Submitted by Tyler Durden: A selected excerpt by David Stockman from his just released interview with Alex Daley of Casey Research:This market isn't real. The two percent on the ten-year, the ninety basis points on the five-year, thirty basis points on a one-year – those are medicated, pegged rates created by the Fed and which fast-money traders trade against as long as they are confident the Fed can keep the whole market rigged. Nobody in their right mind wants to own the ten-year bond at a two percent interest rate. But they're doing it because they can borrow overnight money for free, ten basis points, put it on repo, collect 190 basis points a spread, and laugh all the way to the bank. And they will keep laughing all the way to the bank on Wall Street until they lose confidence in the Fed's ability to keep the yield curve pegged where it is today. If the bond ever starts falling in price, they unwind the carry trade. Then you get a message, "Do not pass go." Sell your bonds, unwind your overnight debt, your repo positions. And the system then begins to contract... The Fed has destroyed the money market. It has destroyed the capital markets.
Full Transcript:
They have something that you can see on the screen called an "interest rate." That isn't a market price of money or a market price of five-year debt capital. That is an administered price that the Fed has set and that every trader watches by the minute to make sure that he's still in a positive spread. And you can't have capitalism if the capital markets are dead, if the capital markets are simply a branch office – branch casino – of the central bank. That's essentially what we have today.
From Casey Research
The New Economic Collapse Video: It makes uncomfortable but urgent viewing.
When Casey Research Chief Technology Investment Analyst Alex Daley
met former Reagan Budget Director David Stockman to talk about the
economy and where he sees it leading taxpayers investors and savers in
the near future, he got some very intriguing insights from a man who
served right at the heart of the US federal government.
True, some if it makes for uncomfortable watching, but the message
is critical if you want to keep your assets safe in what David calls
calls "the great unwind."
Watch the video and secure your money.
Full Transcript:
Interviewed by Alex Daley, Chief Technology Investment Strategist, Casey Research
Alex Daley: Hello. I'm Alex Daley. Welcome to
another edition of Conversations with Casey. Today our guest is former
Reagan Budget Director and Congressman David Stockman. Welcome to the
show, David.
David Stockman: Glad to be here.
Alex: So we're here in Florida talking at the Recovery Reality Check Casey Summit. What do you think: is the United States economy on the road to recovery?
David: I don't think we are at the beginning of the
recovery. I think we are at the end of a disastrous debt supercycle
that has gone on for the last thirty or forty years, really. It started
when Nixon defaulted on our obligations under Bretton Woods and closed
the gold window. Incrementally, year after year since then, we have
been going in a direction of extremely unsound money, of massive
borrowing in both the private and the public sector. We now have an
economy that is saturated with debt: $54 trillion or $53 trillion – 3.5
times the GDP – way off the charts from where it was for a hundred
years prior to the beginning of this. The idea that somehow all of that
debt is irrelevant, as the Keynesians would tell us, is fundamentally
wrong – and the reason why the economy can't get up off the mat.
We're doing all the wrong things. We're adding to the problem, not
subtracting. We are not allowing the debt to be worked down and
liquidated. We're not asking people to save more and consume less,
which is what we really need to do. And so therefore I think policy is
just making it worse, and any day now we will have another recurrence
of the kind of economic crisis we had a few years ago.
Alex: You paint a very stark picture, but if people
just stop spending, start saving, won't companies like Apple see their
earnings hurt? Won't the stock market then start to tumble, people's
net worth fall? Isn't that a negative cycle that feeds on itself?
David: Sure it does, but you can't live beyond your
means because it's pleasant. It's not sustainable. Clearly the level
of debt that we have is not sustainable. We have a whole generation –
the Baby Boom – that's about ready to retire, and they have no
retirement savings. We have a federal government that is bankrupt,
literally. Its [debt is] $16 trillion and growing by a trillion a year.
Something's going to give. We can't pay for all these entitlements.
There won't be the revenue generation in the economy to do it.
So as a result of that, we are deluding ourselves if we think we can
just continue to spend. Look at the GDP that came out in the first
quarter of this year. It was only 2.2%. Most of it was personal
consumption expenditure, and half of that was due to a drawdown of the
savings rate, not because the economy was earning more income or
generating more real output. It was because of a drawdown of savings.
