Peter Schiff
President of Euro Pacific Capital, Inc., Author
"Crash Proof: How to Profit from the Coming Economic Collapse"

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JIM: From both an economic and monetary perspective, the United States is a house of cards: impressive on the outside, but a disaster waiting to happen beneath the surface. In a relatively short period of time, the country has gone from the world’s largest creditor to the greatest debtor; The value of the dollar has declined; and domestic manufacturing has given way to non-exportable services. While these and other issues could potentially spell disaster for your financial well-being, the situation could also present unique opportunities if you’re prepared. And that’s what we’re here to talk about.

Joining me on the program this week is Peter Schiff, he’s author of a new book which I recommend.

It’s great reading, and your survival guide.
It’s called Crash Proof: How to Profit from the Coming Economic Collapse.

And Peter, I want to start out the beginning of our interview with a quote in the introduction of your book, and I’m going to read it – and then I want you to comment what happened:

When business in the United States underwent a mild contraction, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. The Fed succeeded, but it nearly destroyed the economies of the world in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market, triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in breaking the boom. But it was too late – the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching, and a consequent demoralizing of business confidence. As a result, the American economy collapsed.

Why don’t you tell our listeners who wrote that, and what changed his thinking?

PETER SCHIFF: Well, that was written by Alan Greenspan in an article that appeared in The Objectivist in Ayn Rand’s Capitalism: The Unknown Ideal, [read] and Greenspan was talking about the Federal Reserve in the 1920s, and their efforts to prop up the economy through inflation; and their efforts to prop up the British pound. Greenspan was a good Austrian economist back then, and he understood money, and the business cycle. And the point of, in the book, why I wanted to begin with that passage is because it describes exactly what’s been going on: where the Federal Reserve created a bubble in the stock market, the excess credit that they created went into stocks, and produced a speculative bubble. When that bubble burst, the Fed pumped in even more liquidity, which instead went into the real estate market and fed an even bigger speculative bubble there, which is now beginning to finally unravel. You’re seeing what’s happening with the subprime market – that’s just the tip of the iceberg. But the Fed creates these bubbles, and ultimately they burst. And the interesting thing is that Greenspan talks about the Fed’s efforts to rein in – you know, they recognize the error of their ways, and they try to withdraw the excess liquidity. Ben Bernanke has already said that he sees that effort as a mistake, and he would never rein in liquidity. All he would do is print more – that’s when he made his speech about dropping money from helicopters. According to Ben Bernanke, what the Fed did wrong was stopping the credit; he thinks you can keep a boom going indefinitely if you just print enough money. And of course, that would have been an even bigger disaster than a depression because that would have produced hyperinflation, or something that was experienced say in Weimar Republic, Germany. But unfortunately, that could be something that could be in our future, if Ben Bernanke actually carries through with his promise to prevent these speculative imbalances from deflating or unwinding. [4:26]

JIM: In your first chapter, you state: unless investors take measures to protect themselves, their dollar denominated assets are going to collapse in value, and their lifestyles will be painfully lowered. That is a statement, Peter, I think a lot of Americans would find hard to buy today with all the propaganda going on. But state your case why you think that is going to happen.

PETER: Well, everybody has got fiat currency around the world, right? I mean, currency, there is no monetary, or tangible backing, it’s not gold – and so it’s just paper. And basically, think about it, every year, every day, everybody around the world produces products – there are factories all around the world that are turning out products. And unfortunately, not too many of those factories are in America anymore, but people are working and producing products. And then everybody in the world – there are 4 or 5 billion of us on the plant – we all want those products. I mean, everybody wants things that are being produced, but of course, we can’t have them all because there is a limit to how much can be produced. And so there is a giant auction, and everybody bids on the products that they want. Now, Americans walk away from that auction with a disproportionate amount of the world’s output because our dollar is worth so much more relative to other currencies, and so we have an advantage in this auction – but it’s not an advantage that we’re entitled to. We used to be entitled to because we produced a disproportionate amount of the goods, and therefore, we were entitled to a disproportionate amount of the consumption. That’s not the case anymore. But the only reason that we’re able to consume so much more than we produce is because foreign governments are subsidizing it. They’re basically taxing their own citizens to prop up our currency so that we can afford to buy things that their own citizens do without. But I think once this happens – once the Asian central banks stop this practice and allow the dollar to sink, which it will, what’s going to happen is as the dollar loses purchasing power these other currencies will gain it. It doesn’t evaporate from the planet: whatever goods we can no longer afford to consume will simply be consumed by other people who cannot afford them now, but will be able to afford them when their currencies gain value. And so this is how Americans will see their standard of living lowered. Their currency will buy a lot less, things will be a lot more expensive for Americans, and so we will be doing without things that many people around the world are doing without right now. And they are doing without them because we have them. You know, there is not an unlimited amount of goods – they’re scarce; and everybody can’t have everything. And so it’s going to change. And so what Americans have to understand is recognize this. We’re still consuming as if we were producing everything, but we’re not. And when it changes, if people have investments denominated in the currencies that are going to gain the purchasing power that the dollar loses, they can at least preserve their relative standard of living. [7:21]

JIM: At the heart of your thesis is America’s debt and consumption boom which you’ve been talking about. We have gone from a country that used to save, under consume, invest and produce, to a country that has a negative savings rate, we live on debt, we no longer produce, and we just borrow and consume – that is an economic model that does not work.

PETER: No. I mean, the only reason that we can consume so much is because of all the savings and hard work of our fathers, or our grandparents. We are just squandering an inheritance. The problem is modern day economists measure an economy just based on these GDP numbers, and if it is all consumption based on borrowing they don’t differentiate that. They don’t take a look at where the consumption is coming from, and they’ve confused the cart with the horse. The horse is savings and production; the cart is the consumption. You don’t drive an economy by consuming – the consumer is not the engine, the consumer is the caboose – but we’re acting like we’ve got this great economy simply because we consume, and the whole world owes because we’re doing it like we’re doing everybody a favor. It’s just nonsense. On an individual family level, it’s like a guy goes to work everyday, he’s busting his balls working 50 hours, and when he comes home his young children go: “say Dad, you ought to say thank you because we were out here spending money. If it wasn’t for us spending all of this money on toys and summer camp and braces you would have nothing to do all day. You ought to be glad we’re here so you can enjoy your job.” I mean, it’s ridiculous for America to say that the world owes us something because we buy the products that they produce. And in fact, we don’t even buy them. Buying them would imply that we pay for them; and paying for them would mean that we exported something in return, where all we do is print money and give it to them and they can never spend it on anything – how is that paying for products? We’re just getting them for nothing, and all they get in the deal is they get to work. Well, you know, they used to call that slavery. [9:30]

JIM: I want to get back to what built this country which is savings and investing and producing. Peter, I don’t care which political camp you’re listening to – Democrats, Republicans, it’s all the same – this idea of saving, investing and producing is resisted by most politicians. They’re trying to convince Americans that self-sacrifice, under-consumption, saving for a rainy day, are something to be shunned.

PETER: Yeah because these guys want to get elected. And it’s easier to get elected by telling people to have a good time and party, than telling them that they need to deny themselves something, that they should do without something. Everything has been turned upside down. And of course, people try to justify this. I talk about it in the book but people say, “oh, you know, this savings is all nonsense because we’re not counting home equity” – like somehow home equity is the same thing as savings. I mean, people don’t understand the concept of what it means. Sure, home equity can be an asset for somebody potentially but it certainly isn’t savings. I mean, savings is when you don’t consume – that’s under consumption. I mean, you have to refrain from consuming so you free up an asset. Home equity doesn’t free up anything. But rather than admitting that we have a problem, what the modern economists want to do is try to rationalize it and justify it because they don’t want to acknowledge it’s a problem, so they make up all of this nonsense. [10:50]

JIM: I want to get to a popular fallacy that we see today which is our transition from a manufacturing to a service-based economy – that means we are less susceptible to economic cycles, or more stable. Let’s discuss this issue at the micro-level, where let’s say you have a laid-off manufacturing worker who moves into the service sector and his manufacturing job is shipped offshore – what’s wrong with that?

PETER: Well, what’s wrong with it is how are we going to [inaudible]. So let’s say there’s somebody offshore that has a job manufacturing a product, and they’re going to ship that product off to America, what product are we going to ship them? How are we going to pay for it? You see, if we can export our services to pay for those imported products I wouldn’t have a problem with the service economy. But the problem is the services are no good over there: the Japanese and Chinese don’t want our legal services; they can’t eat in an American restaurant; they can’t get their haircut over here. What good are our services to the Japanese and Chinese? We need to make something that we can put on a ship and send over there. [11:56]

JIM: What about wedding planners?

PETER: Well, if they are going to get married over here…We just don’t need it.

I mean here’s how it could work. If our manufacturing sector was so productive that we could still produce enough goods for ourselves and instead of that job going offshore, that guy who lost his job in manufacturing because the American manufacturer automated and found a machine, and we still produced the stuff ourselves but we no longer needed that labor – and then that guy went to the services sector – then that would be fine. That would be fine. Or, like the transition when we went from an agricultural economy to a manufacturing-industrial economy, we did that because farming became so productive that the labor was no longer needed on the farm, and so was freed up to go into a factory. If we were doing that…but we’re not doing that. And it’s interesting so many people point to that transformation as justification for the current move to a services-sector economy; but that ignores the fact that in the 1900s, when we went from a farming economy to an industrial economy we didn’t start running a trade deficit in food; we didn’t start importing food as we transitioned people from agriculture to the factory. In fact, it was the reverse – American farming became so productive that we became the world’s largest exporter of agricultural products. So if today’s transition was really like that, we would be the world’s biggest exporter of manufactured products; we would not have a trade deficit, we would have a huge trade surplus in manufactured products, and we would be transitioning people into the service sector. That’s not what’s happening. [13:33]

JIM: Let’s talk about some of the misinformation that people receive from the financial media and also the information in Washington. And that’s, for example: the views on our trade deficit – our trade deficits are a good sign meaning we’re consuming more; the nonsensical stuff such as the core rate of inflation, hedonic adjustments. I mean the whole apparatus of our economic reporting today is so skewed.

PETER: Sure, I mean it’s right out of George Orwell’s book 1984 – black is white. So, we have these huge trade deficits, and it’s good news. It shows how strong our economy is. It’s amazing you write this out of a work of fiction, but that’s exactly what happened. I suppose then, when we were running large trade surpluses back in the 1970s or 1950s, that meant we had a terrible economy back then; or I suppose all the other economies that have trade surpluses all over Asia, somehow their economies are bad. I mean it’s just all nonsense. I explained it in my book using the analogy that it’s like a little kid coming home with his report card, and he’s got an F, and he says, “yeah, it stands for fabulous.” [But] this is what we do – we turn this around, and the public eats it up, and they buy into it, and no wonder that we’re having these problems.

And of course, on the statistics, people don’t understand the way government statistics work. And most people will concede that politicians lie. They lie to get elected – everybody knows that – they say what they have to say, so I don’t know why people assume that once they get elected they stop lying. I mean that’s all they do. Once you get elected your job is to stay in office. And the way politicians stay in office, is to present a rosy scenario. And so what these guys do is they constantly change the way that economic statistics are calculated so that they can give a better result; so the politicians can point up to these dumbed up statistics as evidence that things have gotten better while they have been in office.

So they constantly change and redefine how things are measured. So the unemployment rate, for example, today, is calculated far differently than it was in the past; if they calculated unemployment during the Great Depression the way we do it now, they would probably have had very little unemployment then either. They calculate GDP differently. There are a lot of things calculated as part of GNP that 5 years ago, 10 years ago, 20 years ago would not have been counted. Everything has changed, so when they compare a number today to one 20 years ago, it’s completely irrelevant comparisons because they’re not doing it the same way. And then of course, when you adjust it all for inflation the reality is back in the 1950s a guy had a job, he can support a wife and a large family – maybe 4 or 5 kids; his wife didn’t have to work; his kids all went to college and none of them had to borrow money; and he saved for his retirement – and he did all that on a middle-class income and a high school education, if that. Today, you need two paychecks to support a family, both of them need to have gone to college, and they can maybe have one or two kids and that’s it. Beyond that, they can’t even afford it – and they still have no savings. With all this booming prosperity how can it be that a middle-class family is so much worse off today than they were in 1950. [16:51]

JIM: Has it surprised you, given all of this information, that Wall Street – you know, there are some pretty smart guys on Wall Street – continue to talk about deflation. It all seems part of a ruse to me.

PETER: Well, I talked about that too initially that it was all a straw man; that the Fed was never worried about deflation; that they were just talking about it so that they could provide cover for inflation. But also, there’s so much confusion in the terms. I mean, most people think of deflation as falling consumer prices – that is not deflation. But falling consumer prices are not bad, I mean that’s another amazing thing that the government has somehow convinced us that a good thing is bad. They have convinced us that a bad thing is good (I mean the trade deficit), but they’ve also convinced us that a good thing is bad. How can falling prices be bad? I mean, I’m a consumer, right – how can a sale be bad for me? How can something be cheaper. Why does the government have to protect me from falling prices? The whole thing is nonsense. But this is what people believe. What’s actually the deflation that’s going to happen is credit. It’s credit that’s going to contract all of this expansion. And the prices that are actually going to fall that the Fed is really worried about falling are not consumer prices, but asset prices that have been propped up – stock prices, real estate prices – that’s what the Fed doesn’t want to fall because our whole economy is based on our ability to leverage those assets, and turn those paper profits into consumption. That’s what the Fed is worried about – they are not worried about falling prices. And they are not going to fall; prices just keep on rising. [18:23]

JIM: I want to get to the root of the problem which is the fiat money system that we have and the creation of the Fed. Why don’t you give our listeners sort of a mini-synopsis of how we got into the mess that we are in today.       

PETER: The Fed, you know, like all roads to hell, I guess it was, are paved with good intentions. The idea was to set up a national bank to issue a superior currency to the various bank notes that were in circulation prior to the Fed. And there were all kinds of banks issuing their own notes, all redeemable by gold; and the idea was to create one note that everybody would use that would be of higher credit quality. And they also wanted to have an elastic money supply: one that would expand when the economy expanded and contract when the economy contracted. It all made sense, and a lot of people bought into it. And so the Federal Reserve was created. But of course, it’s sort of like the camel’s nose under the tent: the minute it was there it kept expanding and growing its role to the point where today it’s simply an engine of perpetual inflation. And it went from being really a private banking syndicate to almost a pseudo-branch of the Federal government. And of course, the constitution never envisioned – or specifically denied the Federal government the power to do exactly what the Fed is doing. I mean the Founding Fathers did not want fiat money; they did not want the Congress printing money; they wanted to be on a gold standard. But through the Federal Reserve, basically what they are doing is exactly what the Founding Fathers did not want them to do – they are creating money. They are using inflation as a revenue source. If this had never been the case, this economy could never have gotten so out of whack and screwed up as it is because the government couldn’t have run these huge deficits – it would have been impossible under a gold standard. Gold would have introduced some discipline to the government. But when you remove that discipline it’s like politicians are like a bunch of little children, and as children they need to be supervised by an adult to keep them in line. When the teacher is not in the classroom, there’s no one there, they are all going to just run wild. And that’s basically what’s been happening. [20:35]

JIM: I want to, for the next two questions, get into the topic of inflation: what it is, and what it isn’t. Fifty years ago people understood that. Today, I think most people have no idea what it is and what causes it.

PETER: Yes. That’s another example of how the government is able to change people’s perceptions to pursue their own interests, and to confuse the public about what inflation is. So inflation is an expansion. The word inflate literally means to expand, to blow up. If you think about it, prices don’t expand. Prices rise and fall, but going up – inflation doesn’t mean to rise. Inflate just means if you blow up a balloon, unless you blow it up with helium, it’s not going to rise; it’s just going to get bigger. So the word inflation meant expansion, and what was expanding was money supply. You were expanding the money supply. Deflation has to do with contraction; and so what is contracting is money supply. Now, as a result of inflation, when money supply has expanded, one of the results is that prices rise. So rising prices, which politicians are trying to tell us is inflation, are actually a result of inflation. But the reason why the government wants to confuse people, if the people properly understood that inflation was an expansion of the money supply, they would know the cause because who expands the money supply? It’s the government. Prices on the other hand get raised by private individuals – by companies, by businessmen. So by confusing the public, now they can vilify the businessman, the entrepreneur; they can blame them for inflation and distract the public from the true cause of inflation which is the government itself. And now the government has a reason for creating inflation; it has a number of reasons for creating inflation. You know, if the government has a program and they want to play Santa Claus, they don’t want to raise taxes to pay for it, so they print money to pay for it – that’s inflation. Right? They debase money, and they rob purchasing power. You see, the government can take your purchasing power directly, through a tax; or they can take it sneakily, surreptitiously through inflation where they just print money and spend it. They are still taking away your purchasing power, only you don’t see it. Now they can blame it on some greedy businessman, they can blame it on the OPEC nations, or whoever is raising the prices. And of course, the government is the world’s biggest debtor, which is why have a huge national debt. Inflation benefits debtors because it wipes out the value of your debt. So as the world’s biggest debtor, the US government certainly has a vested interest in inflating away that debt. But certainly, as the world’s biggest, short-term interest rate borrower, it has the biggest interest in keeping that inflation hidden from the people who are lending it the money – so it certainly wants to lie about inflation, so it keeps inflation and inflation premiums low. [23:25]

JIM: In your book you talk about 5 reasons for creating inflation, and then you had 5 reasons for hiding it. Cover those briefly, if you would.

PETER: I don’t know if I remember all 5 of them, but I mean I just alluded to them. I mean basically, they want to pay for programs without raising taxes. The tax code is indexed for inflation in a couple of ways so if they can underreport inflation, they can get more taxes from the public; also benefits are indexed to inflation, and so they don’t have to raise Social Security as much. Also, to the extent that they underreport inflation, they simultaneously overstate GDP growth – so they kill two birds with one stone because GDP growth is always offset by inflation: so if inflation is 7%, let’s say, and the economy is growing 5%, well, we are actually in a recession. We have a 2% contraction. But if they lie about the inflation rate and they say it’s 3%, instead of 7%, they turn a recession into decent economic growth simply by misstating what the real rate of inflation is. There are so many reasons for the government to do this. And certainly too as far as – the government borrows, the national debt has an average maturity of about 2 ½ years, or 3 years; and if our creditors really believed inflation was really 7 or 8%, they wouldn’t be loaning us money at 4, or 5% – they would want 9 or 10%. So the government certainly can’t be honest with the creditors. But it’s amazing that anybody accepts it. Again, it’s like hiring the fox to guard the henhouse. I mean, do we really think the fox is going to do a good job. [25:06]

JIM: One of the risks that I see here though, and you’re seeing it in this upcoming political campaign where politicians from both parties are promising the voters more cookies and candy, and more free goodies that you can get. And what the average person out there doesn’t understand is, like you alluded to, fifty years ago somebody with a high school education could go out, get a job, support a family, send his kids to college and live a nice lifestyle. Today, it takes both spouses to raise a family – both have to have jobs; and then they have to supplement what they can’t earn with income with debt. And most people don’t realize that all of these goodies that the politicians promise us come at a cost; and that cost is inflation, which is turning many people into slaves.

PETER: Right. And like, the politicians always try to confuse us by saying, “well, we’re a lot better off than people were in the 1950s because we have cell phones, and we have fax machines, and we have high-definition television sets. We have all of these things that people didn’t have back then.” Well, that’s the natural progress of a market. If you want to compare Americans to people in the 1950s, and then you want to say, “wait a minute, wait a minute, let’s go back and compare the Americans of the 1950s, to the Americans of 1910, or 1900.” And say, “wait a minute, it’s a much bigger difference because the transition back then – the industrial revolution – I mean the people in the 1950s they had indoor plumbing, they had lights, they had electricity, they had washing machines, they had refrigeration; air transportation.”

 The fabric of the American economy changed so much more during that period of time – the advancement from 1900 to 1950 was far greater than the advancement from 1950. Americans today…it’s not that much different than it was in the 1950s as opposed to 1900. Imagine, there, if a guy traveled in time from 1900 to 1950, he would be far more amazed at the difference in the way people live than someone going from 1950 to today. You know, they had telephones in 1950 – they weren’t cell phones, but in 1900 they didn’t have anything. I mean, you had to write a letter. So the difference between writing a letter and using a telephone is much bigger than using a land line versus a cell phone. I mean, sure, it’s progress – but the politicians are going to say that’s why we have to struggle, that’s why we have two people working? I mean the politicians of 1950 could have said the same thing, “hey, you know, your spouse has to work because you have a telephone. Your Grandpa didn’t have a telephone.” Or “you have electricity, that’s why your spouse is working because you’re not reading by candlelight.” We had all those advancements back then, and people’s wives still didn’t have to work; people still didn’t go into debt; and they could still send their kids to school without borrowing any money. It shouldn’t be this way. We should be living much, much better than we are. And it’s all because we are supporting this huge group of unproductive bureaucrats who have been taxing and regulating us to death. [28:13]

JIM: Has it surprised you, Peter – not only when the Fed said it was going to get rid of M3, I would have thought that would have sent shockwaves through the bond market. The bond market, which used to be the vigilante – at least when I got in the business in the 70s – has dismissed that, and buys these concepts of core inflation?

PETER: The government has got everybody trained. They are like the puppet master. And they basically get away with anything. That’s not going to be that way forever, but it is amazing how they can do something like that. You know the reason, and it’s amazing – the reason that they gave for doing it was they wanted to save money for the taxpayer. I mean the government does all these things to waste our money, and the one place they decided they are going to try to save a little money is in reporting the money supply. I don’t know – I’m just a little skeptical there, but somehow I don’t think that was the real reason. [29:13]

JIM: Let’s also talk about another concept here that has really bamboozled investors, and you hear this when the talks about moderating economic growth as if growth causes inflation.

PETER: That’s part of the whole idea where the government wants to blame inflation on the public: “oh, there’s inflation because of all this growth.” You’re richer so you can consume more. I guess to the layperson, “ok, yeah, we’re doing better, and if we buy things it pushes up the price.” But if there is real economic growth that means more things are being produced; that means prices don’t go up because there is more stuff. Prices actually fall, right? Because people are producing more things – there’s where the growth is. The only reason it appears that growth causes inflation is because inflation can initially look like growth because they just print more money and now there is more demand but there is no real demand because the demand didn’t come from higher productivity, it came from a printing press. It’s phoney. And so all that happens is that there is no more production – there’s the same production – and so there’s more money chasing the same quantity of goods and prices go up. But it is a false prosperity. It is not real. And that’s what’s happening – it’s the inflation which is causing prices to go up because there is no growth; it’s just inflation disguised as growth. If there was real growth, like during the Industrial Revolution when we had a lot of growth, prices went down. In fact, if you look at a chart – if you’ve ever seen a chart of prices in the United States and it goes from 1780 to 1913, it was almost a diagonal line down. The only time prices went up during that 130-year period was during the Civil War – and coincidentally, that’s when we introduced paper money. In order to finance and pay for the Civil War, the government issued the greenback. That was the first time there was ever any paper money printed in the United States, and when the war was over they stopped doing it. And so, prices blipped up when they printed money, and then when they stopped it…And that’s why a lot of people think that wars cause inflation because there is usually a lot of inflation around wartime. It’s not that the war causes inflation, it’s that the government pays for the war with inflation – it’s just expedient. Rather than raising taxes to pay for all of the ammunition, and all the soldiers, they just print the money. It’s the printing of the money that is causing all of the inflation not the war. [31:30]

JIM: I want to move on to some of the problems that you highlight in your book. And one you get to is real estate. Recently, the media and the Fed has said that the real estate markets have stabilized. I take it you don’t agree with that assumption.

