About this week’s show:
- Consequences of the Fiscal Cliff deal
- Currency war with Asia
- Bernankeism is debtism
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, Richard Duncan has always been a favorite guest of ours, and I know that you have been curious about some of the things that he has been writing about recently.
David: We have the fiscal cliff deal, which combined with QE-3 will have an impact on the economy, will have an impact on asset prices, and I want to talk to Richard about that.
We also want to look at any negative impact on the economy which could fall out from those things. Keep in mind, we have only extended the time frame by two months, so we go from fiscal cliff to debt ceiling and we really have this two-month time frame lingering out in front of us, now less than that, closer to a month.
Kevin: So it’s not game over yet.
David: But we also have the recent developments in Japan where you have fiscal stimulus and more money printing. That should be interesting in terms of its impact into the larger rebalancing effort on a global basis, where different economies are having to figure out surplus versus deficit. How do we get back into balance, and move away from the unhealthy inputs which gave us the crisis in 2006, 2007, and 2008, and arguably before that, but still, where they came to a head there in 2008?
These issues and several others we will talk to Richard about, and of course, we will explore that framework that he set up over a decade ago in The Dollar Crisis, the book that he wrote over a decade ago, and rehash some of the insights that he has from writing the book, The Corruption of Capitalism. From The Dollar Crisis, to The Corruption of Capitalism, to The New Depression, to the here and now and what we see in the markets today, let’s join Richard Duncan.
Kevin: Let’s go to that discussion.
David: Richard, it’s good to be with you. It is good to sit down and have a conversation, not just on the phone, although that has been pleasant in the past, too. There are a lot of things to cover today, a lot of things that that you have been researching and thinking about.
We want to look at several things: Japan, changes that are happening there in terms of monetary policy. There has been a change in leadership. There is going to be new leadership as of April at the Bank of Japan, and that may have major ramifications, not only in Asia, but for us in the U.S., too, and we’ll look at that.
Maybe before we do, we can look at this fiscal cliff issue. It’s behind us because it’s resolved, but that’s usually how Americans deal with issues. If it’s behind us, it’s also out of our minds. What are the consequences of the decisions that were made in December, as we came up to the fiscal cliff?
Richard Duncan: Right. David, it is very nice meeting you. We’ve had several conversations and I’ve enjoyed all of them, but we’ve never met, so this is great to have a chance to meet you finally.
In terms of the deal that was reached earlier this month to resolve the fiscal cliff crisis, I think this is very significant in a number of ways. A deal means, essentially, that taxes in the U.S. will go up by something like 250 billion dollars, maybe more, this year, so that is going to make the U.S. government’s budget deficit 250 billion dollars less than it would have been otherwise.
Every economy is composed of just four parts: Personal consumption expenditure, business investment, net trade, and government spending. By increasing taxes by 250 billion, this is essentially going to reduce personal consumption by a similar amount, 250 billion. So, this is going to make the economy 250 billion dollars smaller than it would have been otherwise. That’s something like 1.6% of GDP. The economy was facing very severe headwinds, even before they decided to increase taxes by 1.6% of GDP and reduce GDP by 1.6%, so this is going to act as a real drag on the economy, and very possibly throw it into a new recession.
On top of that, there are still Republicans and Democrats who are battling each other over the next few months over whether or not to cut spending. If they do cut spending, by whatever amount they cut spending, by that amount the economy will be that much smaller.
David: On the government spending side, that last category you mentioned.
Richard: That’s right, with no obvious positive offsetting benefits to any of the other categories.
David: If that is some of the economic impact, what do you think the impact is into the financial world and specific assets that might be, positively or negatively, impacted?
Richard: Here is the interesting thing. Even though the economy is very surely going to be negatively impacted by the higher taxes, it could be that the stock market actually benefits from this, because let’s think about it. We have the Fed now creating 85 billion dollars of new money every month. If you annualize that, it is just over a trillion dollars. So the Fed is going to create a trillion new paper dollars this year if it continues along at its current pace of money creation.
But the government’s budget deficit now, after the tax increases, is probably going to be somewhere less than 900 billion, so the Fed is actually on course to print more money this year than the entire government budget deficit. So we have to think of this in terms of liquidity, in terms of the supply and demand for paper money.
The government’s budget deficits are the demand for paper money, but the Fed’s paper money creation is the supply of paper money. The Fed is printing more than enough money to finance the entire budget deficit, so this suggests that liquidity conditions are going to be very favorable as long as the Fed keeps printing.