That is exactly the wrong way to go – an indication of how severe the
crisis is going to be.
I'm not saying the economy should stop spending entirely. I'm only
saying you can't save 3% of GDP and spend 97% if you are going to get
out of this fix. As the savings rate goes up both in the public sector
(which means reduction of spending and the deficit) and the household
sector (to seriously reduce debt burden, which has not really happened)
we are going to, on the margin, spend less, save more. It will slow
down the economy. It will undermine profits, I agree. But profits today
are way overstated. They're based on a debt-bloated economy that isn't
sustainable.
Alex: So we can only live beyond our means for so long, as any family knows.
David: Yes.
Alex: Now, the government can reduce its expenses at
any time by simply reducing spending, and it can reduce debt if it
brings in more tax revenue. That's austerity – I think that's how they
refer to it. But won't austerity cause massive joblessness? Won't there
be millions more people in this country not receiving a paycheck?
David: Yes, but the critique, the clamoring and
clattering that you hear from the Keynesians (or even mainstream media,
which is pretty clueless economically) that austerity is bad forgets
the fact that austerity isn't an elective course. Austerity is
something that happens to you when you're broke. And yes, it is painful
and spending will go down and unemployment will go up and incomes will
be impaired, but that is a consequence of the excess debt creation
that we've had for the last thirty years. So austerity is what happens
when you break the rules.
And somehow we have this debate going on. They're making a mistake.
They chose the wrong strategy. Do you think Greece chose the wrong
strategy with austerity? No. No one would lend them money. That's why
they ended up in the place they were. Do you think that Spain today is
teetering on the brink because they said, "Oh, wouldn't it be a good
idea to have austerity?" No, they had a gun to their head. They were
forced to do this because the markets would not continue to lend, and
even now their interest rate is again rising. The markets are losing
confidence, and unless the ECB prints some more money and bails them
out some more, they are going to have austerity. So the austerity upon
us is the backside of the debt supercycle we had for the past thirty
years. It's not discretionary.
Alex: Austerity hasn't been forced upon us yet. The
dollar is up, people are continuing to buy Treasuries – both nations
and banks are buying Treasuries. To all extents and purposes, people
are continuing to show massive confidence in the US government, lend it
money at extremely cheap interest rates, and letting it build up its
debt.
So you are advocating that, unlike Greece or Spain taking it to the
edge and having austerity forced on them, we should volunteer for
austerity today? Instead of just kicking the can down the road and
living high a little bit longer, until the bill collectors finally come
knocking? Why go today, why start austerity now instead of doing what
Greece did and going as long as you possibly can?
David: Because Greece is a $300 billion economy.
Tiny. A rounding error in the great scheme of things. It's – last time I
checked – about eight and a half months' worth of Walmart sales. Okay?
That's a little different than when you have the $15 trillion
heartland of the world economy, and the $11 trillion Treasury market
which is at the center of the whole global financial system buckle and
falter. That's the risk you're taking if you say, "Mañana. Kick the
can; let's just wait for something good to happen."
This market isn't real. The two percent on the ten-year, the ninety
basis points on the five-year, thirty basis points on a one-year –
those are medicated, pegged rates created by the Fed and which
fast-money traders trade against as long as they are confident the Fed
can keep the whole market rigged. Nobody in their right mind wants to
own the ten-year bond at a two percent interest rate. But they're doing
it because they can borrow overnight money for free, ten basis points,
put it on repo, collect 190 basis points a spread, and laugh all the
way to the bank. And they will keep laughing all the way to the bank on
Wall Street until they lose confidence in the Fed's ability to keep
the yield curve pegged where it is today. If the bond ever starts
falling in price, they unwind the carry trade. They unwind the repo,
because then you can't collect 190 basis points.
Then you get a message, "Do not pass go." Sell your bonds, unwind
your overnight debt, your repo positions. And the system then begins to
contract – exactly what happened in September and October of 2008.
