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I recently had the pleasure of speaking with Andrew Schiff, communications director of Euro Pacific Capital and coauthor, with his brother, Peter Schiff, of the recent book How an Economy Grows and Why it Crashes. —Craig Biddle Craig Biddle: Thank you for joining me, Andrew. Andrew Schiff: It’s my pleasure. CB: I’d like to ask you a few questions about your book, interspersed with questions about the current economic situation, the problems we face, and the potential solutions to those problems. To begin, congratulations on your wonderful book, which cleverly presents, in the form of an allegory, the basic principles of economics and the essentials of U.S. economic history. The allegory is an ideal mechanism to convey this material. What inspired you to write such a book? AS: It all began with a story that my father used to tell my brother and me. He’s very knowledgeable about economics, and a great storyteller. When I was seven or eight, my dad started using stories to teach us economics. I remember being in the car when he came up with this one about three men on an island who lived on fish, which they caught with their bare hands. At first, they each caught one fish per day, but then, one guy invented a net—and that began to change everything. The story continues and shows how an economy develops and thrives. That story eventually was used in one of my father’s books, and then he later developed it into an economic cartoon book in 1980 called How an Economy Grows and Why it Doesn’t,which went on to achieve cult status. It was about sixty pages, and it had a Flintstones kind of look to it. The book was very good, but it was quickly dated, as my father wrote it specifically to address the concrete economic issues of the mid- to late-seventies. A couple of years ago, in the wake of Peter’s success with Crash Proof: How to Profit from the Coming Economic Collapse, we were trying to think of another educational project we could undertake, and Peter suggested that we reissue dad’s How an Economy Grows and Why it Doesn’t. I thought we shouldn’t simply reissue that book because it doesn’t have enough clear relevance to what’s going on today; it doesn’t give the whole economic picture. For instance, it doesn’t address the tech bubble or the housing bubble or the Fed’s recent rounds of quantitative easing. It doesn’t address our relationship with China, our various other trade relationships, or wages and prices, or the availability of credit. We realized we wanted to address many things that weren’t in that book, so we decided to take the original idea, elaborate on it, and expand the scope. We figured that what people need right now is a grounding in solid economic principles, and we wanted the book to provide that. But we also wanted to keep it fun and engaging. So in addition to retaining the allegory and the humor, we hired an illustrator, who produced 155 illustrations to accompany the story. CB: What, in a nutshell, do you want readers to understand after they read the book? AS: We want people to see that a national economy is no different than a personal economy; it’s just bigger. We want them to see that what’s economically good for a family is economically good for a nation. And we want them to see that if you understand the fundamentals of economics on a personal level, you can extrapolate from there and see how the entire economy works. CB: You did an admirable job. The beauty of starting at the subsistence level of production—three guys each catching one fish a day—and then layering in one economic advancement at a time and showing the consequences is that it keeps the whole subject grounded in perceptual reality. It shows that economics is a fact-based, understandable science, not a matter of opinion or consensus or mystery. One recurring point throughout the book is that an economy doesn’t grow because people spend; rather, people spend—or are able to spend—because the economy grows. This is basically Say’s Law, the idea that supply or production constitutes demand or wealth. Why is it that so few people, especially politicians and economists today, grasp this fairly elementary point? AS: I’m glad you asked about that because, if you had to underline the thesis sentence of this entire book, I think that’s it. As we put it somewhere in the third or fourth chapter, the economy didn’t grow because the islanders consumed more; they consumed more because the economy grew. This is easy to understand when it’s laid out in stark terms, as it is in the book. But when you turn on the television today, or pick up a newspaper, or listen to the Council of Economic Advisors speak, you will see near unanimity in the belief that economies grow because people spend. The idea is that if the government can stimulate spending, or somehow figure out how to make people spend more, then businesses will sell more goods, and that money will trickle through to their employees, who will spend it, and so on, making the economy grow. You can see how that could seem to make sense to people. Some Americans never see a production line or the inside of a factory. But they all see the inside of a retail store, and