9 April 2017

In this episode, Preston and Stig talk to Macro Economist, Richard Duncan about various world affairs.  Additionally, Mr. Duncan provides an interesting story about his recent conversation with Alan Greenspan.  During the exchange, Mr. Duncan confronted the former FED chairman about China and Japan’s decision to fix their currency to the US dollar and force a major trade imbalance.  Needless to say, Greenspan’s response was fairly alarming.

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  • About Richard Duncan’s recent conversation with former FED Chairman Alan Greenspan.
  • How $10T was suddenly created out of thin air and the impact of the world economy.
  • How the Chinese trade surplus with the US impacts the global economy.
  • How and why China is building out new infrastructure equivalent to 10 US highway systems.
  • How the US should invest in infrastructure.


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

Preston Pysh  0:02  

Hey, how’s everyone doing out there? So this week, we really have an exciting guest with us. It was probably about a year ago, I was on our website’s forum where we have a bunch of different people leaving such extraordinary comments about investing and different ideas. One of the things that we really like to try to learn more about, because it’s definitely not our forte, is macro economics. And on our forum, we had a person who said, “If you want to understand macro, there’s one person you’ve got to study. His name is Richard Duncan.”

So I started looking into Richard Duncan, and this was probably about a year ago, I would guess. And the more that I started to study Richard Duncan, the more I realized this person is a genius when it comes to understanding macro economics. So Richard has written three different books and all of them are big sellers when it comes to understanding macro. For example, he wrote a book called “The Dollar Crisis,” “The Corruption of Capitalism,” and other books. 

He got his career and I think maybe one of the reasons why Richard understands macro so well is he has lived abroad, all over the place. He’s lived in Hong Kong. He’s lived in Bangkok for decades. He’s lived overseas and outside of the United States. He’s also worked as a consultant for the IMF. He’s worked for the World Bank, and so he just has it in his blood to understand this stuff.

Stig Brodersen  1:25  

I think you’re really gonna enjoy this episode. We’re going to talk about the rising government debt in the US. We’re going to talk about the half of trillion current account deficit and what to do about it. And we’re also going to talk about where the dollar is heading. But the most fascinating story in this interview that you’re gonna hear is that Richard Duncan just had a sit down with Alan Greenspan and talked to him about when the economy is heading right now.

Intro  1:54  

You are listening to The Investor’s Podcast where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. 

Preston Pysh  2:15  

All right, how’s everybody doing out there? Like we said in the intro there we have Richard Duncan with us. So, Richard, thanks for coming on the show today.

Richard Duncan  2:23  

Good to be back.

Preston Pysh  2:24  

Well, we’re thrilled to have you. I know after all the awesome feedback we got from the first time you came on the show, we were very excited to be able to bring you back on again. So let’s dive into the first question that we have for you. I’m a follower of you on Twitter and I love reading your posts. I’m also on your email list of the stuff in the discussions that you send out about macro thoughts that you have. One of the things that I noticed recently is you had a post where you posted a picture of you and Alan Greenspan sitting together, and you had an awesome write up about your discussion, and your dialogue that the two of you had. 

What I wanted to do is afford you the opportunity to tell our audience about this unbelievable exchange that you had because you had a real conversation with him for a significant amount of time. And you were asking him some questions that I think we would have loved to have been able to ask him and some of your back and forth was just incredible to read this article. So give us a little bit of a background. Tell us first of all, why you were there with Alan Greenspan, what the event was for?

Richard Duncan  3:31  

Okay. It was a just a wonderful opportunity for me to be able to ask Mr. Greenspan this question. And it took place a couple of months ago in Baltimore at an event put on by Agora Economics Roundtable 2017 and basically, they invited Mr. Greenspan to come up from Washington to Baltimore. About 12 of us sat around a very large wooden conference table and we each got to ask him a question. 