David: Let’s contrast that maybe with 2012. At least one indication of less supply, credit creation, or as you have defined in a number of your books, money creation and credit creation being really the same thing, or quite similar – similar enough that you could call credit money. But we didn’t see a massive increase in 2012. We didn’t see that at all. What would be different in 2013, do you think? If there is that excess liquidity, are you suggesting that might drive equity prices higher? What impact would that have for things like U.S. Treasuries, other safe haven assets, precious metals. Where do you think that will go?
Richard: Let’s go back to the end of 2011. The euro crisis was at one of its worst points then. There were concerns that large French banks were about to fail and bring down all the other banks. The S&P was rapidly falling toward 1100. What changed? The thing that changed is that in December of 2011 the European Central Bank did a complete somersault and announced that it was going to begin printing money also. They announced LTRO [long-term refinancing operations].
Essentially in two phases in December of 2011 and February of 2012, they more or less let the world know that they were going to create a trillion new euros and lend as much money as necessary to back up the European banks. That has set off of very big worldwide global equity rally.
David: This is Draghi saying, we will do anything. There are no limits. When you use broad language and it allows the imagination to go to infinity, then there is the ultimate backstop. Would you say it’s the equivalent of what we used to call the Bernanke put, or the Greenspan put?
Richard: Yes, and so that created a very big global rally in equities in the first quarter of 2012 and then toward the middle of the year the markets were getting a bit tired, but at that stage the Fed started hinting that QE-3 was coming, and on the back of those hints, the market moved up again. So even though there was really no paper money creation of any scale in the U.S. in 2012, between the LTRO and Europe, creating a global rally, and the hints that QE-3 was coming, this created a very nice year for equities in the U.S.
David: Doesn’t that also suggest that the world is interconnected, and we really should care about central bank policies all over the place, whether that is in Central America, or in Singapore, or in New Japan. It is not just here on our own turf in the United States where we have to wonder what is the Fed going to announce and what impact will that have in the markets.
What about the Bank of Japan? Let’s go there. The Bank of Japan hasn’t made any shifts today. Abe was elected basically on two issues: One is from the Nationalist platform, that he would take a stronger arm with the Chinese, which as we speak is a little bit awkward. There is the conflict over the islands just off the coast of Taiwan.
But he was also elected because he was going to resurrect the economy. It was no longer going to be a deflationary malaise that they were stuck in, and it was going to be whatever measures were necessary to do that. Well, obviously, he doesn’t run the B of J. And I don’t think the existing Bank of Japan is as aggressive as he wants them to be. What does the Bank of Japan look like, perhaps, over the next several months? Do you think it will fold to the pressure from political leadership?
Richard: I think these recent developments in Japan are very interesting because I believe that it can show us what is very likely to be our future here in the United States. Japan has increased its government debt from 60% of GDP when this crisis started in 1990, to now 240% of GDP.
Richard: 240. And this year, their budget deficit is something like 9% of GDP, worse even than ours. And still, in Japan, the Japanese voters just elected a man who is campaigning on the platform prompting to radically increase government spending and to force the central bank to expand its paper money creation to an even greater scale than it has done in the past.
What this tells us is that a democracy will not tolerate austerity. The Japanese public, even though they have 2½ times as much government debt-to-GDP as the United States, they just voted to have a lot more, because they are not going to tolerate austerity.
The second thing it tells us is that it is possible for an industrialized country to have a very much higher level of debt than the United States currently has and still be able to finance it at very low interest rates in a post bubble environment. The cost to borrow money for the government in Japan over ten years is 80 basis points, less than 1% interest.
David: A couple of things. That argues for what has been called a widowmaker trade, betting against Japanese debt, and the assumption that rates would have to rise. They call it the widowmaker trade because, how long has it been now? You can keep that trade on for 6 days, 6 weeks, 6 months, 6 years … will it be 6 decades? (laughter)
Circling back around to that number, it is 240% today, debt-to-GDP, are there any natural limits where you do have a debt crisis on the basis of additi … you are really talking about revenues needing to be sufficient to make your debt service payments. That 80 basis points is critical, and in fact, you could make it probably 500% debt-to-GDP, as long as you took that to 20 basis points.
So what is the cost of doing that, in terms of the value of the yen? Help me, from an economic standpoint, see how this is a sustainable set of affairs. It may be the set of affairs that we adopt, but ultimately, is it workable, or am I thinking too much in terms of an Austrian sense of boom and bust, almost an inevitability? Is there really no inevitability?
