We live in unprecedented times. The Western nations, ruling the planet since the 1400s, are now facing eclipse.
So many writers I’ve been reading are discussing it:
– Chris Hedges
– Morris Bermann
– Dambisa Moyo
– Niall Ferguson
– Jared Diamond
A follow up from the quote from Prince’s “Nothing Compares 2 U” at the start of this blogpost:
Mainly shot in Paris, the music video for “Nothing Compares 2 U” was directed by John Maybury. O’Connor’s crying toward the end wasn’t accidental: she stated on VH1’s 100 Greatest Songs of the 90s that it was caused by the lyric “All the flowers that you planted, Mother/in the back yard/All died when you went away,” because she had a very complex relationship with her late mother, who used to abuse her in childhood.
Is the West like Sinéad O’Connor‘s mother in this story? Abusing First Nations/Native Americans, Metis, slaves/cheap labour from Africa/Hawaii/India/China/etc. and even Europeans such as Irish, etc.? Are all the flowers planted in the backyard by America and the West dying and withering away?
Here below are some articles I copied:
“The decline of Rome was the natural and inevitable effect of immoderate greatness. Prosperity ripened the principle of decay; the causes of destruction multiplied with the extent of conquest; and as soon as time or accident had removed the artificial supports, the stupendous fabric yielded to the pressure of its own weight.”
– from Edward Gibbon’s The Decline and Fall of the Roman Empire
After ruling much of the known world for centuries, Rome fell due to a number of factors that, historians believe, would not have been fatal in isolation, but that proved terminal in combination. Military overspending and overreach, an untenable economic system, and currency debasement all played a role. As has been well documented, the Roman emperors attempted to distract the populace from the increasingly dire reality of their situation by providing bread and circuses. But entertainments could not stop the nation-state from yielding to the pressure of its own weight.
There are numerous parallels between the end of the Roman Empire and the path the 226-year-old American republic is now on. One difference in these fast-moving times is that empires can rise more rapidly, but are also likely to decline more rapidly.
Conquest & Overreach
“The decay of trade and industry was not a cause of Rome’s fall. There was a decline in agriculture and land was withdrawn from cultivation, in some cases on a very large scale, sometimes as a direct result of barbarian invasions. However, the chief cause of the agricultural decline was high taxation on the marginal land, driving it out of cultivation. Taxation was spurred by the huge military budget and was thus ‘indirectly’ the result of the barbarian invasion.”
From Arthur Ferrill’s The Fall of the Roman Empire: The Military Explanation
The Roman Empire’s economy was based on the plunder of conquered territories. As the empire expanded, it installed remote military garrisons to maintain control and increasingly relied on Germanic mercenaries to man those garrisons.
Ultimately, as its territorial expansion waned and began to contract, less and less booty became available to support the empire’s widespread ambitions and domestic economy. The outsourcing of the military and the cultural dilution from the bloated empire led to lethargy, complacency, and decadence amongst the formerly self-reliant and hard-working Roman citizenry.
In the modern context, as the only major power whose productive capacity was not destroyed during World War II, the American Empire emerged from the ashes of that conflict.
The parallels with Rome do not repeat, but they do rhyme.
Rather than plunder, the U.S. used its unique status to dictate terms that made the U.S. dollar the world’s de facto reserve currency and positioned its robust new manufacturing sector to supply the world with the cars, machinery, appliances, and electronics it so desperately needed. The U.S. trade surplus with the nations of the world led to escalating U.S. wealth and prosperity.
Meanwhile, the U.S. military, about which I’ll have more to say in a moment, was increasingly asked by the nation’s politicians to take on the role of the world’s policeman, leading to action in dozens of conflicts. And even where no direct military role was taken, the U.S. has shown a keen willingness to exert coercive power – including threats, sanctions, and even assassinations – if it was seen to advance American interests.
Simply, in the 20th century, the U.S. became an empire in all but name.
Bread and Circuses
“Already long ago, from when we sold our vote to no man, the People have abdicated our duties; for the People who once upon a time handed out military command, high civil office, legions — everything, now restrains itself and anxiously hopes for just two things: bread and circuses.”
Roman Poet Juvenal – 77 AD
British historian Andrew J. Toynbee convincingly argues that the Roman Empire had a rotten economic system from its inception and its institutions steadily decayed over time.
The government didn’t have proper budgetary systems, and so it squandered resources maintaining the empire while producing little of value. When the spoils from conquered territories were no longer sufficient to cover its many expenses, it turned to higher taxes, in effect shifting the burden of the immense military structure onto the back of the citizenry. The higher taxes forced many small farmers to let their land go barren. To distract its citizens from the worsening conditions, Roman politicians played the populist card by providing free wheat to the poor and entertaining them with circuses, chariot races, and other entertainments.
