The Real Crash : America's Coming Bankruptcy---How to Save Yourself and Your Country
You might be thinking everything's okay: the stock market is on the rise, jobs are growing, the worst of it is over.
You'd be wrong.
In The Real Crash, New York Times bestselling author Peter D. Schiff argues that America is enjoying a government-inflated bubble, one that reality will explode . . . with disastrous consequences for the economy and for each of us. Schiff demonstrates how the infusion of billions of dollars of stimulus money has only dug a deeper hole: the United States government simply spends too much and does not collect enough money to pay its debts, and in the end, Americans from all walks of life will face a crushing consequence.
We're in hock to China, we can't afford the homes we own, and the entire premise of our currency---backed by the full faith and credit of the United States---is false. Our system is broken, Schiff says, and there are only two paths forward. The one we're on now leads to a currency and sovereign debt crisis that will utterly destroy our economy and impoverish the vast majority of our citizens.
However, if we change course, the road ahead will be a bit rockier at first, but the final destination will be far more appealing. If we want to avoid complete collapse, we must drastically reduce government spending---eliminate entire agencies, end costly foreign military escapades and focus only on national defense---and stop student loan or mortgage interest deductions, as well as drug wars and bank-and-business bailouts. We must also do what no politician or pundit has proposed: America should declare bankruptcy, default on its debts, and reform our system from the ground up.
Persuasively argued and provocative, The Real Crash explains how we got into this mess, how we might get out of it, and what happens if we don't. And, with wisdom born from having predicted the Crash of 2008, Peter Schiff explains how to protect yourself, your family, your money, and your country against what he predicts.
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St. Martin's Press
May 21, 2012
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Excerpt from The Real Crash by Peter Schiff
Where We Are and Where We Are Headed
AS I STATED IN THE introduction, the real crash I predicted in my first book is still coming.
You see, before 2006, I had been predicting an economic catastrophe in the United States, with the burst of the housing bubble being the catalyst. Once that bubble burst and major banks went to the brink of failure, people began crediting me with "calling the crash." But what we saw in 2008 and 2009 wasn't the crash. That was the overture. Now we have to sit through the opera.
The economic unpleasantness of those days was definitely part of the real crash, but only because of the way our politicians responded--replacing one government-created bubble with another, thus putting our economy at even greater risk.
The same bubble machine that fueled the last two boom-bust cycles--the Federal Reserve--is already back in high gear, and we must turn it off. The Fed needs to stop fueling inflation and start sucking dollars back out of the economy. It also needs to let interest rates rise. When the Fed does these two things, Washington's free ride will end--it will no longer be able to borrow at near zero interest. As a result, Congress will have to slash spending, fix our entitlements, and generally shrink government.
These are the right things to do today--they were the right things to do ten years ago. But soon they will become inevitable. We will have no choice.
My past books predicted the crash. This book goes a step further and lays out the steps we need to take in order to make this crash as painless as possible and to rebuild in the aftermath. We need to wind down entitlements, eliminate many government functions, and stop playing with the money supply and interest rates. America needs to start making things again, and the government needs to stop taking. As individuals and as a nation, we need to get out of debt.
And ultimately, we'll have to face up to the fact that we can't pay off all our debts.
The later chapters spell out the solutions, but these first two chapters describe the problem.
Our economy today is once again built on imaginary wealth. Like the proverbial house built on sand, it will collapse. When that happens, when America's tab finally comes due, it will probably be as bad, or worse, than the Great Depression. You'd better be ready for it.
From a Dot-Com Bubble to a Housing Bubble to a Government Bubble
To understand how bad things are and where we're headed, let's quickly go back a decade or so, and retrace the steps that brought us here.
Throughout the 1990s, the Federal Reserve injected tons of money into the economy, which fueled a stock bubble, focused particularly on dot-com companies. In 2000 and 2001, when the stock market turned down and unemployment started to creep up, that was a correction.
Assets that had been overvalued (such as stocks) were returning to a more appropriate price. The dot-com and stock market bubble had misallocated resources, and while investment was fleeing the overvalued sectors, inevitably the economy shrunk and unemployment rose while wealth became more rationally allocated around the economy.
