Peter Schiff: "We're in the Early Stages of a Depression"

Motley Fool ^ | August 9, 2010 | Jennifer Schonberger

[Atlas Sneezed]

(snip)

Schonberger: Sans fiscal stimulus and the Feds' intervention -- quantitative easing -- do you think we would even have GDP [gross domestic product] growth?

Schiff: We don't have economic growth. GDP is going up, but that's not a sign of any economic growth. All we're measuring is what we're consuming. But we are paying for it by going into debt. As a nation, we're in worse shape because of the GDP growth. The real economy is shrinking. All we're doing is borrowing money from economies that are growing, like China, and we're spending their money. But that's going to stop.

Schonberger: You mentioned that you think we're in the early stages of a depression. When do you think we begin to see a double dip back into a recession?

Schiff: We've already seen that. GDP is decelerating now as the stimulus is wearing off, and the hangover is setting in. By next year, I believe we'll be back in recession territory, as far as the GDP numbers.

Schonberger: If we continue on the current policy path, is there a chance the U.S. is facing a Japan scenario where we're in a slow-growth, deflationary malaise?

Schiff: No. There's no chance of us getting off as easy as Japan. Our situation is considerably worse. We're going to have runaway inflation and recession simultaneously. I call what we're going to have an inflationary depression, which is the worst possible depression you can have.

(snip)

[Atlas Sneezed]

And if you have gold and commodities in a deflation, you go broke.

---

Not broke. You could lose your shirt, but you still have the gold, and it’s always been worth something, especially in the long run. Gold never goes to zero, unless you’re in a shipwreck, and it’s in your pocket, dragging you down (read the incredible “Ship of Gold in the Deep Blue Sea” if you find this image compelling).

[Southack]

Hyper-inflation would mean home prices going up; won’t happen.

The U.S. has 19 million vacant homes. Google it.

Hyper-inflation would mean that commercial rents go up; won’t happen. The U.S. has 20% commercial real-estate vacancy rates. Essentially one out of every five office towers is entirely empty.

Well, landlords of empty buildings can’t raise rents, so rental prices can’t go up.

Nope, the opposite is happening: rents are going DOWN because landlords of empty properties are lowering their asking rates in order to poach tenants from their competition.

Deflation.

Watch the 10 Year U.S. Treasury bond yield. If it falls: deflation. If it rises: inflation.

That’s your canary in the coal-mine. That’s your early warning system.

Debt is deflationary. More debt will accelerate the deflation. The speed of money will slow. Prices will fall.

Do this long enough and the liquidity trap becomes a deflationary death spiral ala Japan for the past 21 years.

You can’t game your way out of this by “running a printing press.”

[Freedom_Is_Not_Free]

I have 2 seperate questions for you.

Question 1
What happens if Americans lose faith in the dollar and refuse to accept it?

Question 2
What scenario would cause hyperinflation to occur in America?

[Freedom_Is_Not_Free]

Question #3 if you please:

Why is this wrong? Where is the fallacy in the argument?

http://www.youtube.com/watch?v=hZNkYdsd7_0

[Southack]

The first fallacy in Schiff’s argument is when he claims that interest rates would go up if the U.S. tried to borrow long-term instead of short-term.

The second fallacy in Schiff’s argument is when he claims that lenders will no longer be willing to loan money to the U.S.

His 3rd fallacy is when he claims that we can inflate our way out of debt.

His 4th fallacy is when he claims the Fed will be *forced* to raise interest rates. Look at a Japan. Japan has had 0% interest rates for two straight decades.

Schiff doesn’t get it.

His 5th fallacy is that the Fed buying U.S. debt debases the Dollar. That’s not how the Yen has played out for Japan.

So here’s a shining, multi-decade example of what happens when you buy your own debt in Japan, and Schiff can’t see it.

You don’t get runaway hyper-inflation when you are in a liquidity trap.

Think for a moment what inflation means. Forget the eggheads who say “it’s an expansion of the money supply and has nothing to do with prices.”

Inflation means that too many Dollars are chasing too few goods...that people are bidding up houses...that people are bidding up stocks...that companies are bidding up salaries and poaching employees from each other...that the speed of money has accelerated.

That’s not where we are. Look at Japan. Japan’s speed of money has declined. Japanese real-estate today is worth half what it was worth back in the 1980’s. Japanese stocks today are worth only a quarter of what they once brought back in the 1980’s.

Yet Japan has borrowed and spent **VASTLY** more than has the U.S.

What Japan worked itself into by 1989 was overproduction. Too many goods being chased by too few buyers.

The entire world has this overcapacity problem now. Too many shopping malls. Too many ships. Too many trains. Too many aircraft. Too many office towers. Too many homes. Too many factories.

And all of that production capacity was debt-funded. Everybody owes money on every factory, office tower, ship, aircraft, shopping mall...everything.

You can’t game overcapacity by simply “running the printing press.” Deflation won’t be fooled.

What you *can* do is delay the correction by propping up values at unnatural levels. You can delay the day that the Markets find a true bottom in real-estate, labor, and stocks.

