So, welcome gentlemen. Let’s start right off with the key question today, which is the commodity global market; what’s driving it? Is it economic fundamentals, is it in fact a bubble? Can you start us off, Peter?
Peter Schiff, president, Euro Pacific Capital (Schiff): There’s a lot of people who are bandying about the term “bubble” to describe the commodity market. I think because they missed the past two bubbles in the stock market and in the real estate market, people are very quick to call any movement upward in prices or homes that they don’t understand, a bubble. But I think we certainly did have bubbles in real estate and stocks, and in fact I was one of the few people who identified those bubbles before they burst. But I don’t think what we see is happening in commodities is a bubble; I don’t see the same characteristics that are driving the market.
I think what’s happening here is simply a reflection of what caused those prior two bubbles, which was too much money creation. Money has been debased, the Federal Reserve has created a lot of dollars. Because the dollar is the world’s reserve currency, foreign central banks - particularly in Asia and the Middle East - have been forced to forward a lot of money of their own to buy up all those dollars to prevent the dollar from falling, and so what we’ve seen is an unprecedented amount of global money supply growth. The result of that has been rising prices. As money loses value, you need more money to buy things, and commodities are getting more expensive in terms of depreciated currency; that’s all that’s happening.
Mike Norman, Hard Assets Investor, Economic Contrarian Update (Norman): Well, Peter touched on a lot of things, and basically I think he ran into probably our second topic of discussion. But let me start with what is driving the original question. I think the commodity bull market began - you can go back to 2001, in fact you can probably go back to the late 1990s, 1998, 1999 - commodity prices were very, very low; there was a tremendous amount of underinvestment in resource production throughout the world, and then as we moved into 2001, 2002, following the bursting of the dot-com bubble and the whole Internet stock market bubble, the world entered into a phase of growth upturn. It was a synchronized growth upturn that also included very important newcomers into the global economy in a way and a size that we never saw before.
Specifically, we saw countries like China, like India, come in as large consumers; economic growth consistently year-over-year in double digits. Most of these commodities at the time were trading for or priced below their cost of production. There was not great economic incentive to go out and develop these resources, as I mentioned. The market was basically caught short of these resources, and so there was a real economic fundamental underpinning to this move, which probably carried through until about, I would say, about 2004, 2005.
At that point, I think something started to change, or a new element entered into the equation. That element was that these commodity markets were looked at as assets in a way that really was not seen before. There was not terribly good performance in traditional assets and stock, and equity and bond markets. Investors started to look at rising commodity prices and buy into this notion that if you add raw materials, gold, oil and other commodities, it enhances long-term performance, it adds a level of diversification, it reduces risk, etc.
And at the same time, we saw the emergence of something absolutely new, which was this class of passive investor represented by large, large institutions, pension funds, endowments, that became long-only investors. They bought, they held on, and that was it. And allocation started to rise, and that’s, I think, the phase we’re in now.
I don’t know if it’s a bubble by any definition; I don’t know even know what a definition of a bubble is. If you want to call it a mania, I think to some degree, in some markets it might take on the appearance or it has taken on the appearance of a mania. Certainly pure economic fundamentals in many markets don’t justify, I think, the price levels that we are seeing, and that data shows.
I think I have a chart up here which shows money that has moved into these passive index funds. The data shows that over the last five years, the growth in this investment flow has been exponential and that has been a major contributor to demand, at least demand above and beyond physical demand related to any sort of industrial or actual consumption-based demand.
Zigler: Peter, your views about index investors?
Schiff: I agree with most of what Mike said, particularly when he described the environment in the late 1990s, because so much capital was being devoted or redirected to telecommunications and building fiberoptic networks, and nobody had any desire to explore for energy or other commodities. But the dynamics that have been set into place by the world’s central banks … remember that commodities have intrinsic value, but the paper currencies that we’re pricing them in do not.
Certainly if investors start to lose confidence in the purchasing power of the dollar or other currencies and would rather store their wealth in something tangible, you have to look at the situation that’s driving that; why is that happening? And it has its roots in the monetary excesses here in the United States and abroad, and that what’s really happening, is that these assets are adjusting to reflect not only the loss of value currently in paper currencies, but the prospect for our currencies to lose even more value in the future.
Zigler: Good point. As we’re on that point, do we have any specific examples about commodities in particular that are being influenced by our monetary policy?
Schiff: Certainly gold and other monetary-type metals, gold and silver historically have been used as money substitutes, and I think gold right now is relatively inexpensive relative to some of the other commodities out there, so I think it has quite a way to go. But I think if you measure the increase in commodity prices in terms of gold, you’ll see that the gains in most commodities are much smaller than the gain that you see when you measure it in dollars or other currencies that are depreciating - only not as rapidly as the dollar - like the yen or the euro or the RNB.
You don’t see nearly as big an increase when you price commodities in real money as opposed to fiat money. You put back the oil - oil back in 1970 was $3 a barrel when gold was at $35 an ounce, and if you at the price, the relationship between gold and oil today, the prices barely moved.