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I asked him what I think is a question of really historic importance and one of the few things that we still don’t understand about the economic crisis of 2008, regarding all the trillions of fiat money dollars, well, I should say, the equivalent of trillions of US dollars of money that was being created by the central banks of the trade surplus countries, like China Central Bank, the PBOC, and the Bank of Japan, and the other countries that have large trade surpluses with the United States, because between the year 2000 and 2014, they created the equivalent of $10 trillion. You can see that by looking at their foreign exchange reserves. 

And so my question to him was: how did he think about that while he was Fed Chairman? What impact did he believe that was having on the US economy because these central banks in the trade surplus countries, they were accumulating foreign exchange reserves and then they were investing those foreign exchange reserves primarily in US dollars? 

Okay, now, let me elaborate. We know how quantitative easing works now. Everyone’s very familiar with it. The Fed prints money from thin air, and it uses those dollars to buy US government bonds primarily. And that pushes up the price of the bonds, and that pushes down the yields on the bonds. So that’s how quantitative easing works. 

Well, when a foreign central bank accumulates foreign exchange reserves, it works in very much the same way. So for example, China’s Central Bank, the People’s Bank of China. At the peak they had accumulated $4 trillion of foreign exchange reserves. Now, here’s how that works. China has a very large trade surplus with the United States, roughly 350 billion dollars a year. So the Chinese exporters sell their goods in the United States. They’re paid in dollars, they take the dollars back to China. And they want to convert those dollars into their local currency, the renminbi. China’s Central Bank, the PBOC, it creates money from thin air, its own money RMB or Chinese yuan, and it uses this new money, new RMB to buy all of the dollars coming into China at more or less the fixed exchange rate so that their currency doesn’t appreciate. So that allows whoever brings the money in, they’re then able to convert it into RMB and do anything they want with their money. 

But meanwhile, the PBOC has been accumulating something like 350 billion dollars every year for quite a long time. And in total, at the peak, they had accumulated $4 trillion that way and once they accumulated these dollars, they needed to do something with them if they wanted to earn any interest on them. So they took these dollars and they invested them in US dollar denominated assets, primarily US government bonds. So when the PBOC invested their dollars into US government bonds, it pushed up the price of those bonds, and it pushed down the yields on those bonds, just like quantitative easing does. 

So this foreign exchange accumulation, which is effectively really just currency manipulation to hold down the value of their currency. It is just like quantitative easing with one extra step involved. The Fed prints dollars and it buys treasury bonds. Well, the PBOC prints RMB, then uses the RMB to buy dollars and then uses the dollars to buy treasury bonds. So it’s exactly the same thing with one extra step involved. 

Now, the thing is, this process that I’ve just described, it’s been done by the foreign central banks on a much larger scale than quantitative easing. Quantitative easing all together, it was just about $3.5 or $3.6 trillion, all three rounds of quantitative easing combined. But the foreign central banks have the trade surplus countries increase their foreign exchange reserve holdings by $10 trillion between the year 2000 and 2014. So that’s a $10 trillion increase in fiat money creation.

 So this was money creation on a scale that never occurred in history before, certainly not in peacetime. And of the $10 trillion of foreign exchange reserves that they created, at least 70% of them were invested in US dollars instead of some other currency. So $7 trillion this way was invested into US dollar denominated assets. So this had an extraordinary impact on the US economy. It pushed up the bond prices and it pushed down interest rates. So I asked Mr. Greenspan, what was his thinking about this while he was Fed Chairman because remember, back in 2004, 2005, and 2006, the Fed started increasing interest rates to try to slow down the economy and to try to prevent the property bubble from getting out of control. So between mid 2004 and mid 2006, the Fed increased the federal funds rate by 425 basis points. That’s a lot of hiking. 

