I recently had a great conversation with Peter Schiff, author of Crash Proof, the famous book in which he predicted the 2008 financial crisis. We discussed his new book, The Real Crash, how investors can protect themselves with foreign bonds, and how the country could prevent the real crash from happening.
Peter Schiff On The Real Crash
I started our conversation by asking him to explain the difference between Crash Proof and The Real Crash. His answer is not for the squeamish. In Peter's view, the crash that he predicted in his first book has still not happened. In short, the 2008 real estate crisis was simply "the tremor before the earthquake."
What is the real crash?
A crash in the value of the US Dollar and US Government debt which leads to hyperinflation. In Peter's view, all of the problems that we had before the 2008 "tremor," including too much debt, institutions that are too big to fail, and too much government intervention in the markets are all even worse now. Eventually people are going to "wise up" and stop buying US government debt. When that happens, interest rates will skyrocket and we will have to either default, or seriously devalue our currency in order to pay bondholders back.
How Investors Can Protect Themselves
While there are plenty of people who talk about the problems, very few provide an actionable plan to deal with the crisis, and actually protect your investments from the crash. One of the reasons Peter is so popular is that he not only defines the problem, he gives just such a plan. The good news is that Peter told me the investment advice that he gave in Crash Proof still stands. Here is a very brief summary of that advice:
- Invest in the stock and bond markets of countries who have their fiscal houses in better order than the US.
- Get out of the US Dollar by making foreign investments in their local currencies
- Own Gold
- Stay Liquid
Peter Schiff On Foreign Bonds
Needless to say, Peter does not recommend investing in US Treasuries. He likes the bonds of countries which he feels are in much better financial shape than the US, such as Canada, Australia, Singapore, and Hong Kong. For the clients of his brokerage firm Euro Pacific Capital and his mutual fund company Euro Pacific Funds, they are buying foreign bonds with short durations. This means three things for investors when compared to investing in bonds with longer durations.
If interest rates go up, the value of bonds with short durations will not fall as much.
The bonds mature sooner, so if interest rates go up you will be able to lock in the higher rates sooner as well.
It makes the bond investment more like an investment in the country's currency that allows you to earn some additional yield when compared to a pure currency trade.
Taxes on Foreign Bonds
One very interesting and important point that Peter also brought up is that when currency gains are realized, they are taxed at your ordinary rate of income. Take an example where you buy a Canadian bond, and between the time you buy and sell the bond, the value of the Canadian dollar increased against the US dollar. In this example, the gain on the currency portion of the transaction is taxed as ordinary income, and not as a capital gain as one would expect.
This is one of the reasons why they like floating rate debt, whose interest rate adjusts up and down with inflation. By buying foreign floating rate debt, you do not have to sell and realize the currency gain if interest rates go up in order to benefit from higher rates. This is also one of the reasons why Peter likes foreign stocks. Since stocks never mature, you are never forced to sell and realize the currency gain.
I asked Peter what he thought the time-frame was before the dollar loses substantial value and these investments really start to pay off. Did he think it would be 2 or 3 years or 10 years? He said that he thinks it will be a lot sooner than 2 to 3 years from now.
Peter Schiff on how to fix the government
Unfortunately for the conspiracy theorists out there, Peter does not believe that the Federal Reserve and other behind the scenes players are conspiring to cause hyperinflation. He thinks that it's something much more simple. The Ben Bernankes of the world think they know so much about the economy and how things should work, but the reality is that they don't. The problems are coming from ignorance and not from a conspiracy.
In Peter's view, our problems started when we began moving away from our roots as a republic to become a democracy. In order to get things back to where they should be, we need to enforce the constitution and limit the role of government. If we are going to loot the minority to pay off the majority, we can't survive. To help sum things up, he pointed me to the following quote from the Alexis de Tocqueville, author of the famous book, Democracy in America:
"A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship. The average age of the world's greatest civilizations has been 200 years."
The optimist in me wants to believe that we will heed the warnings from people like Peter and tackle the big problems together as a nation. Unfortunately recent history and the realist in me think otherwise.