Only, that time it was an unwind to the repo on mortgage-backed
securities and CDOs and so forth. That was a minor trial run for the
great unwind that is going to happen when the Treasury market is
finally shattered with a lack of confidence because, on the margin, no
one owns a Treasury bond: they just rent it on borrowed money. If the
price starts falling, they'll get out of that trade as fast as they got
out of toxic CDOs.
Alex: So when people run away from the US, they will run away all at once.
David: Well, if they run away from the Treasury, it
sends compounding forces of contagion through the entire financial
system. It hits next the MBS and the mortgage market. The mortgage
market then scares the hell out of people about the housing recovery,
which hasn't happened anyway. And if there isn't a housing recovery,
middle-class Main-Street confidence isn't going to recover, because it
is the only asset they have, and for 25 million households it's under
water or close to under water.
Alex: We saw something much like that in 2008. All
the markets correlated. Stocks went down. Bonds went down. Gold went
down with them. It sounds like what you're saying is that the Fed is
effectively paying bankers to stay confident in the Fed, and that the
moment that stops – either because the Fed stops paying them or
something else shakes their confidence – this all goes down in one big
house of cards?
David: Yes, I think that's right. The Fed has
destroyed the money market. It has destroyed the capital markets. They
have something that you can see on the screen called an "interest
rate." That isn't a market price of money or a market price of
five-year debt capital. That is an administered price that the Fed has
set and that every trader watches by the minute to make sure that he's
still in a positive spread. And you can't have capitalism if the
capital markets are dead, if the capital markets are simply a branch
office – branch casino – of the central bank. That's essentially what
we have today.
Alex: Last night you told our audience that if you
were elected president, the first thing you would do is quit. Or at
least demand a recount, I believe were your words, which I thought was
telling. Are you saying there are no policy changes we could make today
that would get us out of this? Or at least that wouldn't get you
assassinated?
David: Yeah, there is a paper blueprint. People who
believe in sound money and fiscal responsibility, that you create
wealth the old-fashioned way through savings and work and effort and
not simply by printing money and trading pieces of paper – there is a
plan that they could put together. One would be to put the Fed out of
business. You don't have to "end the Fed," although I like Ron Paul's
phrase. You have to get them out of discretionary, active, day-to-day
meddling in the money markets. Abolish the Open Market Committee.
The Fed has taken its balance sheet to $3 trillion. That's enough
for the next 50 years. They don't have to do a damn thing except maybe
have a discount window that floats above the market, and if things get
tight, let the interest rate go up. People who have been speculating
will be carried out on a stretcher. That's how they used to do it. It
worked prior to 1914. That's the first step: abolish the Open Market
Committee. Abolish discretionary monetary policy.
Let the Fed, if you're going to keep it – I don't even know that you
need to do that, but if you are going to keep it – be only a standby
source. As Badgett said (Walter Badgett, the great 19th-century British financial thinker): provide liquidity at a penalty rate to sound collateral.
Now, that's what J.P. Morgan did in 1907, in the great crisis of
1907, from his library. He didn't have a printing press. He didn't bail
out everybody. He didn't do what Bernanke did and say: "Stop the
presses, freeze everybody, and prop up Morgan Stanley and Goldman Sachs
and all the rest of the speculators." The interest rate, the
call-money interest rate, which was the open-market interest rate at
the time, some days went to 30, 40, 70% – and they were carrying out
the speculators left and right, liquidating margin debt, taking out the
real estate speculators. Eight or ten railroads went bankrupt within a
couple of months. The copper magnates got carried out on their
shields.
This is the only way a capital market can work, but it needs an
honest interest rate. And we have no interest rate, so therefore we
solve nothing and we have the kind of impaired, incapacitated markets
that we have today. They're very dangerous, because they're all
dependent on twelve people. It is what I call "the monetary Politburo
of the Western world," and they are just as dangerous as the Politburo
in Beijing or the Politburo of memory in Moscow.
Alex: A twelve-person Open Market Committee
determining the future of our economy by manipulating rates. Sounds
like central planning to me.
