Join Jason Hartman and author and chief economist at Blackhorse Asset Management in Singapore, Richard Duncan, as they discuss the global economic crisis, how it came about, where we are now, and what happens next. Richard talks about the history of the Great Depression and how we’re back in that same spot today. Richard also shares his solution to permanently end the crisis.
Richard Duncan is the author of The Dollar Crisis: Causes, Consequences, Cures, his prediction of the current global economic disaster, and his new book, The Corruption of Capitalism, a strategy to rebalance the global economy and restore sustainable growth. Richard is an equities analyst, beginning his career in Hong Kong in 1986, and has served as global head of investment strategy at ABN AMRO Asset Management in London, worked as a financial sector specialist for the World Bank in Washington, D.C., as well as headed equity research departments for James Capel Securities and Salomon Brothers in Bangkok and worked as a consultant for the IMF in Thailand during the Asia Crisis. His current position is chief economist at Blackhorse Asset Management in Singapore.
Richard graduated from Vanderbilt University in literature and economics, and Babson College in international finance. He spent a year between the two universities backpacking around the world.
Richard Duncan has appeared on many major media outlets, including CNBC, CNN, BBC, Bloomberg Television, and BBC World Service Radio. He has published articles in The Financial Times, The Far East Economic Review, FinanceAsia and CFO Asia. He is a well-known speaker, having appeared before The World Economic Forum’s East Asia Economic Summit in Singapore, The EuroFinance Conference in Copenhagen, The Chief Financial Officers’ Roundtable in Shanghai, and The World Knowledge Forum in Seoul.
ANNOUNCER: Welcome to Creating Wealth with Jason Hartman! During this program Jason is going to tell you some really exciting things that you probably haven’t thought of before, and a new slant on investing: fresh new approaches to America’s best investment that will enable you to create more wealth and happiness than you ever thought possible. Jason is a genuine, self-made multi-millionaire who not only talks the talk, but walks the walk. He’s been a successful investor for 20 years and currently owns properties in 11 states and 17 cities. This program will help you follow in Jason’s footsteps on the road to financial freedom. You really can do it! And now, here’s your host, Jason Hartman, with the complete solution for real estate investors.
JASON HARTMAN: Welcome to the Creating Wealth Show! This is episode #229, and this is your host, Jason Hartman. Well, I have missed you. Have you missed me? I hope you have. A little bit. Sorry we’ve been out for a little while here, on a mini-sabbatical from the show. And I hope whenever we don’t publish as often, you use that as an opportunity to go and listen to the old episodes. Many of them are up on the website at www.jasonhartman.com, and on iTunes, and the are accessible for free, and some of the selected episodes are, of course, at the members only section at www.jasonhartman.com, and we would love to have you join as a formal member, and be part of our members family for lots of extra benefits there. But, always whenever we’re not publishing as often, or you just have extra time to listen, you know, with the holidays upon us now, you may have extra time, and maybe not—maybe it’ll be the opposite for you. But it’s a great opportunity to listen to the old episodes.
And the great thing about this is that if we were investors in stocks, bonds, mutual funds, and all those things that generally don’t work very well, if we were investors in those, and I was to say, go listen to the old episodes of Jim Cramer, or CNBC in general, or anything like that, a lot of it wouldn’t apply. But with income property, with real estate, of course things change, but the underlying principles really change very, very slowly, if ever. So, you can listen to a show that was recorded a year ago, and it is still very, very informative based on today’s situation. You can listen to a show that was recorded four years ago. And it’s just interesting to get that perspective of what we predicted, and what has come true, and the few things that haven’t. Not everything we’ve predicted has been on top of it. But pretty much we’ve been very good at our record. So you know, our old shows are up there. You can listen to them at any time, and hold us accountable. Take us to task and see how our predictions have borne out on the marketplace.
So, a lot has been going on, and that’s why I haven’t been with you in a couple weeks. And I guess first of all, it’s a good time to talk about my recent whirlwind tour of several of our markets in the Midwest. Just had a great time out there. I flew in, and this is about, I guess, a week and a half, two weeks ago, flew into Kansas City, and looked at properties there. Of course, we’re not super keen on what we’re finding there right at the moment. That may change at any time in the near future. But, did a little bit of a Kansas City tour, and stayed with our local market specialist from St. Robert, who happens to live in Kansas City, and stayed with him and his wife, and just had a great time, learned a lot.
And gosh, I gotta tell you, he’s been on the show, and you’ve heard from him. But, this guy is very, very knowledgeable. And I can’t believe it. I almost hate to admit it. But, looking at some people that are younger than me now and thinking of them as kids, or young people, but you know, a lot of these kids or young people—they really know what they’re talking about. And I don’t want to be thought of as very old, so. I was just impressed with really my visit with Zach, and his wife. And really, just so knowledgeable. I wish I knew all of that stuff when I was 26 years old. And I tell you, if you are—whatever age you are listening today, if you are aware of the things we’re talking about on this show, you’re going to be so far ahead of the game. So far ahead of most of your peers. If you’re aware of what’s going on with monetary policy, with Wall Street, with the banksters, etcetera, etcetera, you are just so far ahead of the game. So, I want you to raise your right hand, and reach over, and pat yourself on the back. You’ll probably be patting the left side of your back. For listening to the Creating Wealth Show, and knowing what’s going on, and being so well informed.
But anyway, back to the tour. So, started in Kansas City, and then took a very, very early morning—about 6 AM, we were on the road to St. Robert, Missouri, and took that rather long drive out there, Zach and I did. And we met with his whole team in St. Robert. For the first time I saw the 10-unit building that I’m an investor in there, and was very impressed with it. I’m really impressed with the occupancy rates. Military tenants—a lot of big advantages there, at Fort Leonard Wood. And really, one of those sort of under-the-radar marketplaces that I was—we’ve been having very good fortune in for our clients for a few years now in that market. And my investment there is going well.
Also—so, was very pleased with my visit. I interviewed the property managers, went to their office, interviewed the construction people, we did some videotapes—maybe we’ll play the audio track of those, or release the videos themselves on our video podcast of the Creating Wealth Show, and you can see those. But if not, you can at least hear them. And you know, we’ll give you some good ideas and good feedback about that market. Very, very good market.
