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January 19, 2008
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to the Next Depression, Part 1
JOHN: Remember in our opening show of the year, Jim, you made a number of forecasts. One was going out to 2010, whereby you forecast another depression. So what we're going to do today is to start a four-part series laying out the case of why, if we continue on the track that we're on right now, the US is headed into a depression.
So the first thing we should do is frame the issue, set the stage and give our listeners some background material on why you believe we are genuinely heading into, not a recession, but a depression.
JIM: Let's talk about setting the background for this kind of a forecast. And by the way, John, we're not the only ones that see this happening. There are a number of individuals, Harry Dent being one of them, he's basing it on demographics. Other people are basing it on debt. So we're not out there just by ourselves, but there are a few of us that see this happening. But what I want to do is discuss why it's going to happen, the policy mistakes that were made, let's say, going back to the last depression and then draw some parallels to the same mistakes that are being made today.
And if you're listening to this broadcast and would like to follow along with us over, let's say, the next four weeks, you can pick up a copy as a good background book on the Great Depression is Murray Rothbard's America's Great Depression. Probably one of the best books ever written about this calamitous event. [1:41]
JOHN: I think it's important too to understand that there never should have been a great depression. This is something if you talk to people who lived through the period, I’ve talked to my mother extensively about it. I wanted to see what it was like to be in that time. She was 14 years old in 1929 when the stock market blew out. What was a market correction and a recession –which is interesting, by the way, a number of the voices on the air on radio around the country today were saying, you have to let it happen, you have to let this blow off or you won't do anything – but what should have been a market correction and a recession turned into a depression (and really what was a great bear market), generally by the policy mistakes made by politicians, both Republican and Democrat.
JIM: That's the surprising thing and we'll get into, for example, the Hoover administration and the New Deal, and then we'll fast forward to where we are today. But the amazing thing, and there are some parallels here, we had a very explosive bull market in the 20s. The economy was growing rather strongly especially with the technology wave that the country was experiencing. Think about it; we had the automobile, we had electrification of homes and cities. We had the airplane, we had radio, talking pictures, all of this great technological innovation that was coming in at the time. So a stock market correction (given the huge rise in stocks that we saw during the 20s) was way overdue. And the economy had slowed down significantly, John, by the summer of 1929 as a result of the Fed rate hikes that began in 1928. Especially after Benjamin Strong had passed away and we got a new Fed chairman that came in.
So a stock market correction, maybe a small bear market and a recession was inevitable given the run up and some of the excesses that we had seen in that time. It was what the Hoover and the Roosevelt administration did that turned this correction and a recession into the Great Depression. [3:45]
JOHN: It's really important to explain the cleansing process for people because when you distort the economy, which is what happens on these cycles, the economy becomes distorted and at some point it tries to correct. And what politicians will typically do is to fight that correction, which never succeeds ultimately; it only gives a little more prolongation of the inevitable. But the country experienced one in 1920 as the government balanced its books after the end of World War I. That was supposed to be the ‘war to end all wars,’ remember.
JIM: Yeah. Business and stock market downturns serve an essential economic purpose. They need to be sharp, but they don't need to be long and that's very key. What they require is on the part of government, business and the public is patience. Had the recession had been allowed to adjust itself, just like in 1929 recession, it would have ended, John, probably within a year. Confidence would have returned, the markets would have recovered and the Great Depression never would have occurred. But you know, politicians today and back then are, like, everybody knows if you go on a drinking binge, you're going to have a hangover. And the hangover is your body trying to get rid of the toxins of the alcohol and cleanse itself so the body can recover. But what we do today is rather than let the economic body recover, we give it more alcohol and keep it juiced up because we don't want to go through a hang over.
JOHN: Right. But if they had, the Great Depression would never have occurred. I mean that's the important thing to understand. It would have corrected, it would have come back out of that. But as such we prolonged it for another 10 years, actually until World War Two broke out.
So if we look at the situation then and now, history doesn't repeat itself, but it does rhyme, we seem to be singing off the same music sheet.
JIM: The one common thread between the 1920s and 1990 and where we are today, the parallels are excessive money and credit expansion in the 20s, which made the economic and stock market boom more robust than they otherwise would have been. So this led to excessive valuations in the stock market and in the economy. And what did we see in the end of the 90s with all of that money printing and the excess money creation is stock valuations got excessive, the internet craze. And so similar to the gains that we saw in the economy in the 20s, similar to the gains that we saw in the US economy in the 90s, we also saw similar attributes: The technology boom spurred on by massive money and credit expansion; like 1928 and similar to 1999, the Fed began to drain the punch bowl through a series of rate hikes to bleed off the excesses. They did it in 1928 to 29. We did it once again in 1999, in the year 2000, and then we began and did it again through 2004 and 2006. [6:47]
JOHN: So as the Fed did this both in 28, 29 and also in 1999, 2000, remember how the market went flat right in the middle of that presidential election. As a matter of fact, the stock market will correct during this time, the economy goes into recession and then it begins to cleanse itself by getting rid of really what are artificial excesses. But that always means economic pain and there is the political issue. So rather than experiencing the cleansing process, politicians begin to meddle with the cleansing process because the government, business and voters don't really have the patience for the cleansing process to just heal where they are at and go for another round of prosperity. They want the prosperity to continue all the time.
JIM: You know, you are exactly right, John. The slide in stocks, the free fall in the economy continued in 1929 and 1930s, not because the government interfered too little, as many experts would claim, but just the opposite. It was because it interfered too much. Hoover began to micromanage the economy, and remember, this is a guy that came up through the 20s managing relief schemes and he began to immediately meddle, order and exhort all kinds of schemes. In fact, many of those schemes only made matters worse, so by 1932, the Dow lost 90% of its value, the economy had gone from a recession to a depression for which basically Hoover lost the election; but the New Deal program was nothing more than a continuation of the Hoover programs. [8:25]
JOHN: Yeah. It's sort of an irony of history because Roosevelt ran against Hoover as a tax and spender, but essentially, the New Deal just perpetuated Hoover's programs; and then added on to that, Roosevelt is calling it a goal to try to finance parts of the New Deal, which was a raw deal really for people who had the gold.
JIM: Absolutely, because he immediately took it and revalued it. But here is the thing. The difference is two fold. Roosevelt actually came in, spent more money, raised taxes even further, but I think he was more successful in many ways because he managed the public relations much more effectively. The real tragedy of the Great Depression was that it wasn't a failure of capitalism, but it was a failure of a hyperactive state, as many people acknowledge today. It would take a world war to pull us out of that recession. The New Deal programs were a complete economic failure. They only made the Depression worse and prolonged it. What started out as a recession and a bear market correction turned into the largest selling wave that we've seen in the history of the markets. I forgot get what unemployment figures were, but wasn't it like almost 25% or 30% of the nation was unemployed? [9:38]
JOHN: Yeah. Somewhere between a quarter and a third depending on where you sampled and when.
JIM: Yeah. So why work? I mean tax rates got up to as high as, I believe it was 94%. Why work? And that's what the rich did is people quit investing. They quit making capital investments. A lot of people just simply put their money in tax-free bonds and rode out the depression collecting tax free checks. Why would you want to invest capital when the government takes 90% of what you make, not counting what the states were taking at that time? [10:23]
JOHN: Yeah. So if we run a mental clip of where we are today, the tech boom bust, if you recall it happened toward the end of the 90s, was followed by a massive amount of money printing. And it should be pointed out, the tech boom really sort of goosed us through the 90s; didn't it? After the Reagan cuts sort of wore off, remember Bush I increased taxes, Clinton increased taxes, and then what coasted us through that was really this extra boom that we experienced with the tech boom; right?