Now, anytime the Fed hikes by 25 basis points, people think that’s significant. Well, during that 24 month period, they hiked by 425 basis points. But even though they were hiking the short term interest rates, the federal funds rate, the 10 year bond yield didn’t go up. And in fact at first, during the REIT tightening cycle, the 10 year bond yield actually went down and even at the end of this process by mid 2006, 10 year bond yield was only 38 basis points higher. The Fed was not effective in pushing up the 10 year bond yield. And some senator asked Mr. Greenspan during this process: Why is this you’ve been hiking the federal funds rate like crazy, but the 10 year bond yield doesn’t go up? And Greenspan said, “I don’t know. It’s a conundrum,” meaning he didn’t understand it. But it seemed to me completely obvious that it was the foreign central banks who were responsible.

Preston Pysh  10:30  

Because they were just sitting on all those 10 year treasuries is what you’re getting at?

Richard Duncan  10:34  

Well, not only were they sitting on, they were accumulating them during that 24 month period. The foreign central banks in the trade surplus countries, they created the equivalent of one and a quarter trillion US dollars. And 70% of that was invested in US dollars. So that’s roughly $900 billion in two years, so they created it. 

Now, during those two years, $900 billion was enough to finance the entire US government budget deficit. In other words, enough to buy up every new treasury bond sold during that 24 month period with $200 billion leftover that had to be invested in other bonds, like Fannie bonds and Freddie bonds. And so this is effectively the reason the Fed lost control over interest rates. 

The Fed wasn’t able to drive up interest rates because their counterparts and the central banks of a half a dozen countries around the world with large trade surpluses with the US, they were manipulating their currency, printing their own money, using their new money to buy dollars to hold down the value of their currency, and then taking the dollars they accumulated and buying treasury bonds pushing up their price and pushing down the yield. And this is the thing that caused the Fed to lose control over interest rates. This is why they couldn’t push up interest rates enough to stop the property bubble from running out of control.

Stig Brodersen  11:59  

And this basically relates back to 1971 and the Nixon shock, the way they took the dollar off the gold standard, right?

Richard Duncan  12:06  

So let’s step back even a bit further. Most of my work is focused on how the global economy works now, relative to how it used to work when we were on a gold standard or the Bretton Woods system. I believe the economy works in a very fundamentally different way than it did before. The Bretton Woods system broke down in 1971. It was a quasi-gold standard. So under the Bretton Woods system, it wasn’t all that long ago that it was in effect. 

Under that system, currencies were effectively pegged to gold. Currencies didn’t fluctuate, all the money was backed up by gold. When the Fed issued a new dollar, it had to have at least 25% gold backing to issue that dollar. And consequently, trade between countries had to balance because if a country had a large trade deficit, It wouldn’t take too many years before that country ran out of gold because it had to pay for its deficit with gold. And when a country ran out of gold, it would have a severe economic crisis and it would stop buying things from other countries. So there was an automatic adjustment mechanism that ensured that there were no trade imbalances. And also, clearly, central banks weren’t free to print as much money as they choose, as they are now, and there were no large scale capital flows between countries. 

So the world works very differently now. Now we have floating currencies. The money dollars are not backed by anything and neither is any other currency. Central banks are free to print as much money as they choose, and we have developed these incredibly large trade imbalances. 

The US trade deficit as it grew larger and larger… Of course, it was fantastically beneficial for the rest of the global economy. With the US buying $800 billion a year more from the rest of the world than the rest of the world bought from the US, this drove economic growth all around the world, especially in countries like China, which had such a large trade surplus with the US. 

So this entire arrangement that I just described is entirely new. It’s something that we really didn’t start having trade imbalances until 1980. And then they grown to be extraordinarily large last year, they were roughly, the US current account deficit is roughly half a trillion dollars. 

So my question to Greenspan was: what did you think about this? Surely you were aware that your counterparts in China and Japan are printing on a very large scale, and using their new money to buy dollars and using those dollars they accumulated every year to buy US Treasury bonds are causing you to lose control over interest rates? What were you thinking along those lines at that time? Alright, so I said, Isn’t that the explanation for the conundrum?

