The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, as we said last week, I am really looking forward to this interview. Steve Forbes has been in the political realm, but he has also been in the business realm, and these are the two areas that I think people are asking questions about right now.
David: For decades, and in fact, inter-generationally, there has been this concept of continuing to give education and guidance and be a conservative voice through Forbes Magazine. Steve has made a considerable contribution, sponsoring the notion of a flat tax, which, obviously, is an amazing concept. When you contrast the road of redistribution that we are heading down now, it is incredibly sensible and incredibly simple, just what we need.
That is not on the table, that is not going to be considered. That won’t be a part of the grand bargain, but we would like to include Steve in the conversation, because, again, combining those political themes with policy-related issues directly tied to the economy and the financial structure, this is where we are, this is where we are going. There are major transitions ahead, and I think that having as much insight on that as possible, today, is vital.
Kevin: He has been a prominent voice. In his magazine, and in other publications, on a return to the gold standard, a steady currency, a steady state where we know, actually, what it is worth on a daily basis.
David: At Freedom Fest, I have been on the speaking platform with Steve a number of times, and that is something that he has taken an interest in because it is related to the ideas which have made this country great. What are the ideas that make this country great? Let’s talk about them. Let’s understand them. Let’s put them into action. He has much more of a deep-seated conviction and commitment to the greatness of this country, and I think that was understated a lot in his letter, but should be appreciated by all of us.
Steve Forbes, thanks for joining us today. Let’s talk about a compromise that Democrats could say yes to. We have rising rates, which, taking us back to the Clinton-era levels, is one side of the equation. What else needs to be done here? We have revenues, if they were to equal expenditures, that are off the charts compared to where we were back in the Clinton era. Maybe you can speak to what a real balanced approach would be to the fiscal cliff, and any sort of agreement you think could be penciled out.
Steve Forbes: Unfortunately, I think, given the ideologies involved, any agreement made now, especially in the haste before year-end, is going to do more harm than good. The best thing they could do is to put it off, put everything off for 6-12 months, so these things can be approached in a constructive manner, instead of trying to do it in haste during the holidays before Christmas.
The Clinton era had higher tax rates than today, but the Clinton era also had things that were conducive to economic growth that the Democrats won’t go along with. One is that there was no Obamacare, and Hilary care then had been rejected by Congress, so you didn’t have that huge regulatory and fiscal burden coming on the economy. You had spending that was proportionately about 500 billion dollars less than it is today. I don’t think too many Democrats are going to go along with those kinds of reductions.
You had a dollar that was very stable, almost as good as gold back in the mid-’90s. You are not going to get that from the current Federal Reserve. And you had a much more benign regulatory environment, on the financial side, and on the EPA side, than you do today. So if want Clinton-like tax rates, Democrats must understand that you had other facets to that era that made economic progress possible.
David: So all things equal, you would have to eliminate Obama Care, you would have to reduce spending by better than 14% and you would have to put a leash on Ben Bernanke. Is that really what you are saying, to have all things equal? It’s kind of a far cry from reality.
Steve: That’s right. So for tax increase advocates to say that they worked in the Clinton era, you have to take the whole thing, you just can’t cherry-pick pieces that you like and leave out the rest that made that era possible. What we have today is a great opportunity to drastically simplify the code, reduce tax rates. That was done in 1986, bi-partisan. The Democrats did not like tax shelters, so they got rid of almost all of the tax shelters in the code. At the same time they simplified the tax rate structure, brought it down to two rates, and cut the top income tax rate from 50% down to 28%.
They can do something in a similar manner today, but I don’t think that is in the cards right now, so I think you are going to see some very hard bargaining and to think that we can get something constructive done in a few days is delusional, and it is going to do the economy real harm. If you look at Western Europe, if you look at Japan, they are all substantially raising taxes, driving those economies into recession. Japan is already in a recession. Germany is about to go into one. France will go into one next year when their tax increases really kick in. So the United States should be very careful before going down that path because we are the only game left in town.
David: Can we avoid a recession next year?
