From a speech on January 19:
The topic is: What’s Really Going on in the Economy? It’s an important topic. If we get the answer right, we will all make better business, investment, and personal financial decisions.
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This all started years ago, when the Federal Reserve was first created. Prior to the creation of the Fed, the value of a dollar rose and fell but mostly ended up where it started. The price of a bushel of wheat in 1780 was about the same as a bushel of wheat decades and even a century later. But after the creation of the Fed, the value of a dollar started falling. Since then, since 1913, the value of the dollar has fallen 97%. In other words, it takes $33 dollars now to buy what a dollar would have bought then.
Money printing by the Fed at high rates has obviously been going on for a long time. But the pace really picked up in the 1990’s. The Fed printed far too much money then. That money didn’t mostly flow into consumer goods and drive up their price. Instead it flowed into what became the dot com/technology/stock market bubble that blew up in 2000. Many people remember the 1990’s as a good era. It wasn’t. It was sowing the seeds for our present troubles.
By the time Clinton left office and Bush came in, the Fed was printing even more money—which Wall Street channeled into housing. After the Crash, the Fed and other world central banks have printed even more money and in the process created even more debt. This time the debt overhang is so great that it is hard to get a general bubble blown up, but there have been lots of little ones. All the new money has to go somewhere. Recently it has gone into Iowa farmland, back into some technology stocks, even into art.
The Fed says that it can’t be printing too much money because consumer prices aren’t rising at an alarming rate. There are two problems with that argument. In the first place, consumer prices are rising faster than the government admits. The way inflation is calculated was changed during the Clinton administration. If calculated the old way, consumer price inflation would be much higher. If you feel that the cost of living is going up faster than they say, you are right.
In the second place, a lot of the newly printed money has simply gone into assets, first stocks and then housing, rather than consumer goods. But it’s still inflation, just asset rather than consumer price inflation. A bubble is a bubble no matter what specific form it takes at the moment.
By citing the dominant role of government, specifically the Federal Reserve, in creating our recent bubbles and crashes, I am not excusing Wall Street. The Crash of ’08 did involve Wall Street greed. But if Wall Street is greedy, is it likely to have been greedy only in 1999 or 2007 or 2008? Something else had to be going on beside greed. Nor is it likely, as some have said, that these crises just come out of nowhere, for no apparent reason, like some sudden plague. If this is a plague, it is one that we have brought on ourselves and there is nothing sudden or unexpected about it.
Speaking of the role of Wall Street, the recent Republican presidential candidate Herman Cain was said that: “protesting Wall Street and the bankers is basically saying you are anti-capitalist.” I couldn’t disagree more.
Wall Street and the big national bankers today have very little to do with capitalism. They represent a business-government partnership almost completely divorced from normal competitive markets.
One of the great insider debates in 2008-2009 was whether to enforce “mark to market” accounting for banks that would require them to value their capital using real market valuations. The whole debate was nonsense. There are no real markets in banking. There are just a host of government rules, regulations, subsidies, and guarantees that have long ago eliminated any real market prices. Interest rates? Controlled by government. The Fed is now even targeting long interest rates. Mortgage rates? There haven’t been any real market mortgage rates for years– the government controls virtually the entire housing market and guarantees most of the mortgages.
What about other parts of Wall Street? The investment banks? The hedge funds? These all benefit from the massive flow of cheap credit engineered by the Fed. This comes to Wall Street first and Wall Street knows how to exploit the new money.
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Wall Street by the way has earned more money in the three years since the Crash than in the eight years leading up to the Crash.
A lot of the people driving our present economic policy come out of Wall Street. The present chairman of the Federal Reserve, Ben Bernanke, doesn’t. He is a professor from Princeton who was appointed first by Bush and then by Obama. This makes me wonder how Obama can claim to have broken with the Bush policies. But I do want to emphasize that Bernanke seems sincere. He honestly thinks that solving a problem of too much money printing and too much debt with even more money printing and even more debt makes sense. He has his theory and he is following his theory—as far as I can tell right over the cliff.
There is another possibility with Bernanke. Maybe he understands what is happening better than he lets on, but doesn’t know what to do about it. He’s just sticking his finger in the dike and hoping for the best. For example, Bernanke said that he was buying US government bonds with made up Fed money in order to help the economy. This was in addition to other foreign central banks also buying our bonds with made up money. But Bernanke might have had another motive he didn’t want to discuss out loud. He might just as easily been afraid that if he didn’t buy the bonds after the Crash, demand for them might have collapsed.
If demand for US bonds collapsed, central banks like the Fed would lose control of interest rates. Rates would head up. Right now the US government pays about 20% of tax receipts in bond interest. But what if nobody wanted the bonds and interest rates could no longer be held down by the Fed. What do you think would happen if it took 60% of tax receipts to pay the interest because rates had tripled to 6%. The house of cards would come tumbling down a lot faster than it is now.