Preston Pysh  14:57  

Is that the word you use when you asked him because that was his vocabulary when he testified, did you say conundrum to him?

Richard Duncan  15:03  

Yes, you can go to my website, RichardDuncanEconomics.com. Yeah, look, this blog they did in February, I think you can read the entire transcript. 

Preston Pysh  15:14  

We’ll have that in the show notes for anybody that’s listening. We’ll put this in the show notes so you guys can see the exact transcript.

Richard Duncan  15:20  

So, I mean, the significance of the question doesn’t end there. Ben Bernanke, he often said that the reason we had a global economic bubble was because there was a global savings glut. And Mr. Greenspan agreed with that assessment. The idea behind the global savings, Bernanke explained, people in the developing world, especially places like China, they had such a high savings rate. Tens of millions of people working in factories, and they had a very high savings rate. And rather than wanting to invest their savings in China’s economy, for instance, which was growing at 10% a year, these people decided collectively that they were going to buy treasury bonds and so that pushed up the price of the treasury bonds and drove down the yields in this global savings glut, is the reason the Fed couldn’t push up the interest rates. 

There’s just so much savings around the world, that it pushed up the treasury bond prices, and pushed down their yields, pushed down interest rates in the US. And there was nothing that anyone could do about it because this was a process that was being driven by tens of millions of people all around the world. So this theory is completely absurd. It was a half a dozen central banks around the world who literally created $10 trillion dollars from thin air between year 2000 and 2014.

Preston Pysh  16:40  

Richard, I want to highlight something real fast for our audience. And I’m sorry to interrupt you, but in your books, for anybody that would read Richard’s books, he goes into the cash inflows and outflows between these countries and proves everything that he’s talking about. For anybody that wants to really dig into this and understand this more, he does such an excellent job backing this up with cold, hard facts and numbers, from information that you pulled from the central banks, you know the information that they published, correct?

Richard Duncan  17:10  

Yes, that’s right, you can see every country’s foreign exchange reserves. You’re gonna get from many different sources.

Preston Pysh  17:16  

So I just want people to know that as they’re listening to this, so keep going, I’m sorry to interrupt you.

Richard Duncan  17:21  

So it was just a half a dozen central banks who by creating this $10 trillion of new money, they were responsible for the global savings glut. The reason this is so important, is because since it was just a half a dozen central banks, and not tens of millions of factory workers around the world saving too much money, something could have been done to stop them from doing this. The US Treasury Secretary could have called up their Minister of Finance and warn them that if they didn’t stop manipulating their currency, we were going to retaliate because they were causing us to lose control over US interest rates and therefore lose control over the US economy. And in the end, we ended up with this extraordinarily large global economic bubble that blew up in 2008. That’s why this question is so important. Something could have been done to stop this from happening.

And so that’s what I wanted Greenspan to answer. I wanted to know what he was thinking. Wasn’t he aware that this was happening at the time? And if he was aware, why didn’t he do something about it? If someone in his position of authority had highlighted this, then we could put an end to all this, if there was a desire to really stop them from doing this? So that was my question. Wasn’t the printing of all this money, the cause of your conundrum and the global savings glut? 

And he said, “No, I don’t think it was.” We went back and forth a couple of rounds. And you know, he’s very famous for talking a lot and trying to confuse his listeners. He once very famously said, “If you believe you understood what I just said, you probably misheard me.” Anyway, you could spin off in some you know, unnecessary directions and I would ride back in as best I could to make him answer the question. Ultimately he ended up saying, “No, that wasn’t the reason.” 

He said the reason was that the Berlin Wall came down and all of the people on the other side of the wall for so many decades had had no place to invest their savings. And it was money coming out of Eastern Europe that was responsible for pushing up the bond prices and pushing down US interest rates. Now, that’s kind of preposterous, because I don’t know how much the people in Poland had saved during the years of communism. But, you know, I would be very surprised if all together, all the money from Eastern Europe going into the US amounting to anywhere near 100 billion, whereas these trade surplus countries created 10 trillion. This was just an explosion of paper money creation.

