As we go through an important paradigm shift in politics, in the global economy, in equity markets, and of course in precious metals too, the fundamental economic principles we used to rely on seem to be increasingly under attack. Central bankers the world over are doubling down on reckless monetary policies, punishing savers and responsible, long-term investors.
In Europe, we have already seen the damage that negative interest rates and protracted QE have inflicted, and will continue to do so, as the European Central Bank recently confirmed its intentions to insist on cheap money policies. Now, as the Fed seems to be going down that same path and as the US President himself is calling for zero and even negative rates, the present challenges for conservative investors are only bound to be compounded.
To get a better understanding of the current situation in the US and of the tremendous impact that the Fed’s decisions have on the economy and on the average citizen’s life, I turned to my good friend Jeff Deist, President of the Mises Institute in Alabama. For decades, Jeff has been a strong advocate for property rights, free markets, self-determination and open debate, while he has also worked as a longtime advisor and chief of staff to Congressman Ron Paul. His experience, his deep understanding of economics and his analysis of the dangers of politicizing monetary policy, not only provide a lot of food for thought, but can also help responsible investors identify the challenges and opportunities that lie ahead.
Claudio Grass (CG): Fears of an upcoming recession are on the rise in the US, rattling investors and dividing analysts. On the one hand, we see robust economic data coming out of the country, like consistently solid jobs reports. On the other hand, the global economic slowdown, the trade war and the overall uncertainty have taken their toll, while the underlying, fundamental problems of the US economy, such as the debt burden, remain unsolved. What is your assessment and expectations for the next couple of years?
Jeff Deist (JD): The economic data produced by the US federal government, in particular GDP, unemployment, and the consumer price index (CPI) are all dubious from the perspective of sensible economics. GDP is nothing more than a Keynesian aggregate that includes government spending (regardless of borrowing/deficits) and makes a fetish out of exports (regardless of consumer preferences). In the early 2010s, Turkey was able to borrow and spend considerable sums on public works, and thus reported very high GDP. But today we see that Turkish prosperity was an illusion, funded by debt. In the same way, US GDP is very much driven by nearly $4T in government spending. A better measure of an economy’s true output is the Rothbard/Salerno “gross private product,” which subtracts government outlays.
Unemployment figures are also unreliable, because they do not measure millions of Americans who have simply stopped looking for work– for example early retirees, housewives, and graduate students who would rather be in full-time jobs. And of course, CPI does not measure food, energy, and taxes, nor does it measure hidden forms of “shrinkflation,” such as when a packaged food item stays at the same price but slightly reduces the ounces contained in the package. John Williams at ShadowStats.com provides much more accurate data on inflation.
Overall, there is a profound sense the American economy is living on borrowed time and borrowed money, all made possible by loose monetary policy and low interest rates engineered by the Federal Reserve. US debt will prove to be a huge drag on growth in the very near future, as interest rates must rise to attract purchasers– otherwise the Fed, the “buyer of last resort,” will become the primary market driver for US debt. But if interest rates rise even to only 5%– well within 100 year norms– debt service will quickly rise to over $1T annually in the US federal government’s budget. Our prosperity is temporary and illusory.
CG: The President tends to blame the Fed for the increased volatility of US markets and has even described Fed Chair Powell as an “enemy”, placing the country’s economic growth at risk. Do you think that a more decisive return to expansionary monetary policies would suffice to protect the US economy and prolong the bull market? Are further rate cuts and more money printing the way forward, and if so, would you expect to see the US join the negative interest rate club?
JD: More QE (i.e. adding to the Fed’s balance sheet via asset purchases, and driving the Fed Funds rate back toward zero or even negative territory) will not revive the US economy any more than increasing the credit limit for an addicted gambler will save him at the casino. Trump’s call for looser monetary policy is unfortunate and deeply misguided. Alan Greenspan recently alluded to the possibility of negative interest rates in the US, and we can only assume the Fed will follow the ECB’s example. The fundamental mistake is in thinking consumption is key to a healthy economy. Negative rates only make sense if one believes in this Keynesian mania, the idea that the goal of fiscal and monetary policy is to encourage or even compel spending. JB Say taught us otherwise; all healthy economies begin with production.
