‘The US needs a new economic theory — Gonoism’

Gideon Gono is the governor of the Reserve Bank of Zimbabwe. His solution to economic problems of Zimbabwe has been very simple. He just prints more and more Zimbabwean dollars. Recently, Gono decided to introduce a new Z$100 trillion note — yes, you read it right, that’s trillion — which is worth about £20 in the black market. The country, unsurprisingly, has astonishing inflation — of 230 million percent!

The United States is also going that way by printing and throwing dollars at all its problems, says Bill Bonner, founder and president of Agora Publishing and the principal author of a well-respected financial column called The Daily Reckoning. “(John Maynard) Keynes’ theory is to save in good times, to spend in bad times. But they never do that. They forgot to save. (Milton) Friedman’s theory is to keep cutting interest rates, but you can’t cut interest rates below zero. They are nearly there. They are out of ammunition. They don’t have any savings and they can’t cut interest rates.  So what they need is Gonoism,” said Bonner, who was recently in India visiting Equitymaster.com, the investment consultancy where he is a director. Bonner speaks to DNA on the coming financial shocks:

To what extent was the low interest rate regime run by Alan Greenspan responsible for the current financial crisis?
Alan Greenspan and George Bush panicked after 9/11. They created the biggest pool of liquidity the world had ever seen. Greenspan’s Federal Reserve brought rates down to 1% and left them there for more than a year. This led to the US government going from a surplus of $250 billion left in the Clinton years to a deficit of around $350 billion. This was the biggest burst of fiscal and monetary stimulation the world had ever seen.

And what did it do? What it did was fundamentally undermine the credit of the US consumer because now he was using his house as an ATM machine.

House prices doubled during that period. The consumer then used his house to get money —- to get money to spend, because his income did not go up. He needed the money. He wanted to participate in this great boom. And he did.

So he took out equity. Taking out equity means you are borrowing against (future) house price increase. But this house price increase was only a part of the fiction of the market because you are not selling your house. In 2006, $200 billion per quarter was withdrawn as home equity. $200 billion per quarter means $800 billion per year, which means that the American consumer was making more on his house than he was making from his job. And he was spending like crazy. It was free money. Of course the market for housing collapsed between 2006 and 2007. What that meant was that $800 billion moved out from the spending economy. The US economy is 71% consumer economy. So, in the end, the consumer did not have any money.

What could happen then? The consumer economy started to go down.

How do you see the impact of the US slowdown on China?
When the financial industry was ruining itself it was also ruining the whole US economy. The Chinese economy has also been ruined. Both these economies depend upon the system of international payments where Americans buy, Americans spend, Chinese lend and Chinese create.

The world economy has been globalised and the world market system has become so pernicious that the US is able to send money to pay for goods made in China. Print up money, send it to China and then the Chinese kept the dollars in there vaults as a reserve currency. So the more Americans shopped, the more Chinese built up reserves. What did they do with the dollar reserves? They bought US treasury bonds. They lent the money back to the US, giving Americans more credit. But you
cannot keep doing that forever.

You got to balance these things out but in the current system it is never balanced out. Chinese have these mountains of dollars and think they are rich. Americans bought gadgets and stuff from China and thought they were rich. Neither group was rich. It was all an illusion and we are now seeing that illusion being destroyed.

The formula that the US is adopting right now is printing more and more dollars and throwing it at the problems that are cropping up.
It is mad in a sense it’s obvious that the real problem is that Americans spent too much money. They are too far in debt. So what’s the cure? Lend them more money. Obviously it can’t work.

It is a part of the theory. They have got only two theories. They have got Keynesianism or they have got Friedmanism. Keynes tells them to spend more money in the public sector and Friedman tells them make money more easily available through lower interest rates. And they have no other theory. It is stupid. but that is the whole thing they have. There is one other theory and I just wrote about it. It’s Gonoism. Gideon Gono is the head of the Central Bank of Zimbabwe. Gono has another solution: just print money. You keep putting big zeroes after the number. No wonder in Zimbabwe they have an inflation rate of 230 million percent. Their whole economy has fallen apart. Gono should be given the Nobel Prize because he has shown that there are worse things than a recession.

How much impact would the stimulus have?
It is hard to say. You can do the numbers. The consumer was not earning more money. So he was taking out money from his house. He was taking out $200 billion per quarter at its peak or $800 billion a year. In addition, he was dis-saving. So the savings rate went to zero. But now he is saving. He has no other choice. He has to pay off his debt and so the savings
rate has gone up.

But when you save, consumption goes down. This stimulus has to replace that consumption. So how much do they have to spend to replace that consumption? With the savings rate at 0%, they need to replace $800 billion to replace that consumption. They also need to take the savings into account. The US savings rate before 1990 was 10% of GDP. That 10% of GDP now is $1.3 trillion. Add that up, and they have to replace $2.1 trillion dollars of consumption per year. They say that with the multiplier effect they need to spend $750 billion to offset that decline. Is that true? Who knows? Who knows how that multiplier works? Nobody is sure, it is all theory.

Then the question is where would they get this $750 billion, if it is right? What about the bailout? They would have to borrow that money too. They have to borrow $2 trillion out of world savings — that is, assuming everything goes right. It’s a lot of money. In fact it is more than world savings. Where is the money going to come from? And that, to me, is the interesting part.

They’ll print the money…
Yeah, they will have to print it. And that’s called Gonoism. Keynes’ theory is to save in good times, to spend in bad times. But Americans never do that. They forgot to save. Friedman’s theory is to keep cutting interest rates, but you can’t cut interest rates below zero. They are nearly there. They are out of ammunition. They don’t have any savings and they can’t cut interest rates. So what they need is Gonoism.

For the first time in world history we have a situation where the reserve currency is fundamentally just paper and the people running that paper are broke and they have the power to create as much paper as they want; to my mind, sooner or later they are going to make a big mistake.

If the (Ben) Bernanke Fed could engineer —- I don’t think they can, though —- (to keep) inflation at 15-20%, we are talking of a fairly modest inflation. The world doesn’t fall apart with an inflation of 20%. But the world financial system will at 20% inflation in the US. Because all those bonds, which are now being sold at the lowest yields in history, all those bonds that investors have bought as a safe investment, will fall and lose their value. A college like Harvard (Business School) has an endowment fund with billions of dollars. So what did they do? They put their money in equity. Now they have lost several billion dollars because of the stock market crash. So what did they do? They don’t walk, they run. Run to treasuries. And that to me is the next big bubble to blow up. Even at 10% inflation all those bonds will be worthless. At 10% inflation you got a bond paying 2% return, you are losing 8% per year. At 20%, inflation all those bonds get wiped out —- assuming that they can do it (manage inflation at 20%). I think they want it to happen, they are aiming for that. But is
central banking that precise a science? I don’t think so.

At some point people may not continue to want to hold onto the US dollar as a reserve currency…
Right now everybody is turning to US dollar credit as safety and that is the biggest mistake made by investors of all times. The question is when and how does that show up? When that mistake shows up, a number of things happen, all at once, and they will happen ferociously. The Chinese will decide that they have been fools. They have got a trillion dollars. They will realise the dollar may not be worth half or a quarter or even 10% of what it is worth today five years from now. What will they do? They will dump them quickly but that will destroy the value of the dollar. So they need to use these dollars. And they have to use it fast. They have got to buy stuff with it. They have to buy assets in the US as fast as they can.

The other thing that will happen, I think, we will see a huge spike in prices for oil, gold, minerals, real things of all sorts, farmland even. Things priced in dollars in global terms will go up. There will also be a big spike up in US prices and all of a sudden US will have to pay more for oil and the domestic inflation in the US will go up. Will it go to 2%, 20% or 200%? All those things will happen about the same time in a way that will shock people and in a way that people will not know what to make of it. They will be scared. And they will not this time run to the safety of the US dollar. They will run away from the US dollar and US treasury, which will lead to the collapse of the treasury bond market. When, I don’t know. You can’t predict these things, we haven’t been here before.

But then why is everybody buying US treasuries now?
There is more demand for US treasury than anytime before. It is a mistake that people are going to pay for. China is going to pay for it too. They have too much faith in the US dollar. But their economy is tied to it. In the US, they think Chinese are prisoners. They think they got to give them this money. If they don’t give us this money, we won’t spend. I think it’s crazy. There are bubbles everywhere. And the last bubble is the US dollar and the US treasury bond.