Friday, September 25, 2009

A Flight of Fancy (Not Fantasy)

If we think about the economic problems that confront us, now at the beginning of the 4th quarter, 2009, we might think that we could be overwhelmed. There are several major, dramatic, colossal problems. At least a partial list includes:
-As John Lewis pointed out, soon we will see the backbone of the welfare state come rolling in to beat the living hell out of us. The potential cost of Medicare and Social Security will take up every dime that isn’t nailed down.
-Obama wants to completely destroy the medical profession and our health. The cost will be far beyond what anyone has been willing to mention in the current “debates”.
-Our trade deficit, which has pumped over $10T out of the country over the last 30 years, has brought down the value of the dollar significantly in the last few years. I don’t think that anyone is foolish enough to actually dump dollars, but the dollar-sell side of international currency markets is going to be continuously stronger as long as there is such an abundance of dollars. Don’t forget that the trade deficit is still occurring, and that the reasons for it existence are still in place.
-The national debt is growing at an unbelievable rate. We will have an amazing debt.
-The amount of money that will needed to support Obama’s programs, and the other run away “entitlements”, plus the fall of the dollar, will lead to a pressure on retail prices that we have not seen since the 70’s.
-We may have another oil price spike, or maybe a little longer one.
-Needless to say, life will be tough, or could be.

But, and this is the biggest “but” I think I could ever write, there is a solution. To many of you, this won’t be a surprise. It is an easy solution. It is no secret. It is the easiest thing in the world. All we need is freedom.

There is actually only one problem. It is the philosophy that gives us the government in place now. If we get rid of that, we are home free. All of these problems will be quickly dealt with and forgotten, except as history. We always want to remember the mistakes in history.

Why do I say that these economic problems will be swept away? After all, for example, those citizens that have become dependent on government programs cannot be just abandoned. I am not claiming that we have a “duty” here. No. But every discussion that I have seen begins with the premise that the change to freedom needs to have some elements of a transition.

Of course, some things would happen immediately, e.g. we would get rid of regulations, market limitations, certain kinds of government spending, property restrictions, ecology controls, and so on. Many government departments would just be liquidated. No unemployment insurance would be in place. The Fed would be taken out of the money manipulation business. As we work back to a gold standard, the dollar will stablize.

But think of it. We would be free to produce. Think of the level of production we could achieve if we were not encumbered. Remember the later Clinton years, when the only stimulus was the lack of new rounds of regulation, and maybe a little half-hearted deregulation (still with enormous amounts of inflation). The economy grew at a pace that “theorists” thought impossible for a “mature” economy. Without restrictions, our growth rate will astound everyone.

A good economist will tell you that the only actually limited resource is people. Guess what, all of a sudden we will find that we have a 10% to 20% increase in our working population, our productive population. All of those people, who have been involved with regulations, taxes, controls, etc., will have to find productive work. Many of these people work for private enterprise today. A significant percentage of businesses’ budgets and personnel will be available for production, not government work.

Yes, a lot of the ex-government employees will not be fit to work. Should we be concerned about them?

The federal deficit will be taken care of in two different methods. Taxes will ramp down. How fast is strictly a practical matter. With real production in our economy, tax rates will not need to be high.

What may not come to mind immediately is that the federal government has considerable assets. Actually, real assets. It has buildings. Thousands of buildings. Most of these buildings are in valuable locations. The buildings themselves may not be worth much, but the locations are. Plus, the government has lots of other stuff that can garner some cash.

Most of all, the assets of our federal government include land. West of the Mississippi, the government owns 66% of all land. Yes, lots of that is in Alaska. Even so, managed properly, the federal land could probably pay off the federal debt all by itself.

Perhaps the biggest problem will be the Medicare mess. Even if we were to start ramping that program down now, it would still be a mess for a couple decades. However, we shouldn’t discount the consequences of bring back freedom, including eliminating the Medicare bureaucracy and all of the limitations that have been placed on the practice of medicine and insurance. There may be some price pressure in the medical sector for a while, but it think that it is something that free men can handle.
So, we do not need to worry about the afterwards, not really. We just need to get rid of Obama and his mentors and followers and let freedom reign.

Tuesday, September 22, 2009

Status of inflation and prices today, September 2009

I have four things to say about inflation, prices, and the state of today’ economy, late September, 2009.

One, since inflation is introduced into our economy by means of credit expansion, which means bank lending. Currently, because of the nature of our current mess, i.e., a financial panic, bank lending has shrunk and credit availability has all but disappeared due to the liquidation of bank capital and reserves. You might ask about the money that the federal government has put into banks. It was a lot of money. That money went into three areas. Some did go into the credit area, as the government purchased bad debt, those sub-prime, mortgage-backed bonds. But the government bought them at an extreme discount, so it did not replace much of the credit. The other two areas in banking that received money were those of reserves and capital accounts. These accounts within a normal functioning bank, consist of a significant percentage of fund, maybe as much as 50% of the bank’s checking deposits. However, these funds are not spent, not really invested. They must remain available for the bank’s needs. Consequently, they have never been part of the money supply, M1 or MZM, and cannot really be considered inflationary. The real problem with all of these measures by the government is that the recession hasn’t been allowed to do its work. The misallocations and created money have not been worked out of the system.

The upperward pressures on consumer prices today come primarily from two sources: one, the fall of the international value of the dollar. Foreign goods and services are now considerably more expensive that they were just a few years ago. The dollar has dropped in value almost 50% in just a couple years.

There is a second consequence for prices. U.S. goods and services are much cheaper for foreign buyers. That might sound good, but what it really means is that there are more dollars chasing our domestic production, which will mean higher prices for us. It is a double whammy of price inflation.

The current fall of the dollar is happening because foreigners hold so many dollars. They are finally spending them instead of holding on to them. They have been accumulating dollars for almost three decades, from our trade deficit. There is almost $11T in dollars overseas. All of these dollars that we have exported were created dollars. Notice that during the time that foreigners accumulated $11T, we still had constant 2% to 3% price inflation as our domestic money supply grew to over $10T. New money was being created at a tremendous rate. Now the overseas money is beginning to return. It is from our past inflation.

Third, there is probably another event that is going to happen soon that will affect us financially. The conditions that produced the oil shock a couple years ago are returning. The world has no new capacity, and none coming on line in the foreseeable future. The existing industrialized countries have not reduced their requirements for oil, and will not do so, unless they retreat from industrialization. Finally, the two largest countries in the world, which are slowly moving into the modern age, and slowly increasing their need for energy, are slowly reemerging from the recession. We are all slowly reemerging from the recession. As we reemerge, more demand for energy will drive the spot prices for oil beyond what it was two years ago. This is not inflation. It is forced shortages. Prices will go up. All goods and services are dependent upon energy, and as energy prices go up, so will all the others.

Finally, in the relatively near future, we come to the fruition of the Medicare and Social Security mess. Medicare already costs more than the annual Medicare taxes bring in, and is consequently taking money out of general taxes. Social Security will follow suit within just a few years. Both programs will begin growing faster than realistic taxes can support. What will happen then? Depends a lot on who is in power and whose voices are being heard. As these two programs grow they will force out everything else, including Obama’s programs, and national defense! If instituted, Obama’s programs will just bring on the mess earlier because the poorer the economy performs, the sooner the shortfall between Medicare and Social Security costs and their direct revenues will occur. Also, the faster consumer price levels rise, the sooner the problem because both programs are tied to the price levels, either directly or indirectly.

Wednesday, September 16, 2009

The Federal Reserve Board and the Money Supply, Part 2

The Fed has this toy, the deposits of 10% of the country’s banks’ checking deposits. By law, the Fed can do two things with that toy. It can change the percentage of deposits required. If there is a limit on the percentage I haven’t found it. If there is a legal limit, it has no practical significance. We are really left with the Fed being able to set the percentage of demand deposits required by law with just the Fed’s “good judgment”!

The Fed also has the right to change the amount of money that is in a bank’s Fed deposit. The Fed can add money or it can take money away. So there are two parties who can change the bank’s deposits: the bank and the Fed. Now the bank is limited in how it can adjust its deposit. It must be close to the correct percentage. The amount of demand deposits the bank has is figured every week and it must reconcile the percentage at that time. It can borrow to cover a shortfall in its deposits. It can borrow from a bank that has a surplus or from the Fed (called the “discount window” and thus the “discount rate” that we hear so much about).

We are now at the key to the expansion of the money supply. Watch this. When the Fed adds money to a bank’s Fed deposit, the bank can consider the larger deposit as “found money”, and regard the new total deposits as the 10% (again, the current percentage requirement) the bank must meet. Since the size of the bank’s Fed deposit is now larger than it was, the bank may turnaround and expand the demand deposits held by the bank to the extent of the new proportion, 10 to 1, 10 parts demand deposits, 1 part Fed deposit. The bank expands its demand deposits by offering loans. Hospokus, we have credit expansion!

Let’s look at an example. Bank XYZ has $100M in demand deposits. From this, it has placed $10M at the Fed, and keeps, let’s say, $30M as actual reserves (I have no idea what banks currently believe is a reasonable, actual reserve, these numbers are made up by me). The Fed, acting upon its good judgment, puts $1M into XYZ’s Fed deposit, raising it to $11M, and whamo, the bank can expand its demand deposits to $110M. ZYX Bank can now loan out $10M more and be completely legal. (What percentage banks actually loan out is not really relevant. The Fed would just keep adding money to the deposits on hand until they reached their target of credit expansion.).