Steve: I think we can, but if we do something quick, in terms of a tax increase now, the answer is that we will have a slowdown. The Federal Reserve is continuing to create an environment that is very hostile for credit, reliable flow of credit to small and medium-sized businesses. The spending shows no signs of real restraint, taxes are an uncertainty, and you have an avalanche of regulations coming, on health care and finance, and the EPA has indicated recently that they are going to get revved up to put numerous new regulations on the energy industry. So it’s not a pretty picture. It’s avoidable, but they don’t seem willing to avoid it. (laughter)
David: You mentioned low rates, and the Federal Reserve’s activity right now. The zero interest rate policy has essentially created a layer of price controls in the financial market, manipulating rates lower, bond prices higher. Look out a few years, prognosticate as to the consequences of those kinds of price controls.
Steve: What they have done already has badly distorted the credit markets. If you can’t get a realistic price of a product or service, you get less availability of that product or service. We should have learned that from price controls going back to the Roman Empire, when they tried that with some disastrous results.
What you have today is that the government has deficits without tears, because it costs virtually nothing for the government to run huge deficits. The Federal Reserve is willing to buy most of the debt. What that means, though, is that since you can’t get a reliable price for credit, small and medium-sized businesses are in a very tough environment. Bank lending has gone down in the last three months, and business investment has stalled, which is not good for the future.
So looking out, at some point the Federal Reserve is going to have to face up to its disastrous policies, let interest rates be set by the market, not by manipulative politicians, and let capital be created again and capital invested again. Right now, if you are a saver, you are being punished, which hurts, particularly, older people who rely on bank CDs and normal interest rates for income. They are getting hurt, and the economy is getting hurt, because you are not getting investment, and you are not getting capital creation.
David: On the issue of debt, we continue to see it ratchet higher. Number one, from a policy standpoint, what is the right course of action? And number two, on the assumption that there will be errors in implementation of those policies, what should individuals be doing? The frustration, you described, of the saver – how do we respond?
Steve: I think it depends, obviously, where you are in life. If you are about to retire, obviously, you need to have some cash around, but if you are not near retirement and you don’t have any big immediate expenses on the horizon, then the best thing to do, which sounds counter-intuitive, is to ride the storm out.
The biggest enemy of investors is emotions, which is why individuals always, as a group, under perform the market, and a lot of institutions, as well, because human nature being what it is, when times are good, you pile into the market, and when times are bad, you go on the sidelines, so you get whipsawed. No one can time the market consistently. Warren Buffet will tell you that.
So what individuals did is, after the horrors of 2008, early 2009, when the market went through a terrible bear market, a lot of individuals pulled out, and they are still out today. But what happened in March of 2009 when people thought the world was coming to an end was that there were some regulatory changes on bank capital that got virtually no notice. Early March, the market turned around, and is today about twice what it was in 2009.
How many individuals who got hurt by the market where able to benefit from that doubling? A lot of them missed it. So, if you don’t have immediate needs for cash, then ride the storm through. If you can do so, put a certain amount aside. It doesn’t matter how much, but do it consistently, whether it is weekly, monthly, quarterly, whatever, and you will do well over time. Dollar cost averaging will help you. But if you let emotions control your investment actions, you are going to end up getting hurt. So save, invest, and ride the market. Eventually, it will turn, even when it looks bleakest.
David: Steve, the last time we talked with John Taylor, he suggested that rates are too low by at least one percentage point. Doesn’t that frustrating set of circumstances increase systemic risk, as investors are more or less forced to higher-yielding assets – not forced, but they choose to go there – seeking to make ends meet? Again, as you say, ride the storm out, but it does appear that there has been a major push toward higher risk assets to compensate for a lack of real rates of return.
Steve: That is where investors are still going into bond funds, and that is not the place to be right now, because even though bonds have done relatively well because of what the Federal Reserve has done, that is an artificial bubble created by the government, and those things do not last forever, so this is not the time to be buying bonds.