Certainly, central banks are the “enemy” of real savings and investment, but not because they have been too tight! The opposite is true, especially in the US. The Fed’s 20 year experiment with cheap money–beginning in 2000 with the “Bernanke put”– has only created the veneer of growth. One need only look at the Japanese economy and the BOJ’s actions to understand this. The frightening possibility is that the Fed will begin buying equities, like the BOJ (and the SNB!).
CG: Could you explain the real, long term effects and mechanisms behind Quantitative Easing and artificially keeping interest extremely low or even negative for so long? Who are winners and who are the losers of this policy direction and how does it interfere with fundamental economic principles like time preference?
JD: Both Cantillon and Mises explained that money is never neutral. New money does not spread across the economy evenly; if it did, prices would quickly adjust and nobody would become richer or poorer. Instead, the benefits of newly-created money and credit flow outward from their source, and those closest to government (e.g. contractors) and central banks (e.g. commercial banks) avail themselves of the new money sooner, before general prices rise. Poor people, and those living on fixed incomes, are hurt the most because they are not early recipients of the expansionary money flow.
Low or negative interest rates affect society and culture far beyond the realm of pure economics. If simple, safe savings vehicles– like CDs or money market funds– only earn 1 or 2% interest, even middle class people and retirees are forced into equity markets seeking yield to keep up with inflation. Rich people benefit because asset prices (real estate, equities, privately held stock and partnership interests) become inflated when the cost of borrowing money is cheap. And poor people, who lack investment capital and knowledge, save less than ever because saving hardly pays any return.
The overall result is a spendthrift society, one that lives today at the expense of tomorrow. Our great-grandparents did the opposite, and in fact all prosperous civilizations save more than they consume, thus bequeathing a surplus to the next generation. Central banks have turned this most human tendency upside down, deeply harming civilization in the process.
Claudio Grass (CG): While President Trump blames the Fed, the Fed blames the President and his trade war for the recent turbulence in the markets. What do you identify as the most important effects of the trade frictions in the country? Do you expect the conflict to be resolved before the next election?
Jeff Deist (JD): Tariffs are a form of economic warfare, and as a protectionist/mercantilist, Trump does not mind incurring casualties in trade wars. I am not sure he fully understands, however, that those casualties are the poorest Americans, those who shop at Wal-Mart for cheap food and clothes. Tariffs are taxes, and like all taxes, they disproportionately hurt the poor, as far more of their income goes to basic consumption of necessities.
Unfortunately, there is stubborn support for trade tariffs among the American public, and this allows politicians to make the same errors time and again. More Americans need to read Henry Hazlitt! If in fact Trump loses the 2020 election, his trade tariffs–and the recession they may well cause– will be the reason.
CG: Speaking of the upcoming election, it can be argued that the intense polarization of the public that started in 2016 will escalate further this time around. With the possible exception of Joe Biden, most leading Democratic candidates, like Bernie Sanders and Elisabeth Warren, seem to have a very radical economic agenda, and a distinct bend toward more centralization and government intervention. Do you think such ideas resonate with the majority of voters, or even the majority of Democrats, or are they only popular with a small subset of supporters, on the left fringes of the party?
JD: Americans like the mythology of self-reliance, but they like the reality of government entitlements, welfare, and militarism. The US is not a libertarian country, but merely a less advanced social democracy. Our polarization is cultural and regional more than political, and it is certainly not ideological. The vast majority of Americans would not advocate a reduction in spending on Social Security, Medicare, national defense, education, or virtually any significant federal programs. Sanders and Warren represent increasingly mainstream economic views; the opposition to them is based almost entirely on social issues like race, abortion, guns, and supposed “climate change.”