And then, in that very same day, we then drove to St. Louis for a St. Louis tour that started that Friday evening. And it was really great to hang out with a couple of our clients. Again, we didn’t have a lot of time to market that one, so it was a fairly small sized tour compared to our Phoenix event several months ago, where we had a decent amount of marketing time to promote the event. But the St. Louis tour was good. And we’ve been doing a lot of business in St. Louis. You know, I talked with one of our investment counselors today, and I know we’ve done about, I don’t know, in the past two weeks I think we’ve done about 10 properties in St. Louis. So, that market is going quite well. And again, it’s a market that we’ve never really promoted very much. But we have done some business there over the years, just kind of without promotion—just people asking for it. And the tour went well, and it was really great to hang out with some of our clients there, and get to know them in depth, and hear about their experiences and so forth. Just really, really cannot tell you how much I enjoyed that. So, that was great.
And the properties in St. Louis—it’s kind of interesting. Because the first day, we saw the properties that were—again, these are older. This is a much older city than what we’re used to in a lot of our markets. And the first day we saw the properties that were, you know, mostly built around the 60s, give or take. That’s pretty old for us. And our local market specialist was in the front of the bus, and everybody else was in the bus there, and I’m maybe four or five rows back, and I said to him, I kind of yelled out, hey, when are we gonna see the newer suburban properties? And this was on Sunday when we were looking at the really old stuff that was built in like the 20s, 1920s, if you can believe that. And he said, well, we already saw that yesterday, Jason. I thought, oh gosh. It’s a different kind of market. But I tell you, the numbers work great. It’s a very desirable city. It has a lot of amenities. And not the least of which was going up in the St. Louis Gateway Arch, which I got to do on Monday morning. And that was really an interesting experience. If you haven’t done it yet, put it on your bucket list. Pretty cool.
But again, if you didn’t get a chance to go on the tour, just remember that we can set up essentially a private tour for you anytime. If you want to go to St. Louis, if you want to go to Atlanta, St. Robert, any of our markets, we can connect you with our local market specialist who can meet you there, tour you around, and show you the properties. So, that’s always available for you, in a less formal and less organized fashion. But it’s definitely available for you. So just let any of our investment counselors know, and we’ll be happy to help you with that.
And then, Indianapolis. That was the next stop on my whirlwind tour. And I went into Indianapolis, I took a look at the properties that I recently purchased there. And just did a deal on one of those, so I’m happy about that. Got that one out of the way and taken care of. And properties are leasing pretty well still in Indianapolis. That’s just been a perennially good market for us. Nothing exciting, but again, fantastic cash flows. And that’s the play, of course, nowadays, as investors. You’re looking at cash on cash returns, anywhere between, just off the top of my head, about 11 to 20%. Annually. And that’s before you take any tax benefits, it’s before any appreciation, or, as we say, regression to replacement cost might occur. So, you’ve got some great opportunities there. Compare it to a dividend paying stock or a bond that is just producing income for you. Call it an income property bond. And that is the play nowadays, because we don’t really think you’re going to see any appreciation in real dollars—any to speak of, I should say. And with so many areas declining—my prediction stands. I think areas like California and other markets like that, still in decline, and destined to lose maybe another 10, even 15%, depending on the price segment of that market and the area.
It was interesting too, because I was talking to the associates of one of my former guests on the show, who will remain nameless for this comment. But you might be able to figure out who it is. And this is a person who was on the show, and is very good at what he does, but likes California. And I just don’t like California that much as a marketplace. Even in places like the Inland Empire. I think it’s okay. I think there will always be a certain element that is drawn to California. And the cash on cash returns aren’t too bad there anymore. But again, I said, hey, you know, you were on my show. I think I should be on your show. And he says, well, you don’t like California, so, we don’t want to have you on the show [LAUGHTER]. So, I thought that was kind of funny.
But anyway, some of our Midwestern markets—fantastic. Just had a great, great time there looking at those, and would highly encourage you to take a look at them at the properties section at www.jasonhartman.com/properties; you can see all of them there, and another market that we are having some, doing very well in, having great inventory in, I know I’ve mentioned it quite a bit, but that is Atlanta, Georgia. So, check out the Atlanta properties on the website as well. One of our vendors there—we have a couple of different local market specialists there—one of our vendors has recently posted some new properties, and they’re looking pretty good. Check those out on the website. Ask your investment counselor about those as well, and we’ll be glad to help you.
So, I got back from Indianapolis on, I believe it was a Tuesday evening. About a week ago Tuesday. Then the next morning at 8:30 AM, I started moving. And I moved into my very swanky new place. I just absolutely love it. And I am a renter! Yes, I have only been a renter a couple times in my whole life. When I moved out of my house, I instantly was an owner! And I’ve been an owner for many years, and then did a short stint as a renter while one of my houses was being built, and I rented in Corona del Mar for a while. Corona del Mar, California, kind of a beach town there, if you’re not familiar with it. And then, for a very short time, I rented again, when I was building a home in Newport Coast, California. But I’ve pretty much always been a homeowner, other than that. And I cannot tell you how much I like being a renter. And here is why. And those of you who went to the Meet the Masters event, the last one, I told you what my deal was. But it was pretty phenomenal.
So, my expense, my housing expense, for the property I sold in California, was about $10,000 a month. And I sold that house, my company, open door auction, sold it for me. And the escrow closed on that property I think on June 10th of this year. And again, I was spending about $10,000 a month. And when you’re a high-end renter, the world is your oyster. You get incredible deals. When you’re a low-end renter, you should probably be buying. So, it all depends on the price segment. Not only the geographic market, but the price segment of that market.
So, let me tell you about my very swanky new penthouse. I’ve always wanted to live in a high rise. I now live in the tallest, highest, all-residential building in the entire state of Arizona. It’s pretty cool. I have forever views on three sides of my building. My penthouse is about 3,000 square feet. I rent it. And if you were to buy this property, and this is, of course, a guesstimate of what it would sell for. But I would guess this property, in today’s market, would sell for about a million—about $1.8 million. Probably at the peak of the market this property would have sold for about $3 million, somewhere around there. Okay? And—maybe I should have a contest on this. How’s that sound, a contest? Why don’t you guess what I’m paying in rent? It’s a pretty darn good deal. And it’s brand new, just stunning. It’s probably got about, I don’t know, you know, I’m just guessing here, maybe six or seven hundred square feet of deck space, views on three sides of the building, I can see forever in every direction, practically.
