David Galland interviews Terry Coxon,
Terry Coxon worked side by side with
best-selling author Harry Browne for years and is a rare expert in the arcane
study of monetary systems. His remarks at this juncture in time, a time that
might end up labeled in the history books as “Money Runs Wild,” are
David Galland: You were
involved with Harry Browne during the last great inflation in the U.S. How
does the increase in the money supply that kicked off in 2007-2008 compare in
terms of scale to what went on leading up to the inflation in the ‘70s?
Terry Coxon: The comparison is
pretty muddled. In terms of the M1 money supply – the total of
checkable deposits and hand-to-hand currency – we haven’t yet
gotten near the persistently high growth rate that occurred in the 1970s. But
the growth in the monetary base has been far more rapid than what happened in
the 1970s. There is some time delay between growth in the monetary base and
growth in M1, but to make the picture really cloudy, I'm afraid the
comparison turns out not to be very useful. Unlike in the 1970s, the Federal
Reserve is now paying interest to banks on their reserves.
other words, the effect is that much of the increase in the monetary base
gets locked up and sequestered because banks want to earn the interest on the
reserves rather than lending the reserves out or buying investments and
increasing the money supply.
DG: You are referring to the excess reserves banks have
left on deposit with the Fed?
DG: Why do you think that the Fed is paying interest on
those reserves? With policy makers and pundits saying that the economy needs
a shot in the arm and a dose of inflation, why would the Fed continue to
encourage banks not to lend or invest, by paying them interest to leave the
money on deposit?
TC: If the Federal Reserve didn’t pay interest on
those reserves, the result would be inflation rates far beyond anything the
U.S. has ever experienced. The monetary base has more than doubled, and
without the Federal Reserve paying interest on the recently created boatload
of reserves that is essentially keeping them immobilized in accounts at the
Federal Reserve Bank in New York, the M1 money supply would more than double
and we would have inflation rates that would make the worst days of inflation
in Brazil and Argentina look tame.
DG: I know you can't give a real number, but what general
level of inflation are you talking about?
TC: Close to a doubling in the CPI in a year's time.
Doubling the CPI over the course of a year would be an inflation rate of
DG: But on the other side of the equation, a deflationist
would say that even if they stopped paying interest on those excess reserves,
there is no loan demand, so the banks can't find anybody to loan to. If
that’s the case, how does the money get out into the system?
TC: If a bank has excess reserves and the Federal Reserve
stops paying interest on them, if the bank can't think of anything else, it
will buy Treasury bills, even if the yields on those Treasury bills are only
0.5% a year. Then the seller of the Treasury bills has the cash.
the seller of the Treasury bills is, we can safely assume he sold his T-bills
because the cash was more attractive to him. And if the cash is more
attractive when it's earning zero, that means the person who sold the
Treasury bills wants to use the cash to buy something else, and that's how
the excess reserves would move from the banks to the general economy.
DG: What about the role the carry trade plays in all of
this? If banks can’t get a return in the U.S., might they take the
money and spend it elsewhere or invest it in countries where interest rates
are higher? That seems to be going on today, in
which case, wouldn’t we effectively export our inflation?
TC: It does have an inflationary effect all around the
world, and it also puts the markets generally on a very fragile footing when
you can borrow U.S. dollars at an artificially suppressed rate of 0.5% and
buy New Zealand dollars and earn 2%. That has the effect of propping up the
New Zealand dollar. And it promises a profit for the carry trader of 1.5%,
but actually collecting that profit depends on exiting the trade at the right
carry trade is in just about every market at this point. People are borrowing
dollars at ultra-low interest rates in the hope of earning a higher return in
something else and also hoping to exit at the right time. Virtually all
markets have been propped up by the carry trade, and all the carry traders
are telling themselves they are going to jump ship at just the right time.
When the time comes, the rails of the ship are going to be crowded, and
markets likely will move down very rapidly.
DG: Discuss the effect of the carry trade on the dollar.
As you said, at this point in time there is a robust dollar carry trade, with
people borrowing dollars and using them to buy, say, New Zealand bonds or
whatever. So, what effect does this have on the dollar?
TC: The carry trade is the proximate cause of the decline
in the dollar in foreign exchange markets. If you look at the whole process,
it starts with printing by the Federal Reserve, but the step that occurs just
before the price of the dollar goes down is the decision by traders to borrow
dollars and buy other currencies. When the carry trade comes to an end, the
process will go into reverse, and the dollar will rally.
DG: So this would again tie back to interest rates. If
U.S. interest rates start moving up, then the carry trade begins to unwind.
TC: It wouldn’t even take that, just an expectation
that interest rates on dollars are about to move up. That would do it.
DG: Yet, historically gold and interest rates and
inflation all tend to move up together. Not to get all tangled up, but if
interest rates in the U.S. move up and the dollar starts to strengthen,
shouldn’t gold then start moving down? But again, that's not the
TC: It’s not as tangled as you think. The answer you
are going to come to for gold depends on what is causing interest rates to
move up. If interest rates are moving up because the expectation of inflation
is moving up, then that won't hurt gold, it will help gold. On the other
hand, if interest rates are moving up because the Federal Reserve is
tightening, then that is bad for almost everything that people have been
borrowing to buy, which includes gold and silver and stocks generally.
DG: And New Zealand dollars.
TC: Yes, foreign currencies as well.