Whamo, we have now witnessed the expansion of the money supply by way of bank credit expansion.

The Fed uses a certain technique to add or subtract money from banks’ Fed deposits. The Fed buys and sells Federal Treasury Bonds on the open market. What it does, when it buys a bond, it buys it through a bank, and places the payment for the bond in the bank’s reserve. So, in the above example, it bought $1M worth of bonds through XYZ bank, and paid XYZ bank via the bank’s Fed deposit. If it wants to contract bank credit, the Fed buys bonds on the open market, and takes the payment from the Fed deposit.
The open market operation of the Fed is carried out by the, wait for it, Open Market Committee, which meets in the New York Branch of the Federal Reserve System. This Committee makes the open market policy and thus determines the rate of credit expansion. The credit expansion in turn causes an increase in the money supply, which may result in higher consumer prices. The credit expansion may also cause booms in stock prices, residential real estate prices, commercial real estate prices, and many other things. It also finances our export of dollars by way of our trade deficit. Credit expansion is handy for all sorts of things.

The Federal Reserve Board and the Money Supply, Part 1

The reason for spending valuable time on the Fed is that it plays an inordinate role in our lives. Interestingly, it is not so much the role that we are use to seeing in the papers. Periodically, during the year the Board of the FRS gets together and sets some policies. The one policy that everyone pays attention to is the setting of the “discount rate”. Few people know what it is discounting, but they know that it has something to do with interest rates. Everyone, it seems, wants the rate to be low.

No, the role the Fed plays in our lives has to do with money, i.e., the amount of money. The Fed is the primary source for the enormous growth in money floating around in our economy. It is my intention here to try and explain how that happens.

The Fed has been in existence since 1913. As far as I can tell, nothing significant has changed in its structure or purpose since then. It has been doing harm for 96 years nearly unchecked. To learn about its early years form a free market oriented historian, read Economics and the Public Welfare by Benjamin McAlester Anderson. It is an excellent history of the U.S. economy from before WW1 to after WW2. I picked up that book from NBI in 1969 and have had a pretty good understanding of what was happening ever since.

In this first part of my explanation I will talk about “reserves”. In part two, I explain what the Fed does with them.

Okay, reserves. This is the “reserves” in “The Federal Reserve System”. For once, here is a government name that gives you a key as to what is what. Yet, in spite of my last statement, “reserves” is also a misnomer. It is an anti-concept. It is also there to mislead you.

When you think of a reserve you think of something that is there when you need it. As these are bank reserves, you may think that this may be good because banks need reserves. They need reserves against unexpected demands for cash, changes in the economic climate, loan failures, and any number of reasons. So reserves are good, right.

However, the reserves at the Fed are not available to the bank. When a bank places their legally required reserves at the Fed that money is there to stay. The bank can’t get at it or use it. The money is actually a deposit. That is what I will call them, deposits. I think that “deposit” makes the whole thing clearer.

So, a federally chartered bank is required to deposit part of its demand deposits at the Fed. (I am not going to discuss why a bank would be federally chartered. There are benefits and requirements.) What is a “demand deposit”? “Demand deposit” is a fancy name for a checking account. Money deposited in a checking account may be demanded at any time the bank is open, without notice. As opposed, for example, to a savings account, which does require you to give notice. Yes, I know, you never have. But if you read the fine print in your savings account agreement with your bank you will see that the bank has the right to require you to give notice, at the banks discretion. So, a checking account is a demand deposit.

The federally chartered bank, which is nearly all banks, certainly all of the big banks, must place a portion of its demand deposits with the Fed. There are different percentages, depending upon the size and location of the bank, but almost all of the total dollar demand deposits in the country have the same percentage and that percentage is the only one I’ll use here. When I checked last in May, 2009, the percentage was 10%. Historically, that is pretty low.

Therefore, the Fed has about 10% of all checking account deposits in the country in its accounts. What a toy!

Friday, September 11, 2009

What is Inflation?

In a discussion of today’s U.S. economy, a serious writer must include inflation. Yes, I am going to talking about inflation. Probably, I am going to talk about it a lot. I guess that makes me a nut, right? I mean only scaremongers and right wing fanatics talk about inflation. Besides, since the early 90’s we have had almost no inflation, I mean only about 2 to 3% a year, which the Fed (the Federal Reserve Board) thinks is close to the right range.

But here is the killer, if you loaned the government $10,000 for a 10-year bond, at a 2.5% inflation rate, you would get back $7,810 of purchasing power. A loss of 22%, guaranteed! If I told you that I was going to give you an investment in which the principle would loose 22% guaranteed, would you like that? (At best, after taxes, the interest paid on the bond would bring the total to maybe $9000. You would still have a loss.)

In addition, any plan to retire ten years later would have to take into account the rate of inflation. None of that sounds as if a “low” inflation rate is a minor deal. And we are talking here about the potential of a higher rate of price inflation in the future, maybe the near future.

Well, what is inflation? That is the question. There are two competing definitions. Actually, if you look practically anywhere on the web, in “official” government materials, or at the writings of mainstream economists, you will find that inflation is defined as “a general raising of prices”. That is, the prices of just about everything in the economy are going up.

Is this definition really helpful? Does it mean something?

Well, maybe you want to know what causes inflation. (Some would argue that a definition should include causes.) This is an area of controversy. We have a difference of opinion. You will quickly find that the sides are drawn this way.

On the side of an answer that is wide ranging and offers little in the way of a means to reduce the threat of inflation. The best statement of this side that I have found so far is: You will note that all sorts of actors in the economy can be at fault including producers, raw material suppliers, and others, many others. It just depends. I always wanted to know how one, or even a combination of these different actors could cause price inflation that went on for years. Any one of these explanations has some plausibility if you hold your frame of reference to a year or two. But how do you get commodity price increases that cause consumer prices go on from 1990 to 2007? I do not think it will work. I think that the people who use these answers do not actually look at the nuts and bolts. I think they are willing to settle for plausible. I do not like that because we are talking about people’s lives and goals here. Inflation eats away at what a person and their family are depending upon over the course of their lives, even 2%.

Really, think about this. We have all heard that the price of something is the result of supply and demand. When you think about all of the items in the economy, what you really have is that each buyer is allocating his money among the things that they have decided to buy at that time. If something costs more than it did, a person will have to make do with hoping something else will be less expensive, the amount they purchase of that item reduced, or taken off the list completely. If prices continue to go up, more stuff must be scrubbed from the list, unless more money is found. What we generally understand about supply and demand, reasonably, I think, is that the supply consists of the products we want to buy and the demand consists of what we want, our choices. More people want something and its price will tend to go up until there is more of it, and so on. In general, especially in a mostly capitalist economy, that is a good way of thinking about prices. But, in considering price inflation, we have to think more concretely.

At root, supply and demand consists of the products (goods or services) vs. the actual currency, dollars offered for the item. It is a purely mathematical/mechanical thing. At a specific time a certain amount of a product is available and a certain number of dollars is offered and the price is the dollars divided by the number of products. If in the next time period the number of dollars offered is higher per item of product, the price goes up. If the price continues to go up, the number dollars per product is continuing to go up. If this is true generally throughout the economy, then there has to be an increase of in the number of dollars overall. It can’t work any other way. If you look at the U.S. money supply over the years, you will find a constantly increasing supply of money. You will be surprised at the size of the steady increase. (This would be the dollars in the U.S. There is still more money being pumped overseas. Nor do the money supply figures include money that has been created and then invested, say in residential real estate, or in a business.)

That is the other definition of inflation: an increase in the money supply, which can and usually does, lead to an increase in consumer prices (which, for want of a better term, I call “price inflation”). Thus, we have had significant inflation for most of the last 60 years.
So the question is, where do all of those dollars come from? That will have to be the subject of another post. Sorry. The answer is long, complicated, and tedious.

Having just devoted “serious” time and space to talking about inflation, some may say, “But isn’t today’s problem the threat of deflation?” or “But they say that prices dropped this year, and probably will next year, too!”

Prices may have dropped in 2009. Government reports should not be accepted just because they are from the government. The government is not omniscient. What is always important is for you to keep an eye on the things that you and your family need and want. Did those prices go up, down, stay the same? Your personal situation is what counts for you.

More to the point here is that we can do little to change what is happening today, or even in the next several months. My concern is for 2010 and the next few years. Given that inflation is the increase in the money supply, Obama’s plans do make me concerned about what is going to happen. His spending and deficits will tend to put a lot of money into our economy. New money is inflation.

To anticipate my technical discussion of the government’s manipulation of the money supply, the U.S. money supply is increased by means of increasing bank credit, bank loans. Since the recent crisis began, banks have cut down their lending to near zero. That means that the primary money pump has not been working, and consequently, less new money (there is another way new money is introduced, but that is not as large as bank credit manipulation). I will talk about the banks and credit as time goes on.

We are also seeing import prices going up across the board. The value of the dollar has been falling. There are many dollars overseas, and the amount is continuing to increase. It takes only a slight increase in the portion of those dollars to begin coming back to lower the value of the dollar. That is happening. So the prices of imports have been rising. The dollars coming back are also competing for our domestic production, and will be a source for higher prices of our own goods. There are upward pressures on prices today. I think we will see more and more upward pressure as time goes on. Forewarned is forearmed.