David: It is. They are monetary central planners who
are attempting to use the crude instrument of interest-rate pegging
and yield-curve manipulation and essentially buying debt that no one
else would buy, in order to keep this whole system afloat. It's Ponzi
economics. Anybody who had financial training before 1970 would
instantly recognize this as Ponzi economics. It is only because of the
last twenty years we got so inured to prosperity out of the end of a
printing press and massive incremental debt that people lost sight of
the fundamental principles of sound money, which, there's nothing
arcane about it. It's just common sense. It is not common sense to
think that 50, 60, 70% of all the debt that's being created by the
federal government can be bought by the Federal Reserve, stuffed in a
vault, and everybody can live happily ever after.
Alex: So the government has certainly put us in a
precarious position, but I don't think they alone have put America in
this position, have they? You mentioned consumer debt becoming a major
burden on the economy. How do we shed ourselves of that? I mean, the
federal government can repudiate its debts if we walk away from it. We
might see a few wars or something from that. It could inflate its way
out of it. It can tax its way out of it. But how do households get out
from under the debt burden that they have today?
David: Well, it's very tough, and they were lured
into it by bad monetary policy when Greenspan panicked in December
2000. The interest rate was 6.5%; we had an economy that was threatened
by competitors around the world. We needed high interest rates, not
low. He panicked after the dot-com crash, and as you remember in two
years they took the interest rate all the way down to 1%, and they
catalyzed an explosion of mortgage borrowing, which was crazy.
When they cut the final rate down to 1% in May, June 2003, in that
quarter – the second quarter of 2003 – the run rate of mortgage
borrowing was $5 trillion at an annual rate. That was nuts! There had
never been even a trillion-dollar annual rate of mortgage borrowing
previously. In that quarter the run rate was $5 trillion, 40% of GDP.
Why? Because the Fed took the rate down to 1%. Floating-rate product
got invented everywhere. Anybody that had a pulse was being given
mortgage loans by the brokers. The mortgage brokers didn't have any
capital or funding. They went to Wall Street. They got warehouse lines,
and the whole thing got out of control. Millions of households were
lured into taking on debt that was insane, and now we have a generation
of debt slaves.
There are 25 million households in America who couldn't move if they
wanted to, because their mortgages are under water. They cannot
generate a down payment and the 5% or 6% broker fee that you need to
move. So we've got 25 million households immobilized, paralyzed, and
worried every day about when they are going to lose property, because
of what the Fed did. It's a terrible indictment.
Alex: Mobility itself is the American dream, isn't
it? It's the ability to pick up and find work and then move and do all
that. So now we have people who are slaves to their debt. How do we get
ourselves out of this? Is this just a matter of personal financial
discipline? Is there a policy move that can happen?
David: It's policy. If we don't do something about
the Fed, if we don't drive the Bernankes and the Dudleys and the
Yellens and the rest of these lunatic money-printers out of the Federal
Reserve and get it under the control of people who have at least a
modicum of sanity, we are just going to bury everybody deeper.
It's unfortunate. The American people are as much a victim of the
Fed's massive errors as anything else. People were not prudent when
they took on debt at 100% of the peak value of their property at some
moment in 2004 and 2005. They were lured into it. But now we're stuck
with something that didn't need to happen.
Alex: The Federal Reserve was founded in 1914, and
it saw America through World War I, World War II. It saw America
through Vietnam, saw America through the biggest boom in the economic
history of the world. Yet now, today, you are calling for the
abolishment of the Fed. Wasn't the Fed here the entire time that
America was a prosperous, growing, wealthy, technology-driven nation?
What's changed?
David: The greatest period of growth in American
history was 1870-1914 – the Fed didn't exist. Right after 1870, when we
recovered from the Civil War we went back on the gold standard. It
worked pretty well. World War I was a catastrophe for the financial
system. The Fed financed it, but I don't give them any credit for that,
okay? We shouldn't have been in that war. It was a stupid thing to get
involved in. But once we got involved in it, the Fed printed money
like crazy, it facilitated borrowing, set the groundwork for the boom
of the 1920s and the collapse of the 1930s.
Even then though, we had great minds who coped with reality in a
pragmatic way in the Fed. Even Marriner Eccles wasn't all that bad. He
stood up to Truman in 1951, when Truman wanted to force the Fed to
continue to peg interest rates at 2% or 2.5% when inflation was 5%.
