Our economy is in crisis and people are looking for someone to blame. A large segment of society blames the government and many now express the view that everything would be fine again if the government would just stop interfering in the markets and allow laissez-faire capitalism to work its magic.
One of the themes that I have tried to develop in this series of blogs is that our economic system has evolved so far away from Capitalism over the last century that any attempt to go back (at least to go directly back) to that kind of economic system would have cataclysmic consequences that our civilization simply might not survive. In this blog, I will describe what the Laissez-Faire Method back to Capitalism would look like and what that would mean for your savings.
Murray Rothbard (1926 to 1995), a student and friend of Ludwig von Mises and an impressive (Austrian) economist in his own right, believed that the Great Depression would have ended much sooner had the government not interfered and simply allowed the economy to adjust by itself. He described what he thought would have happened in that case in his book, America’s Great Depression:
“The laissez-faire method would have permitted the banks of the nation to close – as they probably would have done without governmental intervention. The bankrupt banks could then have been transferred to the ownership of their depositors, who would have taken charge of the invested, frozen assets of the banks. There would have been a vast, but rapid, deflation, with the money supply falling to virtually 100 percent of the nation’s gold stock. The depositors would have been “forced savers” in the existing bank assets (loans and investments). This cleansing surgical operation would have ended, once and for all, the inherently bankrupt fractional-reserve system, would have henceforth grounded loans and investments on people’s voluntary savings rather than artificially-extended credit, and would have brought the country to a truly sound and hard monetary base.” [Murray Rothbard, America’s Great Depression, Ludwig von Mises Institute, 1963.]
Perhaps he was right. On the other hand, perhaps the suffering that would have resulted from that “vast, but rapid, deflation” and “cleansing surgical operation” would have been so great that American Democracy could not have survived it.
Eighty years and $50 trillion in debt later, the suffering that would result from the Laissez-Faire Method this time would be even more extreme. The nation’s gold stock is worth approximately $420 billion (at $1,600 per ounce). Think of the debt deflation that would be necessary to return the credit supply to that level. It would require the destruction of 99% of all the debt in the country. Remember, that one person’s debt is another person’s asset, so the great majority of all the financial assets in the country would evaporate. As a result, all the banks would fail and all the deposits in the banking system would be destroyed. In compensation, you, the depositors, would own the assets left in your bank. Unfortunately, there wouldn’t be any. There are $700 trillion worth of derivatives contracts that would certainly all explode under those conditions. The banks have written most of those contracts.
The stock market would collapse by 95% or more. Home prices might fall just as far. Consumption would collapse and investment would nearly stop, so unemployment would move toward 30% or more. Government tax revenues would nearly disappear; so most government spending would have to stop. That would mean the withdrawal of all US military bases from overseas, and the end of social security, Medicare and unemployment insurance within the US. Many people too old or too sick or too unlucky to find a job would begin to starve. Crime would be uncontrollable. Within weeks the military would take over. Democracy would be a thing of the past. Government power would then be far beyond the control of the people. Freedom would be lost.
That’s what the Laissez-Faire Method would look like. With all due respect to Murray Rothbard (and Ron Paul), I don’t want to go down that path; and I won’t go without kicking and screaming all the way.
The sooner it is understood that the Laissez-Faire Method is not an option, the sooner the quest for a workable method can begin.
Here are the facts.
Our economic system is not Capitalism.
We are not going to employ the Laissez-Faire Method to go back to Capitalism because that would cause our civilization to collapse.
Our economy is on government life support. Without trillion dollar budget deficits, it would collapse into depression.
Even the US government can’t run trillion dollar budget deficits forever. Within 10 years the government will be broke.
If the government changes the way it spends money, if it invests aggressively in transformative 21st Century technologies (a Manhattan Project for nanotechnology and/or an Apollo-like program to develop solar energy) rather than on consumption, we could restructure the US economy by developing new industries, and, thereby, avoid collapse.
That will probably not happen; therefore a dire economic collapse with disastrous geopolitical consequences may be unavoidable.
What, then, can individuals do to protect themselves financially should this prognosis prove correct?
In the short run, follow the Fed. Our economy is like a large rubber raft that has been inflated with credit instead of air. All the asset classes – stocks, bonds and commodities – are floating on the raft. Unfortunately, the raft is defective. Its natural tendency is to sink because the credit, which can’t be repaid, is leaking out numerous holes on all sides of the raft as it is destroyed. Policy makers have only one response: To pump in more credit to replace the credit that is leaking out. That is what they have been doing with QE 1, QE 2 (and LTRO in Europe). And that is what they will continue to do with QE 3 and QE 4 in the not too distant future. When they pump in more credit, the raft inflates and all the asset classes move up together. When they stop pumping in more credit (that is, when no quantitative easing is taking place), the raft and the assets floating on the raft begin to sink. Therefore, asset prices are likely to rise during quantitative easing and to fall when quantitative easing ends. Follow the Fed. This approach will not work forever, but it is likely to continue working in the short run.
Over the long run, if the prognosis above is correct, there will be no place to hide. A tremendous amount of wealth will be destroyed. Depending on which government policy is carried out, it could be destroyed by very high rates of inflation or, should the Laissez-Faire Method be employed, it would be destroyed by extreme deflation. Were it necessary (for whatever reason) to lock in a portfolio for the long run, the best chance of preserving some wealth would be through constructing a broadly diversified portfolio, including 1) blue chip stocks with good dividend yields, 2) government and corporate bonds, 3) gold, 4) residential rental property and 5) fixed interest rate debt (used to finance the rental property). Then, in case of high rates of inflation, your bonds would suffer and your stocks would not do well, but your gold would appreciate. Moreover, the rents on your property would rise, while the fixed interest rate debt would effectively evaporate in the inflation. On the other hand, should there be deflation, the gold would lose value, and the stocks would be weak, but the bonds would do well. The rents may decline, but so would the price of everything else, so you would be hedged.
These topics are discussed in much greater detail in chapters 8 to 10 of my book, The New Depression: The Breakdown Of The Paper Money Economy. They were also among the subjects covered in my recent interview on The McAlvany Weekly Commentary. Here's the link: