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Peter Schiff, who was famously ridiculed for
calling the crisis of 2008, steps up as a prognosticator again in his new
book, The Real Crash: America’s
Coming Bankruptcy - How to Save Yourself and Your Country. We had way too much government and cheap credit
leading up to 2008, he says, and even more government and cheap credit since
then, which is why the next crisis will be the real haymaker.
His book is divided into two main sections. Part I addresses the problems,
while part II, which is by far the lion’s share of his discussion,
presents solutions. In a nutshell, the problem is government, and the
solution is to take an ax to it - again and again. Since this view is
currently unacceptable to policymakers and the public at large, we can only
hope reality will win out before calamity hits.
The Real Crash is encyclopedic in its coverage and highly readable in
its presentation. Is there a government agency that truly serves the
interests of all Americans? He finds few. What about services people actually
want, such as K-12 education: Could they be done better at the state or local
levels? Or better still by the free market? In most cases the answer is a
profound “Yes!” to both.
Living on Bubbles
Our problems stem from a love of bubbles and the flawed economic theory that
blesses them.
During Alan Greenspan’s reign at the federal reserve we had a savings
and loan bubble, followed by a tech bubble, followed by a housing bubble. Now
with Ben Bernanke at the Fed, we have a government bubble, meaning the Fed is
creating money that the banks are then lending to the Treasury to expand
government. “If you keep replacing one bubble with another, you
eventually run out of suds. The government bubble is the final bubble.”
When the dot-com and housing bubbles burst we at least had something to show
for them - “a few good Internet companies and some pretty nice McMansions, [but] no such benefits will remain when the
government bubble pops.”
The Fed, Schiff says, should let interest rates rise so people can start
saving again. The Fed’s low rates discourage savings, which are
the key to
economic growth, as it finances capital investment, which leads to job
creation and increased output of goods and services. A society that does not
save cannot grow. It can fake it for a while,
living off foreign savings and a printing press, but such
“growth” is unsustainable— as we are only now in the
process of finding out.
But for politicians and central bankers, rising
interest rates are an abomination. The cost to service the national debt
would go through the roof, while the economic
contraction that would likely result would raise the deficit. The federal
government would have to spend less, and many of the country’s biggest
companies depend on government spending, through contracting, subsidies, or
consumption.
But rising rates and the terrible pain it would cause is the good news; the
bad news, if the Fed continues to hold rates low, is the economy will
eventually go into hyperinflation. “Rising interest rates will be
productive pain— like medicine,” he writes, “while
hyperinflation will be destructive pain.” If we stay the course and
pretend everything will somehow work out, we could be facing a crisis worse
than the Great Depression.
Bernanke on the Great Depression
Chairman Bernanke, of course, is well-known as an “expert” on the
Great Depression, and many people are betting the farm that he and his
Keynesian staff have the skills to steer us back to sunny beaches and
bikinis. Bernanke’s approach is to keep asset values from falling by
any and all means. One of the reasons the depression of the 1930s became
great, he believes, is because the Fed allowed the money supply to fall following
the Crash. With less money in the economy, prices nosedived. People
didn’t consume as much, consequently businesses didn’t profit as
much, therefore employees got fired, and the economy headed south in a
self-perpetuating spiral.
“Sustained deflation can be highly destructive to a modern economy and
should be strongly resisted,” Bernanke said in a 2002 speech that
inspired his nickname. And by deflation, he means “falling
prices.”
Schiff explains what’s wrong with this analysis.
First, for 100 years prior to the 1929 Crash, bank deposits actually gained
value each year. In other words, we had a century of deflation, that
much-feared condition that Bernanke has vowed to avoid at all costs.
Second, from mid-1921 to mid-1929, the Fed increased the money supply by 55
percent, giving rise to a real estate and stock bubble. Most but not all economists missed
the bubble and its inevitable consequences because rising productivity kept
consumer prices fairly stable. Even as stock prices were falling only days
before the Crash, Irving Fisher said stocks had reached a “permanently
high plateau,” and he expected to see “the stock market a good
deal higher than it is today within a few months.” In 1928, Ludwig von
Mises had published a full critique of Fisher’s monetary theory,
claiming that Fisher’s reliance on price indexes would bring about the
Great Depression. Nonetheless, Fisher’s stable price theory carried the
day, and when the sky fell the Fed, along with Hoover, “did
something,” as Schiff explains:
Hoover’s Fed actually boosted the money supply
by 10 percent in the two weeks following the 1929 crash. Repeatedly
throughout Hoover’s term, the Fed created more money. But the money
supply fell because people began hoarding cash, and banks stopped lending out
their money.
Also,
Deposits went down by 30 percent, but most of that
was due to people pulling their money out.
In other words, the money supply shrank despite the Fed’s
interventions, not because of its inactions.
Did a falling money supply promote massive
unemployment?
Not by itself. Hoover insisted on keeping wages high, and during his
re-election bid in 1932 boasted that the wages of U.S. workers were
“now the highest real wages in the world.” They probably were,
and by not allowing wages to fall along with other prices, unemployment
soared.
Had Hoover simply allowed the free market to
function, the recovery would have been so strong that he likely would have
been elected to a second term, and Teddy would have been the last Roosevelt
to occupy the White House. Instead he handed the Keynesian baton to Franklin
Delano Roosevelt . . .
