Interview With GoldMoney
November 1, 2011
(This originally appeared as a two-part item at GoldMoney.com on November 1 and 2, 2011.)
http://www.goldmoney.com/gold-research/newsdesk/nathan-lewis-interview-part-1.html
http://www.goldmoney.com/gold-research/newsdesk/nathan-lewis-interview-part-2.html
What’s your take on the recently-proposed European Union rescue plan for Greece? Will it lead Greece back to economic stability and growth – or is it merely “kicking the can down the road”?
Nathan: What the government of Greece, or any government that finds itself in a similar situation, should do is to start with a clean sheet of paper and make a list of how things would ideally be in some happy post-crisis era. If I were to make a list like that for Greece, I would put on it a major tax reform that included some sort of flat-tax system like that adopted by neighboring Albania and Bulgaria. I would probably choose to stay with the euro unless the European Central Bank’s mismanagement becomes intolerable. I would decide on what government services we would like to provide, and then I would decide on how many employees would be necessary to provide that, and what a reasonable compensation scheme for them would be. The end result would be a very clean tax system, let’s say a 16% flat income tax and a 15% VAT, and nothing else. And, a lean but effective public sector, leading to a balanced budget. I would take a look at the existing debt, and write it down to the point at which it would be relatively easy to manage.
Then I would start moving in that direction, policy-wise. The EU “rescue plan” accomplishes none of this. Greece’s latest 50%-writedown plan is effectively the same as a default, so we don’t have to worry about “avoiding default” anymore.
Was European Monetary Union a flawed concept from the start? Is the eurozone in its existing form sustainable?
Nathan: No, the European Monetary Union is a perfectly fine concept. Europe has always had a “single currency.” This is because these are small countries, and have always had a lot of trade with each other. Generally speaking, the smaller the country, the more trade it has in relation to its GDP. Greece’s population is about the same as Los Angeles. The size isn’t much different than southern California. Think about the trade that Los Angeles has with the rest of the United States, or the world. You can see why it is advantageous to have a unified currency, rather than separate floating currencies.
In the past, Europe’s unified currency was gold. The franc or the mark or the lira were all linked to gold, and thus their exchange rates were fixed. Today, we don’t have that system, so it is logical that Europe would drift towards some other sort of unified currency system.
The problem is the idea that using the same currency means that there needs to be some sort of fiscal linkage, or central bureaucratic state. This is not true at all. It just means you do business using the same unit of denomination. Just like using the metric system. We don’t need fiscal unification to write contracts using the kilogram or metre. Some people have estimated that about 80% of all dollar bills in existence are in use outside the United States, as the international currency of the world. These people can use the dollar in their business and contracts, and it doesn’t bother anybody.
Indeed, there was a lot of currency sharing even before the euro. Like most smaller countries with low-quality currencies, the government of Greece and most corporate borrowers didn’t issue most of their debt in drachma. Nobody would buy it. Most of the debt was issued in foreign currencies, primarily Deutschemarks I’d guess. This is just like Mexico, which, until recently, issued most of its debt in dollars. So there was already an informal “unified currency” for a lot of business.
The root of this idea, that using the same currency needs fiscal oversight and integration, seems to be in the idea that a sovereign default would lead to turmoil for the euro currency. But this isn’t necessarily true at all. If the euro was falling in value, the European Central Bank could just reduce euro base money, shrinking the supply and thus supporting the value. The euro is just a counting-unit, and if the value of the unit is OK then there’s no real problem.
So, technically, I would say there is no need for fiscal integration at all. However, the euro creators sensed two political problems. First, the ECB would be incompetent. Although solving the problem of a too-low or too-high euro is very easy to do, by adjusting base money, the ECB’s bureaucrats don’t know how to do this. They would be likely to mess it up. Second, in the environment of sovereign default and the inevitable banking and perhaps commercial financial turmoil that would accompany that, the ECB would be under great pressure to do something, such as buying the debt of the struggling government or bank. In short, printing money to solve the problem. This is in fact what the ECB has begun doing today, although it is specifically banned from doing so. The people running the system could not be relied upon to do the proper thing when under stress.