they say, in effect, “Yeah, if I’m spending more money, then the stores can stay open, the lights stay on, people have jobs, everyone’s busy, and that’s good.” But the question remains: Where does this stuff come from? Many people don’t really have any tangible connection with the fact that things have to be made. So they never grasp that production is what makes spending possible. CB: Do you think that part of the problem is poor education? I can see how some people could fail to grasp the relationship of production to consumption on their own. But shouldn’t economics classes be able to clear up the confusion pretty quickly? How has economic education gone so far afoul that even people who have studied economics don’t understand this relatively straightforward point? AS: The academic underpinning for all this confusion is called Keynesianism. [John Maynard] Keynes came up with the idea of a demand-driven economy, an economy that grows by means of spending. One of the things we point out in the book is that Keynesian economics was a Christmas gift for politicians, because it told them that they could make the economy better simply by spending money. It told them that the government could print money, increase the budget, not raise taxes, and thereby make the economy grow. This idea enabled politicians to say, “You don’t need to suffer at all in order to fix the economy. Just elect me. I won’t raise your taxes, but I’ll make the economy better. It won’t cost you a dime.” CB: A pain-free solution. AS: Yes, and it’s supposedly true because some guy won a Nobel Prize for it. It’s the economic equivalent of a miracle diet that calls for no dieting or exercise, but rather for more consumption—which somehow, magically, is followed by weight loss. Of course, politicians love to run on that promise, because the other guy’s going to say, “We need to raise your taxes” or “We need to cut spending” or the like, and that’s not going to win. Moreover, many economists—especially the Keynesians—see themselves as social scientists working for the betterment of humankind. And it’s very hard for them to say, “The best thing we can do is leave the market alone and let it function.” That’s not what they went to school for, and it’s not want they learned in school. They went to school to learn how government can make all our lives better, and Keynesianism taught them that government can do just that—by printing and spending money. CB: Another recurring point in your book involves the consequences of the government’s bailout of failing businesses. You show that when the government removes the freedom to fail, it obliterates the freedom to succeed. Can you elaborate on that point in relation to recent economic history? AS: Sure. Consider the financial sector. By guaranteeing the existence of certain large institutions that the government regards as “too big to fail”—for example, Bank of America—the government has basically said that if you invest money with these institutions, you’re not going to lose the money. In other words, there’s no risk. If I lend money to Bank of America or buy their bonds, there’s no way I’ll lose that money, because the government is behind them, just as it was behind Fannie Mae and Freddie Mac. So there’s certainty: The government has guaranteed that I can’t go wrong here. What does that do? The result is that these large banks enjoy a cost of capital that’s much lower than their competitors who don’t have that advantage. They don’t have to pay very much for the money they raise, because people know it’s safe. Conversely, the financial institutions that don’t have this special status have to pay a lot more for their capital because people know that if they lend them money and the bank or business goes belly-up, they’re not going to get their principal back. So what do you get? You get more capital going to the “too big to fail” banks. And what you don’t get are small businesses starting up to compete with these banks. You don’t get innovation, you entrench the status quo, and you get paralysis—all from taking away the ability of some to fail. CB: Given that the government should not be spending money to “stimulate” the economy or bailing out businesses that are allegedly too big to fail, what should it be doing? What do you regard as the proper role of government? AS: It has a very important role. The government needs to uphold the rule of law and enforce contracts. Unfortunately, one of the things we haven’t had a lot of in this country is a level corporate playing field—level in the sense of equal treatment under the law. As companies get bigger and bigger, they can buy influence in Washington, or at the state level, and exert anticompetitive forces through the government against their competitors. That’s very destructive. The government should stay out of the economic marketplace but uphold the rule of law, enforce contracts, and do so evenly. The government doesn’t need to and shouldn’t regulate what ingredients you can use, who you can sell to, what working conditions you have to have, who you can hire, who you can fire, how much you can pay them, what kind of products you’re permitted to make, or anything of the sort. It’s