And wow, what a great property. I just—I’m absolutely, I love it. It’s awesome. And it is so nice to be able to have all these amenities. A huge fitness center, a business center, all of these beautiful common areas, pools, Jacuzzis, etcetera. And not have to worry about any of them! I mean, I just remember being a homeowner, I was always having to meet with my gardener, the landscaping was never quite right, it was never quite done as well as I wanted it to, the plants weren’t growing right, have the exterminator come over, the gardener, I had a pool in one house, I had a Jacuzzi in another, and dealing with all that stuff that just sucks away all of your time. I just kind of love having that handled for me. And, of course, I love the price.
Because I think my lifestyle has probably doubled, or tripled, in quality, since leaving the Socialist Republic of California. But my expenses actually declined quite a bit. So I’m very happy about that. And I tell you—California, I lived there for virtually all of my life, except for a few years when I was very young. And it used to be a great place. But I just think it’s—it’s highly overrated now. It’s overrated, it’s overregulated, it’s overtaxed, and I just cannot tell you how—you sometimes just don’t realize what a place is lacking until you leave it. And you move to a new place with just a fantastic sense of community, with entertainment, restaurants, lifestyle galore—I’d say the only flaw Arizona really has—maybe there’s two flaws. One thing I miss about California is I kind of miss the greenery. I really liked that greenery, going down the roads in Newport Beach, and around the Irvine area—very green and lush. I must be honest, I do miss that.
And the other thing, of course, in Arizona you have to figure out a way to escape, is the summers. And I moved here in the summer. I put up with it. And it wasn’t as bad as I thought it would be, and frankly, I don’t like heat very much. The weather is gorgeous now, and even in the summer it’s very nice at nighttime. But those days during the summer are very, very warm. But as they say, it’s a dry heat, right? Anyway, enough about that. I just kind of had to tell you, that’s why I’ve been so busy; with that trip, and the move, it’s been quite busy. So, I’m sorry I haven’t been with you in a little while, but we are back on track with publishing new shows.
Hey, John Burns, who was a guest on a prior show—I think that was back around number, I’m gonna guess here, maybe 133—he’s a real estate consultant, and his newsletter today was really interesting, because it talks about how homeownership is going to fall by 8%. 8% decline in homeownership, and here he says, we’ve done a lot of quantitative and qualitative research on the future of homeownership, and concluded that homeownership is likely to fall 8 percentage points, from 70% in 2005, to 62% in 2015. Fox Business News did a nice job interrogating us on homeownership rates, and of course they post a video about it, and it says, from 2005 to 2015, homeownership will fall from 70% to 62.1%, influenced by the following. And they identify three major factors here.
Foreclosures. That will have an effect on homeownership, causing it to decline by 5.6%. It says, foreclosures and short sales will displace an unprecedented number of homeowners. So, those people will recycle into the rental market, and that’s great news for us as landlords, isn’t it? Great, great news for us. We want to see foreclosures. Why? Well, they offer us great buying opportunities, number one, so we can stock up on below cost, below replacement cost, below construction cost properties. Basically be packaged commodities investors. So, that’s wonderful, first of all. And then, we have so many people that are former homeowners that are being recycled into the rental pool. And that’s just a great thing.
Oh, and by the way, I’m not sure if I made my point when I was talking about my move. Being a high-end renter is a great deal. Let me just touch on that for a moment. In Newport Beach, I was considering selling my property, my home that I owned and lived in there, a couple of years ago. And yes, I should have done it. But I was just kind of too busy with my business at the time, and with my investments. And I looked around at that time, and discovered that I could have rented a home in Crystal Cove. Crystal Cove is an area in Newport Beach, or Newport Coast, actually, and it’s this very, very high-end area where the homeowners association fees are over $600 a month just for the HOA. Multi, multi-million dollar homes in that neighborhood. I remember looking at some properties there that would have sold for about $4½ million that you could rent for $10,000 a month.
So, you see how when it comes to price segmentation, not just geographical segmentation, but price segmentation, how incredibly good the deal is, if you want to be a high-end renter? If you’re a low-end renter, you should probably be an owner, depending on the marketplace. So, you know, if someone is paying $12-1700 a month—and of course this depends on geography—in rent, they’d probably be better off being a homeowner. But if someone is paying $3,000 a month, or up to $10,000 a month rent, they’re probably getting a much better deal being a renter than they are being an owner.
Now, most of our tenants—most of the properties we invest in—you might ask yourself, well, why aren’t they owners? They should be owners. Well, the first and most important reason is financial maturity. Financial maturity. Renters, and I know this because when I first got into the traditional real estate business, and I was selling mostly HUD and VA repossessed foreclosure properties—government repos. That’s how I started my career. When I was doing that as a part-time real estate agent, and going to college at the same time, I always noticed that the people that I would try to get to buy properties back then, they would always go through this really, really difficult process of—the non-financially mature people, they couldn’t take a step back in order to take two steps forward. Because they could always rent something a little bit nicer than what they could afford to buy. And it was always hard for them to plan, to save. I dealt with a lot of first-time buyers that were—they just couldn’t save money. They had to spend their money on all the things like Robert Kiyosaki talks about. He calls them doodads. All the doodads of life, okay? And listen. I love doodads too, okay? I spend too much money on doodads. A fair criticism of me, since especially I moved, and I have more stuff than I can possibly use or store or anything. It kind of drives me nuts every time I move, to see all the junk I’ve spent money on. But, I can afford it. The other people, though, they should not be spending their money on doodads. They should be saving up for a down payment, and taking one step back so they can take two steps forward to buy a property. That’s the first thing.
Now, a lot of those people over the past few years got themselves into a lot of trouble, didn’t they? Because they were able to buy properties with no money down; they bought all the doodads they wanted, and they didn’t save money, because the lenders just let them in with lots of debt, didn’t qualify them properly, so they bought properties, and they are now recycling, through foreclosure, back into the renter pool, where they probably should have been in the beginning. Because they didn’t have financial maturity. They didn’t have financial self-discipline. So, that’s a 5.6% effect, of decline in the homeownership rate right there.
