1908 'Inflated: How Money and Debt Built the American Dream' - Freedomain Radio Interviews Chris Whalen
Christopher Whalen is co-founder of Institutional Risk Analytics, a unit of Lord, Whalen LLC, the Los Angeles based provider of bank ratings, risk management tools and consulting services for auditors, regulators and financial professionals. He leads IRA's risk advisory practice and consults for global companies on a variety of financial and regulatory issues. Christopher is the author of the new book, 'Inflated: How Money and Debt Built the American Dream.' Christopher currently edits The Institutional Risk Analyst, a weekly news report and commentary on significant developments in and around the global financial markets. He also contributes articles on the Reuters and Zero Hedge web sites. Christopher has testified before the Congress and the Securities and Exchange Commission on a range of financial and other issues. Christopher is a Fellow of the Networks Financial Institute at Indiana State University.
Hi everybody, it's Stefan Molyneux from Freedom Main Radio.
I hope you're doing very well. I have on the line Christopher Whalen, who is SVP and Managing Director of Institutional Risk Analytics, a unit of Lord Whalen LLC. He's a Los Angeles-based provider of bank, Ratings, risk management tools and consulting services for auditors, regulators and financial professionals.
He leads IRA's risk advisory practice and consults for global companies on a variety of financial and regulatory issues.
Thank you so much, Chris, for taking the time this morning.
Yay, thank you. So, Chris recommended his book, which has just gone into its second printing.
It came out in December 2010.
It was called Inflated!
How Money and Debt Built the American Dream.
And Chris, first of all, I really thank you for the book.
Highly recommend it. It really blew my mind.
And I think it was because...
I've sort of gone on a pendulum in my sort of historical studies of 19th century America in particular, in that everybody gets the sort of progressive socialist argument of predatory capitalism and the robber barons who were restrained by the antitrust acts and then finally controlled by the government taking over the currency.
Then I kind of went to a bit more of the objectivist and Rothbardian view of the golden age of capitalism.
They weren't robber barons and so on.
What I found fascinating about your book was the degree of nuance.
Well, I hope it is.
I think that life is rarely black and white.
It's a continuum.
And I tried to use stories about people to illustrate the historical timeline that I followed in the book.
It makes it more accessible, obviously.
But, you know, history is funny.
Most economists have no political distinctions in mind at all.
They just assume people meant what they say.
And if you look at Teddy Roosevelt, if you look at any of the great figures of that period, they were much more complex than just merely left and right.
William Jennings Bryan was sponsored by the silver interests and others in the West.
He had corporate sponsorship the entire time.
Teddy, on the other hand, was at times a libertarian leftist.
At other times, he was entirely in line with corporate interests and his good friend J.P. Morgan.
So it really depends.
And that's the nature of democracy, of course.
America has never been particularly ideological, but we do have flashpoints, and they're usually economic.
I tried in that book to give context to some of the books and comments that have been coming out about this crisis, just to remind people that we've been here before, and that it's inflation and debt and a certain amount of libertine It's what you always find in a democracy.
Look at Ireland. Ireland is an extreme case, but only in a free society can you have larceny, right?
That's the whole point.
Now, one of the things I found interesting as well is that, of course, there's a pretty significant section of the American libertarian movement who views either bimetallic or a gold standard as the panacea and the final solution for all economic woes.
And I thought that your argument about the self-interest of those who have those metals, particularly the silver inflationists, was really interesting.
Do you think that a gold standard these days, if we were to sort of magically reverse Nixon and get back on it, would solve more problems or would it create more problems in terms of creating these lobbies that so ferociously seem to dominate a lot of the discussion in 19th century America?
Well, exactly. The lobbies became very much a constituency for inflation.
First the railroads and then the banks.
They always liked the idea of paper money.
That was not tied to gold because it made it easier to service their debts.
What you see with Lincoln going forward is that first national banks and then the railroads and then finally all banks became not only constituents for inflation but they became more and more dependent on the government.
The merging, if you will, of the financial sector and the public sector which we're seeing today all over the world.
Having gold as money with a monetary value stamped on the coin is the answer.