The American Empire has reached the point where it now faces similar structural imbalances, but to pay its bills, it has largely chosen to borrow from foreign countries in recent years. And the bills are large.
The $765 billion of annual military expenditures by the United States equals the military expenditures of the rest of the world combined.
The social safety net put in place over the decades by politicians attempting to get reelected has resulted in a large number of Americans now almost totally dependent upon the almighty state for their well-being. Threatening to rip apart the country’s social fabric, the “new American” will vote for anyone who promises to sustain his dependency even as the nation increasingly struggles under the weight of $56 trillion of unfunded liabilities.
The non-farm workforce in the United States totals 133 million people. Of that number, the government directly employs 22.5 million. Millions more are employed by industries heavily dependent on government spending, such as defense, construction, and healthcare. The annual maintenance cost of the country’s safety net now costs American taxpayers hundreds of billions.
- Medicare and Medicaid annual spending $682 billion
- Social Security annual spending $612 billion
- Food stamps & other food programs $ 60 billion
- Federal unemployment payments $ 45 billion
America has evolved from a nation of savers to a nation of consumers with a throw-away mentality and driven by little more than the desire for instant gratification. Worse, large segments of our society are convinced that they are owed something. To most, civic duty has become a quaint, outmoded concept. Happy to accommodate – in exchange for a reliable vote come election time – the government keeps the public satiated and sedated by providing them with an ever-increasing list of “public services.”
Roman poet Juvenal described how the Roman citizens abdicated their duties to the state and turned to bread and circuses. The programs listed above represent just some of the bread that American citizens now feel entitled to.
Here in America, we know how to provide circuses on a grand scale. Roman citizens were satisfied with a good chariot race. In these modern times, Americans can find entertainment and distraction with 24-hour-a-day cable TV, the Internet, iPhones, iPods, Blackberries, 1.1 million retail stores, 1,100 malls, 17,000 golf courses, Britney Spears, Kim Kardashian, Housewives of Orange County, New York, Atlanta, and New Jersey, American Idol, Survivor, Rock of Love, Flip That House, 660 stations with nothing on, Las Vegas, Disney World, MLB, NFL, NBA, NHL, WWF, porn, and mega-churches all competing to fill the void in people’s lives.
There isn’t enough time in the day to take in all of the circuses, but with what little spare time we have available, we are now able to check our email anywhere on Earth and stay in constant contact with the office even in the middle of the night or, more typically these days, in the middle of dinner. And we can text and twitter our every thought to our circle of friends and followers, providing next to no lasting purpose or benefit to anyone.
Approximately 12% of the U.S. population (36 million people) is considered poor, and many of them are totally dependent upon the state. Yet that term seems out of sync with the fact that many of those individuals have cell phones ($500/yr.), cable TV ($900/yr.), Internet access ($500/yr.), cars ($5,000/yr. lease), houses ($6,000/yr.), eat fast food ($1,000/yr.), and can smoke a pack a day ($1,500/yr.).
How can this be?
For the answer, look no further than Alan Greenspan, Ben Bernanke, and the Federal Reserve, in cahoots with the financial geniuses on Wall Street, who made it standard practice to create money out of thin air and encourage anyone with a heartbeat to avail themselves of it in the form of low-cost loans – no proof of income or assets required.
The arrangement worked just fine until the banks could no longer hide the bad debt or sell it to the greater fool. Now it has collapsed onto the backs of American taxpayers.
The supply of foodstuffs in the cities declined. The people in the cities were forced to go back to the country and to return to agricultural life. Consequently, the emperors made laws against this movement. There were laws preventing the city dweller from moving to the country, but such laws were ineffective. As the people did not have anything to eat in the city, as they were starving, no law could keep them from leaving the city and going back into agriculture. The city dweller could no longer work in the processing industries of the cities as an artisan. And, with the loss of the markets in the cities, no one could buy anything there anymore.
Ludwig von Mises – Human Action
Economist Ludwig von Mises argued that flawed economic policies played a key role in the impoverishment and decay of the Roman Empire. He contended that interventionist economic policies, including price controls that resulted in prices substantially below their free-market equilibrium levels, ultimately led to inflation.
Further, Rome was spending more than it could afford. The free food rations for the poor of Rome and Constantinople – as well as the many entertainments – were costing a fortune. The purchasing of exotic spices, silks, and other luxuries from the Orient bled Rome of its gold… gold that didn’t return. Soon Rome didn’t have enough gold to produce coins. And so it debased its coins with lesser metals until there was no gold left.