JIM: Well, it was not just the tax increases. They countered the tax increases. If you look at a graph of M3 before they stopped publishing it, take a look at where it starts to spike up, which is in November of 1994 all of the way to the year 2000. The money supply just began to grow at rates twice the economic growth rate. So the tax increases were countered with money printing and the outlet for that money printing became the stock market, which gave us the tech boom. [11:15]
JOHN: We had the tech boom. That was followed by massive money printing with Greenspan slashing interest rates from 6.5 to 1%, and then that gave us the real estate and the credit bubble which coasted us into the (or drove us really, it's more than a coast), drove us, into the early part of this century after we came around the turn of the Millennium. And the subprime mess, which we're dealing with right now, was the result of that. Instead of allowing these excesses to cleanse, they are back at it again and they are going to tinker with the cleansing process. Obviously this is an election year, there is no tolerance for pain; the public, if you talk to them, don't understand why we are where we are and there is a lot of flack and noise in the system that actually prevents them from understanding that.
JIM: Yeah. I think the choice that we're facing because we keep postponing and postponing and postponing –we've been doing this for nearly three decades now – so \what we're facing are two choices: 1) either a massive deflationary 1929 type depression to cleanse out all of the debt, get rid of it; 2) or a massive inflationary bail out by the Federal Reserve and the government. So what we are going to be seeing in our future is not what occurred in 1929, but an inflationary depression of massive proportions. I mean just take a look at, and we'll get into this later on in quackonomics, but all you have to do is just pick up the headlines. What are they talking about that? What do you see coming from the Fed and coming from politicians. The Fed is talking about monetary stimulus (and substantial monetary stimulus); politicians are talking about bailouts and substantial fiscal stimulus. So we've now embarked on what I call the road to perdition. [13:09]
JOHN: Well, I guess anybody who has been condemned to hell, it reminds me of Dante’s Inferno; right? Is there any way of avoiding this path at this stage? Could we stop it?
JIM: No. I don't think there is anything that can stop it. You just take a look at the debt levels, both at the consumer level, the government level, the state level, from Washington to Wall Street, basically quackonomics is the prevailing economic philosophy. And that's our new word for economic philosophy as practiced in the US. It's this quackonomics that's driving our economy. It's taught first at our universities, and then those that graduate get jobs go to work in government or the private sector, then it's practiced on Wall Street and in Washington. So conventional economics, John, is basically bankrupt. [13:57]
JOHN: Okay. So basically what you're saying is we're condemned to walk this path. There is no hope.
JIM: Not unless we are going to restore the free enterprise system, allow the market to function unencumbered by government interference. Also, we need to place a limit on the chronic expansion of the money supply by the Federal Reserve. That's what gets us these big booms and busts. So you need to go back to honest money. You need to keep the government from debasing the currency. Just listening to government and Wall Street speak and you know that isn't going to happen. And unlike 1929, today there are no limitations in terms of the amount of money the government can spend and print. So this process needs to be carried out to its logical conclusion. Either we allow the debt to collapse and deflate, or we inflate it away. I'm betting on inflation. [14:52]
JOHN: Well, you must admit, history backs you up. In other words, each time a government has ever gotten into this condition, the response is always the same. Let's face it. We're in the silly season. We're just under 300 days here to go until the elections. And the next topic sort of in the Big Picture, the tables have turned rather quickly. Remember we were saying at the beginning of the year and coming out of the last year that suddenly we were going to see radical changes in what the topics of conversation were going to be as these things washed across the candidates. And that's what we're seeing: We've gone from worries over inflation to worries over recession. Even the Democrats have changed their tune from draconian tax hikes and ‘let's get big business’ to tax rebates. And it's amazing when you look at how quickly the presidential debates have changed. Now the R word, recession, is drifting through the air. To rephrase, we're 290 days away from the next election, only less than 12 months away from that crisis window we've been discussing here on the show which spans over the years of 2009 to 2012. I had somebody call me this week and say, “well, I think that stuff may all happen earlier.” And I said you need to understand this is a window in which a whole series of factors are all coming together. You can't quite predict where inside that window they are going to collide. We just know that's the window.
JIM: Yeah, what is an irony here of history is that a man who did his PhD thesis on the Great Depression will actually preside over the next Great Depression. Bernanke is going to have a chance in real time, John, to prove his thesis of a great depression can be avoided by massively printing gigantic amounts of money and debasing the currency. Every time I see him testify before Congress or hear him speak, you know, I immediately get this compulsion within me to go out immediately and buy gold and silver.
Just think of it this way: When you see him on TV, start thinking gold and silver. [16:45]
JOHN: Yeah. There are classes for that by the way, “hi, my name is Jim Puplava.” “Hi, Jim.” “I'm addicted to gold and silver.” “How long have you been troubled with this?” All right. So this is going to be a four-part topic we said we would do over the next few weeks. Where do you think we're going to take this? This is stage one. We framed what the issue is and where we're headed and then where will the series take us?
JIM: Next week, we're going to cover the business cycle, how it works and then we're going to cover the Keynesian response, both the 1929 depression and what our fellow politicians and Wall Streeters are advocating today. Our politicians are leading us right down the same path, committing the same mistakes. If you want to follow us through this process, once again, I recommend you pick up a copy of Murray Rothbard's book. It's called America's Great Depression. It's one of the best books written on that subject. It's going to give you a lot of insights as to what caused the Depression. You'll see a lot of parallels to what's going on in the economy today and it’ll give you some insights in terms of where we're heading. [17:52]
JOHN: So if we had to sort of do a barometer here and your weather forecast with a percentage of probability level, how confident are you that we're actually going to experience another Great Depression? As seen right from now because things could change, but we're saying here is where we're going on this course.
JIM: I would say over 90% confidence. About the only thing I think they can do is perhaps delay its arrival by a year or two depending on what happens in the elections in November. So possibly a delay, but in terms of its eventuality, 90% confidence it's going to happen. [18:30]
JOHN: So basically we're there, we can't avoid it and I'm assuming at some part in the future part of the series you're going to tell us why we need to put our seatbelts on and how we're going to survive the hard landing; right?
JIM: Yeah. Like I said, you might want to make a run to Costco. But this year I expect, believe it or not, as grim as things look right now, I'm optimistic in terms of the outcome this year. What happens after November, like I said, our theory this year is the Oreo: Hard dark outer shell in the first quarter and fourth quarter of the year with a creamy filling in-between. [19:02]
JOHN: Well, it seems like bad language has now assumed the definition of a nine letter word. Everywhere today, you're hearing the R word, recession, which is really ironic because if we just kicked this back six months, this was not in the air; was it? I don't remember hearing it much at all on the talkies.
JIM: No. It was going to be the goldilocks, the soft landing theory, and as you know, John, even like this week's plane landing in Heathrow, these landings are never soft.
JOHN: Well, there is an old expression in flying. Any landing you walk away from is a good landing. A great landing is one where you can reuse the airplane, unlike the landing at Heathrow.
Anyway, the politicians are worried about recession and you mentioned last December in our first program of the year a couple of weeks ago, the Oreo theory of 2008: sort of hard and crunchy on the outside followed by a creamy center – which you usually lick off and eat with milk; that's sort of a ritual – and then it's going to be hard and crunchy as we get to the end. So let's look at what this cookie looks like for the year.
JIM: Well, let's begin with the write downs, which we knew were coming. We saw them last year. We're getting more of them this year. By the end of the third quarter of last year, I think we were up to about 100 billion of writedowns. Now we're getting the next 100 billion. You saw it this week with Citigroup writing down the value of their subprime investments by 18 billion. They are also setting aside 5.2 billion to cover loan losses for home equity loans, auto loans and credit cards. Remember we talked about two of those risks? Also we saw this week, Merrill Lynch wrote off 9.9 billion of its CDOs or collateralized debt obligations, have written off 1.6 billion on its subprime, and then 3.1 billion on exposure to shaky bond insurers. It amounted to roughly about close to about 17 billion. I think they were anticipating 15, so that was higher than expected. That rattled the market.
