THE CHINESE CURRENCY: A BIG SHOE THAT COULD DROP!

For over a year the U.S. economy has been just chugging along without any apparent stresses. I mean, nothing has happened within our economy to cause panic or increase the level of fear people are feeling. Certainly, the economy is far from healthy. It is not growing to speak of. Unemployment is very high and few jobs are being created. Some communities appear to be in depression, while others are only marginally affected.

In the political area, the focus related to the economy is all of the promises made and no results. The current administration isn’t being blamed for making things worse, just not making them better. The government has declared that the “big drop” is over, the recession has ended, but the signs that growth is occurring or may happen in the future are muted at best.

My own mood is that of waiting for the other shoe to drop. Well, there are many shoes that could drop. And any of them could be more disastrous than the big dip of 2007. Which one will it be? Or perhaps the question to ask is which one will be first? Only time will tell. Let’s think about one potential shoe, the push to have the Chinese revalue their currency.

One issue that the politicians are focusing upon is the international value of the Chinese currency. It is contended that if the Chinese currency is valued more in line with real relative national purchasing power, the U.S. dollar would be stronger and the U.S. would benefit from a greater demand for its products. There are several things that are difficult about this. It is true that China’s approach is the old, thoroughly discredited view (among those who are aware of the history of economic ideas) that a nation’s wealth is achieved by hoarding valuables. At the beginning of the exploration of the New World, for example, countries would scour for gold and silver in the Americas, bring it home, and put it in a vault and declare that they were wealthy. So, several Asian countries, including Japan and China, insist on controlling the exchange rates (although Japan is trying counter balance that now) and hoarding the dollar and the Euro (China has a large surplus with the Euro Zone as well).

Of course, hoarding anything is not wealth. A dollar, or any currency is only as valuable as what it will buy. A currency, especially a fiat currency, in international trade is a claim on that country’s production.

On the other hand, a country does need reserves (speaking within today’s structure), i.e., a stash of cash available when and if needed to settle international debt or payments. What cash is available? Well, they aren’t going to begin using gold, if for no other reason than that the process of beginning to use gold would cause the value of the dollar to die. The same problem holds for any other currency that could be chosen other than the dollar. If the process of changing to another currency was done slowly, perhaps the dollar wouldn’t collapse. Unfortunately, such a process should have started a couple decades ago.

As it is, the international system is stuck with dollars into the foreseeable future. Okay, but there is no need for countries like China and Japan to continue accumulating dollars. They have more than they need, and they are worried about the constant flow of dollars and what that means for the future. What they could do is to turn around and begin buying stuff from us with the dollars that they would have hoarded, the current cash flow. Sounds good, right?

We will even ignore the probable, immediate consequence that the dollar would lose significant value just because it wasn’t being hoarded as before. Forget that. Forget that immediately, foreign goods would be significantly more expensive. Let’s just concentrate on our own goods.

The mainstream economists think that to create growth, what is needed is consumption, more spending. That is why they set things up to expand the money supply. More money, more spending, more wealth, they think. Great, huh! So, these same economists would be happy for foreigner to be spending more in the U.S. It means more demand. They felt the same way years ago when the economy seemed to be humming right along, with very high employment, and very low unemployment. We had what some called “full employment”. I always wondered what they thought was going to happen. The unions, progressives, Keynesian economists all thought that more money running after our goods was going to be good, when there was no one to produce them.

Today things are a little different. We have a large number of people unemployed and lots of capacity that is sitting idle. It is not the most efficient capacity, but it is there. What we don’t have is a significant amount of raw material sitting around. Nevertheless, as foreigners began to send those dollars that they don’t hoard back to the U.S., we will now see more dollars running around. At first, the new demand will cause some shortages, and prices will begin to rise, since the actual stock of good will be unaffected, at least for a while. Then, over time, more capacity will be used, more people rehired, more produced. But, then the real bottleneck appears. Or rather two bottlenecks. One will be the need for raw materials for the higher level of production. Costs will have to rise to compensate for the higher costs of materials as users bid for the material available. The other bottleneck is that some new investment will be needed, but the government has soaked up all available savings for its deficit. To get loans or attract investors, businesses wanting to expand will have to bid against the government for savings. That will also tend to raise costs, and the cost of government borrowing will also increase.

What this really means is that the return of all of the money we send out in a year for foreign trade will result in higher prices, both for domestic goods and much more so for foreign goods. It is unlikely that we would see the “gentle” 1-3% inflation we have seen with few exceptions over the last couple of decades. It will be higher.

Now why would we see higher inflation just because foreigners spend the money that we sent for goods? It certainly wasn’t the case throughout our history, right? Wouldn’t it make sense for there to be a balance? Well, yes. But our situation over the last decades is very different. It is hard to understand, apparently. Some supposedly free market bloggers don’t accept my thinking here.