Saturday, September 5, 2009

Schiff, "Crash Proof", Chapter 6 to End

Chapter 6

p. 122: “…collusion between originators and appraisers resulting in faulty documentations, phony appraisals, and lax credit screening practices….” Here we are with another conspiracy theory. One, I might add, which has been accepted by every liberal, every anti-capitalist, every anti-freedom person in the U.S. I am sure that some people out there were not honest. I am sure that there are crooks. But, most weren’t. Most mortgage brokers are businessmen who want to remain in business. They aren’t short-term thinkers. Most did not go to Ivy League schools. But, I will tell this, the people who set the standards of credit in the mortgage industry are Freddie Mac and Fannie Mae. They look over that paperwork. They check it out. The loan coordinator at your local mortgage broker and the bank keep in touch with the people they have to satisfy.

What is little known I found out from a syndicated columnist, Robert J. Samuelson, whom I mentioned above, a year or so ago (I’m looking for the article!). In the early years of this decade, Congress, in its wisdom, changed the law regarding loans taken by their two creations. Congress told Freddie Mac and Fannie Mae that they had to increase the percentage of loans they gave to “low and middle income” families from the low thirties to 42%, close to a third more! (I am not sure if this was an increase in the number of mortgages or in the total value. The later would have been even worse.) You can bet that Fred and Fan weren’t leaving many of these mortgages on the table before this piece of wisdom from Congress. Now what were they going to do?

If there were few additional mortgages available from the lower income segment of the population, Fred and Fan were left with two bad choices: One, reduce the amount of mortgages they accepted until the lower income range made up 42%, which didn’t seem to be what Congress intended at all; or Two, reduce the standards to bring the percentage up. Guess!

Why isn’t this better known? Well, Congress isn’t going to tell, nor are its minions. Finding that fact isn’t easy, so do not count on the media. Schiff? Notice that Schiff basically admits he doesn’t know why this mess began, and the trots out another conspiracy theory. Notice a trend? I do admit that I was just lucky in finding that piece of information. But, I knew that most business people are honest folks, and that the government in the form of Fred and Fan were telling them what was needed, and they tried to accommodate. I am sure that many had misgivings, but, I am sure that they have misgivings about much of what they are told to do by the government, and realize they are given little choice. That is the problem with big government, sensible people are given little choice, little opportunity to follow their own better judgment. Where is Schiff on this issue? MIA.

I will give Schiff’s the recognition that the other important segment of the residential real estate bubble was inflation. The availability of massive amounts of money for loans also had a negative effect on credit worthiness tests. This created money drove up house prices massively, just like the stock market in the late 90’s.

p. 133: Again speculation is at the heart of our problems. Those dirty speculators.

p. 135: “So as real estate continues to decline and the U.S. economy goes further into recession, the dollar really will come under increasing pressure as foreigners, recognizing the relative weakness of our economy, begin bailing out of U.S. assets.” And then: “It’s a spiral that will feed on itself and ultimately cause the American economy to implode.” (emphasis in book)

Well, of course, that did not happen. I think that it didn’t for two main reasons, which I have mentioned before. One, the U.S. economy is not a hollow shell. It has lots of productive strength, in spite of inflation and the rest of the government. Two, which has two parts, the world economy is very connected, so that the U.S. recession had echoes all over, and, foreigner’s reasons for accepting and keeping dollars is only slightly negatively affected by our monetary craziness.

As of the date of this review, housing has dropped in value significantly, but the residential real estate market is stabilizing; the stock market dropped more that 50%, in great part because of the mania on the part of the press and government, but the stock market has rebounded over 40% from its low in only a few months, and is currently about 30% off its high; the dollar’s low was 16 months ago, trade is holding up, and foreigners are still buying U.S. debt.

Since Schiff never defines “crash”, we can look at it any way we want. I would not argue that the stock market “crashed”, the housing market burst, maybe even “crashed”. But I would not consider the value of the dollar to have done much, considering. I am wondering if Schiff feels vindicated or frustrated.

Chapter 7

p. 143-162: This section is a real mish mash. I am not at all sure that the money we have stashed away in our savings accounts adds much to the national capital. On the other hand, having a lot borrowed for consumption, especially at higher interest rates, is not of benefit.

I do not like Schiff’s continued requirement that what an individual does with their personal finances should be to “society’s advantage”.

Schiff’s requirement is savings, not savings and investment. I do not understand why owning a productive asset does not correspond to savings? If I put my money into a savings account and earn interest, does that mean my savings has increased or not? If I buy a stock, sell it when it has appreciated and put the money in a savings account, does that mean I have not increased my savings? He seems to have some idea that there is savings, consumption, and some, middle, mystical ground. I do not understand.

What is the difference between savings and wealth? Does cash in the bank a higher status to Schiff than owning a productive asset? How about having your own business, does that constitute savings, wealth? Does any investment in a productive asset produce something? Aren’t retained profits a form of savings? Isn’t reinvesting profits a form of savings? Doesn’t paying dividends out of profits to a stockholder who uses the income to pay for his retirement constitute consumption?

Debt for consumption means that you have committed to using some future production to pay your loans. As a day-to-day practice, this is a bad idea, I agree. Using debt for the purchase of a house, may make sense, as long as you buy within your real income level. Borrowing for a new TV, or even furniture, and especially wine, for example, is a bad idea. Even more, spending all you make is not good for you. I think Schiff and I agree. He just has some confusions regarding what “savings” is.

p. 163-171: This section is mostly correct, but unexceptional. Nothing new here.

Chapter 8

One thing, here, finally, does Schiff recognize the burden of regulations in the U.S. Yet, I do not think that he recognizes how influenced the governments of the East are by the “American” model. Japan’s government, for one, has a greater role in their economy than the U.S. government. But the other point is well founded, i.e., lower costs. I wonder about the capital costs. The efficiency of the American capital markets are unparalleled. I also wonder about their taxes. However, in this case, I’ll not contest Schiff’s contention. He should exclude Japan, however, because it has a European style cradle to grave welfare system, and with the population shrinking and much older than any other industrialize nation, it is headed towards bankruptcy quickly.

Hindsight is easy, I know. After looking at Schiff’s stock portfolio recommendations, I looked at several pure international mutual funds. They didn’t do any better particularly than the U.S. funds. It’s a world economy, really. If Schiff was correct about the currency risk involved with the U.S., then the funds should have done better. At least, Schiff’s recommendations didn’t hurt him any worse than staying in the U.S. What I saw that I found interesting was that a good international fund was able to keep the appreciation that it had in the preceding few years. It crashed just like the others did, but from a higher level.

International stocks have a very mixed history over the last 40 years. From around 1990 to the early part of this decade, they were definitely well behind U.S. companies, even taking into account the burst bubble centered on tech stocks. Most of the benefit of foreign stocks starting say in 2002 was from the U.S. currency problem, not in the greater profitability of foreign companies, which is what Schiff is referring to. Yet, I agree with Schiff’s attitude toward the dollar. The dollar will continue to fall, due to all of that exported inflation, again, consistently with Schiff’s position. I do not think that we will see a “crash”, however, primarily due to the reasons why foreigners accepted and kept dollars in the first place. Schiff’s explanation is that foreigners did it unthinkingly and because the U.S. pulled the wool over their eyes. Why we would want to put our money with people who have such poor judgment, I do not know.

There is nothing basically wrong with Schiff’s recommendations as to how to select stocks. Mostly, these are the things to which any stock picker should pay attention. Problem is that amateurs are not good stock pickers. It is not a lack of intelligence or interest in the results. It is a lack of interest in the process and access to the information. For example, I have the formal and informal education and a lot of the experience to be a stock picker. But it would be a bad idea, because the process and the company reports, etc., bores me to tears. The division of labor applies as much here as any other form of human activity. I do agree with a lot of what Schiff has to say about mutual funds. There are drawbacks. What I think makes a big difference is that these funds tend to have analysts in the countries in which they invest. They tend to have much better information and understanding of the market. You just want to look for a fund that is doing what you want, has been doing it long enough to show it can consistently make you money, and that the people who did it are there now. There are enough funds that one will come close to what you want.
Regarding costs in mutual funds, as in all other forms of services, you tend to get what you pay for. No one has proven that cheap is really better than paying for talent. There is such a thing as talent, remember?

Chapter 9

As I write, gold has far exceeded the price when Schiff was writing, but then dropped back about 20%. If anyone is ware of any of Schiff’s anticipated demand for a sound currency, please let me know. I would like Schiff’s expectations to occur. I am not really a pessimist, or cynic. I am not negative, really. I just think that it takes more than some economic turmoil to make people doubt their governments, especially after a century of more of accepting more and more government. To a great extent, especially in the U.S., there was little outcry against the government and media claims that it was the free market that caused the problems. A sound currency does not seem to be in anyone’s mind.

