In December of 2007, as Apple was approaching $200 a share, you couldn't say a word about it for fear of backlash from the Apple investment community that insisted it was going to $600 a share. Today, Nouriel Roubini and Peter Schiff are considered gods for predicting the economic turmoil, and anyone discrediting their teachings should be burned at the stake. Well, get the gas and matches, because I have to say that Peter is full of Schiff in his latest article.
A broken clock is still right twice a day. The problem is this: If you look at that clock at that exact "right" moment in time, you should not automatically assume that the clock is always right. Warren Buffett came out recently and said how "dumb" he was in 2008. Should we then assume that Buffett is doomed to be eternally wrong in the future?
The "Credit" Economy
In this March 2nd article on SeekingAlpha, Schiff posits that the government's plan to restore the flow of credit is somehow a plan to entice people to leverage themselves further to the hilt.
Government efforts to simply make credit available, without rebuilding productive capacity or increasing savings, are doomed to destroy what's left of our economy.
True. But then he goes on to explain how a "real economy" works in simple terms:
Suppose there is a very small barter-based economy consisting of only three individuals: a butcher, a baker, and a candlestick maker. If the candlestick maker wants bread or steak, he makes candlesticks and trades. The candlestick maker always wants food, but his demand can only be satisfied if he makes candlesticks, without which he goes hungry. The mere fact that he desires bread and steak is meaningless.
He continues, explaining what would happen if the candlestick maker began borrowing steaks and bread, issuing IOUs, yada yada, until there was a natural disaster that destroyed all the equipment and nobody could produce anything any more. The takeaway lesson: If everyone maxes out their credit cards and a meteor hits Earth and destroys every business and piece of equipment, our economy might have some problems.
(I've got news for you Mr. Schiff: Not everyone is leveraged to the gills.)
Growth in the "Real" World
Let me propose a different scenario to Schiff's doom and gloom economic outlook. We have the same three players above, but we also have a city down the street with ten unemployed, starving citizens. The butcher employs one of these citizens so that he can work a little less. That citizen, now enjoying a paycheck, buys a candle. With increased demand, the candlestick maker hires a citizen, who in turn starts buying bread.
And so on and so forth until all ten citizens are employed.
Credit in the "Real" World
Everything is hunky dory and the three empires — bread, meat, and wax — are expanding into neighboring cities. Demand is through the roof, and the businesses rapidly expand. To fuel this expansion, the three companies put themselves on "credit" — borrowing from each other in the short-term to finance growth. (Example: The candlestick maker needs the fat from the cows to make candles. He'll pay for that fat when he sells the candles.)
Short of a Peter Schiff natural disaster that wipes out the machines needed to make the materials, this system works just fine.
Debt in the "Real" World
The citizens, enjoying their newfound wealth, start spending like crazy — some beyond their means. A few citizens start banks; some start clothing shops. A small portion of them — say, 10% or 20% — borrow too much from the banks to buy from the clothing shops.
It's fine while the system is working; but, along comes a draught. Grains dry up, which puts the baker in a bind. With grass in short supply, cows aren't as fat; so, meat is scarce. Less meat means less material for candle wax.
Not able to produce as much, the "Big Three" employers lay off workers. Some (though not all) of those workers are overextended on their debt; so, they blow off the bank. The bank begins to lose money; so, they stop lending to everyone else.
Unable to borrow money to purchase threads to make 1,000 shirts, the clothing maker now has to make just 400 shirts.
The economy now hits a critical point, at which a decision must be made. Do we let it "work itself out," knowing that we will have real pain and shrinkage at all levels until we find balance, at which point we will have flushed the bad debt out of the system? Or, do we help free up credit so that the rest of the system isn't poisoned by the draught hurting the Big Three?
Finding a Balance
Where Schiff and Roubini have it wrong is in the end result. According to them, everything in the economy is going to zero. We have to reboot the system, which means that we'll all move out of our homes and into the woods to start picking berries and making stone tools until a new butcher, baker, and candlestick maker come along.
During the Great Depression, we couldn't possibly lubricate the system because our currency was tied to the gold that the country had in its coffers. It took a World War and the export of 20%+ of our male "consumers" to bring the butcher, baker, and candlestick maker back.
Today, we can manipulate monetary policy to grease the wheels. Admittedly, we won't see Dow 14,000 for quite some time. Still, without plowing money into the system, the "Greater Depression" would have already been upon us.
People might buy fewer shirts; but, unless you think we're all going to run around naked, the strongest tailors will survive. If they don't, another citizen will step up to seize the opportunity and become tomorrow's employer.
Until we have 100% employment around the world, this is how "real" economies work. We don't live in a limited citizen, fully-employed, this-for-that economy that is being destroyed by an abundance of credit and a series of natural disasters. The problem lies in the non-productive "assets" — an overabundance of "investments" that were believed by many to be assets, but ended up being liabilities.
Pain Today or Pain Tomorrow?
To correct the situation, we have to grease the wheels. I hate it as much as anyone else, but that doesn't change the fact that it needs to be done. Few people believe that we can "sit in the tub" while President Obama takes care of things, as Mr. Schiff suggests.
People will need to make sacrifices — greater than they are now. We need to save more — that goes without saying. For example, the few thousand people that read this article will likely do so on a computer, over somewhat expensive high speed internet, with all the lights on in the room. I'd be willing to bet the TV is on in the background while the cell phone sits quietly, racking up those rollover minutes they pay for but never use.
Before you load up on ammunition and bottled water, realize that today's actions will certainly lead to tomorrow's stagflation or inflation, but the game isn't over. Once panic and fear pushes the pendulum beyond the point of equilibrium, things will start to improve.
Now, the race is on. Who will win? Schiff and Roubini, whom have so convinced people that the end is near that nobody will make changes? (Why should I cancel cable or pay off my debt if everything is going to hell?) Or, the desire for a better tomorrow, at the expense of today's instant gratification? (A vision that a lot of people lost a long time ago.)
Is there more pain ahead? Yes, and probably for a number of years when factoring in the stagflation or inflation that is on the way. Nobody is denying that. Still, to promote a full reboot and going back to a "cash only" society is ridiculous. The problems we face are not due solely to the use of credit; they are due to a massive mispricing of risk at many levels, leveraged by the irresponsible use of credit.
If you want to burn me at the stake, go right ahead. But before you do, consider this: At what point will Roubini and Schiff become bullish on America...on businesses? At what point will they declare that stocks are cheap? If they have their way, you might want to save that match — you'll need it when the power companies shut down and you're foraging the Earth for sustenance.
(For the naysayers that want to immediately jump down my throat without reading this article, keep in mind that Roubini and Schiff were not the only ones to see the writing on the walls — they just have great press agents. While they were booking media appearances and kissing babies, some of us were moving clients largely to cash and/or bonds in 2007 and 2008.)