Road to Perdition
Galland interviews Terry Coxon
by David Galland: The
U.S. Monetary System and Descent into Fascism an Interview With
Dr. Edwin Vieira
worked side by side with best-selling author Harry Browne for years
and is a rare expert in the arcane study of monetary systems. His
remarks at this juncture in time, a time that might end up labeled
in the history books as Money Runs Wild, are especially
You were involved with Harry Browne during the last great inflation
in the U.S. How does the increase in the money supply that kicked
off in 2007-2008 compare in terms of scale to what went on leading
up to the inflation in the 70s?
The comparison is pretty muddled. In terms of the M1 money supply
the total of checkable deposits and hand-to-hand currency
we havent yet gotten near the persistently high growth
rate that occurred in the 1970s. But the growth in the monetary
base has been far more rapid than what happened in the 1970s. There
is some time delay between growth in the monetary base and growth
in M1, but to make the picture really cloudy, I'm afraid the comparison
turns out not to be very useful. Unlike in the 1970s, the Federal
Reserve is now paying interest to banks on their reserves.
In other words,
the effect is that much of the increase in the monetary base gets
locked up and sequestered because banks want to earn the interest
on the reserves rather than lending the reserves out or buying investments
and increasing the money supply.
You are referring to the excess reserves banks have left on deposit
with the Fed?
Why do you think that the Fed is paying interest on those reserves?
With policy makers and pundits saying that the economy needs a shot
in the arm and a dose of inflation, why would the Fed continue to
encourage banks not to lend or invest, by paying them interest to
leave the money on deposit?
If the Federal Reserve didnt pay interest on those reserves,
the result would be inflation rates far beyond anything the U.S.
has ever experienced. The monetary base has more than doubled, and
without the Federal Reserve paying interest on the recently created
boatload of reserves that is essentially keeping them immobilized
in accounts at the Federal Reserve Bank in New York, the M1 money
supply would more than double and we would have inflation rates
that would make the worst days of inflation in Brazil and Argentina
I know you can't give a real number, but what general level of inflation
are you talking about?
Close to a doubling in the CPI in a year's time. Doubling the CPI
over the course of a year would be an inflation rate of 100%.
But on the other side of the equation, a deflationist would say
that even if they stopped paying interest on those excess reserves,
there is no loan demand, so the banks can't find anybody to loan
to. If thats the case, how does the money get out into the
If a bank has excess reserves and the Federal Reserve stops paying
interest on them, if the bank can't think of anything else, it will
buy Treasury bills, even if the yields on those Treasury bills are
only 0.5% a year. Then the seller of the Treasury bills has the
seller of the Treasury bills is, we can safely assume he sold his
T-bills because the cash was more attractive to him. And if the
cash is more attractive when it's earning zero, that means the person
who sold the Treasury bills wants to use the cash to buy something
else, and that's how the excess reserves would move from the banks
to the general economy.
What about the role the carry trade plays in all of this? If banks
cant get a return in the U.S., might they take the money and
spend it elsewhere or invest it in countries where interest rates
are higher? That seems to be going on today, in which case, wouldnt
we effectively export our inflation?
It does have an inflationary effect all around the world, and it
also puts the markets generally on a very fragile footing when you
can borrow U.S. dollars at an artificially suppressed rate of 0.5%
and buy New Zealand dollars and earn 2%. That has the effect of
propping up the New Zealand dollar. And it promises a profit for
the carry trader of 1.5%, but actually collecting that profit depends
on exiting the trade at the right time.
The carry trade
is in just about every market at this point. People are borrowing
dollars at ultra-low interest rates in the hope of earning a higher
return in something else and also hoping to exit at the right time.
Virtually all markets have been propped up by the carry trade, and
all the carry traders are telling themselves they are going to jump
ship at just the right time. When the time comes, the rails of the
ship are going to be crowded, and markets likely will move down
Discuss the effect of the carry trade on the dollar. As you said,
at this point in time there is a robust dollar carry trade, with
people borrowing dollars and using them to buy, say, New Zealand
bonds or whatever. So, what effect does this have on the dollar?
The carry trade is the proximate cause of the decline in the dollar
in foreign exchange markets. If you look at the whole process, it
starts with printing by the Federal Reserve, but the step that occurs
just before the price of the dollar goes down is the decision by
traders to borrow dollars and buy other currencies. When the carry
trade comes to an end, the process will go into reverse, and the
dollar will rally.
So this would again tie back to interest rates. If U.S. interest
rates start moving up, then the carry trade begins to unwind.
It wouldnt even take that, just an expectation that interest
rates on dollars are about to move up. That would do it.
Yet, historically gold and interest rates and inflation all tend
to move up together. Not to get all tangled up, but if interest
rates in the U.S. move up and the dollar starts to strengthen, shouldnt
gold then start moving down? But again, that's not the historic
Its not as tangled as you think. The answer you are going
to come to for gold depends on what is causing interest rates to
move up. If interest rates are moving up because the expectation
of inflation is moving up, then that won't hurt gold, it will help
gold. On the other hand, if interest rates are moving up because
the Federal Reserve is tightening, then that is bad for almost everything
that people have been borrowing to buy, which includes gold and
silver and stocks generally.
And New Zealand dollars.
Yes, foreign currencies as well.
