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ShadowStats.com Editor John Williams—to whom
many Gold Report contributors look for honest data on
the economy that they can trust—sees sure signs of an accelerating
downward economic spiral that will lead to almost unimaginable hyperinflation
in the U.S. As he says in this exclusive interview, we're in for "a much
rougher time than they had in Zimbabwe," because we'll have no black
market currencies around to prevent the cessation of normal commerce.
The Gold Report: When we spoke in May, John, you told us that a
leading indicator of economic activity was the year-over-year change in
adjusted broad money supply, which was declining at that time. You said,
"if you strangle liquidity you always contract an economy and
deliberately or not, liquidity is being strangled, resulting in sharp
declines in consumer credit, commercial and industrial loans." Does this
mean it would spur more economic growth if banks actually started lending?
John Williams: It sure wouldn't hurt. We're still seeing contractions
in liquidity, and that's adjusted for inflation. In real terms, M3 money
supply is down almost 8% year-over-year. It's the sharpest fall in the post
-World War II era. It's not so much the depth of the decline in the liquidity
or the duration, but the fact that the liquidity turns negative
year-over-year that signals the economy turning down.
We had the signal in December of 2009 indicating intensification of the
downturn, in this case, within six to nine months. We're in that timeframe
now and see softening numbers. People are talking about a weaker economy.
Even Mr. Bernanke has described the economy as "unusually
uncertain" in terms of its outlook. Wording like that from the Fed is a
pretty good indication that something's afoot.
TGR: Why is M3 still contracting?
JW: Just as you noted, the banks are not lending. The money the Fed
put into the system in terms of buying mortgage-backed securities from the
banks and trying to help bank liquidity ended up back with the Fed as excess
reserves. We have well over $1 trillion there; had the banks loaned that
money in the normal stream of commerce, it would have added more than $10
trillion to the broad money supply, which otherwise is up around $14
trillion. That certainly would have had some inflationary impact if not in
terms of actual business activity. You can't always get the economy to grow
by pushing money into it. Sometimes it's like pushing on a string.
TGR: And you say that a contracting money supply is a sure sign of
trouble?
JW: When it contracts year-over-year adjusted for inflation, that's a
signal for a downturn or an intensified downturn. It happens every time.
Squeeze liquidity and business activity contracts.
On occasion, we've had recessions without a preceding downturn in the money
supply. And sometimes, the money supply has turned positive but the economy
has not followed—again, pushing on the string. Expanding money supply
has led to upturns as well, so the Feds had to give it a try to stimulate the
economy. But the one sure signal is the downturn. You don't get it often but
it's very powerful when you do.
We're beginning to see the data break. Some unusual factors have been at
work. I expect an accelerating pace of downturn in the next couple of months.
The numbers will turn sharply worse. Consensus estimates are already moving
in that direction and most everything will follow. Industrial production is
still up but retail sales have been falling. Payroll numbers have been flat
when you take out the effects of the census hiring. Those employment numbers
will turn down in the next month or two, providing an important indicator of
renewed economic contraction.
So we'll see how it develops, but we're at that turning point. It is
happening as we speak. At the end of July, we got an estimate of the second
quarter GDP, where the pace of annualized growth slowed to 2.4%. The early
GDP estimates are very heavily guessed at, so most of the time you don't know
if you're getting a positive or a negative number. You get a margin of error
of plus or minus 3% around the early reporting. That happens also to be about
average growth.
Nevertheless, on a quarter-to quarter-basis, I think we'll see GDP down again
in the third quarter. With the bulk of the reported GDP in the first half due
to inventory building, the stage for renewed contraction has been set. By
then we'll find the consensus pretty much in the camp that we're in a
double-dip recession. The popular press will describe it as a double dip, but
we never had a recovery. Actually, this is just a very protracted, very deep
downturn that has had a pattern of falling off a cliff, bottoming out, having
a little bit of bump due to stimulus and then turning down again. Sort of
shaped like the path of a novice skier going down a jump for the first time.
Speeding sharply down the hill, he goes up in the air and starts spinning
wildly as he tries to figure out which end is up with his skis. Then he takes
a pretty bad tumble. We're beginning to spin in the air.