I think only recently maybe the price is maybe $4 or $5 a barrel based on what’s happened in the last couple of months with oil prices moving up to almost $140 a barrel, gold remaining around $850 to $900. But I think that relationship is going to change, and I think oil will be back down to around the $3-to-$4 level, very similar to the price in 1970. So what’s really happened is that money has lost value, oil prices haven’t done anything.
Norman: I take issue with Peter’s assertion that there has been this sort of enormous, monumental expansion in money. If you look at the monetary aggregates that the Fed has most control over, such as the monetary base in the United States or bank reserves, which the Fed controls directly, the growth in those indicators and those aggregates indeed are at - when you look at them at a year-over-year or even at a five-year rate of growth levels - the lowest levels we’ve seen in over 20 or 30 years.
If anything, you’ve got to argue that the Fed has been behind the curve, particularly recently and given the stresses that the financial system faces now. If you look at just the nominal level of money, like M2, even that, when you look at that on a year-over-year rate of change - nothing spectacular. I’ll tell you this, in the last 80 years, M2 has grown on average 6% annually, and currently its growth is at about 6.5% annually.
So don’t forget that most of what we call money is created in the banking system and it comes about as a result for demand for credit and loans - M2 measures a lot of that - and therefore, even if you look at bank credit also growing very modestly, I take opposition to that claim.
The second thing is that I don’t think there is a very strong link between the exchange, the foreign exchange value of the U.S. dollar in commodities for the following reason: If the United States currency, if the dollar loses value - let’s put it the other way - if the dollar loses value against some other currency, those who are buying in the other currency experience an increase in purchasing power; that is true, and it might temporarily add to an increase in demand for that particularly commodity. If your currency doubled against the dollar, you might be able to afford two units of oil as opposed to one.
But by the same token, and simultaneously, U.S.-dollar-based purchasing power of the commodity goes down, so the net influence to demand as a result of exchange rate adjustments is zero; it’s a wash. What influences the price of a commodity like gold or oil or anything else, certainly oil, is supply and demand; that’s what sets the price. Oil today is $140 or $138; it would be $138 whether you priced that in terms of euro, whether you priced it in terms of yen, whether you priced it in terms of Beanie Babies. That price has been arrived at as a result of supply-and-demand conditions, not the exchange value of the currency.
Schiff: On your first point, the government statistics that purport to show money supply growth – it doesn’t make any sense. If you look at the money supply growth reported around the world, money supply is growing at double-digit rates in every country around the world, particularly in Asian currencies. It doesn’t make any sense that the U.S. dollar money supply would be growing very slowly when all these other money supplies that are pegging to the dollar are growing rapidly. The only reason they’re growing rapidly is they’re having to absorb all the excess dollars. We’re causing the rest of the world to create so much money, and you have to look at not just money creation in the United States.
Remember, whenever the Chinese government creates RNB or yuan, they’re in effect creating dollars, because they’re basically pegged. They have the ability to print dollars just like the Fed, because every time they create RNB, they’re creating dollars. So money supply has grown all around the world, not just in the United States.
But sure, foreigners increase their purchasing power and Americans see their purchasing power diminished. the net demand for oil isn’t going to change; it’s going to just be reallocated. The Chinese are going to use a lot more oil because it gets cheaper for them. Americans are going to use a lot less oil because it gets more expensive for us. We’re going to see that in terms of rising prices, and if the dollar collapses, we can be looking at $300 or $400 a barrel, who knows? But the Chinese could be looking at the same price and seeing a decline in a price when measured in their own currency, and so the free market would therefore allocate fewer barrels of oil to Americans and more barrels to China.
Unfortunately, I think in the short run what Americans are doing (even though the price of oil is rising, our demand is not falling that dramatically), we’re finding ways to borrow the money to pay for the more expensive oil. In addition, Americans are refraining from other consumer purchases so that they can afford oil.
But eventually the rise in the price of oil will break the back of Americans’ ability to afford it, and Americans will see a dramatic reduction in the amount of oil that we use, and it’s going to be a very substantial change in our way of life. By the same token, that’s going to free up lots of oil for the Chinese, who will be able to turn in their bicycles and ride an automobile.
Norman: It might be true, but once again, you’re mixing up apples and oranges here. The rise in the price of oil has very little to do with the exchange value of the dollar or the exchange value of any other currency. It has a lot to do with real supply and demand, and some of that demand has to do with the Chinese driving cars as opposed to bicycles. Peter, you’re absolutely right there.
The other thing I want to say here is that you’re fundamentally incorrect in saying that the Chinese Central Bank has the ability to create dollars; it absolutely does not. The sovereign central bank of the currency-issuing nation - that is the United States, which has a sovereign currency - is the only entity that has the ability to create dollar reserves; that is it.