I will say that GLD has done well since it was created in 2005 until early in 2008. In a well thought out portfolio and with a good understand of more than Schiff offers, GLD could provide some important protection. It would work right up to the time that you would want to own the gold physically. But that is getting way ahead of where we are now. As far as the present is concerned, gold is still a very complex, worldwide market. I know that the moves that Obama has made and wants to make will be bad for the economy. The Fed doesn’t have a clue as to what would be a good thing to do. Nevertheless, I would want to see where we are after the dust clears a little to determine a strategy. The U.S. stock market has shown some strength, the dollar has been flat for 16 months, gold has been as well, the banks aren’t lending, Congress is balking a little, and public opinion is turning some.

p. 229: Commodities. Again, the ugly head of the speculator appears. Actually, there are three participants of a futures market, the producer, the user, and the speculator. The Speculator makes the market possible, because the other two groups aren’t large enough to make a market. The reason the producer and the user are there is to protect themselves against adverse price changes. They want to be sure that they get either the price they need to make money or that their costs do not exceed a certain level. Being in the futures market by either buying the contract or the option on the contract gives them the protection they need. Both consider the expense of being in the futures market a business expense. In other words, if the contract period ends and the price did not make them money, and they lost what they had in the market it is okay, since they will be getting the price on the item they had planned on all along.

So, what is it you are trying to do? If you attempting to protect yourself form the fall of the dollar, and not make money on speculation, even an option is good. This approach works if you are using gold futures/options or Euro or Yen futures/options. This approach could also work for someone who expects the price of oil to rise again.

Chapter 10

p. 237: “The monetary and economic implosion I have been predicting throughout these pages could happen tomorrow or could take a few years. It could be cataclysmic, as would be the case if the United States suddenly lost reserve currency status or there were a run on the dollar, or it could be gradual and so well disguised that the purchasing power of the dollar would simply be gone before we knew it and had time to protect ourselves.”

So much for the “crash”. Silly alternatives. Give us a break.

p. 238: “Americans…put dollars into high-yielding investments in foreign currencies or invest in gold may see temporary pullbacks, but will be will positioned for the longer run.”

Okay, I may be picky, but “high-yielding” and conserve don’t seem to be the same thing.

Yes, a little picky. I didn’t really think Schiff didn’t mean that people who followed his instructions wouldn’t profit. But, he did not say so there, elsewhere he says other stuff.

We have exported a lot of inflation, yes, even though foreigners have a reason for keeping a lot of our dollars, we have already experienced a significant drop in the value of the dollar. Additional drops in the value of the dollar are to be expected, especially since we are continuing to export inflation. The drop in the value of the dollar will lower our standard of living both because imports will take a larger number of our dollars, and more dollars will be bidding on our own goods, which will increase prices. The only way the Fed can combat the fall of the dollar would be to reduce or reverse its expansion of our currency, which would be contrary to the needs of supporting the federal government by providing for our budget deficits. Which of these conflicting goals would they support?

Well, back to p. 237, if the situation is “gradual” (the rest of that sentence does not really add up) then we can take care of ourselves in a well controlled manner.

One thing that Schiff did not follow through on is his promise that he would show us how the Fed increased the money supply in several different ways. Actually, I know of only one way the Fed has, which is to increase the supply of credit. If the banking system is not increasing the supply of credit, the Fed in not expanding the money supply. As of this writing, the banks have stopped lending for months. So for months there has not been an expansion of the money supply, and no inflation and no new pressure on prices. There is still a lot of money in the economy that could flush out and have an impact, especially on the current account, i.e., we could still be exporting inflation from previous years.

From what I understand now, the money that the Fed has used for the “bail-out” has not been placed as “money supply” (I am going to take a closer look.). The money given the banks has been used for reserves and capital. Banks need reserves and capital for operations and loan losses. The major banks lost a considerable portion of their loan loss reserves and capital due to mortgage defaults. These reserves and capital were not considered part of the money supply before, and doing so now would give you the wrong idea as to what is happening.

Little of what has been done as part of the bailout is something that is going directly into the money supply. Certainly, the bailout is partially keeping the recession from wiping out the previous inflation. But that does not mean that it is creating new inflation. It is also expected that over the next few months that the Fed is going to work to withdraw much of the money it has created.

I do not mean to say that inflation has stopped. We shall see inflation soon enough. The budget deficit will require the Fed to do a lot to finance the borrowing that the Treasury will need to do. We cannot expect that foreigners will be willing or able to meet Obama’s need. Interest rates will go up, which the Fed will fight. We shall see inflation. We shall see price inflation. How fast? Who knows? You just have to pay attention.

As for Schiff’s realignment to Asia, I think it could happen, but certainly not to the extent that Schiff proposes. Why? The U.S. is not as bad and the Asian’s not as innocent as he suggests. Their central banks produce inflation significant for their economy. The U.S. does produce and has strengths. China still has a Communist Central Committee who thinks that it is in charge, and there will be a conflict.

p. 240: Merk Hard Currency Fund

Up until the 3rd quarter of 2008, this fund underperformed a good international mutual fund, then it didn’t dive as much. Can’t say that I am impressed. It parroted the Euro. I think that it might do well for a hedge. A professional might compare that with currency future options.

For an overview and conclusion about the book, see the review.

Commentary, "Crash Proof", Chapters 4 & 5

Chapter 4

Initially, this chapter is fairly good. Not real clear, a little misleading (maybe he will clear a few things up later), but overall, it is helpful. He does leave many of his earlier statements that include references to inflation as being just sloppy.

p. 72: Then, he is back to his conspiracy theory. What he says about the benefits of inflation to government is true, but to make it intentional, to suggest that many, if any, members of the government or bureaucracy planned it this way or even know anything about this, is really reaching. Especially since it goes across parties, ideologies, professions, and just people who do not like each other. Maybe he is like someone who is confused about the world and is comforted by the feeling that some supreme being is really in charge. Schiff isn’t willing to accept that these people have just fallen into this mess because of lack of education, clarity, foresight, a common, poor education, and their own desire for power. Really, in the present circumstance, Obama has no idea what inflation is.

p. 73: Well, what a surprise. “Much depends on how the new money enters the system and where it is spent first.” This is the key. Schiff offers it causally, without any fanfare. I think that it is central. But at least he offered it. It does raise the level of the book immensely. You just have to wade through a lot of gunk to get to it. Let’s see where he goes with it. [Nowhere]

p. 76: Oil Prices. I do not like this section. Oil, like any other product in an economy is subject to the effects of inflation. It is also one of the biggest political footballs, a major source of wealth, a target of the environmentalists, and one of the most controlled products in the world. Schiff acts as if the environmentalism does not exist. Nowhere, so far, has he mentioned governmental regulation in any regard. The guy has a singular focus.

The international price of oil is controlled more by politics and governments than by inflation. Politics and environmentalism have forced a restriction on the drilling and refining of oil. (Schiff’s comments about low prices leading to underinvestment applies to a couple decades ago, not since gas prices rose above $2 a gallon.) If the demand raises only slightly, the price will skyrocket. That demand could be from inflation, but there are actually other very apparent sources of demand, i.e., real people slowly moving to a more productive economic level, and they need more energy. Inflation would cause oil prices to raise as slowly as the other commodity prices, not sky rocket like it did just a couple years ago, not as it will again shortly.

I particularly do not like his statement that “purchasing power shifts form the United States to Asia”. This sounds as if “purchasing power” is a zero sum game and that in order for someone else to increase theirs the U.S. has to lose it. If he is talking about inflation adjusted value of the dollar to other currencies, he might be accurate, but the statement is not at all clear. My first reading made me think or real economic production, not currency.

p. 78: “Bogus Deflation Threat” Not bad. Incidentally, the Civil War was not the only time that saw an expansion of the money supply significant enough to cause widespread price raises. The gold rushes, especially the California gold rush (the 49’ers) had the same effect.

One factor that Schiff has argued constantly so far is that price inflation is much higher than the indexes the government publishes. In a way, as far as our futures are concerned, who cares. Even 2% price inflation has significant impact. As far as economic impact, high inflation is very bad, but more important is the rate of increase, since fast raising prices make it much more difficult to adjust and make plans. Actually, I think that the best indicator of the impact of inflation is corporate profits. Business can adjust and make at least some headway against lower levels of price inflation that is not growing very rapidly. However, the seventies showed that faster movement, or higher levels on price inflation wreck havoc with business success, and especially depreciation.

I also think that people are attuned to the effects upon their purchasing decisions of price changes, especially, continued increases. As prices raise, I think that people will tend to make their dismay known, regardless of the official indexes.

I think that Schiff feels he needs a number of “enemies” or “villains” in his book for effect. It may also be that he has long harbored negative feelings about government figures (not a completely irrational feeling). Whatever. I just do not think that ranting about the indexes is helping. We saw in the seventies that the indexes looked bad enough when price inflation took off.

p. 83: “How Government-Created Inflation Became Policy”

I think much of his discussion here is close to the truth, except for three points. First, (well, besides the point that there cannot be any non-government-created inflation) control of the money supply, and thus inflation, was the purpose of the Fed from the beginning. And it did its work, thus the inflation in the 20’s, leading up to the choke hold the Fed took around 1929, and that aftermath. The Fed might have been less active at times, but the “gold standard” never really had much impact, because the country had more than enough gold to allow more money to be created. A real gold standard means that all of the monetary gold (as opposed to gold used for jewelry or industry) is the currency. It would mean that every oz. of gold we had would be represented by a gold backed note. It would be a one for one relationship. The Fed never adopted this policy. From the very beginning, the Fed had all of the leeway it wanted to manipulate the money supply.

The reason the U.S. went off the gold standard, was because the money supply had increased to the point that the Fed’s activities had to be curtailed.

Second, there was no conspiracy. It was just government as is thought to be okay in the US, a result of our poor educations and the current philosophy.

