Monday, December 07, 2015

The Schiff Thesis: Introduction

I stumbled across Peter Schiff and his views on the economy a couple of years ago when I was researching the cause of the 2008 financial crisis.  Although there are now several vocal economists who are predicting more or less the same imminent economic disaster that Schiff is, I'm giving Schiff extra credit for being - as far as I know - the first person to widely broadcast warnings about the previous bubble in the mid 2000's, despite receiving plenty of on-screen scorn and ridicule from all of the experts who didn't notice the looming sub-prime crisis.

More recently Schiff has correctly predicted the Fed's ongoing behavior of promising to raise interest rates "any day now", while never actually doing it.  Schiff is further making the case that the coming economic collapse is simply a continuation of the previous crisis that wasn't allowed to fully reach its resolution, so economists who now agree with Schiff that another collapse is coming are, as far as Schiff is concerned, latecomers.  Out of deference to his unusually accurate and early record of big-picture predictions, I'll refer to countries that Schiff generally recommends investing in as "Schiff countries", and funds that invest in those countries as "Schiff funds", even though Peter Schiff doesn't actually manage or endorse these funds.

According to Schiff, the Federal Reserve Bank is the major player in the looming collapse.  The Fed has been engaged in a long term program of lowering interest rates, from its peak of 19% in 1981 down to 0% in 2008.  The Fed sets the interest rate of loans between the Fed and major banks, and this rate tends to propagate to other parts of the economy such as bond yields and interest rates for mortgages and savings accounts.


These ever lower rates have made it easier for the federal government to borrow ever increasing amounts of money, so the Fed is partly to blame for our exponentially growing national debt, which is approaching $19 Trillion.  Low interest rates actually encourage everyone to borrow more money, including families who can buy bigger homes with smaller down payments, and drivers who can buy bigger cars and get cash back on the day of purchase.  Corporations also take advantage of low interest rates by borrowing more money and taking bigger risks than they otherwise would.  Put simply, artificially low interest rates create financial "bubbles" that inevitably "pop", and the lower interest rates are, and the longer they persist, the larger the bubbles get.

Even though it's the Fed's low interest rates that create every doomed-to-pop bubble, the Fed's strategy since about 1990 has been to respond to each economic decline with even lower interest rates, thereby maintaining the debt bubble and re-inflating it to larger proportions in new sectors of the economy. After the dot-com bubble popped in 2001, the Fed set rates below 2% for a couple of years, which started inflating a housing bubble and a second stock market bubble.  When that bubble started popping in 2008, and threatening to take the entire global economy with it, the Fed stepped in one more time and set rates to 0%, where they have now been for seven years.

According to Schiff, it is this most recent period of zero percent interest that has finally created the mother-of-all-bubbles.  Since 0% interest rates weren't sufficient to stop the collapse in 2008, and since setting rates below 0% might cause the world to lose faith in the U.S. economy, the Fed started creating trillions of dollars to bail out banks that loaned too much money and save corporations that risked too much.  Instead of admitting to printing money, which might illicit fears of Weimar Germany or modern Zimbabwe, the Fed used interesting names like "TARP" and "quantitative easing" in place of "inflation".  Whatever term one uses, the combination of zero percent interest and trillions of dollars of printed money has inflated bubbles in many parts of the economy, and at a scale that dwarfs the 2%-for-two-years period that fueled the sub-prime crisis.  Today we're in a third stock market bubble, a second housing bubble, a bond bubble, a car loan bubble, a college loan bubble, and a government bubble.  The path of least resistance, both economically and politically, for all of these bubbles to pop together is for the U.S. dollar to collapse.

The next time the mega-bubble starts to pop, the Fed will probably try to stop it by printing money like never before, and this is true regardless of whether or not Federal Reserve Chair Janet Yellen understands the nature of the problem.  The Fed must be partly aware that the economy is still in a crisis, since it has undertaken three rounds of quantitative easing from 2008 to 2014 and kept interest rates pegged at 0%, but there's no way of knowing what conclusion the Fed is arriving at now that the economy is still stagnant after $3 Trillion of printing.  It is possible that Yellen will conclude that she simply hasn't printed enough, and that $10 Trillion more may finally take the economy out of danger, however the more interesting scenario would be if Yellen wakes up in her bed one morning and realizes that she never should have lowered rates and printed money in the first place, because at that point she would be trapped by her own past mistakes rather than by her current economic philosophy.  Were Yellen to announce that day that she was raising rates to 5%, and that catastrophic bankruptcies and bond defaults would unfortunately result, but that in the long run the economy would be better off for it, she would become public enemy #1 overnight.  No, even if Yellen is wise to what's happened, it's far better for her legacy to print even more money this time and pass on the ticking time bomb to her successor at the Fed.  In the worst case she will cause hyperinflation to start before her tenure is up, but at least she'll be able to claim that she was only trying to help everyone by giving them money and preventing bankruptcies - who could argue with that?

It is the inevitable tidal wave of money printing in response to the inevitable mega-pop that will cause the dollar to collapse, and the decline may start even before the printing starts if foreign creditors realize ahead of time what has to happen and cash out of their U.S. assets.  As the exchange rate between the U.S. dollar and other currencies plummets (or skyrockets, depending on your perspective) foreigners will see prices of U.S. goods plunge, while Americans will see prices for imports go through the roof.  The problem for retirees and people saving money in the U.S. is that the effective value of their nest eggs will plummet along with the value of the dollar.

The solution to preserving wealth during this collapse is to move savings into assets that can't be inflated (gold) and into the stocks and bonds of other countries where the threat of inflation is at a minimum.  Peter Schiff's recommendations for which countries to move money to will be the subject of the next post.

2 comments:

Cathy said...

Taking notes, Hodar.
Taking serious notes.
Thank you.

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