Peter Schiff 5: Will we do the right thing or will it be Hyper-Inflation?

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Part 5, the final part, of our series condensed from a speech Peter Schiff’s gave on March 13, 2009 to the Austrian Scholars Conference.

Our problems existed because the government, with their policies, undermined our productive capacity, undermined our ability to save, undermined our ability to manufacture and nurtured and cultivated the consumer bubble. Their policies created this service sector economy. And now it has collapsed.

The government’s plan to deal with the economic crisis? (1) They want to bail people out, and (2) they want to stimulate the economy.

But government bailouts are the worse thing that you can do. They want to bailout companies that should fail, that should be bankrupted. Bankruptcy is a good thing. It's the way the market cleanses the economy of companies that shouldn’t be there.

Why shouldn’t they be there? Because they are not generating profits. They are not effectively utilizing resources. Those resources need to be freed up but right now they’re being held hostage. We need to free them up so that we can use them productively.

They say we can’t let General Motors go bankrupt because some auto workers will be unemployed. Well, we don’t want work just so that someone can have a job. We want work so that we can produce something. We want the value.

Keeping those jobs just to preserve them doesn’t make any sense, not if they’re unproductive or inefficient.

We need to let companies go bankrupt.

And if we let General Motors go bankrupt, does that mean it’s the end for the automotive industry? Does that mean all those plants in Detroit are going to sit idle? That all those skilled workers are just going to sit there and nobody is going to try and hire them?

Of course not.

What would happen if we let GM go bankrupt is that some entrepreneurs would step up and buy up the assets out of bankruptcy. Then they would no longer be encumbered with big labour union contracts and interest on debt. They would be able to buy the assets without the liabilities and organize them in such a way that they could produce cars profitably.

In addition to letting companies go bankrupt, the government is viewing this whole crisis incorrectly.

The President keeps saying we need to restore credit.

He keeps saying credit is the lifeblood of the economy. We need credit so Americans can go out and buy more stuff. But the last thing we need right now is for Americans to buy more stuff. We need to start making things for the rest of the world.

China needs cars. Look at all their people who ride bicycles. They have lots of our money now, let’s start making cars – profitably – for them.

Bailouts are another problem. The government wants to bailout Wall Street investment banks. Why? Let them fail. What do we need them for? Why do we need Goldman-Sachs? Why do we need Morgan Stanley? Let them fail.

Everyone is trying to blame all of our economic problems right now on the fact the government let Lehman Brothers go out of business. Meanwhile they’ve bailed out everyone else and we are still in this gigantic mess.

Maybe it’s not because they let Lehman fail. Maybe it’s because of all the other bailouts!

But no… now they want to make us believe that because they let Lehman’s fail, they can’t let anyone else fail.

The reality is we don’t need all these investment banks. And if they go away it’s not going to mean that brokerages are going to stop, that investment banking is going to stop. All it means is... that work is going to be done by somebody else.

There are many smaller firms out there would could fill the void. But the government is rewarding the incompetent people and punishing all the competent ones.

Meanwhile look at all the bonuses being paid using bailout money. How can these executives be entitled to multi-million dollar salaries when their companies are failing? They should get paid based on what they are doing. Let them fail, let them go out of business.

So what, exactly, is the government trying to do with the stimulus?

The government is trying to recreate the conditions that lead to the crisis.

When they talk about stimulating the economy, they’re not talking about stimulating economic growth... they’re talking about stimulating spending. They want us to go back to the auto showrooms, back to the mall and buy more stuff.

And they want us going deeper into debt to pay for it.

And if we’re not willing to accumulate the debt on our own, well then the government will do it for us. And they sincerely believe this is the secret. If they can just spend enough money, then the economy is going to magically grow again.

That’s all nonsense.

The only reason it worked in 2000 (and it didn’t really work then), is because we were able to borrow the money from the rest of the world and spend it. And we were able to live in the delusion that we were getting richer even when we were getting poorer.

We believed this because we looked at our asset prices (real estate and stocks) and we saw the prices going up and we said “hey, were actually getting wealthier”.

But we weren’t getting richer because we were spending money at the same time instead of saving money. We would borrow on the asset value and spend it consuming.

And as we spent money, the government counted that money as GDP. And as long as our GDP was rising then we thought our economy was growing.

But the whole time our GDP was going up, we weren’t measuring how much our wealth was going up. We were measuring how much our wealth was dissipating. We thought we were okay because some appraiser said that our house was worth more. Or the stock market was still going up.

All that was an illusion. Because when the bubble burst, our real estate wealth disappeared and our stock market wealth disappeared.

And now that those bubbles have burst, there’s no way to go back to it.

We can't go out and borrow any more money against the value of our real estate... because the real estate value is gone, collapsed.