PETER: No, I mean they’ve topped out. It’s just starting to fall apart. This thing has been a giant bubble. It’s finally starting to blow up. And some of the most amazing things about it – I saw this guy from Freddie Mac (and you know no one talks about this – it’s amazing this isn’t a front page story) – just recently last week, they announced they were going to tighten their standards with respect to subprime mortgages that they buy. Going forward (it’s starting in a few months), they are not going to buy mortgages where there is a strong likelihood that the person can’t make the payment and it’s going to end in default. Now, that’s an amazing statement because it means up until that point they were buying those mortgages. Well, why are they buying mortgages where there is a strong likelihood that the person can’t make the payment? It doesn’t make any sense. And why only limit that to subprime? Basically, they are saying, okay, for people who have bad credit, we think they are going to default, we’re not going to buy the mortgage; but if they have good credit and we think that they are going to default we’re still going to buy it. It’s incredible, but why would they even do it. And the reporter on CNBC – I saw the guy interviewed – asked him, “well, isn’t this a little late. Isn’t this like closing the barn door after the horses have left?” And he said, “no, no, no. It’s not late. We couldn’t have done it any sooner.” And they guy asks, “what do you mean? Why couldn’t you have done it sooner.” And what his answer was: “Well, up until recently, people were making money buying real estate, and real estate prices were rising, and so we didn’t want to tell people who were buying real estate because they thought it would go up, we didn’t want to tell them that they were wrong. We didn’t want to substitute our judgment for theirs, so we didn’t want to interfere with the process.” Basically, what he is saying is they knew that people were lying about their income, were buying houses that they couldn’t afford because they thought they were going to get rich speculating in real estate. They knew that. They didn’t want to interfere. And this is Freddie Mac. I mean this is amazing stuff. But now that the bets are going, now they want to stop people. But of course, no one is going to do it anymore – the party is over. But the problem is: you’ve got all of these millions of people who bought houses where they had a teaser rate where the first two or three years, they could afford the payment but when the payment is reset to reflect the real mortgage they can’t make the payments. But you know, when somebody was looking at a house, buying up a $500,000 house, where they expected it to go up 20% a year, they really didn’t care. They said, “well, okay, we’ll sign on to this mortgage where for the first two years we only have to pay 3 or 4% interest. We can afford those payments. In three years the payments double. We can’t afford those, but who cares? We’ll be rich by then. We’re going to make hundreds of thousands of dollars on the appreciation so it really doesn’t matter what the mortgage payment is in three years. It does matter because we’ll be rich.”

Well, all of a sudden, three years come and the property didn’t go up – it’s the same or it went down. Well, now they can’t afford it. And this is the situation that we’re in. And this is just the beginning because it’s not just subprime. Right? It’s not just people with bad credit who are in over their heads. Everybody bought property they can’t afford. I mean, why do you think there are so many interest-only mortgages in the prime universe. Why do you think there are so many adjustable-rate mortgages among prime borrowers? Because they couldn’t afford the fixed, that’s why. People are in over their heads, and they didn’t care because they thought they were buying into a goose that lays the golden egg. Nobody cared what they paid.

In my book, I pointed out that rising real estate prices it was counterintuitive. people think real estate is going up in price it’s making it less affordable. No – it was making it more affordable because people were factoring in the appreciation into their decision. So if you were to buy a house and thought it was going appreciate by $100,000 a year, if your mortgage payments were $50,000 a year the net cost of buying the house was a positive $50,000. You got paid to buy it. It was actually calculated into your income. It made it cheaper. But the minute people stopped factoring in appreciation all of a sudden the real cost of home ownership becomes obvious when the house isn’t paying you – “wait a minute, I’ve got to pay a mortgage; I’ve got to pay the insurance; I’ve got to pay the maintenance.” So flat real estate prices make real estate very, very expensive. So, of course, people aren’t going to buy it. But this is going to be a real collapse. [36:04]

JIM: I want to move onto something that’s very touchy – and then let’s talk about how people can prepare – and that is Social Security. This in my opinion is one giant Ponzi scheme. And something that shocked me last week, we had Bernanke on Capitol Hill and he was also there in January. In January we have excerpted clips from a Congressman speaking to Bernanke, and he goes: “How can we get around the promises that we’ve made?” That was one tip off. And then last week, one of the congressmen said, “Well, we really sort of don’t have a trust fund, do we?” And when I heard Bernanke say, “Actually, no. We don’t own any real assets per se, like capital assets, and the IOUs would have to be refinanced in the bond market.” That to me was very telling. So it’s like the jig is up around the corner as the boomers head into retirement. Address this issue.

PETER: It’s not just your opinion that it’s a Ponzi scheme – it’s a matter of fact that it’s a Ponzi scheme. It’s exactly a Ponzi scheme. It’s interesting – my father, who I quote a couple of times in my book, in his book The Biggest Con which he wrote in the 1970s, I think he put in there from the Congressional record, there was a conversation that involved Senator Proxmire (who at the time was the Head of the Senate Banking Committee), and they were having a discussion about Social Security [even] back then, about how are we going to make these payments. And then Proxmire says something to the effect that, “well, the Constitution gives us the power to print money.” No, I don’t think it does – but anyway, this is what he said: “The Constitution gives us the power to print money and we will exercise that power. Social Security benefits may be worthless when the recipients receive them, but they will be paid.” And so here’s a US Senator, basically saying, on the floor of the Senate, that we’re going to make these payments in worthless money which is basically the only thing that can be done. Yeah, the government can meet its obligations. It can send the payments. It’s just that the guy that gets the Social Security checks cannot go and buy anything because it is a giant Ponzi scheme. It worked in the beginning because Ponzi schemes always work in the beginning – that’s why they’re illegal. The main difference here is that everybody is forced to contribute, so it didn’t fall apart a long time ago because the government, by force of law, makes everybody participate.

Initially, when Social Security was imposed it was a 1% tax on a small amount of wages, and it didn’t even apply to the self-employed, who didn’t even have to pay. And those people that got in early, they paid a little bit of money, they made out great; they ended up making a lot of money. But now, nobody can make any money. It’s all going to collapse because the people that collect Social Security payments don’t get it out of a giant trust fund, they get the payments from the people who are paying in today. So who are we – who is the baby-boomer going to get their Social Security retirement from? What generation is following them that’s going to be able to afford to support them in retirement? It’s just impossible. It’s not there.