TGR: But we've been in recession for three years now?
JW: The second leg that I'm talking about is the one now underway as
we get to the middle of 2010. December 2007 is when this recession officially
started, although I contend that it started earlier in 2007. At any rate, the
economy plunged through 2008 and well into 2009. The numbers were pretty much
bottom-bouncing during the second half of 2009. The auto deals and the
homebuyer deals added a little spike to the growth pattern, but that growth
was stolen from the future. It didn't create new demand.
Let me just clarify a bit. Recession, at least traditionally, was defined as
two consecutive quarters of contracting real GDP growth adjusted for
inflation. The National Bureau of Economic Research, the defining authority
as to whether we're in a recession, will deny it, but at one time they used
that general guideline as well. They've always used other numbers, too, such
as employment and industrial production, trying to time the beginning or the
end of a recession to a particular month. Significantly they did not call an
end to this recession. They said it was too early to call, but I think they
had a pretty good sense of what was going to happen. So what we're seeing now
just looks like an ongoing deep recession. The next down leg is going to be
particularly painful and I'm afraid particularly protracted.
TGR: Can the governments pull any more stimulus levers yet this year?
JW: Oh, I think they'll try, but nothing much they
can do will have anything other than short-term impact. If they write
everyone a check, people go out and buy things. That would give the economy a
quick boost but do nothing to change the underlying fundamentals or to
correct the structural problems in this recession. Those are tied to the lack
of robust growth in consumer income.
TGR: So consumer income is a key factor.
JW: Absolutely. If you put in housing that's related to the consumer,
that's three-quarters of the GDP. The average household is not staying ahead
of inflation, and unless income grows faster than inflation, the economy
won't grow faster than inflation—and that means that GDP is not
growing. Income sustains consumption. When income grows, consumption grows.
The only way to have sustainable long-term economic growth is to have healthy
growth in income. You can buy some short-term economic growth, though,
without growth in income, through debt expansion, which is what Greenspan
tried.
Most of the growth we'd seen in the last decade prior to this downturn was
due to debt expansion. The debt structures have pretty much been put through
the wringer and consumers are not expanding credit, generally because it's
not available to them. Absent debt expansion and/or significant growth in
income, no way can the consumer expand personal consumption. You have to
address employment, quality of jobs.
TGR: You're suggesting that problems with the quality of jobs, if not
the quantity, goes back to Greenspan—before the recession kicked in.
JW: Yes. A lot of high-paying jobs have been lost to offshore
competition, to U.S. companies moving facilities offshore and to outsourcing
offshore. That's been the primary driver of declining household income.
TGR: We no longer really have the option of expanding the debt and
it's doubtful that even short-term stimulus will have much impact. Looking at
this next leg down against that backdrop, what projections would you make
about unemployment, housing prices, GDP as we look through the end of 2010
and into '11?
JW: Unemployment will be a lot worse than most people expect. Housing
will continue to suffer in terms of weak demand. But in this crazy, almost
perverse circumstance, the renewed weakness to a large extent will help push
us into higher inflation. Real estate tends to do better with higher
inflation, but it's not going to be a happy circumstance for anyone.
The government is effectively bankrupt. Using GAAP accounting principles, the
annual deficit is running in the range of $4 trillion to $5 trillion. That's
beyond containment. The government can't cover it with taxes. They'd still be
in deficit if they took 100% of personal income and corporate profits. They'd
also still be in deficit if they cut every penny of government spending
except for Social Security and Medicare. Washington lacks the will to slash
its social programs severely, to change its approach to ever bigger
government. The only option left going forward is for the government
eventually to print the money for the obligations it cannot otherwise cover,
which sets up a hyperinflation.
All of what I just described was already in place when the systemic solvency
crisis broke. Before this crisis the government was effectively bankrupt. In
response to the crisis, the government may have gone beyond what it had to
do, but you err on the side of conservatism when you're trying to prevent a
systemic collapse. That was a real risk. It still is. Irrespective of the
politics of big government spending, quantitative easing, renewed bailing out
of banks, whatever is involved, I'd argue that the government still will do
whatever it takes to prevent a systemic collapse. That last series of actions
had the effect of rapidly exploding the deficit. In just a year, we went from
something under $500 billion in official reporting, on a cash basis as
opposed to GAAP basis, to something close to $1.5 trillion.
