By Henry Bonner
Richard Duncan is credited with anticipating the global financial crisis of ’08 in this book The Dollar Crisis: Causes, Consequences, Cures, an international best-seller. But Mr. Duncan doesn’t want to reign in the Fed, or get us back on the ‘straight and narrow’ fiscally.
That’s all a fool’s errand, and would probably result in economic collapse; capitalism, he says, disappeared in World War I. The economic boom that we experienced in the 20th century came about thanks to generous government spending and high deficits. Capitalism ‘died’ decades ago, he says, but don’t mourn its loss. We’re actually much better off without it.
Mr. Duncan agrees that we are living in a gigantic credit bubble brought on by central banks, but he says popping that bubble is simply too destructive to be allowed.
His other books include The Corruption of Capitalism: A Strategy to Rebalance the Global Economy and Restore Sustainable Growth, and most recently The New Depression: The Breakdown of The Paper Money Economy. Mr. Duncan also worked as a financial sector specialist for the World Bank, and ran the research department for Solomon Brothers in Bangkok. He’s been invited on CNBC, CNN, the BBC, and published articles in the Financial Times.
He currently publishes his views on his blog Economics in the Age of Fiat Money.
Richard, you’ve said that capitalism ‘died’ decades ago. The idea that you create wealth with savings and investment is no longer true. We’re living in a world where government debt creates prosperity. What about businesses, entrepreneurs, investors? Why don’t they create wealth anymore?
Well, my real point is that at the macro level, the economy is now being directed by the government. Back in the 19th century, you had real capitalism. The government played very little role in the economy. Up until the time of the Great Depression, the government spending was only around 3 percent of GDP. Now, it’s more like 21 percent.
During the financial crisis, it was spending maybe 24 or 25 percent. That meant the US government was spending one out of every four dollars in the economy. On top of that, during the era of capitalism, gold was money. The Fed didn’t have anything to do with currency. Now, the central bank can create money out of thin air; last year they created a trillion dollars and bought a trillion dollars’ worth of financial assets to push up their price. And that’s not capitalism.
As you mentioned, during the 19th century, economic growth came from businessmen. They would invest and some of them would make a profit. They would save that profit and invest again. Investing and saving, repeated over and over, drove the economic growth process. Things have not worked like that for decades now. Since the breakdown of Bretton Woods, it’s no longer investment and savings that are driving the economy, but credit creation and consumption. This kind of credit creation could not have occurred if we had remained on a gold standard.
Since the Bretton Woods gold-backed system broke down, total credit in the US has expanded from 150 percent of GDP in the 1980s to 370 percent of GDP in 2007. Credit growth has been driving economic growth. The problem that occurred in 2007 and 2008 was that credit couldn’t be repaid, so everything started to implode. Had the government not intervened with trillions of dollars of budget deficits and paper money printing to push up asset prices, the economy would have collapsed into a depression. All your entrepreneurs and businessmen would have been out of business, because all the banks that supply the money would have failed.
Sure, there’s still room for entrepreneurs and businessmen at the micro level. But it has to be understood that at the macro level, the government is driving everything.
It’s also very important to understand that we have an enormous credit bubble globally; we are not in any sort of equilibrium. It’s only the government’s intervention that’s keeping this credit bubble inflated. Without government intervention, the credit bubble would implode into a new depression.
Is this how the Fed looks at its expanding balance sheet – as the driving force for prosperity? Do you think they are capable of responsibly managing an ongoing expansion in global credit?
First of all, capitalism never really co-existed with democracy. As soon as every individual has the right to vote, some sort of evolution towards socialism is almost inevitable. In the 19th century for instance, there wasn’t universal suffrage.
When World War I started, governments took almost complete control over the economy. European governments had to print a lot of paper money and create lots of bonds in order to finance the wars. That’s why Europe went off the gold standard in 1914. In other words, capitalism really died in World War I.
