Game Plan

by Kevin D. Freeman

  Still, twenty-three countries have actually defaulted on their debts since 1975. And default, as Martin Fridson of Forbes says, may be more politically palatable than running printing presses to produce inflation: “In America’s case, setting off severe inflation would bring down upon politicians the wrath of savers, many of whom are elderly and conscientious about showing up on Election Day. On the other hand, the Chinese, who would be left holding a large portion of the bag in a U.S. default, are an ocean away and not entitled to vote.”25

  The downside? We depend on foreign nations for so many things like energy, raw materials, manufactured goods, food, and so forth that we would cut ourselves off from the rest of the world if we failed at least to work out our debts. Even then, we still need money to cover the current deficit, which has been running up to $1 trillion per year. We lose superpower status instantly and become vulnerable to all sorts of other attacks. So direct default is a bad deal all around.

  If we’re not going to default on our debts, then we are left with few other options. We could print money excessively, leading to massive inflation and loss of reserve currency status; we could confiscate private wealth from citizens, causing massive economic dislocations; or we could turn, hat in hand, to outside funding sources.

  The idea of confiscating private holdings, at least retirement accounts, has been discussed before and is a tempting idea for cash-strapped governments. Of course, it wouldn’t be called confiscation; it would be a type of “forced investment.” The National Seniors Council has warned, “A recent hearing sponsored by the Treasury and Labor Departments marked the beginning of the Obama administration’s effort to nationalize the nation’s pension system and to eliminate private retirement accounts including IRA’s and 401(k) plans.” Deputy Treasury Secretary J. Mark Iwry reportedly would preside over such a program, destroying 401(k) plans on which millions of Americans rely and in which millions of Americans have invested.26 The Treasury and the Labor Departments have been exploring proposals for government-mandated retirement plans in which the investments would be primarily U.S. Treasury debt.27

  Such schemes have been tried in Argentina and Cyprus. More recently, the Polish government seized a large portion of private pension assets for the government’s use. Reuters reported: “Poland said on Wednesday [September 4, 2013,] it will transfer to the state many of the assets held by private pension funds, slashing public debt but putting in doubt the future of the multi-billion-euro funds, many of them foreign-owned. The changes went deeper than many in the market expected and could fuel investor concerns that the government is ditching some business-friendly policies to try to improve its flagging popularity with voters. The Polish pension funds’ organisation said the changes may be unconstitutional because the government is taking private assets away from them without offering any compensation.”28

  Some German economists want something similar in their country, too. “The rich must give up part of their wealth over the next ten years,” said Professor Peter Bofinger of the German Council of Economic Experts, one of the so-called Five Wise Men advising the chancellor on economics.29

  But such schemes have never resulted in widespread economic growth or in the fiscal security of a broader segment of a population. In the end, there is only so much money to go around, and confiscating wealth depresses the economic activity of those most likely to invest in the new products and services that improve quality of life for everyone.

  Economic realities, however, might not deter the Obama administration. The president’s proposed 2014 budget included provisions to “tax” private IRAs larger than a certain amount.30 The government would declare that self-directed investing is too risky and mandate that a large portion of all investments be placed in government bonds for safety. That is essentially the argument made by those who oppose privatizing Social Security. The government could require a portion of every IRA and 401(k) to be kept in government debt. Or the government could simply rule that accounts over a certain size should be confiscated to save the system. That’s pretty much what happened in Cyprus, and experts believe the approach could spread. Lars Christensen, head of Saxo Bank, explained, “There will be future bail-ins [loss of deposits] and other types of confiscation in the eurozone, without a doubt. There’s no other realistic way forward if politicians continue to fail to deal with the basic indebtedness problem across Europe. They will either have to raise taxes and cut spending, or politicians will take the easier route and take money from the rich.”31

  And it’s coming to America. Jim Rogers, a former partner of George Soros, says confiscation will happen—it’s just a question of when.

  It’s been condoned [now] by the IMF, the European Union, and everybody else in sight; that a government in need, can take assets. We all knew they could tax us . . . but this is the first time that I’m aware of, that they’ve gone in and taken bank accounts. They took gold from people in the U.S. in the 1930s . . . but I’ve never heard of them taking bank accounts. [Now] they’re doing it. So be careful [because], now they can take your bank account under this precedent. . . . [T]hey can do anything they want to now. I for one am worried and I’m taking preparations. Who knows if I’m right or not, but I’d rather be safe than sorry as all of those people who had money in Cyprus have learned. They thought they had a normal bank account . . . but now it’s been [taken] with the sanctions of many governments and institutions.

  Rogers continues, “If people have money in any account, anywhere in the world . . . cut it down to under the guaranteed amount. They might take that too someday when things get desperate, because the precedent has been set, but that’s where I would start if I had money in the bank anywhere in the world.” He suggests that 401(k) plans, IRAs, and pension plans would probably be first on the government hit parade.32

  Of course, the easiest way to seize wealth is under the guise of taxation. Just to balance the budget (assuming limited spending cuts), tax rates would have to double—even for people in the lowest tax brackets. That would not come close to paying off the national debt that we’ve already accrued.33 And higher tax rates would necessarily slow economic activity, requiring even more taxes to make up for the slowdown.