But of course, I point out in the book that the whole thing was a scam from inception because they called it insurance; when you paid your taxes, they called it premiums – Social Security premiums. You are beneficiaries. They used all of this insurance terminology because the way it was sold to the American public initially was not as a pay-as-you-go Ponzi scheme, but as a funded retirement program – that’s what it was supposed to be. If they had initially proposed it – if Roosevelt had said this is what we want to do, it would never have been approved. So it was a lie from the beginning. That’s why the government collected the first Social Security check, they didn’t make the first payment for 5 years because they wanted to create the illusion that they were building up a reserve. If they had made the first payments right away, the public would have said: “Wait a minute! How can you make payments? You haven’t built up the reserve yet.” They call them trust funds, but there is nothing there – it’s all an illusion. Nobody can write themselves a check and then call it an asset; I can’t write myself a check for a million dollars and then claim I got a million dollar asset because it’s offset by a million dollar liability. Right? So people think a government bond is an asset. Well, it’s an asset for me, but it’s not an asset for the government. So if the government has a trust fund full of its own IOUs, it’s got nothing. So all these projections about when the Social Security trust fund goes bankrupt, they are all nonsense because they all don’t assume bankruptcy until the trust funds are depleted. But they are already depleted. So the real date of bankruptcy is the minute they start paying out more than they collect. And that happens…When is that? Probably in 5 to 10 years – that happens pretty soon. And the minute that happens, it’s all over with because now they have to raise taxes, or do something. That’s because there is no trust fund they can draw on; that money was spent a long time ago. [41:01]

JIM: And that’s why I think they are looking at this now because if the trust fund was to be sound until the year 2040 – or whatever stupid year they came up with – when have you ever known a politician who only cares about next year’s election to worry about something that occurs 30 years from now.

PETER: Well, they don’t worry about it. They like to say it’s a long-term problem to appease the voters; and some of the voters don’t care because they say, “I might not be alive in 2030, or 2040.” So they don’t want to think about it. We don’t have that much time. And the irony, the terrible thing about Social Security is that the reason it was supposedly enacted was that the government said that people were not smart enough to save; that the average person was too dumb – this is the elitist attitude of the politician: that the average American is dumb – they are not going to save for their retirement, and when they retire they are going to be broke, so we are going to force them to save; we are going to do it for them. But the reality was – since the government took money away from citizens, that might have been saved and spent every penny of it – Social Security helped destroy our savings. That’s why initially they exempted the self-employed; the government figured, “if you’re smart enough to work for yourself, then I guess you’re smart enough to save for your own retirement.” But later on, when the chain letter was running out of chain, they had to add the self-employed people because they needed more money to pay the beneficiaries. But imagine a self-employed guy – his payroll taxes is at 14%. That’s a lot of money. Most people can’t save 14% of their income. That money might have been saved if the government didn’t take it away from them in the first place. Well, it might have been invested productively; it might have helped them to grow their businesses. And instead, the government just takes it; just spends it on nonsense. [42:50]

JIM: Let’s talk about how to protect oneself. If the dollar is going to collapse, you have to reposition your assets; and you have to think about protecting against this decline. I don’t have to remind anybody who has been listening to news going back just 4 or 5 years ago of what happened to the poor citizens of Argentina when their currency collapsed and the government defaulted on its debt. A lot of people listening today may think, “well, you know what, that’s a long ways out.” I don’t think so. So let’s talk about what investors can do to protect themselves.

PETER: Well, first of all, it’s not a question if the dollar collapses, it’s just a question of when. It has to. It’s like throwing a ball up in the air, it’s not a question of if it comes down, but when it comes down. I mean, there are certain laws of economics just like there are laws of physics. And this is going to happen. The exact timing of it I can’t be sure – I don’t have a crystal ball on that; I’m not psychic. But I do understand the laws of economics, and so I know the dollar is going to collapse. And so what people have to do is, once they recognize this, just not to have it. You don’t want to be holding a bunch of dollars when the music stops. So you’ve got to get rid of them and you turn them into something real; own something that is not going to collapse instead. And I tell my clients: the most important thing from an investor’s perspective is to conserve your purchasing power; not to look at the quantity of dollars (what your portfolio is, how many dollars do I have) because we don’t know what the dollar is going to be worth in the future – if anything. So the key is to have other stores of value, that can provide meaningful income streams to us so that we can live off of our assets instead of our labor. That’s the whole idea behind retirement is that you can afford to retire when you can afford to live off your investment income. So you have to have purchasing power flowing from your investments rather than from your labor. And when we’re in our advanced ages, we don’t want to work that much; we want our money to work for us. So you’re going to have to set aside assets that will be able to deliver meaningful purchasing power. So what I help my clients do is I have 3 chapters in the book that talk about this plan is acquire assets abroad; acquire conservative income producing assets – which end up being things like commercial property trusts, utilities, a lot of natural resource companies, mining companies, oil and gas companies – located around the world that pay good dividends. I mean dividends of 5, 6, 7, 8, 9, or upwards of 10 percent in cash money; and where the dividends are not static, the dividends are able to rise on an annual basis based on the increased earnings of these companies. And we get our assets around the world. We have money coming in – in euros, and Swiss francs, and Norwegian Kroner, Australian and New Zealand dollars and Singapore dollars and Canadian dollars – in all sorts of currencies so that we’re hedged.

We can be on the receiving end. If there is going to be a giant transformation of purchasing power; if Americans are going to see their standard-of-living lowered relative to the rest of the world – we can be in a position to benefit from the transition; not lose. You know, what happens a lot of times, countries collapse – smaller countries that have gotten into the problem similar to ours only on a smaller scale – and their currency collapses; and what happens is foreigners come in with their highly appreciated money and they go in and buy all the choice assets: they buy the best companies; they buy all the beach front property. Go to a lot of these small countries, all the beach front property is owned by Americans and Europeans, not by the indigenous population. They owned it at one time, but they had it bought out from under them in an economic collapse. So when the dollar collapses, expect all the top-notch US corporations – the big Dow stocks, or the big S&P stocks; and all the best properties and all the best ocean front property in Hawaii and California and in the Northeast – all that property is going to be bought by foreigners because they are going to have the purchasing power. But if as an American, we can get our money abroad, we can be in the same position as the wealthy foreigners outbidding the indigenous population for their assets. And so, you’ve got to prepare for that in advance.