To cover the trillions it is spending each year propping up its empire, the U.S. government is now increasingly forced to rely on printing and borrowing the funds to do so, steadily debasing the currency in the process.
But the nation’s currency debasement is nothing new. Rather, it began in 1913 with the creation of the Federal Reserve. It accelerated when FDR confiscated all the gold in the country in the 1930s. When Richard Nixon took the U.S. off the gold standard in 1971, the show really got on the road, as that freed the Federal Reserve to print unlimited amounts of dollars. As a result, the dollar has lost 93% of its value versus gold since 1970.
The Military Complex
Lessons from ancient Rome regarding the cost of maintaining a far-flung empire have been ignored. Today, U.S. boots stomp on the ground of over 117 countries. Even the use of mercenaries, in the form of thousands of Blackwater guards and other private contractors filling roles formerly left to the military, has become commonplace.
Using military assets to pursue political goals, as is the norm in empire building, has led to unintended consequences and wasted opportunities.
One of the most egregious of those lost opportunities came following the bankruptcy and collapse of the Soviet Union. The United States had won the Cold War, but failed to recognize the cautionary signs on the path ahead.
As the only remaining superpower on earth, America fell into the same trap that has befallen previous empires. Instead of concentrating on proactively confronting domestic challenges, such as unfunded Social Security and Medicare liabilities, and developing a comprehensive energy plan to wean ourselves off Middle East oil, we continued to intervene in costly foreign adventures.
Including, among many others, supplying both Osama bin Laden and Saddam Hussein with weapons and money during their fights against our enemies, leading to unintended consequences we live with to this day.
Seeking to maintain its widespread interests and to defend itself from the many enemies created by building and protecting those interests, the American military complex has grown to the point where it now spends an amount equal to 44% of all taxes collected from its citizens.
Since 1991 alone, the U.S. has interceded in Kuwait, Somalia, Bosnia, Sudan, Afghanistan, and Iraq, among others. In no case has Congress fulfilled its obligation of declaring war. Instead, it has delegated sole responsibility for waging war to the president, weakening the structure of our three-branch government. Over that period of time, the U.S. has spent $7 trillion on defense.
The National Debt in 1991 was $3.2 trillion. Today, it is $11.6 trillion, a 360% increase in eighteen years. In 2001, spending on defense was 17% of the government budget. In 2008, defense, Homeland Security, and war spending accounted for 26% of government spending.
Economic history books will likely mark 1980 as the year that the rapid phase of the decline of the American Empire began. That’s when the first wave of the Baby Boomer generation reached the age of 35 and turned its attention to living the American dream – on borrowed money. Since that year, household debt has surged from $1 trillion to $14 trillion, while the savings rate has plunged from 12% to below 0%.
There are many ways to use credit, some quite intelligent and practical. Rotating credit card debt to buy the latest non-necessity does not fall into that category. Today in America, there are $956 billion of credit card debt outstanding, or $9,000 per household. The average American has nine credit cards. A credit card allows every person to live above their means for awhile… just as did the home equity loans taken against artificially elevated house prices anchored on mortgages people couldn’t afford.
This is where reality and fantasy meet. People can only borrow and spend if the Federal Reserve and bankers provide the funds to do so, and without asking a lot of questions about suitability. By creating money out of thin air and handing it out to people with no legitimate means of repaying it, the financial elite and their friends in Washington have played an essential role in bringing the U.S. and even the global economy to its knees.
Yet, for all the evidence, a large swath of Americans still believes the nation hasn’t gone off course. These people consider borrowing in order to live beyond their means a rational choice. They expect the government to save them when they get into trouble and think that taxing the rich to pay for a bigger and bigger safety net is a reasonable idea.
In a truly free-market society, this sizable segment of the public would have already learned a brutal lesson they’d remember for the rest of their lives. Instead, the brutal lesson is being learned by people who played by the rules and didn’t take ridiculous risks, but who are now being coerced by the government to pay for the misdeeds of the over-indebted fools who did.
The crushing levels of debt resulting from decades of excess; the far-reaching military presence; the politically motivated social safety net and other popular but unaffordable programs have now reached the point that the economic decline of the American Empire is a foregone conclusion.
The current downturn is not going to be like previous recessions that lasted on average 16 months. Even as the government responds by trying to borrow and spend the country back to prosperity, there is no ignoring that the economic base has been gutted and the future social program liabilities have essentially bankrupted the country.
As was the case in the final stages of the Roman Empire, the unsustainable military, social, and political excesses have reached the point that, in combination, they are now likely to prove catastrophic.
