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 ShadowStats' John Williams has done his math and
believes his numbers tell the truth. He explains why the U.S. is in a
depression and why a "Hyper-Inflationary Great Depression" is now
unavoidable. John also shares why he selects gold as a metal for asset
conversion in this exclusive interview with The Gold Report.
The
Gold Report: John, last December you stated, "The U.S.
economic and systemic crisis of the past of the past two years are just
precursors to a great collapse," or what you call a
"hyper-inflationary great depression." Is this prediction unique to
the U.S., or do you feel that other economies face the same fate?
John
Williams:
The hyper-inflationary portion largely will be unique to the U.S. If the U.S.
falls into a great depression, there's no way the rest of the world cannot
have some negative economic impact.
TGR: How will the
United States' decreased economic power impact global economies? Will the
rest of the world survive?
JW: People will
find to their happy surprise that they'll be able to survive. Most businesses
are pretty creative. The thing is, the U.S. economic activity accounts for
roughly half that of the globe. There's no way that the U.S. economy can turn
down severely without there being an equivalent, at least a parallel downturn
outside the U.S. with its major trading partners.
When I
talk about a great depression in the United States, it is coincident with a
hyper-inflation. We're already in the deepest and longest economic
contraction seen since the Great Depression. If you look at the timing as set
by the National Bureau of Economic Research, which is the arbiter of U.S.
recessions, as to whether or not we have one, they've refused to call an end
to this one, so far. But assuming you called an end to it back in the middle
of 2009, it would still be the longest recession seen since the first
down-leg of the Great Depression.
In terms
of depth, year-to-year decline in the gross domestic product, or GDP, as
reported in the third quarter of 2009, was the steepest annual decline ever
reported in that series, which goes back to the late '40s on a quarterly
basis. Other than for the shutdown of war production at the end of World War
II, which usually is not counted as a normal business cycle, the full annual
decline in 2009 GDP was the deepest since the Great Depression. There's
strong evidence that we're going to see an intensified downturn ahead, but it
won't become a great depression until a hyper-inflation kicks in. That is
because hyper-inflation will be very disruptive to the normal flow of
commerce and will take you to really low levels of activity that we haven't
seen probably in the history of the Republic.
Let me
define what I mean by depression and great depression, because there's no
formal definition out there that matches the common expectation. Before World
War II, economic downturns commonly were referred to as depressions. If you
drew a graph of the level of activity in a depression over time, it would
show a dip in the economy, and you'd go down and then up. The down part was
referred to as recession and the up part as recovery. The Great Depression
was one that was so severe that in the post-World War II era, those looking
at economic cycles tried to come up with a euphemism for
"depression." They didn't want to create the image of or remind
people of the 1930s. Basically, they called economic downturns recessions,
and most people think of a depression now as a severe recession.
I've
talked with people in the Bureau of Economic Analysis and the National Bureau
of Economic Research in terms of developing a formal depression definition.
The traditional definition of recession—that of two consecutive
quarters of inflation-adjusted contraction in GDP—still is a solid one,
despite recent refinements. Although there's no official consensus on this,
generally, a depression would be considered a recession where peak-to-trough
contraction in the economy was more than 10%; a great depression would be a
recession where the peak-to-trough contraction was more than 25%.
We're
borderline depression in terms of where we're going to be here before I think
the hyper-inflation kicks in. You've certainly seen depression-like numbers
in things such as retail sales, industrial production and new orders for
durable goods, where you're down more than 10% from peak-to-trough. In terms
of housing, you're down more than 75%, and that certainly would be in the
great depression category. With hyper-inflation, you have disruption to the
normal flow of commerce and that will slow things down very remarkably from
where we are now.
TGR: After a period
of recession, isn't inflation considered a good sign?
JW: There are a
couple of things that drive inflation. The one that you're describing is the
relatively happy event where strong economic demand is exceeding production,
and that's pushing prices higher, as well as interest rates. That's a
relatively healthy circumstance. You can also have inflation, which is driven
by factors other than strong economic activity. That's what we've been seeing
in the last couple of years. It's been largely dominated by swings in oil
prices. That hasn't been due really to oil demand, as much as it has been due
to the value of the U.S. dollar. Oil is denominated in U.S. dollars. Big
swings in the U.S. dollar get reflected in oil pricing. If the dollar
weakens, oil rises. That's what you saw if you go back to the 1973-1975
recession, for example. That was an inflationary recession.
