12 September 2008

Schift, Keen on dateline (transcript)

GEORGE NEGUS: Thanks for joining us to talk about Fannie Mae and Freddie Mac. Peter, can I start with you? Is this capitalism in crisis, because you've been howling for quite some time that this could be the beginning of the end of the Western capitalist system as we know it, including the American economy and all that goes with it.

PETER SCHIFF, ANALYST AND BROKER, EURO PACIFIC CAPITAL: It's really socialism in crisis, because that's what we have. Remember, the reason we had the problem with Freddie and Fannie was because of the implicit government guarantee. If the government wasn't guaranteeing their debt, they never would have been allowed to borrow so much money, so basically what happened was you had American citizens were basically able to buy houses, not on their own credit, but on the credit of the US Government. And we had this huge bubble that was inflated that never would have been inflated had we been on a free market economy.
The two biggest creators of the mortgage bubble were the Federal Reserve, which kept interest rates too low, which is a creature of government, not the free market, and Freddie and Fannie, which again were created by government. Absent government in a free market economy, none of these misallocations of resources ever would have taken place.

GEORGE NEGUS: So at this point you're not surprised at what's happened in the last few days, this so-called bail-out, these so-called conservatorship which is in place, which sounds like a fancy word for bankruptcy to me - you're not surprised by what happened?

PETER SCHIFF: I had been forecasting the bankruptcy for Freddie and Fannie for years. I wrote about it in my book 'Crash-proof', which came out in early 2007. I always said the stocks we going to zero, that they would go bankrupt. Now Paulson is try to pretend that this conservatorship is not going to cost US taxpayers any money because there's a guarantee. There's no guarantee at all. All that happens is that if Fannie and Freddie ever have any profits in the future the US Government is the head of common shareholders to receive those profits. But there aren't going to be any profits. There's going to be hundreds of billions of dollars, maybe even over $1 trillion of losses. And they're going to be borne, not just by the US taxpayer, but by anyone anywhere in the world who's unfortunate enough to own US dollars.

GEORGE NEGUS: I have to admit I'm finding it difficult to get my mind around something called Freddie and Fannie being so important to the world's economy. You mention the fact there's this international flow-on. Steve Keen what about this country? Do you think Australians are going to suffer? They're saying in America everybody will be hurt by this. Does that include Australia?

PROFESSOR STEVEN KEEN, ECONOMIST, UNIVERSITY OF WESTERN SYDNEY: It does include Australia and it's not just Australia that's suffering courtesy of America. We have our own bubble over here. And we don't have anything like Fannie and Freddie to explain why we have got a bubble, so it's something which I think goes beyond market socialism. It's actually built into the nature of a financial system that encourages speculation.
The scale of this bubble is twice as big as any previous bubble back when we did have an unregulated financial system, so if you look at the level of debt America got itself into in the Great Depression that was bad enough to cause the biggest economic catastrophe in history. We now have twice as much debt as we had back then. And I think what has happened with the Fannies and Freddies and the US Federal Reserve, it encouraged the financial system to go to twice the level of speculation it would have done without them being there, and that's what I really see is the contribution they have made.

PETER SCHIFF: Also, when you're talking about all the problems around the world, remember, the global problems are the result of America borrowing so much money and not being able to pay it back. The credit crunch is that we've being borrowing money - hundred of billions, trillions of dollars from the rest of the world - and now the world is finally beginning to realise that we're not good for the money. We can't pay it back because we have been borrowing to consume. Nobody has loaned us money to build factories, to build infrastructure. We have nothing to show for the trillions of dollars the world has loaned us except empty houses, plasma TVs, SUVS. We've blown the money on consumption and this is the problem. Ultimately the solution for the rest of the world is to stop lending us money, let the dollar collapse, let the US economy implode, and the rest of the world just goes about its business.

GEORGE NEGUS: Peter, that must be heresy to so many people in America, to suggest that the so-called the strongest and biggest economy in the world is to blame for this.

PETER SCHIFF: Our economy is no sounder than a dotcom stock was or a subprime mortgage. It's all an illusion. We're flooding the world with our IOUs. We are borrowing from everybody in the world and we're sucking up resources and consumer goods that we can't afford.

GEORGE NEGUS: Steve Keen, Peter is actually living up to his name as 'Dr Doom', a doomsayer, but is the picture is bleak as Peter is painting it?

PROFESSOR STEVEN KEEN: I think his nickname is 'Dr Gloom' and it's not quite as bad as Dr Doom but, yes, the picture is in that direction. I certainly think that the idea that America has been living on IOUs is valid. Part of the American arrogance and the end of Second World War was to say we are the biggest, toughest, strongest country on the planet. You're going to use American dollars for international exchange. What that meant was when other countries ran out of American dollars when there are running a trade deficit, particularly back when exchange rates were fixed, there were forced to devalue. They had to do something serious. When America ran out of American dollars, it printed more.

GEORGE NEGUS: So we don't sound like a mutual admiration society here, what's the solution than? If you guys are both convinced the Americans have created their own problem and now it's flowing on to the rest of us, including Australia, Steve, what should they be doing?

PETER SCHIFF: I think the solution - the world needs to recognise that America is not the engine of the global economy. We are the caboose. Anybody can consume. Little children can consume. The key is to produce. The key is to save, not to borrow. And if America stops consuming and stopped borrowing, that's not going to hurt the global economy, that's going to help the global economy. The rest of the world has been living beneath their means so we can live beyond ours.