Then we had William McChesney Martin: brilliant, pragmatic. He wasn't
some kind of gold-standard guy in a pure sense, but a pragmatic guy who
understood that prosperity had to come out of private productivity,
out of investment, out of risk-taking, and the Fed had to be very
careful not to allow speculation to start or inflation to get ignited.
In 1958, he invented the phrase, "The job of the Fed is to take the
punchbowl away." And we had a small recession. Six months after the
recession was over he was actually raising the margin rate on the
stock-market loans in order to quell speculation, and raising interest
rates so that the economy didn't start to inflate again.
Now that was the regime we had until, unfortunately, Lyndon Johnson
came along with his "guns and butter," took William McChesney Martin
down to the ranch, and beat the hell out of him and forced him to
capitulate. But here's the point I would make: In 1960, at the peak of
what I call the golden era – the twilight of fiscal and financial
discipline – we had $30 billion on the balance sheet of the Fed. It had
taken 45 years to build that up. Then, as they began to rapidly expand
the balance sheet of the Fed during the inflation of the '70s and the
'80s, even then it took us until September 2008 – the Lehman collapse –
to get to $900 billion. Had the balance sheet only grown at 3%, which
is what the capacity of the economy to grow, I think, really is, it
would have been $300 billion, so they were overshooting.
Alex: We're three times where we should be.
David: Where we should have been by the Lehman
crisis event. In the next seven weeks, this crazy lunatic who's running
the Fed increased the balance sheet of the Fed by $900 billion, in
seven weeks. In other words, they expanded the balance sheet of the Fed
as rapidly in seven weeks as it had occurred during the first 93 years
of its existence. And that's not all, as they say on late night TV: in
the next six weeks they added another $900 billion. So in thirteen
weeks they tripled the balance sheet of the Fed.
Alex: Wow, that's an incredible…
David: So no wonder we are in totally uncharted
waters, and it's being run by people who are clueless as to how to get
out of the corner they've painted this country into. They really ought
to be run out of town on a rail.
Alex: I think you'd find that a lot of our viewers
would agree with you on that one. You know, the average American is
suffering. It looks like the average American is going to have to
suffer more to get us out of this, but it seems like the only thing the
Fed is interested in these days is propping up the stock market. Why is
that? Where does that come from?
David: The Fed has taken itself hostage with this
whole misbegotten doctrine of wealth effects, which was created by
Greenspan. In other words, if we get the stock market going up and we
get the stock averages going up, people feel wealthier, they will spend
more. If they spend more, there is more production and income and you
get a virtuous circle. Well, that says you can create wealth through
speculation. That can't be true, because if it is true, we should have
had a totally different kind of system than we've had historically.
So they got into that game, and then the crisis came in September,
2008. They panicked and pulled out the stops everywhere. As I said,
tripled the balance sheet in thirteen weeks, [compared to what] they
had done in 93 years. They are now at a point where they don't dare
begin to reduce the balance sheet, begin to contract, or they'll cause
Wall Street to go into a hissy fit. They are afraid to death of Wall
Street going into a hissy fit, so essentially, the robots and the boys
and girls and the fast-money traders on Wall Street run the Fed
indirectly.
Alex: So, in the 1960s, the Fed is taking away the
punchbowl. Sounds like in 2010 the Fed is the one adding the alcohol.
They are afraid to stop, lest everybody riot.
David: Yes, they got the party going, and they're afraid to stop it. As a result of that you have a doomsday machine.
Alex: At some point we are going to be forced to
stop. Market forces will kick in and Europe and China and India will
stop lending us money.
David: Yes. As I say, when the crisis comes in the
Treasury market, it will be the great margin call in the sky. They'll
start unwinding all of the carry trades, all of the repo. Asset prices
generally will be affected, because this will ricochet and compound
through the system.
Alex: When does this happen?