Bernanke also seems to have no idea how important it is to allow free prices in a market economy. A market economy depends on free prices. They provide both producers and consumers with vital information. It has been said, quite accurately, that the Soviet Union collapsed because it never had honest prices.
Unfortunately we don’t have honest prices either. The two biggest prices are interest rates and currency prices. These affect the entire economy. But world central banks won’t leave them alone. They are constantly manipulated (down, down, down). The result is market confusion, bubbles, and busts.
Recently the US Fed announced it will do even more interest rate manipulation, this time in bonds with longer maturities. This is another slap in the face of savers, people who put money aside and want to invest it in reasonably safe ways.
It will also have massive unintended consequences. For example, think about insurance company policies. Don’t be surprised if this latest Fed move drives insurance companies into riskier and riskier bonds. This could lead to insurance company’s going bust. Fed policies already penalize small community banks in favor of the big national banks. We don’t need to ruin the insurance industry too.
Please note that I have referred to free prices. I don’t use the phrase free markets. Free markets implies that we can do whatever we want. Well we can. But that is an easy road to bankruptcy. Markets are actually a system of regulation. They make us worry about our customers and employees, not just ourselves. If we don’t, if we just think about ourselves and what we want to do, then we lose money and lose our business. It is prices that need to be free, and everything the Federal Reserve does interferes with free prices.
Manipulating interest and currency rates is the single worst example of how free prices are thwarted. But I could give you many more examples. They are almost endless. For example, take the student loan program. The idea was to help kids get an education. But all that new money flowing into education has just enabled schools to raise their prices. No wonder the cost of college rose 8.3% last year. The amount of debt young people are graduating with has quintupled in only a dozen years, but the rising cost of school means that the kids aren’t benefiting from the loans.
Now the administration says it wants to help the students who have been left virtually enslaved by all the after school debt.
Before young people feel grateful, they should look more closely. The government is not proposing to reduce the rate at which it lends to students, even though the government is in fact making a big profit off the students. The government lends to students at rates as much as 5% higher than the rate the government itself pays when it borrows the funds in the first place. This profit is supposedly applied to “deficit reduction.” So the students who will inherit all the federal debt and become responsible for its repayment are also expected to pay inflated loan rates now to help the government?
These are the same young people whose medical insurance costs will soar under the administration’s healthcare law because discounts on younger and healthier people will no longer be allowed. And the same young people who cannot find jobs because the bubbles created by the Federal Reserve and other central banks have crashed.
Young people have it really hard, but let’s return to the main thread of the story.
The main thread is as follows. Newly printed money enters the economy in the form of debt. Too much money printing has left the world with far too much debt. Efforts to rescue us from this have just created more debt. And we are still adding to the debt. Even if we taxed 100% of everyone’s income, not just the rich, we still wouldn’t have enough money to close today’s federal deficit. Even without adding to the debt, we already have too much to repay. So where do we go from here?
When there is too much debt, one way to deal with it is through default. Loans that can’t be repaid are liquidated. It is extremely painful. It creates recession or worse. But it doesn’t have to take long, as the depression of the early 1920’s shows. And it does clean the system out and makes possible a fresh start. Default is just recognizing the reality of where we are.
The other approach is to keep printing money until we get inflation in consumer prices as well as in assets. This also wipes out the old debt because the old debt is repaid in money that is worth less and less. The government appears to be trying to do this, but in a gradual and controlled way.
To the degree that they succeed, the economy will look better for awhile. But this is a very dangerous game. There are no known instances where gradual debasement of the currency has worked. It is more likely that total inflation will finally take off, the dollar will fail on world markets, or both. This could however take 5-10 years.
If it is to be debt liquidation, then the best thing to have is cash and the worst thing to have is debt. Many debtors will be bankrupted, more than have been so far. If the eventual outcome is dollar debasement and general inflation, then bonds would be the worst thing to own and cash not so good either.
No one can be sure which way it will go. So the most sensible thing to do if you have any savings is to hold some cash savings but also debt free assets such as gold or real estate. Having some of each is the best protection you can have.
Before I end, I would also like to say something about Marion. I think Marion could have a bright economic future even if the US as a whole continues to struggle. Why? How can Marion do well if New York is in trouble? Here is my reasoning. We all know that vast numbers of baby boomers are reaching retirement age. If they are lucky enough to be able to retire, they often want a warmer place to live. It isn’t really safe for an older person to be navigating ice all the time. Florida has already been converted into a retirement state. Retirees have also moved into South Carolina and parts of Georgia and have brought lots of money with them.
It is reasonable to think that retirees will continue to look into other areas of the South and Marion can be made into a very attractive destination for them. I don’t need to tell all of you about the attractions. People are already retiring here. There could be a lot more of them.
But you can help it happen by working to make Marion as attractive a destination as it can possibly be.
Thanks for listening. Maybe there will be some questions.
Peter Schiff finishes the job, or Why the Economy that Looks Like It Is Improving, Isn’t: