‘And gold will be the last man standing’

“You see, dear reader, we do not believe in the perfectibility of man and his institutions. Instead, we see material progress. Man’s machines and inventions get better. But man himself? He is what he always has been… prey to sin and folly… prone to error… and ready for a good time,” wrote Bill Bonner in a recent column. Bonner is the founder and president of Agora Publishing and the principal author of the daily financial column The Daily Reckoning. He is the co-author of The New York Times bestsellers Mobs, Messiahs, and Markets: Surviving the Public Spectacle in Finance and Politics, Financial Reckoning Day Fallout: Surviving Today’s Global Depression and The New Empire of Debt: The Rise and Fall of an Epic Financial Bubble.
In this interview, Bonner speaks with DNA Money’s Vivek Kaul and
Sachin Mampatta on fiscal deficits, central banks, gonoism, and that thing called gold.

How has the world changed in the year and a half since we last met?
The real crisis hit in September of 2008. In November, it was still going down. And the stock markets went down till March 9, 2009. And how has the world changed? Well it hasn’t changed as much as I thought it would because there hasn’t been any resolution of the crisis situation. The liquidity crisis was caused by the huge build-up of debt in the private sector, mostly in America and Britain. And that debt has not been resolved. There is more debt now than there was then, but now it is government debt. The government has added a lot to that debt.

Any surprises?
The surprise for me has been the slowness with which this crisis is unfolding. The mistake people make now is to think that it is over, that the crisis was a liquidity crisis, which was cured, solved by the governments that introduced a lot of liquidity, beginning at the end of 2008. The problem was not liquidity at all, wasn’t the fact that you couldn’t borrow money. You couldn’t borrow money because people owed too much money. And the debt is still there. The problem is still there, hasn’t been solved. It was misidentified, and mistreated. So that rather than do things or allow the crisis to continue to express itself fully, authorities all over the world reacted in the same way, that is, by making more credit available to the market, which already had too much credit. And the effect of this was to delay and to retard the development of this crisis. And we are waiting to see what happens next.

What about the way the stock markets have rebounded?
One thing that is surprising is that the rebound in the stock market has been so strong. Not in terms of level. If you look at the rebound that happened in 1929, for example, stocks went up about the same amount... they went up about 50%. Now they are up about 70%, which is a bit stronger. But they have been up for much longer. The bounce after 1929 was for about five months and this has gone for a year now, which is extraordinary. And it’s also true that we have never seen so much money and credit applied to a rescue effort.

What about the rescue efforts the world over?
Tim Geithner (the US treasury secretary) said, we are just going to do what works. We are going to try stuff and see what works. And if it works, then we are going to go with it. But you can’t deal with the economy that way. You need a theory. Economies take too long, much too long, years, to react, and when they do, you don’t know why they did what they did anyway. So really what they are doing is following a theory. The theory they are following is the same theory they have been following for the last 50 years, and it is fundamentally wrong. You can’t really increase consumer spending forever, you can increase it for a while and you can encourage it for a while and then you end up with these people in the private sector as you have today, people who have too much debt. You can’t really expect Americans to increase consumer spending now. Their real incomes are going down. They have been going down for a long time. There is no prospect of their incomes going up because they have 10% employment and among men between the age of 30 and 55 or so, the effective unemployment rate is really 20% because men have been particularly hard hit. The sectors like manufacturing and construction are male-dominated and those are the ones that have been hit hard. So we have a situation in which the idea of increasing consumption in the US and Britain is totally ridiculous.

Yet it is the idea behind the theory now being used  by the central banks in the US and in Britain. That theory was also tried very well in Japan with no decent results whatsoever and yet nothing has been learnt. Same mistakes are being made. Nobody knows what will happen but we can assume more or less correctly same results will happen as happened in Japan when they increased the support to the market. What they got was a zombie market. They got banks which needed to go broke, but did not because government supported them. And they got companies that needed to go broke, needed to collapse, needed to fail, needed to default. None of that happened because the Japanese were supporting them with rates so low that you almost couldn’t go bankrupt. You couldn’t go bankrupt as you can borrow money at 0%, you can effectively do that for a long time. And that has happened in Japan and they have had 20 years of this kind of zombie growth. To me that’s what happens when you apply the wrong theory to a certain set of circumstances similar to Japanese circumstances.

The last time you said the US had a new economic theory and it was Gonoism. Are they practicing it?
Are they? Not quite. Not yet. Gonoism refers to the central banker Gideon Gono of Zimbabwe. His solution to economic problems of Zimbabwe was to just print more and more Zimbabwean dollars. And he wasn’t the first to do that. It’s been done several times, but very, very rarely in advanced economies. In fact, the case people mostly look at is the case of Germany. And there was this guy named called Havenstein, head of the central bank (Rudolf E A Havenstein was the president of the Reichsbank or the German central bank, during the hyperinflation of 1921-1923). He was a smart guy trying his best but couldn’t understand why the economy was not responding. Germany back then had the same situation that is there now in the US and Japan, which was they had falling prices. He said, well, prices are falling, I better print up some money. So he did print up some money. He printed up a lot of money. And then the economy kept collapsing and so he printed up more money. And it was an honest smart reaction but he misunderstood what was really going on because when you have an economy which is in deflation, which is fundamentally deflating, like the US is, people don’t want to spend money. So the velocity of money declines very, very rapidly and you get to a situation the government can put in more monetary reserves but you don’t get higher prices. So they say, well, no inflation problem, so we put in more monetary reserves. They continue doing that.

And what happens?
Eventually what happens is, all of a sudden, something goes wrong, like bond prices go up, people become concerned, inflation starts to edge up, people think, ‘Gee, I got to trade my money for something real like gold, oil, sugar, whatever it is’. And all of a sudden, prices go up and they got up like that (makes the gesture of an airplane taking off).

And you reach a point apparently where everybody gets scared, the velocity of money gets zooming up and all of a sudden, everybody wants to get rid of money and that’s how you get hyperinflation. The central banks all think that they can control inflation. They are talking now to increase the target inflation. The target has been 2% worldwide. And they are talking about increasing it to 4%. But they can’t really control inflation that carefully. Inflation rates have been coming down, down, down. They are not coming down because the government controlled them. They are coming down because we are in a period of this credit cycle, which has been going on since 1983; interest rates have been coming down. It is fundamentally a deflationary world. And these guys don’t understand that. They don’t know what is going on. They think they control things, but they don’t. It’s an illusion. So they think they can get the inflation rate from 2% to 4%. Well, how come the inflation rate now is not 2%? They really can’t control it. The Japanese proved that they couldn’t control it because now, after all this monetary inflation put in Japan, it has higher deflation than ever. If I were guessing, you probably got a couple of more years before inflation turns into price inflation. Maybe ten years, I don’t know. I think the easy thing to predict now is that we will have inflation. And because it is easy, it’s probably not right. And my guess is that it will be a while before we get a consumer price inflation.

“The Greek story is a universal tale… It will soon be played by the UK…and then it will be the US,” you wrote in a recent column. Why and how?
Sovereign defaults are the way of the future. It is a very interesting situation. Nobody has ever been here before but Greece and California, New Jersey, other American states, and the smaller European countries are all in the same situation where they either can’t print money or their debts are not in the money they control. So when they get in a pinch, it’s like a big corporation getting in a pinch. They either have to cut expenses or they default. We are going to see a default in the US too at the state level. But what about the bigger countries in Europe like Spain, Italy? And the US? And Britain? Britain’s debts are in its own money, in pounds. A big portion of it is in foreign hands. They are not owed to the English people. They are owed to foreigners. And America? Same situation, basically. What happens when those countries get in a bind like Greece? Do they cut back on public expenses, government expenses, so that they can continue to sell their bonds? Maybe they will. We don’t know because we have never been there before. But I think there is a fair chance that they don’t. There is a fair chance that under political pressure, especially in the US, which is not capable of turning around. You might get a situation where they might say, well we don’t have an inflation problem, we do control the money. Why don’t we do more quantitative easing? I would guess that’s what they are going to do because in February, the US had its biggest deficit ever of $221 billion. You annualise that over the year — that’s over $2.5 trillion. You take all the savings of all the Americans you wouldn’t come up with that much money. So it has to come from somewhere else.

In fact, I remember reading somewhere that the total world savings come to around $2 trillion…
Oh. I thought it would be more than that. So what has to happen is either they cut the budget or they use quantitative easing. My guess is that they will use quantitative easing because as far as anybody can tell it doesn’t do any harm.

So basically they’ll go back to Gonoism?
I think so. Eventually. In order for the US budget to get within limits of  the Maastricht Agreement, which holds the European Union together — US is not covered by the agreement — but  to get the fiscal deficit down to 3% of GDP, it would need to take a trillion dollars out of the budget. That’s a huge amount of money. What can you do? Then you have to cut down on your military operations, you have to cut back on Medicare, and all that kind of stuff. Boy, that’s not going to go down well with the voters.
You wrote in a recent column that “We believe the “expansion” reported in the GDP figures is mostly counterfeit.”

There is a guy named John Williams who runs this service called Shadow Government Statistics.  He shows that numbers are not really counterfeit — they just calculate things incorrectly. We have seen that in the unemployment numbers. They have changed the way they calculate employment numbers. If employment had been calculated today the way it was in the 1930s, you would see the same unemployment that we had in the 1930s. But we have changed the way this is done so that people fall of the list after a few months of being unemployed. My claim is a little bit different. My claim is that they are fraudulent in theory. The GDP growth shows activity, not prosperity. It doesn’t lead to prosperity because the government spending money is not the same as private sector spending money. Private sector spending money comes through buying things that people want, by creating things that people want. But when the government does it, it does it by military contracts, it buys more planes, it buys more uniforms, does all that. And by giveaway programmes. So you have tax credits for this, you have spending for that. Things like that. They contribute to short-term spending but they don’t create any real economic prosperity.