Preston Pysh  19:48  

Did you get the sense that he actually believed that or did you feel like you had them figured out and he was just really putting on a show of performance?

Richard Duncan  19:55  

You know, honestly, Preston, even now I cannot decide whether the man was telling the truth, or whether he was just trying to mislead us, mislead me because it’s always seemed inconceivable to me that he was not aware that this was happening. 

Preston Pysh  20:10  


Richard Duncan  20:11  

As Fed Chairman, with thousands of Fed economists working for him, and in very regular contact with all of his central bank counterparties all around the world, how could he not have known that these central banks were buying up trillions of dollars of treasury bonds? So my work, really going back to my first book, “The Dollar Crisis,” has been all about these trade imbalances destabilizing the global economy. 

But the problem is that now the whole global economy, this has been going on trade imbalances started growing from 1980. Since 1980, the whole global economy has been rebuilt, completely restructured around this new arrangement, around these trade imbalances. And it’s going to be very, very difficult to unwind them in the short term. 

Now, the thing is, when the US has a large, let’s say $500 billion trade deficit as it does now, every country’s balance of payments has to balance. It’s just like a family, when a family spends more than it earns, it has to borrow from someone. So the same with the US, when the US has a half a trillion dollar trade deficit, it will have half a trillion dollars coming in, in terms of foreign investment in the US. In other words, every country’s balance of payments has to balance. So the larger the trade deficit becomes, the larger the capital inflows into the country become. 

Now, last year, the trade deficit was about $500 billion and so, we had capital inflow of about $500 billion. The two things are a mirror image of each other. Therefore, if we were to eliminate the current account deficit, capital inflows would go away, and interest rates would go up, potentially very, very significantly. And that would have a catastrophic consequences on the US economy. 

Stig Brodersen  21:59  

So Richard, I think it’s really interesting that you bring up these different factors and especially the current account deficit. You’re talking about half a trillion dollars, and also you talk about the impact of exchange rates and which we also briefly touched upon before, because the exchange rates, they are determined by demand supply. And right now, what you hear about in the news is that as a result of the relative strength of the US economy, you also see the Fed starting to hike interest rates, at least modestly. You can expect more capital to flow into the US as a result of that. 

Now, I think one could argue that the market knows what’s happening with interest rates, also the expectations that might happen in the future. How much do you think it’s already priced into the current US exchange rates? And where do we expect the dollar to be heading in the medium to long run?

Richard Duncan  22:48  

Okay, well, yes, I mean, as you just mentioned, it’s a very complex question. So, the real reason that the currencies are moving now at least in the short term, is monetary policy divergence. As you mentioned, the Fed is now started to gradually increase the federal funds rate. But at the same time, the European Central Bank and the Bank of Japan, and for that matter, the Bank of England, they’re doing the opposite. They’re actually doing quantitative easing on a very aggressive scale in Japan, and Europe, especially very, very aggressive. So that is putting downward pressure on the euro and the yen and upward pressure on the dollar. 

But, as you said the market has factored much of this in and that had a strong ordinary impact on the global economy that the dollar strength resulted in severe commodity price weakness that damaged the commodity producing countries and caused a very sharp contraction in global trade. And it also hurt US corporate profits and put a lot of downward pressure on the stock markets in the emerging markets and also caused the US stock market to lighten up, for quite some time. So now the question is is what comes next? 

So the Fed surprised everyone somewhat by hiking in March. And sometimes they hint that they’re going to increase even more aggressively. The question is what is Europe going to do? Are they going to end quantitative easing there anytime soon, because quantitative easing there makes their currency weaker? If they stop the quantitative easing, then their currency would become stronger. 