With the carry trade, the interest rate differential is an important
thing to understand, and right now the U.S. is clearly behind the
curve in terms of its interest rates. So the question is
this situation continue for quite a while, with the dollar kept
cheap by the carry trade? Can the dollar just keep going down until
it evaporates, or are you seeing signs of an alternative outcome?
The road to perdition has zigs and zags and loopbacks, and what
causes the loopbacks is a shift in what the Federal Reserve currently
perceives as its worst nightmare. For example, in 2008, 2009 and
into 2010, the Federal Reserve was worried primarily about a deflationary
depression, so it turned on the printing presses.
inflation has returned as a worry, and that can turn into worry
number one on any given day, at which point the Federal Reserve
will slow down the printing or just sit on its hands for a while.
That's when interest rates will start moving up, and that's when
the carry trade will get unwound, triggering a big downdraft in
virtually all markets. But the prominence of inflation as a worry
will eventually be replaced by renewed concern about the economy
contracting, and then the Federal Reserve will shift its weight
again from one foot to the other.
Which brings us to the 8,000-pound gorilla in the room: the debt.
Our readers, and pretty much everyone else, knows that the U.S.
government is sitting on the largest pile of debt in history, and
that much of this debt has been generated for no real useful purpose.
made the point at our spring summit that the last time government
debt was anything close to this as a percentage of GDP was in World
War II. And he pointed out that the money spent back then essentially
bought a victory in World War II, leaving the U.S. with a very strong
economy and leverage over other economies. But those advantages
have been squandered. Now in exchange for all the debt that has
been rung up, Rickards points out that the country has little more
than a lot of flat-screen TVs.
I think it
was probably our very first meeting after you joined Casey Research,
sitting around the table in San Francisco, that I asked, "Is
there any way out?" This was back in 2004, and Doug Casey and
Bud Conrad and you took turns answering, with the answer being essentially
the same, "No, no way out and the situation is going to end
And here we
are seven years later, and the governments debts have only
grown. Obviously, inflation is the standard approach the government
is likely to use to relieve itself of its debt over time, but I
wouldnt rule out an overt default of some sort. Regardless,
it seems like the countrys economic future is going to be
determined by the debt.
So, let me
ask you the same question, do you see any way out? Are there any
options left to the government that dont lead to economic
If by some miracle the people who run the government decided that
Big Government was a bad idea and small government was a much better
idea, and so they set about ending government programs and pushing
the level of federal spending way down, along with the level of
regulation over the economy, then there would be a way out.
But how likely
is that to happen? The time horizon for people in politics is maybe
one or two years, just about the same length of time there is before
the next election. Their goal is always to survive the coming election.
That means what is rational for the politicians looks irrational
to everyone else, and I dont see any reason to expect that
to change. The purpose of a politician examining a problem is not
to solve the problem but to find a way for someone else to get blamed
Doug and I have both written about the fact that we are living in
a steadily degrading democracy at this point, with the public voting
itself all manner of benefits from the public trough. Personally,
I dont see how we get to the point where politicians, where
the voters, decide that a much smaller government is a much better
way to go. At least not unless and until we're forced to. Do you
think this situation can drag on, or will the size of the debt and
deficits force a change sooner rather than later?
That's a political question. At some point, the situation may become
so catastrophic that people are forced to learn new habits and consider
new ideas, but things have to get pretty bad before that happens.
And how would you rate the odds of it getting pretty bad before
this is over?
And the time frame? You typically say these things are variable
and unknowable, but can you be a bit more specific?
It takes a long time. It's not going to happen this year. It's probably
not going to happen next year.
But hasnt this been a long time coming?
Yes, it has, and that should tell you that the process is a slow
So in your view, what are the one or two most important things that
readers need to be doing to protect themselves at this point?
I think the most important thing someone can do is to understand
what's going on. That's what will give the individual staying power
when the markets are temporarily moving against them. The worst
thing you can do is to just pick a leader and do whatever he advises
without thinking it through and understanding it. What makes that
a bad approach is that no matter which intellectual leader you might
choose, there are going to be periods when he is wrong and when
his advice is not working for you. And even if he is right in the
long run, you may not stick with him for the long run if you dont
understand why his advice makes sense. So I think job number one
is to understand what's going on, so that youre not blindly
relying on anyone's advice.
What's job number two?
Job number two, if you see the world as I see it, is to make sure
that a substantial share of your wealth is in precious metals and
perhaps in foreign currencies, but without any leverage.
Thank you very much.
Editor Terry Coxon is the author of Keep
What You Earn and Using
Warrants and the co-author (with Harry Browne) of Inflation-Proofing
Your Investments. He edited Harry Brownes Special Reports
for its 23 years of publication and all of Harry Brownes investment
books since 1974. Terry was the founder and for 22 years the president
of the Permanent Portfolio Fund, a mutual fund that invests in precious
metals as well as stocks and bonds. He is currently president of
Passport Financial, Inc., and for over 30 years has advised clients
on legal ways to internationalize their assets to optimize tax,
wealth protection and estate planning goals.
If you arent
worried about inflation yet, you should be. Because this insidious
parasite keeps eating away at your assets and portfolio gains
probably without you noticing. Read on to find out how to beat inflation
and come out ahead of the game. Free
July 14, 2011
is the managing editor of Casey
© 2011 Casey