Hera Research Newsletter is pleased to present a fascinating interview with Martin
A. Armstrong, founder and former Head of Princeton Economics, Ltd. In the
1980s, Princeton Economics became the leading multinational corporate advisor
with offices in Paris, London, Tokyo, Hong Kong and Sydney and in 1983
Armstrong was named by the Wall Street Journal as the highest paid advisor in
a top currency analyst and frequent contributor to academic journals,
Armstrong’s views on financial markets remain in high demand. Armstrong
was requested by the Presidential Task Force (Brady Commission) investigating
the 1987 U.S. stock market crash and, in 1997, Armstrong was invited to
advise the People’s Bank of China during the Asian Currency Crisis.
on a study of historical gold prices and financial panics, Armstrong
developed a cyclical theory of commodity prices, which lead to the pi-cycle
economic confidence model (ECM), used to make long term forecasts. Using the
ECM, Armstrong predicted both the high-water mark of
the Nikkei in 1989, months ahead of time, and the July 20, 1998 high in the
U.S. equities market, as well as a major top in financial markets on February
27, 2007. The ECM was called “The Secret Cycle” by the New Yorker
Magazine and Justin Fox wrote in Time Magazine that Armstrong’s model
“made several eerily on-the-mark calls using a formula based on the
mathematical constant pi.” (Pg 30; Nov. 30, 2009).
Hera Research Newsletter (HRN): Thank you for joining us today.
Considering the Federal Reserve swap lines and the European Central
Bank’s (ECB) Long Term Refinancing Operation (LTRO), what’s the
outlook for the Euro?
Martin Armstrong: The structure of the Euro is
fundamentally flawed. To put it in American terms, it would be as if all
fifty states were able to issue federal bonds. It would be total, absolute
chaos. What they did, to be politically correct, was to say that, since every
member issues its own federal type bonds, they all have to be reserves and
the large banks have to fairly allocate among them all. It’s completely
crazy. As countries like Greece and Spain and Italy crumble under the debt,
it feeds back into the banking system. In the United States, we had the Long
Term Capital Management (LTCM) collapse and we saw the government bail out a
hedge fund so that they wouldn’t be seen bailing out the New York
banks. They have the same problem in Europe. Basically, the ECB bailing out
European banks is really going through the back door to support European
HRN: Would it be fair to say that the
bailouts of Greece have really been bank bailouts while the LTRO is a
sovereign debt bailout?
Martin Armstrong: Sure. The two words
“political” and “economy” should have been divorced
when they first met. Politicians always do this. In the U.S. Savings and Loan
(S&L) crisis, the politicians encouraged lending into local real estate
markets by allowing thrifts to be federally chartered in 1980 and insuring
them with public dollars. So the S&Ls concentrated their portfolios in
real estate. Then the politicians needed money so they reduced the schedule
for write-offs in real estate. And they didn’t think that would change
the market? They basically expanded credit for real estate, incentivized
S&Ls to invest in real estate, then passed the
Tax Reform Act of 1986. So then about a quarter of S&Ls went bankrupt and
they had an S&L bailout and wanted to lock everybody up when they had
created the problem in the first place. It’s the same type of thing in
HRN: European politicians created the European
sovereign debt crisis by rating all European sovereign bonds as reserves?
Martin Armstrong: Yes. By making all European sovereign
bonds reserves and requiring banks to hold reserves, they made European banks
hold the debt of countries like Greece and Spain. Greece, for example, was
able to borrow at substantially lower rates than they would have normally.
This year, €600 billion in debt has to be rolled forward only for Spain
and Italy. All these bonds were issued at a very low rate. Now they have to
be rolled forward and the new rates are around six or seven percent. The
government budgets are going to grow dramatically and this is going to cause
the real economic crisis.
HRN: Will the European Financial
Stabilization Mechanism (EFSM) help to solve that problem?
Martin Armstrong: No. I told them in 1997 or 1998, when
they were creating the Euro, that they couldn’t do this and they had to
have a single debt. They felt that it would be perceived as a bailout of
members that had more debt at the time. The EFSM, which is part of the
European Financial Stability Fund (EFSF), is moving in that direction but
it’s more of a bailout mechanism, not a consolidation. It’s a
half measure. They need to convert the existing debt into federal bonds and
whatever new debt is issued by European Union member countries would be the
equivalent of U.S. state debt and not acceptable for reserves.
HRN: Can the Euro survive?
Martin Armstrong: I don’t think it will go off the
boards. I think they will do everything in their power to keep it there.