Now, the US economy itself is pretty weak. Last year, the GDP only grew by 1.6% in real terms, and nominal GDP growth, I think was 2.9%. in nominal terms. That was the weakest nominal GDP growth since 1958, except for the depths of the crisis in 2008 and 2009. The US economy is not particularly strong, and it’s very dependent on interest rates staying low. 

Going back to the 1980, back in 1980, interest rates in the US were very high in the double digits. And the level of debt in the country was a lot lower than it is now. The ratio of debt to GDP in 1980 was around 150%. But then after 1980, interest rates started coming down to the point where the 10 year bond yield went to one and a half percent not long ago. And as the interest rates came down, and credit became more affordable, so the Americans borrowed more and spent more. And this ratio of debt to GDP climbed from 150% in 1980, now it’s 360%. 

Now, the problem is if interest rates do start to move higher, then credit is going to begin to contract and when credit begins to contract, then the economy is going to go into severe recession. And in that scenario, then they’ll have to cut interest rates again. So there’s a limit as to how much the US can increase interest rates before it provokes a new recession. In fact, I focus on credit growth a lot because what I’ve seen is that going back to 1950, any time total credit in the US grows by less than 2%, then the US goes into recession. That’s credit growth adjusted for inflation. If we don’t get 2% credit growth adjusted for inflation, then the US goes into recession. 

Last year, that was only 2.7%. And that explains why the economy was so weak last year. I’m looking at my projections. Now, I look at all the major sectors of the economy, there are only about five or six of them in terms of their level of debt. I project out that what I think their debt levels are going to grow by this year and next year. I think the credit growth is going to slow to just 2% this year and 1.9% next year. So I think it’s quite possible that the US is going to go into a recession this year.

Stig Brodersen  26:42  

So Richard, I’m curious because we’re talking about different things and still related things. We’re talking about exchange rates, we’re talking about credit growth, and we’re talking about interest rates. Could you elaborate on the impact on fundamentals in general and also expectations, because macroeconomics which we’re describing right now, each mutation has a really big impact on the fundamentals in turn? So what’s the relationship here?

Preston Pysh  27:07  

I’m glad Stig brought this up, because I almost had the exact same point to explain to our audience, Richard, why an interest rate environment where the interest rates are going up is really bad for the valuation of a stock or a business. Walk people through the basics of that calculation so they understand why you’re saying that we could go into a recession if interest rates start coming up.

Richard Duncan  27:27  

Okay, so when interest rates are low, then people can borrow money very cheaply, and they can use that money to buy property and to buy stocks or do other investments. But if interest rates move higher, then mortgage rates go up. And that tends to push the property market down and also it becomes more expensive to buy stocks. 

For instance, if the 10 year government bond yield is 2%, then no one really wants to buy government bonds. I’d rather invest in the stock market. But if the 10 year government bond yield was 10%, then there will be a lot fewer people buying stocks because it’d be so much more attractive and safe to buy a government bond with such a high yield. So when the interest rates go higher, the stocks tend to go lower. 

Now, we’ve had such low interest rates for such a long time now, the asset prices have become very inflated. There’s one ratio that I look at and it is called the ratio of household sector net worth. In other words, how much Americans are worth, how much Americans have in total all their assets minus all their liabilities. That number is $95 trillion. That number divided by disposable personal income, in other words, income. So we’re looking at wealth to income, it’s a ratio of wealth to income, and that ratio is very high. 

Now, the average for that ratio going back to 1950 was 525%. But during the NASDAQ bubble, it was up to 600%. And then the NASDAQ bubble popped and the ratio went back to its normal level. Then during the property bubble, the ratio went up to 650%. And then that bubble popped, and that ratio went back to its normal level. Well, now that ratio of wealth to income is back 650%, near its all time high. And that is telling us that asset prices are very stretched, the stock market’s overinflated, and property prices are high as well. Of course, bond prices are very high. 