CG: Among the most talked about proposals in the Democratic debates have been Universal Healthcare, the forgiveness of student loans, an extreme increase in regulations and a Wealth Tax. What would you expect the impact of these plans to be on the economy?
JD: These proposals represent the next “great leap forward” in American statism. The Civil War represented the end of federalism and states rights; the progressive era represented the end of substantive economic freedom; the New Deal era represented the entrenchment of entitlements, central banking, and income taxes, and the Great Society era represented the enactment of a permanent welfare state.
Today’s progressives are on the cusp of the next historical turn, toward guaranteed income and taxes on wealth. All of these eras demonstrate the relentlessness of progressivism and the challenge for liberty-minded people. Note that the Right is worthless in this battle; to paraphrase Murray Rothbard, the US GOP merely consolidates the gains of the Left.
CG: Up until today, the Achilles heel of generous promises like that was the question “how will you pay for it?”. Now, however, we see rise of Modern Monetary Theory and the slow normalization of the idea that debt is not a problem, not just in the US, but in Europe as well. Do see this shift as a real threat to the economy and to society or do you rather see it as a passing ideological fad?
JD: Former Vice President Dick Cheney famously said “deficits don’t matter.” This represents a growing belief in America, that our $22.5T debt will never need to be repaid– and in fact, will never have much of an impact on our economy! This is magical thinking, and of course, the rest of the world knows the US will never get its fiscal house in order. In this sense, buyers of US Treasury debt should demand junk bond rates! And of course, we already finance much of our federal spending using debt; in fiscal 2019 the federal government will spend about $4.7T and collect only $3.7T.
So the difference is effectively monetized, over many years, in a roundabout way: the Treasury sells bonds, the public or banks buy them, and the Fed either actually repurchases them (as with QE asset purchases) or creates an implicit backstop (i.e. the public believes it will serve as the buyer of last resort in a crisis). Although the Fed is not directing the Treasury to literally print money (or create digital money), it is in effect already engaging in MMT by financing roughly 25% of the annual federal budget (the deficit).
CG: The past few months have been a very exciting time for gold and interest has once again picked up in the face of increased market volatility. Short-term price moves aside, what is your long-term view on precious metals vs fiat money and what is your own motivation to own gold?
JD: Gold is a hedge not only against financial risk, but against political risk in the form of currency collapses. Will the US dollar, or the Swiss franc for that matter, always be valuable? We cannot know the future, but we can study the past. And gold– unlike many currencies, assets, and investments– has never gone to zero. As Mises explained, the market decides what is money. So far, modern human societies have never rejected gold as money, no matter how hard central banks try. Gold is not an investment, it does not pay dividends. It rises and falls only in relation to the volatility inherent in fiat currencies, but gold is not volatile itself. It holds value precisely because it is not subject to fiat issuance by any government or central bank.
CG: Going forward, there is a multitude of risks for the US and for the global economy. From geopolitical tensions and global political division, to economic red flags and a significant shift in monetary policy by most major central banks. In your view, which are the most important risk factors and pressing challenges that both investors and citizens need to look out for?
JD: Look for western governments increasingly trying to ban or severely restrict the use of cash. Negative interest rate schemes cannot be imposed if people can hold large amounts of physical cash at home or in private non-bank storage. Who would pay interest to a bank when you could hold physical cash instead? By forcing us into digital bank accounts and digital payments, governments can control our lives in countless ways– tracking us, taxing us, and charging us interest for the privilege of operating with our national currencies.
Limitations on cash are nothing more than a form of capital controls, and should be seen in the same cautionary light (just this year Argentine officials attempted to restrict the withdrawal of foreign currencies from their banks). Restrictions on the use of cash are a sign you should get your money out of the country, if at all possible.
Claudio Grass, Hünenberg See, Switzerland
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