Fed

Below is the transcript for the podcast with Eric Janszen: We Are Witnessing The Death of the Dollar.

Chris Martenson:  Hello. Welcome to another Chris Martenson.com podcast. I am, of course, your host Chris Martenson, and today we are speaking to Eric Janszen, founder and president of iTulip. I have been a reader there for quite a while, it is a data driven economic analysis firm started as the website iTulip.com in 1998. Eric is a prolific economic and financial market analyst, and author of several notable books, including the most recent one, The Postcatastrophe Economy.

I have invited Eric to speak here today because he has made more right calls about the global economy than almost anyone I can think of or have been following in the past decade. Today we are going to discuss his "Ka-POOM" framework and what he sees next in his macroeconomic crystal ball. Welcome, Eric. I have been looking forward to speaking with you for some time now; it is great to finally have you as a guest.

Eric Janszen:  Well, it is great to be on, Chris. I guess we saw each other in Denver a couple years ago, so it is good to catch up.

Chris Martenson:  Yeah, we were at the ASPO Conference. And I know that Peak Oil is certainly a part of your framework, it is one of many pieces, and you have been sending warning signals about our macro economic predicament, if I could use that word, since you launched iTulip.com in 1998. So can you give our listeners here the background on the specific concerns that lead you to launch that site and your framework there?

Eric Janszen:  Well, Chris, at the time I was the managing director of a seed-stage venture capital firm called Osborne Capital. This is Jeff Osborn, an old friend of mine out of the technology industry, and he made a bunch of money when UUnet went public. He was the head VP of Sales and Marketing, and he started investing in startups, mostly people that he and I had known over the years in the industry. So he brought me in to sit on the boards of companies and help with the investments and so forth.

So we had what I would describe as a front-row seat into the technology bubble; we could see that something was clearly amiss. So I started to do my research that ultimately resulted in iTulip. And my real objective here was [that] we had all these investments, we invested in 20 companies and we had seven liquidity events, a couple IPOs, sales to Cisco, Microsoft, Nortel, and others. My job was to understand that we were actually participating in a bubble and to know when to get out. So my research led me to believe that it was time to get out in March of 2000, and I started writing about this on iTulip as a way to share some of the information we were getting with the public and to counter  what was coming out of the media at the time. That has really been the mission for iTulip ever since.

Chris Martenson:  Well, that new economy, of course, it is always some sort of false belief or some new adoption of a rationale that enables us to go a little further. Greenspan, of course, adopted many of those rationales, including the idea that risk could be off-loaded and potentially made to disappear. It was no longer a real structure of our financial system and mispriced money accordingly. So in that context, I guess you were just at a Fed meeting of some sort, and you have been clearly observing the Fed for a long time. Do you have any observations you can share from that meeting, and generally speaking, why you follow the Fed and what you think they are up to here?

Eric Janszen:  Well, this is a small conference, invitation-only, at the Boston Federal Reserve. It is on Atlantic Avenue in downtown, the financial district of Boston, and the title of it was "The Aftermath of the Greater Recession." The format was a bunch of academic papers presented mostly by academic economists, peer-reviewed, and then discussed with the group. So the audience is various kinds of economists from investment banks and multi-family practices and so forth to different kinds of funds, and the media of course, CNBC, and lThe Wall Street Journal, The New York Times, and all those guys were there to cover it.

Also, Bernanke gave a speech, and it was actually a very important speech. It was not particularly well covered and I will be happy to talk about that in a minute. But what was interesting about it from my perspective, having covered the cycle of asset bubbles and reflations and various kinds of distortions that we have seen in the economy for 13 years on the site, if you go to a meeting like this, it is kind of a game of make-believe; everyone is talking around the real issues. The best you can really get out of it is to show up and ask some questions and hope by asking the right questions, you start to get people focused on the right subjects.

Chris Martenson:  Are they focused entirely on just the economy, or are they looking at monetary interest rate, all these policy things? Do they have any sense yet of where oil and energy might be impinging on their world view any?

Eric Janszen:  It is not on their radar, at least not in the context of this particular conference. The conference was really about the lingering effects of the so-called Great Recession. For example, there was one paper on the long-term effects of consumer attitudes towards the housing market. It was a very academic analysis, extremely rigorous from a data standpoint, but somehow or other they managed to miss any correlation between the fact that we have massive negative equity in the housing market and the fact that people do not want to buy houses. Also of course, unemployment, which is one of the main drivers of housing prices and drives home sales.

So you have these extremely academic papers very rigorously done that are not really getting to the point of the problem. Simon Johnson was there -- he, of course, was his usual highly confrontational self -- and I asked him a couple questions and he was very forthright in his answers. I did meet Bernanke in passing, I shook his hand on the way out the door, but I did not get to ask him any questions because for some reason at this particular speech, he did not take questions, which I was told was quite unusual.

Chris Martenson:  So let us talk about the Ka-Poom Theory for a while, because this was really your larger framework, and you have held this framework for quite a while. Maybe you can date it for us when you first developed and got it out there, if that was right at the inception I would love to know that. But the Ka-Poom Theory is a way of understanding the macro cycles. If you could explain that for our listeners, I think that would be a real help, because I have a bunch of questions I would like to build off that framework as we try and peer into the future and address what might happen next.

Eric Janszen:  Well what the Ka-Poom Theory intends to do is understand how all the debt built up during the era of the credit bubble. It began in the early 1980’s and accelerated starting around 1995. How it eventually gets resolved in an environment where politically writing down debt is not likely to happen and that ultimately the way that debt is written down is to the exchange rate mechanisms where markets discount the dollar. We could have a sudden dislocation in capital flows commonly known as a "sudden stop" that would apply to the United States. This is an idea that I thought was one way of looking at how this could all turn out that I first developed that back in 1999. Since then I have changed it a couple times, I would describe it as phase shifting it forward, moderating it somewhat. And I think what I have learned from the last two times that we have begun a sudden-stop process and it has been reversed is that we have a system which is difficult to predict in terms of its resiliency. There are trade partners extremely committed to maintaining the system as it is. On the other hand, they have been actively hedging their investment in the system by buying gold, as well, since about 2001.

Chris Martenson:  Right, so in the Ka-Poom Theory, we have an enormous credit run-up eventually that has to give way at some point, It did in 2008 in a fairly spectacular fashion, and then you have the inevitable downward portion of that cycle where we see deflation, deflationary impacts. Certainly, we see that in housing right now, if we look at total credit market debt there is little blips there but it is really the financial credit that has taken a big hit. We have the Fed doing everything it can intervening, we have got trade partners helping. Still, in this Ka-Poom Theory, are we on the downward slope of that deflationary impulse that proceeds what you describe as the reflationary or massive or maybe even hyper inflationary wave that would follow?

Eric Janszen:  Well, Chris, the most important thing to understand to forecast what is going to occur in our political economy is that we have effectively two economies, not one. We have one economy that is called a Buyer Economy, which is oriented around the finance, insurance, and real estate industries, and then a second one that is oriented around productive industries.

And the reason that it is important to keep them separated in your mind is because from a monetary policy standpoint they are treated quite differently. From a monetary standpoint asset, asset price inflation is good, the wage and commodity inflation is bad. And so if you watch for example what the Fed is doing in response to deflationary forces, both in asset prices and in commodity prices, there are two different approaches, right? So Operation Twist is an effort directly to drive down mortgage prices, which is really, if you think about it, a form of price fixing. They are trying to create scarcity, and therefore drive up mortgage prices, and therefore yields down.

This is a direct attempt to try to affect a change in asset prices, in this case the collateral, which is homes of all the outstanding mortgage debt. So they are trying to prevent asset price deflation within the fire economy, and at the same time they are trying to raise inflation in the wage and commodities prices, and the way that is done is through exchange rates. It is not the explicit policy, but it is clearly the apparent policy, which has more recently been dubbed the "weak dollar policy." But the idea is if you can depreciate your currency through fiscal policy and through monetary policy. What tends to happen, particularly through energy prices, you can affect a change in the overall price level throughout the economy, and that’s what been done. So we effectively depreciated the dollar against oil starting in about Q2 2009, and that effectively halted a very brief period of deflation that we had.

Chris Martenson:  So what we are talking about here is a very interventionist Fed that feels like it has the right capability, or maybe the obligation, to then have one hand on the asset lever and one hand on the wage and commodity lever, and then they are going to affect the proper outcome. Is there in your mind any historical precedent to suggest that such a command-and-control approach is a useful approach or workable approach or has a good chance of long-term success? Where you do fall in that whole free-market versus these-things-need-to-be-managed spectrum?

Eric Janszen:  Well, a couple answers to that. Back in 2005 when I was doing my first forecast of how I thought the housing bubble would turn out, I had two forecasts, ten years and fifteen years to revert to the main. Ten years if there was a limited government intervention and the market was able to quickly correct and then come back, and much longer and more painful if it did get involved. I thought government interference in the correction was more likely, because from a political standpoint, the risks to the banking system under the current structure would have been too high, there is far too much concentration in our banking system to allow a “Natural” decline, the so called too-big-to-fail problem.

So you have to remember that Bernanke was the guy that inherited the mess from the Greenspan Fed, and it was really under Greenspan that we had these cycles of asset price inflation that were positioned and postured as free market phenomenon, when in fact they were simply, for the lack of a better term, rackets which were designed to shift risk fundamentally from Wall Street to the taxpayer. Now the way that Bernanke has had to respond to this, my view is that he was handpicked as the right guy to come in after Greenspan because Bernanke, you know, since he was relatively young and an undergrad at Princeton and was writing papers about the Great Depression and what went wrong and how to prevent deflation. So from my perspective he was picked specifically for his background and his interest in doing precisely what he did do, quite predictably, in response to the deflation that resulted from all the credit inflation that precede it.

Chris Martenson:  Yeah, you know, I have always known that we were going to go down this printing road, and I knew that as soon as I read Bernanke’s 2006 Jackson Hole paper, which, I think, was really his application essay for the job. He very clearly laid it out, and it, of course, has been quoted widely and famously, and this is where he gets the helicopter moniker and all that. I am just the kind of person that says look, if somebody says they are going to do something and then they actually do it, there is no real mystery as to what just happened there. I know people are still on the side of the view saying that deflation is still the more powerful force; it is going to overwhelm the ability for the Fed to respond. Bernanke can have his magic printing press all he wants, but the forces here are just too large, too structural, and too embedded. Perhaps something like we see going on in Europe; it is just too big for the system. So you call it a political economy, thinking of the Fed maybe as part of that, or if you want to parse that out further, feel free, but how do you fall on that spectrum? Do you believe deflation, the markets, etc., are larger than the Fed at all, or do they have a number of tricks up their sleeve yet? In fact, can they continue this game for a lot longer?

Eric Janszen:  Well, Chris, I have been hearing this argument from the deflationists since 1998 when I first started iTulip. I remember the first time was we had this big stock market bubble, and I was debating various economics analysts on the likely outcome event. And many of them thought that when the bubble finally collapsed we would have a deflationary depression like we had in the 1930s, the stock market bubble would crash like the stock market of 1929, and so forth.

I tried to explain to them that we, not being on the gold standard, that there was nothing limiting the ability of the Fed to expand its balance sheet to do two things. One to provide liquidity and also assume to take bad assets out of the market and put it on its own. Since most people did not understand that is how the Fed operates now and the situations are different, I understand why they would be confused. And then what I heard back in 2006 when I reopened iTulip was the same argument all over again, but this time, Eric, it is going to involve the whole banking system, the entire structure of credit. There are just too many trillions of dollars, and the Fed can’t possibly back it up.

I said, well, when you look at the Fed’s balance sheet a couple of years from now, you are going to see trillions of dollars of mortgaged back securities and all sorts of other stuff on it, because that is what they said they were going to do. So the answer is, it is a little bit like arguing with somebody over and over again about whether the world is round or flat and you go around the world a couple times and they still do not understand what that means. It means that the world is not flat.

Chris Martenson:  Right, you know, I do not know what the limit is to the Fed balance sheet. If you sat me down five years ago and said we are going to have the Fed balance sheet at 2.8 trillion, I would have said what, no way, but here we are. So could it go to five, or seven, or ten, sure; I cannot think of a technical reason why it cannot. Maybe a political reason, maybe a geo-political reason, so as I look at what the Fed is really up to here, though, maybe you could clear up one mystery for me. So Bloomberg does a big foia thing and pries out of the Fed the fact that they had either directly or through guarantees backstopped an ungodly amount of trillions and trillions of dollars in both domestic and foreign firms both official and private. My question to you is do you have any insight into why it is a lot of those guarantees never showed up in any of the statements I read? They did not show up in the Fed balance sheet in any way; are those extra off balance sheet things? Do they not count guarantees in sort of an accounting standard? Do you have any idea as to what we are looking at on the Fed balance sheet is truly a good measure of what they are on the hook for, or they any way guaranteed?

Eric Janszen:  Well, this is one of the other challenges in talking to economists about our modern economy, because we have a finance-based economy, and most universities have economics departments, and the finance is taught over in the business school. So most economists do not really understand enough about finances to understand how our economy really works.

So when they are confronted with this question of deflation and who is holding the bag, if you actually take a careful look at the Fed's balance sheet, the Fed -- unlike any other kind of bank -- can do magical things. For example, it can take what is a liability for a commercial bank and put it on its balance sheets simultaneously as an asset and a liability that cancels out to zero. So, for example, we will take a few hundred billion dollars in assets backed securities, put it in a Maiden Lane Fund (or whatever those funds are called) as an asset, and simultaneously on the ledger as actually a deposit is technically how it is listed. Before the crisis, the net holdings of the Federal Reserve were something like 35 billion, and after they took on a couple trillion dollars of bad assets, it is still 35 billion dollars. So it is much like some people, it is kind of magical, but in theory, as Greenspan said many years ago, the Fed can in theory expand its balance sheet infinitely. The unique characteristic of the way Central Bank operates is different from the commercial bank.

Chris Martenson:  Oh, that really clears up a mystery for me. So unless we had access to some sort of audit access or records access, we do not really know. I think the Bloomberg data, when I started poring through it, really opened up my eyes to exactly that dynamic that you just explained. So thank you for clearing that up.

So here we have the Fed, the ECB, Bank of Japan, also Bank of England, oh, let's not forget the Swiss National Bank, and probably some others I have forgotten to list, all basically printing at this point in various ways, or we can call it providing liquidity, but let's be fair. There is as much being created out of thin air, in many cases here, to manage all kinds of things, exchange rate risk, and dynamics, to buy up bad assets, to push liquidity back into the system, to recapitalize banks, whatever.

So all the way back from the time I first was aware of your work, you had been a pretty big proponent of gold, and I think you were there right at the second when the market was the beginning of the previous decade. Talk to us about the connection you see between monetary policy now in gold, if any for you, and as well you also talked about rising gold prices as probably going to have several distinct phases. Which phase are we in now?

Eric Janszen:  So, Chris, my thesis in waiting 20 years, I started watching gold back in the mid 1980’s and was very much a stock market bull for most of my career in the high technology industry from the late 1980’s until the early 2000’s. So it was not until 2001 that I finally made a decision to take a 15% position in gold; it was at the same time that we had sold our stock from our equity positions and technology companies and bought Treasury bonds in late 2000, and that wound up being the portfolio was gold and Treasury bonds and has been ever since. The theory behind it is that the system, a global monetary system, was very US-centric, was really designed back in a time when the United States was about 54 - 58% of the global economy. As of now, it is about 18%, so we have this US-centered monetary system attached to a much more broadly based economy.

So here we have this mismatch between the monetary system and actual structure of the economy, and here we also have the United States behaving with these asset bubbles in a way that is not consistent with the country that is the issuer of the world’s reserve currency. To qualify for that position, you have to really stand well above other countries in the world in terms of transparency and other factors that prove the legitimacy of that position, and I saw that beginning to erode back during the period of the stock market bubble and then accelerate during the housing bubble.

There was no Plan B in the global monetary system when it switched over to the US dollar reserve basis for global monetary reserves. The only fallback is gold, gold is the only reserve asset that central banks hold other than dollars, and to some extent euros, but it is mostly gold. So gold is the fallback. So what I thought was going to happen is that over time, gradually, that there would be an increase at some point in gold holdings by central banks as they hedged the marginal increase and the number of Treasury bonds that they needed to hold as a result of conducting trade with the US and also simply maintaining the US economy through low interest rates and providing sufficient investment to continue to offer the US government.

So what is very interesting to me is [that] starting in the second quarter of 2009, right after the financial crisis, is when global central banks became net buyers of gold, which to me indicated that they had as a group, determined that it was time to more seriously hedge their dollar assets, even as they continue to buy Treasury bonds to increase their hedging.

Before that, there were effectively two teams: There were the buyers, who were countries like India and Russia and China, and the sellers, which are most of your European countries. And that structure of the gold market occurred and was maintained until the second quarter of 2009, and it shifted to a much broader base increase in the number of governments participating in the gold market, including Saudi Arabia, Mexico, and other allies of the United States.

Chris Martenson:  Right, so we have the United States here operating the reserve currency, doing it poorly at some point. Because another piece I would like to toss in here is the current account deficit driven by the trade deficits, primarily, which really started to the downside in the early 1990’s right around 1990-1991 and then just never looked back. With that, I also combined the fiscal deficit, which together current account plus fiscal deficit is a pretty whopping funding bill that needs to be supported and is half supported at this point by foreign official buyers and foreign central banks.

As we look into that, we see this thing called the custody account of the Fed, which is one main repository for some of those reserve Treasury holdings and also agency debt, and it is just a whopper. I mean, Eric, when I look at that account, what I see is it is not driven by the response of the crisis in 2008. In fact, you can start in 2002, put a ruler under that current account and just draw a line about 45 degree line up to about a little over 15% annual compounded accumulation in that. What was driving that -- and again, it is not in my mind linked to the crisis we’re in, because you cannot see any wiggle in the trajectory in 2008 or 2009 or 2007; there is no bump in it, it is just a ruler shot from 2002.

Are you saying that that was primarily driven by this, lets call it international global vendor financing, is that the mean dynamic behind that, or is there something else here?

Eric Janszen: Well, Chris, I think there are a number of theories to explain. Well, two things, the growth rate and the consistency of it. If you look at net capital inflows to the US, they grow when the US economy is growing, and the composition of those changes over time between official and private investors. But what is really important is that the growth rate overall be generally maintained in order to ensure markets that there is sufficient inflows to fund US economic activity.

It is probably not particularily well known, but back in 2003 when we had our earlier crisis, there was a point where 70% of the US government operations was being funded by foreign purchases of US debt. So the way the country operates is there are certain times when counting largely on domestic purchases, other times on foreign purchases but fundamentally we are kind of all in it together and this is the way the system works. The Chinese are not all that happy about having all the US Treasury bonds they have, but they know perfectly well what would happen if they were not buyers. On the other hand, they are behaving as if, okay, well, we will buy them, because you know we have to, to maintain the system, but we are going to buy more gold to hedge the risk that investment in US Treasury bonds represents.

Chris Martenson:  All right, so I wanted to cover that territory just a little bit, because if there are two places that a foreign official buyer or central bank is going to stash their money, one is in Treasuries and obligations like that to maintain the system, preserve the status quo. The other being the gold holdings, and so you saw that secular shift away from being net disorders of gold to net accumulators of gold, it is a fairly recent shift, historically speaking, to become accumulators again. Does that change where you think we are in terms of the phase of gold prices at this point? Do you see a sharper trajectory now as the world monetary system experiences the slings and arrows of the fortune here, of certain difficulties, or do you think we are still in a phase of steady rising prices if even that?

Eric Janszen:  Well, that is an interesting question, indeed. It has gone through a number of phases. When I first got into it in 2001, gold was widely derided as a terrible investment and had been going down in price for over 20 years. If you open the Wall Street Journal, you would have to dig around to find any price, never mind a mention of it, and it did not really become a topic of news until quite a few years later. But the fact is it has been going up in price every single year, year after year, for ten years, and in fact, the rise has been so consistent that it has, with respect to almost anything else, particularly stocks, has been much less volatile and more consistent with its rise.

So this is to me indicative of this overall trend which is, I would describe it as, a dissolution of the US Treasury dollar-based monetary system. And that process of dissolution is going through various stages, the most recent one being global central banks becoming net buyers, and you probably saw a recent jump in prices the last couple of days. You can be pretty sure that what is going on in Europe right now is driving some additional sales. I think it is important to understand also that what you can read about who is buying and who has what by looking at the bank for international settlements reports is somewhat limited. I am aware of individuals that as families that are buying very large quantities of gold, in the order of tens of tons, that are not going reported there.

Chris Martenson:  Well. it does not take very many families accumulating tens of tons to distort a market that is actually fairly tight when you look at the total gold market. I know a lot of dollar value of it flips every day, but in terms of the physical market, I have seen some work by Eric Sprott that really details what the physical market actually does, and it is a lot tighter than many sort of suspect the paper markets that give us some churn in the appearance of liquidity. But it is not a very big market. Lets put it that way, compared to the dollar flows that are available to siphon and funnel into one market or the other.

Okay. so I want to ask, so let's talk about for a second, does Peak Oil, I know Peak Oil factors into you macro view a little bit, but if you could just tell us how Peak Oil, maybe peak other natural resources, how do these play in? We have got Jeremy Grantham recently I think really going off the reservation in terms of his investing style to really put his mark down and say look, there is a big looming story here, and he calls it a paradigm shift. I am certainly in that camp of thinking that anybody that has got a, say, an endowment or a pension timeframe to their thinking certainly has to be considering this story, and I argue everybody should because we are there, that is my view. What are you views on this and how do you weave this into your macro view?

Eric Janszen:  Well, I met Jeremy Grantham, and he is obviously very wise and experienced veteran of the industry and has made some very good calls, particularly around the time when I was talking about the technology bubble -- he was, as well, and quite clearly and rigorously. He has also started to build what I call Peak Cheap Oil into his models. It is a term that we adopted back in 2007 to try to distinguish between the overall physical fact of a reduction in the total amount of oil endowment and its impact on prices and on the macro economy.

So the fact is that there is a lot of oil out there still, and when I was writing my book The Post Catastrophe Economy, and I was interviewing people like Joe Petrowski who is the CEO of Gulf Oil and others to try to understand the industry perspective on this process. It became pretty clear that we have gotten in a relatively short period of time, really the last 40 or 50 years, from all that was relatively inexpensively extracted with relatively primitive technology to oil that is increasingly more expensive to extract and produce with extremely sophisticated technology. So I think to understand how wildly sophisticated technology is these days for oil production, you have to look at what is actually done, that the big shift that improved oil production over the last ten years has been in computers.

So we had a lot of data about where the oil was, but not a lot of computing power to crunch the data to determine exactly where the most likely sources are that can be economically extracted. And he used to take a bunch of Cray computers and now just takes a couple workstations. So the good news is we know where the oil is; the bad news is we know where the oil is. Meaning that it is very unlikely to be any large quantities that have not already been located and the economics of their extraction been determined.

Chris Martenson:  And not just the dollar economics, but the energy economics as well, and clearly we are pouring a lot more energy in to get slightly less back out and increasingly less. And of course we run our economy on the net of those activities, whatever the price may be. It certainly is a view that I think anybody who has been solely focused in just the economics sphere really needs to start paying attention to it. It is one of my chief complaints, such as they are, around how the Fed operates. I am not aware that they have anybody with such a view anywhere in their stable of advisors, let alone voting members.

Eric Janszen:  Chris, let me interject. I am not entirely sure that is true. I think that at the moment they have bigger fish to fry; in their view it is a longer-term issue. But I do happen to know that they are thinking about how central bank policy can operate in an environment of persistently rising energy prices because that implies a long-term trend to increased cost-push inflation. And how do you manage monetary policy when input prices to production are continuously rising, which is acting as a tax on consumers? And at the same time, producers are unable to pass on those costs. So generally speaking it is going to be slowing the economy, so I think it presents challenges that they are thinking about, but within the framework of the way our current global central banking system works there really is not an answer.

Chris Martenson:  Right, so it is a very narrow way that they are addressing it, looking at the cost-push components and trying to understand the monetary aspects of that and other pieces. But if you take this other view and we step in from the side and say it is actually about the net energy, it is energy return on energy invested, and we have this central banking superstructure that requires this expansion for whatever reason because of how it is set up, debt-based money, and hey, we need exponential expansion of money and debt. We have a conflict there, so I just am always intrigued when I see who is really paying attention to this, and I see militaries around the world paying attention to this, so they are doing it.

Eric Janszen:  Yes.

Chris Martenson:  So I work with corporations that absolutely have their eye on the ball and are aware of it, do not know what to do with it yet, but certainly are starting to chew on it. So let me differentiate. So I do to know that our government is unaware of it. I would say the institutional career branch, there are people in there that get it; it is the elected portion that I am not quite as clear about at this point in time, and that goes for the Fed as well, at this stage.

Eric Janszen:  I think the explanation of that is just the career timeframes from the standpoint of politicians; it is something that is going to happen later. It is not like the foreclosure crisis, which is an immediate election-impacting issue. And today it looks like oil prices are as much driven by in dollar value is by demand and supply, so there is room for some debate, and if there is room for debate there are ways to avoid it.

Chris Martenson:  Yeah, I agree there are all sorts of reasons to understand the lack of response, and the political angle is an important one here. You have been increasingly vocal. I have noticed that our leaders really wasted the wake up call in 2008. Are there any steps in your mind that we really could take at this point to get the ship back on the right course?

Eric Janszen:  Well, Chris, my warning in my book was that we are going to have a relatively short period of time to get back on the right track starting in the second or third quarter of 2009. We needed to take fairly precipitous actions to get an annual growth rate up to about 4% GBP a year in order to get out of the output gap that was created by the recession. We have managed just north of 2%, so at this rate we will simply never get out of that, and what that means is that the long-term unemployment problem that we have will just get longer and bigger over time. That has political repercussions, as we can see from the Occupy Wall Street movement. And the knock-on effects of that, over time, are very counterproductive and unconstructive policy decisions that simply will pile one bad decision on top another.

Chris Martenson:  So if you are a concerned individual or corporation and you are looking at this framework right now, what steps can individuals, corporations take at this point to insulate themselves from these trends that we just have been talking about?

Eric Janszen:  Well, it depends on the industry, I talked to everything from insurance companies to commercial real estate firms to a lot of technology companies, of course, because that is the industry that I have come out of. It really depends on the industry, for if you are in the energy industry, of course, it is a boon. And I was writing articles back in 2008 when people were asking me, what should I go into to avoid this crash I see coming, and say go and move to Idaho, move to Texas, Oklahoma, places where there are going to be a lot of jobs still. Because despite the recession energy prices are going to remain high.

But aside from the energy sector and also the agricultural sector, which are clearly areas that are going to continue to improve despite of the impact of Peak Cheap Oil and of debt deflation, there are some industries, which I think are going to continue to suffer for the foreseeable future, including residential real estate. I do not see any end in sight for a decline in that industry. I will give you a specific, there was one of the presentations at the Federal Reserve last week by a very thoughtful economist who had a really good plan, I thought, for reprivatizing Sallie and Freddie getting them from being nationalized banks to fully private banks over basically a four-step process, so it might take five or ten years, something like that.

It all seemed very reasonable, except for one small problem: It implies that the mortgages in the secondary market would eventually have to reflect actual default risk, which today would probably put a mortgage around 9% or 10% in the secondary market, and I have friends out on the west coast still lending hard-money mortgages at about 9%. So the question is, how politically is Congress going to be able to push through these plans, reprivatizing Fannie and Freddie as mortgage rates go from 3%, to 6%, to 8%, to 10% or whatever they do, and the housing market goes down and down. Are the real estate lobbyists going to sit around and just watch this happen?

And the answer I got was not; they probably will not. So this is a perfect framework for the problems that we have today, which is we have a bunch of special interests, which likely produced a lot of the problems we have, who are not getting out of the way to allow us to implement policies that are going to address these problems.

Chris Martenson:  And for the concerned individual who has a portfolio, are you still advising gold as a portion of that, does Treasuries still make sense? Do you have advice there, or is that the kind of thing you provide?

Eric Janszen:  Well, you know, we are one with gold since 2001 for the duration, meaning until the end of the current monetary regime. I do not see how this particular regime will last forever, but you never know how much longer it could be maintained. But throughout that process I see gold prices going up back to 2001. My best estimate was somewhere between $2500 and $5000, which sounded kind of crazy back when it was at $270, a little less crazy today.

But in terms of Treasury bonds, it is a lot more tricky, that is one of those situations where you would expect Treasury bonds should decline in price, yields should rise, but Treasury bonds do not behave in assured fashion when they are the reserve asset issued by the world and where everyone is dependent on the stability of that system. So we always strongly advise anybody against shorting them; that is extremely dangerous. And also we are continuing to hold our Treasury bond positions but are gradually diversifying into other things such as funds that take advantage of rising rents and energy prices.

Chris Martenson:  Excellent. Okay, great advice; we are going to have to wrap here. We have been talking with Eric Janszen, Founder and President of iTulip Inc., and of course operator of iTulip.com, a great website. You should check it out if you have not. Lots of excellent advice there, as well as his subscription service, well worth the money. And author as well of The Postcatastrophe Economy. I hope that does well. Eric, it has been a real pleasure talking with you today.

Eric Janszen:  Glad to be here. Thanks, Chris.

Chris Martenson:  All right, have a good day.

Eric Janszen:  Okay, take care. Goodbye.

Chris Martenson:  Bye.

 
Eric Janszen is founder and president of iTulip.com. Eric is a prolific economic and financial market analyst, and author of several notable books, including his most recent one, The Postcatastrophe Economy.

Our series of podcast interviews with notable minds includes:

• Eric Janszen
• Paul Brodsky
• Carolyn Baker
• David Stockman
• Rob Hopkins
• Joel Salatin
• Charles Hugh Smith
• Frank Barbera
• Nate Hagens
• David Morgan
• James Turk
• Eric Sprott
• John Rubino
• Addison Wiggin
• Simon Black
• Axel Merk
• Paul Tustain
• Francis Koster
• Dogs_In_A_Pile
• Bud Conrad
• John Williams
• Robert McFarlane
• David Collum
• Joe Saluzzi
• Jim Rogers
• Bill Fleckenstein
• Marc Faber
• Willet Kempton
• Dan Ariely
• Ted Butler

Below is the transcript for the podcast with David Stockman: Blame the Fed!

Chris Martenson:  Welcome to another ChrisMartenson.com podcast. I am your host, of course, Chris Martenson. And today, we are speaking with a particularly interesting guest, Mr. David Stockman -- economic policy maker, politician, financier. Mr. Stockman represented Southern Michigan in the US House of Representatives from 1976 to 1981, later served as the Director of the Office of Management and Budget, the OMB in the Reagan administration, and was the youngest cabinet member of the twentieth century. Since then, he’s held executive positions in many of the most influential banking, buyout, and private equity firms, including the Blackstone Group and Solomon Brothers. He has many other accomplishments too numerous to list here. Welcome, David. It’s an honor to have you as our guest today.

David Stockman:  Very happy to be with you.

Chris Martenson:  Well, great. Let’s start with where we currently are as a nation. Although the US is arguably in the same fiscal and economic pickle as much of Europe, Japan, other developed countries. So, perhaps, let’s just leave open in our minds the possibility that the US is a component of a larger structural problem. With that said, for the past several years, you’ve been publicly making the case there are no easy fixes here, no monetary adjustments or fiscal tweaks that can save the day. So what are the structural conditions you see that lead to these conclusions? How did we get here?

David Stockman:  Well, I think we had a thirty-year debt spree that is unparalleled in modern history or recorded history. In 1980, our total debt- (public and private) -to-GDP-ratio was about 1.6 times. That had been sustained, more or less, for the last hundred years. It was kind of the golden constant, if you want to use that term. Today, our debt to GDP ratio is 3.6 times. There’s two turns more of debt on the national economy.

We effectively had, over the last thirty years, a national LBO - a leverage buyout of the whole economy. And this is important if you look at the difference between our historic leverage ratio, which seemed to be compatible with a stable and usually growing economy, notwithstanding periods, obviously, of boom and bust. But at 1.6 times, we would have about twenty-two trillion of debt (public and private) on the US economy today. We actually have fifty-two [trillion] at 3.6 times. So the extra two turns have put on the economy -- households, business, government, we can go through the different sectors -- roughly thirty trillion in debt that’s being lugged around by the US economy as it struggles to stay even, to say nothing of recovery today. And until that massive over-leveraging is worked down and reduced and liquidated, which will take years and years in a painful process, we’re not going to get back on track as an economy.

Chris Martenson:  So if we could summarize, it was simply too much debt, here we are after -- I started tracking this from the fifties -- it really sort of started. But it took off, as I noted in the charts, around 1970. And so if we look at the decades from ’70 to ’80 to ’90 to 2000, 2010, we look across those decades, we can see that debt was growing far faster than GDP -- the total credit market debt you’re referring too -- far faster than GDP, and that, just, you can build a very simple spreadsheet that proves that model is not sustainable, yet we’re trying to sustain it, I think, in official actions and monetary actions, stimulus, all of this.

