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26 Sep, 2014 07:17

Blind faith in dollar will lead world to financial Armageddon - leading financial analyst

This year has seen plenty of political turmoil - the waves of instability seem to do little to the world’s economy. Will that remain so for long? And if not - is there an another crisis looming, like the one that left thousands if not millions helpless and in poverty in 2008? And, finally, what does tomorrow hold for dollar? We ask these questions to leading financial analyst and CEO of Euro Pacific Capital. Peter Schiff is on Sophie&Co today.

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Sophie Shevardnadze: Peter Schiff, leading financial analyst, CEO of Euro Pacific Capital, welcome to the program, great to have you with us. Now, you’ve said it’s not global turmoil, but the Federal Reserve that’s causing damage to investors and the U.S. economy. How so?

Peter Schiff:Well, right now, a lot of people don’t appreciate how much damage the Federal Reserve is actually doing, because there’s a lot of false optimism right now regarding the success of the Federal Reserve's QE program, and its 0% interest rates. People believe that it’s been successful at reviving the U.S. economy, and that’s why there's some interest in the dollar in our markets - but all what Fed has succeeded in doing is exacerbating all of the problems that caused the 2008 financial crisis and they’ve inflated a much bigger bubble - so I think the crisis that we have coming is unfortunately going to be much worse that the one we passed.

SS: But if you look at all the geopolitical turmoil across the world, you have the crisis in Ukraine, you have the Middle East, you have ISIS - it does seem that to a large extent the markets are shrugging it all off too - why is that?

PS: I think a lot of people are delusional. They believe in this false narrative, they have confidence in what the Federal Reserve has done, the believe the forecasts of many of the economists about vibrant growth in the U.S. economy in years ahead, and of how Fed will raise interest rates, and the economy continues to expand. All that is impossible. The Federal Reserve has placed itself into position where they can never raise any interest rates - in fact, I don’t think they’re going to be able to go very long without launching another round of quantitative easing, because our bubble economy is completely dependant on the continuation of that policy. When the Fed takes it away, we’re headed for a massive economic collapse.

SS: So just let me clarify: are you saying that the worst is still to come? Is that your prediction?

PS: Why, absolutely. We haven’t solved any of the problems that led to the 2008 financial crisis. In fact, all those problems are now larger than ever, because of what the Fed did. The Fed interfered and prevented the market from solving the problems that years of bad monetary policy created. As a result, those problems are bigger and the crisis looms larger than ever.

SS: Let me ask you a few questions about the sanctions, because, you can imagine, it’s a huge topic over here. Now, from where you stand, from your standpoint, as far as you are concerned - do you believe the U.S. measures are genuinely hurting the Russian economy?

PS: I don’t know how much they have impacted Russian economy, but I do think that the sanctions will undermine the U.S. relationship with Russia and with other nations - and you know, America depends on emerging economies like Russia, for example, to buy our bonds, to buy our treasuries, to help vendor finance the voracious appetite of American consumer even though that appetite to consume is not matched by the ability to produce. America really needs to live off the charity of the rest of the world, and I think, obviously it endangers that relationship when we antagonise with all the people that we depend on.

SS: But how much exactly does America depend on economies like Russia? How long till the U.S. will sustain sanctions against Russia without causing damage to its own economy, because it’s more than bonds - I’m just thinking, Exxonmobil is already feeling the effect of sanctions. They had to shut down the Arctic drilling and all…

PS: I think America is the most dependant country on the planet. We depend on the rest of the world, like no other country does. We don’t have the ability anymore to produce the consumer goods that we require and so we count on the rest of the world to fill the void, to send us all the goods that they produce in exchange for nothing - because we don’t have the exports to pay for our imports. We count on the world to lend us the money to buy the products that they produce. We have the world’s biggest trade deficits, the biggest current account deficits, we’re the worlds’ biggest indebted nation. So, in a way, we’re like a global economic parasite - we feed off the rest of the world and we need to maintain the illusion that the world depends on America instead of the other way around. Of course, in the long run, I think this relationship is doing far more damage to America than to the global economy, because eventually the world is going to figure out what we’re doing, and they’re not going to support us anymore, and the world will pull the plug on america and then, of course, because this has gone on for so many years and our economy has been able to evolve in such an unsustainable bubble fashion - it’s going to be very, very painful when we have to live within our means again and start to produce and save rather than borrow and consume.

