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There is nearly universal agreement that the opening
salvo of the Obama Administration's campaign to restore health to the financial
system, delivered this week by new Treasury Secretary Geithner, fell with a loud
and ugly thud. The most common criticism is that the announcement was short on detail.
What is abundantly clear, however, is that the new Administration intends to push
spending back up to pre-crash levels and to fill the entire credit void that has
disappeared into the black hole of the American financial system. Whether or not
the prior levels of spending and lending were justified by market conditions then,
or now, appears to be largely unexamined.
In the worldview of Geithner and like-minded economists,
credit, rather than savings, is the central figure in the economic equation. Therefore,
he sees anything that eases the process of lending to be an effective economic policy.
With such a view in mind, the centerpiece of Geithner's plan is the commitment of
up to $1 trillion to revive the collapsed market for securitized debt. In the lead
up to the Crash of 2008 securitization, more than anything else, permitted Americans
to borrow more than they had ever borrowed before.
Developed primarily over the last 10 years, securitization
permitted loans of all shapes and sizes to be packaged into investment-ready securities.
The system worked, fueling unprecedented levels of lending in the home, auto, student,
and credit card sectors. But in the last few years as the collateral underpinning
these securities has collapsed in value, the trillions of dollars of securitized
debt now in circulation has become the toxic sludge at the bottom of our financial
pit. Geithner is making the false assumption that cleaning up and rebuilding the
securitization market is a prerequisite for a healthy economy.
Our nation's short history with wide securitization
has simply shown that the process can lead to massive mispricing of assets and risk.
By artificially rebuilding the securitization market, and committing taxpayer funds
as collateral, the U.S. economy will be pushed farther and farther out on a leveraged
limb, until no amount of market medicine can prevent a total economic collapse.
In truth, the only vital function provided by securitization
was that it offered foreign savers a pathway to lend directly to American consumers,
and Wall Street executives a new asset class to over-leverage for massive profits.
Our economy must dispense with these gimmicks if it hopes to pursue a meaningful
recovery.
After more than a decade of unsustainable borrowing
and spending, the private sector is currently attempting to restore balance through
reduced consumer and mortgage credit, greater savings, and lower asset prices. With
its trillions of dollars of credit injections and stimulus programs, the government
hopes to allay this process by force-feeding Americans a diet of more borrowing.
They feel that a restored securitization market will help. It won't. It will just
grease the skids for a quicker collapse.
Credit, whether securitized or not, cannot be created
out of thin air. It only comes into existence though savings, which must be preceded
by under-consumption. Since savings are scarce, any government guarantees toward
consumer credit merely crowd out credit that might otherwise have been available
to business. During the previous decade too much credit was extended to consumers
and not enough to producers (securitization focused almost exclusively on consumer
debt). The market is trying to correct this misallocation, but government policy
is standing in the way. When consumers borrow and spend, society gains nothing.
When producers borrow and invest, our capital stock is improved, and we all benefit
from the increased productivity.
Consumers default on credit much more frequently
than businesses. This is because businesses typically use loans to expand, and then
have greater cash flow to repay the debt. In contrast, consumers typically borrow
to consume and in the process do not improve their ability to repay. As a result,
one would expect consumer credit to be harder and more expensive to obtain. But
that is currently not the case. Government guarantees have altered the playing field,
so that now consumers are still being offered credit while businesses are being
shown the door. By shifting credit away from producers, fewer goods and services
will be produced for consumers to buy and fewer employment opportunities provided
for them to earn money with which to buy the goods.
To restore prosperity, credit (derived from savings
rather than a printing press) must flow to producers. Greater liquidity for business
will lead to legitimate job creation, increased production, and rising living standards.
By further encumbering the economy with burdensome regulation, and by transferring
business decisions to vote-seeking politicians who will bail out the irresponsible,
reward failure and punish success, the government will create a society destined
for misery.
In an interview following his announcement, Geithner
stated that government should replace the demand lost by the private sector. However,
those with even a marginal grasp of economics know that demand is unlimited. It
is the ability to spend that is not. While Americans still want all the things they
wanted years ago, they have made the rational choice that they can no longer afford
to buy at the same levels they once did. Using a printing press to replace this
lost 'demand' will simply cause consumer prices to rise. Printed money does not
create new purchasing power, but merely redistributes it from savers to borrowers.
And since the plan will severely undermine the real productive capacity of our economy,
there will not be much purchasing power left to redistribute!
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Peter Schiff C.E.O. and Chief Global Strategist
Euro Pacific Capital, Inc.
 Mr. Schiff
is one of the few non-biased investment advisors (not committed solely to the short
side of the market) to have correctly called the current bear market before it began
and to have positioned his clients accordingly. As a result of his accurate forecasts
on the U.S. stock market, commodities, gold and the dollar, he is becoming increasingly
more renowned. He has been quoted in many of the nations leading newspapers, including
The Wall Street Journal, Barron's, Investor's Business Daily, The Financial Times,
The New York Times, The Los Angeles Times, The Washington Post, The Chicago Tribune,
The Dallas Morning News, The Miami Herald, The San Francisco Chronicle, The Atlanta
Journal-Constitution, The Arizona Republic, The Philadelphia Inquirer, and the Christian
Science Monitor, and has appeared on CNBC, CNNfn., and Bloomberg. In addition,
his views are frequently quoted locally in the Orange County Register.
Mr. Schiff began his investment career as a financial
consultant with Shearson Lehman Brothers, after having earned a degree in finance
and accounting from U.C. Berkley in 1987. A financial professional for seventeen
years he joined Euro Pacific in 1996 and has served as its President since January
2000. An expert on money, economic theory, and international investing, he is a
highly recommended broker by many of the nation's financial newsletters and advisory
services.
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