unbelievable what the government dictates today. Our company, Euro Pacific Capital, is a financial firm, and the government tells us what kind of investments we can recommend, to which kinds of clients we can recommend them, how we can market those investments, a million different things about how we can and cannot run our business. But the government shouldn’t stand between me and my client. If a potential customer wants what I’m selling, he should be free to buy it from me; if he doesn’t want it, he doesn’t have to buy it. And if I’m selling something fraudulently, there are courts for that—sue me for fraud, and the courts will remedy the problem. That’s what we need in this country: a government that upholds the rule of law and enforces contracts. We don’t need anything more than that. We don’t need government telling us how to run our businesses. They don’t even know how to run them. CB: Amen. I would add that the government has no right to dictate how you run your business. Or, to put it positively, you have a right to act on your judgment, to contract as you see fit, and to succeed or fail based on your own decisions. Another thing you emphasize in the book is the importance of risk and of people being free to take risks. Can you say a few words about that? AS: People who make a lot of money generally do so by taking risks—and that doesn’t mean simply that their businesses might fail; it means more than that. It also means, among other things, that they put up their savings and that they under-consume. The primary example of this in our book is the original scenario of the three men on an island, each catching one fish per day—just enough to survive until the next day, when he can hopefully catch another fish. These men are using their bare hands to catch the fish; that’s the extent of their technology. Then, one man decides that he wants to better his situation, so he takes a risk. He takes a whole day off from fishing—thus risking hunger—and he invents and produces a net. He has no idea whether it’s going to work; it hasn’t been done before. But he takes a chance and spends a whole day’s time and effort producing this new tool. If it doesn’t work, he loses out. No one’s going to give him a fish to compensate for the day that he didn’t fish. In this case, however, the risk pays off; the net works, and he is able to increase his daily catch. He even starts making loans of fish at interest. This process of risk and invention and growth is the natural course of a free economy, and the taking of risk is what gets the whole thing going and keeps it going. CB: So when the government comes in and thwarts that, when it disallows people to take risks and to succeed or fail accordingly, what happens to innovation? AS: My father used to say, “In a communist society, who gets the job of inventing?” CB: How do you respond to claims that communist societies may not flourish, but at least they don’t legalize selfishness, as capitalism does? AS: People usually have very selfish motivations for pursuing their dreams, taking risks, inventing things, and producing goods and services. There’s nothing wrong with that. And, as we show in the book, when people take risks, when they think and plan and succeed, their success helps everybody. It’s actually impossible for somebody’s success to not make a positive impact on the world around them. Now I know that in the recently published review of our book in TOS, the reviewer [Daniel Wahl] criticized us for implying that the justification for capitalism is that people get wealthy by creating benefits for others. While this might not be the justification for capitalism, it is nevertheless true. You can’t get rich except by producing something that the market wants or by generating capital you can lend to other entrepreneurs or the like. Capitalism raises everyone’s standard of living, and this is a demonstrable fact. CB: I certainly think that’s true; capitalism is good for everyone. But I would argue, as Ayn Rand did, that the justification for capitalism is that people have a moral right to act on their own judgment, to contract as they see fit, to keep and use the product of their effort, and to live their own lives for their own sake. I think this is what Daniel Wahl was implying in his review. AS: Oh, yes. I totally agree. I just think that when you’re trying to make the case for capitalism, it makes sense to acknowledge its universal benefit. Everyone can appreciate the fact that capitalism is the best way to raise living standards, because it’s impossible to get rich without providing benefits to the people around you. Impossible, that is, if you are living in a capitalistic society. If you’re living in a totalitarian society, or a society that doesn’t uphold the rule of law or enforce contracts, then some people—namely, the ruling class—can get rich and provide no benefits. Like parasites. CB: Given that a system of individual rights, free markets, and the rule of law—in a word, capitalism—is what enables an economy to flourish, what do you say to those who blame capitalism for our current economic woes? AS: I point out that what we have today is not capitalism. Consider the 2008 recession or