Third, there are other factors operating in our world, not just inflation. Inflation is very important, certainly, but other wrong actions by our government also can be important. Other governments, too, can do bad things, and the oil mess was one example.

p. 85: “How the Federal Reserve Defied the Constitution” Actually, it was the Congress. I suspect that he is correct in his discussion. Certainly, the Founding Fathers knew about debasing of the currency and would have not wanted a government to have that power. It would be nice if Schiff had some reference to support his contention.

p. 94: “As the U.S. economy contracts, the federal budget deficit will grow and the perceived appeal of U.S. financial assets will be lost.” Didn’t quite happen that way. Everybody contracted. In considering the U.S. to be a hollow shell, he forgets about the interconnectedness of the world economy.

Chapter 5

This chapter is about the wisdom of owning American companies. First and foremost, Schiff’s arguments depend upon his claim that there is no productive capacity in the American economy. That the American private enterprise is worthless, or at least, worth very little. I have already made arguments that he cannot justify that claim.

Further, I have several arguments with many of his comments about investing, especially, over the long-term. For example, “Some stocks will gain, of course, but only at the expense of other companies, whose earnings shrink. If the market is trading at a given multiple, there have to be stocks whose earnings go up and stocks whose earnings go down. They all can’t be winners.” Some people call this a zero-sum game. It isn’t. Let’s leave aside the point that some companies are going to be poorly run, make bad decisions, have the wrong product at the wrong time, and so on. We aren’t talking about failure. Nothing Schiff said indicates that he is talking about failure. No. Schiff’s view is that, in normal circumstances, if one stock goes up, another has to go down. Mr. Schiff, what is wealth creation? If there is such a thing as wealth creation, it occurs over time, and then, as a whole, the value of the ownership of American companies would grow and be worth more. The value of a company on a free market will be determined by its profits, and anticipated future profits, this in spite of Schiff’s requirement of dividends.

Maybe what is happening here is that Schiff has the myopia that you see in Wall Street of so often these days, that can only deal with the next 90 days, or 30 days, or until the closing bell. Sorry. Humans live a lifetime. That is our time-frame. 90 days is besides the point. [Schiff seems to provide evidence that he does not have this myopia elsewhere, which makes the discussion here less clear.]

p. 106: “The only acceptable reward for taking the risk of ownership is dividend yield. A cash dividend policy is the only insurance an investor has that a business will be operated for the benefit of shareholders. Non-dividend-paying growth stocks can be attractive but should be viewed as speculation rather than investing.”

This statement is very curious, I don’t mean the point about shareholder interest, but the last part. What is the significance between investing and speculation? Certainly, most speculation is done in the short-term. If you buy a stock that pays no dividend and hold it for 10 years, then yes, you are doing so because for some reason, hopefully a good one, you expect the price of the stock to rise in real terms. You expect it to create wealth through its profitability. Would you buy a dividend paying stock and not expect its price to raise over time? One of the differences between a bond’s interest and a stock’s dividend, is that the interest remains flat during the bond’s lifetime. You do expect the stock’s dividend to increase in stride with the company’s growth over time as it remains profitable and creates wealth.

Actually, I have always considered speculation to be a category of investing, just as selling short, buying or selling options or futures. It is not gambling, but that seems to be Schiff’s implication.

It is also the case that you will only get dividend paying stocks from mature, established companies. New, smaller companies need to put their profits back into the company in order to grow. If you want to start your own company, you will be told that. You will be told that you cannot draw out money until the company has enough revenue, etc. Even then, most business owners are drawing salary or wages, not dividends. Their businesses are not sufficiently successful to generate a return on their capital in cash. Maybe they could in capital gains when they sell the company, if they can. [I am not clear how his dividend requirement relates to his latter instruction to buy smaller companies outside the U.S.]

I think that Schiff is drawing a false differentiation. He is also looking at speculation as something less than investing, as if it was slightly dirty.

As for the point about shareholder interest, I think that the motives and purposes of a company’s management become clear over time. It is part of doing your research to determine if a particular company fits in with your investment goals. And, you do have to continue to watch.

I think Schiff sees conspiracies and malfeasance everywhere. Certainly, there is some, more malfeasance than conspiracies. I don’t think that it is really healthy or helpful to approach things as if most people are unworthy of trust. It is actually more helpful, I think, to realize that the government and business leaders all went to the same schools, read the same texts, heard the same lectures, and they were exposed to a lot of ideas that have no connection to reality. Consequently, they are acting the way they were taught and bad stuff is happening. That approach is much clearer, understandable, and true.

p. 110: “Adjusting for inflation, if you bought the Dow Jones Industrial Average in 1966, you would have waited until 1995, nearly 30 years, to get your money back.”

Did you ever see a salesman who picked exactly the figures that made him look good, and ignored the one that wouldn’t? Schiff has cherry picked these dates. 1966 is the year that begins the problems with price inflation. Remember, I mentioned earlier that companies’ profits decline during higher periods of inflation. They did. From 1966 to 1982, profits and thus stock market performance stayed pretty flat. Interestingly, considering Schiff’s views, this performance is vastly understated because the Dow is made up of mature, fairly successful companies, almost all of whom pay dividends. When dividends are factored in, the Dow did somewhat better, but, that is besides the point. Then, however, if you factor in inflation, even that thought sours, since the Dow stayed fairly flat, in real terms, those companies lost well over half their real value. [Schiff makes this point later.]

However, since 1982, the market was robust, and a significant reason was that price inflation had subsided.

Between 1966 and 1982, stocks, bonds, and cash were bad places for money, until the last part of that period, when interest rates began to fall, and then you should have bought bonds, and then held them until interest rates stabilized or were low, relatively speaking. To show you why I’ll use a made up example. Let’s say you bought a bond paying 16% and five years later it was paying 4% and you sold. You would have sold for almost 4 times what you paid for it. In a price inflation environment, that is the only way to make money in bonds.
An annoying part of this statement on p. 110 is his comment about “adjusting for inflation”. Is he talking about his view of what prices have done during that period or the CPI? He doesn’t say. It makes a difference. If he is using his view, then we would need an idea of what that rate is. If he is using the CPI, why?

Commentary, Crash Proof, Chapters 2 & 3


Actually, the first few pages are not too bad. But, then he gets to his assertions.

p. 27: “Our trade deficit…threatens to ruin us.”

This is a recurring refrain. But, it is an assertion. He claims that we cannot pay, as if we produce nothing of value to the world, are completely worthless, and once the bubble is burst, we will completely default. Nonsense. This is an insult to Americans. We are productive and competent.

We would suffer for the years of inflation that has driven up our trade deficits. But, BUT!!, many of the reasons why foreigners have bought our debt and kept our dollars still hold. Even if other countries begin to solve their own problems and no longer need or want our dollars, it will take years, and the dollars will come back to us over time. We will see price inflation for that, but a collapse is not imperative.

There is no explanation, really, of why or how we became a “service” economy. How did the decisions leading to that result go wrong, Mr. Schiff?

A methodological error or maybe an intellectual policy decision that Schiff makes is to tell us repeatedly what the deficit is, but not what the total trade figures are. Well, here are some numbers for 2008.

With the release of December 2008 U.S. International Trade in Goods and Services report by the Department of Commerce’s U.S. Census Bureau and the Bureau of Economic Analysis, U.S. exports of goods and services grew by 12.0% in 2008 to $1.84 trillion, while imports increased 7.4% to $2.52 trillion.

Exports comprised 13.1% of U.S. GDP in 2008. To put in historical terms, exports were 9.5% of U.S. GDP five years earlier (2003), and 5.3% 40 years ago (1968).

Capital goods represent the largest goods export category (end-use) for the U.S. with $469.5 billion worth of exports in 2008. The U.S. trade surplus in capital goods rose $12.8 billion to reach $15.7 billion in 2008, up from a surplus of $2.9 billion in 2007.

Services were just less than a third of our total exports.

I do not regard a trade deficit of $700B as insignificant. It is huge! We will suffer at some time for this gap. But to keep Schiff’s discussion of the situation in mind, realize that the US is still exporting a tremendous of goods. Something around 80% of the total of exports is goods, imports more like 90%. Therefore, we are still a significant exporter of manufactured good. (There are some foodstuffs there, too.)

The deficit really represents three things, first, our continued exportation of our inflation, and, two, other countries unwillingness to let the dollar slide to a position of market equilibrium, and, three, foreigners willingness to hold dollars instead of their own currencies (there are actually three small countries who dollars as their currency).

Schiff is correct only insofar as our inflation is concerned. The other portions of the trade gap is the result of the decisions of foreign central bankers and individual businessmen and individuals.

p. 29: “Inflation:….” Here, Schiff does not actually discuss inflation. He makes some statements, talks about the CPI and PPI, goes back to talking about dept, again. He says that he talks about inflation in Chapter 4.

p. 31: “The Housing Bubble” This is already past history. At the point that Schiff is writing the mess was beginning. He says that he will discuss it in Chapter 6.

p. 32: More on inflation. (Why is he talking about it here for several paragraphs when he says that he will talk about it in a later chapter?) What bothers me about this section is that he seems to be equating inflation with increasing prices. Then, sometimes he connects inflation with the housing balloon. Then he equates inflation solely with prices. I hope he clarifies his points later. Then (p. 62) “highly inflationary monetary policy of extremely low interest rates”? I know what he means. I am not certain if most people have a clue. Schiff often does not explain himself. Did he have an editor?

And on he goes about the measuring of prices, what is core, what effects certain parts of the CPI, and on and on. Anyone who worries about this is missing the point. Really!