So if interest rates now begin to move higher, then that ratio is going to contract again. In other words, wealth is going to contract. There will be in negative wealth effect. So higher interest rates would really be a double whammy. First, it would cause credit to contract which would cause the economy to go into severe recession. And on top of that, it would cause asset prices to deflate significantly. That would cause a very negative wealth effect, which also causes us to go into significant recession.

Preston Pysh  29:54  

So Richard, I want to shift gears a little bit. I want to talk about an interview that I was listening to with billionaire Mark Cuban. He was talking about his opinions with the challenges that the current administration is going to have with some of their objectives. So one in particular was an interesting argument that Cuban had, and he suggested that President Trump’s campaign was one on bringing jobs back to America that were lost overseas. And a lot of the stuff that we were talking about earlier about the currency manipulation and things like that keeping their labor costs very low overseas, just had a flood of the labor leave the US and those jobs went overseas. 

Cuban’s argument is that although that might have been true for the last 20 years, 30 years, more recently, in the last three to four years, those jobs are currently being lost more due to technological advancements, call it robots. I think the classic example is Amazon with all the robots running around their facilities and things like that. I’m curious to hear your thoughts on whether you agree with Cuban’s take on that being maybe one of the new and more important drivers is this technological revolution that’s happening and taking a lot of jobs. Do you agree with that?

Richard Duncan  31:09  

Well, I think that’s significant. But I don’t agree that that is the primary issue here. I’ve lived in Asia for the last 30 years and I can tell you, there are tenss of millions of factory workers in Asia who have jobs making things to sell in the United States at Walmart. So yes, technology is having an impact, as he mentioned. Still, at this point, I don’t think it is the primary issue and primary issue is that we have a nearly infinite supply of low cost labor in the world and our global economy. 

Out of the 7 billion people on the planet, 2 billion of them are said to live on less than $3 a day. So we have essentially for the next two generations, we have an infinite supply of people willing to work for $5 a day and that is going to continue to depress US wages as long as this globalization, this free trade that we have allowed ourselves to enter into with low wage countries continues. But I certainly do agree that President Trump is going to have difficulties achieving many of his objectives. I made a macro watch video called “President Trump, you can make America’s economy great again, here’s how.” It’s freely available on YouTube. Anybody can Google it and check it out. 

But if he does try to bring the jobs back to the US, or if he puts up 45% trade tariffs on Chinese goods, as he said he would do and 35% trade tariffs on Mexican goods, or a border tax of 20%, this is going to cause US inflation to spike because obviously the US imports so much from abroad. He put up trade tariffs and things are going to cost more. And if inflation goes up and interest rates are going to go up, and then we’re back at the problem that I was describing earlier. If interest rates go up, then asset prices crash and credit contracts. We have a severe economic crisis. Similarly, if you cut taxes on the corporations, and at the same time, increase spending on infrastructure and on the military, then the government’s going to have to borrow more, much more.

Stig Brodersen  33:16  

So, Richard, what you’re basically saying is that something that’s really hot right now, that is a lot of people looking towards governments for public spending, and you think that might be a good idea. Clearly, again, depending on what the money is spent on, but you also saying that it will increase the government debt to GDP, which might in turn spike interest rates, which will lead to recession. So could you take us through the different steps or whether or not I’m misinterpreting what you’re saying here?

Richard Duncan  33:42  

Okay. Well, let me be clear, you know, I think we’re in a very regrettable situation. If we had remained on the gold standard and continued to back dollars with gold, as we had always done in the past, then we wouldn’t be in this crisis. Now, of course, when we stopped doing that, that allowed credit to explode and that created a very big global economic bubble. It completely transformed the global economy, global economy grew very much faster than it would have if we had stayed on a gold standard. 