David Stockman:  I would like to comment on that, because I think that is dead on, and it’s exactly the point I’ve tried to make many times. If you go back to the 1970s before this leverage ratio took off, before the real national LBO got going, if you had dollar GDP expansion, it tends to be accompanied by about a dollar-fifty of debt, so the ratio stayed about the same. By the time we got to the late ‘90s, we were adding two and a half to three dollars of debt for every dollar of GDP. And we reached the peak of all this in 2007, during which we increased credit market debt by four trillion and GDP by about seven hundred million. So we were pushing six dollars of debt into the economy, nearly, for every dollar of GDP that was coming out the other end. That was the end point. That’s when the system buckled; that’s when the music stopped.

Obviously, we had the huge crisis the next year, and the meltdown, and so forth. Now, since then, we’ve been treading water. Basically, private debt has been liquidated to some degree; the shadow banking debt has been massively liquidated. But it’s been replaced by public debt. And so we have gained no ground whatsoever in terms of the total debt burden on the economy. We’ve just shifted it. And so now the crisis is moving from too much leverage on the household sector and in the shadow banking system in 2007, 2008 to the sovereign debt crisis that we have in 2011 and for many years to come. Because that’s really the end game. I would say one way to describe all this is that we’re nearing, if not at, the Keynesian end game.

Chris Martenson:  The Keynesian end game. So where we came through a period where we put on four trillion of debt [and] got seven hundred billion of economic activity for our troubles. Here we are, we’re pumping money in like crazy, we’re stimulating like crazy. I think a position I happen to share with you is that I’m not a fan of either monetary or fiscal stimulus, the tools we seem to be enamored with to try and get out of this mess. What’s wrong with a little stimulus in a time of need, and what is the Keynesian end game?

David Stockman:  Well, stimulus, it’s very well demonstrated right now that there’s no multiplier effect, there is no pump priming going on. Stimulus is simply borrowing from next year or next decade or next generation through the credit of the United States; some money to hand out, like this ridiculous holiday on the payroll tax. So people spend for twelve months and then you’re back to where you started. And this makes no sense whatsoever. And the idea that now is being pushed by the White House is just symptomatic of how far our thinking has gone off into the ditch here. They’re proposing, even though Social Security is bleeding and last year we had seventy billion more -- and by that I mean the fiscal year that just ended in September -- seventy billion more went out the door for Social Security checks than came in in the payroll tax.

Notwithstanding that, Obama wants to have a one-year holiday to reduce three out of the six points that the people pay in the payroll tax so that they what...? Can go out and buy some more Happy Meals that they don’t need or some Coach bags that they can’t afford. Because one year later, they’re going to be right back paying the higher rate. This makes no sense. It is really primitive Keynesian thinking that says all we have to do is drop money from a helicopter and that’ll pump up spending and then that’ll get the machinery of the economy going. The problem with that view is it ignores the fact there’s a balance sheet, as well as an income statement, in the economy. And if you get to the edge of your balance sheet, if you use up the credit, so to speak, or the credit card, then additional stimulus only buries you deeper and it does move the economy forward.

Chris Martenson:  Well, the federal government, of course, is expanding its balance sheet like mad. And I think the Federal Reserve is enabling that. It certainly did with QE2 and indirectly, with QE1 - buying all that MBS paper - where was all that money going to go?

David Stockman:  Right.

Chris Martenson:  It’s going into Treasuries, obviously, in part. And so here with Operation Twist, they’re just enabling the federal government to take advantage of some long borrowing at that, what I consider to be, abnormal, grotesquely distorted rates that do not really seem to take the risk into account in the pricing. So we’ve got the federal government really blowing its balance sheet out at this point in time. How does that story end, in your mind?

David Stockman:  Well, it ends badly. But I think we have to go right to the source. You’ve hit on it. It is the Federal Reserve and it’s the current leadership of the Federal Reserve. As far as I’m concerned, Bernanke is the monetary Darth Vader. He has destroyed the bond market. Because fundamentally, in a healthy capitalist system, the interest rate in the money market and in the longer-term capital market is the price of money and the price of capital. And if the pricing system isn’t working, if it’s been totally crushed, disabled, manipulated, rigged, medicated, everything that the Fed has done with QE1, QE2, zero interest rates, Operation Twist, all the rest of this insanity, then we’ve destroyed the ability of the capital market to function and we’re giving false signals in every direction. One, we’re saying you can count on the fact that overnight money is going to be free or close to zero through 2013. That is an open invitation to speculators to put on a carry trade, because the Fed isn’t going to surprise you with your ninety-eight cents on the dollar that you’re carrying the trade with, borrowing overnight, so that you can carry a two- or three- or four-percent return asset, or speculate in currencies or all of the other so called risk assets, and pocket the ARB. Now, this is really crazy.

It is totally undermining the healthy function of a capitalist economy. Now, beyond that -- and here’s where I get to the fiscal issue -- it’s hard enough for politicians to face the music, to dispense bad news, to make hard choices, allocate pain to constituencies whether it’s spending cut or tax increase. But when the Fed destroys the bond market, which is the benchmark for the whole capital market, and tells the Congress that you can borrow money for two years at eighteen basis points, which is -- as far as Washington’s concerned -- that’s a rounding error. It’s the same as free. Or you can borrow five-year money, which you can right now -- I’m looking at the screen -- at .78, at less than one point. When you’re giving that kind of signal, then there is no incentive, there’s no motivation for people to walk the plank and face down this monster of a fiscal deficit and imbalance that we have.

So the Fed has been the great enabler. The many, many costs to this policy that we’ve had -- and we could talk about those -- but one of them that is not remarked upon enough is that it has destroyed the government bond market and therefore, undermined the fiscal governance process in this country, because Washington thinks you can kick the can down the road, the debt is more or less free, and we’ll get around to solving the problem. But today, let’s not make any tough choices. That’s where we are.

Chris Martenson:  Absolutely. I see it that way, as well. There’s two things that I think Bernanke was really doing in his policies. One was, as you mentioned, enabling, I believe, a false sense of security on the spending side because after all, if money is free it’s really not a big problem here. Look, our interest costs are dropping. On the other side, I think what he was really doing was helping to recapitalize banks. You give them free money and let them park it back with you and give them a quarter point on it, and I know it’s not a lot, but that was part of it, buying their assets off of them at par or something close to par, not market rates, I’m going to suggest here. That’s helping to recapitalize the banks. So guess what? He helped recapitalize bank balance sheets for the bad decisions they’d made so we got the whole moral hazard story looming there.

On the other side, what he’s done is he’s taken everybody who was prudent, everybody who was a saver, everybody who is on a fixed income or is relying on some sort of an income stream, and forced them to live at negative real rates of return for a number of years, and it looks like he’s set to continue that program. I think there’s social costs here for his actions that go well beyond just the financial world. I think, from where I look, I see real damage happening to what I’m going to call the prudent portions of our society. How do you see it?

David Stockman:  I agree with that a hundred percent. You know, the banking system has been saved on the back of the savers of the United States. We have totally destroyed any incentive for thrift, for deferred gratification. The Fed has become more Keynesian than Keynes. And to think that a Republican White House appointed this Bernanke guy who had, you know, he was recorded everywhere at that point as talking about dropping money out of helicopters. There was no doubt he was an out-and-out Keynesian. They appoint him, and here is what we get. Now, the fact is, if you were going to bail out the banking system with this kind of transfer -- I calculate it at three or four hundred billion a year -- the suppression of interest rates on depositors, on the seven trillion or so of deposit base that we have, is at least three or four hundred billion a year. And that’s the same thing as taxing the public by three or four hundred billion and redistributing it to banks based on the distribution of their deposit base.

That wouldn’t get one vote. Okay, in other words, what I’m saying is, if it were done in a proper way as a fiscal transfer, put before the democracy to review and vote up or down, it would be voted down, overwhelmingly. It would be shouted down. It would not even see the light of day out of committee, to say nothing of the floor of the House or Senate. And yet, we have twelve people who can sit on the open market committee and affect a half-trillion-dollar transfer arbitrarily. They haven’t been elected, they haven’t been authorized to do this, they’re totally twisting and exaggerating their mandate, their so called "dual mandate." This ought to be grounds for a serious constitutional crisis, if nothing else. The Fed is operating as the central planning agency of the US economy. It is exercising plenary power from stem to stern in the US economy, and that is not the kind of system, 1) that’ll work, or 2) that’s compatible with all of our traditional notions of a private sector of a free market economy, of a distinction and separation between the realm of the State and the realm of private activity.

