Monday, May 26, 2014

The Real Crash by Peter Schiff

 There's nothing very surprising in the early going in Peter Schiff's new book, though it does serve as a good introductory work for those who aren't familiar with the workings of the Federal Reserve, and the role which the government has played in the most of the financial crises recently, such as the dot-com bubble, the housing bubble and the credit bubble.

Schiff relates the tale of what happened in the Harding administration after WWI, when the economy saw an increase in unemployment and a lack of economic growth - the last time in our history that a politician had the courage to let us suffer the pain of doing the right thing - and Harding "paid off the war bonds, slashing the national debt by one third".  The money used to pay off that debt was removed from the money supply, which put a downward pressure on prices, and an upward pressure on interest rates, which discouraged borrowing and encouraged saving.

"Instead of trying to fix the lagging economy through stimulus, the Fed responded to the economic contraction with monetary contraction."

Within a few years, unemployment had shrunk to 2.4%, and the stock market had exceeded its previous highs.

Quite a contrast to our government's response to the 2008 crash, and quite a contrast in results, as well.

On the creation of the dot-com bubble, Schiff writes,

"Many liberal economists and Fed defenders will argue that the Fed didn't create the stock market and dot-com bubble of the late 1990s. They blame 'greed' and 'manias.' There's a small degree to which they are right: the Fed did not specifically steer capital toward dot-com stocks. The Fed just created the excess capital that needed a home, and market forces and other government policies determined where that money went."

Schiff brings up an interesting distinction regarding the mortgage interest deduction.

"This is a huge mortgage distorts the market in favor of homeownership (more precisely, leveraged homeownership)."

The real estate bubble, he argues, was also brought on primarily by the Fed and other government policies. Fannie Mae and Freddie Mac guaranteed subprime mortgages in numbers never seen before, the Fed made cheap money readily available to lenders, the Community Reinvestment Act pushed banks to lend to poor people who would never have previously qualified for a loan, and the Bush administration, through the American Dream Downpayment Act,  provided grants to first time homebuyers.

The next bubble Schiff sees forming is the "government bubble",  a rapidly growing federal debt caused by out of control spending, reckless borrowing, and the Fed's inflationary policies.

Schiff busts the myth of government "job creation", by showing its many failures in that area, but also showing that the government's attempts to create jobs actually misallocate resources that could create jobs in other areas the government hasn't blessed with its favors.

The money quote:

"The problem isn't that the government bets on the wrong horses. It's that the government should be at the track in the first place."

In fact, government can best create jobs by staying out of the way.

"Jobs come from (a) the incentive to make a profit and (b) capital formation. The harder government makes it for employers to earn profits and the less we save to finance capital formation, the fewer jobs that will be created."

He spends a bit of time talking about "Hiring Taxes", those costs associated with creating a new job for employers, such as the employer match on Medicare and Social Security, unemployment insurance, worker's compensation, and other taxes, including new costs imposed by the ACA, aka Obamacare.

Schiff claims that people could take the additional money they would be paid if these hiring taxes were eliminated to "self insure" on some of these things. I have to differ with him there. Most people, unfortunately, will not do the wise or prudent thing, they'll simply spend the excess on consumer goods. We've seen this with the optional retirement plans like 401Ks and IRAs, we've seen it with young healthy folks failing to sign up for employer-provided health insurance, and recently the ACA, and if we went to an optional "social security" system, they'd probably not put anything away for retirement there unless forced to.

Heh. In contrast to the whole "follow your passion" movement these days, Schiff mentions in passing,

"With a few exceptions most people have jobs only because they need a job in order to afford the stuff they really want and need."

And, under the category of "preaching to the choir", he says,

"Entry-level jobs are not supposed to provide enough income to support a family. By the time individuals are old enough to marry and have children they should have acquired the skills necessary to command much higher pay. They acquire those skills working for low wages while still in their teens and prior to marriage. If the (artificially and legislatively high) minimum wage prevents them from getting those jobs, they will never acquire the skills necessary to support a family. In other words, the minimum wage knocks the bottom rung off the job ladder, making it impossible for many ever to climb up."

I like,

"While politicians and the media portray regulations as a way to keep 'big business' in check, the real effect of regulation is often to crush their smaller competitors and to keep others from even entering the fray to begin with."