Despite all this, note today that the euro – the currency itself – has actually been fine. It hasn’t been plummeting into a black hole or something like that.
The idea that a currency union needs a centralised state is being very heavily promoted right now. If you think about it for twenty minutes, I think you will agree that the government of Germany doesn’t need to pay the government of Greece’s debts, just because they use the same currency. It is no different than me and you. We both use dollars, but that doesn’t mean that I have to pay your credit card bills. This shows how many people are actually thinking about it – almost none. They are just hearing something somewhere, and then repeating it. The banks (the main source of financial information for the media) and the media are heavily influenced by those who want a centralised, non-democratic European state. There is a propaganda campaign going on. It’s a form of problem-reaction-solution.
Do you expect to see the European Central Bank resorting to large-scale money printing in an effort to “paper over” problems in the eurozone?
Nathan: Yes, I think they will do this eventually. This is because the governments don’t seem to be able to manage the proper solution, which is to let governments default. Greece has been in default for most of the past 200 years. So it’s nothing new. Banks would be restructured and recapitalised by having the bondholders take a loss, or convert to equity. No taxpayer money is needed. This is what’s supposed to happen, but governments don’t want to go there. I think this is founded in basic incompetence. The people who should be leading this process, namely France and Germany, don’t have enough confidence in their abilities to come up with a constructive outcome. Probably for good reason. So, they try to avoid it. So far, this has been done mostly by issuing more government debt. However, as we are discovering, it’s hard to solve a government debt problem with more debt. They have already started to rely on the ECB’s printing press. This will likely become more pronounced as their ability to issue debt declines. The newest EFSF plan sounds nice on paper, but we’ll see what happens when you have to come up with some real cash. So far, the Italian government bonds, which is really what this is for, have barely registered any improvement.
You have written extensively about gold’s past role in the monetary system. Do you foresee a return to some form of gold standard? Is this desirable?
Nathan: It is becoming clear to a lot of people that the present system isn’t working. They are looking for solutions. The euro was supposed to be a solution. It was supposed to be an alternative to the dollar as a world reserve currency. That’s not working out so well. What about the Chinese yuan? The yuan is linked to the dollar. It doesn’t even trade independently, and hasn’t for the last 60 years. The Chinese have no experience running a floating fiat currency. Forget about the Japanese yen. It is becoming clearer that no bureaucrat-managed floating fiat currency is reliable for any sort of long term. They might have a few good years, and then there’s some sort of problem, and the central bankers don’t know how to fix it. Probably they are causing the problem themselves.
People remember, at some basic level, that the gold standard system worked. We have many decades, even centuries of proven success. It is not some goofy idea that some academic dreamed up while sitting on the potty, which has never been tested.
The main problem today is that there are very few people – almost none – who have the technical knowledge to establish and maintain a successful gold standard system. I say that it is like an airplane. We can all stand around and talk about how wonderful it would be to fly in an airplane. However, if nobody knows how to design, build and fly one, then we aren’t going to be flying anywhere. There is some specific technical knowledge involved. Obviously, the academics and today’s central bankers don’t have it. Fortunately, it’s pretty simple. It is much simpler than an airplane! When I wrote my book, I wanted to have a one-volume resource that anyone with a bit of technical skill, like a computer programmer or a financial analyst, could pick up and have everything they need to build a new world monetary system based on gold. Even 50 or 100 years from now. We really need a few more people with this knowledge.
Along with this, we need people who can express coherently the purpose and advantages of a gold standard system. For example, the primary purpose of a gold standard system, I would say, is to produce a currency of stable value. That’s it. That’s what it is for. It is a tool that you use to achieve that goal. If you read Alan Greenspan’s famous essay Gold and Economic Freedom, you’ll notice that he doesn’t mention this anywhere. This is not just an oversight. It is evidence, I would say, that Alan Greenspan, and the writers of similar polemics today, don’t actually know what a gold standard is for, or anyway don’t have a clear enough concept that they can express it in writing.