TGR: How big will that deficit grow in this second painful and
protracted period?
JW: I can't give you a hard number, but I can tell you this. The
markets came into this year on consensus projections that we'd have positive
economic growth. Forecasts for the federal deficit, treasury fundings, banking system solvency, etc. all were based on
assumptions of recovery, of positive growth. Those assumptions presumably
still underlie what I consider to be an irrational stock market.
But those projections and assumptions were wrong. We're going to have
negative growth. The downturn will intensify. We're not in recovery. We have
states on the brink of bankruptcy. The federal government isn't going to let
California or New York or Illinois collapse. Those are threats to the
systemic survival. They're also going to spend a lot more to support people
on unemployment. Again, putting aside election year politics and such, the
banking industry will need further bailout as solvency issues come to a head
again. The federal deficit is going to balloon. It's going to blow up much worse
than any formulas would give you, and Treasury funding needs will explode.
TGR: Clearly you see us spiraling out of control.
JW: We've been talking about an economic recession, but we are headed
for something far worse. I define a depression as a 10% peak-to-trough
contraction in the economy. In terms of the broad economy, we're not down 10%
in GDP yet. So while we're not formally in depression, we're certainly seeing
it in a number of indicators and I think we'll be in a depression, with GDP
down 10%, in the near future.
A contraction greater than 25% peak-to-trough puts you in a great depression.
That is what I envision, but we'll be taken there by hyperinflation and a
resultant cessation of normal commerce.
TGR: Hyperinflation means different things to different people. How do
you define it?
JW: My definition has been and will remain very simple. When the
largest-denomination note in circulation—the $100 bill in the case of
the U.S. dollar—has the same value as toilet paper, you have a
hyperinflation. You saw that in the Weimar Republic. People papered their
walls with money.
TGR: I think you've said that the only reason that Zimbabwe's economy
survived is because they started using dollars as black market currency.
JW: But you don't have anything like that in the United States as a
backup. We're going to have a much rougher time in the U.S., of all places,
than they had in Zimbabwe. Zimbabwe was able to function because people could
exchange the local currency into dollars, and then buy things with the
dollars, so the economy continued to function. Without some kind of a backup
system, as the currency becomes worthless you'll see disruptions to key
supply chains. When people don't have food, you end up in very dangerous
circumstances.
TGR: Do you see any real potential for precious metals or another
currency as a backup?
JW: Well, yes. I think they will become a backup fairly quickly, but
we don't have any widely developed black market for another currency at this
point because the dollar remains the world's reserve currency. All sorts of
things may develop that we don't anticipate. What will be used to cover for
the dollar? Gold and silver? The precious metals are limited in supply and
not widely held by the population in general. Hard currency from Canada or
Australia? That wouldn't be in wide circulation, at least not early on. I
think a barter system is where it will go until the currency system is
stabilized, but the currency system can't stabilize until the government's
fiscal house is in order.
There's no sense in setting up a currency on a gold standard if you can't
live within your means, because you'd just end up going through successive
devaluations against gold. So whatever's done to set up a new currency system
will have to be in general conjunction with the overhaul of the government's
fiscal condition. But in the interim, something of a barter system would
evolve. Even that, though, is something that may take six months to get
stabilized.
TGR: It's hard to imagine.
JW: In the Weimar Republic, you could go into a fine restaurant one
evening and enjoy its most expensive bottle of wine with a nice dinner. You'd
probably negotiate the price before you sat down, because the price would be
higher by the time you finished dinner. By the next morning, the empty wine
bottle would be worth more as scrap glass than it had been worth as an
expensive bottle of wine the night before. That's how rapidly things change
in a hyperinflation.
But we have a circumstance that did not exist in the Weimar Republic. Our
society is heavily dependent on electronic cash. Say you have a credit card
with a $10,000 limit. In hyperinflation, that $10,000 might be enough to buy
you a loaf of bread.
TGR: There's not even enough physical cash running around anywhere in
the United States that actually represents what goes back and forth
electronically. If you can't use your debit card, how do you pay for your
coffee at Starbucks? And how will companies and banks adjust?