SS: You’re saying that it’s an illusion that everything depends on the U.S. economy so heavily, so would the U.S. have any real leverage in this economic stand-off with Russia if it wasn’t for Europe, if it wasn’t for the EU which is imposing the tough sanctions?

PS: Certainly, Europe is an important part of it. But the only leverage we have, really, is one of the false perception of the true nature of the U.S. economy - I mean, we still project an aura of strength, but people don’t look beneath the surface to really figure out how vulnerable and how weak the U.S. economy really is, and how much it depends upon the generosity of the rest of the world, and really, the foolishness of the rest of the world, to continue to loan America money that America can never repay and will never repay. We simply borrow more and more money - and of course, we still project strenght through our military. We do have an enormous military capacity, but we count on the world to pay for it. Left to our own abilities, America cannot afford the military that we have. Certainly, we couldn’t afford the presence that we have around the world. We couldn’t afford to maintain and supply our troops weren’t it for the money that we were able to borrow in many cases from the people that we are theoretically defending ourselves against.

SS: But the U.S. produces on key product - the dollar - and it happens to dominate the world’s financial system. So, are we going to see that change?

PS: The dollar is not really a product. It’s an IOU - but there’s nothing really behind it. It doesn’t cost us any money to create dollars, I mean, there’s no resources expended, we don’t need big dollar factories. The Fed just pushes the button and they magically come into existence and there’s no real value there - you can’t consume it. It’s all about perception, the fact that people think the dollar will have value in the future and they’ll be able to exchange it for things that they really need. But once that perception no longer persists, when people realise that the dollar is nothing but an empty promise, and IOU nothing, nobody is going to want our dollars anymore. I mean, at one point, the dollar was backed by gold, so people wanted dollars because they could get gold - but now you can’t get anything from your dollars. At one point, people also wanted dollars to buy the products that America has produced - but people don’t want American products, they want Chinese products - so what good are dollars?

SS: Hold on, but when does that perception of dollars becomes obsolete? Right now, it doesn’t seem to bother anybody.

PS: I know! Well, sometimes, these old habits die hard. It takes people a long time to recognise something. Think about the .com bubble or think about the housing bubble and think about all the crazy things that so many otherwise intelligent people believed until one day they no longer believed it. You have a lot of people that have misplaced sense of confidence in the U.S. dollar, and, ironically, because there’s so many problems in the world, there’s problems in Europe, there’s problems in Japan, and politicians and Central bankers are doing foolish things in those countries too - we don’t have a monopoly on economic stupidity in the U.S. - but because so many other countries are doing foolish things, people take refuge in dollar. They buy dollar as a safe haven even though they ignore the fact that the problems in the U.S. are actually larger than in the countries whose currencies they are selling in order to buy dollars. So, we benefit from everybody else’s problems - even though our are bigger than anyone elses.

SS: Ok, but beyond the dollar, which you say is just a bogus piece of paper backed with nothing - I mean, the U.S. is one of the world’s top manufacturers. It is the world’s #1 economy. Surely, it’s economy is based on more than just a paper?

PS: Well it’s only the #1 economy because we have access to so much cheap credit coming in from around the world, and because we can run these huge deficits. If that wasn’t the cause, the real value of U.S. GDP would implode and we’ll no longer be as large of economy as we’re now, thanks to the fact that the rest of the world artificially props it up. I think that those actions of diverting scarce resources to the U.S. undermines economic growth outside of the U.S. But, yes, to answer your question, there is a competitive part of the U.S. economy that still remains - but that portion of the U.S. economy that is productive and is competitive gets smaller every month. We keep contrapting that part of our economy and we keep replacing it with the bubble part of the economy to consume, to spend, the government sector continues to expand whereas the real wealth-producing component of the U.S. economy continues to shrink in proportion to the whole.

SS:Now, like you’ve said, the U.S. economy policy allows it to take economic advantage of other countries, and yeah, we’ve seen many instances of that - growing richer as others grow poorer. Is that sustainable? Because it does seem to be working for America somehow…

PS: No, it’s not sustainable, because eventually, people who are working in factories for low wages around the world to produce products that Americans can enjoy but they don’t produce - eventually, the people in other countries are going to want to experience the gains, they’re going to want to enjoy the fruits of their labor. Right now, America enjoys the fruits of everybody else’s labor, and this is unsustainable. The crazy part about this is that economists even in the countries that are undermining their own standard of living in an effort to prop up an artificially high living standard in the U.S., think that they’re acting in their own economic self-interest. You have countries that think that having a weak currency is good and promoting exports is good. But it’s not! Exports are only means to an end, it’s only important to export to pay for imports. You don’t export for the sake of exporting, and you don’t export for jobs. Again, jobs are means to an end - what everybody really wants is a higher living standard which means that they want to have access to more consumer goods at lower prices, and most countries are pursuing economic policies that are at odds with their own self-interest. What would be better for other countries to do is to allow the dollar to drop, to stop buying dollars in treasuries, to allow their own citizens to enjoy the enhanced purchasing power that would come with a stronger currency, so that they could buy more consumer goods and enjoy higher standard of living themselves.