But that also delays the recovery. Those artificially high prices won’t stay high forever. Eventually they will fall to their real bottom.

Deflation.

Not hyper-inflation.

The opposite.

Deflation.

[Southack]

"What scenario would cause hyperinflation to occur in America?"

A shortage of goods, labor, and debt...combined with a surplus of credit and savings.

[Freedom_Is_Not_Free]

I need to ask a follow up question.

You said, "You can’t game overcapacity by simply “running the printing press. Deflation won’t be fooled."

I asked, "What scenario would cause hyperinflation to occur in America?"

You said, "A shortage of goods, labor, and debt...combined with a surplus of credit and savings."

Here is my final question, at least I think it is final.

If America were to in effect print $75 Trillion dollars over the next decade, to pay off all creditors and pay all unfunded liabilities, would that not cause hyperinflation through currency destruction caused by loss of confidence in the dollar by Americans and foreign parties alike?

[Freedom_Is_Not_Free]

I keep reading your post over and over trying to digest it.

[Freedom_Is_Not_Free]

Those predicting hyperinflation - the basis for the prediction is a loss of confidence in the currency leading to debasement.

Japan’s 2 lost decades is a result of a failure to lose confidence in the yen. I don’t know why this is so. I don’t know if their debt is not yet sufficiently large for the Japanese people and the world to have lost confidence in it, or if it is because the Japanese and others know that the Japanese people have the ability to pay down the debt over time with high savings rates.

In any event, the lost decade of Japan’s deflationary era is a result of confidence in the yen.

I have to wonder if the dollar will get the same benefit being based on a nation of historically over-consuming people with miniscule savings rates. What is it that the US post-FIRE economy is supposed to do that will let us grow the economy and pay down the debt? I don’t know.

Default is coming, just a matter of how. I take it your conclusion is that the US government will one day tell China, Japan, Canada and the Saudis, “thanks for the bond money, we can’t pay you, sorry”.

And if we did that, would that result in more deflation or collapse of the currency?

[Southack]

"If America were to in effect print $75 Trillion dollars over the next decade, to pay off all creditors and pay all unfunded liabilities, would that not cause hyperinflation..."

Nope. To print a U.S. Dollar, the government has to borrow a $1 first.

New money is introduced via new debt. Debt is deflationary. Debt is also cummulative. It doesn't go away.

New spending is the opposite: inflationary...but only for the short-term. Spending *does* go away.

Thus, at some point accumulated debt overcomes new spending. The deflation of the accumulated debt overwhelms the temporary inflation of new spending.

Once you reach this point, you enter a liquidity trap. Remain in the liquidity trap for too long and you will enter into a deflationary death spiral.

After you've reached this point, you can't simply run the printing presses to escape. That would merely add more debt (each new $1 printed comes with $1 in new debt).

That is why Japan's deflation is accelerating. Japan is printing more money/debt, well past the first inflection point of debt overwhelming new spending.

[Southack]

"Default is coming, just a matter of how."

Just watch Japan. Japan is 21 years ahead of the U.S. on this path. If Japan ever defaults someday, then you've probably got a couple of decades before the U.S. follows suit.

[Freedom_Is_Not_Free]

Call me dense, I’m not getting it. I appreciate your attempts however. Honestly. I’m trying to understand this.

[NVDave]

Look at the table of US treasury debt rates today, yesterday, last week, last month:

http://finance.yahoo.com/bonds

And we see US Treasury debt is going down, down, down in yield. As Southhack indicates, when bonds go down, you should usually expect deflation (absent panic buying of US Treasury debt as a ‘safe haven.’)

The reason why debt can be deflationary is that at some point, there is so much debt extant that there is NO way it can all be repaid. As that point, we know, a priori, that a whole bunch of ‘money’ that was brought into being by virtue of stupid lending is going to disappear out of the banking system and economy when the debt is defaulted upon, and “poof” - the ‘money’ disappears.

[Freedom_Is_Not_Free]

There are a few things I understand.

Americans are laden with public and private debt so vast that we can’t hope to pay it off.

I understand that we have massive over-capacity from both over-production and misallocation.

We are currently deleveraging and everything I see, like Southack sees, points toward deflation. I expect a deflationary depression. Since debt is the cause and deleveraging is the cure, the governments massive new debt spending will make the depression worse than if they had allowed our own austery program. The massive additional government spending and debt is actually hurting the economy by some multiplier.

I think you and Southack might agree with the substance of what I wrote above.

I know a deflationary depression is coming. I know Ben Bernanke wants to attempt to print his way out of deflation and into inflation to avoid a deflationary death spiral. I know this has never worked in history. And I know that Japan tried it and failed.

And this is where my question comes and where I cannot see as clearly as you and Southack.

Bear with me, I am a layman and I always get confused on the specific details of whether it is the Fed or Treasury who can print money, and how debt is monetized, etc... so I do get my terms wrong and mis-state technical details.

Cutting to the chase, where I am struggling is that I can imaging America printing so much money that Americans and the rest of the world flat lose faith in the dollar, causing a hyperinflation.

