what we had after World War II. They certainly won’t bring back a full gold standard if they can possibly avoid it. I don’t expect that to happen, but that is what is needed, because that is the only way to really control government, as you said, and prevent more and more of the same Keynesian policies of print money, spend money, borrow, spend, and bailouts. All of that would not be possible under a true gold standard.

David. We had an interesting conversation with Giulio Gallarotti, and his comment was that under a system of universal suffrage, it is very difficult to maintain those disciplines. Politicians are inclined to spend more on their constituency groups than under a gold standard, or what a gold standard would allow for, so perhaps a return to disciplines reflective of the gold standard, but certainly not a return to the full gold standard. And he said the era of post World War II was different. We have moved toward universal suffrage, and politicians won’t allow for it, and frankly, neither would constituency groups, because it would mean less money from the government trough. Would you feel like that is an accurate assessment?

Hunter: No, because the problem is not the universal suffrage, the problem is the special interest groups.

David: Yes.

Hunter: The special interest groups, the big businesses, the unions, the trial lawyers, and so on – they are the people who are active in Washington and Wall Street, who are actually deriving benefits from all these Keynesian policies, and the country as a whole is not, the average voter is not. If the average voter really understood what was going on, they certainly wouldn’t support this kind of thing.

David: That’s a very good distinction.

Hunter: There is nothing about democracy, I think, that leads us to this problem. In fact, we need more participation from the average voter and the average person, not less.

David: You see the present monetary system unwinding. Any thoughts on the euro? Any thoughts on a basket of currencies? Certainly, Keynes was fond of the Bancorp idea. The IMF and the SDR structure is certainly being bandied about a bit. What do you see as the world’s money system 3 or 4 years out? What would you speculate would be our reality?

Hunter: The most likely outcome would be to try to go back to the system that Nixon destroyed – the post World War II system. But certainly, we don’t need Bancorp, we don’t need the SDRs. That is just an international organization printing money, in addition to individual governments printing money, so that just magnifies the problem and makes it even worse. What we need to stop is all the money printing. That certainly doesn’t take us where we need to go.

David: Something very similar to Bretton Woods where currencies relate to a particular sound, or more sound, currency. That was the dollar. Do you think that is the dollar still? Barry Eichengreen would argue, probably not, it will have to be a duopoly, certainly not a dollar monopoly, any longer.

Hunter: Yes, it is quite hard to imagine that the dollar would remain the sole reserve currency under a new system. That certainly is not very likely. In terms of the euro, I was just hearing on the radio yesterday, a distinguished commentator saying, “We have a choice here, either the European governments will intervene and rescue the euro and save the day, by basically bailing out Greece, and other countries, or they will let the euro collapse and that will be a disaster, and that will cost the European government much more money in the long run – six times as much money.”

But that is just all fallacious, because bailing out Greece, or bailing out Portugal, doesn’t solve anything. Again, you have to accept the reality that their debts simply cannot be repaid, you have to accept default, and you have to rebuild from there. The idea that those are the only two choices is just basically ridiculous. And we also have to keep in mind that, actually, if they kicked Greece out of the euro, the euro could appreciate considerably, so there actually is the possibility that if the Germans don’t buckle under, and they kick bad performers out, they could actually make the euro a very attractive currency again, more attractive than the dollar. No one is talking about that possibility.

David: That has been our position, that if you take the barnacles off the underside of the boat, you have much smoother sailing.

Hunter: Right.

David: What you said about the distinguished commentator from Europe giving those two alternatives, I just want to come back to your book, because this is one of the gifts that you have, Hunter, in pointing out the logical inconsistencies. Here is one example of the fallacy of false alternatives. You look at Keynes and you say, “Come on, he is misusing technical language, he shifts definitions, he misuses even common terms, he confuses cause and effect, he creates things that are representative of false determinism. And I think it is a very fair portrayal. You let him speak, and then you add some comment to it, and say, “Guys, come on, wait a minute. Does this make sense to you?” It is not just common sense, but also a keen criticality, a real insightful, logical appraisal of where Keynes went wrong.