Now, the other one is cyclical trends. We’re back to the John Burns newsletter now. Okay, cyclical trends. Again, here we’re subtracting another 3% from the homeownership rate. The propensity of households to own a home will fall from the peak of the housing cycle, and will overshoot the historical norm due to a fledgling economy, poor consumer confidence, tightening mortgage credit, and other factors. So here, you’ve just got all of those cyclical trends. You could even call that part of the business cycle, although it’s not exactly the business cycle. But, it’s kind of the business cycle in housing and lending and construction, maybe. And then, you combine that with consumer confidence. So, there we lose another 3% from the homeownership rate.
And then, positive demographics are a 0.7% effect on the homeownership rate, okay? And this is positive—positive demographics of an aging population whose propensity to own increases as they age, until they reach age 70, will push homeownership upward. So, that’s the last positive trend that counteracts the two major much larger negative trends.
So, here we’ve got an 8% reduction predicted in the homeownership rate up until 2015, just four years from now. Now, remember, we did a presentation at maybe three Meet the Masters events ago, where we talked about six years, six million new renters. And we think that’s a conservative number still. We think it could be as many as 25 million new renters, a phenomenal, phenomenal opportunity for investors. So folks, we are at the time, the inflection point, the golden opportunity to own good properties in the right markets. It doesn’t apply to every market, obviously. It doesn’t apply to every property, obviously. I would not want to buy the place in which I live. I’m much better off renting it. But boy, I’ll buy a lot of little, little properties.
Oh, and I should give you a little update on my big deal, my biggest deal ever, that 125-unit apartment building in Scottsdale. We just got the commitment letter from the lender today, who is going to—well, they’re proposing a refinance on the property. Now keep in mind, we’ve only owned this property for a couple of months. And I will go in depth about this deal on a future show. And I just kind of want to get it all done and solidified. But boy, this is looking like a phenomenal deal. I love income property. 125-unit building, we purchased it, myself and a client, $3.9 million—we purchased the note, we foreclosed a week later, and have been working on turning the property around with our vendor there, and remodeling and rehabbing a lot of the units. Our vacancies are pretty high right now, and if they were lower, we could ever get a better refinance loan. But this is pretty amazing; it looks like we’re probably going to get a 10-year fixed interest rate loan—get this—right around 4.6%. Wow. Is that just a phenomenal opportunity? 4.6%, fixed rate, 10 years. And I mean, the inflation rate right now is easily well over 9% in real numbers, if you ask me. And if you ask a lot of other people in the know, they will say the same thing.
I love income property. I mean, the opportunities right now are nothing short of phenomenal. Stock up on these great little properties. if you’re starting your career, if you’re just progressing in your career as an investor, keep buying the single-family homes, the duplexes, the triplexes, the fourplexes. Those are great. We’re here to help you along the way with any of these. And then, work your way up to the larger multi-family properties, just as I did. Anybody can do it, folks. I started with virtually nothing, and just did this myself. Just over the years, just accumulating more and more properties. And it is, without a doubt, the most historically proven wealth creator in America today.
So, we’ve got a guest. Yes, after all this, this long intro, we do have a guest today. And this is going to be a fairly pessimistic view of the future here, but I think it’s important that you hear it. Because in every cloud, there is a silver lining, and we all know, all of us regular listeners to the Creating Wealth Show, know what the silver linings are. They are inflation, the demise of the dollar. It looks like the Euro is on the verge of collapse, if you’ve been following the European news. And that again will create a lot of despair, but a lot of opportunities at the same time. So that’s what we’re here for today, is to look at the real picture, the real world picture of what’s going on, and figure out how to exploit it. That’s what the Creating Wealth Show is about, that’s what you can find out more about at www.jasonhartman.com, and we will be right back with our guest in just a minute.
ANNOUNCER: What’s great about the shows you’ll find on www.jasonhartman.com is that, if you want to learn about investing in and managing income properties for college students, there’s a show for that! If you want to learn how to get noticed online and in social media, there’s a show for that! If you want to know how to save on life’s largest expense, there’s a show for that! And if you’d like to know about America’s crime of the century, there’s even a show for that. Yep! There’s a show for just about anything. Only from www.jasonhartman.com. Or type in Jason Hartman in the iTunes store.
JASON HARTMAN: It’s my pleasure to welcome Richard Duncan to the show! He is the author most recently of The Dollar Crisis: Causes, Consequences, and Cures, by John Wiley & Sons, and—actually, I believe his more recent book, I apologize, is The Corruption of Capitalism. I think you’ll learn a lot from this interview, and it’s my pleasure to welcome, from Bangkok, Thailand, Richard Duncan. Richard, how are you over there?
RICHARD DUNCAN: Very well, thank you. Thank you for having me on your program.
JASON HARTMAN: Well, it’s good to have you on, even noting this extreme time difference that we have. There is a lot going on in the financial world. We’ve got Greece on the verge of catastrophe, the Euro’s in the mess, we’ve got talks about another quantitative easing, and wow. We are living in interesting times, aren’t we?
RICHARD DUNCAN: Unfortunately, very interesting times. On the macro scale, anyway.
JASON HARTMAN: Well, how did we get to this point, Richard? So many people are quick to blame the subprime crisis, which is certainly part of it. But what is your take on it?
RICHARD DUNCAN: A disaster of this magnitude doesn’t just develop overnight. This crisis originated back in the 1960s, when US government leaders abandoned the core principles of economic orthodoxy: balanced budgets, and sound money backed by gold. And when our leaders abandoned these core princples of economic orthodoxy, this opened Pandora’s box, and all kinds of evils have flown out, that we’re now having to deal with.
JASON HARTMAN: Well, so, did it really stem, then, from Nixon taking us off the gold standard in ’71? Or, what were the origins before that?
RICHARD DUNCAN: Well, it preceded that a little bit, I would say. Because this really began under president Johnson. Johnson was spending too much money on the Vietnam War overseas, and domestically on the Great Society welfare programs. And by spending too much, this stimulated the US economy. When the government spends a lot of money, it stimulates the economy. And when the economy is booming, the country imports more from abroad. And in the 1960s, the US was still under the Bretton Woods system. And so as we imported more, and shipped dollars overseas to pay for our imports, other countries had the right to convert those dollars into US gold, and as a result, during the 1960s, the United States lost half of its gold reserves. It lost 250 million ounces of gold. And so by the time—by 1971, when Nixon ended the Bretton Woods system by unilaterally declaring that the US would no longer allow its dollars to be converted into gold—well, he really didn’t have very much choice, because the US just simply didn’t have enough gold left to allow the dollars to be converted into gold. And so, at that point, after 1971, there was no longer any gold backing the dollar whatsoever. And then extraordinary things started to happen.
