Peter Schiff

From Chapter 1 of Crash Proof 2.0: How To Profit From the Economic Collapse

2009 UPDATE

The slope was slippery, all right! The ink in Crash Proof was hardly dry before the phony, borrow-and-consume U.S. economy began to unravel. As I had predicted, it started when the real estate bubble, already leaking air, finally burst in 2007, triggering a credit crunch that quickly became global and plunged the American economy into deep recession and virtual bankruptcy. In a paradox as valid as it is bizarre, that’s actually the good news!

The failing banks, corporate and personal bankruptcies, massive layoffs, falling stock, and real estate prices, home foreclosures, and other consequences of the current economic collapse, however painful the personal and social effects, are free-market forces trying to correct economic imbalances and restore economic viability. An overleveraged economy — leverage referring to debt — is trying now to reverse its errant ways by deleveraging. What is perceived as the problem is really the solution. The problem is what I described earlier in this chapter. The government should get out of the way and let the markets rebalance our economy. It won’t, though, and that is the bad news.

Keeping Our Collapses Straight

The collapse I was predicting when I chose my original title, Crash Proof: How to Profit from the Coming Economic Collapse, hasn’t happened yet. It is largely still ahead of us. The ill-fated dollar, after a bear market rally in 2008, still has a long way to fall. Inflated bond prices, the inverse result of artificially low interest rates, are a bubble still searching for a pin, with effects potentially more devastating than the real estate meltdown.

Maybe a couple of fairy tales will help clarify my point. The mess we are in happened because our government defied free-market forces and tried to engineer a “ Goldilocks” economy, one neither too cold nor too hot, but just right. That seemed for a while to be working, but it was actually working against us. What we had instead was a “ Humpty Dumpty ” economy that sat high on a wall and had a great fall. Now our friends in Washington are trying to do what all the king’s horses and all the king’s men couldn’t do, which is to put Humpty Dumpty back together again. That exercise in futility has a price tag of trillions of dollars, which we will have to either borrow or print at the cost of crippling debt or massive infl ation. When I wrote Crash Proof, excluding Social Security, Medicare, and other unfunded obligations, our government owed the better part of $8.5 trillion. The figure is now over $10 trillion and about to start mounting much higher. The budget deficit, which was running $300 billion to $400 billion annually, is projected to exceed $1.8 trillion this year and despite government projections, to keep growing thereafter.

The main problem is that the very individuals who assured us that all was well are the ones now entrusted to solve the problem. But how can they solve a problem they still do not understand? The Goldilocks crowd wants to rehabilitate their prodigal daughter. If they can just get her borrowing and spending again, she can once again skip blissfully picking daisies. It has not dawned on them that they embraced the wrong fairy tale and are now unknowingly scrambling to put Humpty Dumpty back together again.

The Real Estate Meltdown and Its Consequences

As I predicted, subprime mortgages granted on indiscriminate terms to unqualified borrowers, which totaled a staggering $600 billion or 20 percent of all new mortgages in 2006 alone, became a nationwide foreclosure problem in 2007. But defaults quickly spread to prime mortgages, as neighborhoods got seedier and housing prices declined, wiping out the home equity Americans relied on as a substitute for savings and a source of available credit.

Mortgage lenders and institutional investors, such as banks, Wall Street investment banks, and other investors in mortgage-backed bonds or structured mortgage - backed securities called collateralized debt obligations (CDOs), took huge write - offs that jeopardized their required leverage ratios or resulted in insolvency. With loan portfolios full of toxic paper, banks stopped lending, not just to homeowners but to everybody, including businesses large and small and even other banks. Some got emergency cash infusions from external sources (Citigroup got $7 billion from Abu Dhabi, for example) and others from that bottomless well (of printer’s ink), the United States Treasury. Such bailouts were deemed necessary because the recipients were presumed to be “too big to fail. ” (Paul Volcker, former Federal Reserve chairman and now economic adviser to President Barack Obama, took a small liberty with that phrase in February 2009 when he sardonically and perhaps prophetically observed they were “too big to exist, ” a rather profound comment when you think about it.) The result was a global credit freeze. Businesses curtailed operations and consumers reduced spending, causing declining sales, bankruptcies, and massive layoffs. The CEOs of the big three automakers boarded separate corporate jets and flew to Washington with hats in hand, telling Congress that without a government bailout they (with the exception of Ford) would go out of business and take a network of parts suppliers and dealerships with them (Unfortunately they got their bailout money, then got even more when they filed for bankruptcy anyway several months later). By 2009, the U.S. economy was in free fall, economies abroad were in varying degrees of distress, and states, businesses, and strapped consumers were getting more desperate by the day. In efforts to stimulate bank lending and consumer spending, the federal funds rate was cut to a range of zero to ¼ percent, rebate checks were mailed to taxpayers under a Bush program, and half of a $700 billion bank bailout bill known as the Troubled Asset Relief Program (TARP) was used to bolster the capital at several banks. None of that stimulus made a dime’s worth of difference. Rather than lend the money, the banks added to their reserves or acquired other banks. Government intervention was proving impotent in the face of market forces, which were having a constructive effect, as I look at things. To my way of thinking, a bank that got into trouble making bad loans deserves applause rather than opprobrium for being unwilling to use a cash bailout to make more bad loans. Similarly, consumers who are cutting back on spending are doing what I believe they should be doing, creating savings that will become the basis for future bank lending and provide the capital investment that entrepreneurs need to create jobs and finance the production of exportable goods.