I want to encourage listeners, if you don’t feel like you know what is being done to you, not necessarily for you, but to you, under the current administration, the past administrations, and as we have pointed out in this conversation, not just here in the United States, but globally, by the fiscal and monetary authorities, you should know Keynes. You should know him on a first-name basis. You need to get to know him. Make your introduction to him. Get a copy of Hunter’s book. If you have interest beyond that, then certainly, order an original copy of Keynes’s writing, and dig into the primary text, as well, but this is a great introduction.

Hunter, I want to thank you for opening up the conversation and getting people thinking. We don’t know, in the future, what will have turned the tide, but you have offered an opportunity. You have set something out there that I think critical thinkers, people who care about our country and the direction it goes, and frankly, the world, can look at and say, “Wow, I didn’t think about that. I need to reappraise. I need to check my assumptions. As logical as my macro-economics class in college seemed, it appears that the professor, and myself, didn’t reassess our assumptions, and that needs to be done.” Thank you for raising the questions, and presenting that for the average American to take a look at and say, “We need a different set of ideas. Let’s see if we can get that done.”

Hunter: Thank you, it’s been a pleasure.

David: We look forward to our future conversations, and again, you can find Where Keynes Went Wrong at amazon.com, or at any of the media outlets, in either hardback or paperback. We ordered it by the case, and hope you will, too.

Posted in TranscriptsComments Off

September 14, 2011; Handing Over the Keynes to the Kingdom: European Discipline Destroyed


The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, we’ve been talking a lot about Europe on our show, and the repeating theme is: Are we going to default? Or is austerity going to work? Where is the next bailout going to come from?

Look at China. China seems to step in almost like a super-hero right at the last minute and say, “Oh, well, we’re just going to go ahead and bail out Europe, one more time.” Is this repeating theme going anywhere, or is this just going to continue, ad infinitum?

David: Kevin, it’s kind of the death from a thousand cuts. We are looking at policy-makers experimenting with things that they have experimented with already, and they have failed over and over and over again, but that does not keep them from doing what Einstein thought was utter insanity. If something doesn’t work, you just have to stop it. Don’t continue to punish yourself with insanity.

There is nothing in Europe that we haven’t already discussed up to this point. The emergent crisis 18 months ago was a part of our conversation then. We included a detailed discussion with the European Central Bank co-founder, Otmar Issing, in an attempt to bring an aerial view to the things happening on the ground in Europe, at that point, in a very developmental stage.

I sometimes feel like we are looking at the issues over, and over, and over again, and my hope is that we are not just aimlessly repeating ourselves. Maybe it is that we are searching for nuance and the differences in perspective, in order to aid – whether it is our listeners or clients – in a decision-making process.

The end goal is for people to understand the times. The end goal is for people to take perspicacious, or wise, action, and be in a position where they can both preserve value and preserve assets, and see them grow. So again, we look at Europe because that is what is front and center today.

Kevin: David, we have had Bill King on a number of times as a guest. He outlines a simple, continually repeating theme that we probably need to understand overlays, as a structure, what we are seeing in Europe. His quote is, “Nations first try to inflate over their debt. Then they seek bailouts that are contingent on austerity plans.” Sounds familiar, doesn’t it? “But the austerity causes the economy to sink, impairing the ability to service debt. Citizens then violently protest the austerity measures, so countries then default and restructure the debt.”

That last step, we have not gotten to. We get right to the edge of this Greek default. In fact, 98% chance of a Greek default, according to the credit markets at this point.

David: Exactly, up from a 91% chance on Friday, so it’s a daily deterioration, and I think imminent has to be the word of the week. These are interesting times, as we watch materialize, in real time, something that is restructuring Europe as we know it, and, potentially, U.S./European relationships via the currency relationship in the capital markets.

We have the British, who are talking about completely restructuring their banks, and doing, frankly, what we described in conversation with Larry Kotlikoff not long ago – basically, ring-fencing the vital parts of the bank and allowing the speculative trade desks to be spun off, or run separately, with the risk managed very differently. There is a reconstructive process happening behind the scenes, and it is a very tricky situation for investors to be in, certainly one where you need to keep your eyes and ears very much open.

Kevin: When we talk about these overlying structures, these patterns, we have seen 3 of 4 steps. We know that when the 4th step comes, as in this particular case, countries then default and restructure their debt. That is the 4th step in this process.