Politicians never want to admit a mistake. If they have to inflate they will
inflate. Germany has capitulated.
HRN: Will this cause another financial
Martin Armstrong: The next crisis we’re going to
see will be from 2015 on. It doesn’t take more than a three year old
with a pocket calculator to see the long term trends.
HRN: Do you mean the European sovereign debt
Martin Armstrong: It’s not just the Euro zone. The
entire idea that you can borrow perpetually year after year and never pay
anything back and that, somehow, that’s less inflationary than if you
just print money is absolutely insane. In the U.S., if we had just printed
the money, the national debt would only be 40% as much as it is today.
We’re both creating currency and also paying interest on it.
HRN: Do you see Japan as having the same
problem as well?
Martin Armstrong: Japan’s debt is slightly below
300% of GDP. The only reason the yen has remained strong is because money is
being drawn back into Japan. I think we’re approaching a bottom in
Japan that will be followed by inflation and that will probably be the last
HRN: How would you compare the U.S. dollar
to the Euro and the yen?
Martin Armstrong: The U.S. dollar is the best looking of
the three ugly sisters. Europe is a basket case because of its structure.
They’d have to federalize Europe and I don’t think there’s
a political will to do that. Japan is totally hopeless at this stage.
HRN: Does this call into question the whole
concept of central banking?
Martin Armstrong: Central banks can step up and add cash
to the system when necessary, taking in the longer term assets. That was
basically the original idea of the Federal Reserve.
HRN: Isn’t the Federal Reserve System
the main reason why the U.S. national debt is so high compared to what would
have happened if the U.S. government issued its own currency?
Martin Armstrong: When the Federal Reserve was created
there really wasn’t any national debt. The U.S. national debt began
with World War I and then World War II. When the Federal Reserve wanted to
stimulate the economy it bought corporate paper not federal bonds and that
really did stimulate the economy. The politicians have completely distorted
what the Federal Reserve was supposed to be. In order to issue all the debt
for the wars, the politicians instructed the Federal Reserve not to buy
corporate paper but to buy federal paper. Throughout World War II they also
instructed that the Federal Reserve maintain the par value of those bonds.
HRN: Politicians altered the role of the
Martin Armstrong: When the Federal Reserve was created,
in 1913, it really was a kind of an insurance mechanism to help manage the
banks and it was owned by them. It wasn’t as sinister as many people
have portrayed it. It was closer to something like the Securities Investor
Protection Corporation (SIPC) or the Federal Deposit Insurance Corporation
(FDIC). It was World War I that changed the role of the Federal Reserve. They
came up with this theory that inflation was an increase in the money supply
and, since the Federal Reserve was in charge of the money supply, the
politicians basically said to the Federal Reserve that inflation was their
problem. The vast majority of the members of Congress don’t think they
have any responsibility for the economy. They throw their hands up in the air
and say “well, that’s the Fed’s job.”
HRN: Fractional reserve banking systems are
Martin Armstrong: Well, it’s really a leveraging
system. You’re increasing the money supply by taking the same money and
lending it out several times, so if I deposit $100 and the bank lends you
$100 we both think we have $100 but there’s only one $100 deposit. Take
the mortgage market where the Federal Reserve created trillions by buying
mortgage backed securities (MBS). The mortgage market contracted by maybe $5
trillion from the top. So, you have deleveraging at the same time. If the
Federal Reserve created $3 trillion when there was no deflation then that
would be inflationary, but, in this type of system, every time you get a
decline in the economy it’s deflation and deleveraging. In a deflation,
everyone wants cash so asset values fall. The cash is only a small fraction
of the total asset value at the peak. If Bill Gates sold all his Microsoft
stock at once it wouldn’t be worth as much as it is on paper.
It’s a yin and yang between leverage and deflation.
HRN: What’s the difference between
leveraging deposits to loan out $10 for every $1 on deposit and creating
money out of thin air?
Martin Armstrong: The current banking system that we have
in the world today is really a fraud. You used to pay the bank as a storage
facility to store your money but they began lending it out to make more
money. They figured out a long time ago that they only needed to keep 6% or
10% of deposits. When the economy goes down it’s a kind of a run on the
bank. But the real problem is that they borrow short term on demand deposits
and lend long term to make the spreads. When a crisis comes, their assets are
tied up for ten or twenty or thirty years but they’ve got short term
demand saying ‘give me my money now’. So the system doesn’t
really work on a perpetual basis.
HRN: Let’s talk about the gold
standard. Would it have prevented the European sovereign debt crisis?