We can't go out and borrow any more money against the value of our stocks... because the stock market value is gone, collapsed.

Restoring credit by bailing out the banks won't work.

And it doesn’t matter that the stock market is rising again. Because you’re going to have ups and downs, but stocks are still too expensive. These rallys are doomed to collapse again because, based on any kind of historic measure of value, the P/E’s are high and the yields are low for our companies.

Stocks are overpriced, even today.

Houses are overpriced, even today.

Our assets are still overpriced despite the fact that they have fallen.

Our whole economy is phony.

Why? Because the malinvestments we have now is this entire service sector economy.

We have built an economy based on the idea that we can borrow and spend in perpetuity. And that’s just as phony as the idea that real estate prices will always rise.

So we have a lot of Americans working in jobs they really shouldn’t be in.

We have a lot of Americans who work in retail, who work in shopping centres, who work in restaurants, who work in financial services. We have a whole lot of Americans working in jobs they really shouldn’t do because we are too broke to patronize their businesses.

We need more Americans making stuff, producing things.

What do we produce right now?

And in order to have American labour available for productive capacity, they have to leave those jobs. Somebody has to loose their job in the service sector in order to get a job in goods production. And to get the jobs in goods production, we need the capital. I mean you can’t produce anything without machines, without tools. And where is that going to come from? You need Americans to have savings. Someone is going to have to borrow the money to make those investments. You need people to save their money.

If no one has any savings to lend, then we are going to have to convince someone in another country to take their savings and lend us that money for our productive purposes (and not just to lend it to us to spend).

It’s not like the 1800s when we ran huge deficits.

Bach then we borrowed money to make investments, to build infrastructure, to build factories, to build farms… to build a productive economy. We invested the money, we didn’t just spend it on stuff. When you borrow money and invest it in productive capacity, then you have a real asset. And the asset can generate real revenue. That’s what we did. We produced things that the British and French could buy, that’s how we made enough money to pay back what they lent us.

We became the world’s wealthiest economy because we borrowed to produce.

What we have done recently is to borrow to consume.

So how can we possibly pay this money back?

So if we want to build a viable economy, and we don’t have our own savings, we’re going to have to convince the Chinese and the Japanese to build factories here. But why would they want to do that? With the high regulations we have right now, with the high taxes we have right now, we’re just not competitive.

So the only way we are ever going to rebuild a sound economy in the United States is if we stop all the stimulus and stop all the bailouts and let the free market work.

What we have to understand is that what is going on, the recession, is the solution not the problem.

The problem was the bubble inflating, blowing up. Not the deflation.

We have to allow the pain, no matter how unpleasant it is. We have to understand that anything we do to delay this is going to make it worse.

And Obama and Berananke are making the exact same mistakes as Bush and Greenspan did in 2000, only on a much grander scale. The bailouts are preventing the solution from being allowed to work.

It’s the same philosophy. Nothing has changed. This might as well be the third Bush term because Obama is doing the same exact stuff. They are arguing the economic growth is a function of people spending money and we need our government to stimulate the economy. Therefore we should bailout the people who fail and punish the people who succeed, and that we should have a zero interest rate with the Fed cranking out money.

It’s the wrong direction.

We need to allow these companies to fail, and allow Americans to stop spending (through the pain of recession). The credit crunch is a good thing. The fact that credit is being denied to Americans is a good thing. It’s a good thing because credit is scarce. Credit isn’t unlimited; it’s a function of savings. And if we want to have a real economy, if we want to have production, then savings need to go to producers.

Well they’re not going to go to producers if they’re being squandered by consumers.

They’re not going to go to producers if the government is borrowing all the money.

So what do we need? We need the government to eliminate the deficit and go to a surplus. We need the government to stop spending money and depleting our savings. We need consumers to stop spending money and rebuild their savings.

We need a recession.

We need one badly. And we need to have the government say to us, “Yes. This is the price we pay for years of indulgence and reckless spending, now comes the sacrifice. And there is nothing the government can do about it.”

We also need sound money. Unfortunately the means we need high interest rates.

That’s what we need but Obama and Bernanke is giving us what Bush and Greenspan gave us. And it’s going to fail.

And what is it going to give us? What are going to be the consequences of what we are doing now?

What I think is going to happen is that, ultimately, people like the chinese and the rest of the world - the saudis and the japenese and everyone else, they are going to figure this out. And they are not going to want to play this game anymore.

You know, we have them conned right now.

In my book, crash proof, I compare it to Tom Sawyer. You know there was that passage in Tom Sawyer where Tom gets everyone in the neighbourhood to whitewash his fence. And he gets them to pay for the privilege of doing his chores. When Mark Twain wrote that passage he probably had no idea that it would form the basis of the entire world economy.

