Submitted by David Galland of The Casey Report
The Road To Perdition
David Galland interviews Terry Coxon, The Casey Report
Coxon worked side by side with best-selling author Harry Browne for
years and is a rare expert in the arcane study of monetary systems. His
remarks at this juncture in time, a time that might end up labeled in
the history books as “Money Runs Wild,” are especially germane.
You were involved with Harry Browne during the last great inflation in
the U.S. How does the increase in the money supply that kicked off in
2007-2008 compare in terms of scale to what went on leading up to the
inflation in the ‘70s?
Terry Coxon: The
comparison is pretty muddled. In terms of the M1 money supply – the
total of checkable deposits and hand-to-hand currency – we haven’t yet
gotten near the persistently high growth rate that occurred in the
1970s. But the growth in the monetary base has been far more rapid than
what happened in the 1970s. There is some time delay between growth in
the monetary base and growth in M1, but to make the picture really
cloudy, I'm afraid the comparison turns out not to be very useful.
Unlike in the 1970s, the Federal Reserve is now paying interest to banks
on their reserves.
In other words, the effect is that much of the
increase in the monetary base gets locked up and sequestered because
banks want to earn the interest on the reserves rather than lending the
reserves out or buying investments and increasing the money supply.
DG: You are referring to the excess reserves banks have left on deposit with the Fed?
Why do you think that the Fed is paying interest on those reserves?
With policy makers and pundits saying that the economy needs a shot in
the arm and a dose of inflation, why would the Fed continue to encourage
banks not to lend or invest, by paying them interest to leave the money
TC: If the Federal Reserve didn’t
pay interest on those reserves, the result would be inflation rates far
beyond anything the U.S. has ever experienced. The monetary base has
more than doubled, and without the Federal Reserve paying interest on
the recently created boatload of reserves that is essentially keeping
them immobilized in accounts at the Federal Reserve Bank in New York,
the M1 money supply would more than double and we would have inflation
rates that would make the worst days of inflation in Brazil and
Argentina look tame.
DG: I know you can't give a real number, but what general level of inflation are you talking about?
TC: Close to a doubling in the CPI in a year's time. Doubling the CPI over the course of a year would be an inflation rate of 100%.
But on the other side of the equation, a deflationist would say that
even if they stopped paying interest on those excess reserves, there is
no loan demand, so the banks can't find anybody to loan to. If that’s
the case, how does the money get out into the system?
If a bank has excess reserves and the Federal Reserve stops paying
interest on them, if the bank can't think of anything else, it will buy
Treasury bills, even if the yields on those Treasury bills are only 0.5%
a year. Then the seller of the Treasury bills has the cash.
the seller of the Treasury bills is, we can safely assume he sold his
T-bills because the cash was more attractive to him. And if the cash is
more attractive when it's earning zero, that means the person who sold
the Treasury bills wants to use the cash to buy something else, and
that's how the excess reserves would move from the banks to the general
DG: What about the role the carry trade
plays in all of this? If banks can’t get a return in the U.S., might
they take the money and spend it elsewhere or invest it in countries
where interest rates are higher? That seems to be going on today, in
which case, wouldn’t we effectively export our inflation?
It does have an inflationary effect all around the world, and it also
puts the markets generally on a very fragile footing when you can borrow
U.S. dollars at an artificially suppressed rate of 0.5% and buy New
Zealand dollars and earn 2%. That has the effect of propping up the New
Zealand dollar. And it promises a profit for the carry trader of 1.5%,
but actually collecting that profit depends on exiting the trade at the
The carry trade is in just about every market at this
point. People are borrowing dollars at ultra-low interest rates in the
hope of earning a higher return in something else and also hoping to
exit at the right time. Virtually all markets have been propped up by
the carry trade, and all the carry traders are telling themselves they
are going to jump ship at just the right time. When the time comes, the
rails of the ship are going to be crowded, and markets likely will move
down very rapidly.
DG: Discuss the effect of the
carry trade on the dollar. As you said, at this point in time there is a
robust dollar carry trade, with people borrowing dollars and using them
to buy, say, New Zealand bonds or whatever. So, what effect does this
have on the dollar?
TC: The carry trade is the
proximate cause of the decline in the dollar in foreign exchange
markets. If you look at the whole process, it starts with printing by
the Federal Reserve, but the step that occurs just before the price of
the dollar goes down is the decision by traders to borrow dollars and
buy other currencies. When the carry trade comes to an end, the process
will go into reverse, and the dollar will rally.
DG: So this would again tie back to interest rates. If U.S. interest rates start moving up, then the carry trade begins to unwind.
TC: It wouldn’t even take that, just an expectation that interest rates on dollars are about to move up. That would do it.
Yet, historically gold and interest rates and inflation all tend to
move up together. Not to get all tangled up, but if interest rates in
the U.S. move up and the dollar starts to strengthen, shouldn’t gold
then start moving down? But again, that's not the historic case.