The Wrong Way to Go

The Obama administration’s Economic Recovery and Reinvestment Program initially provides some $800-plus billion in combined spending and tax relief, but has the expressed aim of spending whatever money is required to create jobs, get credit flowing again, and put the economy back on track. A small but important percentage of the funds will go to states and municipalities for public works projects that will replace deteriorated infrastructure and perhaps ultimately improve productivity. The projects are supposed to be “shovel ready” and thus will create new jobs within a short time frame.

While some of the infrastructure spending is likely long overdue and badly needed, making the repairs will not help the economy. The bottom line is that we simply cannot afford to pay the bill right now. Imagine an out-of-work, overly indebted individual deciding to have her kitchen remodeled to solve her financial problems. Even if her kitchen were badly dated, with avocado appliances, orange counter tops, and dark wood - paneled cabinets, going deeper into debt to fix it up would only worsen her predicament.

The reality is there are more pressing uses for our scarce resources right now than making our roads nicer. Once we rebuild our savings and start producing stuff again, then we can afford to remodel. Until then we need the government to get out of the way and allow market forces to reallocate resources, including labor.

If that means people are going to lose jobs in the service and financial sectors, it is a sacrifice we must make. Human resources should be allocated where they are productive and contribute to a strong economy that benefits everybody. Nobody wants to see people out of work, but which is more humane: 5 million unemployed today, or 10 million unemployed a few years from now?

In my view, that is the choice we face.

Lost in translation, of course, is that we do not want jobs merely to keep ourselves busy, but for the purchasing power that working at a job creates. But nonproductive government jobs, or private sector jobs subsidized by government money, confer limited purchasing power to workers; in the end we may all be employed but have little to show for our efforts.

I fear that government spending on the scale being contemplated will change the character of our economy by moving us in the direction of central planning. That is the opposite of free-market capitalism. Our economy needs to be restructured from the foundation up to regain the viability it had when profit-minded people were making the important decisions and the United States was becoming the world’s leading industrial power.

Yet what the government is about to do is spend massive amounts of taxpayer money to reflate a consumer-driven bubble economy. Its objective is to get consumers using credit again, to go back to the malls, to buy more cars, to carry more credit cards, and to take out more student loans. But buying stuff we couldn’t afford with money we didn’t have was what got us into this fix.

We’ve consumed too much and have more than we need, and until we stop consuming and start saving and producing, our economy will never enjoy a real recovery.

Disclosure:
Data from various sources was used in the preparation of this book, the information is believed to be reliable, accurate and appropriate; but it is not guaranteed in any way.  The forecasts and strategies contained herein are statements of opinion, and therefore may prove to be inaccurate.  They are in fact the author’s own opinion, and payment was not received in any form that influenced his opinion.  Peter Schiff and the employees of Euro Pacific Capital implement many of the strategies described in the book.  This book contains the names of some companies used as examples of the strategies described, as well as a mutual fund that can only be sold by prospectus; but none can be deemed recommendations to the readers of this book.  These strategies will be inappropriate for some investors, and we urge you to speak with a financial professional and carefully review any pertinent disclosures before implementing any investment strategy.

In addition to being the President, Peter Schiff is also a registered representative and owner of Euro Pacific Capital, Inc. (Euro Pacific).  Euro Pacific is a FINRA registered Broker-Dealer and a member of the SIPC.  This book has been prepared solely for informational purposes, and it is not an offer to buy or sell, or a solicitation to buy or sell any security or instrument, or to participate in any particular trading strategy.  Investment strategies described in this book may ultimately lose value even if the opinions and forecasts presented prove to be accurate.  All investments involve varying amounts of risk, and their values will fluctuate.  Investments may increase or decrease in value, and investors may lose money.