Martin Armstrong: No. In the U.S., they could have kept
the gold standard but they had to raise the price of gold. They kept the
official price at $35 and went to a two tier system in 1968 where the free
market also had a price. They continually issued more paper but didn’t
change the ratio. They didn’t think, at some point, it was going to go
bust? Politicians always spend more than they have. We had a gold standard
and they blew it up. It’s “vote for me and I’ll give you a
chicken in every pot.” Nothing is funded. In the U.S., there has been
no planning for Social Security. It’s just politicians standing up and
saying “vote for me and I’ll give you this and that” but
nobody pays for it.
HRN: Do you favor returning to a gold
Martin Armstrong: We have to deal directly with the
government spending. Eliminate the ability to borrow. That’s more
important than what you are going to call money. In theory, what are they
trying to do with the gold standard? They are trying to say, if we put the
gold standard in then you can’t create money beyond what you have in
gold, but they did that the last time. I don’t see where that is some
sort of magic bean that’s going to stop them from doing it again. It
gets to a stage where it doesn’t matter if you use conch shells for
money or gold. There is no fiscal responsibility in government. We have to
eliminate the core problem and eliminate government borrowing except in time
HRN: Is that an argument for smaller government?
Martin Armstrong: Absolutely. During the Great
Depression, unemployment had only gotten up to where it is now but then we
had the Dust Bowl. It was what Schumpeter called creative destruction. It
started the American workforce on a path to skilled labor. Before the Great
Depression nearly half of the workforce was in agriculture. By 1980 only 3%
was in agriculture. We are facing the same problem now only 40% of the
workforce is in government. They produce nothing and don’t contribute
anything at all to the gross domestic product (GDP). Of course, the
government statistics include both the government’s spending and also
the wages of government employees, so, if the government hires someone, the
GDP goes up twice as fast.
HRN: That would suggest that the debt to GDP
situation is worse than it appears.
Martin Armstrong: Yes. The government basically finagles
every number under the sun. We’re looking at a very, very serious
situation. The only country that has funded its pension plan is Australia.
The U.S. has $60 trillion in unfunded liabilities. At the peak, in 2007, the
total of U.S. mortgages was $15 trillion. We are facing dire circumstances
ahead. This is why the government is going after what they call the rich,
etc. The rich now include anyone with household income of $250,000 or more.
If you and your wife both have a job that pays $125,000 per year you’re
part of the rich. Since young people are staying with their parents longer,
their income may be a part of household income too.
HRN: Isn’t that what’s left of
the middle class?
Martin Armstrong: They always bring out people like
Warren Buffett or Bill Gates but there aren’t that many of those people
and if the government took everything they had it wouldn’t even balance
the budget for a year. This is effectively a war against the American middle
class. The ceiling will start to cave in when they can’t sell bonds
anymore. At that point, the bond market will be absolutely devastated.
HRN: Do you expect the Federal Reserve to
continue monetizing U.S. Treasuries: QE3, for example?
Martin Armstrong: They are forced into monetization but
it won’t stimulate the economy. It isn’t only Americans that own
30 year bonds. Maybe the Chinese sell their bonds to the Federal Reserve and
then say thanks and take the money back to China. You can’t stimulate
just a domestic economy. The theories the Federal Reserve has are antiquated.
They’re based on the domestic economy and even on the old gold
standard. These are theories based on things that don’t even exist anymore.
Look at the universities. They don’t even teach hedging at the London
School of Economics. It’s amazing.
HRN: Do you think we’ll see U.S.
Martin Armstrong: No, because the economy would not
survive long enough to reach the stage of hyperinflation. Everything would
collapse before that happens. What’s important to understand is that
Americans tend to focus on American numbers but Europe is in far more serious
trouble. A lot of the European banks are still owned by the governments.
HRN: What can the U.S. government do to get
the economy back on track?
Martin Armstrong: It’s hard to get them to do
anything that’s actually going to be beneficial to the economy. They
don’t get it. There are also record highs in terms of corporate cash in
the U.S. because the politics are so bad.
HRN: What is it that members of Congress
Martin Armstrong: I testified before the House Committee
on Ways and Means in 1996 and they wanted to know why no American companies
had gotten any of the contracts to build the Yellow River dam. I said that
the U.S. and Japan are the only countries in the world that tax worldwide
income. We hear about companies paying their fair share, but if they’re
not in the United States, what is a fair share? As far as the U.S. government
is concerned, you’re an economic slave. If you’re born in the
United States, you owe taxes in the U.S. even if you’re not in the U.S.
and don’t receive any benefits. Other countries don’t do that. A
German company, for example, bidding on the same contract in China is
automatically cheaper than an American company.