If you want, you can go into stocks that have dividends, a good record of dividends, that is, you want profitable companies that pay a nice dividend, 2-4%, because at least they can be nimble enough to survive whatever destructive policies come out of Washington, and in the meantime, they give you some money. But again, don’t let daily stock prices influence you on this. You can get some yield, but don’t go into high-yield funds just because they have a yield that looks high by today’s standards. We know, historically, those yields stink. (laughter)
David: Looking at an article you wrote a few months back, if you see gold playing a part in our monetary system in the future, is it fair to assume that it has a place in an individual portfolio? To what degree, again, looking at Ben Bernanke’s penchant to monetize paper assets with more money, does that drive the issue?
Steve: Yes, eventually, and I think within a few years it will happen. Eventually, we are going to have the dollar re-linked to gold. All that means is that the dollar will have a steady value, like 60 minutes in an hour, or when you go to the supermarket and buy a pound of hamburger, you assume it is 16 ounces, not 13, not 10, not 20. It doesn’t float each day, it is a fixed measure, and stable money is always a necessity for long-term prosperity, sustainable prosperity.
But that lesson, even though we have had 4,000 years of experience, is absolutely lost on today’s crop of central bankers and economists, and it is very, very destructive. Right now this country is consuming, thanks to Washington, more wealth than it is creating. The government gets all it wants, when we know government does not create wealth, and wealth-creators, entrepreneurs, job-creators, are pushed on the sidelines. Not a good thing.
David: Maybe you have seen Lewis Lehrman’s piece on establishing the gold standard, a workbook, if you will, toward that end. What probability do you see of that occurring, and is there a precipitating event, or a set of circumstances where the general public says, “This is what we want?” As you said, a fixed measure.
Steve: I think Lew Lehrman is right, that eventually we will get a gold standard, and you asked the right question. Is it going to be precipitated by crisis, or more happily, will it be done by a new set of policy-makers who realize that is the way to go, so that we don’t have to go through some horrific crisis that would be even worse than 2008, to do something we should have never undone in the 1970s?
As you know, the U.S. dollar, one way or the other, was linked to gold for most of its first 180 years of this country’s existence, but since the 1970s that has not been the case, and we have had these ever more destructive financial, currency, and banking crises. So, I would hope that after this president leaves office, and we get a new Federal Reserve Chairman, we will move to a genuine monetary stability and not have to go through some disaster to wake up our ever-ignorant policy-makers in Washington.
David: Yes, and you know, easy money policies continue to feed the federal leviathan. Is it going to be a GOP-driven initiative? Is this something we have to wait until 2014 or 2016? Can you even speculate as to what a time frame would be?
Steve: I think we will eventually push this in the next five years. There is growing interest in gold, not as investment, but as a base for a new monetary system. A number of Republicans, and a number of people in the Tea Party, recognize instinctively that a weak dollar is not good for the country, not good for prosperity, so I think the tide is beginning to turn
This was not the case when Ronald Reagan came into office, even though we had a terrible inflation in the 1970s. There was virtually no understanding of a gold-based system. Lewis Lehrman at the time, Ron Paul at the time, and still today, but they were a very, very distinct minority. But there is growing interest. We are not there yet, in terms of anywhere near consensus for gold, but you see the stirrings. A number of Republican members of the house are interested, and smart Democrats who see beyond this disastrous administration should embrace it because they are going to need something to go to the voters with then this economy continues to perform in a miserable manner.
David: If you look at the old Summers-Barsky thesis, it argued that zero, or even low real rates of return, drive investor component, the demand for gold. How do we square that with the Fed’s renewed commitment to keep rates low through 2015, early 2016? Even if Bernanke leaves, we have Janet Yellen, we have a number of people waiting in the wings who have affirmed the notion of zero rates as far as the eye can see.
Steve: Yes, that’s why I think when you get a change at the Fed it’s going to be more than just the chairman. It’s going to be a mandate from Congress and from the White House and the Treasury Department, saying, “We’re not going to continue with this destructive nonsense.” Ben Bernanke is a living example of insanity. As we know, one definition of insanity is that you keep doing something that doesn’t work and hoping that next time it will. This perpetual QE policy – I think we are at about number ten coming up – is manifestly not working. It’s like doctors long ago who would bleed their patients and the patient would die, but they would continue to bleed their patients.