Can you give an example?
Japan proved this. They did it by building roads, bridges and mostly infrastructure projects. You would see, well, doesn’t that contribute to prosperity? My answer is no. They have built roads to nowhere, roads which have no traffic. They have channelled rivers. They have bridges which go nowhere. Those things are not real contributors to prosperity. They look like prosperity because they give people jobs. And they show people activity and so on. And they show up in GDP and that’s what I mean by GDP being fraudulent. That’s why I mean GDP shows something but it doesn’t really measure what people think it measures. It measures activity but it doesn’t measure prosperity. That’s why the Soviet Union had high GDP. There numbers during the seventies led to major American economists commenting that the growth figures were very good. They even said that the Soviet economy would overtake the US economy. But the missiles and all those things that the Soviets were building, they don’t contribute to prosperity.  The only way you can have prosperity is in a free market. Only in a free market are people doing with their money what they want done. Nobody wants a bridge that doesn’t go anywhere. Only the government would do such a thing.

So does it make sense then to hold onto physical assets?
Not in the short run. I don’t believe in speculating, so I’d say I want to hold gold now and practically all I want to hold is gold. I don’t trust paper money. Stocks are overvalued. Commodities are going to go down the tube when China blows up, which it will. So what does that leave? Just gold, for this period and only this period, in which we are waiting for this calamity to happen. We are waiting for the destruction of the monetary system that was set up in 1971. Until that is destroyed, wiped away, and something else is put in its place, gold waits.  Gold is the only good thing to buy. My guess is that there will be some big crisis, and catastrophe, blow-ups and all kinds of things. And gold will be the last man standing, through that and end of that thing. When that happens you want to get rid of gold because then gold is just a protection against this kind of stuff. There are only a few times in history, when you need gold and you want gold, this is one of those times.

Would you say the big Western Economies and Japan are insolvent?
The US is insolvent. Japan I don’t know. Japan has huge net assets in its reserves and so on. The US is bankrupt. If the US had to subject its balance sheet to GAAP (Generally Accepted Accounting Principles) accounting standards you would see it has a deficit of something like $54 trillion because GAAP forces you to recognise currently future obligations. And the entire wealth of the American households is $52trillion. So even if you took all the wealth of all the Americans the government would be broke.

You wrote recently that the China story is largely a stimulus story too. That being the case, do you see the rapid growth rates in China continuing? 
Not possible. We are going to see either one of two things. One is that China is going to blow up and fantastically blow up. And all of a sudden Chinese companies go broke, the banks are broke. China is a central planning story. They are building cities that don’t have any people in them. That is not a good idea. Some bank in China has bonds as debt for those cities. It’s impossible that debt is good. So far the Chinese are supporting, the banks are lending. But keep in mind that there is no such thing like the credit boom like the one that China has had — where they doubled bank lending last year (and it was) not being followed by a credit bust. We are seeing empty cities, empty factories, empty office buildings there. So they are probably going to blow up. And the blow-up could take a form like the 2008 blow-up on the Wall Street. Or it could take the form of a slowdown. Who knows?

People don’t even know who runs China. It is run by central planners; we don’t even know who they are. Nobody knows. A slowdown in China to say 6% growth will be a catastrophe. It is catastrophe for Brazil, because Brazil sells stuff to China. It’s a chop for Russia for all the material producers that are out there digging, drilling, flapping, hopping and they are doing that to provide stuff for China’s 10% growth. If China’s growth goes down to 6%, there would be a whole worldwide sell-off  led by the commodities and followed into the emerging markets. India’s stock market will go down a lot because it depends on foreign investment. The funny situation is that the economy does not depend in exports, the stock market does.

What about all the US debt that China holds?
It’s a big bubble. Eventually — I don’t know when — the US debt will become hard to finance like Greece. Eventually it will become hard to make somebody lend enough money that will cover the US deficit. Then US will be in Greece’s situation, where they will have to say, look, we either cut expenses or we fund that debt ourselves by printing money. If we fund it ourselves, then all the dollar holders all over the world, including China are going to say “Wow, this does not look good.” I have got $2.4 trillion and these Americans are printing more money. In that case China will then sell its debt. But remember all this takes place in the context of a global meltdown. China is melting down. When China melts down then US melts down too but it melts down in a funny way. Because when China melts down, people go for safety. Where do they go? They go to US bonds. In fact, I would guess is that what we are going to see is a meltdown, maybe slow, maybe fast, maybe catastrophic, maybe gentle, we don’t know. And that meltdown will lead people back to the US dollar, back to US bonds for safety, which will shore up US for a while. The US will continue to borrow tremendous amount of money and then eventually it will be hard for them to borrow money too. Interest rates will go up, dollar will go down, and China will dump some of its US bonds and so on. I don’t know how fast all this will happen though it is all there waiting to happen.

So right now China is probably in a Catch-22 situation?
Yes. They have got all the stuff and they can’t get rid of it. (Laughs)