JW: You're not going to have electronic payments that are in-barter
equivalent that I can foresee. That would be a fairly sophisticated system
and the needs are going to be immediate. When hyperinflation starts to break,
it can unfold in a matter of weeks, months. You'll need to be able to handle
things rapidly. Frankly I think the system will tend to break down. It's not
a happy circumstance. How will a small company get its goods to people? There
might be blackouts. Who's going to get the fuel to the power plants?
TGR: And to the gas stations for the cars for people who still have
jobs?
JW: Yup. It will get very difficult. Society won't run as we're used
to it. People will find a way, but it's going to take a little while for that
to stabilize.
In an electronic society it's going to take some creative thinking by
businesses. I'm sure some people will figure out some ways to accommodate
these changes, but it's going to be a painful, costly process that won't be
conducive to normal revenue flows—at least not as measured in
inflation-adjusted dollars.
TGR: I'm almost afraid to ask, but how will the stock markets fare
when the system breaks down?
JW: Stocks generally tend to reflect inflation, since revenues and
profits are in inflated dollars. If you look at stock prices adjusted for
inflation, you can have a bear market as well as a bull market. But these are
not going to be good economic times. So I think we're going to have a real
bad stock market adjusted for inflation. I'd stay out of stocks in the U.S.
With the U.S. markets in serious trouble, the rest of the world probably will
see lower stock prices as well, but they're not going to have the
hyperinflation.
TGR: What will plunge us into this abyss? And when?
JW: I think the odds are extremely high that we'll see it break within
the next year. I would put it six months to a year, outside. We're getting
extraordinary protestations from other central banks about the U.S. finances,
its solvency, risk of the dollar. Before the current
crisis you never would have heard any central banker making such comments. As
this breaks, it's going to be obvious that the U.S. is moving to debase its
dollar. It'll have no option to do otherwise. I would fully expect some
foreign holders looking to dump the Treasuries. With the dollar plunging, the
Treasury won't be able to get the funding that it needs from a practical
standpoint in the open markets.
The Fed will come in to salvage that situation, becoming the lender of last
resort to the Treasury—literally monetizing the Treasury debt. The Fed
might have a couple different ways to address the dollar situation, from
raising interest rates to direct intervention, slapping on currency controls.
I can't tell you exactly how it's going to go. But you'll have an environment
that's effectively creating a perfect storm for the U.S. dollar. I hate to
use the term but it's a good one.
Heavy dollar selling will be exceptionally inflationary. Oil prices will
spike in response to the weakness in the dollar. Oil is a primary commodity
that drives consumer inflation; that's how you can have inflation in a
recession. The traditional wisdom is that strong demand against limited
supply causes inflation, but you can also have inflation due to commodity
price distortions, which is what we had back in '73 and what we've seen over
the last year or so.
Most of the recent volatility in the CPI has been due to swings in oil
prices, which have been directly tied to swings in the value of the U.S.
dollar. About $7 trillion in liquid dollar assets that overhang the market
outside the U.S. could be dumped overnight. We're going to be seeing a lot of
pressure to accept that back in our system, and it will be very inflationary.
The Fed's options will be limited, but again I'd expect them to try and
maintain systemic solvency.
So what we end up with is a circumstance where the dollar is under heavy
selling pressure. People will feel the squeeze on their inflation-adjusted
income with much higher prices for gasoline and fuel oil. The route to the
monetary inflation will take hold from the Fed's direct monetization of
Treasury debt. As we discussed earlier, the mortgage-backed securities taken
off the bank balance sheets have generally gone to excess reserves and are
sitting with the Fed. That hasn't been inflationary so far because it hasn't
gone into the money supply.
TGR: How do we get through this, John?
JW: If there's no solution for the system—and I don't see one; I
think it just has to run its course—there still is good news. We as
individuals have ways of protecting ourselves, our families, our friends, our
businesses—whatever is important to us. To do that we have to preserve
the value of our wealth and assets in order to ride out the storm. As
terrible as it will be, it will end. A time will come when things become
self-righting and the people who have been able to survive will be able to do
some extraordinary things.
TGR: And what do you advocate in terms of individuals preserving
wealth and assets?