We have got the world painting our fences. Like they don't have their own fences that need painting.

But the world is not going to accept this con. You've had Hillary Clinton, when she went over to China, a couple of weeks ago to get them, to beg them to buy our bonds.

She'd tell them, we're all in this together. And basically this is what she tells the Chinese:

"You need to take money away from your citizens and loan it to us, so that we can give it to our citizens, so they can use it to buy products made in your country, to keep your people employed."

That's the deal that we are making with them.

Now what the Chinese should say to Clinton is:

"you know what, I have a better idea. Why don't we just leave our money with our own people, and then they can use the money to buy their own products. That way we get to keep our stuff."

You know, the way it is right now, we get all the stuff and all they get is the jobs.

What good are jobs without stuff?

That's slavery.

So they're gonna figure it out. And what's gonna happen is they're not going to buy our bonds and the Fed is going to start buying all the bonds, and the dollar is going to plunge.

And this crisis is going to end up being a currency crisis. And when it becomes a currency crisis.. then... you're going to have higher consumer prices, and you're going to have higher interest rates.

Right now we are creating a lot of inflation and people are talking, they're saying "it's not inflation, it's deflation".

That's all nonsense.

Real estate prices are falling because they are too high. Stock prices are falling. But that's not deflation.

That's just falling prices.

There is no contraction of the money supply, it's growing like crazy.

But the expansion of the money supply is not immediately showing up in rising prices for commodities and consumer goods because there are other temporary factors pushing prices down at the same time inflation is pushing prices up.

You've got deleveraging, you've got bankruptcies, going out of business sales, you've got a lot of companies liquidating their inventory and you have the dollar strong.

Paradoxically, while this was happening as this crisis began, money flowed into America instead of fleeing America. Ultimately it will flee, but currently it is flowing into America.

Can you imagine? It's as if there was this giant explosion and everyone is running towards the blast... that's what's going on with all this money flowing in.

We caused the explosion. It's our system that has collapsed. And people are plowing their money into our system as a safe haven.

And we are rationalizing to ourselves right now. We look around the world and say, "well people are coming to America because as bad as it is every place else it's so much better here." But that's nonsense. That's just what we justify, just like we tried to justify the real estate bubble. Or the internet bubble. It's all nonsense.

Why is it so bad in the rest of the world right now? It's because they loaned us so much money and we can't pay them back.

And now they're losing, based on their bad loans.

What's really causing the global credit crunch and making things so bad in the rest of the world is that we're borrowing so much money right now that were crowding out everyone else.

The fact that people are loaning us so much money means that private businesses around the world can't get capital.

Why?

Because it's all going to the US government, that's why.

So... the world is suffering. And the world is suffering, not because our economy is collapsing and we can't buy their stuff anymore, but because they are foolishly trying to prop up our economy.

And, when they figure this out, then were really going to get an economic crisis.

Because when they figure this out, they will stop proping our economy up. China and the rest of them will stop buying our treasury bonds. And when the dollar starts to plunge - and it will - then we are going to see prices rising sharply for consumer goods and we will see interest rates rising.

And if we think we have problems now wait till we see how much worse they get when we throw rising consumer prices and rising interest rates into the mix.

And there is nothing the government is going to be able to do about it.

You know, right now, unemployed people are getting the benefit of lower prices. Imagine when you are out of work AND your prices are going up.

Because that's what's going to happen. And then this is going to be a real economic crisis. And we are going to be in for some very, very difficult choices.

And unfortunately, the worse case scenario, is one that is looking increasingly more likely, which is hyper-inflation.

Hyper-inflationwill come when no one will lend us money.

The Fed will have to buy up all the bonds in order to keep interest rates down and to maintain deficit spending. And then the velocity of money will really start to pick up, and no one is going to want our money, not even American citizens will want it.

And they will try to spend it as quickly as they can. I mean the government will try and keep it together a little bit longer, with regulation. Maybe we will have capital controls. Maybe they will make it illegal for Americans to do what I am doing with my clients right now, which is buying foreign currencies, foreign stocks.

Maybe they will make it illegal to buy gold. As prices really start to escalate, private parties will try to make contracts, with payment in gold or other currencies. Maybe the government will make that illegal.

There might be stores where people don't want to accept dollars, because their value is dropping too rapidly.

The government will make that illegal.

And that means we will have a black market. If you want to buy something, you will have to buy it on the black market. Just like they did in the Soviet Union. The only reason you could buy anything there was because you did it illegally.

A lot of these things are going to happen. I think early on, probably in Barack Obama's first term of office, I think were going to have price controls. I think prices will be rising so rapidly, maybe even by next year, that they are going to impose price controls on a number of products. Probably energy, probably gasoline, probably milk, bread. I mean we are repeating all the mistakes of the 1930s, we might as well repeat all the mistakes of the 1970s.