Readjustments in the economy involve short-term pain, just as the cure to a sickness often tastes bitter. Short-term pain, however, was unacceptable to the politicians and central bankers in 2000 and 2001.
Federal Reserve Chairman Alan Greenspan manipulated interest rates lower. This made borrowing cheaper, inspired more businesses to invest, and softened the employment crunch. But the economy wasn't really getting stronger. That is, there weren't more businesses producing things of value. As there were few good business investments, all this cheap capital flowed into housing.
As housing values skyrocketed, Americans were getting richer on paper. This made it seem as if things were okay. In other words, Greenspan accomplished his goal of forestalling any significant pain. By the same token, he also kept the economy from healing properly, which would have laid the foundation for a stronger and lasting recovery.
When market realities started to bear down on the economy, and the housing bubble popped, with the broader credit bubble right behind, the government was running out of things to artificially inflate. So the Fed and the Obama administration decided to pump money desperately into government.
I'll explore this "how-we-got-here" story in more depth in Chapter 2, but for now, I'll make this point:
Just as the housing bubble delayed the economic collapse for much of last decade on the strength of imaginary wealth, the government bubble is propping us up now. The pressure within the bubble will grow so great that the Federal Reserve will soon have only two options: (a) to finally contract the money supply and let interest rates spike--which will cause immensely more pain than if we had let this happen back in 2002 or 2008; or (b) just keep pumping dollars into the economy, causing hyperinflation and all the evils that come with it.
The politically easier choice will be the latter, wiping out the dollar through hyperinflation. The grown-up choice will be the former, electing for some painful tightening--which will also entail the federal government admitting that it cannot fulfill all the promises it has made, and it cannot repay everything it owes.
In either case, we'll get the real crash.
The National Debt
As a professional investor, when I study the American economy today, I see debilitating weaknesses. Most obvious is the debt. As this book went to press, the national debt was $17 trillion. That works out to approximately $140,000 per taxpayer. Let's talk a bit about what this means.
Whenever the government wants to spend money it doesn't have, it borrows. Our government borrows by selling T-bills and Treasury bonds, or "Treasuries." The buyer gets an IOU, and the government gets cash. So, various bondholders--individual investors, U.S. banks, the Chinese government, the Federal Reserve, even parts of the U.S. government--hold in aggregate $17 trillion in IOUs. These bonds and bills come due all the time, and typically, the Treasury pays them off by borrowing again.
Every day, the debt grows. First, it grows because it accumulates interest. In 2010, taxpayers paid $414 billion in interest on the national debt, but that wasn't enough to keep the debt from growing. Another reason the debt keeps growing: our government keeps borrowing more in order to spend more.
Barack Obama's $800 billion stimulus in 2009, for instance, was entirely funded by borrowing. In Fiscal Year 2011, the U.S. Government spent $3.6 trillion, but brought in only $2.3 trillion in revenues. The extra $1.3 trillion--the budget deficit for the year--was paid for through borrowing.
As a businessman or the head of a household, if you spend more than you earn in a given month, you're doing one of two things: you're either spending down your savings, or leaving a balance on your credit card. But the federal government has no net savings. That leaves only one option: every dime of deficit is added to our national debt--plus interest.
State governments are in the red, too. Nearly every state ran a deficit in 2010, and the aggregate of state debt is about $1.3 trillion. Local governments owe a combined $1.8 trillion. Add that $3.1 trillion in state and local debt to Uncle Sam's $17 trillion, and our public debt tops $20 trillion. Much worse, when off-budget and contingent liabilities are thrown in, total government debt tops 100 trillion!
State of Bankruptcy
In some ways, our state governments are in worse shape than the federal government. While most states don't have huge ticking time bombs like Medicare, they have just as much--or more--trouble breaking even.
For Fiscal Year 2012, more than forty states were in the red. Twenty-seven states (a majority of states and a vast majority of the country) were running deficits of 10 percent or more, according to data from the Center on Budget and Policy Priorities.
California is probably the most famous of the insolvent states because of the massive size of its annual shortfall: more than $25 billion in 2012.
To poison the fiscal waters so completely, it took a special brew of big-government liberalism, anti-tax-hike ballot measures, powerful public employee unions, and ridiculous public pension laws. These factors created what Manhattan Institute scholar Josh Barro calls "California's permanent budget crisis."