Other institutions, John, are going to follow as we see writedowns of another 100 billion or so this quarter, or 100 billion for the fourth quarter, that is. So expect more of these writedowns in the first quarter as we move to take that even into the second quarter, you'll continue to see these write downs. But the write downs are going to accelerate, but this is part of that cleansing process that we talked about in the first hour. We should be a good deal through that process by the end of the first quarter with about maybe another 200 billion in writedowns coming the rest of the year. [21:43]
JOHN: Well, we know the write-offs are going to just get worse. Especially as more subprime mortgages get reset. I mean that's in the mill and it's in process right now. What about other bad stuff? Is there anything else out there waiting to spring upon us some dirty laundry out there?
JIM: Well, what are we seeing all of this week? We saw the politicians talking about an economic stimulus. The President came out Friday after coming back from his Middle East trip. You've got Congressional leaders meeting and talking together. So we know that a slow down in economic growth is the other thing that we're going to hear a lot about. We saw a little over a week ago, the ISM numbers went below 50 indicating the manufacturing economy’s contracting. And we're also going to see some GDP numbers. We know that GDP slowed in the fourth quarter. The unemployment rate jumped up to 5%. And there is probably going to be a little bit more than that: The Bureau of Labor Statistics is also going to be making its adjustment to its birth-death model this month, so look for them to report the job market wasn't as robust as originally reported last year.
So I expect to see much lower economic numbers for the fourth quarter of last year, and for those numbers to get even worse in the first quarter and the second quarter of this year. That's one of the reasons why they are scrambling right now because I don't care if you're a Democrat or a Republican, if economic conditions in your sector of the world are deteriorating, you don't want to be seen like you're not doing anything. So if you're a Democrat and your area is hit very hard on the economy side, you can get thrown out of office; if you're Republican, the same thing. So that's why you're seeing this bipartisanship because the wrath of the voter at the polls in a recession is not something that politicians want to face. So that's why they are scrambling right now.
And one of the key things they keep talking about is the stimulus package needs to be quick and immediate because they know that we're heading into a recession.
So, as I said, I expect to see that the numbers will get worse in the first and second quarter of this year and that's why they are going to have to come up with, you know, unless they come up with some miracle statistical adjustment that hides these facts. For example, last year we saw a weak first quarter of last year, and then the economy picked up in the second and third quarter as a result of the lowest inflation rates since Eisenhower was president. So maybe we get, I don't know, Woodrow Wilson inflation rates or something. But this is an election year, so, you know, they are going to play a little bit fast and loose with the economic and inflation numbers. And that's why you're going to be hearing in just a moment from John Williams in Other Voices on what's really happening with the money supply because there is a lot of disinformation out there saying, “the money supply isn't really growing.” Well, it's growing at over 15%, the highest level of increase in the money supply I think in history. [24:49]
JOHN: And part of this game too, by the way, is for each party to take credit for the bailout or the rescue, so to speak. So not only do you have to arrange a rescue in the midst of all of this, then you have to be sure that the credit, of course, goes to the right party making the right decision there, and who the right target people are, say, for these rebates that we're talking about that.
So we've got financial writedowns, the economy is heading into a recession, we've got both the Fed and politicians talking about doing very silly things. Okay. Anything else that might give us a Maalox moment here along the route?
JIM: Well, this sort of goes along with the economic numbers: When the economy begin to slow down, concomitant with that economic slow down is a slow down in corporate earnings. And we're heading into the Q4 earnings season. They are going to be upon us next week. Now, the good news is recently analysts have been slashing earnings estimates before the companies start reporting. So they have moved the profit bar considerably lower. It's kind of like, picture a pole-vaulter. We started out the bar is set at 10 feet. The analysts have lowered that bar down to three feet, so there shouldn't be any major surprises on the earnings front. We even had, for example, in the Friday we're talking, GE came out and announced their profits increased by 15% as a result of international sales. So I don't expect any major surprises there, but nonetheless, we're going to see a drop in earnings. That happens when the economy slows. Corporate earnings have already peaked. And there may be a chance that there could be a few surprises that maybe catch the market by surprise. So earnings slow down is another thing you're going to see besides economic slow down and the write downs that we've been talking about that. [26:32]
JOHN: So as we discussed during our first show of the year in the Oreo theory, all of this stuff represents the dark outer shell of the cookie, large financial writedowns, the economy heading into a recession, lower corporate earnings. And of course, then, this gets followed by massive monetary and fiscal stimulus both by the Fed and the government which eventually sets us up for the creamy filling during the second half of the year. And this was going to be what? about second and third quarters, which of course coasts us right into the elections. So do you anticipate some kind of “phew, we dodged the bullet everybody, isn't that great! The action on the part of the Fed and your government did this,” and of course by the time we get into the hard crunch on the other side, the elections are over.
JIM: Well, you know, you're right, John, because that's why they are moving quickly on all of the economic fronts, the monetary front, the fiscal stimulus. I mean, when have you seen this administration and Congress cooperate since 2006; they haven't cooperated on anything. Virtually, there has been no legislation passed in the last couple of years that has been meaningful – and maybe that's a good thing. [27:38]
JOHN: Yeah. But here there is common survival at stake. You must admit that.
JIM: Yeah. I mean, here they are all saying, “we could lose our jobs if the voters get ticked off.” So you're going to see massive stimulus. Originally you saw some of the guys –and we'll get into this in the second hour – as we get into the silly season here, they were talking about stimulus packages, 70 billion, 75 billion. What does it tell you when they are now talking 145, 150 billion? So you're going to see on the government side of the ledger, massive stimulus; and then you're going to see interest rates head down to 3% or below. It could go down below 3% if we head actually into a recession. And with the sentiment this negative that we're now seeing in the markets, we're now setting ourselves up for a rally. Sentiment is definitely decisively bearish. We've got oversold conditions. And historically, whenever you get the earnings revisions slipping into negative territory as we have for the fourth quarter, you're usually close to getting to a market bottom. You also have now massive reflation about ready to kick into high gear, and you're also starting to see some very attractive valuations here. [28:49]
JOHN: You know, if the interest rates go down and assuming you could, the whole loan industry has become real skittery right now, but assuming you could qualify for a loan, are we going to see better loan rates than we did, remember, when there was this rash of refis going on a couple of years ago? Will that be back with us?
JIM: Oh, absolutely. In fact, the latest refinancing is up considerably on the credit side because everybody is ditching their adjustable rate mortgages and locking in, I think the fixed-rate mortgage has now fallen to somewhere around 5 ½%. I've just talked to a client who got a loan last summer who is already refinancing at a half a percent lower than what his loan was last summer. So you're going to see a lot of that, and that's going to be positive. Now, assuming that you have good credit. I mean if you've lost your job and you don't have good credit, these low interest rates aren't probably going to do much for you depending on the bailout package that they come out from Congress. But you're right, John, these interest rates are looking very attractive right now because on the Friday that we're talking, the 10 year treasury note just hit 3.6%. You're talking about the 30 year Treasury bond below 4.3%. So obviously this is spilling over into the mortgage market. And I'd also think that as more and more people are able to refinance and those that are capable of refinancing, that's going to be good news, and that will sort of help in this recovery process. [30:10]
JOHN: Any other bright spots? I mean obviously there will be places where people could be to their advantage. So if you had to name some of these bright spots what would they be?
JIM: You know, if there is a bright spot on the economy right now, it would be the corporate sector which is generating healthy returns on capital, profits, although slowing down somewhat, are still very healthy; and you still have positive international growth rates in the emerging world. I mean a good example is the day we're talking, General Electric reported fourth quarter earnings. They were up 15%, and General Electric cited a good bulk of that was coming from their overseas sales where they are just basically growing and growing at double digits, especially in their infrastructure division. So that's a very positive side, and investment business spending, those are the positive elements, I think, in this economy.