Southack knows I’m wrong, but I can’t get it in my head WHY I am wrong.

I even asked him to imagine printing an absurd flood of $75 trillion dollars, and I chose such an absurd value so that on the face of it, it is obvious the Chinese, Saudis and everyone on the planet would completely lose faith in the dollar. Southack did not take the bait. He treated my absurd number as if it was a real world possiblity saying that the $75 trillion would just cause more harm than good in causing more deflation. My gut tells me it would cause a complete loss of faith in the dollar, resulting in hyperinflation.

So while I agree with everything you and Southack have stated about existing conditions and where we are going (deflation), my dense stubborness can’t conceive why printing mass quantities of dollars would not cause a loss of faith in the dollar and resulting hyperinflation.

I guess my qustions to you would be:

1) Will the US choose to default outright on our debt (sorry, we can’t pay you so go away) or print (here is your $13 trillion in funny money we printed last night).

2) If the US chose to print $13 trillion, wouldn’t this collapse the value of the dollar against all assets and other currencies, and why would deflation still occur, as opposed to hyperinflation from loss of confidence in the dollar.

I am dense but not stupid, and I am really struggling to see why printing massive quantities of dollars would not result in loss of confidence and hyperinflation.

Frankly, I am poised better for even strong deflation than I am for hyperinflation, so I would prefer you and Southack being right. I would prefer to see my mother living on a fixed income in a deflationary depression, then being a destitute beggar with here life net worth wiped out by hyperinflation.

I’m not hoping for it - I am terrified of it. I would love to sleep at nights knowing this possibility can’t occur but I see it as the likely outcome over a long deflationary depression, because Bernanke has made it clear he will *attempt* to print our way out.

Southack is saying that Bernanke won’t succeed in reversing a deflationary spiral. I can’t see his point because I see there have been plenty of modern hyperinflations caused by unlimited printing by governments. Japan seems to be the exception to me, and not the rule.

WHAT AM I MISSING? I’m really struggling with this. Please help me out. Thanks. There are a dozen, really astute people here, you among them, and there is no way I disregard your viewpoints, so when we disagree, I always ask myself “WHAT AM I MISSING?”

[Freedom_Is_Not_Free]

I have a question regarding the table of US treasury debt.

I can see that the long end shows very low rates. What does that mean? Is this because people are locking up 30 year bonds because they expect 3 decades of deflation, or is this because what little 30 years are selling in a “flight to safety” is driving down their yields, or because the Fed is buying them?

Please teach me, but I was under the impression that sales of long bonds have fallen off a cliff and most investors are on the very short end due to the clear uncertainty of what rates will go to in the future?

I see the table but I don’t know how to analze the data. If the volume of 30 year bonds is huge, I would expect that to mean people are locking up their money at 4% because they think 30 years out that will be a good rate. If people are buying huge volumes of 2 year notes and shunning the 30 year, that tells me that people know rates will leap up and don’t want to lock up their money for any length of time.

Do you know which is happening?

[NVDave]

I can’t exppain everything you ask in a short note. I’m swamped this week and into next week. I’m not ducking you question, I just know how much I had to read to understand these issues.

So please ping me late next week and I will get back to you on this.

There is some reading which is useful to spot commonality in debt deflations: Kindleberger’s “Manias, Panics and Crashes” is a good history of major financial blow-ups and some of the aftermath. While history never repeats exactly, it does rhyme quite a bit.

Next is to read Fisher’s paper on debt deflations! Available on the St. Louis Fed Reserve web site. Just google “Fisher deb deflation” and you’ll find it.

The google around for Hyman Minsky’s work on debt economies.

All of this stuff helps paint the background on debt deflations and what happens as a result.

The last thing I will point you to is the Fed’s “FRED” database of economic data. Google “federal reserve fred” and you get it pronto. Just start reading the charts and explanations of same. This will take you a week easily. But pay special attention to bank reserve information and credit formation data.

Last, consider this: When Japan’s melt down started, they were a creditor nation, with about 30% debt:GDP ratio. Now they’re at 230% debt:GDP. Interest rates are still rock-bottom low, they’re resorting to deliberately devaluing rhe yen to maonyain their exports and they’re going on 20 years of slow to no growth.
The common school of thought would have us believe that the level of spending by Japan’s government would have spurred inflation. Many economists STILL believe this, and they keep telling Japan and the BOJ to throw more money into a non-functional policy.

[Freedom_Is_Not_Free]

The reading list is the best reply you could give me at this point. Thank you.

On the flip side, what do you recommend to read about hyperinflations so I can read that after I finish the material you listed above? Or is that a waste of my time for now?

THANKS!!!!

[Freedom_Is_Not_Free]

I can’t tell you how much I appreciate your help. This is the internet at its best. In the old days, I would not have access to people who could recommend where to start reading and I would be lost, thumbing through library index cards and shooting in the dark.

This is good. Thanks. Sometimes this Free Republic forum is the most indispensable clearing house of information, and networking site I have available to me. Times like this.