Indeed, since 2005, the California state legislature has been fighting an annual "crisis." Barro explains:
California's permanent budget crisis stems from institutional failures. Ballot measures have made it nearly impossible to raise taxes or cut spending, and have cemented the idea in voters' minds that they can get government services without paying for them. The state has repeatedly failed to reform its inefficient tax code (which relies too much on highly volatile taxes on high-income people, and not enough on property taxes) or to tackle the problem of runaway public employee compensation.
California is special in many regards. (For instance, no other state has city managers paying themselves nearly a million dollars a year, as the folks of Bell, California, were caught doing.) But many of the problems with California are present elsewhere.
One is the tendency of states to go wild during boom years in revenue. Many individuals who did well during the boom years bought McMansions with huge mortgages on the assumption that every year would be just as good. Many states did the same thing. Nevada is a classic example. Nevada enjoyed faster population growth than any other state in the 1990s and most of the 2000s. This coincided with the nationwide housing bubble, and sent home prices through the roof. As a result, property tax receipts went way up. State and local politicians spent all this money on the crazy theory that Las Vegas--in the middle of a desert--was being "Manhattanized."
You might recall that Nevada was hit harder by the housing bust than any other state. Record foreclosures both sent people out of the state and dragged down property values. Revenues dropped, but expenditures didn't keep pace. The result: huge deficits.
Public employee unions are another central cause. Like any union, the American Federation of State, County, & Municipal Employees, the American Federation of Teachers, and their cohorts exist to get as much pay and benefits as possible for their members.
But unlike most unions, government unions are negotiating with people who are spending someone else's money: politicians. Often those politicians were elected thanks to campaign contributions from the unions. This is a vicious cycle: taxpayers pay government workers whose money goes to government unions, whose money goes to the campaigns of politicians, who approve more taxpayer money for the unions, who then contribute more to the politicians.
How has Washington responded to the budget crises in the states? Mostly by making things worse.
The 2009 stimulus bill included hundreds of billions of dollars in aid to states, allowing them to continue their spending binges. Had federal money not been available, states would have been forced to do the right thing and cut their spending.
Congress even took up a bill in 2011, the Public Safety Employer-Employee Cooperation Act, that gives special bargaining privileges to the unions of police officers, firemen, and emergency medical personnel. Many Republicans even backed the measure, probably because these public safety unions are far more supportive of Republicans than other government unions.
Bankrupt states are one more virus in our sick economy.
Government Driving People Deeper into the Red
The American people are pretty deep in hock, too.
Thanks to a housing bubble and artificially low interest rates, a lot of people borrowed money that they could not pay back in order to pay inflated prices for houses they could not afford. All told, Americans are laboring under about $13 trillion in mortgage debt.
But it's not in the past. After a brief period of paying down debt and increasing savings, thanks to the Fed, American families are once again borrowing more than they're saving.
Total consumer debt is $2.5 trillion, while credit card debt is $789 billion. That's a grand total of $16.2 trillion in personal debt, or $200,000 per family. In addition, federally backed student loans now top one trillion, exceeding total credit card debt for the first time in 2011. On the other side of the ledger is approximately $7,000 in savings per family.
In the next chapter, I'll talk more about how private indebtedness got so bad, but for now let me just note that bad government policy and the bad economics of the chattering class have contributed to this situation. Government rewards borrowing (the biggest tax deduction for most families is the deduction for mortgage interest) but often punishes saving (by taxing investment gains and interest on CDs and savings accounts).
The biggest culprit in discouraging savings, though, is the Federal Reserve. For one thing, the Fed creates new dollars, driving up prices. That means the dollars you sock away today are worth less when you pull them out next month. Better to spend them today.
Even when there is not a significant increase in consumer prices--such as existed from late 2008 through 2011--the Federal Reserve deliberately warded off falling prices by inflating the dollar supply. Put another way: the Federal Reserve is putting upward pressure on prices, and thus keeping the dollar from gaining in value.
The Fed also keeps interest rates artificially low. Were interest rates as high as the market would set them, and were dollars not being cheapened, people would have more incentive to save and less incentive to borrow.
Spending Is Patriotic
Part of the problem, peddled by the media and politicians, is the notion that prosperity comes from consumer spending.