JASON HARTMAN: Well, it seems to me that for politicians who love to spend money to buy votes, whether it be with the social programs, Great Society type programs, or back to FDR, or to support the military industrial complex, or whoever puts them in office, getting off the gold standard is a pretty good deal if you’re a politician, isn’t it?
RICHARD DUNCAN: Well, it is in the short run. But unfortunately, it led to really a worldwide credit bubble of enormous proportions. And that credit bubble now is popping, as every credit eventually does. Because eventually there’s just so much debt outstanding, that people don’t earn enough money in their real jobs to pay the interest on all the debt. And when that happens, the debt blows up, and that destroys the capital and the banking system. The capital really is nothing more than money invested in other kinds of financial assets. And that’s how our banking crisis erupted in 2008; when subprime mortgages couldn’t be repaid, then that destroyed, essentially destroyed all the capital in the financial system. Not only in the US, but essentially globally. And the government had to respond by jumping in and replacing that lost capital through the Fed’s program of quantitative easing round 1, and they had to also stimulate the global economy through trillion dollar budget deficits to stave off a new Great Depression.
JASON HARTMAN: And so, when you look at this picture, I mean, the first part of the financial crisis was really quite deflationary. And now we are seeing signs, at least in terms of what really matters to people, which is largely food and energy, we’re seeing real signs of inflation. Are we past the deflationary cycle in the credit bubble bursting, and on to the inflationary cycle where governments, especially the US being the most profligate, think they can just print their way out of the disaster, with more quantitative easing? Where are we in the cycle of this?
RICHARD DUNCAN: Well, in a sense, we’re on the razor’s edge. On the one hand, if the government doesn’t intervene by printing money and having these massive trillion dollar budget deficits, then the global economy is going to deflate, and that would result in deflation and depression. On the other hand, if they print too much money, and have budget deficits that are too large, then we’re going to flip over into a situation where we have higher prices and inflation. So what we have seen most recently is, as a result of QE2, with the Fed printing $600 billion extra, this has created inflation in certain areas. Particularly in food prices around the world. Food prices have spiked globally, and this is a very severe problem, because two billion people on the planet live on less than $2 a day, and these people have started becoming even more hungry, and these people have also begun overthrowing their governments. In North Africa, for instance, and the Middle East. And if they don’t stop the QE2 in the near future, it’s likely that food prices will keep going higher, and there’s a real risk that these food riots could spread east, across Asia, into Pakistan, India, even China, Vietnam, Indonesia. So, at the food price level, there really is quite a humanitarian disaster going on.
JASON HARTMAN: Yeah, there sure is, there sure is. Bill Gross is predicting that there’s going to be a QE3 that the Fed is going to unveil at Jackson Hole. Do you think there will just be continued easing? You explained that governments really, especially the US, have those two choices; either print, and keep the deflationary depression from happening, or just let it happen, and eventually we heal from it. It’s really a Catch-22. There is no good way out of this. And what the company line at the Fed just seems to be is just well, we’re going to just play the razor’s edge. And we’re going to print now, and when we get to the point where inflation is a real fear, we have other tools, as Bernanke famously said in his first 60 Minutes interview. Which is, he thinks he can just turn off inflation at a whim, which I don’t think is possible. It can’t be contained; that’s the problem. But, what do you think is next? I mean, do you think a QE3 is on its way?
RICHARD DUNCAN: Well, I think it’s crucial for everyone to understand that the global economy is now on government life support. In other words, it is the deficit spending by the US government that is preventing us from collapsing into a new Great Depression. Now, the Great Depression itself came about for reasons very similar to—in fact, identical—to the reasons that produced our current crisis. The Great Depression originated in World War I, when all the countries in Europe went off the gold standard to fight the war. They didn’t have enough gold to fight the war, so they all started printing a lot of paper money, and issuing enormous amounts of government debt. Well, all the government debt that they created at that time, that led to a worldwide credit boom, that we now think of as the Roaring 20s. Well, the Roaring 20s were great fun, but in 1930, the credit couldn’t be repaid, and at that time, the governments didn’t do very much of anything. They just more or less stepped back and let market forces work.
They let market forces reestablish a market-determined equilibrium in the global economy. And that’s what happened. Market forces did work. Unfortunately, the equilibrium that was reestablished was at a level of economic output that was 45% less than it had been in 1929, and at a level of unemployment that exceeded 20% for a decade. And the Depression didn’t end until the US government started spending massive amounts of money to fight World War II. And when that occurred, then that was a complete game-changer for the global economy. But now, here we find ourselves exactly in the same position again. When the Bretton Woods system broke down in 1971, after that, the US government started issuing enormous amounts of debt to pay for its budget deficits, and also its trade deficits abroad. All of the debt that the US created, led to a 30 year worldwide boom that we’ve really all enjoyed all throughout our lives.
Unfortunately, in 2008, that credit couldn’t be repaid. And this time, the government realized that if they did the same thing they did in 1930—in other words, very little—then we would have a depression. A worldwide depression. And of course, the outcome of that is so uncertain—the Great Depression itself really led to World War II. And enormous suffering around the world. So, in order to prevent that sort of scenario from being repeated, this time the governments have jumped in, and instead of allowing market forces to do their thing, and to establish a market-determined equilibrium, the governments are doing everything in their power to prevent that from happening. And what they’re doing in the United States is that the government is spending a great deal of money; it has a budget deficit that’s roughly $1.4 trillion this year. That’s 10% of GDP. If it were not for that 10% of GDP budget deficit, the economy of the United States would shrink by 10% relative to what it will be this year. And then it will get worse next year. So, we are on government life support. Now, of course that’s in many senses humiliating for the proud, capitalist American economy, to be supported by the government. But it beats the alternative, which is collapse into worldwide depression, with unknown geopolitical consequences. So, that’s where the QE2 comes in, the Fed comes in.