PROFESSOR STEVEN KEEN: I wish that were true.

PETER SCHIFF: I think for the world the solution is to write off the US.

PROFESSOR STEVEN KEEN: I wish Peter were right that the rest of the world had its act in order. The rest of the OECD doesn't. It isn't just America that been borrowing more money than it's been earning - the whole of the OECD bar one country, which has France, has been having an increase in ratio of its debt to GDP for the last 30 years. So we're all in the borrowing game. We've all made the mistake of confusing money generated by real production with money you can borrow from a bank. And that's kept on going for so long that it's reached the point now where that game is over. If you like, it's the old "greater fool" philosophy. You make money if you find a greater fool who borrows more money than you did to buy the same asset off you and you get away rich and they end up with even more

GEORGE NEGUS: What do we do, Peter? If you are running either the Fed in America or the Treasury, if you had all the power that comes with the stroke of a pen or hitting a computer key, what would you do right now to make sure this situation didn't get a lot, lot worse before it gets better?

PETER SCHIFF: There is nothing I can do. It's got to get worse before it gets better. Unfortunately for America the only way to cure these imbalances is to suffer a severe recession. There's no way round it. All the government is doing is trying to make the situation worse in the long run by postponing it. We need to stop all this reckless consumption. We need to have much higher interest rates in the United States and we will need to allow companies to go bankrupt. We need to allow real estate prices to collapse, we need to rebalance our economy. That can't be done without a lot of pain.
But the rest of the world - somebody is saving, somebody is loaning us this money and there are a lot of consumer goods all around America. There are factories somewhere in the world that are producing this stuff. That's real wealth and the world has that - we don't.

GEORGE NEGUS: Meanwhile, the upshot of all of this, of course, is people, whether it's in Australia with the flow-on to this country, or in America, where people are losing their homes, losing their life savings, losing everything that matters to them, the whole core of their existence. It's a very human problem in the long run, we’re talking high finance here.

PETER SCHIFF: But they never had any life savings. It was an illusion to begin with. And they're not losing places to live. The one problem we don't have in America is housing. We've got so many houses that are empty. Nobody is on the street. They are losing the fantasy of home equity. So you move out of one house and you rent another one. Nobody is going homeless.

GEORGE NEGUS: Peter mentioned the Americans should in fact raise interest rates. We have just had a lowering of interest rates in this country. Are we heading the wrong direction?

PROFESSOR STEVEN KEEN: No, no, no. The whole belief that you can manipulate the economy using interest rates has been fallacious. It's been focusing on the rate of inflation, and believing there's a simple inverse relationship between the rate of inflation and the rate of interest that means you can fine-tune the economy, totally ignoring in the background the explosion in private debt that's the thing both Peter and I are focusing on.

GEORGE NEGUS: So, lower interest rates or not, are people going to lose their homes in this country?

PROFESSOR STEVEN KEEN: Yes. The scale of debt is so enormous there isn't the physical production to back it. It's even worse in Australia than in America - the de-industrialisation of our society in the last two decades.

GEORGE NEGUS: Are we talking here, Peter, of people's expectations just being too high altogether because of the ready access to loan money? People think they can afford to live in ways that they can't live.

PETER SCHIFF: People think the government has real wealth, the government can help solve problems. They can't. All they have is a printing press. They can debase money, they can rearrange the losses, but they can't make them go away and they can't produce anything. And the problem on interest rates is we shouldn't have governments setting interest rates, just as we don't have governments setting the price of anything. They're going to do it wrong and of course when it comes to inflation our government lies about inflation. They claim our inflation is non-existent. In the GDP deflator, where they tried to manufacture a 3% growth, the government claimed inflation in America is running at a 1.2% annual rate - the lowest in 10 years. Our inflation is over 10% a year. The government cooks the books. If the free market set interest rates, they would be much higher because nobody would loan money for below the rate of inflation.

GEORGE NEGUS: At least in this country we can say that the government are not lying about inflation. They're actually blaming it for all the problems we have. But are they missing the point as well when they keep harping on the way they do about inflation and in fact we don't hear much about this enormous public and private debt?

PROFESSOR STEVEN KEEN: The central banks of the world, including our Reserve Bank, and certainly the American FRB, they have forgotten the reason they were created was to some extent to prevent an occurrence like the Great Depression. They have ignored debt completely and in the meantime focused on inflation. Debt has gone through the roof. We have gone back to twice as much debt as we had before the Great Depression began and inflation, which is low, they are trying

GEORGE NEGUS: Running out of time, unfortunately, gentlemen. If I can put this to you in conclusion - would you like to be either John McCain or Barack Obama inheriting this situation as president of the United States of America in a few months time?

PETER SCHIFF: I would like to have the job, but neither one of them is up to it. They're going to walk into a landmine and they're going to step on every one. It's going to be a complete disaster whoever is president and our country is in serious, serious trouble. Other countries have smaller problems but nothing like the United States. It's a real mess and all I can say is, anybody who's watching this in Australia, if you've got any money invested in any US dollar-denominated equities or debt, just sell the first chance you get.

GEORGE NEGUS: Peter, thanks very much for talking to us. I know we could go on all day or all night, depending what part of the world you're in. Thank you very much for talking to us. Professor Steven Keen, thank you


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