Schiff: But the RNB is in effect the dollar, because if somebody owns the RNB, they have the dollar. In fact, they have something better than the dollar, because the RNB can only go up; it doesn’t go down, but it’s pegged. So when you own the RNB, you can spend them as if they were dollars. Yeah, they are not dollars per se, but they act like dollars in the marketplace; they have the same purchasing power or credibility as dollars. For all practical purposes, they are as good as dollars.
Norman: You’re wrong, because the dollar is a nonconvertible currency and the Chinese cannot come to the U.S. Federal Reserve or the Treasury with a boatload of RNB and say, “We now want dollars.” They cannot do that.
Schiff: The Chinese can use their RNB to buy all the dollars they want. They’ve holding over a trillion of them, maybe getting close to 2 trillion now. They can print RNB until the cows come home and buy all the dollars that they want; that’s the point.
Norman: Peter, if they did that, if they printed paper RNB to buy dollars, the value of the RNB would decline to zero; they’d have no purchasing power.
Schiff: Mike, the value of the RNB is declining. That’s one of the reasons the price of oil is rising. All paper currencies are losing value; that’s the point. Everybody is printing because of us; we’re the exporter of global inflation.
Norman: I would recommend you look at a chart of the RNB and the dollar - and the RNB is rising, it’s up about 15%.
Schiff: The dollar is falling against gold, Mike; it is falling against commodities. When you measure one paper currency against another paper currency, you get a false representation because they’re all falling simultaneously. What’s different is the relative rate of decline. The dollar is losing value faster than the RNB, but both currencies are falling in value, and that’s why prices are rising for everybody.
Norman: The prices are rising, Peter, because of what we said before; it’s because of supply and demand, it has nothing to do…
Zigler: If I could ask you gentlemen this: We’re talking about the dollar’s rise relative to other currencies, relative to an asset like gold or oil. Where do you think we’re headed dollar-wise from here?
Schiff: I think the dollar is going a lot lower. I think eventually the world’s central banks are going to decouple from the dollar. Those currencies that peg to the dollar will de-peg, and I think the world will go to solve their inflation problems by allowing the dollar to collapse. And when that happens, our inflation problems are really going to come home to roost because the dollar is just going to plunge and prices are going to go through the roof for Americans. They’ll finally stop rising and maybe even fall substantially for the Chinese, but Americans are going to see the cost of everything that they want, that they consume, just literally explode through the roof.
Norman: I have a different take. Exchange rates fluctuate, let me say that. This is not the first time the dollar has experienced a period of weakness and it’s probably not going to be the last. But by the same token, the dollar since last November has been rising against the British pound, it has been rising against the Canadian dollar, it has recently now hit a four-month high against the Japanese yen, it is rising against the South African rand, it is rising against the Indian rupee, it is rising against many, many currencies in the last six or eight months with the exception of the euro. Now the euro is being influenced by policy from the ECB; they’re focused on inflation, they’re keeping interest rates and monetary policy tight, interest rates high.
It’s hard for me to imagine that a country like China - which depends so heavily on exports to the largest economy in the world, the United States, and they’ve done this through a sort of a financial engineering, by keeping their currency artificially low, by subsidizing export industries to the exclusion of domestic spending - it’s hard to imagine that they’re going to abandon this very important source of economic growth; they’re moving in that direction slowly.
And I grant you that this has been a contributory factor to the decline in the dollar against the RNB. However, they’re not going to just all of a sudden in one fell swoop give up that economic relationship, because it would be disastrous for their country.
Schiff: It would disastrous for our economy. See, we depend on them; they don’t depend on us. There’s a billion people in China. They’re perfectly capable of consuming what they produce; they don’t have to allow us that pleasure.
Norman: They why don’t they?
Schiff: Because they’re not doing it now because their government is suppressing the purchasing power of their citizens by keeping the RNB artificially low. If they allow the RNB to rise, the value of the average Chinese worker’s wages and savings would increase dramatically.
Norman: Peter, you’re just not paying attention to the facts. The RNB has been rising; it’s up almost 20%.
Schiff: It needs to go up a lot more than that, Mike. I think it could go up at least fivefold. You talk about the dollar rising or a big rally in the dollar. The dollar is at an all-time low against the Australian dollar right now.
Norman: The other thing is that there has to be no other motivation except for the fact that the Chinese desire to accumulate a dollar’s worth of exchange value. Because they’re essentially building finished goods and products, sending them to us, which we have the luxury of using and consuming, and they get a nonconvertible piece of paper in exchange. I don’t see how you can possibly say that they’re benefitting from that. You have to consume to live.
Schiff: Mike, we’re benefitting, we get something for nothing. Sure, people are accepting dollars. A couple of years ago people were accumulating subprime mortgages and they thought they actually had value, and one morning they woke up and they realized they had nothing but hot air. The same thing is going to happen. The Chinese are accumulating these dollars, our IOUs, because they think there’s real value there, because they think they can exchange them for something. When they find out they can’t exchange them for anything, the game is going to be over.