SS: Do you believe the U.S. dollar is bound to lose its reserve currency status at some point?

PS: Yes, I do, because I believe we will continue to live beyond our means in America, we will continue to print dollars and borrow money that we can’t repay until finally we owe the world so much money, the world finally recognises that they’re never going to get paid and they stop throwing good money after bad. And when that happens, the dollar will collapse, I don’t think we’ll be able to raise rates substantially enough to stop the decline because our economy is too over leverage, and politicians will resist the solution - and so, I think, the dollar’s days are numbered as a reserve currency. How large that number is - I don’t know. I’ve been overestimating for some time now the intelligence of the global community to figure this out - so people are a lot dumber than I thought. When they’re all going to wise up - I have no way of knowing, but you know, there’s an old saying: “you can’t fool all people all the time” and, America is not going to be able to fool the entire world indefinitely, with respect to the U.S. dollar.

SS: Now, the Republican party recently endorsed a platform that supports a return to gold standard - how real is that? And if that ever happens, when? How exactly would that happen?

PS: A return to the gold standard is inevitable in the U.S., not only there but around the world - the Swiss are going to be voting at least in that direction in November, about whether to require the Swiss National bank, the Reserve Bank of Switzerland to maintain 20% of its reserves in gold. Hopefully, the Swiss will vote that way and that will be a step in the right direction for the Swiss to reclaim the soundness of the Swiss Franc. But ultimately the system that the world is on now is fiat system, where the dollar is at the center of it, does not work. It is the root cause of all global economic imbalances: the booms and the busts and the financial crises have their roots in the current monetary system that cannot work and cannot function overtime. So, eventually we will go back to monetary system that works and that is one that is anchored in gold, because money must have real value. It can’t just be pieces of paper that politicians can print in unlimited supply - it must be tied to real production, it must have intrinsic value, there’s must be some limiting factor to limit its supply - and gold works better than anything else. It has worked spectacularly well in the past, and it will work just as well again in the future once we re-embrace it.

SS: Then what are the guarantees though? What are the guarantees that return to fixed currency would work now in XXI century? It would mean a more volatile economy, higher average unemployment - what are the benefits of the gold standard for the U.S. now?

PS: No! It wouldn’t. If you go back to XIX century, certainly, the latter part of the XIX century and the early XX century, when we were on a gold standard and nations were on gold standards - the economies grew more rapidly. Certainly, in the U.S. we had more economic growth, we had lower unemployment, we had a smaller divide between the rich and the poor - you know, the country operated far more efficiently and to the benefit of far more people when we operated under the discipline of the gold standard. The Founding Fathers, those who wrote the Constitution and founded the American Republic, they understood the benefits of sound money and the evils of paper money. They’ve put America on a gold standard from the very birth of the republic and we should heed their wise - they were very learned men. I think they were much more educated and understanding about economics then the people who lead the U.S. today. So, to try to suggest that we will have less robust economy if we went back to gold standard - mostly, that’s propaganda from Central Bankers and politicians, who want to scare us from going back to something that works, because when you go back to free market, the politicians and bankers will lose their power, and they want to maintain their power by scaring people into thinking that if we just go back to freedom and market forces, that’s somehow is going to be bad and we have to surrender our freedoms to politicians and bankers because they know much better than the market. They can define the proper rate of interest and they can manage the money supplier, centrally planning the economy, and it’s going to be more effective than free market capitalism - and that is just not the case.

SS: Now, some countries are already beginning to move away from the dollar. For instance, Russian oil companies are now accepting Yuan payments, for example, and the Chinese currency may well substitute the dollar as the world reserve. Will that be a healthy move?