And it's going to be important if they do come up with a stimulus package that does something besides try to buy votes, that they do create incentives for businesses to go out, build a new plant, maybe buy new equipment. It's interesting with the dollar’s fall over the last five or six years, you are now seeing a rebirth in the beginning stages of American manufacturing. You even have companies like Airbus that are considering relocating here. Look at the number of foreign firms, whether it's BMW, Toyota, Honda, Mercedes, that are building new factories here. So that's the positive thing we're seeing here. [31:43]
JOHN: Yeah. Is there anything that you like in this area? I guess what I'm saying is if you were investing, where would you be buying things right now?
JIM: Well, what do we have? We have massive monetary stimulus and fiscal stimulus. That means I would be buying precious metals. Any time you hear the US economy slowing down so everybody is saying, “oh, that's going to mean less demand for energy,” and we'll get into the fourth segment, buy them while they are cheap, I would be buying energy right here because they are basically just selling the energy sector off in a panic; and I expect higher energy prices this year. So precious metals and energy are probably the top of the list, large cap technology stocks look very attractive to us. And another sector that I think that is going to be very attractive, if you haven't done so already, is the agricultural sector, which is correcting now. And if that continues, I'd look to add some of the agricultural stocks.
JOHN: Anything that would be a screaming buy? I mean something where you back up the truck or you lie awake nights thinking you've just got to have it?
JIM: Oh, absolutely. I see three things that you want to almost back up the trucks here. Right now, one of them of course is going to be juniors, but why don't we save that for the final segment? We'll get into what I think are just screaming buys currently as we look at the markets. [33:03]
JOHN: And you're listening to the Financial Sense Newshour at www.financialsense.com on the internet. Our files are posted usually by about 7:00 a.m. Greenwich meantime on Saturdays, and so you make your own time adjustments. That works to somewhere about 3:00 or 4:00 a.m. on the east coast depending on whether you’re on daylight or standard time. Coming up next, Other Voices.
Other Voices: John Williams, Shadow Government Statistics
JIM: There’s a lot of talk on Wall Street these days: They’re talking about the core rate behaving moderately; they’re talking about inflation expectations well-anchored; that the Fed has room to move aggressively. There’s also talk that the Fed really isn’t injecting that much money into the system. Well, we’re going to clarify that for you today with my guest John Williams from Shadow Government Statistics.
And John, I want to talk about an article you wrote for the Financial Sense website called Near Record Money Growth Threatens Monetary Inflation; and this is a line from the opening that you wrote: You haven’t seen this kind of monetary growth since August of 1971. Monetary inflation pressure in the US on top of existing pressures from oil and food prices and a weakening US dollar, all of this foreshadows inflation is going to get much bigger than what we’re talking about today.
JOHN WILLIAMS: It sure is.
JIM: John, one of the things I think your article goes into and maybe this is perhaps the best way that we can start this conversation. Why don’t we talk about the three M’s: M1, M2 and M3, and how if you look at the monetary base (or M1) it looks like it’s shrinking, yet M3 is exploding. I wonder if we might distinguish between that for our listeners.
JOHN WILLIAMS: There used to be three primary measures of the money supply: M1, M2 and M3. M1 being the smallest – M1 is basically cash in the system and checking accounts; M2 is M1 plus savings accounts, money market funds and such; and then M3 had the large time deposits (you have the small time deposits in M2), institutional money funds. What happened with M3 was that back in March of 2006 the Fed ceased publishing it, which is extraordinarily unusual. They claimed at the time that the money supply numbers M3 were no longer relevant, too expensive to compile. That’s absolute nonsense. M2 – which is now the broadest measure that they publish has in it small time deposits, but M3 had in it the large time deposits – the jumbo CDs. And how can the small time deposits be relevant and the large time deposits not be? Or the money market funds that they had in M2; in M3 you had the institutional money funds. They’re saying that’s irrelevant. But those two items alone in M3 were worth something like $4 trillion which is something like half the M2 that’s being reported right now. So saying the numbers were meaningless is absolute nonsense.
I’ve been working in building econometric models, making economic forecasts over the last 25 years using these numbers, and I can tell that if you’re trying to forecast inflation what you want to use is the broadest measure of liquidity in the system, which until recently was M3. The narrower measures have their uses, but the broader the measure the better it is as a predictor of inflation. Now, the problem of what we’re seeing right now is that you only get the M2 number; it’s going along around 6% growth; M1 which is just the cash and the checking deposits is actually showing slightly negative growth. In between the different levels you have cash that switches. I think the Fed was aware of what was going to happen in the year ahead when they made the decision not to publish M3 anymore. What happens when you come to a peak in rates is that people try to lock in the jumbo CDs and such. And with that you’ll see cash flows from the lower M’s into M3. So the M3 growth is the best measure overall of total system liquidity.
We’ve tried to estimate M3 using other numbers published by the Fed; and the Fed still publishes most of the components. Right now we’re seeing that M3 growth is over 15%, which as you mentioned earlier is the highest level of broad money growth seen since 1971. And whenever you’ve had double digit M3 growth, which we have now, usually within a year or two you’ve seen double digit consumer price inflation. [38:21]
JIM: Something that I think, John, that we need to clarify for people is there are two ways that you can expand the money supply: 1) you can do it through the domestic banking system – the Fed injects money into the bank; or 2) you can do it through central banking. And I think one of the points that a lot of analysts miss is the huge injections that have come into the United States through foreign central banks. I think in your article just in the last 12 months it has grown by 287 billion (or 16.2%). And I wonder if you might explain that if a central bank does not sterilize that you’re basically expanding your money supply. And I wonder if you might address that issue.
JOHN WILLIAMS: One of the jobs that the Federal Reserve has is control of the money supply growth. And when a central bank puts cash with the Fed and says “hey guys, here we have a couple of hundred billion dollars in dollars we’re not going to try and cash in, so buy Treasury bills or Treasury bonds for us and hold them for us,” the Fed acts as custodian. And what it does is it goes out and it buys the T-bills or the bonds. Well, that going out and buying Treasuries is one way that the Fed normally goes out and injects liquidity into the system; it buys the Treasuries and the cash goes out into the system.
Now, if the Fed does not sterilize that transaction – effectively reverse it – to keep the extra cash from being pumped into the system, it’s exactly the same thing for the system as if the Fed went in there on its own account and bought that couple of hundred billion dollars worth of Treasuries. It has exactly the same effect. That’s what’s been growing so rapidly and has been helping to spike the broad money growth. What you’ll see in some of the day-to-day transactions just on the Fed’s account in the open market may have been relatively neutral over time. You have to look at the full picture. And if you look at the full picture, you’ll find, and indeed, there’s been a very significant pumping of liquidity into the system. [40:27]
JIM: It almost relates back too because I know in the 70s we used to watch those M numbers religiously. In fact the bond market or the stock market would move on the announcement of those numbers; and especially, for example, the M3 figures where all of this high powered money that you’ve been talking about exists. And I find it rather strange that they would say that first of all we’re going to save money, it’s too costly. You’re talking about an organization that prints money. But more importantly, if we didn’t have those central banks inject $287 billion into our system last year, basically they’re doing the Fed’s dirty work in a way; they’re monetizing, because if those central banks didn’t do it wouldn’t the Federal Reserve have to step up to the plate?
JOHN WILLIAMS: The Fed absolutely would otherwise be doing it itself. No question. Mr. Bernanke is a student of what happened back in the 1930s and he has expressed a very open desire not to see any kind of a liquidity collapse similar to what happened in the Great Depression with the collapse of the money supply. So there’s sort of an implicit promise there that he’s going to make sure that the liquidity keeps flowing into the system, that you don’t have the money supply collapse. And indeed, if you look at the broad measure, far from collapsing it’s actually showing the strongest growth it’s seen in 36 years. [41:52]
JIM: And it shouldn’t come as any surprise then when we look at, for example, the headline inflation numbers on the day you and I are speaking which is Wednesday that we saw these numbers go up year over year, and even though we know they’re jury-rigged they’re still up over 4%.