You cannot say enough about the danger of the deluded people who were running the Federal Reserve, and that’s why I’m so happy to see, finally, the Republicans waking up and the letter that came out a couple days ago warning them no more of this, you’ve done too much already. At least there’s a dawning recognition that we have a profound constitutional crisis emerging as a result of the Gang of Four. Yes, there’s twelve people on the open market committee. It’s the Gang of Four -- Dudley, Bernanke, Yellen, and Evans -- who have seized power in this country and really need to be called out.

Chris Martenson:  You know, I think that this most recent Fed announcement, which just came out on September 22^nd, I guess, or 21^st, and it was around Operation Twist. That was a real disappointment to Wall Street. I think we’re seeing that on some of our screens today and yesterday, obviously, and maybe across the world. So maybe they did get a little bit of the message that, you know, you talked about some of the political and social risks that exist in this. I’d like to talk a bit about the economic and financial or monetary risks that occur. And I don’t really ascribe to any particular school of economics, but there is one quote from Ludwig Von Mises of the Austrian school that does stick with me because it rings true. And that quote is that, “There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved.” I can’t find a lot of fault in that. I’ve analyzed that statement a lot, and it feels like we’re fully down that path at this point in time. What are the financial and -- particularly the ones I’m most concerned with here -- the monetary risks that you see in our current trajectory?

David Stockman:  Well, there are big risks. But I think that quote is spot on. It was never more applicable than to our recent past. And it’s important to dwell on it, to focus on it, because the reason we have this crazy thrashing about by the Fed today, and by Washington with the front door stimulus, the back door stimulus, the absurdity of one-year tax holidays on payroll taxes that we desperately need, and so forth, is there is not a proper understanding of what caused the crisis in the fall of 2008, what caused the meltdown. And the answer is, it grew out of the preceding unsustainable reckless boom, exactly as Mises said. And as a result of failing to understand that, we have an implicit theory, which I think is remarkable in the mainstream of Keynesian policy makers or just politicians who would like to help, and that is that they don’t know where this crisis came from.

It was like a one-in-a-hundred-year flood; maybe it was a contagion that came in on a comet from deep space. But they have no explanation for it; it was bad luck. It hurt us so now let’s dig our way out and use the balance sheet of the Fed, the balance sheet of the federal government to compensate until we get back to normal. Well, that’s absolutely wrong, that we’re in a depressed economy right now because in 2003, -4, -5, and -6 and -7, we had an overheated bubble economy that wasn’t real, wasn’t sustainable, that created millions of jobs based on the margin credit extensions that couldn’t be sustained. And all of that was taken back by Mr. Market in 2007 and 2008 when the first debt liquidation started. And therefore, we’re totally on the wrong track, if we’re trying to restore demand that was never honest demand, or legitimate demand based on earned income and production in the first place.

And that fundamental issue is why policy has gone off the deep end and become so dangerous. Because now, they’re just pouring gasoline on the fire, as I think we all believe. Why would they think at the Fed that with the economy as sick as it is, the housing market as damaged as it is, that if you could get thirty basis points more on the long-term mortgage rate that somehow this is going to make everything better? And Operation Twist is, I would say, further evidence of ritual incantation. The Fed is so locked into this erroneous Keynesian world view that it’s indulging in a ritual incantation just doing the same thing over and over and over, when almost anyone who thinks about it can see why twenty or thirty basis points -- if they can get that from Operation Twist -- [would] solve anything that the last four or five hundred basis points of interest rate reduction haven’t solved, and what are the negative consequences of going in and manipulating and distorting the fundamental capital market of the world for thirty basis points? It’s not even a close question. It’s an evidence that they’re locked into almost insane policy making.

Chris Martenson:  Well, so we’ve got the Federal Reserve headed by Bernanke. They’ve maybe [been] prescribing some excellent cures. Unfortunately, they have the wrong diagnosis, with ritual incantations. So Bernanke, is he Darth Vader, or is he a witch doctor? We’ve got some good metaphors to work with here.

David Stockman:  Maybe we could apply both of them. But you know, I think, if you look at Operation Twist, there’s also an irony to it, which I think people who are trying to understand what’s happened, not just in the last year or two but the last decades or few, would be interested in. And that is the original Operation Twist, ironically, which I think was implemented in February or March 1961, was done as a valiant effort -- although misguided -- to protect the gold dollar, okay? It was still under the old exchange rate, and the threat at that point was there was a lot of hot money flowing out of the US because they worried about the expansionary fiscal policy and new economics of the new administration coming in -- and properly so -- Kennedy and all of those Keynesian advisors he had from Harvard. And so the Treasury, which was still run by orthodox people -- including Douglas Dillon, who became Secretary of the Treasury -- came up with an expedient whereby they could sharply raise short-term interest rates.

They pressured the Fed to do that in order to stem the outflow of hot money and support the dollar and support the waning days of the gold exchange standard. And, on the other hand, [they] wanted to push down the long-term interest rate to encourage investment and growth. But the point is, today, the aim is the opposite. Bernanke’s trying to destroy the dollar with Operation Twist and all the other monetary medicine that he’s dispensed. And yet, it didn’t work in 1961, for a good purpose. And today, to reincarnate Operation Twist as part of this capital market and currency market destruction that’s underway, I think is quite ironic.

Chris Martenson:  It’s interesting. You know, I think it was a little over a year ago in the New York Times, you had an op-ed piece titled “The Four Deformations of the Apocalypse.” And if I paraphrase, you essentially said that Democrats lean towards, maybe, 'tax and spend' and the Republicans lean towards 'borrow and spend,' but that there’s really no effective daylight between their spending habits. Certainly there is, if we look at marginal priorities for where the money goes, but not in terms of either the amounts of the long term -- even short term -- fiscal prudence. What’s the reality of the situation? And how, when, or even why will economic or fiscal reality finally gain purchase with our decision makers?

David Stockman:  Well, you know, that’s the heart of the crisis. It’s deep and stubborn. And it begins with the fact that after the early 1980s, we developed two free lunch parties in this country. The Democrats were always the free-lunch party of the welfare state and the Great Society programs and so forth. And the job of the Republican party, which was accomplished pretty reasonably under Eisenhower and, actually, initially under Nixon, who then finally threw in the towel and went totally Keynesian, but at least in 1969, he was attempting to maintain some fiscal discipline. So the job of the Republican party was to be the party that said no, the party that was the watchdog of the Treasury, the party that raised for the public the issue of fiscal discipline and the consequences of not maintaining it.

Well, after 1980, I was a supply sider, but not a free-lunch supply sider. And when the free-lunch version of supply sides set in and then became party doctrine, we ended up by 2010 with both parties wanting to give away the credit of the United States. The Democrats with more spending or defending the spending was their entitlements that were growing insupportably like Medicare or Social Security. And the Republicans cutting taxes randomly, continuously, and under every imaginable economic circumstance without offsetting spending cuts or a total framework of fiscal discipline. So we get to the point today where you now have Republicans saying no taxes, any way, any shape, any form, when the revenue is at fifteen percent of GDP, the lowest in history. And you have the Democrats defending what I call the twenty-four-percent line; that’s where spending is. And you have the President a few days ago threatening to veto a bill if it reforms entitlements and is put on his desk and it doesn’t tax the rich at the same time.

Now, that is a prescription for Banana Republic fiscal policy at best, and even more irresponsibility if you look at the real facts. Now, why did we get into a situation where our democracy became deformed and both parties became free-lunch parties and we no longer have a fiscally conservative party left? I blame it on the Fed. I blame it on the 1971 decision by Nixon to close the gold window and let the dollar float. Because out of that has evolved -- or morphed -- a central banking policy in the world that absorbs unlimited amounts of government debt. And so we went on what I call the 'T-bill standard' or the 'federal debt standard.' And the other central banks of the emerging mercantilist Asian economies -- Japan, Korea, and now, especially, the People’s Printing Press of China -- have absorbed this massive emission of debt that otherwise would’ve created powerful negative consequences that would’ve forced politicians to act long ago. But as long as the debt… In other words, higher interest rates, pressure for inflationary monetary policy, and the actual appearance of price inflation. But we got away for twenty or twenty-five years with, you know, to use the phrase, “deficits without tears.” And because all the bonds on the margin were being absorbed by the central banks.