PS: I think, for the rest of the world - yes. The more distance the world can place between itself and the dollar - the better, especially if they don’t want to be subjected to the whim of American politicians. If you look at the sanctions that have been levied against foreign banks by the U.S. government, the ability of the U.S. government to sanction a German bank or a French bank or a British bank or even a Russian bank - all of that is because of the dollar’s role as the reserve currency. If the dollar wasn’t used as often, then our power would be gone. I can already see that. I own a bank in the Caribbean, Euro Pacific bank, and I’ve already seen in the 2-3 years I’ve been operating that bank a substantial decline in our dollar volume and our dollar wire volume. We now are doing more business in Euros than dollars and this is because the banking sector is moving away from dollars. We’re being punished for using dollars, it’s more and more difficult because larger banks do not want to process wires in U.S. dollars, as they are afraid of the regulatory impact that that’s going to have, coming from the U.S. It’s really the currency that nobody wants to deal with in the global banking community, certainly for the smaller banks like mine. So, this is a beginning of a trend, are more and more people are going to be forced to move away from the dollar, and this is something that they should have done anyway. The crazy thing about it is that the U.S. government is accelerating the process on its own with FACTA and with other regulations that have been implemented, which substantially increase the costs of doing business in U.S. dollars and therefore undermine the desirability of doing business in U.S. dollars.

SS: Several years ago, the World Bank said the world’s financial system will be based on multiple currencies by 2020-25. Do you agree with that, and which currencies could step in?

PS: Well, it’s already based on multiple currencies, but certainly the dollar is the most important of those currencies and I do think that that will change overtime, but I think that a currency crisis that’s coming, a dollar crisis that’s coming, will shake the foundations of the global currency markets, and I don’t think we can just move from the dollar - one irredeemable fiat currency - to another. I don’t think Yuan is going to be the reserve currency, I don’t think the Euro could be a reserve currency. I don’t think there’s some old currency today that has the stature that the U.S. currency had when it was originally given that role. So, I think the only thing that would make sense to me would be for individual Central Banks to once again hold gold as their primary monetary reserve, so that no single currency would dominate. Gold would the anchor, the backing behind the currencies, and of course, Central Banks could hold other currencies in addition to gold, but the role of gold is going to have to increase dramatically, particularly among the emerging markets. If you look at a lot of south-east Asian economies and Latin America economies - they had just a tiny percentage of their reserves in gold. The more mature European economies of course have much higher percentages of their reserves in gold.

SS: You’ve argued in many instances that crisis worse than we seen in 2008 is going to happen. When are we to expect that?

PS: To me, we’re living, literally, on borrowed time, and probably, what’s going to be the catalyst is the world is waiting for the Fed to raise interest rates. I think before that happens the Fed Reserve is going to launch even bigger round of QE than the one they are almost finished tapering off. And i think, when the world is shocked into reality, when all of sudden instead of wondering when the next rate hike is coming, it’s how much more QE we’re going to get. I think that’s a game-changer in the dollar, and I think when the dollar resumes it’s long term decline, and that begins to put much more awkward pressure on consumer prices in the U.S., and the rate of inflation really begins to accelerate as measured by the CPI and the Federal Reserve does nothing about it, and basically accepts the increased rate of inflation, dismisses it, tries to rationalise why it’s a good thing - and that simply accelerates the loss of confidence in the dollar, and the dollar’s decline accelerates the downsides - I think this will be the beginning of the currency crisis that will ultimately lead into this financial crisis. When the dollar really starts to fall, the Fed Reserve has really just two options: aggressively raise interest rates to defend dollar, which will cause crash in the stocks market, a crash in the real state market, cause the majority of U.S. banks to fail and force the U.S. government to basically default on its obligations, including treasury debt - or, not raise interest rates, continue to subsidise and perpetuate the bubbles, and we have runaway inflation and dollar becomes practically worthless. Those are the two alternatives. Neither one is going to be very good. Of course, runaway inflation and worthless dollar, I think, are worse than the U.S. government defaulting on its Treasury bonds - but one of those things are going to happen, and of course it’s all a default. If the government admits it can’t pay it’s bills and defaults on its debts, or it repays its debts in money that has no value, the result is really the same from the perspective of our creditors. They don’t get repaid: either they get repaid in worthless money, or they don’t get any money. But the bottom line is still the same, because they can’t buy anything with the value of the dollars they get for the bonds that they hold.

SS: Alright. Peter, thank you very much for this interesting insight. We were talking to Peter Schiff from the Euro Pacific Bank, leading financial analyst. We were talking about the role of dollar, the future of dollar in the world’s financial system, and also when the next global financial crisis will hit us. Thanks for this interview, this is it for this edition of Sophie&Co, I’ll see you next time.