Zigler: What’s your opinion, gentlemen, about U.S. monetary policy and where we’re headed presently? Is the Fed doing something that’s going to help the situation vis-à-vis commodity prices for U.S. producers and consumers, or hurting them?
Schiff: I think it’s going to make it a lot worse. I think unfortunately we’re headed in a direction of hyperinflation right now à la Argentina or Weimar-Republic Germany. I hope we veer from this course. I don’t think that it’s a certainty that we’re going to experience that type of inflation, but if we stay on our present path we will.
What the Fed needs to do is dramatically and aggressively raise interest rates; not a quarter of a point but hundreds and hundreds of basis points, and they need to stop creating money, they need to stop buying government debt.
Now this is going to precipitate a massive collapse in our economy of course, but that’s the lesser of the two evils and the Fed needs to do it, and the Fed needs to impose discipline on government, on Congress, to have to rein in its spending, because when it can’t afford to borrow and when the Fed won’t monetize it by printing, maybe that will force the government to cut back on its spending. But unfortunately we don’t have Paul Volcker in the Fed, we have Ben Bernanke, and he’s leading us down …
Norman: The things he said right now are just flat-out ridiculous. I mean, first of all, I think the Fed has done the proper job up until now in focusing on growth and the very precarious and stressed nature of the financial system; that is a primary job and responsibility of the Fed.
Second of all, I think it’s absurd to think that if the Fed were to raise interest rates in a very draconian manner in the environment that we’re in right now, that somehow that would be some sort of a wonderful remedy.
It seems to me, that’s like saying you got high blood pressure, and in order to cure your high blood pressure, you commit suicide. It doesn’t make any sense at all. Furthermore, a government that spends and borrows in its own currency is never, ever, ever, ever spending-constrained. The only constraint it has is to what degree that spending creates a money inflation.
And again, I go back to the data. There is nothing in the monetary aggregates - whether you use the monetary base, bank reserves or M2 - that suggests that we are in some kind of a wild money inflation. So this assertion or this claim that we’re somehow headed toward the Weimar Germany, just that statement shows how little economic history you know, because Germany was forced to make war reparations in a currency other than its own.
That puts in a situation like what Argentina used to be in, when they were on a currency board. Any country that spends and borrows in its own currency is never, ever, ever spending-constrained; it can always pay its debts.
The only question we need to have here, the only debate we need to have here, is whether or not that spending leads to some sort of a money inflation, and I challenge you to show me in any of the monetary aggregates right now any sign whatsoever. I just went over it - of a money inflation - there isn’t.
Schiff: All you’ve got to do is open your eyes. The reason that my forecasts on commodity prices, on foreign currency, have been so accurate over the years has been because I understood this, because I understood inflation.
Norman: But you don’t.
Schiff: If you have the same assumptions, you’ve been saying short oil since it was $40 a barrel, stop $50, whatever. But the reason you didn’t understand that is because you didn’t connect the dots properly. You’re saying, where is the evidence that there’s too much money printing? I put it to you that $140 barrel oil, that $900 gold, grain prices where they are, industrial metal prices where they are, that the dollar exchange rate where it is, proves that we’re creating too much money. If we weren’t creating too much money, the dollar wouldn’t be so low and commodity prices wouldn’t rise.
Rather than looking at what the government says is going on, just look at what’s actually happened. Just because our debts are in dollars doesn’t mean we’re not going to have hyperinflation. If we print too many dollars to pay all those debts, they won’t have any value; that’s the problem.
I’m not saying that we’re definitely going to have that hyperinflation; we’re going to have it if we don’t change course from the path we’re on now. I’m hopeful that we will alter course, but we can’t do that without inflicting a lot of economic pain. But unfortunately, if we try to postpone that pain, the pain of hyperinflation is going to be far worse.
Norman: You’ve been a very strong voice saying that gold is a hedge against inflation now, and that corresponds to your view that somehow the Fed is creating a money inflation. We have a chart here of gold price in constant dollars. It’s one thing to say, “Well, gold is $900 on a nominal price basis,” but you have to adjust that too for inflation.
If you look at that gold price chart, you will see that gold right now is still far below where it was in 1980 when priced in constant dollars, which means that either gold has been a terrible hedge against inflation, or there is not the level of money inflation that you purport. So if we could get the chart up, people could see it.
Schiff: I look at the other way. First of all, I think that if we use a real measure of inflation and not the government’s measure, gold would even be cheaper than that chart suggests. But my point is, that just shows you how undervalued gold still is, how cheap it actually is in absolute terms. And people should buy it, because in a few years, the chart’s not going to look like that at all.
Gold is going to go parabolic, and so what people should do is recognize that there’s a lot of inflation out there that people don’t perceive, and when people start to perceive how much inflation there is and how much they’ve been lied to by their governments and by their central banks, people are going to rush to buy gold. The idea is to have it before, but yet gold is still very cheap, I agree with you.
Norman: That’s an opinion; that’s a forecast. What you’re saying is that we have had inflation caused by the Fed, and so that’s a statement, and it’s just not showing up in the gold price. Perhaps gold has not been a good representation of that; I do not know.