Yes, he is attempting to say that the stated CPI numbers attempt to hide the “real” rate of inflation and make people feel safe. This is Schiff’s brand of a conspiracy theory. The federal beaucrats are not particularly competent. I am very hesitant to think that 10s of thousands of them, along with the entire last four administrations are involved in a conspiracy. Schiff has a few pet peeves we get to experience. Thanks, dude.

p. 36: Two points. First, oil. He sort of implies that oil prices will continue to be high. Now, he did not foresee that oil prices would fall during the recession that began after he wrote his book. That’s okay. I did not see any of that either (I only mean that foresight is almost impossible). I think that to a certain extend of what he says about high oil prices is still valid. I do expect oil prices to go back up, way up.

Second, he is wrong to discuss oil as being inflation. Inflation is not some particular price going up. Nor is price inflation some particular price going up. Claiming so just adds to the confusion. Inflation is the expansion of the money supply. Price inflation is a general increase of prices as a result of the expansion of the money supply, of inflation. Oil prices are going up because of a world wide enforced restriction of the supply of oil. Supply and demand, restrict the supply, and prices will go up. Nor is this just a case of inflation impinging upon the supply restriction. No, this is mostly the increase of demand because some major parts of the world population, India and China, for example, are starting to become a little more productive. If the populations of India and China increase their demand only slightly, the pressure on the oil market will be enormous! Inflation will make it worse.

p. 37: “The Deflation Ruse” Now here, finally, is a section that I agree with. This discussion is pretty much correct. Well, except that he reveals his confusion and limitations in his understanding of inflation. He says that “inflation results from an expansion of the supply of money and credit”. No, inflation is that expansion. Not realizing that, he is confused about our trade deficits, the bubbles in stocks and real estate we have experienced, and prices generally.

But you can forget about deflation fears. We should be so lucky!

If you accept that deflation means falling prices, deflation is actually good. During the last half of the 19C, when the US experienced the greatest increase in standard of living and had the greatest freedom that the world has ever seen, deflation was a constant, both prices and wages constantly fell. Wow, were we well off! If deflation means a contraction of the money supply, especially in a sharpe, sudden manner, then you can look at 1929 and the following few years. Slow, moderate contraction of the money supply probably would not be so bad, but it would be unfair to borrowers. Level is good. Actually, since the amount of gold is not a constant, but changes depending upon consumption and mining, the amount of money connected to gold tended to raise, especially as new mining techniques and technology evolved.

p. 38: “The Productivity Myth” Well that was short lived. Schiff has this tendency in his arguments to state that there is a shortcoming in a certain way and then declare that the thing does not exist. My statement is poorly put, so an example, a portion, not a small portion, but only a portion, our balance of trade is a deficit, therefore, Americans are a sham (see pp. 14-17 or pp. 21-23, both insults). So he does the same here, the way improvements in computing production is measured is screwy and computers have not added to the productivity in other industries has been overstated, so any increase in productivity in American industry is a myth. This is just poor thinking.

p. 41 to the end of this chapter: GDP. Consumer Confidence. Not worth discussing.

The thought that pops into my mind, thinking about the underlying theme of this chapter, is: profits. Why didn’t he talk about profits. In a capitalist economy, the surest sign of health is profits. All of the rest of that is merely government prattle. The Treasury reports, the Commerce Department, all of them, their stuff is prattle. Is Schiff saying the same for the thousands of companies in the US that are reporting profits? That is where productivity shows up. If price inflation was as significant as Schiff says it is, we would see a decline in profits. Does Schiff know that the bubbles he has talked about in stocks and residential real estate wipe out a good part of the inflation previously created?

Chapter 3

p. 64: “The declining dollar is the result of an American economy characterized by declining production, inadequate savings, reckless consumption, soaring household debt, ballooning federal budget deficits, and an overly accommodating Fed.” (Italics in text). Ahh. No. Schiff has not actually presented proof about the declining production. As I have mentioned, he does not show a very consistent reasoning pattern. The US economy does have problems with consumption, consumer debt, the Federal Budget, and some others, like enormous regulatory apparatus. Where is Schiff on that? But, the declining dollar is a consequence of inflation. No inflation, no huge export of dollars, no problem. Inflation is the creation of money by the Fed. Soaring household debt and reckless consumption are symptoms of the same thing. This is hard of Schiff to recognize in part because of his confused ideas about inflation and money creation. They do not seem to be straight in his head.

p. 65: the end game. “dollars that are on deposit in China and Japan and elsewhere are going to come flooding back”. Why? I mean, he has built a case for people to trust dollars less. But, why flooding? I mentioned it before, but he doesn’t really have an explanation as to why foreigners, including a lot of private banks, businesses, and individuals, have kept dollars in the first place, and continue to do so. Without an answer to that, we really do not know what would change their mind, and if, even then, they are willing to go through the mess that would result if they were to flood the US. Schiff just does not have, or I should say, he has not presented an argument as to why they would flood the US. I think that he may think that he has shown at least a basis, but, I hope you see, his thinking is badly flawed, and the international community knows better. I mean, they understand that it is not in their interest to flood the US with the dollars they hold. Instead, they will continue to let the dollar slide. If the slide becomes too steep, they will tend to pull it back a little. The consequence for us will not be good, either way. Schiff is right that these deficits are bad for us. The consequences will come.

Why will central banks stop lending to us? Look, for the central banker, the issue isn’t, “Should I invest in the US or not?” The question for him is, “I have money sitting here, where should I put it?” Now he has certain requirements as a central banker. The investment must have very limited probability of default, it must be “safe”. It must provide an income (the central banker does not have to worry about taxes) that is relatively competitive. It must have a market large enough that his investment will not affect it. When you run through the options, you have got to realize that there is only one market that meets these requirements. The US Government bond market. No other bond market in the world is as large or is considered as safe. The Central Banker may put some of his money in another market, maybe Germany, or England, but he has to be careful. No other countries debt has a market as well supplied with securities and as organized as the US market. The central banker’s major choice is then, the US government bonds, or cash, i.e., dollars. People proposing Euros or Yen, or a basket of currencies come into the same problem as the bond suggestions. There aren’t enough. To transit from a dollar denominated international reserve to anything else is going to require time planning and some means to move without destroying all of those assets. Wild dumping of dollars makes no sense to anyone, except, apparently, Schiff. The central banker may not be rational, in that he doesn’t understand economics, he thinks the world is putty in certain respects, but he really is not crazy. Even the Chinese central bankers aren’t crazy. Now, the Chinese Communist leaders are crazy, there is a crack in the money dyke.
Here is a good overview of some of the issues surrounding the trade issues. Robert J. Samuelson is good on certain, narrowly limited economic matters. For example, here he completely misses the role of U.S. inflation. But the rest is not bad.

Commentary, "Crash Proof", Introduction & Chapter 1


p. ix: “The continued demand for U.S. government investments among central bankers has its explanation, I think, in robotic bureaucratic momentum.”

The problem with our thinking about “central bankers” is that “robotic bureaucratic momentum” is an easy one to accept. In fact, to at least some extent, it may be true. But, it will be to our folly, as economic analysts, if we allow ourselves to stop our thinking at the easy and convenient. Many central bankers have gone to schools that have excellent reputations and good classes on bond portfolios. They know that their bosses want certain results from their activities, and they are aware of their opportunities. It is folly to accuse people of being stupid just to make your own point. It makes your point questionable.

Central bankers have a problem when considering as to where to place their money, which is to say their accumulated dollars. They have a lot of them. In one estimate I saw, non-U.S. central bankers have $10T sitting around. And there hoard is growing daily, several hundred billion dollars a year.

Since they have so many dollars they have to have markets large enough to place that money. Of course, they don’t have to do it all at once. They just have to be able to place the new money and the funds that they have received from interest payments and redemptions whey the bonds mature. They also must have a security that has a certain high degree of safety. Well, there is only one market. The U.S. government bonds. Other markets are too small or the security does not have the creditworthiness. The last time I saw the comparison, the bond market in the U.S. is eight (8!) time the size of the U.S. stock market, the largest in the world. The central banker could place some in other markets, and probably is. But the other markets are just not enough to make any significant difference. The central banker is stuck, whether he does suffer from any robotic tendencies or not. This is also the reason that the U.S. bond markets have underperformed. The demand for our securities drives the performance down. If we had to compete more for bond buyers, the interest rates would go up.

There is another problem for Schiff’s position. These central bankers do not want to have the U.S. dollar collapse. It would be bad for themselves and their citizens. A collapsed U.S. would be bad for the entire world. We are still the dominant economic engine. A world without a healthy U.S. would be a world in a deep economic depression. A crash is bad, and they are smart enough to know that, well, at least most of them most of the time. Frankly, the people most likely to screw up this mess is the U.S. Congress and the Chinese “leaders”.

None of this argument is in any way meant to imply that our Current Account deficits are a good thing. It is definitely the result of our inflation. It will come to bite us, yes. I don’t think that it will be a crash. See my comments elsewhere.

p. x: “In contrast, the economies of Japan or China are portrayed with images of billowing smokestacks, busy production lines, robots assembling, and people actually making things.”

Schiff has the opinion that the production of “things” is the only means to real wealth. Producing things does produce real wealth, but for the capitalist. The factory is the tool, used by capitalists. Somehow software, services, management know how, knowledge of how to use the international division of labor, etc. does not quite rate Schiff’s attention. He does not grasp how the process is going on, especially in China.