A Final Thought
For over a thousand years, Roman conquerors returning from the wars enjoyed the honor of a triumph – a tumultuous parade. In the procession came trumpeters and musicians and strange animals from the conquered territories, together with carts laden with treasure and captured armaments. The conqueror rode in a triumphal chariot, the dazed prisoners walking in chains before him. Sometimes his children, robed in white, stood with him in the chariot, or rode the trace horses. A slave stood behind the conqueror, holding a golden crown, and whispering in his ear a warning: that all glory is fleeting.
George C. Scott as Patton
Which begs the question, who is now standing behind the current political leadership, reminding them that their elevated positions are temporal? Unfortunately, the excesses they have created, and the dislocations caused by those excesses, will be with this country for generations.
 TheBurningPlatform.com : http://theburningplatform.com/economy/decline-and-fall-of-the-american-empire
 Casey Research: http://www.caseyresearch.com/
 Daily Dispatch: http://www.caseyresearch.com/casey-services/free-publications/caseys-daily-dispatch/
WATCH THIS VIDEO
Interviewed by Alex Daley, Chief Technology Investment Strategist, Casey Research
Alex Daley: Hello. I’m Alex Daley. Welcome to another edition of Conversations with Casey. Today our guest is former Reagan Budget Director and Congressman David Stockman. Welcome to the show, David.
David Stockman: Glad to be here.
Alex: So we’re here in Florida talking at the Recovery Reality Check Casey Summit. What do you think: is the United States economy on the road to recovery?
David: I don’t think we are at the beginning of the recovery. I think we are at the end of a disastrous debt supercycle that has gone on for the last thirty or forty years, really. It started when Nixon defaulted on our obligations under Bretton Woods and closed the gold window. Incrementally, year after year since then, we have been going in a direction of extremely unsound money, of massive borrowing in both the private and the public sector. We now have an economy that is saturated with debt: $54 trillion or $53 trillion – 3.5 times the GDP – way off the charts from where it was for a hundred years prior to the beginning of this. The idea that somehow all of that debt is irrelevant, as the Keynesians would tell us, is fundamentally wrong – and the reason why the economy can’t get up off the mat.
We’re doing all the wrong things. We’re adding to the problem, not subtracting. We are not allowing the debt to be worked down and liquidated. We’re not asking people to save more and consume less, which is what we really need to do. And so therefore I think policy is just making it worse, and any day now we will have another recurrence of the kind of economic crisis we had a few years ago.
Alex: You paint a very stark picture, but if people just stop spending, start saving, won’t companies like Apple see their earnings hurt? Won’t the stock market then start to tumble, people’s net worth fall? Isn’t that a negative cycle that feeds on itself?
David: Sure it does, but you can’t live beyond your means because it’s pleasant. It’s not sustainable. Clearly the level of debt that we have is not sustainable. We have a whole generation – the Baby Boom – that’s about ready to retire, and they have no retirement savings. We have a federal government that is bankrupt, literally. Its [debt is] $16 trillion and growing by a trillion a year. Something’s going to give. We can’t pay for all these entitlements. There won’t be the revenue generation in the economy to do it.
So as a result of that, we are deluding ourselves if we think we can just continue to spend. Look at the GDP that came out in the first quarter of this year. It was only 2.2%. Most of it was personal consumption expenditure, and half of that was due to a drawdown of the savings rate, not because the economy was earning more income or generating more real output. It was because of a drawdown of savings. That is exactly the wrong way to go – an indication of how severe the crisis is going to be.
I’m not saying the economy should stop spending entirely. I’m only saying you can’t save 3% of GDP and spend 97% if you are going to get out of this fix. As the savings rate goes up both in the public sector (which means reduction of spending and the deficit) and the household sector (to seriously reduce debt burden, which has not really happened) we are going to, on the margin, spend less, save more. It will slow down the economy. It will undermine profits, I agree. But profits today are way overstated. They’re based on a debt-bloated economy that isn’t sustainable.
Alex: So we can only live beyond our means for so long, as any family knows.
Alex: Now, the government can reduce its expenses at any time by simply reducing spending, and it can reduce debt if it brings in more tax revenue. That’s austerity – I think that’s how they refer to it. But won’t austerity cause massive joblessness? Won’t there be millions more people in this country not receiving a paycheck?
David: Yes, but the critique, the clamoring and clattering that you hear from the Keynesians (or even mainstream media, which is pretty clueless economically) that austerity is bad forgets the fact that austerity isn’t an elective course. Austerity is something that happens to you when you’re broke. And yes, it is painful and spending will go down and unemployment will go up and incomes will be impaired, but that is a consequence of the excess debt creation that we’ve had for the last thirty years. So austerity is what happens when you break the rules.
