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Subject: Speech given by Peter Schiff on the Economic Crisis
Hugo    6/16/2009 10:06:00 AM
I'm not sure to apologize for what to some might seem like a bombardment here recently but I felt this too good not to share for its simplicity and clarity. The below is a transcript of a speech so is read in that form. I think it is a good summary for what went wrong and why US policy choices are going to make things worse. I wish it weren't so. Why the Meltdown Should Have Surprised No One Mises Daily by Peter Schiff | Posted on 6/12/2009 12:00:00 AM [Henry Hazlitt Memorial Lecture, Austrian Scholars Conference, March 13, 2009. An MP3 audio version of this lecture is available for download. You can also watch the video. Transcript provided by Jennifer Lewis.] Introduction by Joseph Salerno It is my great and distinct pleasure to introduce the Henry Hazlitt Lecturer, Peter Schiff. Schiff, president of Euro Pacific Capital, is familiar to everyone who has watched financial coverage in the last year. He is famed for being the most vocal financial economist to have perfectly predicted the crash. He also happens to be a dedicated student of the Austrian school. He is the author of the prophetic Crash Proof and, most recently, The Little Book of Bull Moves in Bear Markets. Whenever he speaks about finance and economics, he also seeks to teach sound economic theory, writing for publications such as the New York Times and the Washington Post. Today he will speak on the relationship between theory and practice in financial markets. Peter Schiff. Peter Schiff I just looked at the topic for my speech about thirty seconds ago before I walked in the door. But apparently I'm talking about why is it that people didn't see this coming, or should people have known that this meltdown was coming. I don't know. Is there anyone in this room that was surprised by the economic meltdown? Does anybody think it's over? Anybody? Raise your hand if you think it's over. And does anybody think that the government solutions are going to work or that they're going to help? Is there anybody? One. All right. So, I guess there's really no reason for me to speak here. I don't know that I'm going to tell anybody anything they don't know. But, if you want to indulge me, I guess I could talk about it a little bit anyway. But I don't know why so few people seem to understand what was going to happen. I guess when you're living inside a bubble, it's very difficult to actually see what's going on, from your point. But I lived through two of them, because I'm a stockbroker. I lived through the NASDAQ bubble. And to me, at that point in time, it seemed pretty obvious what was going on, in 1997, '98, '99. It seemed obvious to me that these companies that people were touting couldn't possibly be worth the prices that people were paying. Yet nobody seemed to be able to figure that out back then. Everybody seemed to be living in this new era, and the Internet had captured everybody's imagination. To me, I couldn't see the difference between the Internet, really, and a catalog or a telephone. People were saying that everybody's going to buy everything on the Internet. Why? Why aren't people just shopping by telephone? Or why aren't they just buying everything in a Spiegel catalog? It didn't seem that it was any different. And I knew that the valuations they were putting on a lot of these companies, I knew they'd come out with a company, maybe it'd be Doorknobs.com, or whatever it was. And you'd say, "Well, gee, even if they sold every doorknob in the world, they couldn't possibly be worth the multiples that they're trading at." And of course they didn't even make any money selling them. And the whole idea behind so much of the e-commerce was just nonsense. The idea that it was more cost effective to individually FedEx items to people, as opposed to letting them show up and buy them and put them in their cars and leave. There's no way. There are certain items that lend themselves to online sales, but most items didn't, but it didn't matter. Everybody was going public. And people were getting rich, but none of the people were getting rich because the businesses were successful. The people were getting rich because suckers were buying their stock. The guy that started eToys lived in my apartment building in downtown Los Angeles. And I started my company, Euro Pacific Capital, about the same time he started his. He made a lot more money than I did, but he didn't make a profit. He never made a profit. But he made a lot of money because he found people to buy into his idea. And at one point, eToys was worth more than Toys "R" Us. I remember when I was trying to get clients, back when I was starting out at Euro Pacific Capital, and I was trying to get people to buy foreign stocks. And I remember one country I was active in was New Zealand, and I remember trying to convince people who owned shares of stocks, like Yahoo, why they should sell their Yahoo and buy a stock in New Zealand. I would point out that Yahoo was worth twice
 
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GovernmentsChains       6/17/2009 9:40:05 PM
You're right that an economy doesn't have to be completely based on solid goods. The ultimate point, which Schiff makes repeatedly at least in other contexts, is that when it comes to international trade a country cannot import more value than it exports.  Exports can take the form of goods, resources, services, whatever so long as someone is willing to trade for it with value.  Usually goods are easier to trade over international borders, hence the focus on manufacturing.  At the end of the day, trade is value for value and a nation's imports come from its ability to generate equally valued exports.  We can't just export "reserve-status" paper currency and think it will do.  The free market will act to correct the imbalance. 
 
