Peter Schiff: The Economy Needs a Painful Restructuring Thanks to the Fed

Peter Schiff: The Economy Needs a Painful Restructuring Thanks to the Fed by

Stock markets have been extremely volatile this week, with massive swings in both directions. The markets rallied on Wednesday, primarily due to optimism about progress in the trade war. On the week, the Dow is up around 100 points, but it also put in new lows.

In his most recent podcast, Peter Schiff said he thinks the volatility will continue. It’s a sign of trouble in the economy – trouble ultimately created by Federal Reserve monetary policy.

The financial stocks have been particularly weak. Even with the Dow way up Wednesday, the financials only managed modest gains and many of them closed negative on the day.

If the financials are sick, what is that telling you about the overall economy and the overall market? Because this is a financial market. It’s a financial bubble. It’s all about credit and cheap money. And so, the financials were at the epicenter of this bubble. I mean, that’s why the financials took so much of a beating in 2008. That’s why they had to be bailed out, because they were extending all the credit and they, of course, were the biggest casualties when the credit dried up and the loans went bad and the bubble popped. And that’s exactly what is happening now. We are in the early stages of this bubble popping.”

Peter noted that a lot of the mainstream sources have suddenly started talking about recession. This represents a huge change from where people were just a few months ago. Oddly, even with the sudden awareness that recession may be on the horizon, there is still a tone of optimism out in the markets.

If you think recession is so close, how much longer can you remain so confident? Confident about what? The economy doesn’t have much longer before it hits recession, so to the extent that you were confident, you thought you were going to make money, well, your window of opportunity to make money is going to rapidly close.”

One place they don’t seem to be factoring in the possibility of an economic downturn is at the Federal Reserve, the White House or on Capitol Hill.

Ironically, Janet Yellen suddenly did an about-face. After claiming we won’t see another crisis in our lifetime just 18 months ago, the former Fed chair sounded the alarm this week. Meanwhile, the current crop of central bankers still seems to think they can keep things under control, But there is some cracking.

The problem for the Federal Reserve is they’re trying to keep this bubble from imploding, but the task is impossible because enough air has already come out of it. Interest rates have already risen to the point where the camel’s back has been broken.”

Late last month, current Fed chair Jerome Powell launched a trial balloon, hinting that the current rate might be close to neutral. This despite the fact that if you factor in the consumer price index numbers, the Fed funds rate is actually still negative. And when you add taxes to the equation, the after-tax yield on government money is very negative.

Simply put, current rates are still highly stimulative.

Of course, the Federal Reserve needs to maintain a high amount of stimulus if it wants to prevent the bubble from popping. Now, it’s not going to work. The air is going to come out anyway. But the Fed is trying to delay the day of reckoning as long as it can.”

Peter said the best thing it could do for the long-term health of the economy is let the bubble pop. The reason they have to keep rates so low is that they want to maintain the enormous level of debt. In simple terms, they can’t push rates up in an economy built on debt.

But if interest rates stay this low, we’re never going to have a real economy because if you have negative interest rates, nobody is going to save. Why would you save if the return on savings is negative?”

Without savings, we’re not going to get any capital investment or any real economic growth.

The Fed has put itself in an impossible position. In order to allow interest rates to rise to a normal level that will encourage saving and investment, it has to make the current debt levels unsustainable. That means a lot of defaults. Peter said that would be preferable to the status quo.

I would much rather see a lot of debt defaulted so that the overall total level of debt comes down to a managable level because a lot of the loans are not repaid and a lot of the lenders don’t get their money back. We have a lot of bankruptcies. We de-lever the economy. And now, interest rates can rise to a level high enough to facilitate, encourage more savings and investment.”

Of course, this would mean a lot of losses and a lot of pain for a lot of people, but this is a necessary part of the painful restructuring.

If the Fed didn’t want the economy to go through this pain, they shouldn’t have jacked it up with all this cheap money. They shouldn’t have done the crime if they weren’t willing to do the time.”

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Peter Schiff

Mr. Schiff began his investment career as a financial consultant with Shearson Lehman Brothers, after having earned a degree in finance and accounting from U.C. Berkeley in 1987. A financial professional for more than twenty years, he joined Euro Pacific in 1996 and served as its President until December 2010, when he became CEO. An expert on money, economic theory, and international investing, he is a highly sought after speaker at conferences and symposia around the world. He served as an economic advisor to the 2008 Ron Paul presidential campaign and ran unsuccessfully for the U.S. Senate in Connecticut in 2010.