And somehow we have this debate going on. They’re making a mistake. They chose the wrong strategy. Do you think Greece chose the wrong strategy with austerity? No. No one would lend them money. That’s why they ended up in the place they were. Do you think that Spain today is teetering on the brink because they said, “Oh, wouldn’t it be a good idea to have austerity?” No, they had a gun to their head. They were forced to do this because the markets would not continue to lend, and even now their interest rate is again rising. The markets are losing confidence, and unless the ECB prints some more money and bails them out some more, they are going to have austerity. So the austerity upon us is the backside of the debt supercycle we had for the past thirty years. It’s not discretionary.
Alex: Austerity hasn’t been forced upon us yet. The dollar is up, people are continuing to buy Treasuries – both nations and banks are buying Treasuries. To all extents and purposes, people are continuing to show massive confidence in the US government, lend it money at extremely cheap interest rates, and letting it build up its debt.
So you are advocating that, unlike Greece or Spain taking it to the edge and having austerity forced on them, we should volunteer for austerity today? Instead of just kicking the can down the road and living high a little bit longer, until the bill collectors finally come knocking? Why go today, why start austerity now instead of doing what Greece did and going as long as you possibly can?
David: Because Greece is a $300 billion economy. Tiny. A rounding error in the great scheme of things. It’s – last time I checked – about eight and a half months’ worth of Walmart sales. Okay? That’s a little different than when you have the $15 trillion heartland of the world economy, and the $11 trillion Treasury market which is at the center of the whole global financial system buckle and falter. That’s the risk you’re taking if you say, “Mañana. Kick the can; let’s just wait for something good to happen.”
This market isn’t real. The two percent on the ten-year, the ninety basis points on the five-year, thirty basis points on a one-year – those are medicated, pegged rates created by the Fed and which fast-money traders trade against as long as they are confident the Fed can keep the whole market rigged. Nobody in their right mind wants to own the ten-year bond at a two percent interest rate. But they’re doing it because they can borrow overnight money for free, ten basis points, put it on repo, collect 190 basis points a spread, and laugh all the way to the bank. And they will keep laughing all the way to the bank on Wall Street until they lose confidence in the Fed’s ability to keep the yield curve pegged where it is today. If the bond ever starts falling in price, they unwind the carry trade. They unwind the repo, because then you can’t collect 190 basis points.
Then you get a message, “Do not pass go.” Sell your bonds, unwind your overnight debt, your repo positions. And the system then begins to contract – exactly what happened in September and October of 2008. Only, that time it was an unwind to the repo on mortgage-backed securities and CDOs and so forth. That was a minor trial run for the great unwind that is going to happen when the Treasury market is finally shattered with a lack of confidence because, on the margin, no one owns a Treasury bond: they just rent it on borrowed money. If the price starts falling, they’ll get out of that trade as fast as they got out of toxic CDOs.
Alex: So when people run away from the US, they will run away all at once.
David: Well, if they run away from the Treasury, it sends compounding forces of contagion through the entire financial system. It hits next the MBS and the mortgage market. The mortgage market then scares the hell out of people about the housing recovery, which hasn’t happened anyway. And if there isn’t a housing recovery, middle-class Main-Street confidence isn’t going to recover, because it is the only asset they have, and for 25 million households it’s under water or close to under water.
Alex: We saw something much like that in 2008. All the markets correlated. Stocks went down. Bonds went down. Gold went down with them. It sounds like what you’re saying is that the Fed is effectively paying bankers to stay confident in the Fed, and that the moment that stops – either because the Fed stops paying them or something else shakes their confidence – this all goes down in one big house of cards?
David: Yes, I think that’s right. The Fed has destroyed the money market. It has destroyed the capital markets. They have something that you can see on the screen called an “interest rate.” That isn’t a market price of money or a market price of five-year debt capital. That is an administered price that the Fed has set and that every trader watches by the minute to make sure that he’s still in a positive spread. And you can’t have capitalism if the capital markets are dead, if the capital markets are simply a branch office – branch casino – of the central bank. That’s essentially what we have today.
Alex: Last night you told our audience that if you were elected president, the first thing you would do is quit. Or at least demand a recount, I believe were your words, which I thought was telling. Are you saying there are no policy changes we could make today that would get us out of this? Or at least that wouldn’t get you assassinated?
David: Yeah, there is a paper blueprint. People who believe in sound money and fiscal responsibility, that you create wealth the old-fashioned way through savings and work and effort and not simply by printing money and trading pieces of paper – there is a plan that they could put together. One would be to put the Fed out of business. You don’t have to “end the Fed,” although I like Ron Paul’s phrase. You have to get them out of discretionary, active, day-to-day meddling in the money markets. Abolish the Open Market Committee.