David: People looked at the housing market and the
mortgage market way back in 2003 – there were some smart people looking
at this. They looked at the run rate of gross mortgage issuance, the
$5 trillion I was talking about, and said: "This is insane, this is off
the charts, this is so far beyond anything that has ever happened
before, something bad is going to come of this." It's obvious, if you
pour debt into markets… I mean a lot of people leveraged 98%, or
whatever they were doing at the time with so-called mortgage insurance,
and just high loan to value ratios. They were driving up prices, and
so there was a housing-price boom going on. It was sucking the whole
middle class into speculation. So that's the nature of the system, and
now they don't know how to unwind it.
Alex: That's a pretty stark picture. So as an
individual investor, what are we to do? How do we protect ourselves in
this type of situation? Should I be owning bonds and staying out of
stocks? Should I be owning stocks?
David: No, I would stay out of any security markets.
These are unsafe markets at any speed. It's all tied together. As I
was saying when the great margin call comes and they start selling the
Treasury bond, they'll take everything else with it. Real estate is
priced off Treasuries. Mortgaged-backed securities are priced off
Treasuries. Corporates are priced off Treasuries. Junk bonds are priced
off Treasuries. Everything. The stock market will go into a panic. We
don't know when the timing will come – we've never been in a world
where there is $15 trillion worth of central-bank balance sheets, like
we have today. The only thing I think you can conclude is preservation
is the only thing you are about as an investor. Forget about yield.
Forget about return. Just keep yourself liquid and preserve your
capital, because you can't predict the day when, as I say, the great
margin call in the sky comes down.
Alex: So if it's not about coming out ahead, it's
about coming out not behind everybody else. It's just losing a little
less. What's the most effective way to do that? Do you want to hold
cash? Alternative options?
David: Yes. I don't even think there's nothing wrong
with owning Treasury bills. I mean, if you want to get, for a one-year
Treasury, what is the thing now? Twenty basis points or something?
Alex: So when the great Treasury crash comes, I should own Treasury bills?
David: Well, it doesn't mean the price of the Treasury is going to crash, no.
Alex: Okay, so we are just going to see interest rates skyrocket on new issues. The US government is not going to be able to borrow.
David: That's why you're short. If you're in a thirty-day piece of paper, you're not going to lose principal.
Alex: What happens to the dollar in all of this? If I'm holding dollar denominated assets –?
David: Well, the dollar, in theory, people would
think is going to crash. I don't think it is because all the rest of
the currencies in the world are worse.
Alex: So once again, America is not that bad off.
David: Well, we're bad off because when the
financial markets reprice drastically, it's going to have a shocking
effect on economic activity. It's going to paralyze things. It's going
to finally cause consumption to come down. It's going to cause
government spending to be retracted.
You know, the Keynesians are right. Borrowing does add to GDP
accounts. But it doesn't add to wealth. It doesn't add to real
productivity, but it does add to GDP as it's calculated and published –
because GDP accounts were designed by Keynesians who don't believe in a
balance sheet. So they said, "If the public sector and the household
sector are borrowing, let's say, $10 trillion next year, run it though
GDP, you'll get a big bump to GDP." But sooner or later your balance
sheet will collapse. They forgot about that one. So my point is that
we've gone through a thirty-year expansion of the balance sheet, an
artificial growth in GDP; now we're going to have to be retracting the
collective balance sheets. That means that GDP will not grow. It may
even contract, and no one's prepared for that.
Alex: So the economy will collapse. The dollar will
be okay, because we still need a medium of exchange and the dollar is
the least-bad currency in the world. How does gold fit into the
picture? Do you think that gold is a good asset?
David: Yes, I think that gold is a good asset. It's the only currency that anybody is going to believe in after a while.
Alex: Okay, so maybe hold that as an insurance policy. Do you own gold yourself?
David: Yes, as an insurance policy.
Alex: Where else do you invest in today?
David: I'm preserving capital. I'm in cash. I don't think the risk of the system is worth it.
Alex: So you are practicing what you preach, 100%?
David: Yes.
Alex: That's great. It's good to hear. This is
excellent advice for our subscribers as well, to consider that there's a
lot of potential energy built up in the system. You've articulated it
well, a lot of painful policy moves ahead of us, and probably something
that makes 2008 look like a preview, if you will.
David: It was just a warm-up.
Alex: Just a warm-up. Thank you very much.
David: Thank you.
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