My daughter lives in Manhattan, and the forecast a few weeks ago was that Hurricane Irene was going to come in. I had been planning to go visit her anyway, but we actually moved the ticket up because when you know a storm is coming, you prepare, and New York was not ready for a large storm. Thank the Lord, it passed over New York, as it could have been a horrible disaster.

But it was interesting, watching people prepare. Most people in New York really didn’t do a thing about it until hours before they heard the stores were going to close and the subways were going to shut down. Then all of a sudden people started buying bottles of water and tuna, though it wouldn’t have lasted them very long, and I’m wondering if the Europeans right now are prepared for what’s just about to happen.

David: I think the Germans are certainly trying to limit what would be the fallout from major structural changes within the EMU with membership changing potentially, even within days. When you know a storm is coming, Kevin, you are right, you prepare, and Germany has chosen to anticipate the worst. They are putting together a plan, as we speak, to aid their banks, and they are assuming a default in Greece. So they are now moving into – not triage, because the event has not occurred – but anticipation, “Do we have the supplies we need?”

Kevin: So the question is not if, but when, at this point – for Germany anyway.

David: Exactly, and they need to soften the blows for the banks, because the banks serve as a conduit of liquidity. The banks serve the economy as the connecting point. They are prized more critically than any other industry, particularly in this type of crisis.

Kevin: It sounds like the United States. We prized our banks more than anything else back in 2008.

David: We are on the cusp of an official default, and what that means is that we will see a write-down, or a marking down, of assets on bank balance sheets to reflect the already depreciated assets they hold. This is something that most people may not be aware of. But if you hold something to maturity, you can continue, for accounting purposes, to treat it as if it is a full-value asset, as opposed to something that has been impaired, or something that has lost value in the interim. So when the default occurs, there is an immediate marking down of that paper. It is no longer treated as a held-to-maturity asset.

Kevin: Let me make sure I understand what you are saying. When you give your kids saving bonds, it would be as if they were counting the end-maturity value the whole time, at the full amount?

David: Yes, even if it is trading at a discount. And of course, the Greek paper is trading at an extreme discount today. A default prices the asset immediately, and in the case of the Greek paper we are talking about, it implies a 50% loss, or more, by the assets held. This is different from institution to institution. There are certain institutions that hold sovereign paper on their balance sheets, and then you also have institutions that have branch banks in Greece, which is a different kind of Greek exposure. Particularly, when you are looking at the French banks, there are some that actually have branches, as I mentioned, and some, like a BNP, that are just chock full of the Greek debt, itself.

Kevin: And it’s not just the Greek debt. Since you are bringing up Greeks, we may as well go back to an ancient Greek who said, “Give me a lever long enough, and I can move the world.” The issue is leverage, right?

David: The issue is clearly leverage, because banks profit themselves, and they profit their shareholders, by enhancing their returns via leveraging the assets they have. The investments they have exceed the actual bank capital, and that allows them to see growth as long as they have an economic environment that is supportive to those assets appreciating. But that is the problem. If the assets go down instead, your losses can exceed the entirety of bank capital.

Kevin: That’s called bankruptcy, David.

David: That’s correct. So, to avoid bankruptcy for these financial institutions, governments have been – as we saw in 2008 and are seeing at present – committing larger and larger amounts of funds to supplement bank capital. It is all well and good to say to a bank via Basel II, or Basel III, “You need to raise the amount of capital that you have.” Well, raising capital is difficult to do in a stressed environment. You are basically going to the general public and saying, “Will you give me an IOU?” Or, “Will you be an investor in my bank?”

We will look at this in a minute, Kevin, but we are watching banks in the European context that have lost 40%, 50%, 60% of their equity value since the middle of the summer – just in the last few months – so this is a challenged effort. You can’t go to the general public and say, “Please, extend a loan. Will you? We’re good for it.” Because we are now in an environment where, actually, this is exactly like what bankers do to us. When you don’t need money, they are there to give you all that you want, on friendly terms. And when you need money, “Oh, no, no, no. No, you cannot have our precious capital.” So it is just being played in reverse. This is why governments are so involved, because the market says, “No. Bad bet. Not interested. Can’t have my hard-earned money.” So the government steps in for the sake of preserving normalcy and market stability, and it is pledging to support bank capital.