The Fed has taken its balance sheet to $3 trillion. That’s enough for the next 50 years. They don’t have to do a damn thing except maybe have a discount window that floats above the market, and if things get tight, let the interest rate go up. People who have been speculating will be carried out on a stretcher. That’s how they used to do it. It worked prior to 1914. That’s the first step: abolish the Open Market Committee. Abolish discretionary monetary policy.
Let the Fed, if you’re going to keep it – I don’t even know that you need to do that, but if you are going to keep it – be only a standby source. As Badgett said (Walter Badgett, the great 19th-century British financial thinker): provide liquidity at a penalty rate to sound collateral.
Now, that’s what J.P. Morgan did in 1907, in the great crisis of 1907, from his library. He didn’t have a printing press. He didn’t bail out everybody. He didn’t do what Bernanke did and say: “Stop the presses, freeze everybody, and prop up Morgan Stanley and Goldman Sachs and all the rest of the speculators.” The interest rate, the call-money interest rate, which was the open-market interest rate at the time, some days went to 30, 40, 70% – and they were carrying out the speculators left and right, liquidating margin debt, taking out the real estate speculators. Eight or ten railroads went bankrupt within a couple of months. The copper magnates got carried out on their shields.
This is the only way a capital market can work, but it needs an honest interest rate. And we have no interest rate, so therefore we solve nothing and we have the kind of impaired, incapacitated markets that we have today. They’re very dangerous, because they’re all dependent on twelve people. It is what I call “the monetary Politburo of the Western world,” and they are just as dangerous as the Politburo in Beijing or the Politburo of memory in Moscow.
Alex: A twelve-person Open Market Committee determining the future of our economy by manipulating rates. Sounds like central planning to me.
David: It is. They are monetary central planners who are attempting to use the crude instrument of interest-rate pegging and yield-curve manipulation and essentially buying debt that no one else would buy, in order to keep this whole system afloat. It’s Ponzi economics. Anybody who had financial training before 1970 would instantly recognize this as Ponzi economics. It is only because of the last twenty years we got so inured to prosperity out of the end of a printing press and massive incremental debt that people lost sight of the fundamental principles of sound money, which, there’s nothing arcane about it. It’s just common sense. It is not common sense to think that 50, 60, 70% of all the debt that’s being created by the federal government can be bought by the Federal Reserve, stuffed in a vault, and everybody can live happily ever after.
Alex: So the government has certainly put us in a precarious position, but I don’t think they alone have put America in this position, have they? You mentioned consumer debt becoming a major burden on the economy. How do we shed ourselves of that? I mean, the federal government can repudiate its debts if we walk away from it. We might see a few wars or something from that. It could inflate its way out of it. It can tax its way out of it. But how do households get out from under the debt burden that they have today?
David: Well, it’s very tough, and they were lured into it by bad monetary policy when Greenspan panicked in December 2000. The interest rate was 6.5%; we had an economy that was threatened by competitors around the world. We needed high interest rates, not low. He panicked after the dot-com crash, and as you remember in two years they took the interest rate all the way down to 1%, and they catalyzed an explosion of mortgage borrowing, which was crazy.
When they cut the final rate down to 1% in May, June 2003, in that quarter – the second quarter of 2003 – the run rate of mortgage borrowing was $5 trillion at an annual rate. That was nuts! There had never been even a trillion-dollar annual rate of mortgage borrowing previously. In that quarter the run rate was $5 trillion, 40% of GDP. Why? Because the Fed took the rate down to 1%. Floating-rate product got invented everywhere. Anybody that had a pulse was being given mortgage loans by the brokers. The mortgage brokers didn’t have any capital or funding. They went to Wall Street. They got warehouse lines, and the whole thing got out of control. Millions of households were lured into taking on debt that was insane, and now we have a generation of debt slaves.
There are 25 million households in America who couldn’t move if they wanted to, because their mortgages are under water. They cannot generate a down payment and the 5% or 6% broker fee that you need to move. So we’ve got 25 million households immobilized, paralyzed, and worried every day about when they are going to lose property, because of what the Fed did. It’s a terrible indictment.
Alex: Mobility itself is the American dream, isn’t it? It’s the ability to pick up and find work and then move and do all that. So now we have people who are slaves to their debt. How do we get ourselves out of this? Is this just a matter of personal financial discipline? Is there a policy move that can happen?
David: It’s policy. If we don’t do something about the Fed, if we don’t drive the Bernankes and the Dudleys and the Yellens and the rest of these lunatic money-printers out of the Federal Reserve and get it under the control of people who have at least a modicum of sanity, we are just going to bury everybody deeper.