Richard: I think this will certainly have a bad ending in Japan sooner or later, but will that unhappy ending begin at 250% government debt-to-GDP? At 350%? Or 450? Well, we just don’t know. People would have never imagined that it could have gone on so long. But what we do have before us is an example of a country that has been in crisis for 22 years, 23 years, that has run up its debt to 250% to GDP.
We have been talking a number of times now, and I know you know my thoughts on this, but I have often said that in the United States, we as a democratic society really only have three possible paths forward. The first option is to immediately cut the budget deficit, balance the budget deficit, in which case we are certainly going to spiral into a new depression. I think Japan demonstrates that is just clinically impossible. A democracy will not tolerate austerity, so option number one is not going to happen.
Option number two is to follow the Japan model, to continue spending massive amounts of government money and run up budget deficits year after year, and waste all the money spending it on make-work projects, building bridges to nowhere, paving the Japanese countryside with cement, just to keep people employed. That’s what we are doing now. Over the last four years we have run up 5 trillion dollars of budget deficits.
David: And don’t have much to show for it.
Richard: Well, what we have to show for it is that we are not in a 1930s-style great depression, and that’s what Japan has to show for this over the last 22 years. They did not collapse into a great depression. So we are following the Japan model. And I think that is the model that we are going to continue to follow. We are going to continue to do this year after year, not employing any new thinking or any imagination.
We’re just going to do enough to keep the economy growing at 2% a year, and we can keep doing this, I believe, for another ten years, with no difficulty whatsoever, and I think that’s probably what we will do. But what we should do, and what I would like for us to do, and what I believe very strongly we should do is to learn from Japan’s mistakes. We don’t have to have austerity. We do not have to go backward and suffer some sort of penance for our sins. We can go forward.
Our debt now is roughly 100% of GDP. Before it reached 250% of GDP, we could borrow another 24 trillion dollars at the government level, even if the GDP didn’t grow at all.
David: This is absolutely critical, because one of the things that we did talk about last time we were on the phone was that if you spend the money effectively, you are going to end up with a different kind of economic result, so if you are digging trenches and then refilling them, and then digging trenches and refilling them, you are going to spend money, and you will keep a few people employed, but it’s largely the broken window fallacy. You are really not creating anything new. You are not adding more benefit. So what do you do to add to the creative process, to remake an economy? And I think you have suggested a couple of things. Let’s come back to what can be done, what should be done, before we move away from Japan, because I think there are a couple of things there.
One, the confusion I have, and I’d like for you to set me straight on this, if Abe gets what he wants and he targets 2% inflation, how do you have a strong inflation target on the one hand, and maintain an 80 basis point average cost to your debt? This is sort of wanting to have your cake and eat it too, but deflation has given you the ability to finance things at a very low rate and allows that 240% debt-to-GDP ratio to not be critical, as in killing them.
But if you begin to target inflation at 1½, or even 2%, and who knows, maybe they overshoot, maybe they don’t, and they undershoot, but if they hit their target, aren’t you remaking the Japanese fiscal situation in terms of revenue necessary from the debt-servicing requirements?
Richard: I’ve been wondering the same thing. Clearly, if you have 2% inflation, the markets are going to demand more than 80 basis points to lend the government money. So perhaps Abe doesn’t really want to have 2% inflation. He just wants the Bank of Japan to print a lot of money to make the yen weaker, and a weaker yen will help the Japanese exporters, and that will help the Japanese economy, and it will also help finance Abe’s spending programs at low levels of interest.
David: What are the consequences if they do adopt that easy money policy and just print to give the exporters an advantage? A couple of things: If the yen is weaker, you are dealing with a country that has to deal with a massive amount of oil imports, and so you are putting yourself at a disadvantage from that vantage point. But again, even outside of Japan, what are the consequences for their trade partners, as they begin to destroy value of the yen, not destroy the yen, but certainly shave off – they’ve already done, what, 10-12%?
David: And all it has been is talking. Talk, talk, talk. They haven’t had to put anything in motion. The Bank of Japan has not had to do anything. They have talked their way down 12%. Trade partners – what are the ramifications for trade partners? And farther afield, we don’t necessarily think of Germany and the impact in Germany that you might have from money-printing in Japan, but as you just pointed out, 2012 was not about U.S. money-printing, it was about ECB money-printing.
The European Central Bank and the LTRO programs, two programs that they launched in 2011 and 2012, that were sufficient to get everyone excited, in terms of ebullience in the stock markets globally. Is this new measure in Japan going to be the 2013 fix for global equity markets, where there may be a positive impact – a market impact as opposed to a purely economic impact.