JOHN WILLIAMS: They’re talking about a 17-year high there. We also work on trying to estimate what inflation would be if you took out all the gimmicks that have been added in over the last couple of decades. And amazingly enough, you put it back it in and you’ll find yourself back in the early 80s, late 70s, in terms of parallel level of inflation. There is a relationship there between money supply and inflation despite claims to the contrary. [42:33]
JIM: So while you might have some analysts saying, “look, basically the rollover money that the Fed is doing in the Repo Market, they’re really not expanding the money supply,” but I just looked at the information that came in on foreign capital flows in the month of November and they’re still at very large levels. So whether it’s the Fed doing it or it’s the Bank of Japan or it’s some Asian central bank doing it, it’s accomplishing the same thing: it’s expanding the supply of money.
JOHN WILLIAMS: Yup. Well, in fact, the numbers in the article are up through the first week in January as reported by the Federal Reserve in terms of what they’re holding for the foreign central banks.
JIM: So now we hear talk that given Mr. Bernanke’s speech last week, and he’ll be before Congress on Thursday, that the Fed is going to get more aggressive. That to me says more monetary inflation, and higher inflation as a result down the road.
JOHN WILLIAMS: Yes. I think that’s a safe conclusion. What you’re seeing here there’s a systemic crisis right now in terms of the solvency of the banking system. And if you think the Fed is going to stand by and watch any major bank fail, or any major financial institution, you’re going to have a surprise there. They’re going to spend every last dollar that they can print to make sure the system stays afloat. They don’t want the system to crash. They don’t want the money supply to crash. And the error there, the effect of what they have to do to keep the system afloat, the cost is higher monetary growth, higher inflation. [44:09]
JIM: Now there’s been a number of articles lately with the debt crisis that we’re in, we have mortgage problems, we have Citigroup reported they’re having problems, they’re setting aside reserves for credit card defaults; there was an article in the Wall Street Journal on Wednesday talking about banks basically just walking away from home equity loans (in other words they’re not going to foreclose because it just isn’t worth it.) So we’re in a credit problem. And my definition of deflation is a contracting money supply, and I don’t see anything that I’m following – and I’m following the figures that you report – that shows despite the 100 billion we’ve written off (maybe another couple hundred billion) the money supply is still growing. It’s not contracting. [44:56]
JOHN WILLIAMS: It is. And the banks may be losing some money but they’re getting more capital pumped in to keep them afloat. You do have a circumstance here which is a little unusual but not as unusual as Wall Street would like to have you think, that is we have an inflationary recession. We’ve had inflationary recessions before including back in the 70s. As contradictory as that may be we’re seeing inflation pressures here that are not driven by strong...they’ve been driven by the oil prices, they’ve been driven by the weakness in the dollar – now we’re beginning to see the monetary pressure.
One thing about the money supply and as it relates to the economy as well as to inflation: when you see sharp money growth, sometimes you can have strong economic growth with it, other times you don’t. It doesn’t always work on the upside. It always works on the downside. If the Fed wanted to drive the economy into recession it could contract the money supply and that would do it, but oftentimes when they pump up the money supply in terms of the economy it’s like pushing on a string; it doesn’t happen. And that’s what we’re seeing right now. We’re in a long term structural economic downturn, but at the same time we’re beginning to see increasing monetary inflation on top of these other factors. You really have the worst of all worlds for the financial markets: it’s an inflationary recession by its nature as bad for both the equity and the credit markets. Of course, there are things such as gold which tend to do well in that environment; and being outside the dollar is another area where generally the results will be much more favorable. [46:32]
JIM: The thing that just fascinates me, and of course we’re seeing it now in terms of an economic stimulus package, they’re talking about helicopter drops where they’re going to cut checks. So here comes the helicopter money. What is amazing, John, and I don’t know if you share this view, I feel the route that we’re going you’re hearing...I heard a speech by a politician talking about freezing interest rates for five years, which is basically price controls. And you know, this almost right out of Murray Rothbard’s book America’s Great Depression. It’s amazing, 80 years later our politicians are marching us down, making the same mistakes that the Hoover administration and Roosevelt made in the Great Depression. I think we’re going to have a depression by 2010 and this time it’s going to be an inflationary one. Any thoughts on that idea?
JOHN WILLIAMS: I’m in agreement with you. In fact, I think it’s going to eventually evolve into a hyperinflationary great depression. But the depression part of it is already in play. One thing which is clear even in the government statistics today with the inflation that they reported – this is the official inflation, CPI – the real average weekly earnings for the average fellows out there working day to day didn’t keep up with inflation this last year. Now, there are a variety of problems with that including for the person who’s not able to keep up with inflation, but when you put it on to a national scale you’re in a circumstance where it’s physically impossible to have sustained economic growth. In order to have sustained economic growth, you have to have sustained growth in inflation-adjusted income. They measure the economic growth adjusted for inflation, and if your income net of inflation is shrinking you can’t sustain continued growth in consumption which is two-thirds of the economy. The only way that you can do that is by taking on more debt or liquidating savings. And both of those factors are short lived. And in fact both have been pushed to extremes; we’re at the limits there. So there’s really very little the government can do in the short term to come up with a stimulus package that will give you sustained economic growth going forward.
Beyond that, the government is fiscally bankrupt. If you look at the government’s financial statements published a couple of weeks ago prepared using the Generally Accepted Accounting Principles as though the government were a corporation, we’re still seeing an annual deficit there on a GAAP basis of something over $4 trillion when you take out some of the gimmicks they still have in the statements. That’s $4 trillion! That’s not the 168 billion that they were talking about officially as the deficit for the last year, but an actual shortfall of four trillion, including the change in the unfunded liabilities for Social Security and Medicare adjusted for the time value of money. And the significance of that magnitude is that the system is out of control. If the federal government wanted to bring the deficit under control to actually show a surplus, or just a balance, if it raised taxes to take 100% of everyone’s income and corporate profits, it would still be in deficit. It’s beyond containment. That’s the current political mess. On the other side, they can always cut spending but I’ll challenge you to find more than one person in Washington who’s talking about cutting Social Security and Medicare. [50:10]
JIM: No, they’re talking about adding a new healthcare benefit at a time when we know Social Security and Medicare are bankrupt.
JOHN WILLIAMS: And they’re going to add a stimulus package and send everyone a check. They don’t have the money! It’s not funded. And it’s just a matter of time before the foreign investors who have been kind enough to put all of these dollars into our system to buy the Treasuries throw up their hands and say, “here, Fed, you can take the Treasuries back.” That’s when the problems really begin. And I don’t think we’re too far from that happening. [50:37]
JIM: Well, John, I’m going to recommend our listeners go to the site, our Financial Sense website. We’re going to keep John’s article, it’s called Near Record Money Growth Threatens Monetary Inflation. And John, if our listeners would like to get more information about your newsletter, why don’t you give out your website because a lot of this stuff that you and I are talking about you publish stuff that you don’t see elsewhere. And if a person wants to become informed, reading your newsletter would be one way to do so. So why don’t you give out your website.
JOHN WILLIAMS: The website is www.shadowstats.com. On the site we have a lot of publicly availably information, including series of articles describing the problems with the government reporting. We have archives of materials written more than six months ago. We show graphs of our alternate measures on the CPI, the Gross Domestic Product; we publish a graph which shows you where M3 growth is going. And of course if anyone would like to become a subscriber, we’re also very happy to take subscriptions. So all of the material anyone would look for is there on the site at www.shadowstats.com. [51:50]
JIM: A very informative newsletter at that. Well, John, as always it’s a pleasure to have you on the program and I appreciate you writing an article clarifying why we have this explosive money growth because there are a lot of people out there talking about, “well, gee, the money supply just isn’t what people say it is.” And I think they’re missing out on something you clarified, which is foreign central banks basically bringing it in to the system. It’s the same effect whether the Fed was doing it.