"So there you see the real threat the FDIC was created to battle: banks were losing business because customer didn't trust them. The real effect of government deposit insurance is not to protect depositors, but to protect banks."

When the Fed inflates our money supply, Schiff says,

"When inflation's effects show up in the form of rising prices, consumers don't typically blame politicians, they blame the merchants. In fact, politicians - the ones who caused the higher prices - are often the first ones to scapegoat merchants or manufacturers when prices start rising."

Schiff also debunks Warren Buffet's mantra that he pays a lower tax rate than his secretary. It seems Warren is only talking about his personal income tax rate, not the amount that Berkshire Hathaway, of which Buffet is the primary owner, paid on its earnings - $5.6 billion.

He proposes some "macro" solutions in the middle section of the book, including:
  • Return the Fed to its original mandate
  • Tax Reform
  • Return to the Gold Standard
  • Eliminate Social Security, Medicare and Medicaid
  • Deregulate the Financial Industry
  • Fix Higher Education
  • Fix Healthcare
  • Shrink Government
I think we've seen over the last few decades that there is little actual political will to allow free market policies and the principles of limited government "fix" these problems. They all sound like great ideas, but I am really doubtful that any of them will ever come to pass, absent a black swan event that forces us in that direction. Schiff's Real Crash may be that event, but the magic eight ball isn't giving out any answers right now.

During all of the years my kids were going to school and participating in band, orchestra and choir, I got to listen to music teachers lecture the parents about how it was a proven fact that learning to play music was good for children's grades in all the other subjects. I had my own theory about that, since I would see the same group of parents - heavily involved with their children's success - at all of the other school events, soccer games, football games, and so forth. The parents encouragement and active participation in making sure their children's lives were enriched and educational was, in my opinion, more important than whether or not they played music.

Schiff says something similar about the mantra that people who attend college will earn a significantly higher income than those who do not.

"In other words, all the factors (being a hard worker, coming from wealth, attending private or good public schools, being smart, having parents who attended college) that make someone more likely to go to college and finish college are also the same factors that, in and of themselves, raise a person's likely income."

Another thing upon which he and I agree, and which I have believed since I first attended college, decades ago:

"As an employer, even if you think college has no value, you might count on colleges to perform a screening function. Getting into college and finishing college indicates some level of competence and ability to follow instructions."

With respect to the huge "public service" push to make sure that all students in the U.S. attend college:

"Who is the real beneficiary from policies and cultural biases that push more and more eighteen-year-olds to go to college? The answer, of course, is the educational establishment itself."

It's all about the benjamins, baby.

And the reason for the skyrocketing college costs we've seen (applies to healthcare also):

"This is typical government action. Wreck an industry with subsidies and regulation; blame the ensuing failure on capitalism; then 'solve' the problem with a complete government takeover."


Regarding ridiculous student loan debt:

"'s hypocritical for Congress to push eighteen-year-olds to take on $20,000 or more in debt. Our federal government is always trying to say who shouldn't be borrowing, and which loans are 'predatory,' claiming that lenders are exploiting people who don't know better. Is there any clearer example of someone who doesn't understand debt than a high school senior who has never handled his on finances on a meaningful level?"

Schiff does a great job of identifying many of the root causes of our huge debt problem, and lays out another prediction of how it will all end - badly, of course. He proffers some libertarian-flavored solutions for most of the causes, which will, in my opinion, never get implemented due to lack of political will to do the right or necessary thing. It's far simpler to bury our heads in the sand and pretend everything is all right.

Also unfortunately, the "personal" solutions he offers aren't much better, for the lower to mid- middle class. His company, EuroPacific Capital, only serves high income, high net worth individuals, and the types of services they provide for wealth protection and management are unavailable to average hard-working folks. Nothing he prescribes is significantly different than what I've seen before from other Cassandras, and the practical issues remain the same. If it is possible for you to do so, he recommends getting your money out of America and out of the US dollar.

I've got a bit of Kiwi shrapnel* lying around somewhere, I should be ok.

This is a book which most people would benefit from reading, but it's unlikely that the ones who need it the most, will.

*a New Zealand slang term for pocket change

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