Kevin: But David, there are strange beneficiaries to these types of crises. If you owned the printing presses, or the company that prints currencies (laughter), these guys are printing like there is no tomorrow, are they not? Isn’t there a printer in Europe right now that is doing quite well? They are very busy.

David: It’s a classic business model, Kevin. Think of the Gutenberg printing press, think of all the good things that have come from printing presses, and there are many good things that have come from printing presses. The things that aren’t necessarily advantageous or attractive all seem to come from De La Rue, which is the British printer that has been responsible for printing currencies for over 150 different countries around the world.

Kevin: So the question is, “Oh, you want more currency? Just put your order in.”

David: (laughter). Now, of course, Kevin, when we are talking about support to the banking industry, we are really talking about digital credits and debits, but what is interesting is that it is already being rumored that a European currency has already been printed. ??… Who is that?

Kevin: Are you being conspiratorial? How strong is this rumor, Dave?

David: Not at all. I think if you look at the Greek leadership, and they know that default is inevitable, that is not necessarily how they are going to posture in front of the press. They will keep their game face on until the very last minute.

Kevin: But it is how they will posture in front of the printing press.

David: Well, that’s what is next, to say, “Unfortunately, we have had to make other arrangements, and will no longer be EMU participants.”

Kevin: I have a question, though, because the backbone of the European Union was supposed to be German integrity, German discipline, Bundesbank background. Even when we talked to Otmar Issing, these guys don’t want to see inflation. What we are talking about is inflationary.

David: It is inflationary, specifically, in the Greek context, but if you look at the original exchange rates, as any of these peripheral countries came into the EMU, if you look at the exchange rate that they had, it was hundreds-to-one, implying that they had been irresponsible with their inflation rates for decades. This is par for the course.

Kevin: So David, Athens airport is still operating. There are reporters going in right now to report what could be an imminent event. Are there other planes that are maybe stuffed full of currency?

David: Kevin, this is the rumor, that they have already printed the money. I don’t know if it is drachma, I don’t know what they are going to call it, but if they break from the EMU, it is to eliminate the debt burden, and they can do that via printing. “We’ll pay you back every dollar, it’s just going to be with a depreciating piece of paper.” We are back to the classic version of devaluation. We are back to the classic version of default. Not the kind that they are being forced to the brink of. They may very well default and have to make partial payments.

Kevin: But this is more South American.

David: This is more of a South American kind of default, where you just print and pay, and print and pay, and print and pay, and it may actually also be a North American version, as we are doing the same thing. But what they are regaining is monetary sovereignty, if they, in fact, leave the EMU. That’s what they gave up when they entered the union. Potentially, Kevin, at the Athens airport you may see transports delivering currency over the next few weeks. We are not positive, but we do know that change is imminent.

Kevin: David, going back to the subject of the Bundesbank, we interviewed Otmar Issing last year and we talked about the discipline of the background that the Germans had faced, and how they didn’t want to go through that again. Bundesbank and German mentality has played very much into the European Central Bank at this point. Is that still the case?

David: That’s what seems to be changing, and I think if there is anything of grave significance in Europe in the last ten days, it is not what is happening with Greece. That is attention-getting, because it is in the news and it defines something that is more of a spectacle, but something that we have been predicting and seeing for some time. Seeing Jürgen Stark resign last week, as one of the key principles at the European Central Bank…

Kevin: He was a Bundesbank guy in the past.

David: Exactly, and he represented a voice that brought stability, that was sort of an anchor, if you will. He says he resigned for personal reasons, and that is fine, but three years ahead of his term ending? In the midst of utter chaos within the European context? After last week being in direct conflict with other members of the ECB over the renewed purchase of European bonds? They have been doing this now for a couple of weeks, specifically, with Spanish and Italian paper, and they are driving the yields down, purchasing these bonds as they are issued, and having some success in doing that. But Kevin, this has been the problem. The Bundesbank judgment is, when you monetize, you will create inflation.

Kevin: We’ve seen it before.