Now in contrast - and we have another chart here - if you look at the return, the inflation-adjusted return of the Dow Jones … by the way, from the period in question, back to 1971 when we de-linked from the gold standard, that has performed far better than gold, which means the growth in the economy and the return on stocks has been better, it has outpaced. It has in fact, I’ll tell you this, that going back to 1913, from the creation of the Federal Reserve, the stock market has returned on a inflation-adjusted basis 2.03% compounded annually, and that’s before dividends are taken into account.
Over the same period of time gold, has returned 0.85% compounded annually. If you put dividends into the stock returns, you blow away. So this assertion that ever since - this is data - ever since the creation of the Fed, you’re somehow been, as you constantly say, debasing the money supply, just does not hold water when you look at the facts.
Schiff: Let me just get a couple of other facts in. First of all, I would hope that over long periods of time, stocks - which actually represent investments - would outperform money, gold, and assuming no interest on the money if you’re just holding gold coins as opposed to making loans, but you’re using government inflation numbers...
If you just want to use raw prices, you can go back to key points. In 1929, the Dow was worth 20 oz of gold; today it’s worth 13 oz. of gold. In 1966, the Dow was worth 20 oz. of gold; today, as I said, it’s worth 13 oz. of gold. There have been periods of time - in 1932 and 1980 - when you could buy the entire Dow Jones for just 1 oz. of gold.
So there have been periods of time when stocks have been very expensive relative to gold, and there’s been periods of time when stocks have been very cheap. But you can go back to 1929 at the peak before the crash, when the Dow was at 360 in nominal terms. But in real terms - even though the Dow was knocked from 360 to 11,000 in nominal terms - in real terms, the Dow was gone from 20 oz. of gold to 13 oz. of gold. The Dow actually lost value.
But I’m a believer in stocks if you buy them cheap, if you buy them when the yields are high and you’re a long-term investor. I do that for a living; I’m a stockbroker. But I recognize that during periods of time in bear markets, it doesn’t make sense to ride them out. They can be severe, and I fully expect the Dow Jones to get down to close to 1 oz. of gold again, and when it does, I’ll probably buy it.
Norman: First of all, gold was held at a fixed exchange rate for decades and decades, so the release from the exchange rate caused it to achieve more of its equilibrium value, its true value. Second of all, I don’t see how you could skirt around the point. The point is that the real return of holding stocks has been far higher than the real return holding gold.
Schiff: I’m not trying to skirt around the point. You’re talking about an investment that has dividends compared to just money in a mattress. Obviously if you have gold, you can also lend it out, you can earn some type of interest on that gold; but you’re talking about over a 100 years.
Norman: We’ve got, I think, a chart here from 1971; we have both.
Schiff: Obviously, but Mike, if somebody bought stocks in 1929 versus buying gold in 1929, they’re better off in gold.
Norman: No they’re not.
Schiff: In 1966, the Dow was at 20 oz. of gold; it’s only at 13. Now maybe you made enough in dividends to offset for that huge decline, but you can also take gold and loan it out and earn a return. You can lend gold to somebody; you don’t have to just bury it in your mattress.
Norman: And that return that you owned is exactly equal to what the overall return was; it’s basically that we’re talking about the same thing here. And by the way, I don’t think we get anywhere - because we’re trying to have a serious discussion here - if you constantly fall back on this rationale or this excuse that the numbers are phony. We have to have some basis for an argument.
Schiff: Some of the numbers are phony.
Norman: I think then you’ve got to go and have this debate on a different website, like websites that believe in all these crazy stories.
Schiff: I’m not talking about some conspiracy theory bunkers somewhere, but the fact that government massages GDP numbers, inflation numbers.
Norman: How do they massage it?
Schiff: It’s a fact. Because they changed the way they calculate them, they changed the methodology.
Norman: They improve it.
Schiff: No, they don’t improve it; they improve it from their perspective. Look, take unemployment. At one point if you were unemployed, you were considered unemployed. Now if you’re unemployed but you’re not looking for a job, you’re not unemployed anymore. If you’re discouraged, you’re not unemployed. There are a lot of people who would have been counted in the unemployed statistics 10 years ago, 20 years ago, who today do not get counted because the government changes the definition over time over who’s unemployed. They did it with inflation. The government has changed the way they calculate prices. They introduced geometric weighting, substitution, all sorts of things so that we no longer have a fixed basket that we compare.
Norman: But that’s because you have improvements in things. Thirty years ago, you bought a new car.
Zigler: Let’s bring down the polaric a little bit here. I think we can both agree, I think we can all agree, that there is one figure that the government has not only changed, but has completely eliminated, and that is M3. The government doesn’t compute it any longer, and that’s of course the broadest measure of the money supply. Do you have a point of view on that?
Schiff: I think private people have estimated it; I think it’s growing still at double-digit rates.