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Hugo    Buzzard   6/18/2009 3:55:16 AM

He's right and he's wrong. He's another of those people who discounts the service economy, which really isn't valid. Our industrial output is higher than it ever has been before, but that is due to automation and more efficient processes. We make more using fewer people. That is simply the way of progress. Hell, he could just as soon whine about the lack of farmers, but most people are quite happy that agriculture is well automated and we don't need most of our population busting their backs out in the fields behind a plow.


 

Much of the service economy is the knowledge economy. They don't produce hard goods, but they produce ideas, entertainment, education, and analysis. If you assume only a hard good has value, then what the hell is that man's job? He's a bloody financial analysis. That's the poster child of the service economy. 


 

He is correct about the bubbles and surfeit of debt, but he doesn't understand the solution any more than many other people. Not everything of value has to be a solid good. If you somehow assume that it does, we're pooched. There is very little in the way of competitive advantage  that a factory in the U.S. will have over some other country with cheap labor and low regulation. Unless we leverage our comparatively high levels of education and entrepreneurship, we will get creamed even if we do clean up all the debt, and feel all the pain that is coming. He's right about having to take out licks, but he should know better about what is a possible future economy. 


 

It's amazing how many financial analysis (and MBAs) don't know squat about actual industrial production, even the free market ones. It's as if they hearken back to the pre- welfare state days as a model, and since they were industrializing then, we have to do it now. 



 
I disagree. Mr Schiff subscribes to the Austrian school of economic thought so it's implausible that he discounts the value of the service sector. Services are important and they are of equal worth in a modern economy as any physical good.  That is not the issue. Mr Schiff denounces the practice of Americans (and other Westerners - the UK for example is no different) of borrowing to pay for consumer goods - these include services such as restaurant meals but equally applies to plasma televisions, a new car or anything else. In essence, it makes sense to borrow only for investment goods - something that will derive an income, a cashflow that can service that debt. The meal, the television, the SUV in the driveway, the new kitchen, none of those derive income and none can service debt and thus should not be paid for with such generally speaking. Mr Schiff is quite right when he says that living standards should only improve when value is created and value is created by providing both better and more goods and services to consumers in a free market. No value is created through the US government inspired wealth effect.

The idea that the United States ought to return to some industrial society of the nineteenth century is not one that Schiff is making. Modern industrial companies like Boeing, GE, etc need to provide a vast service offering related to their products to remain competitive. Mr Schiff is arguing that the concept of Americans not producing greatly more value whilst consuming vastly more value is unsustainable and unnatural - induced only by government policy. Currently this is being done with debt, lent to consumers by producers beyond US shores. This is not the result of some vast deficiency of prudence amongst the US populace - and Mr Schiff is quite right in laying the blame at the door of the US authorities. They are the ones who are distorting markets. They are the ones who inspired the false idea that Americans were getting wealthier because of the increase in their home values and thus could consume more. They are the ones who inflated the prices of American homes giving false signals to both homeowners and investors. They are the ones now bending backwards to prop up those false prices in order to encourage the private citizen to continue spending in order to keep the charade going and paper over the now gaping structural holes in the US economy. 

A bubble is great for a politician - look at how Clinton self congratulated himself for the prosperity of the 90s, look at how Greenspan

 
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Hugo    EF   6/18/2009 4:49:07 AM
 

I don't believe the Euro has been overvalued or manipulated by currency investors.  The value of the Euro hasn't improved against other currencies dramatically but only against the US dollar - and has dropped in value against gold. In other words the US dollar has lost value not so much that the Euro has gained value. I'm not aware of George Soros' speculation in Euro/Dollar values. 

 

The Euro is a fiat currency and its destiny may very well resemble that of the Greenback someday. From a personal perspective I only hope it never becomes the world's reserve currency (I don?t believe it will). But there is a difference between the two currencies. The US dollar's quantity is manipulated to a far greater extent than that of the Euro. Unlike the Federal Reserve, the European Central Bank's tradition and mandate was inherited from the old German Bundesbank that has a very conservative approach to interest rate setting. This is a consequence of the hyperinflation experienced in Germany in the 1920s which, interestingly, remains ingrained in the memories of Germans. The French and Italians are continually pushing for a devaluation but the Germans were clear at the ECB's inception that it would remain independent and true to its mandate - recently it has come under enormous pressure - including from your new government - to free up credit but so far moves have been relatively mild particularly compared with your own government. If European governments want the benefits of using the Deutsche Mark as their own currency then they'll need to accept the resonsibilities otherwise they can return to their Liras, Francs and Drachmas.