David: Their job as central bankers is to look at inflation very carefully. Price stability is a mandate. It is a critical mandate. Unlike the U.S., they don’t have the dual mandate of price stability and full employment, so they’re focusing on price stability and saying, “No, what you are doing is putting into the pipeline a degree of inflation which we will not be able to contain. We disapprove of the monetization of this debt.”

Otmar Issing, from the sidelines, has been more and more critical of what the ECB is doing in support of the rest of Europe, and the European debt markets. This is what we talked about last week, Kevin. It is because what is implied is a quasi-fiscal union if one entity is now supporting the debt structure of all these individual countries. That was not supposed to be. Maybe it was desired, from behind the scenes. We don’t know. But we know that the original agreement was a monetary union only – a monetary union, not a fiscal union. With Jürgen Stark leaving, we really don’t have a counterweight to someone like Trichet. We don’t have a counterweight, frankly, to someone like Mario Draghi.

Kevin: This is what I’m asking. Granted, he may not act like an Italian, but he has an Italian name, and isn’t Italy the issue right now? (laughter)

David: That actually argues for him taking more of a hawkish view to inflation, and being less accommodative…

Kevin: Because he doesn’t want to look like an Italian.

David: Exactly. “I may be an Italian, I may be a Goldman man, but don’t paint me into that corner. I can do the right thing.” We’ll see how long he can do the right thing. This is the issue, Kevin. Draghi takes the reigns at the ECB from Trichet November 1st, and will his policies be as accommodative? Will he be as interventionist as Trichet has been? Likely, but with caveats. He needs to protect himself, because there is some suspicion relating to his home country, and perhaps loyalties therein.

The question is, the former Goldman man – can he prioritize European stability, or will he ultimately be taking calls from his Goldman cohorts to discuss who thrives and who fails over the next 2-4 years in the Eurozone?

Kevin: Now Dave, are you accusing Goldman-Sachs of possibly front-running, or getting inside information, or possibly even manipulating a situation for a particular outcome, and winning on the bet?

David: They have rolodexes that are impeccably designed, and probably kept under lock and key. This implies nothing, Kevin. They are not ever doing things that are clever.

Kevin: They’re doing God’s work. Isn’t that what we heard last year?

David: Godman-Sachs… (laughter). Kevin, this is the issue. They are so well-placed. We are talking about professional discussions amongst fellow bank CEOs and G20 leaders. These things have to be discussed in order to prevent disorderly chaos in the marketplace. So, “No, we’re not discussing these amongst ourselves, to then go have weekend soirees and figure out how we will personally trade against it, or trade for it. No, we’re not determining who is going to be going long, or who is going to be going short, taking positions in light of what our friend, Draghi, might be telling us.” No, I don’t think we can assume that Goldman will be doing any of that, or that Draghi would be participating. He is a man above reproach, as we have found all Goldman men to be.

Kevin: Let’s get to the crux of the matter, then, on the EMU. Let’s just try to think ahead a little bit. Let’s say we could get into a time machine, go forward a few weeks, a few months, maybe a couple of years. Where are the EMU participants going?

David: The crux is that they have to either move to fiscal union, which is the first option, or they can consolidate around a smaller core. Remember the credit market adjustments that took place as individual countries joined the euro – they saw their credit ratings improve, and they saw their credit costs decline. And what was that in light of?

Kevin: It was basically because Germany was involved.

David: Exactly. They had the benefit, by proxy, of being related to Germany. The recently proposed Eurobond carried the same mark of German credit. That is why people were thinking it was an interesting solution. The problem was that it was an implicit fiscal union, and therefore, on the basis of a referendum vote, was not likely to be approved. This idea of fiscal union is very unpopular. The question is, can the folks who are so for the eurozone get it pulled off without a referendum?

Kevin: David, we have talked before about the price of gold telling the truth on leaders, but so does the interest rate spread between different types of bonds. In the beginning, they were actually giving the rest of Europe the benefit of the doubt, based on Germany being there. But aren’t interest rates starting to tell a different tale?

David: Over the last 12-18 months, we have watched the spread between German bonds – the difference between German bonds and other European paper – widen further and further, which is just acknowledging the actual balance sheet differences that exist between the various European states. And, just to reiterate, there are really only two choices that exist. There is fiscal union, on the one hand, or a shrinking membership role, and a number of countries would be leaving of their own accord, not pressured out, preserving the EMU and allowing it even to become a better currency alternative on the open market.