I think what you have to appreciate is that there's always an arbitrage between pieces of paper and real things, whether it's gold or real estate or any number of other precious metals, copper, for example.
So any freely traded commodity where you can shelter yourself from the continuous inflation that you find in most currency systems, I think is the way you go.
And I would love to see us coin gold again, but with a weight.
I don't need to have a monetary value arbitrarily put on the coin.
I would have quarter and half and one ounce gold coins in circulation, and people could look in the newspaper every day and figure out what it was worth.
All we have to do is change the tax laws.
You know, right now, gold is a collectible.
You can't get a capital gains tax rate, for example, on profits in gold.
And this goes back to FDR's confiscation, which we talk about in the book.
That was just one of the many, many silly and stupid things that he did that made the depression worse.
That's the great irony.
After FDR came into office, everything fell apart because he did just what Obama did, was attack the business community and basically made them uncertain.
So they did nothing.
And we had horrible deflation as a result.
I was really fascinated, and you mentioned this at the end of the book, and you've also talked about it, I think, in your speech, in some of your speeches on television, which was you talked to a senior Federal Reserve official at some point fairly recently, I suppose, who said, look at the 1990s and count how many quarters of growth that you've had without either stimulus or some jigging of the interest rates.
I wonder if you could break down the importance of that in terms of understanding whether or not the economy has actually grown over the last decade or two.
Well, it's pretty clear that really since the 70s, the U.S. has had a problem with growth and employment.
The Congress tried to deal with this legislatively, Humphrey Hawkins, where the Fed was told price stability and employment are your two mandates legally, and you must make your policy fit this.
The trouble is, is that Since the war, the dollar has essentially been pegged.
Even though it does go down against other currencies, it hasn't gone down nearly as much as it would have if the US was just another country and if all currencies essentially were used in an equal sense in world trade.
Most trade goes through the dollar.
And that's why the dollar is still supported, not because of the interest rates that the Fed pays on debt.
Or the treasury auction being a success or not, because the Chinese show up, as people often say.
But it's really the fact that two-thirds to three-quarters of world commerce still flows through dollars.
So unfortunately for American workers, this means that you become less and less competitive over time.
On the other hand, the other nations of the world have rebuilt themselves and more, in part because our overvalued dollars were then buying goods and services from them.
And the entire world economy was wired this way.
So I don't think the US really has been growing very much over the last couple of decades.
We have such a big financial component to our economy that we can make the flows grow, if you know what I'm saying, in terms of the numbers.
But in real terms, is employment or wealth or real income growing for Americans?
No. I think we're all under a lot of margin compression, rising costs, But no real pricing ability.
We don't have any power to demand more revenue, if you will, either individually or as a country.
So to me, I think the way we solve this is we admit that we're still getting over World War II 100 years later.
And we have to have a conversation with the other nations of the world about how we change the monetary system.
So it's not so easy for us to issue debt.
Probably the dollar would be lower.
If we don't get our act together in fiscal terms, then the dollar should go down.
That will be one way of disciplining American consumption, but it will also make us more competitive.
The funny thing is, at the end of the day, everybody wants to keep their money in the United States because of our political system.
Our chaotic, volatile, unpredictable democracy is still much preferred to just about any other venue in the world.
All things being equal, If we just moderately behave ourselves on the fiscal side, and this is the part your gold bugs won't like, you could have an underlying rate of inflation in single digits all the time and people wouldn't mind.
They would shelter themselves in precious metals, real estate, what have you, in terms of savings.
But as a means of exchange, they would be happy to use the dollar, even with a high inflation rate, because they can hide here.
I mean, if you talk to a Chinese Communist Party official, where does he want to buy a house?
On the west coast of the United States.
He's not going to hide his money in China because they're going to steal it.
I've done a lot of work in emerging markets.
Capital flight is a very important issue to keep in the back of your mind.
Right. So it's not maybe so much the argument that America is so great, but rather that the other countries are even more dangerous.
It's not like we live in a great neighborhood.
It's like the other neighborhoods are even more dangerous and therefore there's some momentum towards the US. Well, we are still the new world.
One of the points I make in my book is that America is a very young country.