Dance around this with me a little bit. The economic impacts of what the Japanese are talking about doing, the market impacts of what they are talking about doing, risk and reward.
Richard: I don’t think that the amount of money that the Bank of Japan will print will be on the same scale as the amount of money that the Fed is likely to print, or the ECB is likely to print. Of course, the bigger economies have more capacity to create more money. So I don’t think that BOJ printing, whatever that actually turns out to be, will be significant enough to drive the globally economy in any significant way.
But I do think it will be enough to improve the global competitiveness of the Japanese exporters and create a better domestic economic environment in Japan, employing more people, and making their industries and their products more globally competitive. That, as we are seeing, is pushing up the stock market.
David: 23%, 25%, 12% down in the yen, twice that in terms of the percentage gained in the NIKKEI. All this is talking, this is not any actual commitments or money spent. It’s phenomenal. If only we could talk ourselves into fortunes, personally, like this.
Richard: (laughter) So this is the Abe boom, based on aggressive fiscal and monetary stimulus, starting from a mountain-high level of government debt.
David: What about the consequences on a broader scale, into the world economy? You said it’s not enough to drive the world economy as the engine, but is it enough to stimulate growth in the world’s stock markets, and that be enough to stimulate a wealth effect?
Richard: I think this is going to create a wealth effect in Japan that will help Japan’s economy, but my impression is that it will, to some extent, have a negative impact on all of Japan’s trading partners, just to the extent that a weaker yen makes Japan more competitive globally, and therefore makes other countries less competitive, globally.
But the other countries can hardly complain, given that almost all the major countries are actively engaged in paper money creation on a very aggressive scale, including, of course, China. China has been manipulating its currency for decades, creating yuan and buying dollars in order to hold down the value of the Chinese currency, to perpetuate their low-wage export advantage.
David: Between Japan and China, and of course Japan centers in the news, not just because of their monetary policy, but also some political – geopolitical – moves they have made. Abe starts the grand tour through Asia and gives the Chinese a sense of being somewhat ring-fenced. There is a conflict over the islands, and trade is dropping dramatically between Japan and China, China being Japan’s number-two trade partner.
There are things that are happening in Asia, between these two countries in particular, but I am very interested in your opinion on what the view is in Asia. What is the potential fallout in this breaking of relationship between the Japanese and Chinese? I’m not suggesting that it has ever been that cozy, but at least in terms of trade, there is a lot of money that flows – it’s a 340-billion-dollar relationship. That counts for something to someone. You have lived in Asia over a quarter of a century. What is the sense in Thailand, Singapore, and Hong Kong, of the things that are afoot, politically or geopolitically, that could actually be destabilizing?
Richard: As you know, I live in Thailand, and my impression is that Thais who think about these sorts of things feel like they will be a major beneficiary of this breach in relations — deterioration in relations – between Japan and China, because the Japanese are going to begin to invest more in building factories in Thailand again, rather than having over-concentration of factories in China, and I would imagine that the other Southeast Asian countries feel the same.
I also suspect that the Asian countries are not too worried that this is going to result in a real military conflict.
David: What do you think of the U.S. wanting to re-establish a military presence in the area? There has been a lot of talk and a lot of action and if you spend any time in downtown Manila, there are a lot of U.S. persons who weren’t there 3-4 years ago, who are there now. What impact would it have if we reopened our naval bases in the Philippines and created more of a presence there? Does that threaten China to the point where they feel like they have been poked with a sharp stick? Or does it create other opportunities for regional countries, whether it is Thailand, Myanmar, Vietnam, when you know that there is going to be greater stability, and they certainly aren’t going to be bullied?
Richard: For the most part, I believe that the Asians welcome the American presence. They are accustomed to it. They have had the U.S. security umbrella now for decades, and I think they are generally quite comfortable with that. I thought it was very interesting that President Obama’s first trip overseas after his re-election was to Burma. That was quite a strong statement, because up until very recently, China had free rein in terms of moving into Burma and developing very close ties with the Burmese, and now the U.S. has let it be known that there are rewards that could be offered to Burma while having a closer relationship with the United States, such as having access to selling their goods in the U.S. market, which is the thing that has caused all of their Asian neighbors to be transformed from very poor to quite prosperous countries.
David: Isn’t this one more example of the U.S. pulling the rug out from underneath the Chinese? Again, if you were sitting in a politburo meeting, would this be something that you just frankly don’t appreciate, from a geopolitical standpoint, a policy that says, “Here is a sphere of influence where we would like to expand our influence and it is being challenged, not by a regional player.”