Kevin: If you had to take a bet, one way or the other, right now, is fiscal union on the horizon? Or are we going to see this consolidation and remaining a monetary union?

David: I think a fiscal union is possible as long as it avoids a public vote, because that would never pass. It would never pass muster, so we are talking now about the cigar-filled, oak-paneled rooms, where men and women are making decisions behind the scenes, and “We have approved, for your benefit, the future of Europe.” The Lisbon Treaty is a part of this, Kevin. It can’t go that way, unless it is done surreptitiously.

Kevin: So whatever happens, they are going to have to find a way of increasing efficiency to continue to move. They are completely immobile at this point.

David: Well, if they scrape the barnacles off the bottom of the boat, they will find that efficiency, and that is essentially taking the peripheral countries out, or voluntarily letting them leave. This is an interesting thing, Kevin, because a lot of the power-hungry folks in Europe, the true socialist elite, don’t want to concede defeat in any part, and they are using very strong language – the term, “irrevocable,” regarding the commitment to the EMU. It was voluntary up front.

Kevin: Yes, when did it become irrevocable?

David: Well, that’s what is interesting. They are saying the treaty signed cannot be undone. I don’t think we have the complexity there in Europe that we had with the federalist north and the states’ rights south, here in the United States, several hundred years ago, but we do have this strange, “No, we’re in control, and you may not leave. We’re not approving that.”

Kevin: David, it’s Hotel California. You can check in, but you can never leave.

David: Well, I don’t know what is going to happen, Kevin. Nobody does know what is going to happen. But we do know that there are advantages to being able to inflate away your debt. We do know that, politically, austerity measures are death to the existing parties in power. You can’t tell the Greeks that they are going to be the ones that suffer. You can’t tell them that and expect to be re-elected. That is what we are seeing fall apart. It is political chaos, because the only thing that the Greek government can do is put in place austerity measures – fiscal measures. They lost their monetary tools. The contrast between us and them is so significant, because we can bandy about different fiscal measures, we can talk about the jobs creation program last week…

Kevin: And we can just print reserve currency.

David: And then we can just print, and print, and print, and we can pretend to try to solve the problem. Kevin, what is the cost of Obama’s new jobs program?

Kevin: 477 billion, amongst friends – especially if it’s already paid for.

David: I know, well, that’s what he said, originally. But it actually looks more like a 421-billion dollar tax hike.

Kevin: Oh, so it wasn’t already paid for.

David: No, no, no. If you look at it, this is what drives me crazy with politicians. They can’t just speak the simple truth. They have to pack it with so much ethos, they have to pack it with so much pathos, you feel guilty. “I’m abusing the elderly, and young children, if I don’t approve this jobs program!” Kevin – 477 billion dollars? And he thinks he is going to create half a million to two million jobs? That’s a million dollars per job created. A million dollars per job created, or if he does actually create two million jobs – 250 million.

Kevin: Maybe we just send people millions of dollars and just say, “Retire.”

David: Why don’t you find 10 million people that need an extra 50 grand? Because it’s going to end up making its way into the economy far more effectively than the government bureaucracy trying to “create jobs.” Kevin, this is the insanity.

Kevin: You’re just a Negative Nancy, Dave. You’re a Debbie Downer. I’m sorry, this is the wrong way to look at it, you should be supporting your president right now.

David: I would like to support the president. I would like to support a statesman. I would like to support leadership. I would like to support ideas that don’t have negative consequences. And Kevin, I fear what we are facing is the ultimate demise of our American dream, up and until we have adequate leadership to draw us out and through the other side.

Kevin: David, you are talking about how much it costs to bring about just a single new job under the president’s jobs plan, but the problem is, we are also paying for jobs over in Europe. We are talking about European bailouts, and Germans, and we are talking about austerity, and then we are talking about the ECB having a new lease on life, but what about us? We have spent an awful lot of money, more than the Chinese, more than the Russians, in the bailout of Europe.