Indeed,
the counterpart to what you were suggesting earlier about the strong demand
and higher inflation is that usually in a recession you see low inflation.
The '73 to '75 experience, however, was an inflationary recession because of
the problem with oil prices. That's what we were seeing early in this cycle,
where a weakening dollar rallied oil prices, and then the dollar reversed
sharply and oil prices collapsed. We have passed through a brief period of
shallow year-to-year deflation in the consumer price index, but, as oil
prices bottomed out and headed higher since the end of 2009, we're now seeing
higher inflation, again.
I'm
looking at hyper-inflation, which is a rather drastic forecast. This has been
in place as an ultimate fate for the system for a number of years. Back in
the '70s, the then Big 10 accounting firms got together and approached the
government and said, "Hey guys, you know you need to keep your books the
way a big corporation does. You're the largest financial operator on
earth." The government then, as well as today, operates on a cash basis
with no accrual accounting and such. Yet, over a period of 30 years, the
accountants and government put together generally accepted accounting
principles, or GAAP, accounting for the federal government and introduced
formal financial statements on that basis in 2002, which supplement the
annual cash-based accounting.
If you
look at those GAAP-based statements and include in the deficit the
year-to-year change in the net present value of the unfunded liabilities for
Social Security and Medicare, what you'll find is that the annual operating
shortfall is running between $4 and $5 trillion; not $500 billion as we saw
before the crisis or the $1.4 trillion that they announced for fiscal 2009.
Now to put that into perspective, if the government wanted to balance its
deficit on a GAAP basis for a year, and it seized all personal income and
corporate profits, taxing everything 100%, it would still be in deficit. It
can't raise taxes enough to contain this. On the other side, if it cut all
government spending except for Social Security and Medicare, it still would
be in deficit. With no political will to contain the spending, eventually the
government meets its obligations by revving up the currency printing press.
TGR: With all this
new paper money coming into the system, wouldn't we see a bigger bubble than
we've ever seen prior to a hyper-inflationary great depression?
JW: No, in fact,
it's a very unusual circumstance that we have now. Put yourself in Mr.
Bernanke's situation—he had to prevent a collapse of the banking
system. He was afraid of a severe deflation as was seen in the Great
Depression, when a lot of banks went out of business. The depositors lost
funds and the money supply just collapsed. He wanted to prevent a collapse of
the money supply and keep the depository institutions afloat. Generally, that
has happened. The FDIC expanded its coverage and everything that had to be
done to keep the system from imploding was done. The effects eventually will
be inflationary.
In the
process, what Mr. Bernanke did was to expand the monetary base
extraordinarily, more than doubling it over a period of a year. The monetary
base is money currently in circulation plus bank reserves. If you go back to
before September 2008, the bank reserves were in the $50 to $60 billion
range. Where the currency was maybe $800 billion, we've gone over $2 trillion
in total reserves. Most of that is in excess reserves and not required
reserves that banks have to keep to support their deposits. Normally banks
would take their excess reserves and lend them out into the regular stream of
commerce, and in doing so, that would create money supply. Instead they're
leaving the excess reserves on deposit with the Fed. Money supply and credit
are now generally contracting. We're going to see an intensified downturn in
the near future. I specialize in looking at leading indicators that have very
successful track records in terms of predicting economic or financial turns.
One such indicator is the broad money supply.
Whenever
the broad money supply–adjusted for inflation–has turned negative
year over year, the economy has gone into recession, or if it already was in
a recession, the downturn intensified. It's happened four times before now,
in modern reporting. You saw it in the terrible downturn of '73 to '75, the
early '80s and again in the early '90s. In December of 2009, annual growth in
real M3 turned negative. It's now at a record low in terms of decline, down
more than 6% year over year. What that suggests is that in the immediate future
you're going to see renewed downturn in economic activity.