depression, whichever it turns out to be. (Peter says it will be the Great Depression II.) As we show in the book with our discussion of the credit crisis—which we call the “hut glut,” because they built too many huts on the island—this problem was a creation of government. Wall Street, of course, made a lot of stupid decisions and acted irresponsibly, but that’s only because they were playing the hand that was dealt to them by the federal government and the Federal Reserve. The government guaranteed that would happen by creating all the conditions necessary for a credit and housing bubble: interest rates near zero, pressure on banks to provide mortgages to people who couldn’t afford them, Fannie Mae and Freddie Mac buying up debt in the secondary mortgage market, and so on. As Peter says, “Yes, Wall Street got drunk, but who provided the booze? Who liquored them up?” CB: And the booze from the Federal Reserve in the form of easy money did more than give rise to a “hut glut.” Can you say a few words about the broader effects of the Fed’s expansion of the money supply? AS: Well, it destroys the currency. The only reason it hasn’t visibly destroyed the U.S. currency so far is that the U.S. dollar has reserve status—meaning that other countries peg their currency to the U.S. dollar—and we’re able, through that, to export our inflation, for instance, to China. Normally you wouldn’t have inflation in China today, because the Chinese are rapidly expanding their production. And, as we point out in the book, when production expands rapidly, as it did during our industrial revolution, prices drop. This is because when expanded production is combined with sound money, money gains purchasing power—which is the natural state of things in a growing economy. But China pegs its currency to the dollar. So when the dollar plummets, China’s currency gets debased. When a government prints money, it not only debases the real money; it also stealthily transfers wealth from those who have savings to those who don’t. Contrary to the Keynesians’ belief, the government’s printing of money doesn’t create wealth. If it did, there would be no reason to have an economy at all. All we’d need is a printing press, and everyone could be rich. Inflation—the government’s printing of money—just redistributes wealth from those who have existing dollars to those who get the new dollars. This is like the dilution of shares when a company issues new stock. The company takes value from existing shareholders and gives it to new shareholders in the form of new shares. That’s what inflation does—only not by mutual consent. Inflation transfers wealth from those who have savings to those who receive the new dollars. And because there are then more dollars in circulation—but the same net amount of wealth—prices go up. In short, inflation destroys the savings in an economy by transferring wealth from the savers to the spenders. And since inflation destroys the value of savings, it essentially destroys an economy. CB: You point out in your book that Americans, on the personal level, are spending more and more and saving less and less than they have historically. Why is this? AS: Well, when there’s a lot of inflation, no one wants to save. Why save money if fifty years from now it’s not going to be worth as much as it is today? In such a case, saving doesn’t make any economic sense. For 150 years in this country when prices fell over time, savings made a lot of sense. That’s why Franklin said “a penny saved is a penny earned”—he wasn’t an idiot. His aphorism was true. If you saved a penny, decades later it was actually worth more! That was the incentive to save. But inflation discourages savings and encourages spending. It encourages people to spend their money as soon as they make it—before it loses value. CB: And then there’s the government spending, which is made possible in large part by our ability to borrow from China. How long can this borrowing go on? How do you think it will end? How do you think it should end? AS: That’s the $64,000 question—although that $64,000 seems painfully antiquated at this point. Who knows? The international rhetoric in the past two months has really started to percolate. China’s frustration is evident; Germany’s frustration is evident; Brazil is complaining. The major countries America deals with are unhappy with our policies, especially as we’re starting to launch the second round of “quantitative easing.” But so far their actions are not matching their statements. For instance, right now the Chinese are not net sellers (or if they are, it’s not by a wide margin). They’re carefully managing their holdings, and they’re continuing to buy the U.S. dollar. Of course, if all of these countries decided to sell their dollar holdings at once, there’d be a complete rout and the dollar market would completely crash in a couple of days. But that’s not going to happen. They’re going to try to implement some kind of exit strategy in which they don’t need to hold as many dollars, a strategy in which they slowly allow their currency to rise. They’re going to try to manage that process. But, as we show in the book, there will come a day when they can’t manage that process, when the stress on the system is too great, when the outflow of dollars is too great. There will come a day when the process runs out of control. The question is, when? I really doubt it can go on for another five years, especially since we’re doubling down. I think our policy makers are very arrogant in thinking that people will stick behind the U.S. dollar and not completely abandon it even as we pursue these insanely irresponsible monetary policies. We’re definitely tempting fate. CB: It seems that the Chinese are tempting fate, too—by continuing to lend us money and prop us up. Doesn’t this cause them trouble from both sides of the inflation equation? Obviously they don’t want the United States to default, but if we inflate in order to pay them, the dollars they receive aren’t worth much. So they’re damned if we do and damned if we don’t. AS: Right. And I think they should cut their losses. At some point, they have to realize that they should quit throwing good money after bad. They do own well over a trillion dollars in U.S. assets, but their economy is worth more than that. They have a lot more yuan than they have dollars, so if they let the dollar collapse, then the yuan’s worth more and they have more purchasing power. It doesn’t really matter how many dollars they have because they have production; they are growing wealth, the ability to buy. CB: How do you respond to claims that a weak currency isn’t all bad, because, for instance, it fuels exports? AS: There is no virtue in a weak currency; it just makes you poorer. Sure, it allows you to compete on price—but that doesn’t matter because your sale isn’t worth as much; you can’t buy as much with it. You don’t export things for the sake of exporting them; exporting is not an end in itself. You export only so that you can import, or enjoy consumption at home. If a weak currency doesn’t get you that from your exports, what good is it? CB: What key policies do you think Americans should demand from politicians toward solving our economic problems? AS: Cut federal spending; allow interest rates to rise; cut regulation; cut corporate and personal taxes; make meaningful, structural changes to Social Security and Medicare; and, lastly (perhaps most controversially), end the minimum wage law so that people can get working again. CB: Let’s hope that Americans start advocating such solutions and that politicians start thinking. In the meantime, what investment advice do you have for Americans on how to weather this continuing and likely worsening economic storm? AS: Well, we have a lot of investing advice at Europac, where we specialize in overseas investments. And we’re not bearish; we’re actually quite bullish on the world economy—just not the U.S. economy. We see a lot of things that tend toward economic growth: greater freedom in large portions of the world—Asia, in particular, where people are moving from serfdom toward capitalism, creating wealth, creating new technologies, and greatly expanding production. So we see a lot of economic growth, which is the fertilizer for investors; it’s what they need for their investments to succeed. At the same time, we understand that the U.S. dollar has been living on its reserve status for a couple generations now, and we’ve been squandering that status. It’s likely that the U.S. dollar is going to continue to deteriorate until it loses its reserve status—in which case, it could lose the majority of its value. Americans who have investment capital need to understand that, and they need to protect themselves against it by owning stocks and bonds that are not denominated in dollars. Even if there were no currency element, a lot of overseas markets trade at better multiples, have higher dividend yields, their companies operate with less regulation, and they have better growth figures. So even setting currency issues aside, a lot of foreign stocks make good sense. But when you start thinking about where the currencies can go over the next few years—and then over the next generation or so—you have substantial incentive to get out of the dollar. Right now there aren’t any restrictions on buying foreign stocks. We’re a U.S. brokerage firm, with U.S. brokerage accounts, but we recommend buying and holding foreign stocks that pay dividends. Those dividends go up in nominal terms as the dollar falls, because they’re all sourced in foreign currency. If you own these stocks and the dollar falls, you won’t lose purchasing power. Some people think we’re unpatriotic for recommending that people invest overseas. But it’s not patriotic to go broke! In any event, if you’ve invested more of your money overseas and the U.S. dollar does fall precipitously, you can repatriate that money then. CB: Thank you for those nuggets of advice. If readers want more, how can they contact you? AS: I’m usually at my desk in the New York City office of Euro Pacific Capital. You can look me up on our website, www.europac.net. CB: I appreciate your time today, Andrew, and I’m sure our readers will be happy to hear your thoughts. Hopefully they’ll also be inspired to buy your book—which, incidentally, makes a great Christmas gift! AS: Indeed it does! Thank you. And, again, my pleasure.