JOHN: [sound of ducks quacking] Quack, quack, quack, quack, quack. Well, Jim, there you have a live recording right off of C-Span of our congressmen in action. Very obviously, somebody must have told a really good joke judging from the response of some of them there. We are going to talk about quackonomics today because it is real clear that as you listen to what's going on on C-Span, I would say well over 90% of our elected representatives do not have a clue when it come to monetary policy. Just even based on their responses and the questions they are asking in some of the Congressional hearings. Only a couple seemed to really grapple with it.
JIM: I don't think any of these people know or understand what creates jobs in an economy. It gets back to the theory that we talked about last week: Do you want to give people fish or build your fishing industry? Building the fishing industry creates more jobs. Just giving people fish, once they consume that fish, what do you do next? So why don't we set the stage here because when Bernanke was on Capitol Hill this week, I think one congressman said: “All right, summarize it for me, are we heading into a recession what do you think economically?” Let's go to the Bernanke clip.
CONGRESSMAN: To sum it up, what is the Fed's overall diagnosis of the course of the economy over the next year to 18 months?
BERNANKE: Well, we currently see the economy as continuing to grow, but growing at a relatively slow pace, particularly in the first half of this year. As the housing contraction begins to wane, as it should sometime during this year, the economy should pick up a bit later in this year. But we believe we'll see below trend growth, certainly in 2008, and probably early into 2009 as well.
CONGRESSMAN: You indicate in your testimony that conditions appear to be worsening in 2008?
BERNANKE: Yes. The latter half of 2007 was actually reasonably good. The third quarter we saw a growth of about 5%. Growth slowed significantly in the fourth quarter but is still moderate. Recent indications suggest, though, that the economy has softened somewhat and that growth prospects for 2008 are certainly below that of last year.
CONGRESSMAN: But as I listen to you read the first several pages of your testimony describing the conditions in the financial markets, in particular, the swollen non-conforming mortgage portfolios, the lack of investor confidence in the valuation of their investment and then the lack of confidence and institutions holding those assets – a long litany of fairly distinct and unique problems – it doesn't appear to be your garden variety business cycle recession of the kind we were used to in the years after the end of the last war.
BERNANKE: Well, again, we're not forecasting a recession, but rather at this point, slow growth. But you're absolutely correct, Mr. Chairman, that there are a number of characteristics of this period that are somewhat unique including the financial market turmoil we've seen, pressures on the banks. We are hit on the other side by these rapid increases in oil and commodity prices which create some inflation risk and create a problem on that side. The housing sector, of course, has been in a very sharp contraction and relatively unusual pattern that we've seen there as well. So there really is a confluence of different events that makes this a difficult combination of circumstances. [3:45]
JIM: So there you have it, John, he's given his assessment, “nope, we are not heading for a recession.” But remember, these are the guys that can't even spot a bubble much less spot a recession. So one thing you need to do is take with a grain of salt open comments made by a Fed chairman or anybody in the FOMC meeting. Most of the stuff of what they forecast, whether it's on the economy, inflation rates or unemployment rates are almost meaningless and worthless. Let's put it this way. You wouldn't have politicians scrambling in the same way that you have right now if we were not heading into a recession. Why don't we go to the clip with the president's opening speech on Friday where he's talking about that we need to get working on this, do it quickly and it needs to be big.
PRESIDENT BUSH: After careful consideration and after discussions with members of Congress, I've concluded that additional action is needed. To keep our economy growing and creating jobs, Congress and the administration need to work to enact an economic growth package as soon as possible. As Congress considers such a plan, there are certain principles that must guide its deliberations. This growth package must be big enough to make a difference in an economy as large and dynamic as ours, which means it should be about 1% of GDP. This growth package must be built on broad-based tax relief that will directly affect economic growth. And not the kind of spending projects that would have little immediate impact on our economy. This growth package must be temporary and take effect right away so we can get help to our economy when it need it's most. And this growth package must not include any tax increases. Specifically, this growth package should bolster both business investment and consumer spending which are critical to economic growth. [5:48]
JOHN: So basically if we contrast what Ben Bernanke was saying versus what President Bush was saying, Bernanke is saying a slowdown but no recession. (Although I think he coined the term growsession this week. I heard that one floating around there). But at the same time, the President is jumping in there and saying crisis, we need a stimulus package; and both parties normally at each other's throats are willing to work together on this one. That's quite a contrast between the two.
JIM: Yeah. Especially if you contrast the presidential debates going on in both parties just last year. Nobody was talking like this one month ago. And so I think the drop in the ISM, the jump in the unemployment numbers that we got at the first of the year is all of a sudden people are saying, “holy cow, this is serious.” And the other thing too is even within both parties, we had earlier in the week, we had testimonies before Congress of Larry Summers who was a former Clinton economic advisor. He was saying, you need to cut taxes and get a stimulus program. Let's go to the Congressional testimony of not only Larry Summers, but even more importantly, I think his name was Beach because that will tell you where we want to go with this. [7:08]
SUMMERS: Stagflation, big issue. Part of the reason why a balanced program of fiscal and monetary stimulus is, in my judgment, a better idea than relying only on monetary policy is because it's less likely for a variety of reasons, particularly involving commodity prices, to be inflationary.
BEACH: There are stimulus packages that work. There are stimulus packages that sound good but are empty. And the ones that we have tried where we have stimulated demand just haven't delivered as much as one would have hoped for them. On the other hand, those that are targeted on the investment side, building new plant equipment to create jobs and improve incomes and thus through improving incomes stimulate demand tend to perform very, very well. If you're going to suspend PAYGO rules, do it for programs that have a proven record of success rather than ones that don't have a proven record of success; and it doesn't cost you a thing today to signal what you're going to do on taxes in three years. That doesn't even qualify for the PAYGO rules. And your speech is important. I am very concerned about spending. Spending is a drag on the economy if it is for non-productive purposes or purposes which have less productive purposes than similar money used for private concerns. You're right to be concerned about it. I would hope the Congress would find a way to get this done without having to depart from a discipline and a signal, which was so important at the beginning of this year, that Democrats and Republicans are really going to be serious about spending. [8:42]
JIM: You know, John, that is the heart of the matter because he said “I hope you don't do something and spend money for something that doesn't do anything to really help the economy.” And you remember when we were in the recession of 2001, initially Bush when he came into office, his first tax cut was let's give them a little rebate; and they found out it really didn't do anything for the economy. And that’s what this economist was talking about that. And unfortunately that's what they are going to want to do. They are going to want to make a good majority of this a large amount of money that they are going to give to voters because number one, that buys votes. Number two, it stimulates spending but it's like I don't know what the check is going to be, whether it's going to be $300, 600 dollars, 800, 1200, whatever the figure is, John, what happens after you spend the money? Then what? And that's why this economist here was saying, “look, if you really want to help the economy, you have to have stimulus that is going to actually go out and create jobs.” You want business entrepreneurs to go out and say, “you know what, we're going to buy a new piece of equipment to make or help us manufacture widgets and do it more efficiently. We're going to build a new factory.” That's what creates jobs. And it gets back to the fish analogy. You know, you want to build your fishing industry, not just give people fish. And that's what Beach was talking about when he was saying, “I hope you don't do a dumb stimulus package where you're really not going to get any bang for your buck.” I mean somebody goes out and spends a couple of hundred bucks and then it's over.