In all
the prior instances that I mentioned, this event led recessions, except for
'73 to '75. That's when you had the oil spike and a recession that came from
that. When the money supply turned down in that recession, the economy
accelerated in its decline. We're going to see something along those lines,
now, with about a six-month lead time. You're going to have negative economic
growth this year. The implications for that are extraordinary, because the
projections on the federal budget deficit, a number of the state deficits,
and the solvency and stress tests for the banking system all were structured
assuming positive economic growth in the 2% to 3% range for 2010. Instead
it's going to be negative. Many states are going to be in greater difficulty
than they thought. Most likely, you're going to have federal bailouts there.
The banks are going to have more troubles. All this means more government
support, more government spending, greater deficits and greater funding needs
for the U.S. Treasury. We have a global market that already is increasingly
reluctant to hold the dollars and U.S. Treasuries.
TGR: The U.S.
dollar is still the reserve currency, and it's holding its value while the
euro struggles. Wouldn't decoupling precede hyper-inflation?
JW: I don't know
if it will decouple from being the reserve currency formally, but it will de
facto. The reserve status is the reason the dollar didn't collapse per se a
year and a half ago during the September '08 panic. The movement is already
afoot, however, to try to relegate the dollar to some status other than a
reserve currency. For example, OPEC purportedly is looking to price oil in
something other than U.S. dollars. The pressure is there to change the
status.
Again, if
you start to see a great depreciation of the U.S. currency or a tremendous
increase in lack of confidence in the soundness of the government's fiscal
condition, there is a problem. You mentioned Greece, for example. The
sovereign solvency issues there are minuscule compared to what we have with
the United States, which is the elephant in the bathtub. The markets know
it's there. The central bankers know it's there. Again, with the downturn in
the economy, all the issues are going to be brought to a head. As they come
to a head, there will be that effort to dump the dollar. I would expect that,
indeed, it will be decoupled from its reserve status, although it could
follow after the fact as opposed to before the fact.
TGR: Major economic
indicators suggest significant improvement; even the IMF has stated that
we've averted a global depression. What are you seeing that these governing
bodies are not?
JW: What I'm using
is a leading indicator of economic activity: year-to-year change in
inflation-adjusted broad money supply. We're now seeing a very sharp
year-over-year decline, which has not been seen since the 1990 recession.
This indicator does not work always in the upside; it doesn't necessarily
give you a signal for a rising economy. It is, however, basic. If you
strangle liquidity you can always contract an economy. Deliberately or not,
liquidity's being strangled. You're seeing very sharp declines in consumer
credit, commercial and industrial loans and commercial paper outstanding.
You are
getting happy news from governments, central banks, financial markets, Wall
Street analysts and the popular media, which does tend to cater to Wall
Street. Such is standard practice. Happy news is what sells and you don't
want to discourage people. The Obama administration, interestingly, started
talking-down the economy when it wanted to get its stimulus package in place.
As soon as that was done, it started talking-up the economy. Everything was
just fine and dandy again. This is the most extraordinary downturn most
people living today have ever seen. In terms of modern economic reporting,
which basically started after World War II, we've never had a downturn as
long or as severe. Perversely, the extreme nature of the downturn actually
has warped recent reporting of seasonally-adjusted data to the upside.
TGR: Earlier you
mentioned that business around the world will survive in the event of a
depression. Aren't there sustainable businesses in the U.S. as well? Won't an
influx of printed currency and green-tech job creation offer some value? At
some point, doesn't stimulus money become real cash producing real goods?
Surely the economy would be viable at some level?
JW: Not without
income growth. There's nothing there that you've described to me that is
growing, aside from inflation. To have sustainable growth in the economy, you
have to income growth, net of inflation. That is not happening, and there is
nothing in existing government stimulus that will cause real income growth.
Beyond
income issues, the problem with the hyper-inflation is that very quickly the
use of cash will cease. Let me contrast our circumstance here with a very
popularly followed hyper-inflation case that's now run its course in
Zimbabwe. There you had probably the worst hyper-inflation that anyone's ever
seen. After devaluation upon devaluation, they successively lopped the zeros
off the bills. If you took a $2 bill that they first issued back in the '80s
and then tried to come up with the equivalent of a $2 bill in the last form
of the currency, it would be very difficult to do because it was so
worthless. If you put a pile of those together to equal the original $2 bill,
it would actually stretch from the earth to the Andromeda Galaxy. We're
talking light years. There are not enough trees on earth to print them. Yet
the Zimbabwe economy survived and functioned. They had a lot of problems, but
they operated. The reason they functioned was because they had a back-up
system, which was a black market in U.S. dollars. People switched out of the
Zimbabwe dollar to U.S. dollars. They could live with that. In the U.S., we
don't have a back-up system.