We still haven't had time to make most of the mistakes that Europeans have made multiple times.
And so there's still more opportunity here.
There's still more turmoil.
Of more upheaval, we still resolve bankruptcies and foreclosures and whatnot in a fairly quick way, unlike Europe, where everything is ossified.
You have generations of corruption and arrangements politically, so there's very little labor mobility, very little opportunity for people to change the class in which they're born into, one way or another.
Now, I think you've also had a great explanation.
I mean, Austrian economists as a whole believe that fiscal stimulus, such as the, you know, QE and QE2, the fiscal stimulus will provide bulges in certain parts of the economy at the hidden expense of most other parts of the economy.
But we haven't really seen that in America with the last fix.
It seems to have just basically been flushed into a giant hole.
And you had, I think, a good explanation as to why the money that's going to the banks is not getting out to the remnants of the entrepreneurial free market.
I wonder if you could talk a little about that.
Well, it goes back to growth, really.
If you think of the 70s, especially the 80s on, real estate and housing became a very important part of your marginal GDP growth.
That's where policy flowed.
Every time the Fed lowered interest rates, mortgage prices would fall, and you would also have a liquefaction of the household because remember, at the time, inflation was still pretty brisk.
My parents were buying single-family homes in Washington in the 70s and 80s.
You held the house for five or six years, you could double your money.
So you had this de facto inflation in the system, and as we rolled forward, Rates went lower and lower because we're getting less bang for the buck each time we lower rates.
And so today, when the Fed was easing through quantitative easing, we're basically treading water in terms of producing even nominal GDP growth.
The other thing is, remember, rates are very low.
Do you really want to finance a 30-year mortgage at 2%?
No. That's not economic.
To have a fixed rate mortgage of that duration that's going to have enough profit in it for the bank so that they can manage a portfolio and deal with defaults and everything else, it's got to be 5-6%.
So really the Fed, especially Greenspan from 2000 on, was goosing growth in a nominal sense, even though we're losing ground in a real sense.
So what you mean is sort of the wages have remained stagnant, but the GDP, because of growth in housing prices, appears to have been growing, right?
And, you know, the state sector is an issue too.
I don't like to, you know, I am very much of a fan of the Austrian school.
In fact, I just bought my A new copy of Human Action from Mises because they have a great deal.
You can get the audio version and the little book for 15 bucks.
But I think you need to talk in more American terms because Americans don't care about dead Austrians.
They care a lot about Jefferson and Adams and Andrew Jackson and Teddy Roosevelt.
And if you put the same arguments that the Austrians made, because they're all classical liberals.
I mean, the American founders, the real origins of the Austrian school would all agree.
On most points. So what you have to do is tell it in a way that is accessible for Americans and say, yeah, limited government, compartmentalizing government and fiscal issues at the state level, there's a reason for this.
When corporations get to a certain size, they naturally want to take over the government because it's in their interest to do so.
And that's really what we're facing in our country today.
It's a combination of the war and the monetary system we were left with after the war.
Where the US basically remade the world in its own image.
At the same time, we have just let monopolies and cartels run amok in our system.
That's why Teddy is one of my favorite presidents.
We need another Teddy to use the Sherman Act to break up some of these banks and companies and restore opportunity to the US economy.
I don't believe in an interventionist state, but I do believe the federal government Should follow Roosevelt's dictum that when a company acts with malice, it needs to be broken up.
And the other thought, you have a lot of great and interesting approaches, very stimulating ideas that I haven't seen elsewhere, for which, you know, I compliment you on your originality, assuming that it's original and you haven't cobbled it from someone else, which I'm sure you haven't.
But I really liked the approach that you took to the development of what you call the trust in the sort of mid to late 19th century.
I had a little bit of trouble following some of the legal And economic drivers behind those.
I wonder if you could break down, because of course it wasn't anti-company, it was anti-trust.
And these trusts seem to be particularly predatory.
How did they come about?
Were there particular regulatory changes?
Was it a financial innovation like some of the instruments that were developed in the 2000s?
Well, in a way, I think you had seen these developments in Europe already.
So America was simply following that model.