Now, the US didn’t enter the war until 1917, so things weren’t as strained in the United States. In fact, the United States benefitted enormously from World War I, economically speaking. They sold war materials to the Europeans, and importantly, they were paid with European gold. This combination of gold leaving for the US and paper money being printed in Europe led to a credit explosion. The result was the roaring twenties, which were essentially a worldwide credit bubble. In 1930, debts couldn’t be repaid. Policymakers didn’t do anything about it – because they didn’t know how. The credit bubble imploded into a depression; a third of all the banks in the US failed; international trade and the international banking system collapsed. We had 10 years of depression.
Democracy also fell apart in Europe. The Germans ended up invading parts of Europe and Japan did the same in Asia. 60 million people were killed in as a result in World War II.
When World War II started, the US government increased spending by 900 percent. That re-inflated the credit bubble and completely changed the nature of the economy. The US government took complete control of the economy – production, distribution, labor, pricing, and everything else. They spent enormous amounts of money. After that, the economy never returned to anything resembling capitalism. Government spending never dropped off, even after the war. In 1971, Nixon took the US off the Bretton Woods system, which allowed a credit explosion to occur. Capitalism turned into something I call ‘creditism.’ Growth wasn’t coming from investments and savings; instead it was driven by credit and consumption.
In 2008, just like in 1929, credit levels started to implode. Had the government not intervened, it would have been just like the 1930s. Our economy would have collapsed into a new great depression. After a four-decade boom in which total credit in the US expanded from $1 trillion to $50 trillion – a 50-fold expansion of credit in 43 years – the depression that would have followed would have been so severe that no one alive today would live long enough to see the end of it.
If we had stayed on the gold standard, never had World War I, World War II, or the Cold War, then we could have remained on the capitalist system that we had in the 19th century. In my opinion, the world economy would have been very much less prosperous. Instead, we’ve had massive government intervention and an explosion of credit which has generated a world-wide credit bubble. If that bubble pops, we’ll be spiraling back to the dark ages. In 2008, unlike in 1929, policymakers did do something to prevent more damage. Everything they’ve done since then has been directed towards keeping this economic bubble inflated. They have succeeded so far thanks to trillions of dollars of paper money creation.
It’s fine to pine for long-lost capitalism, but capitalism ended a very long time ago. Now, we have a very different economy where the government directs it at every level. The sooner everyone understands this, the sooner we can have more effective government policy rather than this ‘ad hoc’ we have now that barely works.
What makes you believe that it’s not the other way around? You could argue that economic growth has minimized the negative effects of the Fed expanding its balance sheet, absorbing all the excess liquidity. What makes you certain that it’s the credit bubble that is driving the economy, and not a booming economy that is enabling a credit boom?
Well, if you look at ratio of total debt to GDP, for a long time it was around 150 percent. But that started to change in the 1980s. So what happened? President Reagan did. He radically increased military spending and cut taxes at the same time. He gave us greater budget deficits than ever before in peace time.
The Reagan budget deficits averaged more than 5 percent of GDP for 5 years in a row. That radically increased overall size of debt, from about 150 percent of GDP to 230 percent. It was that expansion of government debt and government spending that created prosperity in the 1980s. If there had been some kind of economic boom as the driver, then the government’s tax revenues would have gone up and the budget deficit would have become smaller. Instead, government spending and massive deficits caused credit to expand, which drove the economy.
In the period around 2006, subprime mortgage brokers were making loans on a massive scale to people who could not afford them. For the most part, they sold these subprime mortgages to organizations like Fannie Mae and Freddie Mac. This pumping up of poor people with debts they couldn’t afford caused total US debt to rise to 370 percent. That is what drove the economic growth during that period.
Businesses became more profitable and hired more workers, bought more raw materials, and expanded capacity. They paid more taxes to the government which then had more money to spend. In turn, this caused asset prices to inflate in an upwards spiral, creating even more collateral to borrow against. The problem, just as Austrian economists have pointed out, comes when credit can’t be repaid and everything suddenly bursts. That’s when a depression occurs.
I spend most of my time writing about the investment implications of all this. I believe that to invest successfully, it’s necessary to understand that the government is driving the economy at the macro level and to anticipate what the government is going to do next – because that will determine which way asset prices move.
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