David: And this was an interesting disclosure this summer. We found that, actually, we were very, very active in supporting foreign institutions in the 2008 period, via the Fed swap lines, and this is, I think, what we will see open here in the next few months, liquefying the world, the U.S. being the lender of last resort, and very ironically, the world’s largest debtor, in those moments of crisis, also being the world’s largest creditor at the same time. It is the ubiquity of our currency, and the limitlessness of it, that allows us to lend very short-term, overnight, via digital credits and debits.

Kevin, I think this is the stability component which the Fed has scripted for itself. It is going to spend an infinite number of dollars to maintain stability in the international markets. And we have, right now, in front of us, something that is begging for those swap lines to open. French banks are under pressure. German banks are under pressure. Why? Because of the assets that they hold via Greece. It is a strange web of interconnectedness, Kevin, but French banks have been under pressure since June 15th. We had Societe Generale sell off by 55% — 55%! Their stock is down 55% in a matter of months. BNP Paribas down 42%. Credit Agricole down 45%.

Kevin: David, recall 2008 here in America. We are seeing these same types of things happening right now in France.

David: Right, and this is what we were talking about last week, Kevin – the idea that a number of these institutions will have to merge to survive. The question is, what gets them through a moment of crisis where there is panic in the marketplace, and good reason to jump ship as an equity owner? Looking at insolvency, looking at your liabilities exceeding your total capital by 2, 3, 5, 10 times, because your equity has been sold off so precipitously. That is why the Fed is there. The Fed is there to make sure that the world does not come unglued financially. Does this have echoes of 2008? Yes, only we are not talking about single institution stability, Kevin, we are talking about entire countries, not just singular institutions.

Kevin: This is, in fact, a worldwide default, if it is allowed to go on. We have been joking about planes coming into Greece and replacing the currency, we have been talking about the ECB having a new lease, we have been talking about all these things, but they are highly, highly inflationary. Let me use a different word: Currency devaluationary. In other words, the European currency has been falling in its buying power. The U.S. dollar has been falling in its buying power. The only currency that really wasn’t falling in its buying power was the Swiss franc until they pegged the currency last week.

David: To the euro. Yes, so Kevin, I think the peg, at one point, also, is an interesting scenario. I don’t know that there is the resolve with the Swiss National Bank, or the depth of pocket, to continue to write the check and maintain that stated peg.

Kevin: What you are saying is, they may print money for a while to try to keep their currency down and stay pegged to the euro, but if the euro falls too far, do you think the Swiss might still break away?

David: The question is, how much money are they willing to spend in that effort? They could ultimately destabilize their own price stability, if you will, or purchasing power, in their own country.

Kevin: But you are not going to count this as a stable hedge, right now? In other words, you are not going to tell a client, “Hey, go buy the Swiss franc because it may still be a better hedge than another currency?”

David: Here’s the irony. It now stinks, like all the other fiat currencies. It just happens to be a better bet than the U.S. dollar, and other things that stink even worse. It is question of lesser evils. It is not a question of greater goods. That is where, I think, we come back to the gold bull market and see a duration for this market, as years – years. Why? This is really the point. It will endure as long as the Keynesian bias, long dominating the halls of the Fed, long dominating the halls of the Treasury, long dominating universities – as long as the Keynesian bias remains.

Kevin: And the Keynesian bias is, print money, or change fiscal policy, but basically, stay away from gold, stay away from discipline. We can spend hours talking about what currency is the best currency, and what is going to happen next to this paper market, or that paper market. Why is it that people avoid gold, which seems to be a natural answer. We are seeing the Europeans, at this point, start to compete with us, as far as buying gold. We have been buying gold from Europeans for years – your dad’s company, and now you run the company. That’s where we have gotten a lot of our gold. The Europeans are starting to finally wake up and say, well, maybe it’s not in Europe. Maybe it’s not in U.S. dollars. And maybe, after last week, it’s not in Swiss franc.

David: It was interesting, when I was down in Argentina, I ran into a German family that was on vacation. He worked for BMW, had been working for BMW for about 30 years in their HR department, and loves the company, loves the euro, loves the ease with which he can go from one country to the next. I asked him, flat out, what he thought about the stability of the euro, and he said, “It will always be stable. It has to be. Nobody wants to go back to changing currencies at borders.” I was thinking to myself, “Is that your only perspective? It’s just an issue of convenience?” There are deeper issues here. When we are talking about issues of convenience, that is one of the things that has had gold on the outside and U.S. dollars on the inside.