In fact, the The Europeanization of the libertarian republic called America is an important theme in the book, and it really accelerates with World War I and World War II, obviously.
Look, it's the natural tendency of humans to concentrate and grow.
In other words, companies buy other companies.
They grow their market share.
When they do that, they start to naturally try to limit competition, and that's what the trusts were for.
You had trust for everything in this country.
You had trust for toilets. You had trust for any manner of consumer product, commodities, whatnot, because at the time, there were large entrepreneurs who had access to the credit markets and were not afraid to use debt to, say, roll up railroads.
Even when the railroads by, say, the 1870s, 1880s were starting to lose their profitability and they had basically expanded all over the United States.
You still had all of these trust vehicles, which were basically shell-holding companies, buying and selling these assets and effectively trying to corner the market so they could gain pricing power.
You saw this with coal.
You saw it with oil, with standard oil.
And so you always have to appreciate that humans tend to be anti-competitive, and it is only that enlightened sense of the public good that prevents us from all being monopolists and cartel owners.
It's just the way things are, and this is an interesting tension that you see in American history.
Right now, I think we've swung very much over to the corporatist monopolist phase, and we don't have much of a left in this country, to be fair, so they don't do a very good job talking about it.
The progressives died at the end of the 1800s in a political sense, and so now all we're left with is big business Republicans and big government Democrats.
And there's really nobody fighting to fight for the individual.
That's, to me, the real lesson from my research on the book.
And that is, of course, the horrifying and it seems almost inevitable tragedy of statism or having a government, which is that, as you say, human beings are rent-seeking.
We always want to increase our resource consumption and minimize our resource expenditure.
And so we create a government to control these rampant self-interested people who then immediately use the government to increase their rent-seeking.
It's a real challenge that I don't know.
The funny thing is, there is hope, and the hope comes in the fiscal constraint that both the US and other nations are feeling.
I think you're going to see the Republicans use their growing influence in Washington to not only starve the federal government, but they're going to probably revisit the Nixon-era new federalism and start pushing a lot of functionality back down to the state level, which is a good thing, because if you're going to argue about money, You want to do it at the local level.
When you have it off in Washington, there's too much of an opportunity for corruption and shenanigans, which is normal in a democracy.
You're never going to get rid of it.
But if you have it at the local level, it's a little easier to manage.
Instead of having one kind of closed fight in Washington, we can have 50 more open local fights at the state level, which I think would be much more fun.
And it would be much more expensive for lobbyists.
They would have to run around the country willy-nilly and spend a lot more money.
So I think that would be good for the airline industry, for example.
Whatever we can do to raise the price of entry for lobbyists, I'm entirely behind that.
No, I think we should have open outcry bidding for members of Congress.
I think we should treat members of Congress like futures go.
You can have a guy in a big hat, you know, with big steps in the hat.
Why not? We have the technology. And I think we should have real-time disclosure of when a lobbyist makes a contribution to a politician and when they visit them.
Do you think that we'd be able to hear any debates over the constant bell ringing?
I mean, it would pretty much be like a fire alarm going off continually.
It would be tough to hear anything. It's important.
I'll give you an example. When Barney Frank comes out and rattles his saber about one thing or another or his Republican colleagues, half the time they're just trying to raise money to hold a hearing and have this little kabuki theater on whatever issue it is.
And then the checks will flow and then they'll forget about it.
We'll go back to what they were doing.
Nothing has changed since the time of Mark Twain.
If you just read Twain on the US Congress, You know everything you need to know.
Or maybe what we could do is, you know, how they have those decals on NASCARs.
We could just get congressmen covered with whatever product placement ads they have been paid for.
That's what I was thinking. Little orange jumpsuits so that when we put them in print, we don't have to change their wardrobe.
Yeah, just peel the stickers off and now say that they're owned by the military industrial complex that they've been supporting all these years.
Well, no, you see, it's the housing industrial complex.
We had the military... And in a fairly constant sense through the 60s and the 70s, but then in nominal terms, the U.S. started to grow much faster than military spending, and that was housing.
Those have been the two components over the last century.