It’s not as tangled as you think. The answer you are going to come to
for gold depends on what is causing interest rates to move up. If
interest rates are moving up because the expectation of inflation is
moving up, then that won't hurt gold, it will help gold. On the other
hand, if interest rates are moving up because the Federal Reserve is
tightening, then that is bad for almost everything that people have been
borrowing to buy, which includes gold and silver and stocks generally.
DG: And New Zealand dollars.
TC: Yes, foreign currencies as well.
With the carry trade, the interest rate differential is an important
thing to understand, and right now the U.S. is clearly behind the curve
in terms of its interest rates. So the question is… could this situation
continue for quite a while, with the dollar kept cheap by the carry
trade? Can the dollar just keep going down until it evaporates, or are
you seeing signs of an alternative outcome?
The road to perdition has zigs and zags and loopbacks, and what causes
the loopbacks is a shift in what the Federal Reserve currently perceives
as its worst nightmare. For example, in 2008, 2009 and into 2010, the
Federal Reserve was worried primarily about a deflationary depression,
so it turned on the printing presses.
More recently, inflation has
returned as a worry, and that can turn into worry number one on any
given day, at which point the Federal Reserve will slow down the
printing or just sit on its hands for a while. That's when interest
rates will start moving up, and that's when the carry trade will get
unwound, triggering a big downdraft in virtually all markets. But the
prominence of inflation as a worry will eventually be replaced by
renewed concern about the economy contracting, and then the Federal
Reserve will shift its weight again from one foot to the other.
Which brings us to the 8,000-pound gorilla in the room: the debt. Our
readers, and pretty much everyone else, knows that the U.S. government
is sitting on the largest pile of debt in history, and that much of this
debt has been generated for no real useful purpose.
Rickards made the point at our spring summit that the last time
government debt was anything close to this as a percentage of GDP was in
World War II. And he pointed out that the money spent back then
essentially bought a victory in World War II, leaving the U.S. with a
very strong economy and leverage over other economies. But those
advantages have been squandered. Now in exchange for all the debt that
has been rung up, Rickards points out that the country has little more
than a lot of flat-screen TVs.
I think it was probably our very
first meeting after you joined Casey Research, sitting around the table
in San Francisco, that I asked, "Is there any way out?" This was back in
2004, and Doug Casey and Bud Conrad and you took turns answering, with
the answer being essentially the same, "No, no way out and the situation
is going to end badly."
And here we are seven years later, and
the government’s debts have only grown. Obviously, inflation is the
standard approach the government is likely to use to relieve itself of
its debt over time, but I wouldn’t rule out an overt default of some
sort. Regardless, it seems like the country’s economic future is going
to be determined by the debt.
So, let me ask you the same
question, do you see any way out? Are there any options left to the
government that don’t lead to economic chaos?
If by some miracle the people who run the government decided that Big
Government was a bad idea and small government was a much better idea,
and so they set about ending government programs and pushing the level
of federal spending way down, along with the level of regulation over
the economy, then there would be a way out.
But how likely is that
to happen? The time horizon for people in politics is maybe one or two
years, just about the same length of time there is before the next
election. Their goal is always to survive the coming election. That
means what is rational for the politicians looks irrational to everyone
else, and I don’t see any reason to expect that to change. The purpose
of a politician examining a problem is not to solve the problem but to
find a way for someone else to get blamed for it.
Doug and I have both written about the fact that we are living in a
steadily degrading democracy at this point, with the public voting
itself all manner of benefits from the public trough. Personally, I
don’t see how we get to the point where politicians, where the voters,
decide that a much smaller government is a much better way to go. At
least not unless and until we're forced to. Do you think this situation
can drag on, or will the size of the debt and deficits force a change
sooner rather than later?
TC: That's a political
question. At some point, the situation may become so catastrophic that
people are forced to learn new habits and consider new ideas, but things
have to get pretty bad before that happens.
DG: And how would you rate the odds of it getting pretty bad before this is over?
TC: Very high.
DG: And the time frame? You typically say these things are variable and unknowable, but can you be a bit more specific?
TC: It takes a long time. It's not going to happen this year. It's probably not going to happen next year.
DG: But hasn’t this been a long time coming?
TC: Yes, it has, and that should tell you that the process is a slow one.
So in your view, what are the one or two most important things that
readers need to be doing to protect themselves at this point?
I think the most important thing someone can do is to understand what's
going on. That's what will give the individual staying power when the
markets are temporarily moving against them. The worst thing you can do
is to just pick a leader and do whatever he advises without thinking it
through and understanding it. What makes that a bad approach is that no
matter which intellectual leader you might choose, there are going to be
periods when he is wrong and when his advice is not working for you.
And even if he is right in the long run, you may not stick with him for
the long run if you don’t understand why his advice makes sense. So I
think job number one is to understand what's going on, so that you’re
not blindly relying on anyone's advice.
DG: What's job number two?
Job number two, if you see the world as I see it, is to make sure that a
substantial share of your wealth is in precious metals and perhaps in
foreign currencies, but without any leverage.
DG: Thank you very much.