Norman: Look, I would refer you to the Fed’s website and read their reason why. It included very, very broad things outside the U.S.: euro dollar deposits, things like this. Go to the Fed and read their reason why. I don’t know why we’re getting into why they dropped out of M3, M2. I started as a trader in 1979. That was when Volcker and the monetarism – we were looking at money supply figures every single Thursday afternoon. Everyone looked at M2. I don’t know how come there’s this conspiratorial thing about the dropping of M3. I’d like to go on to the next question.
Schiff: It’s not a conspiracy; it’s just the government did it.
Norman: I don’t think it adds to anything. Even if you had M3 up there … by the way. if you put M3 up there and if looked at…
Zigler: It’s a basis of comparison, since the other nations are still computing a broad M3 measure.
Norman: I’ll tell you this, Brad. The fastest-growing money aggregates are not the broader ones. If you put M3 up there, if you looked at it as I think it’s proper to look at it, which is either on a year-over-year percent change basis or on a five-year rate of change, you would not see very strong growth; it would be very similar to the 6.5% growth rate I talked about in F2. The fastest monetary growth rate right now is in what’s called MZM, which is Money of Zero Maturity. That is what you would call … like money market accounts, stuff like that … and that has been growing rapidly.
However, that is a reflection of fear and worry. People tend to put their money into safe money market accounts. If you look back historically and you look at other points in time such as right after 9/11 and right after 1980, right at the time of the 1980 stock market, ’87 stock market crash, I looked at these. The growth in MZM far, far surpassed the growth rate that we are seeing right now. So yes, while that money aggregate has been showing some acceleration recently, it’s nowhere near the rate of growth that we saw in previous times of crisis.
Schiff: Mike, you don’t even have to look to the government data to know that money supply is growing. All you have to do is see the results of the increased supply of money and look at the prices that everybody is paying for everything.
Norman: What about houses?
Schiff: Houses - even though housing prices are falling - the cost of home ownership is rising. You buy a house today and you look at what it’s going to cost to make your mortgage payment now because you have higher interest rates on the mortgages, the depreciation in the home, you look at the maintenance costs, you look at the costs of utilities -it actually costs people more to buy homes even though the prices themselves are falling. The cost of home ownership is actually rising.
Norman: I would say to people that do this, it’s something very easy to do. If you go to the Bureau of Labor Statistics, and you pull up the CPI, they give you the list of every single item on there. I’ve gone over this, and there’s not one single item in there - it includes food and shelter and clothing and education and medical costs and everything you could possibly imagine - there’s not one thing in my life that I don’t consume or use that’s not on that list. And look at things that have been going up rapidly, like energy -they say 40% increase year-over-year - I don’t think they’re lying about that, that’s what it is, and other things have gone down. You might argue, but I can’t find anything not included on that list that I don’t use every single day. I think that’s a very fair representation.
Schiff: Yes, but the government claims that all of those things are only going up at 4% a year; that’s pure nonsense.
Norman: No they don’t. Look Peter, you’re entitled to your own opinion but you’re not entitled to your own facts. I challenge: Go there and look at their energy increases: 40% year-over-year; they’re on there. Other things have gone down.
Schiff: What about the actual rate of inflation for the whole year? They’re saying it’s 4%; that’s nonsense. They’re not counting price increases properly; they’re distorting them in the process of measuring them.
Zigler: Let’s deal with this question as we … because I know we’re starting to get some participants wanting to pose their questions. About the resolution that may await us here, I think we can both agree that there is some level of inflation in commodity prices. Whether it’s accurate or not is another issue, but we all feel the pain at the pump. So the question that we have is, what’s the answer here? Should it be left to market forces to resolve this, or is there some intervention needed?
Schiff: I always prefer market forces. I never like governments to intervene. It’s the government intervention that’s created these problems. It’s a free market that’s going to potentially and ultimately solve them, but not without a lot of pain.
Norman: First of all, I don’t think it’s a free market; there’s a cartel that controls 40% of the world’s oil supply. The only country in the world that has any excess capacity right now is Saudi Arabia, which puts them in the position of the marginal price setter. They are the price setters because of that extra capacity that they have.
Look, I’m a big believer in the free market. I think right now we have a situation where prices are being distorted by this index. I’m not even going to call it speculation because traditional speculation like people buying and selling and providing liquidity and risk transfer to the market and part of the price discovery, that’s fine. I don’t think that has any contributory effect.
However, the long-only passive investors and the amount of money that has gone in … I don’t think frankly, as a matter of public policy, it is a good idea to allow these large institutions to essentially hoard scarce or ever-more-growing-scarce resources. I think that’s not good public policy.
Remedies are being discussed right now as we speak today. The Senate is holding more hearings on this, one of the proposals being - I don’t know if it’s going to happen, but it’s been suggested by Senator Joe Lieberman, who’s the chairman of one of these committees looking into this - an outright ban on this index speculation by pension funds and other large institutions.