This budget deficit—it’s a very large number. $1.4 trillion. How can that be financed? Normally when the government borrows so much money, it pushes up interest rates, which prevents everyone else from borrowing and spending. So, instead of allowing that to occur, the government’s budget deficit is being financed by the Fed printing money. So, what we’ve been seeing now since QE2 started in November, is the Fed has printed $600 billion roughly over 7 months. Well, during that 7 months, that was enough to finance the entire government budget deficit over that period, and keep interest rates at a very low level. The problem now is, when QE2 ends at the end of this month, there will be no one to finance the government’s budget deficit in that way. So it’s very likely that that will cause interest rates to go up, and higher interest rates will cause stock prices to go down, and commodity prices will go down also. In other words, by printing money, and buying government bonds, this has forced the people who would have bought those government bonds to buy other things instead, like stocks. So this has produced the enormous stock market rally that we’ve enjoyed since QE2 was announced.
Higher stock prices have created a wealth effect, and that’s supported spending and consumption in the United States. And now, all these things are likely to be reversed. When the Fed stops printing money, the bond prices will drop, the stock prices will drop, the commodity prices will drop, and probably including gold and oil and silver. And then the US economy will weaken again. And I suspect that sometime around by the end of the year, the Fed will be so concerned, and other government policymakers, that the Fed will once again begin a new round of quantitative easing, QE3, in order to drive stock prices and bond prices back up again, and interest rates lower.
JASON HARTMAN: So, I assume we’re going to see an increase in the debt ceiling then?
RICHARD DUNCAN: Yes; if we don’t, there will be a depression.
JASON HARTMAN: This is a real mess. It’s just a real, real mess. So, what would you be recommending to people? Now, I want to delve more into that, but what are your suggestions, in terms of investment? I mean, what should one do with their money? And maybe even their business interests, career path? Any advice you have for listeners, whatsoever.
RICHARD DUNCAN: Every investor is in a different personal and professional position. Some people have billions of dollars to invest, and others, a few thousand. So, of course, it depends on everyone’s financial position differs. But generalizing, I think that everyone should understand that we’re on government life support. It is the government—what the government does that will determine the direction of asset prices. So therefore, investors, rather than trying to do microeconomic research, and looking at factors effecting the supply and demand of individual corporations and their profitability—forget all that. What matters is macro. What is the government going to do?
Government policy is going to drive the asset prices. And there are two main drivers there. There’s fiscal policy, and there’s monetary policy. So, on the monetary side, listen to the Fed. They make lots of announcements, publish lots of papers, and now, even Bernanke’s giving a press conference following the FOMC meetings each six weeks or so. So, when the Fed tells us that they’re going to stop printing money, which they have seven recent announcements, that’s likely—that suggests that asset prices are going to drop. And so, it’s a good idea then for investors to reduce risk.
Reduce their waiting and risky stocks, and also, get out of the commodity markets, if they are there. And similarly, the other driver for the economy is the government’s budget deficit, the fiscal spending. If the government spends less, the economy is going to grow less. That’s just that simple. Let me explain. Every economy is made up of just really four major categories. There’s personal spending, business investment, net trade, and government spending. In the US, the personal spending makes up about 70% of GDP. The business investment is about 16%. The net trade is a negative number, because the US has such a big trade deficit; that actually deducts 4% from GDP. And the rest, about 20%, is government spending. So, now we’re in a situation where the on the personal spending side, the outlook of that is very weak, because the households are so heavily indebted, they can’t access any more credit.
So therefore, the outlook for personal consumption is bad. Businesses aren’t going to invest more, because there’s already too much capacity already. Net trade is a negative number to start with; that’s not going to help. So the country’s economy is being driven by government spending. If the government cuts its budget deficit, then it’s just arithmetic. By whatever amount it cuts its budget deficit, that’s the amount by which the economy is going to grow less. Now, in the old days, people thought, and rightly so, that when the government borrowed and spent a lot of money through deficit spending, this was bad, because it pushed up interest rates by—there was always a fixed amount of money under the gold standard, and if the government borrowed it, it pushed up interest rates, and other people couldn’t borrow and spend. And therefore, it was always a good thing for the government to spend less. Because if they borrowed less, than interest rates would come down, and that would benefit the economy.
But that’s not the world we live in any more. We live in the world of paper money. And now, if the government spends less, well, interest rates aren’t going to go any lower. Interest rates are at rock bottom levels already. So if the government spends less, this is not going to magically boost consumption, or magically boost investment. Just the opposite, in fact. When the government spends less, fewer people will have jobs, so there will be less personal spending, and less investment. And interest rates won’t fall, because they’re already at rock bottom levels.
JASON HARTMAN: Let me take a brief pause; we’ll be back in just a minute.
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JASON HARTMAN: Let me ask a question, just before you go on there Richard, about that. Isn’t the common thinking, at least on the conservative or libertarian side, that the private sector should be making up for the government—I mean, you know, get the government out of the economy as much as possible? And of course you have to have some, but the government has grown to such a behemoth, monstrous proportion, that can’t there be private sector? That’s not a fixed thing, that if the government just spends less then there are fewer jobs. Maybe there are during a transition period, but ideally, if the government spends less, then the government gets smaller, and the taxes are potentially lower. I mean, and then, more money is available to be in the private sector, right? Or no? Where’s the distinction there, maybe?
RICHARD DUNCAN: Well, a couple of things. On the tax side, actually, the US—the amount of revenue the United States government is taking in in taxes is less than 15% of GDP. That’s the lowest it’s been since the 1950s.
JASON HARTMAN: And, before you go on—I would argue that the reason that is so low is because we’re not practicing enough trickle down economics. When you raise taxes and interfere more, you actually reduce tax revenue ultimately. I don’t know if you agree with me politically on that, but that’s what I think.
RICHARD DUNCAN: Well, I think we tried the trickle down economics, and we’ve cut the taxes, and the budget deficits keep getting larger and larger. I don’t think if we cut the taxes any further that it’s going to improve the budget deficit; if we cut taxes, we’ll just have less tax revenue, and the budget deficit will get bigger. And in terms of the GDP, in terms of the whole economy, we’re not beginning from some sort of laissez-faire Garden of Eden. We can’t just take one step back and be back in a situation where we’re in some sort of, starting from day one, stepping out of the Garden of Eden. The government has spent so much money for so long, it’s completely transformed the nature of the economy.
