Peter Schiff, the president and chief global strategist for Euro Capital Management, is a star of sorts on YouTube, especially among the contrarians and gold bugs. One popular video clip, entitled Peter Schiff Was Right (2nd edition), includes an August 2006 appearance on CNBC, in which Mr. Schiff’s dire economic outlook was ridiculed by Art Laffer, a key economic advisor to former U.S. president Ronald Reagan. “The U.S. economy has never been in better shape,” said an incredulous Mr. Laffer, in response to Mr. Schiff’s prediction that Americans’ home equity was destined to evaporate, the U.S. consumer was set to embark on a long hibernation and a deep, long recession was near. “I think Peter is totally off base. I don’t know where he’s getting his stuff,” Mr. Laffer told the CNBC host. It is now clear Mr. Schiff saw what others ignored. Still, many contend the worst is behind the United States, largely due to the unprecedented action from the White House, Congress and the Federal Reserve to avoid another 1930s-style depression. However, Mr. Schiff is among those who believe the worst is yet to come for the U.S. economy. This bleak group argues that all the U.S. policymakers have done with the trillions in stimulus -- through the expansion of the Fed’s balance sheet to spending on construction projects and schemes like cash-for-clunkers -- is delay the day of reckoning by a year or two. “The people who are touting this recovery still don’t understand the real problem we have to recover from,” Mr. Schiff says in an interview with the Financial Post. “We have an economy that is a big leveraged pyramid -- it is almost like a Ponzi [scheme] economy. It can’t work. The problem is the politicians find a way to bring it back up.” Mr. Schiff, who is likely to campaign next year to become a U.S. senator for the state of Connecticut, says policymakers are attempting to maintain the status quo, whereas what’s needed is a recession that separates the weak from the strong, and forces households to scale back their debt-induced lifestyles. “What’s the new lease on life? Flood the world with cash,” Mr. Schiff says. “And the result once all this money is spent? We are in a deeper hole than we were before.” He has a point. The White House’s Office of Management and Budget warned last month the cumulative 10-year deficit is expected to reach a stunning US$9.05-trillion. Other analysts, meanwhile, contend the shortfall looks far worse when you incorporate the unfunded liabilities within the social security and medicare schemes, which the government is reluctant to do. When these factors are taken into account, they say, the U.S. deficit in the previous fiscal year, ended Sept. 30, 2008, was US$5.1-trillion, not the US$454.8-billion as reported by the U.S. Treasury. This massive amount of debt is destined to become the albatross around America’s neck, naysayers warn. What appears to be a recovery in the making is nothing more than a temporary replenishment of inventories after they were drawn down drastically following the events of a year ago. Instead of steady growth, the United States could head back into recession, or a depression, the pessimists say. Along the way the world’s largest economy could see a massive devaluation of its currency, hyperinflation and, perhaps worst of all, social unrest. Most lay blame with Washington, either with the Fed, which has allowed its balance sheet to balloon to over US$2-trillion to avert a 1930s-style depression, and Washington, for running up deficits for years before the recent stimulus is added on. The Fed has played down the risk of inflation. Others say this is nonsense, given the amount of liquidity policymakers have made available that is bound to chase goods. “The Fed succeeded in the process of stopping price deflation. But the side effect is to unleash inflation that will be very difficult for it to stop,” says Eric Janszen, founder and president of iTulip Inc., an economic forecaster and consultancy. As the bears see it, the amount of debt the U.S. Treasury needs to issue to finance day-to-day operations will drive up bond yields, and hence borrowing costs across the spectrum. Further, the amount of debt will eventually pull down the value of the U.S. dollar -- and the drop could be acute if foreigners who have gobbled up the bonds over the years take a pass. That would ultimately force the Fed to step in, print money and act as a buyer of last resort. John Williams, an economist and publisher of the Shadow Government Statistics newsletter, says countries like China and the Gulf states have expressed their concern about U.S. debt by wondering aloud about a new global reserve currency. He acknowledges that there may be some arm-twisting and covert deal-making to get foreigners to continue buying treasuries. But he reckons the Fed will be left with no choice but to take on treasuries, as it has recently as part of its quantitative easing program, or risk further disruption to the U.S. economy and equity markets. “The foreigners will not be there because the U.S. dollar is a sure loser,” he says. “These people aren’t stupid. We are going to end up like most countries that spend more than they can [afford] which is rev up the printing presses and pay it off in cheap currency.” Meanwhile, Mr. Janszen and others warn that once Americans realize their plight -- mired in debt, facing higher prices and having less take-home pay from the inevitable tax increases to pay for burgeoning government deficits -- they might turn to political alternatives that could send shock waves across foreign markets. “It will lead to the election of populists that will probably make things worse for everybody,” warns Axel Merk, president and chief investment officer of Merk Mutual Funds, which manages US$416-million on behalf of clients in funds. One of the big risks populists might bring in terms of policy is stripping the Fed of its independence, especially if consumers and legislators revolt in response to aggressive rates hikes to combat inflation. “Everyone is trying to recreate the past, but it won’t work,” Mr. Janszen warns. “All these efforts to maintain the status quo will lead to worse crises. We are going to have to take a hit to our standard of living for a period of time. That epiphany will occur.” Financial Post pvieira@nationalpost.comBUSINESS
U.S. economic recovery 'can't work': Peter Schiff
Monday, 21 September 2009
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