Well, a point that I also found very interesting was, and, you know, correct me, of course, if I'm mischaracterizing anything, but you seem to describe the financial industry as a service sector.
Not quite a necessary evil, but it's sort of like health, the healthcare.
I mean, nobody really wants it, but you kind of need it.
And financial services are kind of like that, and we're a pretty small component of the American economy and the world economy in many ways for some time, I mean, outside of war.
And now you say that it's considered an economic driver or something that's going to lift us out of the recession, according to certain politicians.
And I wonder if you could talk about, I mean, that seems to me like a completely nutty idea.
Oh, it is nutty. Yeah, it is.
Talk a little bit about that, because I think people don't really understand the degree to which all the actors are being put in the basket of the financial sector, which can't itself do anything other than manage other people's money.
It can't create in the same way entrepreneurs do.
Oh, no, and it doesn't.
The size of financial services is a function of demographics.
It's a function of the baby boomers and other workers around the world saving and hoping that they can retire on those assets.
It's also a function, in the US particularly, of a certain class of financier manufacturing opportunities that don't exist.
The classical view of banking and finance is that it's a function of the real economy.
And that it only exists to serve real commerce.
But as the U.S. has become less and less competitive in the world economy, we have essentially created games in the financial sector to generate nominal returns.
Part of this is because you have a central bank that is expanding the supply of money.
And so all of the people who hold these pieces of paper are looking for a return.
Now, if you're not going to underwrite bonds for steel mills and ships and real industry, What do you do?
Well, it's Wall Street because you want to earn a commission, right?
Everything's about yield to commission on Wall Street.
They will create securities.
That's what derivatives are all about.
That's what structured finance is all about.
So there's this games quality to the financial sector, which is quite disturbing.
And it's also why you can expect more collapses.
There's just no substance under a lot of these so-called assets.
I've worked through the tech bubble as a banker and I've worked for a number of different clients in retailing and financial services.
You can tell the difference between a good company and a bad company.
Good companies earn profits on operating lines.
Bad companies tend to earn a good part of their money from financial activities.
That's one of the things we always look at at my firm when we're doing an analysis.
How much of their earnings come from non-operating activities?
Because that's very variable and it's also usually very speculative.
And that's really what you say when you go about talking about financial services, people saying that they are a growth driver in the economy.
No. You know we have a problem when you hear people talking that way.
Wall Street is only a good influence on society when it is financing real economic activity.
Otherwise, it's adding that risk to the system.
Well, which is catastrophic negative payoffs.
I mean, I've often wondered what the economy would look like without sort of the two major factors that I see driving people's money into the stock market or into these sort of financial instruments.
The one, of course, is inflation.
And the other is the fact that their money is herded into the stock market through 401ks, through other forms of tax deductions or legal maneuverings that are just pushing people's money.
I think like one one-hundredth Of the people who are currently in these financial services or financial sectors of the stock market should actually be there because everybody's been turned into a speculator and that's not really what the point of the stock market was.
The government's herding everyone's money in there, which means that companies start to chase short-term profits over long-term gains because they can make so much money out of these stock changes.
The Fed rate policy is penalizing you for holding interest rate instruments.
All of the citizens of the United States have done the right thing.
And planned and bought conservative bond or annuity type portfolios have been getting killed while the Fed has been transferring hundreds of billions of dollars a year to the banks.
And this illustrates your earlier question, which is, we lower rates, but we don't get any growth.
And in fact, there's a net transfer of available funds from the real economy to the financial economy.
The financial sector has become so large and it is so parasitic that it's actually killing the real economy.
That's one of the reasons I've been an advocate of restructuring.
The only way you get real growth is if you go back to the American founders and the fact that they put bankruptcy in the US Constitution.
They didn't do that because they wanted to welch on their debts even though Jefferson was a debtor all his life.
They did that because they knew it was more efficient for society and that you needed to clear defaults and put the assets in the strong hands and thereby get recovery.
That's what we haven't done in this cycle.
Ben Bernanke and all of the politicians are essentially captive of the banks and they all want to pretend that these bonds are still worth par.
When you can look at the housing market, you can say, no, those banks are probably not worth par right now.