So when the put on price controls, what that's going to lead to? Shortages? Blackouts? Long lines for gas? Long lines for food?

Civil unre... I mean a lot of things are going to happen.

People say we can't repeat the mistakes of the 1930s... well that's exactly what we are doing.

I mean, the popular notion is that we had a depression because Hoover was so irresponsible that he trusted the free market and he did nothing.

And because he did nothing, we had a depression.

And then Roosevelt rode to the rescue and saved the day with big government.

Well, the reality of course is that we had a depression because we had a Federal Reserve that was too easy in the 1920s and created a boom and when the boom bust, Hoover ignored the good advice of his secretary of the treasury (which is maybe the last time the secretary of the treasury ever gave anyone any good advice) and instead of allowing the free market to work, he came up with all kinds of crazy things to bail people out and prop things up and distort prices and fix wages and all kinds of things, that created the depression.

And then Roosevelt came in and proceeded to make it worse. And everything that Roosevelt did exacerbated it and made the depression 'Great'.

And we eventually got out of it after the second world war, but how can anyone say we got out of it because of Roosevelt?

We got out of it despite Roosevelt.

We would have got out of it a lot faster had Roosevelt not just expanded the failed policies of Hoover.

And that is very similar to what is happening now.

You got Bush, who is the Hoover, now, of this generation, who was associated with the free market but was anything like the free market.

And now we have Barack Obama, like Roosevelt, coming in to save the economy with big government.

Of course, the government is already huge, maybe he hasn't figured that out.

When Hoover left office, I think the federal budget was about four billion dollars.

That was the whole thing.

And Roosevelt doubled it to about 8 Billion.

Now we're 3 Trillion. That means the government is huge.

Of course when Roosevelt came in, we had a sound economy beneath the surface. I mean we had a productive economy, we saved, we made stuff, we exported, we didn't have a huge social welfare state, no body got cheques from the government. We were in much better shape.

If they did that much damage to a sound economy, imagine what they can do with the one we got now?

Plus back then we had real money, we were on the gold standard.

Now look at us.

I mean, look at the problems we had in the 1970s. Still we had a fundamentally sound economy then.

We had a bubble in the 60s, the same stock market bubble, we printed too much money, we went to Vietnam, we went to the moon, we had the war on poverty, the government created too much money... and they gave us the 1970s.

That was the payback for the 1960s.

But then in the 1980s, we got some sensible government. We shrank goverment and we raised interest rates.

We went for sound money and smaller government.

But what do we have today?

We have a huge trade deficit but we have no domestic savings. And we're already loaded up with debt. And the only hope we have of artificially stimulating our economy is that we borrow the money from the rest of the world.

We don't have it, on our own.

So, when the world stops financing this, and it's gonna come to an end. And we're gonna have to make some hard choices. Is it going to be hyper-inflation or are we gonna do the right thing?

But the rest of the world, and a lot of people think this is never going to happen - and I've had a lot of arguments, and people call it decoupling - they say "this is never gonna happen"... or "when America stops consuming, the whole world is finished".

They're not finished. We're not the engine of the world's economy. We're the caboose. And if you decouple the caboose, the cars move faster.

Ya know, were not doing the world any favours consuming their stuff. It's vendor financing. But people say 'we're their best customer'. We're not. We're the worst customer because we don't pay.

Your good customer pays you.

And in the world of trade, you pay for imports with exports. And if you don't have anything to export you, you don't pay. And that's what we have, we issue an IOU.

And when the world finally lets the dollar collapse, and they will, our purchasing power isn't going to vanish, it's going to be re-distributed.

Other currencies are going to rise. And people in other countries, people who are working in factories right now in China, people who are making products and just shipping them abroad and waving goodbye, all of a sudden... they will be able to afford them.

The Chinese will be able to turn in their bicycles and buy automobiles. Because steel will be cheaper, because cars will be cheaper, because the value of their wages will rise, because their currency will gain purchasing power.

It's Americans who will be buying the bicycles. Because, all of a sudden, cars will be too expensive for us. Gasoline will be too expensive for us. Because we will be bidding with currency of much less value.

And that's what's gonna happen. The world is not going to suffer because we don't buy their stuff, they're gonna benefit because now theirs going to be more stuff for them.

I mean, right now, because the world lends us so much money, there's a capital shortage.

Wouldn't the world be better off investing their savings productively in their own countries? Rather than just giving their savings to us?

Wouldn't they be better off enjoying the fruits of their own labour rather than labouring while we enjoy the fruits?

It's obvious and wery shortly now they are going to realize that.

And when they do hyper-inflation, and all that comes with it, is gonna happen.