If that were to happen (and I take sort of a centrist position; maybe I’m a little bit forward in a sense because I think markets are getting distorted to some degree, and people who are very, very vulnerable right now - low-income people, people around the world who have shortages - and we’ve linked the food inflation to oil via the biofuels), people are getting seriously hurt. I don’t think it’s good policy, I don’t know if they’re going to ban it.
They might just go with a less-aggressive measure, like saying the CFTC has to look into things a little bit more closely, but it’s something being considered right now. If they do that, I think you shut off a lot of the funding that we’ve seen since the last few years and prices will come [down] significantly. Long term, does oil go up? Probably yeah, but if you take this out, you’d have a serious impact to price right now.
Schiff: I actually disagree. I think that to the extent that the government is able to control what they consider speculation, I think they end up driving up the costs to producers; they make hedging a more costly … or in many cases maybe make it so you can’t hedge, and it makes production inherently riskier and more expensive. Most likely, whatever the government is doing is going to backfire, and it’s likely to lead to greater shortages and bigger price increases in the future that would otherwise have been the case had the speculators been allowed to remain in the market and to help pick up some of today’s supply for delivery into the future, which would ease prices in the future.
Norman: Nobody is proposing a ban on somebody who wants to go cash their paycheck and buy futures. We’re just talking about this institutional index speculation. And by the way Peter, I was a NYMEX member. I started as a NYMEX member in 1983 before there even was a crude oil contract and there was still hedging going on. There was still delivery of oils, there was still price discovery, and in fact, there are some markets where there are no organized futures such as steel, and the same thing happens: You get deliveries, consumers can hedge purchases, producers can hedge production, there is price discovery.
So I don’t think necessarily that … look they did it. The country of India back in May banned speculation, futures speculation, on a number of important agricultural commodities. When they did that, everyone said it was going to lead to shortages and food riots and prices skyrocketing. Exactly the opposite happened: prices stabilized, they de-linked from world prices, people had supplies, there were no riots, everything was very orderly. I don’t see why it wouldn’t be the same thing now.
Schiff: Governments are always trying to find scapegoats and they’re trying to blame speculators for rising prices to take the spotlight off of their own responsibility in their monetary policy for creating those higher prices in the first place. Just like all government programs, they’re going to backfire. Whenever the government tries to do something, they pass a law, they pass a bill, and whatever problem they were trying to solve, they end up exacerbating it.
By focusing on price instead of the cause of the rising prices - which is the money supply - we get distracted. You even mention yourself that there’s no futures market in steel, yet steel prices are going up just like markets where there are futures. Prices are rising everywhere. It’s not the speculators, it’s the monetary policy that’s doing it.
Norman: Again, I don’t know what you mean by “monetary policy is doing it,” because low interest rates did not create a shortage of oil in the world, nor will high interest rates suddenly cause us to find enormous new discoveries of oil. It’s an exogenous thing; it’s outside the influence of monetary policy.
Schiff: Prices are a function of the value of the money that you use to buy things. If money is diminished in value because it’s created in more abundance, if there are more dollars and more euros and more yen, then prices have to rise to clear the market. That’s supply and demand. If you have more supply of currencies, the currency has less value. Prices have to rise to clear the market.
Norman: Central banks do not target money supply, they target the overnight lending rate, and they are obligated. By that activity, they are obligated to provide whatever reserves, or take away whatever reserves to the banking system as demanded or necessary or needed by the banking system. That is totally determined, again exogenously, by demand from businesses and individuals who want to take on credit or hold cash. They do not target money supply. So they target interest rates; we’re going to have a 2% interest rate…
Schiff: The way the Fed is able to keep rates low is, it has to create money; that’s to buy government debt. It just can’t say that rates are lower; they have to actually do something to achieve those lower rates - and they go into the market and they buy up treasuries, or now they buy up mortgage-backed securities or credit-card-backed debt, whatever they have, and put more money into the economy and bring down the interest rates.
Norman: They put more reserves into the banking system to the extent that it achieves their aim of maintaining an interest rate; that’s it.
Schiff: But the process of doing that expands the money supply.
Norman: Not necessarily. The Bank of Japan from 1996 on kept the interest rate at 0% and money didn’t grow at all. You have to have demand for money in the private sector, even in the form of credit, or some money, bank accounts … you have to have demand for money for that to be created. Any bank is never constrained by reserves. If a bank is in business to make money, if it sees a lending opportunity and it doesn’t have reserves, it could borrow reserves and the bank creates the money, not the Fed.
Zigler: Gentlemen, I think we’ve touched on this subject sufficiently. We have a number of questions that have been posed from our other participants. First of all, one participant asked about the ratios between the oil and gold, and how telling these ratios are. They have been skyrocketing in favor of oil with respect to the oil/gold ratio. What do those kinds of indicators tell you?