Listen to any TV or radio newscaster discuss economic news, especially during a downturn, and there's one hard and fast rule for them: consumers spending more money is good, and consumers spending less money is bad. Shopping is good for the country. Paying down debt or saving is bad for the country.
That's not just overly simplistic, it's almost completely wrong. If people are spending money they don't have, that may be good in the short term for stores and manufacturers, but it's often bad in the long term for the whole economy.
If people are borrowing as a way to finance productivity, then indebtedness isn't bad, and it is often beneficial.
Sure enough, this isn't the first time Americans have borrowed lots of money. But in the past, we borrowed money to invest in productive capacity, such as building a factory. That factory makes goods at a profit, and that profit then pays off the loan. Today's borrowing and debt, however, isn't primarily for investment.
These days, because people are going into debt for the sake of consumption--buying a fancy dress or tickets to a basketball game--then U.S. indebtedness grows while productive capacity doesn't. That credit card debt doesn't go away. The dollar a person charges today is a $1.10 he'll have to pay off tomorrow.
Imagine a rational, well-informed owner of the general store in a small town. If he sees all his customers running up credit card debt, what is he going to do? He'll stop stocking the shelves as much, because he knows the day will come when his customers will max out their cards. Not only will the customers no longer be able to spend more than they earn, they won't be able to spend even as much as they earn, because some of their income will go toward paying off debt, plus interest.
When that day comes, the prudent storeowner might be fine--if he saved up his surplus from the boom days. Many downtown businesses will suffer: if they believed this boom in spending represented real wealth and so they expanded or hired more employees, those higher overhead costs will not be sustainable when the town's shoppers become more austere.
Yet, whenever the economy slowed down in the past decade, politicians always looked for ways to get people borrowing and spending as much as before. In other words, Washington wouldn't let people recover from their spending binges.
On September 20, 2001, nine days after terrorists took down the twin towers, President Bush told average Americans how they could help the economy: "Your continued participation and confidence in the American economy would be greatly appreciated." Bush urged Americans to go out and spend. (In contrast, when World War II broke out Americans were urged to save. The public purchased war bonds and consumer goods were rationed.)
Barack Obama rightly mocked Bush's version of civic duty, saying on the 2008 campaign trail of Bush after 9/11, "when he spoke to the American people, he said, 'Go out and shop.'"
But Obama was no different during the recession in 2009. A month into his presidency, he declared it his goal "to quicken the day when we re-start lending to the American people and American business." One of Obama's programs, "Cash for Clunkers" was designed to get Americans to buy cars they otherwise could not afford. So we destroyed fully paid-for cars that still worked, to go deeper into debt to buy newer ones, many of them imports, saddling car owners with additional debts at times when they should have been rebuilding their savings.
He put it more forcefully elsewhere in the same speech: "We will act with the full force of the federal government to ensure that the major banks that Americans depend on have enough confidence and enough money to lend even in more difficult times."
Of course, banks' lending more means consumers' borrowing more. Both Bush and Obama told the American people that when times are bad, they should run up credit card debt--it's the patriotic thing to do.
Saving Is Unpatriotic
While Obama was "act[ing] with the full force of the federal government" to get Americans borrowing and spending more, many people were--smartly--going in the other direction. In the second quarter of 2009, personal savings hit a seventeen-year high of 7.2 percent as a percentage of disposable income.
According to the Bureau of Economic Research, the American people saved $793 billion that quarter. This was at a time that personal income, at $12.2 trillion, was far lower than it had been during any point in 2008. People were behaving rationally--the economy had turned down, their friends and neighbors were losing jobs, and so people with income started saving it.
This had to stop, according to President Obama. Sure enough, artificially low interest rates and subsidies for home buying helped discourage people from saving, and the savings rate quickly dropped.
By the end of 2010, consumer debt was rising again, according to data from the Federal Reserve,1 and the contraction of overall household debt had ended. We were back on the road to "normal levels of lending," that is, normal levels of indebtedness. Mission accomplished.
Of course, the biggest problem is that savings is the key to economic growth, as it finances capital investment, which leads to job creation and increased output of goods and services. A society that does not save cannot grow. It can fake it for a while, living off foreign savings and a printing press, but such "growth" is unsustainable--as we are only now in the process of finding out (more on that later).