 

The result is that the Euro-zone rate of interest is closer to what the market left to its own devices would determine (though not nearly close enough) and thus there are fewer false signals to investors and less malinvestment of the kind we've seen in the US. In the EU we have seen serious malinvestment as a result of government macro policy, like in the US, and the results are clear now that bubbles have burst in multiple nations across Europe. Politicians here, like elsewhere have been falling over themselves trying to blame "bankers," business leaders and even capitalism itself. It's true that many persons, not least amongst the banks, are guilty of serious moral failings. But the distortions in our economies that encouraged moral dereliction are entirely the fault of those we elected.  Governments both encourage bad behaviour and set a poor example.  Imagine how we'd all behave if we could all go to the bank and borrow against the future earnings of our children?

 

You're right about the massive government debt levels in Europe and that is a result of politicians not being honest enough to tell their electorates that we cannot afford their promises. Personal debt levels however are much lower (with some exceptions e.g. the UK) and the personal savings rate of the Germans compares with that of the Japanese, perhaps a cultural phenomenon. A serious reduction in debt had been a major policy goal for the German finance minister but the crash has put that on the back burner (hopefully not indefinitely - I don't want my ten-month old paying the piper for a "stimulus" package). The US government (and other keynesians like the UK) has been putting enormous political pressure on the German government to increase spending in the world's third largest economy. I am grateful that the German government has had the honesty to tell them that they are wrong, there is no evidence that stimulus packages help (see Japan for evidence to the contrary over the past twenty years) and indeed Merkel even recently implicitly blamed the US Federal Reserve for the current crisis and warned that another would eventuate if it didn't change track - intellectual honesty that is a breath of fresh air coming from a contemporary politician. 

 
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buzzard       6/18/2009 9:10:03 AM
I disagree. Mr Schiff subscribes to the Austrian school of economic thought so it's implausible that he discounts the value of the service sector. Services are important and they are of equal worth in a modern economy as any physical good.  That is not the issue. Mr Schiff denounces the practice of Americans (and other Westerners - the UK for example is no different) of borrowing to pay for consumer goods - these include services such as restaurant meals but equally applies to plasma televisions, a new car or anything else. In essence, it makes sense to borrow only for investment goods - something that will derive an income, a cashflow that can service that debt. The meal, the television, the SUV in the driveway, the new kitchen, none of those derive income and none can service debt and thus should not be paid for with such generally speaking. Mr Schiff is quite right when he says that living standards should only improve when value is created and value is created by providing both better and more goods and services to consumers in a free market. No value is created through the US government inspired wealth effect.

The idea that the United States ought to return to some industrial society of the nineteenth century is not one that Schiff is making. Modern industrial companies like Boeing, GE, etc need to provide a vast service offering related to their products to remain competitive. Mr Schiff is arguing that the concept of Americans not producing greatly more value whilst consuming vastly more value is unsustainable and unnatural - induced only by government policy. Currently this is being done with debt, lent to consumers by producers beyond US shores. This is not the result of some vast deficiency of prudence amongst the US populace - and Mr Schiff is quite right in laying the blame at the door of the US authorities. They are the ones who are distorting markets. They are the ones who inspired the false idea that Americans were getting wealthier because of the increase in their home values and thus could consume more. They are the ones who inflated the prices of American homes giving false signals to both homeowners and investors. They are the ones now bending backwards to prop up those false prices in order to encourage the private citizen to continue spending in order to keep the charade going and paper over the now gaping structural holes in the US economy.

 
I'm a big fan of Austrian School economists as a rule, but I still think you are missing some of what he is saying in favor of seeing the good things. 
 
Here's the relevant point which I base my contention on:
 
So we have a lot of Americans that are working in jobs that they really shouldn't be in. We got a lot of Americans that work in retail, that work in shopping centers, that work in restaurants, that work in financial services.
There are a whole host of Americans employed doing things that they really shouldn't do, because, you know what, we're too broke to patronize their businesses. We need more Americans making stuff, producing things.
And, in order to have American labor available for productive capacity, they have to leave where they are right now. If somebody has to lose their job in the service sector in order to get a job in goods production...
And, of course, in order to get a job in goods production, we need capital. You can't produce anything without machines, without tools. Where's that stuff going to come from? You can't just wave a wand.
 