Richard: From my perspective, the U.S. has the power to cause China to collapse at any time. China exists in this current form as a result of its 330-billion-dollar-a-year trade surplus with the United States. If the United States wanted to harm China, it could put in a 10% trade barrier, 20%, or scaled in – 5% this year, 15% three years from now – and China’s economy would implode. That would be the end of the China threat, as far as America is concerned. It would cause some inflation in the U.S., but we could move the factories into other low-wage countries, like India.
And so, the Chinese understand that they depend on selling goods to the United States, that their economic model absolutely depends on selling goods to the United States, so they can’t view the United States as being particularly hostile to them, or the United States wouldn’t permit this. China’s trade surplus reached a new all-time high with the U.S. last year. I think the relations between China and the U.S. are better and stronger than many people in the press like to speculate recently.
David: Would it be fair to say that their discussion of economic rebalancing away from government investment projects and export-led growth, and toward internal consumption, is, to some degree, a release from the control of the U.S. government, where, yes we could right now raise those trade barriers, put tariffs on anything that is coming into the United States, and we could harm their economy. We could harm them, we could destroy the country.
Do they know that, and know that the smartest thing that they could do is to continue to engage with America, but have the freedom to not engage if they ever so chose? The only way forward for them is to really extricate themselves from the way their economy is organized today, a reshuffle toward something that gives them greater autonomy. Is that smart?
Richard: Well, yes, it would be smart if it were possible to do, but unfortunately, it’s just not possible to restructure their economy in that way. When the U.S. recent crisis started, in 2009 China’s trade surplus with the U.S. dipped quite sharply because the U.S. was in crisis and bought less, and the headlines in all the major newspapers around the world read that 20 million Chinese factory workers lost their jobs and had to go back to the countryside and start working on the farms again.
There is no easy way to transition these tens of millions of Chinese factory workers who have jobs in factories making things to supply to the Americans. There is no easy way to move the economy from being export-oriented to being domestic-driven, because much of the domestic demand that exists there already is dependent on the wages of these people who are working in factories, making things to sell to the Americans. Recently, the minimum wage in China just went up to the astronomical level of $13 a day in Shanghai and Beijing, the two major cities, not throughout the rest of the country. These are the two biggest cities.
David: I guess that’s what is important to keep in mind because the income growth rates are off the charts, 7% a year. The last couple of years we have seen 15-20% growth rates in income in China, talking specifically about wages. (laughter) We are just talking about moving from pennies a day, to dollars a day, and it’s intriguing, but it’s really not that much, still.
This is an issue, too, which we have talked about before, and you’ve mentioned in your books before, that globalization and the expansion of globalization, a lot of this has had to do with labor rates, and we see low wages driving a deflationary benefit here in the United States.
We get to buy our goods from China. We get to buy our goods from different places around the world, and we pay very low prices for these goods because the labor input costs have been lower. Those wages are beginning to rise, and on top of that we’ve had oil, the last ten years, move up 4-5 fold. What once was $15-20 dollars a barrel, now between $80 and $105 depending on whether you are talking about WTI or Brent. What happens when labor costs rise?
Again, this is the globalization thing. We have been used to international cooperation. We have been used to working closer and closer and closer. The G20 is today the popular theme. It was the G3, then it was the G7, then the G8. We are getting broader and broader in our scope, and everyone is a part of this global club, as everyone is doing better and better. But, as wages rise, one of the things that changes is that it reconfigures some of the things that were driving globalization to being with.
Richard: It is not at all certain that wages are going to keep rising. This crisis that began in 2008 is far from resolved. China has had to respond to this crisis. Because credit is not growing rapidly enough in the U.S. anymore, U.S. imports are no longer growing. Therefore, China’s exports are no longer growing, and European exports are no longer growing.
So world trade is teetering on the verge of beginning to contract, and China has had to respond to this in the immediate aftermath of the crisis during 2009, 2010, or so. To prevent their economy from collapsing they expanded total bank loans by 60% in two years. What would happen to the economy of Denver if all the banks here expand the bank loans by 60% in 24 months? Property prices would double or triple, everybody would have jobs, wages would go up, and everyone would be feeling pretty good about themselves.
But then in years 4 and 5 no one could repay the money, the banks would fail, and they would have to be bailed out by the government. These are the sorts of measures China has had to take to prevent the economy from collapsing.