Nor does he understand how the trade deficit has occurred. Schiff does not compute the difference between our current system of currencies and the way a gold system would work, or even one in which governments weren’t in control. One real reason we have a trade deficit is that the relation between currencies is not allowed to resolve, especially, with the Chinese. The reason is that people and banks outside the U.S. tend to prefer to hold dollars to their own currencies, which tends to make sense. But, mostly, the reason we have a trade imbalance is that we export our inflation. If the Fed stopped making money, the deficit would dwindle, maybe not disappear, because the people and central banks overseas would have to act differently, but the deficit would be a less significant thing. If we did stop exporting our inflation, the value of the dollar would still need to fall because of past inflation, especially against those currencies that have not been allowed to devalue the dollar.

Thus, to rant about the deficit is to miss the point.

Schiff may get to that point, later, I hope.

p. 1: “The economy of the United States, long the world’s dominate creditor, now the world’s largest debtor, is fighting a losing battle against trade and financial imbalances that are growing daily and are caused by dislocations too fundamental to reverse.”

Too fundamental to reverse? Apparently, we are dead men walking. But, Mr. Schiff, why do you say that? Proof, please. So disappointing.

To be the world’s largest creditor is not good, I know. The debt is largely our federal debt, i.e., overspending by Congress. I do not like it, the debt. It is not going to be fun paying it off. I do think of the Clinton administration. Remember, we began having surpluses? Now, the Fed was busy printing money, and we did have a inflation caused stock market bubble, and Clinton significantly weakened our military, but, on the whole, really, the 90’s was a period of increases production and wealth creation, brought on by lower taxes and reduced regulation. Think what would happen if we began moving toward freedom and capitalism, for a change. Not only would the productive people we have increase output, but there would be hundreds of thousands who are not considered employed, but are in jobs that are actually burdens on the economy, who could be actually productive. Plus, there is an enormous amount of federally owned land and property that could be sold. I don’t worry much about the federal debt as much as I worry about moving further away from Capitalism. We can’t pay any debt when we are not allowed to be productive.

p. 2: “…nonexportable services” We export lots of services. His statement is merely an unsupported assertion. There are services that we cannot export, surely, but there is more than Schiff apparently knows about.

p. 3: “Because Americans are not saving and producing but are borrowing and consuming, we have become precariously dependent on foreign suppliers and lenders.”

p. 7: “The fatal flaw in the modern economy is that any attempt to save and under consume, which would bring about a badly needed recession, is resisted by government policy….”

The idea here is that personal savings, according to Schiff, is necessary for capital accumulation. But, that is not so. Capital is accumulated by capitalists, not by the man in the street. Schiff is actually very influenced by modern economists.

p. 7: “…selfish…” Not good when Schiff regards this idea as a pejorative.

P. 8: ref to Bretton Woods agreement.

Says that we are immune to consequences due to status as reserve currency, but disregards fall of the dollar for last several years.

p. 9: “Abroad, in contrast, there was a spirit of rebuilding, an awareness that natural resources were scarce and must be conserved, lower taxes and wages, and generally fewer government obstacles to economic development.”

Where exactly. This description corresponds to nowhere that I know of. It is just wrong. Further, the “awareness that natural resources were scarce” (which is basically wrong!) has caused more government controls, and lower potential economic development. The only thing correct about this statement is that in certain areas, first Japan, but mainly in the Far East, wages were lower. Taxes were not, particularly.

In the seventies and eighties, Japan was touted as the next big thing, being much better than the US, even at some of the Objectivist Conferences. However, American business took stock and remade itself, and left Japan in our dust. Since then, Japan has had little growth, has not reviewed its cumbersome government structure and controls, and is actually shrinking with its population.

p. 10: “The popular notion that in the post-industrial service economy money-valued services are an acceptable substitute for goods because both generate money ignores the distinction between money and wealth. Money is a medium of exchange. Wealth is what is received in that exchange.”

This is absolute nonsense. If you have $10,000,000 in net assets, all in financial assets of some kind, you have wealth. Wealth is the ownership of assets, not possession of goods. I have no idea of what he is trying to say. Probably, he is trying to make some kind of point about manufacturing is better than other kinds of businesses. What the U.S. has demonstrated more than anything is that business management is the most wealth-producting activity. As Objectivists, we know that the fountainhead of wealth is the man of the mind. One consequences of that is that the broader the view, the more integrated the understanding, the wider integration, the more effective, productive, creative the individual is. Such an individual would use the best, least cost, most productive business elements from around the world. In that environment, the software company who creates a program that improves productivity could easily be producing more wealth than a manufacturing plant.

Schiff has not demonstrated that an economy needs to be mostly manufacturing in order to produce wealth. His comments are merely assertions, including those about services. I recognize that I am not presenting a case for a service-based economy. I do not have the research to do so. It may need a real academic. But Schiff’s text does not provide justification that we are not a productive economy.

p. 11: “…but I don’t agree that we can ever replace manufacturing with information. There is simply an insufficient quantity of such products….”

Simply assertions.

“The resulting trade deficits prove that our so-called information/service economy is in reality a sham.”

Since there are other issues in our deficit, e.g., our inflation, the desire of foreigners to posses dollars, the unwillingness of certain governments to allow their currencies to move towards equilibrium, and the reserve status of the dollar, I think Schiff’s statement is without justification.

I think that we are more productive and competitive in a far broader extent than Schiff is willing to consider. Having said that, I recognize that I am merely making an assertion, stating an opinion, as is Schiff. My opinion, however, is certainly consistent of what I see about me. Schiff’s would require that my experience be an illusion.

p. 11: service jobs pay less than mfg jobs. Again an assertion. This assertion is even more an error when you consider two things, one, that mfg jobs in the U.S. have been over paid for decades, and, two, he has made a straw man in representing service jobs by the hamburger flipper. Bad form. Implies that he cannot support his position without the straw man. Additionally, service industry jobs are not low paying. U.S. incomes have not fallen precipitously.

p. 12: straw man lives

p. 13: Schiff gives us the alternative of Consumers vs. Savers
There are so many strange and questionable ideas put in this paragraph that it is hard to figure where to start.
- financial services org deregulated – making it sound as if regulation is good
- financial services org lowering their standards – generally, no, they didn’t
- foisting loans – the idea that advertising or salesmanship, etc., breads bad actions
- the value of stocks and houses wholly dependent upon inflation

p. 14: Schiff equates our “excess consumption” with all we do. While any loss of “excess consumption” would be a marginal loss to some, if we collapse, our complete loss or a very large reduction of our importing would be a significant loss to many. We are everyone’s largest trading-partner. The problem here is that Schiff forgets the part that foreigners buy from us. The trading numbers show us having a deficit, but the total amount of trade is very large. Loss of a significant percentage of that, on both sides, would be a major blow for everyone.

His castaway example is an insult. Today, yes, some of what we pay for is in the form of IOUs, i.e., dollars that are not returned. But it still is a fraction that was small and gotten larger.

Further, the idea that the Americans are the only ones who have the problem with inflation and IOUs is amazing. According to Schiff, Americans are the lone scavengers in the world. The Japanese are known for not inflating their economy as others have, the same is true of the Germans, and to a lesser extent, the English. But the rest of the countries of the world, and now especially the Chinese, are busy doing the same. The U.S. has the position it has among these countries because of its greater productivity and creativity because of its freedoms. Schiff does not know of any of this. Our real problem is the continued erosion of our freedoms, which do translate into a reduction of our productive ability.

p. 17: Schiff speaks so offhandedly about the “disruptions”.

p. 19: Confused at best. Who is doing what? People, especially in the U.S., are demanding that China allow their currency to obtain parity to other currencies. The Chinese have enourmous trade deficits with every industrialized country. It is Chinese government policy that has created much of this situation.

Further, how does Schiff suppose these Asian economies are going to stop producing for the U.S. The U.S. is not going in at gunpoint. The countries (except maybe China) are not forcing their people to sell to the U.S. Schiff ignores that all of this trade is essentially free. The only element of force is the U.S. inflation and the reserve currency agreement. He also fails to give foreigners any credit for recognizing that dollars are still often a better deal than their own currencies and their own government.

p.20: A whole lot less eating. Let’s see, our trade deficit is around $800B. Out total output is about $15T. So our deficit is something like 5.3% of our total economy. I’m sorry. I don’t get how this means that we are going to have to restructure our entire economy. If our international trade grew to be in balance and the dollar drifted down as foreigners sold off the dollars they didn’t want, we would see our goods and imports become more expensive and our standard of living fall. But, as in the past, given the opportunity, i.e., if Obama didn’t stand in the way, we would continue to improve our economy, making economic decisions upon costs and goals. Just as it should be. Schiff has made a major leap.

The balance of trade is not a minor issue. The cause is right here at the Fed. However, the Fed actions have had other, more significant adverse consequences than the trade deficit. It we handle the Fed, the trade issue will become less severe.

Frankly, this chapter is so far gone that I do not think that there is any redeeming feature. It is true that Schiff does realize that the major source of the trade deficit is our inflation, but he is so carried away about it that he loses his perspective. Nor has he addressed the downward movement of the dollar already experienced. This need not be a collapse. There is also the problem that he does not recognize the problems created by other governments and those effects on trade. It is the bad U.S. all of the time.