HRN: Are you saying that the U.S. federal
government’s tax policies have driven companies offshore?
Martin Armstrong: In order to compete internationally,
American companies have to leave the United States. It isn’t just
because of the labor costs because you have to have a skilled labor force. I
helped take a lot of companies into Europe. You have to balance the type of
labor force versus tax advantages. You can’t just put an automaker in
Zimbabwe. It’s much more of a delicate balance than what politicians
tend to say.
HRN: Is there anything that policymakers can
do to bring companies back to the U.S.?
Martin Armstrong: One of the primary things is that the
tax rate should be cast in stone and it should not change for every election.
That is why corporate cash is at record highs. Why should a company start to
hire people when all you hear is “we’re going to get the
rich”, “we’re going to get the corporations” and
they’re going to have to pay more. This is why corporate cash is at an
all time high. Why should you start hiring people now and then next year you
might have to pay 20% more? You can’t do things that way. No one, on a
personal level, would go sign a lease on an apartment where the lease said
the landlord can change your rent at any time he wants if he spent too much
money for himself. A contract is a contract and you’re not going to
have stability until you have something set in stone. A lot of countries have
attracted capital by doing precisely this. If you go there and set up a
plant, they guarantee not to increase taxes for 20, 30, 40 years. If
you’re going to do a business plan then you need to know what your
costs are. It can’t be maybe $1 mill this year and next year it’s
25% more. Business plans don’t work like that. The politicians need to
just cast it in stone and that’s it; take it off the table. Stop the
rhetoric. They’re not going to create jobs without that. Why should anyone
build a plant in the U.S. if the government can change everything in 6
months? That’s not the way to build an economy.
HRN: So, uncertainty is one of the main
problems with the U.S. economy?
Martin Armstrong: The major problem is the whole debt
structure. Uncertainty is why cash is at record levels and it’s been
that way for at least 2 years now. Lack of stability dampens confidence. In
order for somebody to invest, there has to be confidence. This is why
interest rates can go to 0%, but if you don’t think you can make 1%
then you’re not going to borrow at 0%. Interest rates always go down
dramatically during a depression because no one is willing to borrow. There
is a lack of confidence in the future, so you’re not going to have
somebody opening a new restaurant or hiring a bunch of people. Small
companies, in particular, are not hiring because they can’t get a loan
from a bank. They’re cut off more than a large company. A large
company, if it’s public, has shares and banks will lend more against
them then they will against a small business owner. Small businesses create
the most jobs but they get bashed the most by the banks and they are less
likely to hire because they can’t borrow to do so.
HRN: What else should the U.S. government do
to get the economy back on track?
Martin Armstrong: The government has to stop the
perpetual borrowing and we have to really deal with the national debt. It
would have to change the tax policies and they would have to cast it in stone
that it can’t change. It can’t flip back and forth for every
election because when you do that then you are undermining confidence. Why
should somebody build a plant or hire more people until after the next
HRN: How can monetary policy help?
Martin Armstrong: As soon as something happens the
politicians throw their hands up in the air and say it’s the Federal
Reserve’s fault. It’s not the Fed’s fault. The politicians
are the ones actually doing the spending. The Federal Reserve can’t
control Congressional spending. There’s not much it can do to change
the dynamics of the problem. The Fed can seize any company it thinks is too
big to fail, so now we’re outside the scope of banking. They can seize
Ford Motor Company if they want to. We are so far from what the Federal
Reserve was supposed to be, it’s just insane. It wasn’t supposed
to be in charge of the money supply. It wasn’t supposed to be in charge
of inflation or bailing out companies that are too big to fail. It was never
designed to do this, it was simply there as an insurance fund for banks,
period. The Congress assumes they have no responsibility. Nobody takes
responsibility. It’s just one big party down in D.C.
HRN: Thank you for your time.
Martin Armstrong: It’s my pleasure.
Armstrong, founder of Princeton Economics, Ltd. is one of the most sought
after experts in the world on financial markets, global capital flows and
currencies. His frank assessment of the monetary and economic problems facing
the U.S., the EU and Japan today points to government spending, tax policies
and meddling in the banking system by politicians as the root causes. The
solution starts with cutting government spending, instituting consistent,
long term tax rates and tackling the real reasons why American companies have
moved offshore. Without fundamental changes, out of control spending, failure
to take responsibility, lack of accountability and crippling uncertainty will
prolong poor economic conditions and high unemployment indefinitely.