David: That also argues for there being something of a decade of depression, or a year or two of depression, where we revert to the mean. If they expand credit like that in a short period of time, what do the next 3, 5, 7, 10 years look like for China? It’s probably not as positive as what you are seeing in the Shanghai stock exchange. It’s finally gaining a little bit of traction, but probably at just the wrong time if you are looking at the economy, and not the stock market.
Richard: That’s right, and then more recently, just as everyone realized that China’s economy was in trouble, in about the middle of last year, the third quarter, and it became the talk of all the market participants, China once again stepped on the gas pedal toward year-end. and yes, they’ve revved it up again by making more and more credit available, but this credit is never going to be repaid.
This is a kind of credit-induced boom that is not sustainable over the long run. China’s economy is going to keep slowing, and it is not at all certain that China’s wages are going to keep going up at the rate that they have been, and if they do, then the manufacturing jobs are going to leave China, and they are going to go to Vietnam, and Indonesia, and India. In India, there are probably 500 million people who would gladly work for $5 a day.
David: Versus the $13 like you were saying.
Richard: And $13 is only in the major cities.
David: Exactly, yes. Well, boiling this down, there are a couple of things. We are now in the ten-year anniversary of the publishing of your book The Dollar Crisis. Excellent book. You wrote it ten years ago, and anyone could buy it today, read it today, learn a tremendous amount today. It is not, in my opinion, one of those books that is good for six months, you learn something, it helps you have an insight into something that happened past tense, it’s history, and you have to move on. That’s sort of popular business liturgy, frankly.
But you wrote a book ten years ago that is just as important today, in my opinion, as it was ten years ago. What do you think about some of the things that you wrote about in The Dollar Crisis? Maybe you could give some comment to that, and then let’s go the full circle back to where you were leading us before, toward what needs to be done, what needs to be done from a policy standpoint to avoid what you call in your most recent book, The New Depression. How can we avoid that eventuality?
Richard: The hardback of The Dollar Crisis was finished in September 2002 and the book came out the following spring. Two years later, the paperback version came out with an extra 60 pages and something significant had happened between the two.
David: I need to get those 60 pages from you, by the way. I have the old hardback.
Richard: What happened, and I believe it was just after the original book was sent off to the printer, I think it was in November of 2002, Ben Bernanke, then governor, made his “Deflation, Making Sure It Doesn’t Happen Here” speech, in which he truly outlined what the Fed could do in terms of turning on the printing press, creating money from nothing, and buying government bonds to support a physical stimulus program.
That was enormously important, because you could see that that would work for quite a long time if actually implemented, a combination of aggressive fiscal policy, finance as necessary for paper money creation, so long as there was no inflation, and there was likely to be inflation because globalization was likely to continue driving wages down globally as all the manufacturing jobs continue to exit the U.S.
On the last page or so of the paperback version, I wrote that when the U.S. property bubble popped and this crisis that I expected to occur in The Dollar Crisis, when it occurred, then we would have something that I call Bernankeism.
Bernankeism was the name of the last chapter of the book and Benankeism would be paper money creation on a large scale to finance budget deficits that could hit a trillion dollars a year, and at that point no one could see the trillion-dollar budget deficits. So that’s really where we are now, and that’s where we have been for the last four years. You could call it Bernankeism. It’s not capitalism.
We are on government life support. The crisis hit, and the policy response hit, and now here we are, and on the last page of the paperback version I wrote that this could go on for quite a long time, a number of years, but not forever, because sooner or later, dropping money from helicopters is going to result in people just simply refusing to take any more paper money.
So that’s where we are. We are at this point now where we are on government life support. The economy is not self-sustaining. We have a 16-trillion-dollar economy, almost, but the budget deficit is more than a trillion dollars. So take away the budget deficit, balance the budget deficit, and our 16 trillion dollar economy becomes 15 trillion immediately.
David: When we talk about 1, 2, or 3% GDP growth, we are really playing games with ourselves to make us feel better about the situation. If you took away that deficit spending, we’ve got negative – and I think we can all be thankful that the government has done this or we would be in the 1930s all over again – but we have negative GDP growth on par with the Great Depression.
Richard: That’s right, with equally dire political consequences.
David: But it makes it absolutely imperative that, however they spend the money they are spending as they improve the debt, it is effective – that it retools the economy, because frankly, it’s going to have to really retool the economy. We spent 30-40 years buying gizmos, gadgets, and baubles, not taking the wealth of the nation and investing in greater productive means. And of course, there has been amazing innovation in the last 30 years. But I am just asking how the average middle class family spends their money. Is it investments or new toys? It’s new toys, which have a huge depreciation the day you take them out of the store, they are worth virtually nothing.