You know, I can see were you may want to extend unemployment benefits to help those who have lost their job, but the rebate stuff, you know, we know it didn't work in 2001. It didn't work with Jimmy Carter. All it does is buy you votes in a election year. It's a short term remedy that doesn't really fix anything. The real remedy, and you remember the reference there, it doesn't cost you anything to talk about tax cuts three years out. Basically he was saying, “look, we’ve already got these tax cut in place. Keep them in place because what are businesses going to think about when you know that, for example, the tax rates are going to go up at a time when the economy is weakening?” The marriage penalty comes back, the child tax credit comes back, people that were off the tax rolls now go on the tax rolls. People that were in a 10% tax rate go into a 15% tax rate. People in a 15 go into a 25. And that's what he was referring there. He said make those tax cuts permanent. It doesn't cost you anything because they are already in place, but you need to build something here because otherwise people are saying, “wait a minute, you're going to raise capital gains taxes back to 28%, you're going to double tax dividends again and get rid of the 15% tax on dividends. You're going to raise the tax rates, you're going to penalize...” – all of that stuff. That's what's weighing in on the market. And I think he was making a very strong case here: Don't do something stupid just because this is an election year because if you do, you're just going to drive up the budget deficit and you're not going to get a real increase in the economy. And it's the real increase in the economy when jobs are created, when people invest in plant and equipment that brings in the tax revenue that pays for these cuts. [12:22]
JOHN: Yeah. But reason doesn't tend to carry that in politics. Do you understand? In other words, politics is always – the German world is shein (appearance). It's always more done for appearances than for reality.
JIM: There is going to be some kind of rebate. There they are just going to do it. This is an election year. They need to buy votes. They are probably going to extend the unemployment benefits. But what they really need to do here is create some incentives for businesses because there is a great uncertainty right now. For example, if you look at estate taxes, the exemption, I think, is a little over 3 million right now and I think in the year 2010, we get one year with no estate tax rates and then things go back to the way they were when Ronald Reagan was president. The exemption goes back down to 600. The tax rates go up. I mean, so people in the industry are individuals that are trying to plan their estates are left with a quandary right now in terms of, “my goodness, what are we going to end up with?” If you are an investor, long term investor or a business, they are talking about allowing the capital gains rates, if they expire, to go back up to 28%. And no wonder the market is nervous. So those are the things that we should be doing. Whether we're going to do them, that remains to be seen. The one positive thing right now is both parties are talking to each other because I think they both know that, hey, look, the entire house is up for election, one third of the Senate. And so nobody wants to be seen here as “no, I want to raise your taxes instead of cutting them.” But whether these guys do something foolish – in fact, some of the news talk shows were talking about that. Let's go to the Lou Dobb's clip that says basically, “I hope these idiots don't do something stupid.” [14:10]
LOU DOBBS: The fact is this administration has not done anything. It has been aware of the crisis in terms of our credit markets for the better part of a half a year at the very least. They understand what is happening to this middle class. This is pure politics. It's got to be removed from the issue and we've got to start talking about how we're going to move ahead.
KITTY PILGRIM, CNN CORRESPONDENT: You're absolutely right, Lou. The evidence has been plain for quite some time. Certainly they cannot be thinking about it for the first time right now.
LOU: In terms of monetary policy, Ben Bernanke, the chairman of the Federal Reserve, he now has come to the conclusion that perhaps we might think about dropping interest rates. I mean across the board there has to be some intelligence. One of the things that is driving these markets and investors nuts worldwide is the United States is exhibiting a lack of leadership. Irrespective of the program or the approach taken by this administration and this Congress, the fact is we have such befuddled leadership in this country, the rest of the world has got to be looking at us, and our markets and wondering what in the world are those fools going to do next. None of which helps in terms of the credit market crisis, none of which helps in terms of interest rates or the strength of the dollar. And these befuddled fools in this administration and leading this Congress all very well understand that what I'm saying is the abject and absolute truth. So try to do a little thinking, folks, if you will, out there on Capitol Hill, Pennsylvania Avenue, wherever you may be tonight. [15:31]
JIM: And another issue, and we'll go to another clip here is don't come in at a time the economy is weakening and strangle it with taxes, strangle it with regulation, strangle it with new welfare give-away programs that just place major burdens on this economy, because, John, it's a debt ridden economy and that is not what we need right now. [15:55]
JOHN: One of the things that has been banging around in the back of my head listening to you here is, you know, we talk about giving these rebates. Who is going to pay for this? I always ask that whenever a politician says anything. Who is paying for this? This money is coming from somewhere. Is the Fed going to create it, or are we looking at another wealth transfer here?
JIM: You're looking at a wealth transfer. You're looking at a budget deficit. I mean the official budget deficit numbers are probably going to go up by a couple of hundred million. We'll probably be back up into the 300, 400 billion deficit range, which given the size of the economy, would probably put that somewhere in the neighborhood of 2 to 3% of GDP, which is actually much lower than other countries around the world.
When an economy goes into a recession, what happens is tax revenue falls. That's number one so, the government gets less money. Number two, government spending goes up because transfer payments go up; unemployment benefits go up. All of the things that we do in our welfare-type state, all of those costs are to go up because people are losing their jobs, business is less robust; the government is getting less revenue from individuals because they lose their jobs; they are getting less tax revenue from businesses because profits are down. And at the same time, their expenses are going up. So what you really want to do, if you're going to do something, is encourage what drives an economy. And what drives an economy is the private sector. It's when entrepreneurs invent an idea and take that idea and turn it into a business that hires people. That's what creates jobs right here. That's why I think that one economist was warning and what you don't want to do is turn this into a nanny state and then come in with all kinds of regulations and tell you this is what you're going to do, this is what you can't do. Let's go to the Glenn Beck cut right here.
GLENN BECK: It's my house. I know it's wasteful, going to be bad for the economy, it will be bad for energy, it will be bad for, you know, the trees and the little seals that are crying, but it's my money and my house. Mind your own damn business. It's none of your business. It's none of Arnold Schwarzenegger's business. It's time to take our country back, America. More and more politicians want to play nanny to the American people. Well, I don't want a fricking nanny. Take that father-knows-best approach and shove it right where the sun doesn't shine. It is interesting that liberals are always the first to say, “there is Big Brother, look at how evil Dick Cheney is. Get Dick Cheney out of my bedroom.” But you don't mind, as long as Dick Cheney is there just with his hand on the thermostat watching away.
[SPEAKER]: I have blood shoot out of my eyes when I hear this stuff. We are – we are entering a state where both left and right want to haul us into fascism, want to, with a smiley face say, “oh, look, we know what's good for you.” They want to tell us every step of the way what we can and cannot do because it's good for us. You know what? I have a right to die from emphysema. I don't have a right to drain everybody's coffers because I want government assistance for emphysema, but I have a right to die in my home alone with emphysema. Get off my back.
JOHN: That was a conservative opinion there on the part of Glenn Beck. But strangely enough, remember Ron Paul was saying that a few weeks ago. People are saying, “leave me alone.” And Glenn Beck echoed the same sentiment. Both parties are dragging us this way. Each one blaming the other for doing it, and as far as violating constitutional rights, etc, they are both doing it.
JIM: This is the thing that the Ron Paul campaign is addressing. Get government off our backs. And this goes back to Ronald Reagan where he said, government isn't the solution. It's the problem.”
But, John, once again, how did we get here? We got here by loose monetary policies – Going back to a topic that we covered in the first hour. When the tech bubble began to bust and began to cleanse itself, yes, we went into a recession. That recession, you know, maybe it lasted a year, but they were saying, “oh, no, we can't have a recession. We have got to slash interest rates. We cannot have any pain and we can't allow any cleansing process.” So Greenspan slashes interest rates from 6 ½ down to 1% and it created this artificial stimulus that encouraged people to go out and buy more real estate than they could realistically afford. It caused lenders to get really silly in terms of the type of loans they were making. It got Wall Street to get even sillier saying, “you know what, we can take these things, these subprime loans, we can dice them up and we can turn a junk mortgage into an AAA security, and sell it to somebody thinking that they are buying high quality debt.” And this is the stuff that we get when we have loose monetary policy.
And here we are, the cleansing process is beginning. Corporations are cleansing their debt. They are writing off, getting rid of the bad stuff. This is all part of the recovery stuff. But rather than allow the economy to go into a recession, to cleanse itself, they are going to fight it.