And I also talk about in the book, about keeping some liquidity where the liquidity would be foreign; you can have cash but they don’t have to be dollars; you can have foreign currencies; you can own government bonds – all governments are borrowing money, you don’t just have to lend it to the United States, you might as well lend it to a government that has a greater probability of repaying you in money of similar value to what you lent them.

And then I talk a lot about commodities and precious metals. And I really do think that gold is going to reemerge as money. I think that for the last 20 years gold has lost that money premium; I think that central bankers have duped everybody in to thinking that they don’t need gold – that they can trust them. And I think people are going to realize that trusting a politician with a printing press is not a smart move. And as more people start to wake up to all this chicanery, and realize they’ve been pulling wool over their eyes, I think more and more people around the world are going to return to gold as people have for thousands of years; and they will put their trust into that rather than a politician. And I think you’re going to start to see the demand for gold – and I personally think that the world is in a better position today to be on a gold standard than it ever was. I think gold is a lot more convenient and easier to use and function as money as it was in the past. I think one of the reasons that gold was a little awkward was because you have to carry it around, you know, what if you want to buy something that is very small, how do you chop up the ounce into very small pieces. And so we would end up printing money, but I think with the internet and with debit cards it’s just as easy for someone to have bullion on deposit with a bank and that bank to give them a debit card; and they can spend grams of gold just as easily as they can dollars or euros. So I do think you’re going to see a movement towards real money again. So I think when that happens gold is going to be valued much, much more than it is today. So it makes sense to buy it now. [49:13]

JIM: What is your take on Bernanke telling everybody that growth is going to pick up in the third and fourth quarter, and Alan Greenspan almost for the second time saying, “No. There’s a possibility of a recession.”

PETER: He keeps changing his mind. Now he’s saying there’s a one-third probability of a recession. What’s amazing is that everybody can see that it’s all a bunch of talk. It’s like they want Greenspan to shut up so this guy can talk up the economy. I mean, like his job is to go out there and say positive things: “If we can all just keep telling everybody how great things are...” It shouldn’t matter: if we really had a strong economy, who cares what anybody says. Who cares – the economy would be strong. We don’t have to worry about somebody saying something and causing a recession if we have a sound economy. It’s all nonsense. His job – it’s unfortunate but the job of the Treasury Secretary, and the job of the Federal Reserve is to talk up the economy; they’re a bunch of confidence men; their job is to maintain confidence in the US dollar and the US economy. So all they do is they go up there and say how great things are. It doesn’t matter how things really are. And I think enough people on Wall Street should know that, so why do they care what these guys say. They are going to say how great it is no matter what. It doesn’t matter – we could be completely collapsing and all they are going to say is things are great; everything is great. It’s like the captain of a ship, he’s up to his eyeballs in water, and he’s like, “no, everything is fine! Everything is smooth sailing.” [50:39]

JIM: Yeah – “we’re on the Titanic, we hit an iceberg, but not to worry.”

PETER: But not even then – when the ship is all the way down. I mean he’s like, “b-b-b-but, everything is fine.”

He’s just going to say it’s all great, it’s all great. I mean Paulson is coming out and saying that the housing market has bottomed, that everything is fine and it’s stabilizing. How can they say that? It is just starting. It has just started; the decline has just begun. That’s like the NASDAQ bubble, when the NASDAQ goes from 5000 to 4500, and they go, “oh, look, we’ve bottomed out, it’s all over, it’s all stabilized, don’t worry we’re going back up, we’re making new highs.” [51:16]

JIM: “We got our 10% correction so it’s time to buy.”

PETER: “You know, it’s just a couple of small internet stocks that blew up; that’s all. It’s not going to spill over. It’s a couple of crazy dotcoms, that’s all. Don’t worry about it. Everything is sound.” [51:28]

JIM: I saw you yesterday with Mark Haines. I thought he did you a nice favor by playing the cut he did where we had you on a couple of weeks ago.

PETER: Well, he didn’t play it – the producers played it. He doesn’t have any control over that. But no – what I’d wished they’d have played because it was funny was the subprime thing is what’s all over the place, and two weeks ago on that show, I said, “Mark, aren’t you looking at what’s happening in the subprime market. I mean aren’t you worried about the spill [over]…”

And he goes, “Aw no, that’s well contained. It’s not spilling over into anything. It’s no big deal.”

And I said, “what do you mean it’s not. It’s just started. Give it some time.”

And now, all they’re doing is talking about the spill over. When I mentioned it a couple of weeks ago before it was big in the news, and they go, “what are you talking about?” It’s funny – I did a show, and Mike Norman [ph.] was on this show – on Fox News – and I started talking about, “look, this is a real estate bubble, we’ve got all these lax lending standards.” And then this guy gets on and says, “I don’t know what Peter Schiff is talking about, what does he mean lax lending standards?” – like the guy is completely oblivious – “what do you mean lax lending standards?” [52:29]

JIM: Oh my god. What planet does this guy come from?

PETER: They’re arguing that what am I talking about. They say the loans are sound, nobody is...the default rate…

I go, “when real estate prices were rising, nobody was defaulting. Sure. Why? Because real estate prices were going up. It wasn’t until prices started to go down that you start to see how bad these loans are. And it’s just like the dotcoms – when these stocks were going up it wasn’t a problem. It wasn’t a problem until they started to come down. So sure, as long as real estate prices rise indefinitely then I guess you can loan money to anybody because they’re always going to be able to pay it back. It’s when they stop rising that all the problems come out, and so now this is happening.”

And it’s huge – this is just the beginning. These subprime mortgages are going into default because people are missing their first payment – that’s like you buy a house and you can’t even make your first payment. So these guys are defaulting first, but the rest of the loans are going to go too; I mean, people are going to default on these. [53:19]

JIM: Did you see that Wall Street Journal article last week about the Alt-A mortgages?

PETER: Yeah. I’d never even heard of an Alt-A mortgage until this thing. But yeah, apparently those are the ones that are not quite subprime but are kind of in the middle.