None of this, as we know, is even close to the
standard view of the Depression. Instead, we’re
told
that
government needs to play a bigger role in battling downturns, and the Fed
needs to pump in cash to jump-start the economy. This bad lesson stays with
us today, and beginning in the early 1990s, this way of thinking started the
cycle of bubbles that put us where we are now
End Keep the Fed
The one puzzling part of Peter Schiff’s masterpiece is his view that
the federal reserve, as originally conceived, was a good idea. He describes
the Fed as “reckless,” the “biggest culprit in discouraging
savings,” and insists “we never should have trusted the Fed to
respect its boundaries.” But
he also says:
The original intention of the Fed was something I
might have supported had I been around back then. In theory, it was an agent
of stability that could also promote economic growth. . . .
The Fed would increase the money supply as the economy expanded, and then
reduce the money supply as the economy contracted. . . .
In theory the Fed was a good idea. It’s just that in practice it did
not work, because politicians quickly abused it.
He argues that before 1913, banks were issuing their
own currencies backed “by assets, such as gold, and by the banks’
loan portfolios.” If “you traveled to California, your bank note
from Connecticut might not be honored by other merchants or the California
banks.”
Thus, he concludes, it was natural “for bankers to hatch an idea of a
“banks’ bank. Banks could deposit some of their assets—
commercial paper or gold— with the Fed, and the Fed in return would
issue its own bank notes to the individual bank.”
While this may sound plausible, questions arise as to (1) why the
“banks’ bank” needed “guns and badges” (i.e., government cartelization) to make it work; (2) why loan portfolios or
commercial paper can be assumed to be an acceptable substitute for gold coin;
(3) why a central bank is needed to expand and contract the money supply - in
other words, why assume the supply/demand relation of the free market fails
when the good in question is commodity money; (4) why the historical record
of central banks acting as an agent of stability and sustainable economic
growth is short on examples; and (5) why did the Fed, at its creation, possess a massive inflationary structure if
it was sold as a means to promote stability?
I believe central banking, by its nature, is a means of institutionalizing,
centralizing, and cartelizing moral hazard. It is my view that the Fed was
never a good idea, but one of the absolute worst ever brought to fruition.
These concerns notwithstanding, his critique of the Fed as it currently
exists is emphatically on the money. Though he doesn’t support its
abolition he does say, “In an ideal world, there would be no Fed, and I
think the nation would be better off if the Fed had never been
created.”
How we can save ourselves
Readers of his book don’t have to be swept up in the impending
disaster. Unlike the crash of 2008 when investors flocked to the dollar as a
safe haven, he believes the dollar and U.S. bonds will collapse before the
U.S. economy goes under. He devotes a chapter to crisis investing based on
the observation that since Americans have been living beyond their means,
many others have been living beneath their means.
Elsewhere in the world there are more creditors than
debtors, and there is pent-up demand and excess production. In the future,
these economies will see a surge in demand, while ours will see demand fall.
. . .
Bottom line: purchasing power is shifting. You should try to invest in
companies that will benefit from this shift. These will primarily be foreign
companies. Of course, many foreign companies sell to the United States. These
aren’t the businesses I’m talking about.
He describes his investment strategy as
a stool with
three solid legs: (1) quality dividend-paying foreign stocks in the right
sectors; (2) liquidity, and less volatile investments, such as cash and
foreign bonds; and (3) gold and gold mining stocks.
Of particular interest to this reader was his
section on the poor man’s investment strategy. If consumer prices head
for the moon the government will likely impose price controls, thereby
creating shortages. Solution: buy in bulk now and stock up. One advantage is
that
any returns are
tax free. For example, if you buy a box of cornflakes today and eat it two
years from now when the price of a new box is 40 percent higher, that’s
a 40 percent tax-free return.
His writing is full of fresh and sometimes bold
insights on long-standing issues. Readers will find his discussions on drug
prohibition, marriage, abortion, guns, health care, and prostitution
especially engaging, I believe. His detailed historical and legal discussion
of the income tax is the best I’ve ever read, nor does he pull punches
in describing it:
It’s hard to imagine a tax more destructive of
productivity, more destructive of entrepreneurship, more destructive of our
lives, more difficult and costly to comply with, more subject to gaming, or
more absurd in its logical consequences. Congress should immediately, fully,
and permanently abolish the income tax, and the Internal Revenue Service
(IRS) along with it.
He would replace the tax with a revenue-raising
tariff on imports.
Yes, tariffs suck. But they suck less than income
tax. In fact, they might be preferable to a national sales tax.
Conclusion
Peter Schiff has written a riveting guide on what to do about our snowballing
social, financial, and economic problems. Inasmuch as he recommends freeing
people from government, his solutions are far from pain-free and consequently
will not be popular with the political class or their dependents. Well,
it’s time they got over it. As Schiff writes in his introduction,
it’s as if we’re headed down an icy hill with politicians in the
driver’s seat accelerating toward the bottom.
We need a grown-up to grab the wheel and steer us
into the ditch on the side of the road. That won’t be pretty, but
it’s better to go into the ditch at 80 miles an hour than crash into a
brick wall at the bottom of the hill at 120.
The Real Crash is a
must-read.
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