Now, if they do things that are productive, if they come up with a stimulus package and say, wait a minute, the private sector are really the horses that pull the wagons, so let's do some smart things, as that economist warned the Congress. Don't do something stupid. Actually do something that will help businesses to expand and create jobs because when you do that, when more people go back to work, that's more tax revenue for you. When businesses expand and make more profits, that's more revenues that come back to you. So the tax cuts, in a sense, are paid for.
And John, we saw this. When the first program that Bush came in was the tax rebates, it didn't work, so they had to come back in 2003 and slash the income tax rate, create the stimulus and that's what got economic revenue going again. And as we know, the government collected actually more tax revenue, which is one of the reasons why the actual deficits went down.
But the real danger here is, as you know, Washington is all about compromise, so we're going to get some very dumb and stupid things, probably weaved in with some things that will be smart. So it will be halfway measures and that's what gets us to what I call the creamy filling in the Oreo theory. [22:40]
JOHN: Looking at the economic proposals of the various candidates, I’m trying to remember, Jim, who has come out with one. Senator Clinton has established one. I can't think of any on the Republican side –aside from Ron Paul whose whole platform, a large part of it, seems to rest on sound economic policy from a Libertarian perspective.
JIM: Yeah. I would say, let me see, John Edwards is supposed to be coming out with an economic program. Hillary Clinton has got one out, so why don't we go to the Hillary Clinton clip because she was one of the first out there. Give her credit for it. I disagree with just about everything in the program, but at least she has one. The Republicans haven't come out really with one, but I would suspect in the next couple of weeks and with the country talking about stimulus, you're going to see the Republicans jump all over each other to come out with who can out stimulate the other. So when they come out with some programs we'll be critical of them as well. So let's go to the Clinton economic program. [23:32]
BILL GRIFFITH: It is clear that since the last time you were with us the economy has taken center stage in this campaign. You have an economic stimulus package, $70 billion on the table. Senator Obama has a similar package on the table in terms of the amount of dollars. Senator Edwards has talked about stimulus as well. Robert Samuelson writing in the current issue of Newsweek magazine is not impressed, the economist. He calls it lollipop economics saying of a $14 trillion economy, $70 billion is at most nothing –more political symbolism – and at worse a small drop in the bucket. What do you say?
HILLARY CLINTON: I've been talking about the economy. I’ve talked about it with you some weeks ago because I could feel that we were going to end up where we are today sliding into a recession. The president going hat in hand to the Saudis basically saying please help us out again. We have to get focused on what we need to do short, medium and long term. And that's going to require new leadership.
GRIFFITH: Quickly, let's be clear though. Are you saying that you can – you can avoid a recession with a plan like this, or do we just let the business cycle take its course at this point?
CLINTON: No. I don't know that we can. Some economists, as you know, say we already are. In fact, the government of Nevada says that his state is already in one, but we can certainly do what is necessary to try to make it shallower and less long lasting. And I think we've got to do that because we're really in a different environment globally right now. We know that we've got the huge spike in oil prices over the last several years. I mean look at spike in oil prices since George Bush became president. We know that we are increasingly indebted to other countries and now we are not only indebted to them, but our private institutions are borrowing from sovereign wealth funds so that we’ve got it kind of coming and going. We don't have a sensible energy policy, and I think that's one of the biggest problems in the economy. The fiscal stimulus that Bush pushed so hard in 01, and beyond, has gone primarily to people who are going to weather this crisis because they are so wealthy and they are so much better off than the rest of us. So I think we need to say, look, we've got to take some short term action right now. That's what a stimulus is for. Then we've got to do a much better job in getting back to fiscal responsibility. Let's make investments that will make us richer and safer and smarter and stronger, like in clean energy for example. Then we've got to take stock of the indebtedness, the $9 trillion debt and the rest of what is happening now in the global economy that I believe can undermine our fiscal sovereignty. And I take that very serious. [26:25]
JOHN: You know, Bill Griffith made at the beginning of the interview that he did on CNBC with Senator Clinton was talking about the fact that if you analyze what's going on, he calls it lollipop economics because there is nothing substantive here. It's all just candy.
JIM: Once again we get back to the “give a man fish or teach him to fish.” And what you really want to do is build the fishing industry, not just give people fish. I mean she talked about 30 billion in tax rebates here with the reserve fund of 40 billion if that doesn't work. Well, we know it doesn't work. It didn't work with Jimmy Carter. It didn't work with George Bush when he put that through in 2001. So that's not going to build the fishing industry. All you're doing is giving people a few fish. Once they eat the fish, then what do you do. And that's why a lot of these programs put out by the candidates are getting harsh criticism.
I have not seen, John, at least yet, any of the Republican candidates. I think Rudy Giuliani is working on permanent tax cuts, and he's going to outline that. I'm not sure about the other Republican candidates, but at least, you know, when you listen to Huckabee, there is nothing that he says that makes a lot of sense to me. McCain was against the tax cuts. Now he's for tax cuts. So he's flip-flopped on that issue. About the only guy that economically that makes a lot of sense out there is Ron Paul. It was amazing. I was watching a television program and I think you saw it, and some weird group was endorsing him, but they were talking about his economic philosophy as being extreme. And if you listen to what Ron Paul says: we need sound money, we need to adhere to the Constitution; we need free markets and unencumbered markets; and we need to get government off the backs of the people. Now that is considered right wing. It's absolutely amazing where we've gone in this decade in terms of our economic and political thinking. [28:18]
JOHN: Well, okay, so we get to this point, they are talking about stimulus. I guess there is a plus here in that the parties are talking to each other, but it's sort of like a couple of prima donnas in an opera. (I don't know if that's a plural of prima donna or not. Two primas donna in a opera.) They both want the key role in this whole thing, and so we are likely in the midst of it to see a lot of silly stuff because of this jockeying for position here even though they are still talking to each other.
JIM: What you're going to get, as you always get from Washington, which is compromise. So you're going to have maybe three quarters of the billion just giving people fish, and maybe one quarter of benefits trying to encourage to build the fishing industry. And unfortunately, there are people losing jobs, so maybe extending the unemployment benefits...But I would be more in favor of things that are designed to encourage companies to build factories here, to encourage companies to go out and buy plant and equipment to modernize their business, to make them more competitive in a global marketplace. That's why I go back to that comment made by the economist, Beach, who said, “you know, whatever you do, folks, do something that's smart here.” To go out and just give a bunch of lollipops to the voters in an election year isn't very smart. All you're going to do is drive up the deficit and you're not going to get a return on your investment. But if you do something that actually stimulates business to go out and build factories and buy equipment, that's going to create real jobs and you will get the tax cuts back in the form of added tax revenues as the economy expands.” And that's why he was warning them. But you know, once again, John, this is an election year and that's why probably what we're going to get is a lot of quackonomics than anything that makes sense here.
JOHN: Listening to the Financial Sense Newshour and a part of the program called the Big Picture right here at www.financialsense.com.
Other Voices: Eric King, Metals
Analyst, Trader
JIM: Well, as the markets head down to single digit losses (we’ve got the Dow down roughly 8%, S&P down 9%) the gold markets have been doing rather well –in fact, all commodity markets – the HUI Index is up a little over 7%, and we have the XAU up about 3%. Gold prices are still up for the year even though they’re pulling back somewhat. There are some technicians that are saying, “well, the gold market has topped out. It’s all over.”
Joining me on the program is Eric King, a private investor.
Eric, why don’t we start out with the gold market. We’ve seen a bit of a pull back here in the last week. Do you believe the top is in? I don’t. Do you?
ERIC KING: No, absolutely not, Jim. This is a secular bull market, prone to corrections. I was looking at the HUI, at top to bottom in just a few days, it had a 12 ¼% correction –so not for the faint of heart but certainly. And again, and we’ve talked about this many times, people just need to stay away from the computer if they’re long term investors during that time. We always joke about “go kick a soccer ball” or go have fun with the family because these shake-outs are ki