Richard: Financed on credit.
David: Financed on credit. So they bought things they couldn’t afford.
To avoid a deflation, you talk in one of your books about a number of ways that you can get through this, the government measures that let you get through this. You talk about five different things: nationalization, which we have not seen; money creation; data acquisition; debt guarantees; and forbearance. This is not your most recent book, this is your book, The Corruption of Capitalism.
Let me just stop and give you an unabashed plug. If someone hasn’t read The Dollar Crisis, it needs to be on your library shelf, not as a token. Read it, study it, you have to. If you haven’t read it already, you need to. If you haven’t read The Corruption of Capitalism, you need to read it. You have to read it. This is a part of your education as an informed investor. If you haven’t read The New Depression, you need to do so.
Richard, I think you’ve made an incredible contribution. You were talking, in The Dollar Crisis, just to illustrate your contribution, about what you believed was an absolutely unsustainable set of circumstances in the U.S. mortgage market, and the fact that probably by 2004 – okay, you were early, it took a little bit longer, but by 2004 we had a collapse in real estate, we had major problems with Fannie Mae and Freddie Mac. It was just by the numbers, and I think you’ve done a great job doing that.
Again, you have these rescue tools. Let’s go back to that issue of these five rescue tools, money creation, debt acquisition, debt guarantees, forbearance. We have these things in motion. You do argue that we should take the trillions that we are spending, or the money that the government is borrowing and spending, and just make it effective.
Let’s say that that is done. We still have a lot of time before that remakes the economy. That needs to be done, not just for 2013, but between 2013 and 2020, we need to have a remade U.S. economy, a reconfigured U.S. economy, investment that has an impact. What do you and I do, just you and me, what do we do between here and there? You are saying to yourself, “Yes, I’m listening to this, and I understand that, but I’m looking at $50,000 in my retirement account and I am just flat concerned. I’m not sure what the next few years look like. I’m not sure that the government is going to do the right things, and it is now in the hands of policy-makers, whether it is the fiscal cliff or the debt ceiling, or whatever it is, I’m not sure that they have my confidence.”
We just saw the Germans move toward bringing their gold back from the United States. This is central banks saying we don’t have trust and confidence. I mean, this is reading between the lines, this was not the printed word from the Bundesbank, but between the lines, you have the German Central Bank saying, we don’t have a lot of confidence in the policy-makers, or perhaps central bankers there in the United States, probably the policy-makers because they just witnessed a circus here in the United States. Well so has everyone across the country, and maybe around the world.
So there are implications in terms of the social perception, the psychological perception of decision-makers, decisions that will be made, policy-makers, policies that will be implemented over the next several years and that leaves people very uncertain as to what they should do. Their answer as to whether or not they are going to receive their social security check or, as one politician said, “Absolutely, you’ll receive your Social Security check, I just can’t guarantee that it will buy anything.” And that’s the sense of, “What does this mean for me?” Boil it down to what it means for Joe Sixpack, who wants to grasp what is happening, but has to make some solid decisions, too.
Richard: Let me give you a very long answer to that question. I think it is not that difficult for people to have a very, very clear understanding of what is happening with the economy, and the most important thing that individuals need to be able to anticipate is what the government is going to do next. And, if you can anticipate what the government is going to do next, it’s the government policy that impacts the asset prices. When the government has fiscal stimulus like Japan is doing now and prints a lot of paper money, then guess what? Asset prices go up.
When the fed announces it is going to print 85 million dollars of new paper money every month, then stocks go up, and gold goes up, and other assets go up. So, the trick is to anticipate, to have enough understanding of what is going on in the global economy to anticipate what the government is going to be forced to do next.
And here is how you do this. The trick is to understand that credit growth drives economic growth. We now have 55 trillion dollars worth of credit in the U.S., and, if you look back, going almost all the way to World War II, going back to 1952, in total credit, and by that I mean government debt, household sector debt, corporate debt, financial sector debt, all debt, total debt is equal to total credit, two sides of the same coin.
Every time, going back to 1952, if credit in this country grows by less than 2%, adjusted for inflation, then we have a recession, and the recession doesn’t end until we have another big surge of credit expansion. We have had such an explosion of credit since 1968 when we broke the link between dollars and gold, total credit in this country has gone from 1 trillion dollars, now to 50 trillion dollars, in less than 50 years.