For decades we have had not only a trade deficit, but a cash-flow deficit, called a current account deficit. While the trade category covers trade, obviously, it doesn’t include investment flows between nations and government transfers. Normally, if a country has a trade imbalance, the difference is made up by the return of the deficit in investment, or the purchase of government bonds, for example. Even then, if the current account is not in balance one year, it swings back the other way the next, or at least over time a country’s current account will balance out. This has not been the case for the U.S. for a long time. The current account deficit will be less than the trade deficit.

One way to understand what is happening would be to imagine that you are a country and buying from other people – countries – often. Your purchases are all made by check. You send out many checks and everybody honors them and sends you the merchandise you want. But, you find out, by analyzing your checkbook that some of your trading partners are not cashing your checks. They are just keeping them (for some strange reasons – your crazy cousin has all kinds of weird theories as to why, saying that they want your checks as reserves, that your partners use them as cash with other people, etc.). So, you have both the things you bought and the money you with which you thought you bought them. Sounds like a good deal. It is sort of. But, if your honest, and know that there is a future, you might be somewhat worried about what happens when all of those checks come wondering back, especially if they all come back at once!

Let’s take 2009. The U.S. bought more stuff than it sold by $374 B. The current account difference was $378 B (usually, the current account deficit is smaller than the trade deficit). You can look at the history of the U.S. current account here. So, there have been billions upon billions of dollars that have left the country and not come back, not even as loans to our government. My discussion in this post is limited just about this year’s money not returning. (Think how bad things would be if the money from past years returned as well!)

Under a gold system, if money left every year and didn’t return, the money supply would continue to shrink and there would be a corresponding drop in prices. There would be ramification of a continued outflow of dollars. There are ramifications under the present circumstance, just not the ones that would occur in a rational economy. In the present circumstance, the U.S. price level actually continues to creep up. That is because the money supply continues to creep up. The money supply creeps up in spite of billions of dollars being lost every year to foreigners. Where is the money that is being lost coming from? I am sure that you know the answer. It is the Fed., the official U.S. money maker upper!

One key fact to remember about international trade is that it functions completely on credit. When an importer buys, he sends a letter of credit, which does not pay the exporter until the goods are received and accepted by the importer. The letter of credit is a bank document, and is what it says it is, a credit, a loan. Purchases by U.S. importers are financed by bank credit pushed by the Fed. We see that even though banks in the U.S. are not making loans to businesses for new production, they are making loans for importing, i.e., we still have a big trade deficit. The money we have been exporting for years is all made up, Fed. produced money. So the Fed increased the money supply, we sent it overseas to buy stuff, and those people kept the money, just like the example with your checks. (Why? See my discussion of Schiff’s book, Crashproof. The “Why?” is even more a big question after they have kept so many dollars after so many years.)

The situation is not good for the Chinese and other countries that have built up big surpluses of foreign money (which is mostly in digital form). Recently, there was a push to move away from dollars toward a “basket” of currencies, including Euros. The wisdom of that idea was demonstrated this summer as many of the Euro Zone countries have been shown to be in financial difficulties. Maybe people will begin to realize that fiat currencies of any stripe will not stand up to normal, mixed economy political processes. The dollar became strong, i.e., higher priced against the Euro, for a while because the dollar again looked like the strongest, safest currency. That view will fade. So the Chinese, to use them as the example because they have the biggest hoard, are sitting on vast sums of dollars, some of which are “invested” in U.S. government debt, a little of which is invested in other countries, both real assets and government debt, and some of which is sitting as reserves, as gold would sit. If and when the dollar falls, the value of these massive holdings will fall, which would not be good for the Chinese economy. Thus, the Chinese are walking a tight rope, trying to keep the dollar from a death dive, which also means their currency at a lower price, and make small moves to reduce their dependency on the dollar. Everyone is watching them. They have to be careful.

Which also means that they are confused by the U.S. political leaders constant demands that they increase the value of their currency. The Chinese realize to some extent the consequences of that action. They can only be astounded by the U.S. politicians. Those fine people, the Congressional leaders don’t seem to have much understanding of international economics (not surprisingly, since they don’t have much understanding of domestic economics, either). They do understand that the jobs issue plays very well in this country. They see that demanding that the Chinese buy more U.S. stuff there might be more U.S. jobs, and play it for all they can. Real consequences are far out weighted by political appearance. They can always blame someone else for the unexpected consequence.

But if the Chinese, and the other Asian countries begin spending those dollars on U.S. goods, we begin to see those made up dollars running after the few goods we have purchased and prices begin to rise, interest rates begin to rise, and the quiet calm that we have had, a quiet calm in which we have been able to have good fight for our lives, will end and who knows what could happen then.

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.

Commentary, "Crash Proof", Introduction & Chapter 1

COMENTARY

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.