JIM: Yeah, the option-ARMs, the ARMs, the interest-only. Now it’s spilling over into that section.

PETER: But they’re all going to go. And people are not looking at the moral hazards, too. They’re not looking at when they have a $500,000 mortgage on a $300,000 house – are they really going to make the payment, especially if they have to struggle to do it.           

JIM: The thing that disturbs me even more. Did you see the article in the Journal talking about Wall Street firms buying the subprime lenders.

PETER: Well, they had bought them in the past because a lot of the profits from big Wall Street firms were being made by underwriting. Because remember, here’s what was happening. Listen to this profit machine because these loans are getting underwritten to these subprime borrowers, right? The teaser rates were like 3% - 3 or 4%, whatever it was. But then they reset to 9 or 10% for the next 27 years. So Wall Street would average that out. So they would average out the first three years at the low rate, and then the next 27 years at the high rate; and they would have a certificate that’s yielding let’s say, 8 or 9%. Then they would package that up in these securitized bundles and resell it with a AAA credit rating where the coupon was only 5%, or 4 ½%. Do you know how much profit they created by doing that – by taking a note that’s yielding 9% and packaging it with a yield of 4 or 5%? It’s huge. And they were able to stick a AAA rating on it – on 65%. Basically, 65% of these crap loans got AAA ratings because of the way they packaged them up. And of course, the people were committing to making these payments – these 9 or 10% payments; but there’s no way they could ever do it. But they were able to make the first few years, so they were able to take them on their books. This was a huge, huge scam. [55:16]

JIM: It reminds me of the way they used to do junk bonds. A company needed to raise 70 or 80 million, and they would raise 100 million, and they’d put so much money aside to make the payments for the first couple of years and then they would go belly up.

PETER: Yeah, it’s the same thing. Of course, that all blew up – Michael Milken and all that.

This whole thing was a scam because these buyers were committing to loan payments that they couldn’t possibly afford but nobody cared – nobody cared; nobody questioned it. I even had arguments, years ago, with loan officers; I would call and talk to them at Wells Fargo when they would have a piece of property, the Orange County Register would run these [articles]: how much would it cost to buy a home? And it would say the various ways. Okay, so if you want to buy a $500,000 house, and you want to use a fixed-rate mortgage then you have to have an annual income of 175,000; but you can buy it with an adjustable-rate mortgage, if your income is only $125,000. And I would say, now wait a minute, now how can this be? Because the fixed-rate mortgage is 6 ½%; the adjustable-rate mortgage can go up to 9%. Why would you be able to buy a mortgage that can go to 9% with less income than one that can only go to 6 ½%. And they would say, “well, it doesn’t matter. You’re qualified based on the introductory rate. So you only have to prove that you can make the low payment. You don’t have to be able to make the high payment.” But I said, “well, what happens if the rate goes up?”

And they said, “Well, we figure they’ll figure out how to do it.”

“Well, then you mean then…” This is nonsense. [56:36]

JIM: I see these guys, and I see some of these debates on TV and I wonder to myself thinking, what school did these people go to because when I went through graduate school and when I started in the business in the 70s, we knew what money supply meant. And if you had double-digit money supply growth, we knew that that meant inflation. Today, you’ve got these idiots that say, “Well, that’s no longer important. The Fed doesn’t think that M3 is that important” – so they dismiss it. I’m absolutely blown away, and especially by these guys in the bond market. Why would you accept a 10 year Treasury note at 4 ½ %, when inflation is running higher than that?

PETER: Well, obviously you wouldn’t. I’ve written about this that I think that the buyers for bonds – there are no real buyers. Nobody is buying bonds to hold them to clip the coupons. The buyers are foreign central banks that are doing it for political reasons; and hedge funds or other leveraged speculators who are buying these bonds as part of strategies – they’re part of a trade, and they’re not in them to keep them. They’re in them only until they’ve got to get out of a position. And so you have a lot of leveraged speculators. Look at all these bonds that are being bought in the Caribbean – one of the biggest buyers of US government bonds by nation are the Caribbean countries; those are all hedge funds buying these things. So they’re not real buyers. It’s just like so many of these homes that real estate developers were developing and selling, they weren’t selling them to real buyers, they were selling them to the speculators that were looking to flip them. So they really didn’t put them in strong hands of people who were going to live in them for 30 years and pay off their mortgages; they were selling them to people who were looking to sell them again. So they weren’t really sold – and that’s why they’re coming back on the market and getting burned because they really didn’t sell them; they pretended to sell them. So all of a sudden, one day, all of these government bonds that the US government has been selling they’ve been putting them in very weak hands, and all of a sudden they can decide they want out. And then what happens? It’s a real mess. [58:36]

JIM: You know, Peter, as we conclude here, I want to compliment you on the job that you’ve done in your book Crash Proof. What I like about the book itself is you explain the concept of money, the fallacy of some of the economic myths and paradigms that people hear on a daily basis; and a lot of this information which is fed to them. So that maybe they are sitting there, they’re a couple where both of them are working, they’re a little bit in debt and they don’t understand what’s going on in their life because as you have pointed out, if you pick up the paper, turn on some of the cable channels, they tell you everything is wonderful, when you and I know that underneath the surface there’s a storm brewing here. Very well put together, very well written, very easy to understand. And I’d recommend anybody listening to the program go out and pick up Peter’s book. I very seldom endorse books, but Peter, this is one I’m going to endorse.

PETER: I appreciate it. And what my whole idea too with the book is to really put these concepts into simple terms – not using a lot of technical jargon; it’s common-sense. And also, in a way, there are a lot of people too that have friends – I have a lot of clients too where one spouse is totally with me and the other thinks we’re out to lunch. This is the type of book that you can give to somebody who just doesn’t seem to understand it, or who you’re arguing with. Maybe if they took the time to read it, they might all of a sudden see things a little clearer and understand where we’re coming from when we’re talking about these problems. [1:00:04]

JIM: Once again, very well done. The name of the book is called Crash Proof: How to Profit From the Coming Economic Collapse by Peter Schiff.

Peter, thanks so much for joining us this week on the Financial Sense Newshour.

PETER: And thanks for having me.