DG: With the carry trade, the interest rate differential
is an important thing to understand, and right now the U.S. is clearly behind
the curve in terms of its interest rates. So the question is… could
this situation continue for quite a while, with the dollar kept cheap by the
carry trade? Can the dollar just keep going down until it evaporates, or are
you seeing signs of an alternative outcome?
TC: The road to perdition has zigs
and zags and loopbacks, and what causes the
loopbacks is a shift in what the Federal Reserve currently perceives as its
worst nightmare. For example, in 2008, 2009 and into 2010, the Federal
Reserve was worried primarily about a deflationary depression, so it turned on
the printing presses.
recently, inflation has returned as a worry, and that can turn into worry
number one on any given day, at which point the Federal Reserve will slow
down the printing or just sit on its hands for a while. That's when interest
rates will start moving up, and that's when the carry trade will get unwound,
triggering a big downdraft in virtually all markets. But the prominence of
inflation as a worry will eventually be replaced by renewed concern about the
economy contracting, and then the Federal Reserve will shift its weight again
from one foot to the other.
DG: Which brings us to the 8,000-pound
gorilla in the room: the debt. Our readers, and pretty much everyone
else, knows that the U.S. government is sitting on the largest pile of debt
in history, and that much of this debt has been generated for no real useful
Rickards made the point at our spring summit that
the last time government debt was anything close to this as a percentage of
GDP was in World War II. And he pointed out that the money spent back then
essentially bought a victory in World War II, leaving the U.S. with a very
strong economy and leverage over other economies. But those advantages have
been squandered. Now in exchange for all the debt that has been rung up, Rickards points out that the country has little more than
a lot of flat-screen TVs.
think it was probably our very first meeting after you joined Casey Research,
sitting around the table in San Francisco, that I asked, "Is there any
way out?" This was back in 2004, and Doug Casey and Bud Conrad and you
took turns answering, with the answer being essentially the same, "No,
no way out and the situation is going to end badly."
here we are seven years later, and the government’s debts have only grown.
Obviously, inflation is the standard approach the government is likely to use
to relieve itself of its debt over time, but I wouldn’t rule out an
overt default of some sort. Regardless, it seems like the country’s
economic future is going to be determined by the debt.
let me ask you the same question, do you see any way out? Are there any
options left to the government that don’t lead to economic chaos?
TC: If by some miracle the people who run the government
decided that Big Government was a bad idea and small government was a much
better idea, and so they set about ending government programs and pushing the
level of federal spending way down, along with the level of regulation over
the economy, then there would be a way out.
how likely is that to happen? The time horizon for people in politics is
maybe one or two years, just about the same length of time there is before
the next election. Their goal is always to survive the coming election. That
means what is rational for the politicians looks irrational to everyone else,
and I don’t see any reason to expect that to change. The purpose of a
politician examining a problem is not to solve the problem but to find a way
for someone else to get blamed for it.
DG: Doug and I have both written about the fact that we
are living in a steadily degrading democracy at this point, with the public
voting itself all manner of benefits from the public trough. Personally, I
don’t see how we get to the point where politicians, where the voters,
decide that a much smaller government is a much better way to go. At least
not unless and until we're forced to. Do you think this situation can drag
on, or will the size of the debt and deficits force a change sooner rather
TC: That's a political question. At some point, the
situation may become so catastrophic that people are forced to learn new
habits and consider new ideas, but things have to get pretty bad before that
DG: And how would you rate the odds of it getting pretty
bad before this is over?
TC: Very high.
DG: And the time frame? You typically say these things are
variable and unknowable, but can you be a bit more specific?
TC: It takes a long time. It's not going to happen this
year. It's probably not going to happen next year.
DG: But hasn’t this been a long time coming?
TC: Yes, it has, and that should tell you that the process
is a slow one.
DG: So in your view, what are the one or two most
important things that readers need to be doing to protect themselves at this
TC: I think the most important thing someone can do is to
understand what's going on. That's what will give the individual staying
power when the markets are temporarily moving against them. The worst thing
you can do is to just pick a leader and do whatever he advises without
thinking it through and understanding it. What makes that a bad approach is
that no matter which intellectual leader you might choose, there are going to
be periods when he is wrong and when his advice is not working for you. And
even if he is right in the long run, you may not stick with him for the long
run if you don’t understand why his advice makes sense. So I think job
number one is to understand what's going on, so that you’re not blindly
relying on anyone's advice.
DG: What's job number two?
TC: Job number two, if you see the world as I see it, is
to make sure that a substantial share of your wealth is in precious metals
and perhaps in foreign currencies, but without any leverage.
DG: Thank you very much.
Contributing Editor Terry Coxon is the author
of Keep What You Earn and Using
Warrants and the co-author
(with Harry Browne) of Inflation-Proofing Your Investments. He edited Harry Browne’s
Special Reports for its 23 years of publication and all of Harry
Browne’s investment books since 1974.Terry was the founder and for 22
years the president of the Permanent Portfolio Fund, a mutual fund that
invests in precious metals as well as stocks and bonds. He is currently
president of Passport Financial, Inc., and for over 30 years has advised
clients on legal ways to internationalize their assets to optimize tax,
wealth protection and estate planning goals.
aren’t worried about inflation yet, you should be. Because this
insidious parasite keeps eating away at your assets and portfolio gains
– probably without you noticing. Read on to find out how to beat
inflation and come out ahead of the game. Free
Editor, Casey Research