 That is a pretty much straight up claim that we need more industry and need to produce more solid things. You don't use machines and tools to produce ideas (unless you decide to stretch the definitions).
 
Also slamming the service economy as "shopping centers, restaurants and financial services" is rubbish. That is only a small portion of the service economy, and while the numbers of those jobs might vary in size, they will always exist. In a world of efficient industries, you can't have everyone in industry, other people have to provide the services for those who produce hard goods, and you will probably have more of them.
 
I agree that you can't make an economic foundation on debt. That's a house of cards waiting to topple. However he seems fixated on a false definition of service economy and what is actually important for a viable future economy. 
 
 I
 
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Hugo    Buzzard   6/18/2009 11:06:54 AM
 

I agree with you in many instances Buzzard but disagree that you disagree with Mr Schiff : )

 

Looking again at the following quote of Schiff's,

 

So we have a lot of Americans that are working in jobs that they really shouldn't be in. We got a lot of Americans that work in retail, that work in shopping centers, that work in restaurants, that work in financial services.
There are a whole host of Americans employed doing things that they really shouldn't do, because, you know what, we're too broke to patronize their businesses. We need more Americans making stuff, producing things.
And, in order to have American labor available for productive capacity, they have to leave where they are right now.

The argument that Mr Schiff is making here is that because of the expansion of credit and the associated malinvestment, US resources have been shifted into retail, restaurants and financial services - all industries that have benefitted from the credit expansion. In the absence of those distorting signals to investors  employment, in Mr Schiff's view, would have been created in producing consumer goods (rather than services). This is a very valid point though you may also have a valid point in assuming that some of those employed as a result of malinvestment may have been employed in alternative consumer services - though I believe that is only likely to be a small number on account of the vast increase in jobs already created in retail, construction and government services. I believe more than 90% of job creation has been in the service sector, it seem reasonable to me that if it were not for malinvestment, some of that would have gone into production - which itself requires services from engineers, scientists etc - though of a different variety that have been created these past years.

Also slamming the service economy as "shopping centers, restaurants and financial services" is rubbish. That is only a small portion of the service economy

Even if he were suggesting it, it's not entirely rubbish. According to US census data, retail and wholesale trade together accounts for over 20 million jobs - the largest portion of services employment. After that you have healthcare and social assistance (how many of these are government related?) with around 15m and then you have accommodation and food services with 10m. These are the top service employers.

 

In fact, in addition to government, that is precisely where jobs have been created these past twenty years. They haven't been created in manufacturing and US trade deficits have been ballooning. The idea that the United States has a competitive advantage in retail, construction or government services is a non starter because those services cannot in most instances be exported - the US could have the best hairdressers in the world (you probably do) but that gives you no competitive advantage. 

 

Sure, the US has in the past had a competitive advantage in financial services but much of that has been squandered in recent years as the US reputation for financial management has taken an enormous hit to its credibility. That competence isn't really lost, only your government has encouraged the creation of a vast financial services sector focused on the creation of toxic debt instruments linked to the real estate bubble that was itself a result of the credit expansion. This sector hasn?t created value - nothing has been produced except vastly overpriced speculative products - but instead this government inspired sector has destroyed value. Resources have been shifted towards financial services products that have not only proven to be wealth generation but actually wealth destroying. Those resources could have been used in other areas of US financial services for which she genuinely has a competitive advantage. In that sense not only have those resources been squandered but their diversion may have depleted the true comparative advantages in financial services that the US h

 
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buzzard       6/18/2009 12:12:13 PM
I'm not sure I'd be modeling anything on the German economy given their tendency towards high unemployment and low growth. To be quite honest, being a high exporter and low importer is no better than being the converse. A balance is the best way to be.
 
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Hugo       6/18/2009 4:16:55 PM

I'm not sure I'd be modeling anything on the German economy given their tendency towards high unemployment and low growth. To be quite honest, being a high exporter and low importer is no better than being the converse. A balance is the best way to be.

High unemployment in Germany (around 8.5%) is a result of government labour market policy and ought not be confused with the structural distorting effects of a credit expansion.  High unemployment in Germany (similar levels in the US) is also, in part, due to the absorption of the former East Germany which like all socialist countries experienced the greatest government distortion of all.  Growth in Germany, and elsewhere in Europe, is measured differently than in the US.  The Economist a couple of years ago investigated the economic growth rates of major European economies and the USA over the ten years previous and found that they were similar.  The US government's numbers aren't much more reliable than those of Enron's.
 
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