  If printing, confiscating, or taxing can’t produce enough money, external sources will have to be developed. At various points, the Federal Reserve has purchased nearly two-thirds of all U.S. debt issuance.34 But the Fed can buy that debt only by essentially printing money. Such money printing will devalue the currency and make it even less likely that other nations would buy our debt.

  What about the IMF and World Bank?

  Won’t the IMF and World Bank step in and support America’s debt at some point? Well, no. The IMF and World Bank receive more funding from the United States than from any other nation. In fact, it isn’t even close. Our share of the total IMF and World Bank budget is almost 18 percent. The next closest is Japan, at less than 7 percent.35 Much of the other major sources of funding for the IMF and World Bank are from Western nations directly tied to American prosperity. Should we go down in flames, the IMF would not be in a position to bail out the American economy.

  In the case of a U.S. failure, those who held America’s debt would be the ones handing down terms. They would likely structure an alternative to the IMF, as Vladimir Putin and representatives of other BRICS nations have been attempting to do. Such a new financial world order would result in the economic colonization of our nation. Those with capital and those who hold our debt would take control of critical resources, manufacturing capacity, technology, land, and intellectual property. There would be a “fire sale” to extinguish or reduce American debts. The foreign countries recently under duress have accused the United States of doing the same thing to them. The international “human rights organization” Global Exchange, for example, complains about the “structural adjustment policies” (SAPs) that the IMF imposes on the countries it bails out, calling them “an immoral system of modern day colonialism.”36 This would
be their “payback” time.

  We are not seeing this happen—yet. But we are seeing an increasing interest in acquiring U.S. properties. In May 2013, China’s Shuanghui International tried to buy the pork company Smithfield in a deal worth up to $7 billion. In 2005, China tried to take over Unocal with its oil and gas conglomerate CNOOC. The deal, which would have been worth $18.5 billion, was stopped by U.S. lawmakers, enraging the Chinese. China also tried to buy Maytag in 2005 and Hawker Beechcraft in 2012. In 2013, Chinese companies bought ten American companies worth an aggregate of $10.5 billion.37

  Forbes notes, “Foreign firms are moving in and buying up household names from sea to shining sea, and then some.” Nirmalya Kumar, professor of marketing at the London Business School, warns us, “The Chinese are using American money from its trade deficit with you and putting it to use to acquire American brands. Every sector in China has a company Beijing wants to develop into a market leader. They have an acquisition agenda. It is hard to predict which one will break out.”38 China already owns AMC Theaters, which is now a division of Dalian Wanda. Chinese investment in the United States topped $6.5 billion in 2013. “We are in the midst of a structural growth story that will transform the China-U.S. investment relationship from a one-way street into a two-way street,” Thilo Hanemann of Rhodium Group told CNBC.39

  The Chinese appreciate America’s weak economic position. And they understand that debtors can’t say much when creditors come asking for payback. Foreign nations, acting separately or together, are prepared to hand down terms. The American employer, employee, and consumer would all be losers.

  The Dangers of Inflation

  For a lot of reasons, inflation may be the most likely outcome of our precarious economic position. Inflation is in many ways a natural result of any serious crisis, short of total collapse. That’s because, as we’ve noted, the central banks of the world are trying to create it. They just don’t want it to get out of hand. But that’s the problem: inflation feeds on itself.

  So why haven’t we seen the fallout from inflation yet?

  The reason we have had so much Fed stimulus with so little inflation is because the velocity of money has fallen sharply. Money has been coming from the Fed into the banking system, but the banks haven’t loaned the money out. Instead, they have put it back on deposit at the Fed. Michael Snyder has pointed out that U.S. banks “have more than $1.8 trillion parked at the Federal Reserve. . . . [T]he truth is that the vast majority of the money that the Fed has created through quantitative easing has not even gotten into the system.” That’s because in 2008, Fed chair Ben Bernanke stated that the Fed would pay interest on reserves kept at the Fed. “[N]ow that big pile of money is sitting out there, and at some point it is going to come pouring in to the U.S. economy. When that happens, we could very well see an absolutely massive tsunami of inflation,” Snyder points out.40

  At a certain point, such extraordinary stimulus will eventually find its way into the real economy, and that’s the problem. Such a tsunami would end one of two ways, says Martin Hutchinson, a global investing specialist: “Eventually—like it did in 1929, the volume of malinvestment becomes so great that a crash occurs, in which all the bad investments have to be written off, huge losses are taken and a wave of bankruptcies sweeps across the economy.” Or, we could follow the Japanese example: “This didn’t happen in Japan. The banks went on lending to bad companies, creating a collection of zombies which sapped the vitality from the Japanese economy and has produced more than 20 years of economic stagnation.”41

  Hyperinflation is not guaranteed, but it remains a risk. High inflation hurts savers, investors, and consumers. Hyperinflation is much worse. In Greece in October 1944, just before the end of World War II, monthly inflation was 13,800 percent, with prices doubling every 4.3 days. That means that no one could keep up with wages. Thanks to military expenditures rising quickly and tax revenues dropping dramatically, Greek finances fell apart. The Bank of Greece simply printed money to cover all the spending.