Where we are today is that the central banks of the world own five trillion of Treasury paper, from bills to thirty-year bonds. That’s half of the ten trillion outstanding. So I refer to this system, the Fed and all its subsidiary central banks, as a chain of monetary roach motels. The bonds go in; they never come out. That has totally distorted the capital markets of the world in fiscal policy making. In the last few years, especially. More than half of the debt, even though on average, half of it is owned by central banks and other official institutions, well more than half has been absorbed by the central banks in the last few years.

And so, as a result of that, the reckless irresponsibility of the two free-lunch parties has had no check. And as a result, the positions have become politically institutionalized. I mean, the Republicans can’t help themselves on the tax issue because nothing bad has happened so far, and, as Chaney said inappropriately, they have the view that deficits don’t matter. And so far, they haven’t, because the central banks have absorbed it all. But I think we’re at the end of the road for this monetary roach motel chain, as well. China is red hot with inflation. The People’s Printing Press is going to have to let the currency rise. When they stop pegging, they will therefore be buying less Treasury paper and one bid is removed from the market. I hope the Fed is done with any additional balance-sheet expansion. And if they don’t expand the balance sheet, then on the margin they won't be able to absorb incremental debt issuance by the Treasury.

Other central banks are in the same position. So that’s why we’re coming now into a very dangerous phase, because we had a twenty-five year, let’s say, interregnum, here, where the consequence of massive debt issuance was not felt in the real economy in the short term, so that there would be a feedback that would cause at least some politicians to want to change course. Now, we have the central banks out of business and massive debt flow in both Europe and here that’s turning into the sovereign debt crisis, and that’s just another name for the fact that there isn’t enough private, legitimate private savings in the world to absorb debt at this issuance rate.

Chris Martenson:  You know, I’m right with you on all this, because for years -- and it’s gone on longer than I ever thought it could -- but I’ve been watching with alarm the custody account at the Fed, which is really just a measure of the reserve balances growing in central banks across the world…

David Stockman:  Sure, right. That’s three trillion right now.

Chris Martenson:  Yeah, and it’s not just a little bit. This is like twenty, twenty-three, twenty-five percent year-over-year growth for years.

David Stockman:  Right, right.

Chris Martenson:  It’s an astonishing compounding that’s happening there.

David Stockman:  Yeah, and add, if I could, just then add the 1.7 trillion of Treasury paper on the Fed’s balance sheet, and therefore, you have close to five trillion of the real outstandings. But actually, it’s worse than that, because if you take all the mortgages back, the GSE paper, that’s just a back-door form of Federal debt anyway, now that we’ve guaranteed the security holders with the bailout in September 2008. So if you look at the real sovereign and quasi-sovereign issuance of the United States, a massive share of it -- both Treasury paper, per se, and the MBS paper, is in the Fed in the other central banks of the world. And if it were that simple, well, let’s just get it over with and have the governments issue trillions of new debt, drop it out of the air from the helicopter, and put it in the central banks. Now, we know, historically, that you can’t print your way to prosperity. And that’s essentially what policy amounts to today. 

Chris Martenson:  Right. And so assuming we can’t do that - and I’m in agreement with you that that can’t persist forever and that we might be very close to the end of the road on that -- my question here is, essentially what we’re talking about then is a massive debt deflation if we’re going to write down -- let’s throw a number out there -- if the US has maybe twenty or thirty trillion of excessive total credit market debt, has to walk that off, what kind of economic impacts are we talking about? What happens to unemployment? How much does GDP actually contract, let alone not grow all that, right? So what do you think happens there if we really walk down that path of austerity?

David Stockman:  Well, I think that’s where the gloomy outlook materializes in living color. I think the unemployment rate is actually higher than nine percent right now. It’s only nine percent on a mathematically calculated basis because we’re driving people out of the labor force, because they lose hope that it’s worthwhile to look for a job, or we lure them into not looking with unemployment insurance; one of the two. So I think we’re over double digits right now. Even if you take the labor force participation rate of two years ago and divide that into the number of jobs that exist right now, you’ll find that you get a double digit result. I think we’re going to stay at double digits from now till as far as the eye can see. I think we’re going to have a crisis of incomes in our private economy, because sooner or later, the ninety-nine weeks of unemployment’s going to run out. The safety net is under tremendous pressure, and that’s one side of the equation.

The other side of the equation is, I don’t see why we have any growth at all. The only growth that we’ve had is statistical growth over the last two years as a result on the margin of the federal government borrowing money and then redistributing it back through transfer payments or through direct purchases in these stimulus programs we’ve had. The number that I look at, that I think demonstrates that in spades -- and this is kind of in round terms, but it demonstrates the point and it’s accurate within a few ten billion -- but we’ve had a one trillion growth since the fall of 2007, when, allegedly, the cycle peaked in DPI -- Disposable Personal Income. And that is the fundamental metric that measures the capacity for spending - PCE, Personal Consumption Expenditure - to grow. Or savings to grow. But the point I’m making is of the one trillion growth of DPI in the last four years, about eighty percent of it is due to either lower personal taxes or higher government transfer payments. And on the margin, the lower taxes -- which may sound nice to some conservatives - but every dollar was borrowed because we were already deeply in debt before they started cutting taxes to stimulate the economy. And obviously, every dollar of the huge increase in transfer payments during that period was borrowed, as well.

So almost all of the DPI growth has been borrowed money using, taxing, the last bit of balance sheet that we had left, both as a political matter and as a financial matter. Now, I think finally, the politics had reached the point where physical expansion -- I don’t know that we’re going to cure the problem, but hopefully it’s not going to get worse. The Republicans at least put a line in the sand on that. And as a result, I don’t see where we get much growth in the income statement of the economy. And without that, obviously, you’re not going to get GDP either.

David Stockman: That we need to have a giant alarm going off in the entire economy. And maybe that’s beginning what’s been happening for several weeks now, but in the last couple of days, finally, I think people are beginning to realize that this was an entirely artificial rebound in the financial markets, not in the real economy. And that the props that were under this monetary expansion and fiscal stimulus are no longer operative.

Chris Martenson:  Well, so here we are looking at a period of austerity that’s going to be imposed, I guess. I’m thinking Greece is our metaphor here; that eventually the markets catch up with you. The Federal Reserve has a lot of power, but it’s not omnipotent. So I think in the past you said there are actually two primordial forces -- the welfare state and the warfare state -- that are really driving the federal spending machine. First, neither of those states, I think, are going to be particularly happy with the type of austerity you’re describing. So, first, I want to know how you might expect them to react to that austerity. And second, where do we really go for spending cuts here at this juncture, given how much mandatory spending we seem to have that’s essentially untouchable?

David Stockman:  Yeah, well, those are really good questions because I think that’s why we’re seeing the utter paralysis in Washington that manifests itself daily. You hear all the talking heads on financial TV saying isn’t that disgusting? What’s wrong with these people? Can’t they realize they shouldn’t be fiddling while Rome burns and all that. But I think that is a superficial misperception. What is actually happening is that we’ve allowed the welfare state to grow so large, the warfare state to remain so unnecessarily huge, and the tax rolls to be cut so dramatically that we now have a gap that is so imposing that the politicians can’t cope with it. They’re paralyzed.

Anything they might want to do seems too insignificant relative to the size of the problem that they simply repair to inaction. So therefore, the military-industrial complex is hanging on for dear life and has actually driven through the House Armed Services Committee a budget for 2012 that’s up by three percent or so from 2011. Now why in the world, with the crisis as dramatic and as clear and as present as we see it now after having gone through the August debt ceiling crisis and the downgrade, would a Republican Armed Services Committee think you need to raise the defense budget in a world where we have no industrial enemies, where Al Qaeda is down to forty people, where the great holy warrior of Al Qaeda is dead, what are we thinking when they raise the defense budget? But I think it’s the military industrial complex that’s so dug in. And unfortunately, they see defense as a jobs program as opposed to what it really is -- and utter and complete economic waste -- that no progress is made. And of course, the same thing is true on this welfare state side.

I heard the White House press office the other day say that unemployment was a great jobs program. Unemployment insurance is a great jobs program. Now, how in the world could someone make that kind of preposterous statement? But it was only in the primitive Keynesian derivative sense that, well, if you send out the checks, people will use it to buy some food at the grocery store and someone will then work at the checkout counter. You know, that is the problem. Every feature of this is now being seen as a jobs program because the economy is stalled out. And the gaps are so great that it seems as there’s no political will or capacity to take on the warfare state when it should be dramatically shrunk and demobilized, and we can talk about that. Or the welfare state starting with Social Security.