It’s unfortunate. The American people are as much a victim of the Fed’s massive errors as anything else. People were not prudent when they took on debt at 100% of the peak value of their property at some moment in 2004 and 2005. They were lured into it. But now we’re stuck with something that didn’t need to happen.
Alex: The Federal Reserve was founded in 1914, and it saw America through World War I, World War II. It saw America through Vietnam, saw America through the biggest boom in the economic history of the world. Yet now, today, you are calling for the abolishment of the Fed. Wasn’t the Fed here the entire time that America was a prosperous, growing, wealthy, technology-driven nation? What’s changed?
David: The greatest period of growth in American history was 1870-1914 – the Fed didn’t exist. Right after 1870, when we recovered from the Civil War we went back on the gold standard. It worked pretty well. World War I was a catastrophe for the financial system. The Fed financed it, but I don’t give them any credit for that, okay? We shouldn’t have been in that war. It was a stupid thing to get involved in. But once we got involved in it, the Fed printed money like crazy, it facilitated borrowing, set the groundwork for the boom of the 1920s and the collapse of the 1930s.
Even then though, we had great minds who coped with reality in a pragmatic way in the Fed. Even Marriner Eccles wasn’t all that bad. He stood up to Truman in 1951, when Truman wanted to force the Fed to continue to peg interest rates at 2% or 2.5% when inflation was 5%. Then we had William McChesney Martin: brilliant, pragmatic. He wasn’t some kind of gold-standard guy in a pure sense, but a pragmatic guy who understood that prosperity had to come out of private productivity, out of investment, out of risk-taking, and the Fed had to be very careful not to allow speculation to start or inflation to get ignited. In 1958, he invented the phrase, “The job of the Fed is to take the punchbowl away.” And we had a small recession. Six months after the recession was over he was actually raising the margin rate on the stock-market loans in order to quell speculation, and raising interest rates so that the economy didn’t start to inflate again.
Now that was the regime we had until, unfortunately, Lyndon Johnson came along with his “guns and butter,” took William McChesney Martin down to the ranch, and beat the hell out of him and forced him to capitulate. But here’s the point I would make: In 1960, at the peak of what I call the golden era – the twilight of fiscal and financial discipline – we had $30 billion on the balance sheet of the Fed. It had taken 45 years to build that up. Then, as they began to rapidly expand the balance sheet of the Fed during the inflation of the ’70s and the ’80s, even then it took us until September 2008 – the Lehman collapse – to get to $900 billion. Had the balance sheet only grown at 3%, which is what the capacity of the economy to grow, I think, really is, it would have been $300 billion, so they were overshooting.
Alex: We’re three times where we should be.
David: Where we should have been by the Lehman crisis event. In the next seven weeks, this crazy lunatic who’s running the Fed increased the balance sheet of the Fed by $900 billion, in seven weeks. In other words, they expanded the balance sheet of the Fed as rapidly in seven weeks as it had occurred during the first 93 years of its existence. And that’s not all, as they say on late night TV: in the next six weeks they added another $900 billion. So in thirteen weeks they tripled the balance sheet of the Fed.
Alex: Wow, that’s an incredible…
David: So no wonder we are in totally uncharted waters, and it’s being run by people who are clueless as to how to get out of the corner they’ve painted this country into. They really ought to be run out of town on a rail.
Alex: I think you’d find that a lot of our viewers would agree with you on that one. You know, the average American is suffering. It looks like the average American is going to have to suffer more to get us out of this, but it seems like the only thing the Fed is interested in these days is propping up the stock market. Why is that? Where does that come from?
David: The Fed has taken itself hostage with this whole misbegotten doctrine of wealth effects, which was created by Greenspan. In other words, if we get the stock market going up and we get the stock averages going up, people feel wealthier, they will spend more. If they spend more, there is more production and income and you get a virtuous circle. Well, that says you can create wealth through speculation. That can’t be true, because if it is true, we should have had a totally different kind of system than we’ve had historically.
So they got into that game, and then the crisis came in September, 2008. They panicked and pulled out the stops everywhere. As I said, tripled the balance sheet in thirteen weeks, [compared to what] they had done in 93 years. They are now at a point where they don’t dare begin to reduce the balance sheet, begin to contract, or they’ll cause Wall Street to go into a hissy fit. They are afraid to death of Wall Street going into a hissy fit, so essentially, the robots and the boys and girls and the fast-money traders on Wall Street run the Fed indirectly.
Alex: So, in the 1960s, the Fed is taking away the punchbowl. Sounds like in 2010 the Fed is the one adding the alcohol. They are afraid to stop, lest everybody riot.
David: Yes, they got the party going, and they’re afraid to stop it. As a result of that you have a doomsday machine.