Expansion of credit has driven global growth and global prosperity. It has ushered in globalization. If the total credit contracts in a significant way, we are going to collapse into a new great depression. Milton Friedman convinced Ben Bernanke that the Fed could have prevented the Great Depression if the Fed had prevented the money supply from contracting in 1931. That’s what Ben Bernanke believes. But money is not what it used to be. Money used to be gold.
David: (laughter) Isn’t that that truth?
Richard: Now, there is no difference between a dollar bill and a ten-year Treasury bond. There was a clear difference between money and credit.
David: Now they are the same thing.
Richard: Now they are the same thing. Ben Bernanke understands that the way to prevent a great depression now is to keep the credit supply from contracting, and that’s what his policy is built around. When he understood that the fiscal cliff was going to reduce the government’s budget deficit, that means the government is going to borrow less, that means total credit is going to grow less, he needs to talk that up with more paper money creation, to make sure that credit doesn’t start to expand. So the policy is designed to make his 50 trillion dollars of credit keep growing.
David: 60, 70 …
Richard: Whatever it takes. Now, in order to get credit to grow by 2% after inflation is becoming increasingly difficult on such a big base. We have 55 trillion dollars of credit now. Assuming we have a 2% inflation rate, we need credit to grow by 4% to get 2% after credit, and I believe that means we need 2.2 trillion dollars in credit growth just to hit the 2% barrier. Anything less than 2% is recession. To get any kind of healthy economic growth we need credit to grow by 6%.
David: Which is well in excess of the 2.2 trillion.
Richard: It would be 3.3 trillion, I believe. Now, this year, because of the fiscal cliff deal, the budget deficit is only going to be 900 billion, less than a trillion, so who is going to borrow another 1 or 2 trillion to hit the 2% or the 4% credit growth that we need to drive the economy? The households? No. Fannie and Freddie? No.
The corporates don’t need any more cash, so it is going to be very challenging to make credit growth grow enough to have any meaningful economic growth this year, and that is why the Fed is coming in with a trillion dollars of paper money creation and even with that it is uncertain that we are going to hit this 2.2 or even 3.3 trillion dollar target growth.
David: That circles this back around to having access to credit from the Japanese and this notion of them wanting to degrade the yen and doing that, in part, by buying U.S. Treasuries. They have, I think, 1.3 trillion in U.S. paper, most of that Treasuries today, and the discussion point is, again, if you are going to be taking down the value of the yen, buying U.S. Treasuries is a part of that scheme. 500 billion? Trillion? But again, you are saying that this is an annual issue. The Japanese, even if they signed on for buying a trillion dollars’ worth of Treasuries, that helps us in 2013. That doesn’t help us in 2014, 2015, and 2016.
Let me jump ahead a little bit. I think this is why we titled our film series this year, The Fuse Is Lit. I don’t know if it is 2013 where we have a credit market disruption, but the expectation is that we need that 2% growth. If we don’t meet the expectation, what you are really talking about is slipping back into, again, the title of your new book, The New Depression.
Richard: That’s right. It is going to be challenging to have meaningful economic growth in the years ahead. I think the economy looks like it is going to be very weak this year, given the tax increases, and so everyone is now being hit with a higher payroll tax. That is going to hurt consumption. It is very possible that we could have a recession this year, but the Americans are going to tire of austerity pretty quickly, and there could be a backlash in 2014, and we might see an American Abe come forward and say, “We don’t have to tolerate more austerity. We can take this forward and actually have more stimulus. Look at what Japan has done, and it stimulated their economy.”
David: Would his last name perhaps be Havenstein [Rudolph Havenstein, president of the Reichsbank during the German hyperinflation of 1921-23]?
David: I’m just kidding. Listen, there are so many things we could talk about, and we will continue to, not only over dinner, but in future years, and so as we have you back on our program, as I look at my library and the growth of that library, I know that my thoughts have been influenced better and grown by what you have been willing to distill from your professional experience as an analyst and as a writer, and I am very thankful for that.
I do hope that every one of our listeners considers the Christmas stocking stuffer gift list and makes sure that Richard Duncan is on it. The Dollar Crisis, The Corruption of Capitalism, — we have had quite a lot of corruption in capitalism and of capitalism – and the most recent book, the one that you are here in the U.S. talking about quite a lot, The New Depression, The Breakdown of the Paper Money Economy. So we look forward to having you back on the program, appreciate your insights, and just want to thank you for joining us this week for The McAlvany Weekly Commentary.