TGR: You mentioned
in a recent interview with CNN that you're recommending individuals move into
both cash and gold. With the euro and the dollar in jeopardy, where does that
leave us?
JW: I don't like
the euro. I don't think that's going to hold together, and I've thought so
for some time. If it should break up and you have a new German currency, a
new mark or something like that might be a strong one option. At the moment I
like the Canadian dollar, the Australian dollar and the Swiss franc. For
anyone living in the United States, rather than looking at the short-term
volatility in the markets and trying to make money off of that, this is the
time to batten down the hatches and to look to preserve your wealth and
assets.
In terms
of preserving the purchasing power of your assets, the best thing I can think
of is physical gold. That's worked over the millennia. I'm not per se a gold
bug. It just happens to be a circumstance in which it's the cleanest asset
around for that. You don't need to put all your assets into gold, but hold
some. Hold some silver. I'd look to get some assets out of the U.S. dollar
and look to get some assets out of the U.S. When I say outside of the U.S.
dollar, again, I look at the Canadian dollar, Australian dollar, Swiss franc
in particular. I think they will tend to do particularly well, whereas the
U.S. dollar is going to become effectively worthless.
As the
dollar breaks down, you'll also likely see disruptions in supply chains,
including shipments of food to grocery stores. People should consider
maintaining stockpiles of basic goods needed for living, much as they would
for a natural disaster. I sit on the Hayward fault in California. I have a
supply of goods and basic necessities in case something terrible
happens—natural or man-made—that will carry me for a couple of
months. It may take that long for a barter system to evolve, which I think is
what you're going to end up with; at least until a new currency system is
reorganized and you get a government that's able to bring its fiscal house
into order. No currency system in the U.S. is going to work unless the fiscal
conditions that drove it into oblivion are also addressed.
On a
global basis, where the dollar is the world's reserve currency, 80% of
currency transactions involve the U.S. dollar. There's going to have to be an
overhaul of the global currency system. To gain credibility with the public,
the powers that be likely will design a system that has some kind of a tie to
gold, but that's purely speculative.
TGR: From a
personal investment point of view, you emphasized that this is a time to
conserve assets, including gold and other currencies. How else can investors
protect themselves?
JW: I like
physical gold and silver. I look to gold as a primary hedge. If you can come
out of this holding gold, you'll be in a position where you'll be able to
take advantage of some extraordinary investment opportunities that will
follow. With inflation, real estate is usually a pretty good bet. It tends to
hold its value over time. There may be periods of illiquidity, though, and
it's not portable. Neither of those limitations is an issue with gold. Maybe
gold will become the black market to support U.S. economic activity. It
certainly would be the area that people will try to transfer their assets to
as time goes along.
You see
people now as gold gets to a new high saying, "Oh my goodness, I bought
at $200, and I can sell out at $1,100 making a good profit." What people
don't realize is that they haven't made a real profit. What they've done is
retained the purchasing power of the dollars that they invested in gold, and
they've lost proportionately the purchasing power of the amounts left in
dollar-denominated paper assets over the same time. Gold is a long-term
wealth preserver. Again, where many people are used to an investment
environment where they can buy a stock, make a quick profit and then sell,
with gold you need to hold on for the long haul as an insurance policy, not
as a quick investment.
TGR: Thank you very
much for your time.
Walter
J. "John" Williams was born in 1949. He received an A.B. in
Economics, cum laude, from Dartmouth College in 1971, and was awarded a
M.B.A. from Dartmouth's Amos Tuck School of Business Administration in 1972,
where he was named an Edward Tuck Scholar. During his career as a consulting
economist, John has worked with individuals as well as Fortune 500 companies.
For more than 25 years he has been a private consulting economist and a
specialist in government economic reporting. His analysis and commentary have
been featured widely in the popular media both in the U.S. and globally. Mr.
Williams provides insight and analysis on his website, www.shadowstats.com.
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