JASON HARTMAN: That I will agree with. Absolutely. And unfortunately—
RICHARD DUNCAN: And so now, if the government spends less, that’s just going to cut jobs and cut investment. And there’s no reason that magically somehow new jobs are going to pop up to replace those jobs. Underlying this entire very bad situation, is the fact that now the US economy is just simply no longer viable the way it’s currently structured. The main reason it’s not viable is because of the result of globalization, the US economy is de-industrializing. And all the manufacturing jobs are disappearing, because the prevailing wage rate globally in the manufacturing sector, is $5 a day. And in the United States, the wage rate in the manufacturing sector, if you include benefits, is probably something closer to $200 a day. So, our wage rates in manufacturing are a good 30, if not 40 times higher than the prevailing wage rate globally.
JASON HARTMAN: So the pressure is to see those equalize. And I would argue that the reason that’s true is because of government interference, and especially when you look at like Michigan, or the Rust Belt—unions. And those are largely supported by the leftist government. And that has made the US—that has made that disparity so large. And then you put NAFTA and all these different free trade agreements on top of that—it’s Ross Perot. The giant sucking sound. There it goes, there go the jobs. You can’t have an open, free trade type of world, and a bunch of unions, and environmentalists, and regulations, and OSHA, and all of that stuff at the same time. They can’t coexist, it seems to me.
RICHARD DUNCAN: Well of course, if our wage rates dropped to $5 a day, then they’ll be no one left to buy any manufactured goods. Not US manufactured goods or Chinese manufactured goods. Really, what we has seen is—I mean, 70% of the US economy is consumption. And at the end of the day, consumption is based on wages. Or else credit. And we’ve hit the point now where the credit that we have already borrowed can’t be repaid. So, if wages go down, consumption goes down, the economy goes down. I mean, we’re really, because of the sudden emergence of globalization—in many ways, it takes us back to where we were at the beginning of the Industrial Revolution; when the English and the Scots first invented the factory system, well, this resulted in a huge expansion of society’s ability to produce goods. Factories, you could make a lot more goods than you could in cottages. And so, the supply side expanded enormously. Production exploded. The problem was that wage rates, the people in the manufacturing jobs at that time were paid just subsistence wages, just enough to keep them alive, more or less. And so those people couldn’t afford to buy the things they were making in the factories.
JASON HARTMAN: Right, and that was sort of like Henry Ford’s philosophy, is pay the workers more, so they can afford to buy my cars, right?
RICHARD DUNCAN: Well, that’s right. When he started paying his workers $5 a day, 100 years ago, people thought he was insane. At least, the other wealthy people did. But pretty soon those people did start buying his cars.
JASON HARTMAN: That is true. All I’m saying, to follow up on my previous statement, is that you can’t—the wages have got to equalize between the US and all of the other countries like China. Or we’ve got to have protectionism. It just can’t be both ways, right?
RICHARD DUNCAN: Well, that’s right. And wages aren’t going to equalize, because the reason that wages are still $5 a day globally is because demographic trends are so adverse—there’s so many people coming into the workforce in places like China and India, that wages just can’t go up if left to the law of supply and demand. So, I’m not sure how many manufacturing jobs there are in the world. 3, 4, 500 million at the most? Well, I can assure you there are 500 million Indians who will happily work for $5 a day. And that’s not going to change for decades. And so, wages aren’t going to go up there. And so, if we’re talking about wage equalization, that means wages in the US are going to go down to $5 a day.
JASON HARTMAN: That’s what I was suggesting. I think that’s what we’re seeing. I mean really, and I almost hate to say this, but why is it fair that some factory worker in Detroit should make $40 an hour while his counterpart in Bangladesh makes 5 bucks a day, or probably less in Bangladesh? That’s probably the Chinese worker making 5 bucks a day. Frankly, it’s inequitable. Why should it be that way?
RICHARD DUNCAN: Well, when we start talking about what’s fair and what’s not fair, that’s a very complicated situation. I mean, in terms of fairness, why should investment bankers make $10 million bonuses when factory workers in Bangladesh make $2 a day?
JASON HARTMAN: I agree, but that’s a much more complicated thing.
RICHARD DUNCAN: But yes. There’s a lot of fairness issues we could discuss. But in terms of practical policy, the reality is that the United States has a democracy, and the Americans are not going to accept their wages falling anywhere near $5 a day. There will be another Ross Perot type political leader that comes around and points out to everyone that globalization the way it’s currently structured is really not working out very well for the United States.
JASON HARTMAN: And I think people are really realizing that now, and they have the past 10 years or so. That seems very top of mind to most people.
RICHARD DUNCAN: And the Americans will vote for protectionism, and that will be bad for the US. It will be terrible for the world, and it will be catastrophic for countries like China, that are dependent on export-led growth. The geopolitical consequences of that sort of breakdown of globalization could be catastrophic.
JASON HARTMAN: So what should be done? What is the right way out of this? The thing I like about your work, Richard, is that you actually propose some solutions. Whereas most people just talk about the problem. But you have some ideas along those lines.
RICHARD DUNCAN: Right. I think, rather than accepting protectionism and the collapse of globalization as inevitable, or instead of blaming government spending for all of our problems, I think we need to understand exactly where we are now, and how we got here, and understand that it is the government spending that got us into this mess, but right now the government spending is keeping us from collapsing into depression. It’s kind of a sort of stop cap measure that is keeping us from falling into severe economic distress in the United States and around the world. And if that occurs again, normally, in that sort of situation, war erupts. So, what we need to do, is develop new policy tools for the new century. The US government now has roughly 100% debt-to-GDP. That’s a very large amount of debt. But Japan, on the other hand, has something like 225% debt-to-GDP. Their bubble popped 20 years ago.
JASON HARTMAN: And they’ve been languishing ever since.
RICHARD DUNCAN: They’ve been languishing, but they’ve also managed not to collapse into a Great Depression. But their story is going to have a very unhappy ending sooner or later. Maybe they can take their debt up to 250% of GDP. Maybe 300% of GDP. But sooner or later it is going to end very badly.
JASON HARTMAN: And they have a terrible demographic problem in Japan. They’re just not having children.