  Greece isn’t even the top of the list of inflationary disasters. In October 1923 the monthly inflation rate in Germany was 29,500 percent, with prices doubling every 3.7 days. In January 1994 the Yugoslavian currency saw an inflation rate of 313 million percent, with prices doubling every day and a half. Zimbabwe infamously saw a monthly inflation rate of nearly 80 billion percent, with prices doubling every twenty-four hours.42 In 1998, a Zimbabwe hundred-dollar bill was worth about twenty U.S. dollars. Ten years later, Zimbabwe was producing bills marked $100 trillion, and they weren’t worth a penny.

  Some argue that hyperinflation is not possible in the United States, but they assume that we will always have the reserve currency of the world. Matthew O’Brien of the Atlantic, for example, writes, “U.S. government finances might look Zimbabwe-esque, but a look back at some of history’s worst hyperinflation episodes show why goldbugs’ fears are completely unfounded now.” O’Brien says that hyperinflation in the United States is impossible because “(1) we don’t have any problems selling our debt; (2) we aren’t actually printing money; and (3) the United States is a highly productive economy that is nothing like bombed-out Budapest.”43 This is only half true. We don’t have problems selling our debt right now thanks to other economies’ problems—but that won’t remain true for long. As for the notion that the United States isn’t printing money, that may be technically true, but only technically—the Fed is buying longer-term bonds from banks for cash and injecting money into the economy. At a certain point, there will be no more long-term bonds to buy. As for our functioning economy, that won’t last long with the current attempt to spend our way out of every problem we’ve ever had, and tax and regulate ourselves in order to do so.

  Higher inflation is inevitable, and even without true Zimbabwe-style hyperinflation, consistently rising prices can be a problem. Carmen Reinhart and Kenneth Rogoff, authors of This Time Is Different, suggest that debt levels above 90 percent of GDP lead to much higher inflation; when that number is reached, inflation jumps to 6 percent. Bud Conrad, chief economist of Casey Research, said that we’re currently at 110 percent.44

  We don’t suffer from hyperinflation, but we don’t need hyperinflation to devastate the economy, as we learned during the Jimmy Carter years. In Britain, for example, inflation rates reached almost 25 percent per year in the 1970s. Not hyperinflation, but terribly destructive nonetheless.

  The Worst-Case Scenario

  Finally, there’s the worst-case scenario: complete financial collapse.

  What would it look like? A complete financial collapse could happen in several ways: a full currency collapse, a shutdown of the financial transaction network from hacking, an EMP, a complete collapse in the rule of law. While these scenarios may seem far fetched to Americans fed a steady diet of “normalcy bias,” they remain reasonable possibilities of which we must be aware.

  Whatever the cause, however, financial collapse would be devastating. Society would become lawless. Barter would be the only way to buy and sell. Think of a bad Kevin Costner movie about the end of days (Waterworld, The Postman). Or maybe a Mad Max movie with Mel Gibson.

  The problem is that we live in a “just in time” society. There is only enough food on the shelves to last a few days with our inventory systems and dependence on regular trucking supplies. According to a report from the American Trucking Associations, “Significant shortages will occur in as little as three days, especially for perishable items following a national emergency and a ban on truck traffic. Consumer fear and panic will exacerbate shortages. News of a truck stoppage—whether on the local level, state or regional level, or nationwide—will spur hoarding and drastic increases in consumer purchases of essential goods.” Water will run dry within a month. Healthcare will be jeopardized. Gas stations will run out of fuel within two days. Sewage will pile up.45

  Congress established a blue-ribbon commission to evaluate the threat of an electromagnetic pulse attack on America’s electrical infr
astructure. The commission’s 2004 report addressed the consequences of a failure of the country’s food infrastructure (by EMP or any other cause):

  Even today, according to the USDA, 33.6 million Americans, almost 12 percent of the national population, live in “food-insecure households.” Food-insecure households, as defined by the USDA, are households that are uncertain of having or are unable to acquire enough food to meet the nutritional needs of all their members because they have insufficient money or other resources.

  A natural disaster or deliberate attack that makes food less available, or more expensive, would place at least America’s poor, 33.6 million people, at grave risk. They would have the least food stockpiled at home and be the first to need food supplies. A work force preoccupied with finding food would be unable to perform its normal jobs. Social order likely would decay if a food shortage were protracted. A government that cannot supply the population with enough food to preserve health and life could face anarchy.

  In the event of a crisis, often merely in the event of bad weather, supermarket shelves are quickly stripped as some people begin to hoard food. Hoarding deprives government of the opportunity to ration local food supplies to ensure that all people are adequately fed in the event of a food shortage. The ability to promptly replenish supermarket food supplies becomes imperative in order to avoid mass hunger. . . .

  Federal, state, and local agencies combined would find it difficult to cope immediately or even over a protracted period of days or weeks following an EMP attack that causes the food infrastructure to fail across a broad geographic area encompassing one or more states. Infrastructure failure at the level of food distribution because of disruption of the transportation system, as is likely during an EMP attack, could bring on food shortages affecting the general population in as little as 24 hours.46