Alex: At some point we are going to be forced to stop. Market forces will kick in and Europe and China and India will stop lending us money.
David: Yes. As I say, when the crisis comes in the Treasury market, it will be the great margin call in the sky. They’ll start unwinding all of the carry trades, all of the repo. Asset prices generally will be affected, because this will ricochet and compound through the system.
Alex: When does this happen?
David: People looked at the housing market and the mortgage market way back in 2003 – there were some smart people looking at this. They looked at the run rate of gross mortgage issuance, the $5 trillion I was talking about, and said: “This is insane, this is off the charts, this is so far beyond anything that has ever happened before, something bad is going to come of this.” It’s obvious, if you pour debt into markets… I mean a lot of people leveraged 98%, or whatever they were doing at the time with so-called mortgage insurance, and just high loan to value ratios. They were driving up prices, and so there was a housing-price boom going on. It was sucking the whole middle class into speculation. So that’s the nature of the system, and now they don’t know how to unwind it.
Alex: That’s a pretty stark picture. So as an individual investor, what are we to do? How do we protect ourselves in this type of situation? Should I be owning bonds and staying out of stocks? Should I be owning stocks?
David: No, I would stay out of any security markets. These are unsafe markets at any speed. It’s all tied together. As I was saying when the great margin call comes and they start selling the Treasury bond, they’ll take everything else with it. Real estate is priced off Treasuries. Mortgaged-backed securities are priced off Treasuries. Corporates are priced off Treasuries. Junk bonds are priced off Treasuries. Everything. The stock market will go into a panic. We don’t know when the timing will come – we’ve never been in a world where there is $15 trillion worth of central-bank balance sheets, like we have today. The only thing I think you can conclude is preservation is the only thing you are about as an investor. Forget about yield. Forget about return. Just keep yourself liquid and preserve your capital, because you can’t predict the day when, as I say, the great margin call in the sky comes down.
Alex: So if it’s not about coming out ahead, it’s about coming out not behind everybody else. It’s just losing a little less. What’s the most effective way to do that? Do you want to hold cash? Alternative options?
David: Yes. I don’t even think there’s nothing wrong with owning Treasury bills. I mean, if you want to get, for a one-year Treasury, what is the thing now? Twenty basis points or something?
Alex: So when the great Treasury crash comes, I should own Treasury bills?
David: Well, it doesn’t mean the price of the Treasury is going to crash, no.
Alex: Okay, so we are just going to see interest rates skyrocket on new issues. The US government is not going to be able to borrow.
David: That’s why you’re short. If you’re in a thirty-day piece of paper, you’re not going to lose principal.
Alex: What happens to the dollar in all of this? If I’m holding dollar denominated assets –?
David: Well, the dollar, in theory, people would think is going to crash. I don’t think it is because all the rest of the currencies in the world are worse.
Alex: So once again, America is not that bad off.
David: Well, we’re bad off because when the financial markets reprice drastically, it’s going to have a shocking effect on economic activity. It’s going to paralyze things. It’s going to finally cause consumption to come down. It’s going to cause government spending to be retracted.
You know, the Keynesians are right. Borrowing does add to GDP accounts. But it doesn’t add to wealth. It doesn’t add to real productivity, but it does add to GDP as it’s calculated and published – because GDP accounts were designed by Keynesians who don’t believe in a balance sheet. So they said, “If the public sector and the household sector are borrowing, let’s say, $10 trillion next year, run it though GDP, you’ll get a big bump to GDP.” But sooner or later your balance sheet will collapse. They forgot about that one. So my point is that we’ve gone through a thirty-year expansion of the balance sheet, an artificial growth in GDP; now we’re going to have to be retracting the collective balance sheets. That means that GDP will not grow. It may even contract, and no one’s prepared for that.
Alex: So the economy will collapse. The dollar will be okay, because we still need a medium of exchange and the dollar is the least-bad currency in the world. How does gold fit into the picture? Do you think that gold is a good asset?
David: Yes, I think that gold is a good asset. It’s the only currency that anybody is going to believe in after a while.
Alex: Okay, so maybe hold that as an insurance policy. Do you own gold yourself?
David: Yes, as an insurance policy.
Alex: Where else do you invest in today?
David: I’m preserving capital. I’m in cash. I don’t think the risk of the system is worth it.
Alex: So you are practicing what you preach, 100%?
Alex: That’s great. It’s good to hear. This is excellent advice for our subscribers as well, to consider that there’s a lot of potential energy built up in the system. You’ve articulated it well, a lot of painful policy moves ahead of us, and probably something that makes 2008 look like a preview, if you will.
David: It was just a warm-up.
Alex: Just a warm-up. Thank you very much.
David: Thank you.