Schiff: To me it says that oil is expensive right now relative to gold, but I think more important, it’s a better way to measure. When you have a ratio of oil to gold, it’s just a better way of measuring the real price of oil, because you’re measuring it in something that doesn’t diminish in value over time, like a fiat currency. So if you really want to see what’s happening to oil prices, if you denominate them or relate them to gold rather than to the dollar, then you have a better picture of what’s actually happening.
I think when you do that, you see that oil prices until very recently haven’t really risen at all; it’s simply been money that’s lost value. Now I think that what’s happened recently is a temporary diversion. I don’t think much of it other than a buying opportunity for gold, and I think gold will catch up to oil.
Norman: My answer is that the price of commodities are set by supply and demand. I’m not sure you can really factor anything in to these ratios other than as Peter said - I would agree with him - there could be times when the disparities are so huge historically, you get a reversion back to the mean; that’s about all that I could add to that.
Zigler: Some time ago, you were both on Fox News. Mike, you said the weaker dollar is definitely adding as a stimulus to the economy. If the Fed devalues the dollar lower, what impact is that going to have on prices?
Norman: On prices? Well, it will have a negative impact, or I guess you could say, a positive impact on import prices, which will go up, and we’ve been seeing that. There’s no question about it. Imports comprise about 15% of the GDP, so it has an impact and it’s been high, it’s been elevated recently. But the economy here is big enough that we can still weather this. On the flip side of this is that one of the only areas of demand growth in the U.S. economy on the private sector side - not coming from government spending - one of the only areas where we see growth in aggregate demand has been in exports, so this has been helping to the extent that a lot of companies now are tapping into this trend, and that’s keeping the economy from going into a recession.
If the Fed were to change that now, I think the question is, if the Fed continues to lower rates, I think that will be a support for the economy. If the Fed tries now to target the dollar and push it up, I think it’s going to have a negative effect because you’re going to shut off an area of growth in the economy where there aren’t too many right now.
Schiff: I think that we’re actually already in a recession; I think it’s going to get worse. When the Fed creates money or debases the dollar, it doesn’t just cause import prices to rise, it causes all prices to rise - prices of products produced domestically, because remember, domestic products still need resources, that as prices rise, are incurred costs.
A lot of American manufacturers have imported components in their parts, and so the cost of those imports goes up. But also American manufacturers or producers have the option of selling their products overseas, so as the dollar comes down and an American farmer, for example, can get more money by selling his corn in Asia, then that’s where he’s going to sell it, and the Americans are going to have to compete.
The only prices that probably won’t go up dramatically will be services that are incapable of being exported, so the price of a haircut or a massage or something like that probably won’t go up as fast. But everything that’s capable of being exported will go up in price dramatically as a result of the decline of the value of the dollar.
Norman: I know we’re just going to take one more question, but I’d like to make a quick response to that - that interest rates are an input cost into production. Interest is also something the government pays, so the higher the interest rate goes, the more it pays out in interest to savers, and that results in an income boost to them.
Schiff: Unfortunately most of those people live abroad right now, so it hurts us.
Norman: The numbers here on savings, if you look at money and money market accounts … if you look at money holders of government bonds, which the government directly pays interest on, it’s still a pretty significant number.
Zigler: With respect to that, gentlemen, this will be the final question that we’ll have time for: What do you think about the Fed’s balance sheet; is it telling the whole story?
Norman: Yeah, what you do mean? The Fed right now has about $950 billion in assets; there are about $880 billion in currency in circulation. All the currency therefore is backed. What story do you want it to tell?
Schiff: The big problem with the Fed’s balance sheet is now it’s increasingly composed of mortgage-backed securities and securitized products that are backed by credit cards and auto loans and all of that.
Norman: What percent, Peter?
Schiff: It’s several hundred billion right now.
Zigler: We’ve got about $850 billion in treasury shares.
Norman: Yeah, most of it is in treasury.
Schiff: We’ve got $400 billion I think in these other assets …
Norman: The Fed has like a $950 billion balance sheet.
Schiff: The balance sheet of the Fed is now comprised of very shaky and questionable collateral. My thinking is that it’s going to continue in that direction, and ultimately the Fed is going to be buying up a lot more mortgages because a lot more of them are going to go bad, and they want to try to pretend that these assets still have value, and they want to take them off the books of all the lenders and all the investment banks that hold them. So the Fed keeps taking this security in and substituting it for treasuries.
Norman: Brad, you’re right. More than 50% of the assets on the books of the Fed are U.S. government securities. I can conclude by saying this: Peter, if you had $10 million in cash and I had $10 million in treasuries, we’d both be going to the same country club; there’d be no difference between me and you. In fact, I’d probably be a little bit better off because I’d be getting interest on my treasuries. In other words, those things are as good as money.
Zigler: Gentlemen, on that happy note that we’re all going to be making money so that we can afford country club fees, I’d like to thank you for taking the time to chat with us today. Your insights have been invaluable. I wish we had more time to continue this. Once again, thank you for being here, we greatly appreciate it. |
5 Ratings
Loading data ...
Peter just makes too much sense. Mike gets dominate again. Miiiiike, why can't you get it???