RICHARD DUNCAN: Right. That certainly makes their situation even worse. So, the US needs to learn from Japan’s experience. We need to learn really three important lessons. First, when a big bubble pops, the government is going to have massive budget deficits for years into the future to prevent the economy from imploding. And that’s what we’ve seen since our bubble popped, and that’s what’s going to continue for years to come. The second point is that when a bubble pops, it’s a lot cheaper to finance all this government debt than people fear. Japan has 225% government debt to GDP, but the yield on their 10 year government bonds is a little more than 1%. And in the US, we have trillion dollar budget deficits, but now the 10 year bond yield is less than 3%.
So, that’s good news, because when the bubble pops, no one wants to borrow any money. There are no viable places to invest the money anymore, and so interest rates decline. Now, the third and most important lesson we need to learn from Japan, is understanding that we are going to spend massive amounts of government money for years to come. The point is, what we need to understand from Japan’s experience is not to waste all that money building bridges to nowhere, the way they said the Japanese did. If the Japanese had realized 20 years ago that they were going to take their government debt up to such enormous levels, they would have come up with a very clever plan on how to spend that government money. They could have spent that money in a way that could have completely restructured their Japanese economy.
So that’s what the US needs to do. Like it or hate it, the government is going to spend trillions and trillions of dollars over the next 10 years. The only question is, is that money going to be wasted, or is it going to be invested wisely? If we actually invest that money wisely, we could completely restructure the US economy, and develop new industries that would allow us to sell new products to other countries, that balance our trade deficit and generate new jobs. For instance, it looks very likely that the US government is going to have $10 trillion of budget deficits over the next 10 years. Now, what I would recommend is, instead of having $10 trillion of budget deficits and really accomplishing nothing except getting further down the road to ruin, the US government should spend an extra $3 trillion.
The government should spend a trillion dollars on solar, or some sort of other renewable energy—fusion, perhaps—the government should spend a trillion dollars on genetic and biotech, and the government should spend a trillion dollars on nanotechnology. And those investments would give the United States an absolutely unassailable lead in 21st century technologies and industries. By spending a trillion dollars on solar, 10 years from now the United States could have complete energy independence. Free eternal energy. That would cut our trade deficit by 40%, because we wouldn’t have to import any more foreign oil. Moreover, we could cut our military spending by $200 billion a year, because we wouldn’t have to defend the foreign oil. And on top of that, the government could tax the domestically generated electricity, and bring down the budget deficit.
If the government spend a trillion dollars on genetic technology and biotech, it’s very likely that we could create medical miracles, and as soon as the United States government starts selling a cancer vaccine, not only would we be able to balance that year’s budget deficit, it wouldn’t take long to pay off the entire national debt. So in other words, instead of just wasting the money, spending it and consuming this money that’s going to be spent, we need to invest the money. Invest it in a way that will actually generate investment returns, and in a way that would restructure the economy so that we can do a lot of new industries, new products that we can sell abroad, and develop new jobs and new industries to tax, so that we can bring our trade deficit back into balance, bring our budget deficit back into balance, and transition back to the point where we can return to economic orthodoxy where we do have balanced budgets. And hopefully, once they can reestablish sound money, as well we can get credit back under control.
JASON HARTMAN: Well, certainly no one in their right mind would disagree with you that investment, rather than consumption spending, is wise. Everyone in their right mind would agree with that. I guess the only question is, what strides can be made for that amount of money? Say, in your example, a trillion on each. And then when you do that, what structural components sort of start lodging themselves in the economy and never go away? That seems to be always the problem with government; you spend money, and then all you do is sort of create another thing that’s just there forever, and it becomes hollowed out by special interests, and greed, and corruption, and fraud. It’s just so depressing.
RICHARD DUNCAN: Well yes. But you know, we have a democracy. So, the people should know that it’s wrong to blame the government. We are the government. If the elected officials are not doing the right thing, and not putting in place the right policies, it is our responsibilities as citizens to replace them with policies that work. If there is fraud, we as citizens, it is our responsibility to send those fraudulent individuals to prison, and to put in virtuous politicians. It is our duty. We are the government. If we cannot handle our responsibility, then our democracy will fail, and it will be our fault. We the people. So, we are capable of having good government, and it is our responsibility to make sure that we do.
JASON HARTMAN: No question about it. It’s just, the only problem comes in effect when you have that voter who has that responsibility, as you say, reaping the benefits of the government largess, and then they always vote for their own pocketbook. It’s not perfect; it’s just better than anything else so far. And that is for certain. Tell us about your books, if you would, and where people can get them. And you have three so far? Is that correct?
RICHARD DUNCAN: Two, and the third one is a work in progress. The first book is called The Dollar Crisis. It was published in 2003. And it explains why this global disaster was inevitable, given the flaws in the post-Bretton Woods international monetary system. The second book is called The Corruption of Capitalism, and that’s now available on Kindle. That came out about a year and a half ago. The Kindle version has a new preface that was just written about a month ago or so. The Corruption of Capitalism is divided into three parts: the past, the present, and the future. Describing in the past, how we got into this disaster, with a long series of government policy mistakes that brought us here. And the present describes the government life support now that’s keeping us from collapsing into a depression. And the future describes what must be done in terms of reform to permanently resolve this disaster before the government does go broke, resulting in a new and long lasting depression. So, the past, the present, and the future. I have a website and a blog. My website is www.RichardDuncanEconomics.com, and everyone’s welcome to go there and sign up for my blog. The blog’s free, if you input your email address it’ll be sent to you when I write it every week or so.
JASON HARTMAN: Fantastic. Well Richard, thank you so much for your insights today. We really appreciated it, and by the way, I never asked you—what are you doing in Bangkok? Are you living there permanently?
RICHARD DUNCAN: Yes. I have been living in Asia most of the time since I started my career in Hong Kong in 1986. So, I have spent almost all of my adult life living outside the United States. Most of that time, in Asia, living around Hong Kong, Singapore, and Thailand.
JASON HARTMAN: Fantastic. Well, thank you for coming to us from such a long distance tonight, and we really appreciate having you on the show, and everyone should go out and get those books, and check out your blog as well. Appreciate having you on, Richard.
RICHARD DUNCAN: Jason, it’s been a pleasure talking with you. Thank you for having me.
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The Jason Hartman Team
Episode: CW 229: Understanding the Global Economic Crisis with Richard Duncan Author of ‘The Corruption of Capitalism’
Guest: Richard Duncan
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