So, the main hurdle right now is this sort of intellectual hurdle. Once that is completed, and we are making good progress today, then the implementation will be much more straightforward. We will know what we want and how to get it.
Would it be possible and desirable for a country to transition to a free market in money – that is, one without government legal tender laws?
Nathan: Most countries have something like this already, at least informally. You can go to Honduras or Vietnam today and spend your US dollars at any shop or restaurant. Europe has had “eurodollars” for decades. It would be better if this was formally recognised, with no legal tender laws, fees or taxes on using whatever currency you like.
This is actually an important idea today, because we have to find some sort of way to transition from the dollar-centric world monetary system to whatever comes next – ideally a gold-based system. Unless the dollar itself gets a gold link, then there will have to be some sort of transition period from one to the other. During this transition period, I think it would be good to have the option to do business in whatever currency you like. Each person will be able to decide for themselves the timing of when they use one currency or another.
For example, let’s say you are a businessman in China, using the yuan. The yuan is basically linked to the dollar. The Chinese government can’t easily use a gold standard for the yuan today, because the extreme violence of the exchange rate between gold and the dollar would cause all sorts of commercial difficulties. However, at some point, people may decide, during the potential long demise of the dollar, that enough is enough. They aren’t going to get paid in increasingly worthless dollars (or yuan pegged to the dollar) anymore, they will demand payment in a gold-linked currency which was perhaps introduced earlier and has been circulating alongside in a minor way. So you see, if you have two currencies available, people can decide, based on their own personal circumstances, which one is best for them.
Another good element of the “multi-currency” idea is that it allows the gold standard advocates a little time to practice in real-world situations. People sense that the gold standard advocates are a little shy on technical knowledge, so they need some practice. Get a bunch of systems up and running, and let people work out the problems.
The State of Utah has already taken a step to assert their Constitutional rights and allow a parallel currency based on gold. Surprisingly, I think this will have less pushback from the Feds than you might think. They will probably look at it as a sort of odd curiosity, like the many “local currencies” already in place today. However, as you say, it is important that people can trade in these currencies without regulations, fees or taxes.
I am hearing a lot of positive interest in this sort of “multi-currency” approach, even from Keynesian types.
What economic trends are likely to dominate the global economy over the next few years?
Nathan: I see the present period as the final failure of Keynesianism, which grew out of the last economic crisis, the Great Depression. There’s a sort of grand logic there. We can see that governments are pushing deficit spending to a point that has never been seen outside of wartime. Central banks have adopted “zero percent rates” and now “quantitative easing” for the first time ever. It’s not working. Actually, it’s making new problems. Sovereign governments are pushing themselves into default before our eyes. Currencies everywhere are losing value, as a consequence of these “easy money” policies, and still the central banks are pushing for more. The Bank of England just implemented a new round of “quantitative easing,” the Bank of Japan is back after kicking the habit for several years, and now the Fed is making noises about a new asset-purchasing program centered on mortgage securities. I don’t know if we will end up with hyperinflation, but I think we will at least get to the point where there is widespread fear of hyperinflation, which would create the political consensus to stop what we are doing. There is no such fear today.
What are the implications of these trends for savers and investors?
Nathan: When I wrote my book, mostly in 2000, I didn’t really have any expectations that we would have a “bull market in gold” which is really a period of currency depreciation. It wasn’t supposed to be about that. What I am saying is, I am not in the business of selling gold-related products, or the kind of doomy scenarios that often accompany sales of gold-related products. However, I have to say that my understanding of gold’s role among asset classes has proved very beneficial over the past few years. At some point, I will be happy to own more stocks and bonds again, when conditions are in their favor.