Kevin: Sure, because you don’t go to the grocery store with an ounce of gold.

David: Exactly. We have these biases on the basis of patterned behavior and ease of use, or convenience, which do dictate how we feel about certain asset classes. Gold, Kevin, is going to continue to remain front and center as a priority in peoples’ portfolios as long as we have negative real rates of return. We have talked, how many times, about Gibson’s Paradox and the Summers-Barsky Thesis.

Kevin: Right, which is simply if interest rates are too low, and inflation is too high, it’s not going to work.

David: If what you are earning on your investments, what you would qualify as your productive capital, what is supposed to be growing in terms of capital gains or providing income, if your real rate of return after you pay your taxes, and after you account for inflation, is negative, strip out all the reward – why did you take the risk? It did not make sense. So market participants come to the conclusion, in a negative real-rate environment – “I’m gonna opt out. At some point I will re-engage, when I can put my capital to work productively, but until that point, don’t force me to take risk without reward. Strip away the reward, and I’m just not gonna play.”

That is the growing awareness globally, Kevin, as we see interest rate suppression, not just in the United States, but in Europe, as well. We have seen the Europeans – Trichet just recently has qualified with the most recent inflation numbers. That is largely a balanced issue. They are no longer concerned about inflation. What he is doing is trying to set Draghi up to, in the first few months of being in office, be able to lower rates below the 1.5%, and again create that same, almost zero interest rate environment we have here in the United States. It ends up driving investor interest into gold, because there is a frustration. Where do you go when real world inflation, not the stated rate of inflation, but real world inflation, is nearing double digits, and taxes are on the increase because governments are desperate for revenue? You go to a place where you don’t have to take risk, or at least, in that environment, it is deemed as less risky than your other alternatives.

Kevin: David, what we have seen is about 80 years of a flawed system, the Keynesian system, that started out looking like it was working because of other factors. But really, Keynes talks about printing worthless money, spending it, and lowering interest rates when they shouldn’t be lowered. We have seen where Keynes has gone wrong. We are coming to a turning point. I think back to a great interview we had last year with a man named Hunter Lewis who wrote the book, Where Keynes Went Wrong. I think maybe it would be time to revisit that.

David: Kevin, just the discussion, because so many of Keynes’s ideas are assumed to be true. It is the basis upon which our policy-makers behave and act and think. And again, we never want to be construed as being disrespectful to the folks at the Fed and the Treasury. We are talking about people who earned their degrees, worked hard, stayed up late nights, drank lots of coffee, I am sure, in putting together what they thought was sort of their personal magnum opus. The problem is that good logic, with bad assumptions, ends you back with mistakes – mistakes. So we are not faulting their logic, we are faulting their assumptions, so many of which are based on the ideas of John Maynard Keynes.

Kevin: That is what makes it so hard to learn economics, to be honest with you, because Keynesian economics doesn’t make sense. You can get something for nothing? Money does grow on trees? And that’s okay? Because my parents didn’t tell me that.

David: I think you are right Kevin. Bringing Hunter Lewis back into the equation, and having him explore with us, again, where Keynes went wrong, why the Europeans, as well as those in the U.S., continue to bow to the throne of a dead academic? And are there better sets of ideas out there? Kevin, I don’t know what the revolution of ideas will look like, from a business standpoint, they view the gold bull market as something that is limited in scope, that the next 2-3 years, perhaps, will see its ultimate peak price.

But, when I consider how hard it is to see ideas change, and the fact that we are really talking about the death of an ideology, and until that ideology or world view changes, gold will have its place front and center, because that is, in fact, what is driving the price higher – the abuse of the Keynesian system. Now we are talking about an extension of 5-10 years. I don’t know.

We need a revolution of ideas, and the part of me that likes capital gains doesn’t mind seeing Keynes win the day. But the other part of me that says, “I love my children, my children’s children, and my children’s children’s children, and I want them to inherit plenty, not want,” wants to see change now, and wants to see the end of the gold bull market now, because it’s a better place to live. It’s a better place to exist. It’s a place that is based on right ideas, versus ideas that just seemed intelligent when they were adopted.

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