David: In the past, over-indebtedness has been addressed by defaulting, but typically, that is when the debt was denominated in a foreign currency, or by printing, the second alternative, and that may be just a subtle form of default, which is quite effective if you can get away with it. (laughter) Of course, it has nasty side effects.
But there is also this issue of financial repression that we have, what we have been talking about with zero interest rates, and do you see our foreign creditors playing along with this abuse of privilege? On the one hand, we are printing more money than we should be. On the other hand we have rates repressed, which acts as a subsidy to Treasury debt. It is a redirection of capital, which would have gone to the consumer or the saver, and instead, is going as a subsidy to government. How long do creditors say, “We’ll go along, we’ll play along?” Or do they just wash their hands, and why?
Steve: It is impossible to know what the scenario will be that will bring this to an end, other than new policy-makers coming in, because we have never done something like this before, where we have the chief central bank of the world just gouging itself on long-term debt. Traditionally, the Fed always buys short-term debt, and now they are gobbling up all long-term bonds, gobbling up mortgage-backed securities. This we have never seen before, and in terms of people still buying U.S. government bonds, it is more because of what the alternative is than because they really like it.
If you look around the world, all currencies have been debased, it is just a matter of degree. So, you may be a 98-pound weakling, but if the competitor is an 88-pound weakling, you will look relatively strong. You’re not going to win the Olympics, but it’s what is the least junky thing out there? And U.S. capital markets are still the deepest in the world. That won’t remain forever if we continue this nonsense, but because we do have huge capital markets, people are willing to buy our paper because they know there is liquidity and they can move in and out, what you don’t get with bonds denominated in euros or pounds or yen. So it is by default that people are buying this stuff, not because they really think it is of long-term value.
David: Steve, we have talked some about policies, we have talked some about technical market issues. You have a lot of wisdom, a lot of time in the business, not only publishing, but the markets, and we are very interested in your perspective and concerns. When you look at the next generation, how do we honor them with our actions today?
Steve: By leaving them with a set of principles and policies that reflect what made this country unique in the first place. One of those principles is sound money, an environment where people can do things to, as Abraham Lincoln put it, improve their lot in life. Right now, we are creating an environment where stagnation is going to be the norm, not progress. I think it’s not a new normal, I think it’s a new abnormal, and it’s not going to last. Obama doesn’t realize it, but the worst thing that happened to him was his re-election, because by the time his second term ends, it is going to be, unfortunately, fearfully clear even to his supporters, that his experiment in socialism was an abject failure.
David: That really does get to that issue of Maggie Thatcher saying that the game is up when you have run out of other people’s money.
Steve: Yes, and printing money is not real money.
David: Thank you for joining us. We enjoyed the conservation and look forward to having you back.
Steve: Terrific. Thank you.
Kevin: David, as promised, that was a fascinating interview. I think it is fascinating, too, that he sees the problem as the policy-makers. This is not going to get done without new policy-makers. Even at the Federal Reserve, he is not seeing just a change in the Federal Reserve Chairman, he is talking about a change of the whole thing.
David: And a mandate from above, that will require, I think, a new stock of people in D.C., with a new set of eyes on the problem. We had a number of things in the past which have done that, but it was a new set of policy-makers. When you look at what happened in the transition of 1979 to 1980 here in the United States, it was Paul Volcker coming in, supported by a presidential administration – that worked.
We had the same thing across the pond with Maggie Thatcher, of course. They tapped into the North Sea oil in 1979, and that was a financial tailwind, if you will, for policy implementation. Maybe it is a combination of energy reforms in the United States, and new policy-makers. Again, this may be 2016 before we get to it, but I think we need to know what the game plan is, and how to press the advantage when the opportunity is given.
Kevin: I think we can take courage, Dave, as we talked about last week, that what we thought the new normal was, which was redistribution and socialism, is actually the new abnormal, and he said that probably the worst thing for socialism and Obama’s policies was the re-election of Obama, because we are going to get to test it. We are going to get to see the ramifications and the consequences.
David: But the best thing for the country is that socialism and this boondoggle of an experience, gets to be tested, tried in the public square, and hopefully, voted out for many generations.