In a currency depreciation event, gold tends to beat all other asset classes, such as bonds, stocks and real estate (at least, unlevered real estate). The reason for this is simple. Gold’s value doesn’t change much. However, a currency depreciation event tends to be an economic negative, so the value of assets linked to the economy or currency, which is basically all of them, tend to lose value. In broad terms, I can say with a high degree of confidence that gold will outperform other asset classes until the macro conditions change such that the currency depreciation trend comes to an end. This currency depreciation trend is already about 10 years old, and I don’t think it will end until central banks become very hawkish, or perhaps they transition to a gold standard system. By “very hawkish” I mean a Fed funds rate that is dramatically positive in “real” terms. Like about 5% positive, compared to the government’s official CPI. Since we are around a 3% official CPI today, that would be something like an 8% Fed funds rate. However, when that time comes, we might have an official CPI of something like 15%. So, it would be more like a 20% Fed funds rate. You can see that we are nowhere near that today. So I expect gold bullion to outperform other asset classes for several more years at least.
Ever since the outbreak of our current financial problems in 2007, debate has raged between “inflationists” and “deflationists” as to whether or not rising prices or falling prices will predominate in the US economy. With M2 money supply now surging, banks starting to lend again, and producer and consumer prices ticking higher, do you think the inflationists have been proved right?
Nathan: These terms are confusing. If you use different terms, things immediately become obvious. The “inflationists” are basically saying that currencies are declining in value. We can see that in their exchange rate with gold, and also with other commodities. The “deflationists” are basically saying that there’s a recession. Maybe, on top of that, we are in an extended period of credit contraction, or “deleveraging” as some say. I would agree with that too. The reason that we have such easy monetary policy today, which is causing the currency decline, is the fact that we have a recession and probably a secular credit contraction. So I don’t see any contradictions there.
Nevertheless, it is quite unnerving to see how far the currency has been devalued, without much effect on wages.
People have made comparisons between post-1989 Japan and the US economy of today. Are there many similarities, or is this a flawed comparison?
Nathan: You may not know this, but I used to be a Japan macro analyst, and lived there for a number of years in the 1990s, when I studied the economy closely. I used to write a lot about Japan maybe ten years ago.
So, I think that a lot of the comparisons with Japan are flawed. I don’t think most people have any idea what has been happening in Japan over the past 20 years. For example, in 1992, the government put a 90% tax rate on short-term (under two years) capital gains on property. I think the long-term rate was 50%. These rates stayed until 1998. Another thing that happened is that property tax revenues about doubled, while official property prices fell about 80%. If you do the math, that means the effective property tax, as a percentage of property value, went up by about a factor of eight. Put those two together. Do you think that might have some sort of effect on property values? The Keynesian economists say that the “lesson they learned from Japan” is that they should adopt a more aggressive monetary policy sooner. These people are dopes.
In the 1990s, Japan had genuine monetary deflation. The currency was rising. It was about 80,000 yen per ounce of gold in the mid-1980s, and then rose to about 28,000 yen per ounce of gold in 2000. That is a huge currency rise, almost a tripling of currency value, and very deflationary. Yen prices of commodities and so forth reflected this rise. Of course this is the exact opposite of what we have had in the US over the past 10 years.
So, I would say that the details of both situations have been very different. However, there has been a common thread of political incompetence. Japan’s government has generally tried to maintain the “status quo” via government deficit spending. It is similar to what we see in the US Nobody is fixing the underlying problems. Instead, they are making them worse. So, I would definitely say that we could have a 20-plus year period of difficulty for the US. We have already had 11 years! Japan didn’t have a government debt problem when their recession started in 1990. However, at this point, I would say that the difficulties in Japan are not likely to end until the government debt issue is resolved. This will probably be some form of default. It might mean hyperinflation. In the US, we also didn’t start with a government debt problem, but we have one now. I sense that we also will not have an end to our difficulties until the government debt problem is resolved, possibly through default but more likely via what amounts to a major currency devaluation.
Do you have any long-term price targets for gold and silver?