How can someone not believe that at least the top five or ten million beneficiaries out of fifty ought to be means tested and if we can’t afford to give these people their full checks, since nobody earned it anyway, then the check needs to be cut back or eliminated. But there’s no capacity, really, to take on any of those issues. And so the system is falling into paralysis; not because the politicians are totally cowardly or stupid. It’s that the system has drifted into such massive gaps that the capacity for Democratic consensus and for positive action to slow down the doomsday machine is being lost. And that’s what the Keynesians never thought about, you know? They never thought you would reach the end of the balance sheet, that you would reach a crisis point like they’re having in Greece or Portugal or Europe, generally, or now in the United States. And they never thought about the weaknesses and the imperfections of democracy in terms of its ability to cope and make policy.

The whole Keynesian myth, I believe, is based on the erroneous idea that the private sector has its imperfections and its cycle instability, and government needs to step in with compensatory policy and make up for it without any examination of the State and the capacity of politicians to actually manage fiscal policy according to the Keynesian formula. The answer that we’re learning is they can’t, that the State has more imperfections built into the process of democratic action, and that this whole policy we’ve had for fifty years of managing the business cycle of macro-economic policy, the whole project of macro-economic policy, has been a giant error. It’s being discredited; it’s led us into this public sector sovereign debt trap that the political system can not work out of. That’s the real danger. That’s the real crisis at the moment.

Chris Martenson:  Yeah, I agree. Where I think we had an opportunity to fall off of a small stepladder back in the mid ‘80s, early ‘90s, we’ve now gotten ourselves forty feet up an extension ladder. And so I think politicians are rightly scared of how we manage the fall from here. At the same time, I see defending the status quo and business-as-usual not being terribly, let me say, leader-like positions to take at this juncture of history. So we’re talking about political blind spots. I’d like to just talk about one of the larger blind spots that I see, quickly get your take on it. And one of my key tenets is our monetary system; you know, through its essential design of loaning money into existence and our entire economic and institutional scaffolding, which we then built around that monetary condition. Well, it all kind of requires endless exponential growth. Not a lot. Two percent, three percent a year mind you. But endless growth nonetheless. And without such growth, the entire system becomes shaky, groans ominously, threatens to collapse, maybe systemically.

So when we look at this, a second key tenet of mine is that, look, nonrenewable natural resources, they are the headwaters of all economic activity. With resources, you build an economy. Without them, you can’t. So at the top of this list has to be petroleum, given its unique role in fostering economic activity. It’s the original spring, then, that feeds all the tributaries. Where does Peak Oil fit into your world view here, if at all? To us at my site, it’s that and competition for other critically depleting natural resources including maybe land or fish or whatever that seems to be one of the fundamental issues at hand. And the US current leadership seems either ignorant or intentionally avoidant of this entire topic. Is it on the political radar at all? And if not, why not?

David Stockman: Well, it’s on the political radar but in a very superficial way. And I happen to have the screen on right now and I’m seeing someone sitting before a Congressional committee taking the Fifth Amendment on the guaranteed loans that Solyndra got from the federal government. Now that is symptomatic of everything that’s wrong. We can not have a State run solution to a very complex, subtle market problem. I agree that there is something in the nature of Peak Oil happening, but I think that’s a metaphor for the fact that a delivered BTU, whether it comes out of a conventional oil well or whether it comes out of the tar sands or whether it comes out of some new or more efficient form of consumption or combustion, the price, the real price of the BTU delivered or consumed is rising. And as the real price rises, I believe the market could keep things balanced, but it would slow down the rate of total output growth as the BTU factor weighs on the mix that goes into economic activity.

I think that is being totally ignored. It is another one of the headwinds or constraints that we’re facing, along with the demographic time bomb of this huge generation retiring. And if you look at all of these, there’s no reason to expect much economic growth for the next ten or twenty years, even if you had a healthy monetary and fiscal situation. But given the situation that we’ve described and given the massive excess private leverage that was built up in the thirty-year debt spree, we have sort of added insult to injury. We have maybe an inevitable question of the rising real cost of the BTU, being added to the demographic question, being added to the totally distorted world labor market that the central banks have produced, which is another whole topic. But when you put all those together, the headwinds are truly frightening.

Chris Martenson:  I agree. So I see there’s a multiple convergence of forces here. And okay, so if I take the summary of this and I say, listen, you know, if a betting person now decides that the odds favor crisis over willing structural reform; that is, they come to the conclusion that maybe our future is more likely to be shaped by disaster than design, what would your advice be to the concerned American who wants these problems addressed responsibly, and what should they, as individuals, be doing to mitigate or protect themselves from what you see coming?

David Stockman:  Well, the first thing is to protect yourselves, you must get out of the risk asset markets. This whole thing, in my view, is a scam that has been promoted by the day and hour by the talking heads of Wall Street and the so-called economists that they trot out on the financial media constantly with all kinds of spurious explanations as to why there’s a light at the end of the tunnel, that we’ve solved the problem, that the crisis is over, and that the normal machinery of economic recovery is back in shape. All of that, I think, is a dangerous delusion. And therefore, all of the risk assets are dramatically overpriced, from copper futures to the SNP index and especially, the higher baited names in the stock market. So my point would be it’s a dangerous place. Both the bond market, we’re in the greatest bubble of all times, it’s been driven by the Feds’ bond buying, which is now coming to the end. So the bond market, the fixed income market, is an extremely dangerous place that should be avoided at all hazards.

The stock market and the various derivative markets that relate to it are exceedingly dangerous. And so the best thing to do at the present time is conserve capital. And ultimately, the monetary systems of the world are coming apart. They’re falling apart. They’re losing their credibility, and therefore, gold is becoming the de facto money. We’re going to be back to a gold standard one way or another, through the back door, in only a matter of time, simply because the central banks are dominated by the ritual incantation of dying Keynesian theory. And therefore, I would say that’s what someone needs to do to protect themselves. What do you need to do politically? I see not a lot of hope at the present time, because both parties, as I’ve indicated, are in denial. They have their heads in the sand. They’re more or less embracing free-lunch economics. And I think until we have a thundering crisis in the bond market that truly puts the fear of God into Washington, we’re not going to get any break from the path of drift towards disaster that we’re on right now.

Chris Martenson:  That’s an excellent summary. And I think we’re going to leave it there today. I really enjoyed this interview, and your views mirror a lot of my own. Maybe that’s why I enjoyed it so much.

David Stockman:  Well, your questions were great, and these matters go right to the heart of what’s behind the moment-to-moment headlines and impulses that seem to drive the markets but are really not the underlying reality that people need to focus on.

Chris Martenson:  Absolutely. And it’s reality which is the piece that I like to focus on. And there’s certain pieces of data and evidence that just can’t be spun and we talked about a bunch of them today. There’s more to be found on my website and I’m sure, as people follow you in the news out there, you’ll continue to make these points. And let’s just hope somehow we can shape that future by design rather than disaster, but plan as if maybe the opposite will happen.

David Stockman:  Very good.

Chris Martenson:  All right, thank you much.

David Stockman:  I agree with that.

Chris Martenson:  All right.

David Stockman:  Bye.

 
Mr. Stockman is the founding partner of Heartland Industrial Partners. He was formerly a senior managing director of The Blackstone Group. Prior to joining Blackstone, Mr. Stockman was a managing director at Salomon Brothers, Inc.

He served as the director of the Office of Management and Budget in the Reagan administration and was the youngest Cabinet member of the twentieth century. From 1976 to 1981, Mr. Stockman represented Michigan in the House of Representatives.

He is also the author of the book "Triumph of Politics: The Inside Story of the Reagan Revolution".

Our series of podcast interviews with notable minds includes:

• David Stockman
• Rob Hopkins
• Joel Salatin
• Charles Hugh Smith
• Frank Barbera
• Nate Hagens
• David Morgan
• James Turk
• Eric Sprott
• John Rubino
• Addison Wiggin
• Simon Black
• Axel Merk
• Paul Tustain
• Francis Koster
• Dogs_In_A_Pile
• Bud Conrad
• John Williams
• Robert McFarlane
• David Collum
• Joe Saluzzi
• Jim Rogers
• Bill Fleckenstein
• Marc Faber
• Willet Kempton
• Dan Ariely
• Ted Butler