JW: Hold some gold, silver, precious metals. I'm talking physical
possession. Preferably coins because coins, sovereign coins, are recognized
as such. They don't have liquidity issues. Having some assets outside the
U.S., and certainly some assets outside the U.S. dollar, is a good thing. I
like the Australian dollar, the Canadian dollar, the Swiss franc in
particular. They won't suffer the same hyperinflation in Australia, Canada
and Switzerland as we do in the U.S., so those currencies will tend to act as
ways of preserving wealth. Over time real estate is a traditional store of
wealth, but it's not portable and sometimes it's not liquid.
If I'm right about what's going to unfold, a significant shift in government
is possible; suppose the government moved so far to the left where maybe
private ownership of property was not allowed. Having a lot of assets in real
estate under those circumstances might not be so good. I think generally real
estate is a good bet but you also have to consider the risks. Use common
sense. Think through different things that could happen.
Most importantly, build up a store of supplies, more than you would normally
consume over a couple of months, particularly food and water, canned goods.
Having those goods can save your life in a number of ways. You'd have food to
eat, and if you have extra you can use it to barter. I met a guy who'd been
through hyperinflation and found for purposes of the barter system those
airline-size bottles of high-quality scotch proved quite valuable. Buy things
that you would otherwise consume and rotate your inventory. Don't go out
buying all sorts of things you'll never use. Keep what makes sense to you and
your circumstances. Make sure you have things that are stable. Not too
perishable.
I had a professor at Dartmouth who'd lived for a while in a hyperinflationary
environment that devolved into a barter system. He told a story about how his
father had traded his shirt for a can of sardines. He decided to eat the
sardines, which was a mistake because they had gone bad. But nonetheless that
can of sardines had taken on monetary value. So when
you look to trade things you want to be careful what you're doing.
TGR: How long does a hyperinflation environment typically last?
JW: I guess it depends on how comfortable people can be in the
environment. It went on for a couple of years in Zimbabwe, but they were able
to function. Here, in a system that can't function well with it, it's not
going to last too long. You won't have a usable currency. It's likely a
barter system would evolve, and if it became stable and functioned well, it
could last for a while. People don't want to starve. If that's a real risk,
they will take action to protect themselves. We may
have rioting in the streets. The government might declare martial law. If
people can live comfortably with hyperinflation it would tend to linger. The
more difficult things are, the faster people will
move to remedy it.
TGR: Well on that note is there anything that we can do as voting
citizens to turn this around? Or minimize the impact?
JW: If things break slowly enough that people can see what's coming
and respond, tremendous change may result from what
comes out of elections. Incumbents are going to have a rough time. The
circumstance is open for the development of a major third party that could
knock out either the Republicans or the Democrats as a second party. Over
time, pocketbook issues tend to dominate elections. If things are going well,
if people are prosperous, they ignore the corruption in political circles as
being just part of the system. But when they're hurting, they turn out the
bastards and look to put in some change. We sure need change. I can tell you
that. It's not just one party. Both major parties have an equal share of
guilt in what's unfolding. Whichever one is in power keeps making it worse.
TGR: Not very happy thoughts, John, but we appreciate your insights
and look forward to talking with you again as we move through these trying
times.
Walter J. "John" Williams, is a Baby Boomer who has been a
private consulting economist and a specialist in government economic
reporting for more than 25 years, working with individuals and Fortune 500
companies alike. He received his AB. in economics, cum laude, from Dartmouth
College in 1971, and earned his MBA from Dartmouth's Amos Tuck School of
Business Administration in 1972, where he was named an Edward Tuck Scholar.
John, whose early work prompted him to study economic reporting and interview
key government officials involved in the process, also surveyed business
economists for their thinking about the quality of government statistics.
What he learned led to front page stories in the New York Times and
Investors Business Daily, considerable coverage
in the broadcast media and a joint meeting with representatives of all the
government's statistical agencies. Despite a number of changes to the system
since those days, he says that government reporting has deteriorated sharply
in the last decade or so. On the bright side, it keeps John and his economic
consultancy, Shadow Government Statistics (www. ShadowStats.com
) in the limelight. His analyses and commentaries have been featured
widely in the popular domestic and international media.
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