And the last question I'd like to ask you, and I know this is always a real challenge, you sort of turn that miner's hat light into the future and look to where things are going.
I mean, I've heard everything from, we're fine, you know, we'll just muddle along the way we always have.
And I say we, I'm in Canada, it's pretty much, we're We're sort of a remora fish eating the scraps coming off the U.S. shark's jaws.
And other people who say, well, it's going to be more like the zombie economy of the last 20 years in Japan, and other people who say it's going to be, you know, hyperinflation and war and Weimar and all that kind of stuff.
Where do you fall along that continuum?
Or is there some other possibility for the future that hasn't been discussed yet, at least on this show?
Well, I'm not in the apocalyptic camp.
I think you're going to see higher inflation in the U.S., and you're also going to see a political rotation back to, I think, a much more fiscally conservative view, because that's just where the people of the U.S. are migrating now.
We've had 70 years of neo-Keynesian construction in the U.S., and I think we've kind of reached a limit.
As I said before, housing was one of the drivers.
Federal spending, federal debt was one of the other drivers.
But every nation has a cycle, and the biggest factor is usually demographic.
So I expect to see lower growth in the US. I think you're going to see us cut back military spending rather dramatically over the next couple of decades, and we will see the boys and girls come home, which is all to the good.
Remember, the big driver was the U.S. taking over the British Empire after the 1950s and the reliance on oil.
If it wasn't for that, if the U.S. starts to move towards a more energy-independent model, then you won't see the aggressive U.S. military policy in the Middle East.
We'd have no reason to be there.
And, you know, sad to say, but we wouldn't be in Afghanistan.
We wouldn't be in Iraq were it not for oil.
I always tell people you have to rent the wonderful series Riley Ace of Spies with Sam Neill as the real James Bond who went to Baku to steal the maps of the Persian Gulf from the Russians at the turn of last century.
That's governed everything that has happened geopolitically in the past hundred years in the world.
And I think that's the key for where America is going.
If we become energy independent, then we can get our economy back under control.
We don't have to be an empire anymore.
That's really the bottom line.
I think it's probably fair to say that there may be a significant shift in assets away from the state and towards the private sector because the government's going to have to have a fire sale to pay off at least some of its obligations if it starts to run out of cash.
So that's going to, you know, the government's been absorbing a whole bunch of stuff, materials and resources and capital.
Some of that, I think, is going to flow back to the free market as people bid on government buildings and government land.
And that's going to be a bit of a renaissance, I think, that's potentially possible in the free market, a freer market, as things move in that direction.
Look, when there's a default and someone has to sell a house for pennies on the dollar, someone buys a house for pennies on the dollar.
And so, yes, there's a loser and a winner.
In the classical liberal world, that's good because, like you say, the assets are in strong hands and somebody can go off and make them productive again.
When you don't have clearing and you don't have restructuring, then you have stagnation.
So I'm confident America is not going to beat Japan.
You know, the Japanese just stick their heads in the sands.
Our courts are open every day.
So while Tim Geithner can window dress the macro view for a while, the restructuring continues.
The banks, for example, now are slowing down foreclosures because they're not able to sell the properties.
There's just no bid.
But that's going to change because the courts are open every day and the process will move on.
Well, certainly America has a much more socially confrontational culture than Japan does, which I think helps I wanted to make sure that people got the chance to look at your material, R.C. Whalen, W-H-A-L-E-N.com.
The book, again, is Inflated, How Money and Debt Built the American Dream.
You can go and download it on your Kindle.
It's also available in the Apple Store.
And, of course, you can buy it at Amazon and other places.
Is the second printing out yet, or is that being worked on at the moment?
I think it is. The amazing world of On Demand, the guys at Wiley don't even have warehouses anymore.
They can print 10,000 books in a week.
Beautiful. In fact, we have a Chinese deal we just did.
They're going to translate it into Chinese and start selling it there in a couple months.
No, no, I don't think we want the Chinese to know that America is addicted.
That, I think, is treasonous, and you may pay for that.
Thanks so much, Chris. I really appreciate it.
It was a great conversation. I appreciate your time.