Review: "Crash Proof" by Peter D. Schiff

In the 1970’s there was a spate of “crash” books, many by Harry Brown, that are very similar to this book by Peter D. Schiff. These “crash” books presented a set of problems that the economy was suffering and promised that these problems would lead to a “crash”, and if you were well positioned, you could profit. I don’t remember any “crashes” during that time. There was horrible price inflation. There was a blip in 1987. But, we had modest recessions in the early 1990’s and in the early 2000’s, and then now. This is a mess, we had a panic, we have unemployment higher than we have had in decades, and the banks aren’t lending. But, is it a “crash”? And how does the current situation correspond to what Schiff is expecting. One of the biggest problems I have with this book is that Schiff does not tell us what a “crash” is.

Although Schiff did expect the housing market to do something close to what has happened, and the stock market has dropped to levels he thought were closer to the proper level in 2006, the central theme of his book has not been fulfilled. Schiff’s “crash” clearly centers around a significant drop in the value of the dollar. That event has not happened, at least at this writing, and there doesn’t seem to be any real movement either. Against the Euro, there has been no significant upward movement since early 2008.

Actually, since I had seen references to Crash Proof on sites that I wanted to like, I had high hopes for this book. Mostly, I was very disappointed. My disappointment centers mostly upon three main, closely related points.

To get to those points, let’s set up Schiff’s U.S. scenario. The U.S. has been exporting significant amounts of money since the about 1983, 26 years. This money was created by the Fed (The Federal Reserve System). It is inflation (Schiff doesn’t call it that, but he does recognize the connection. I will talk about inflation a lot in forthcoming blogs.). I agree with this completely.

So foreigners, foreign central banks, foreign businessmen, foreign citizens, are accepting U.S. money and keeping it. Here is the first point that Schiff and I part ways. I want to know why foreigners are doing that. Schiff’s explanation is two fold: foreign citizens and central bankers and are keeping and hoarding U.S. dollars because the U.S. has fooled them into thinking that U.S. dollars are worth something. U.S. dollars are in fact worthless, according to Schiff, because the U.S. produces nothing, i.e., we are no longer a manufacturing powerhouse, we are a service economy. We do produce dollars however, and that contributes to their worthlessness, which is true, as a natural result of inflation. So, in a manner that Schiff does not explain, foreigners believe that the dollar is worth something and accept it as a reserve currency. For clarity, I must say that Schiff’s explanation is meant to explain current behavior rather than the reason why foreigners began accepting money in the first place, which began after WWII.

I will leave it to an economist to examine the question of the strength and viability of a manufacturing vs. a “service” economy. Frankly, I found Schiff’s comments on this and the role of Americans to be short of the truth and often insulting, esp. p. 14ff. (See my commentary about the level of manufacturing in our exports.)

That leaves us with Schiff’s argument that we are purposely misleading foreigners. Schiff says that as soon as they realize that the dollar is worthless, they will begin off-loading dollars and the value of the dollar will crash. (Sometimes Schiff says that this process could take a long time, which I guess is a slow-motion crash.)

I think that the reasons why foreigners began accepting and keeping dollars has something to do with whey they might begin selling.

A long history lesson will not be appreciated by most readers, so let me just say quickly, that the two underlying reasons why people began and still do accept and keep dollars are, one, that they all agreed to do so. At the time of the agreement the U.S. was the major economy in the world and few countries had any gold. Two, the currency of their own country was not stable.

Point one is still true, although less so than after WWII. Foreigners do find a lot to buy from the U.S. Point two is also still true, only a few currencies in the world are stable. The dollar is not as stable as it was (more on that elsewhere). Also, over time, more and more places around the world are accepted dollars without question. It became the international currency. You walk into just about any bank anywhere and offer dollars and you get smiles. The same is true for many retail stores, even in parts of Europe. Try either of those efforts with Euros or the Yen, and you will not be as successful. So many businesses and investors find using the dollar to be convenient and probably less expensive (by saving on currency exchange costs, etc.).

For the international community to decide that the dollar is worthless, would be a crippling blow to international trade. That the dollar is not as desired or revered as it was, and has fallen in value to the Euro, the Pound, and Yen significantly, is not to say that foreigners have rejected it.

As correct as Schiff’s beginning scenario is, since he ignores the context in which the non-U.S. participants began this mess, he really cannot jump to the conclusion that they are going to dump dollars. It is a leap. I don’t think the “fooled them” explanation works at all. I think that he pulled that one out because he couldn’t figure out any other rational explanation for people to accept currency Schiff believes is worthless. Actually, point of fact, every currency is worthless, since they are all fiat currencies. In that sense, foolishness is widespread.

For clarity, my three closely related points are: one, neither the dollar or the U.S. economy is worthless; two, there is a better explanation as to why foreigners accept and keep the U.S. dollar; and three, there will be no “crash” of the dollar as it would be a crash of the world system (not just “dislocations”).

That doesn’t mean that we are out of the woods regarding the value of the dollar. A significant amount of that exported inflation is going to come back. Some of it is in the form of a lower dollar vs. other strong currencies. It is not a question of the strength of the different economies, but of the quantity of our exported dollars.

Now briefly, I will list a few of the other themes in the book I find to be very questionable:

1. The U.S. government has consciously and purposely engaged in fooling the world and its own citizens by manipulating all kinds of statistics, programs, etc., over generations, different administrations, various departments, and literally thousands of employees of various levels, talents, and loyalties.
2. Speculation is presented as bad, or at least ignoble.
3. Inflation is the cause of everything bad in our economy (this stand is lessened in the last chapter or two).
4. Schiff's one-note song is even worse when other disastrous policies are going to be bombarding us, e.g., social security and medicare. How will Schiff's investment ideas hold up to that, especially considering that those same problems are going to cripple Japan and several other countries?
4. Manufacturing is the root of all wealth.
5. He also has some strange, conflicted ideas as to what is savings and what to do with it.

I am not a big fan of the prescriptive chapters at the end of the book. Much of what he has to say is more conventional than I expected, especially given what he said by way of build up in the early part of the book. His recommendation to invest solely in foreign equities has not panned out well so far. His recommendation of GLD is a bright spot for him from mid ’05 to early ‘08. Since then GLD has moved with the other markets. That is not a record on which I would like to base a long-term strategy. Until the dust clears a little, I do not think that we have a reason to anticipate anything in particular (yes, with Obama in charge, it can’t be good).

In my notes on the book I didn’t discuss the last chapters with much enthusiasm or detail. I would respond to questions.

So, if you have read this book or are considering doing so, look at it closely. Watch for those many points in the book in which he makes unsupported assertions and be prepared for the leaps in his thinking.
In the following posts I will publish my notes from my reading in which I discuss many points in greater detail. It isn’t comprehensive, just a running commentary on the points I thought needed elaboration.

Got to Keep Watch!

Recently I have found that a good friend was not aware of some goings-on in the government/economy that I considered old hat, even givens. This was, of course, really bad stuff. I was shocked. I just thought that people, especially people I knew to be rational, knew this stuff. I was wrong. I was projecting, thinking that other people had some ideas similar to mine. If asked, I would have said right away that such projecting just gets you into trouble. Intellectually, I knew that. I just didn’t connect it to that particular issue.

I understand why my friend did not know these issues. They are way outside of his area of expertise and interest. Also, these issues have not been brought up in any political contest, not in any other Objectivist oriented site, that I know of, and I haven’t talked about them. You see, I always talked about stuff I thought we both found interesting. That was my mistake and my error. I really should have talked about issues that I knew were important, just to make sure that he knew they were there.

This really brings up two points. One, I now realize that I am going to have to bring up these issues on this blog. For those of you who find some of these things pedestrian, please keep in mind that they have got to be presented for those who have other interests.

The second point is more important. Everyone who is interested in their freedom and well-being needs to keep track of certain things. In today’s world, vigilance is necessary. I am not being excessive or alarmist: NECESSARY!

You have got to keep track of what is happening to your money, your retirement investments, your housing, and the government’s commitments. I mean this in the context of a human being, which means: over time. I mean the phrase “what is happening” means the consequences of today’s and yesterday’s government actions over the next 10, 20 years. The recent “dire” warning posted by John Lewis should not come as a surprise. Even some middle of the road columnists have know about this for years. (“Dire” is perhaps an understatement. Obama is merely going to make it worse, which means the really bad consequences will occur sooner.)

Fortunately, today, it is easy to keep track of this stuff. The internet and your computer can get you to the information you need quickly. Find sites that will give you graphs and keep you up to date (hopefully, this one will be of some help). You need independent sources. Set up favorites of, for example, the dollar vs. the Euro and the Yen, Federal debt, interest rates – the 10-year Treasury Bond and CDs, the CPI (whether this reports the full inflation or not is besides the point, upward movement is upward movement). You will want to see what the Federal Reserve is doing. This isn’t easy, and I do not know anyone but myself who is watching. As I find sources, I will post them. If anyone finds a good sources, give to us, please.

Writing just now I realized that if I am going to do a good job on this blog, I am going to have to have my own periodic report. But, I could get hit by a truck, so you need to sit down with your own means of self-protection so you can look through the murk and find a means of watching them yourself. Seriously, this is important. They realize the importance of putting their buracratic maze between themselves and the world. You just have to suck it up and get in there. Just keep your own values and safety in mind.
For the economics challenged, keeping track of this stuff will be difficult, but no more so than keeping up with your medical condition. Both are necessary. We know that ignorance is not bliss.