Nathan: I think we will get to a point at which there is widespread concern about the decline of the value of the dollar as represented by the gold price in dollars. I would guess this is around $7,000 or so. Could be $12,000. At that point, we might get a political consensus of “this must stop immediately.” That might be the end of the “gold bull market” or dollar devaluation period. On the other hand, we might get to that point, but the government will be so reliant upon printing press finance that it will feel unable to stop the process. In that case, we could have any number you want to throw out there. Sometimes hyperinflations reach silly proportions. Then you get the ten billion dollar bills and so forth. But, often it doesn’t go so far as that. In the 1980s, the Mexican peso went from 12/dollar to around 2,500. That’s about a 200:1 devaluation. Since we began this around $350/oz., a similar devaluation would take us to about $70,000 per ounce of gold. It is mostly a question of politics.
Do you expect to see commodity prices generally supported by central banks’ money printing efforts?
Nathan: I think the rise in commodity prices over the last ten years can be 100% explained by central banks’ policies and the consequent effects on currency value. Around 2005-2008, when emerging markets were really hot, you could see some effects of industrial demand on the price of copper, steel or crude oil. However, economies mostly stink today so there really isn’t the same kind of industrial demand. Despite “peak oil,” which I think is indeed happening, the slack demand caused by the recession since 2008 has made any supply issues somewhat irrelevant for the time being. So, it’s really just another currency devaluation story for now.
What should people be looking to do in order to best face the economic headwinds that are likely to confront them in the coming years?
Nathan: Americans have never had a strong inflation/hyperinflation event so they don’t really know how to deal with it very well. They have a good picture of a 1930’s style recession. They remember the 1970s, but mostly as a time of sex, drugs, rock and roll, and rising house prices. There were a lot of economic difficulties but it wasn’t so bad for the typical family.
Even trained economists in the US claim today that inflation and unemployment cannot coexist. Latin Americans think these people are idiots.
In terms of investments, I would definitely have at least 20% of your portfolio in gold bullion. I mean physical coins and bars. Or maybe something like GoldMoney, which is a lot more reliable than an ETF held through a brokerage account. Personally, I think more like 50% is appropriate but most people aren’t ready for that sort of thing. Bonds can become worthless, and stocks don’t do much better. Just make your “portfolio allocation” and leave it alone. It will be an incredible time for speculators, but most people don’t have enough background to do that well.
The typical recession advice is valid. Keep your expenses low. The present system still exists for now, so it is OK to continue to play that game, such as improving your professional credentials and so forth. However, I would be mentally prepared to do something that is not part of the “present system.” For example, if you have a typical office job, you might want to at least limber up mentally for a switch to something else if the present system begins to disintegrate as it did in the collapse of the Soviet system in the 1990s. Dmitriy Orlov has written a lot of insightful things about what happens to people in those situations. Some middle-aged men in management positions just sit down and drink themselves to death when their office jobs disappear. Others might become a local merchant in kerosene and potatoes on the black market. The most ambitious might try to accumulate industrial assets that are being abandoned, and a few years later they become known as oligarchs.
Are my Soviet comparisons are silly? I recently had the pleasure of meeting Judy Shelton, who is known for writing a book called Money Meltdown. However, she was something of a Kremlinologist in the late 1980s, and was one of the few who predicted that the Soviet Union would collapse. She based this prediction on the observation that the central government had begun to fund itself with the printing press.
In general, a proactive and entrepreneurial approach might be good. Economic dislocations are just not that uncommon. What do you think it was like in Japan in 1951? In Germany in 1919? Russia in 1994? Peru in 1985? China in 1936? These things that “never happen” in fact happen all the time.
Orlov says that Russians were surprised when Boris Yeltsin first used the term “former Soviet Union,” or what we abbreviate as “FSU.” That was when Soviet Republics like Ukraine broke off and became separate countries. Most of Ukraine became part of the Russian empire in 1774. Texas was an independent republic until it joined the United States in 1845. Maybe, before this is over, Texas will become an independent republic again. We could become the “former United States,” or FUS. In other words, we could be F-ed.
I don’t know if that will happen. But, it is the sort of thing that happens in these times of crisis. So, I wouldn’t insist that it won’t happen.