But now we find ourselves in a situation where we are verging on collapsing into a very severe depression. Now, as I’ve mentioned, anytime credit goes by less than 2%, the US goes into recession. This bubble has become so large, that if we actually go into a recession, it could very easily spiral out of control and collapse into a depression. Just think about what would have happened in 2008, if the government had stepped back and done nothing. Well, the banks were all failing. So they would have collapsed, all the banks would have failed everywhere. So all the savings would have been destroyed. And therefore the US economy would have collapsed like it did in the 30s. The GDP would have shrunk by about half. Unemployment would have gone up again to say 25%. Government tax revenues would have completely collapsed, so there wouldn’t be enough for the government to continue to maintain US army bases around the world, or to maintain this level of Social Security and Medicare spending. Yhe entire global system would have collapsed, trade barriers would have gone up. And higher trade barriers would have caused China’s bubble to implode. 

China has the greatest economic bubble the world has ever seen. If US puts up trade barriers against China, then China’s economy is going to implode. And the consequences there could be catastrophic for the Chinese people and no telling how they would respond to their neighbors. It could have very dire geopolitical consequences. They would have stayed in this depressed state for decades. And the only reason that depression came to an end is because World War Two started, and at that point, the government spending increased by 900%. 

So I think that’s where we’re starting from. We have an enormous bubble. If it deflates, we are basically, as they say, essentially doomed. So we have to find a way to keep the bubble inflated, and the private sector already has too much money to take on more debt. So that just leaves the government. 

Now, the US government has something like I think you said 105% of GDP. That sounds about right. Well, Japan’s bubble popped 26 years ago. And at that time, Japan’s government had 60% government debt to GDP. Well, now it has 250% government debt to GD, and through increasing the government spending over the last 26 years, Japan has had a generation without a depression. 

Something quite similar is now occurring in the US. Our bubble popped well, nine years ago, right? And since then, our government debt has doubled. It’s now 105% of GDP. But there’s still a very long way to go in terms of how much government debt the US could take on. 

So I said Japan has 250% government debt to GDP. The US GDP is approaching $19 trillion. That suggests the US government can borrow and deficit spend another $19 trillion, let’s say over the next 10 years before it even hit 200% government debt to GDP. So, as long as globalization continues, and interest rates are low, there’s almost no limit as to how long the government could continue borrowing and deficit spending to keep the economy from collapsing into depression. Now, the issue is whether or not this government spending is sustainable in the long run. It all comes down to how the government spends the money.

Stig Brodersen  37:28  

Richard, I would like to transition into a discussion more about fiscal policy, and also infrastructure. And before we talked about the infrastructure in the US, I would also really like to talk about China and their plans of the “One Belt, One Road” project that they actually *own well already back in 2013. But I’ve experienced that since it’s been given surprising little attention in the US. So just to give some context to this for the audience. It’s a massive infrastructure project, connecting 65 countries 3.8 billion people, and it costs around $4 trillion. So it’s trillion with a T. It’s a lot of money. Just to give you something to compare it to, it’s around 10 us interstate highway systems. Being in the US and looking to China for a project like that, you could look at it as a threat to the US or should be rather embrace it as an initiative to drive global trade and growth?

Richard Duncan  38:28  

Some a boat and more beyond. It was a very clever policy, I think, for them to announce this “One Road, One Belt” policy, and it is getting a lot of attention here in Asia. China, as I said they have a massive economic bubble. For instance, I say that in just three years, I think 2010, 2011, 2012, China produced more cement than the United States did during the entire 20th century. They account for something like half of global steel production and global steel capacity utilization is very low. 

So their big concern is how do they keep their 1.2 billion people, 1.3 billion people employed? If they don’t keep them employed and keep them working and keep them fed, then there will be potentially very severe political crisis that would threaten the power of the Chinese Communist Party. So they have to do something, they have massive excess capacity, they’ve been driven by export led and investment driven growth. But now the global economy is too weak for them to continue to grow through export led growth. 

What we see with the… There’s now a very severe backlash against globalization, resulting in Brexit and the election of Donald Trump. And so their whole economic growth model is in crisis. And it’s not at all certain that this is going to be enough to keep their bubble from imploding. But it’s very good effort. 

Meanwhile, they’re not only doing that. They are also investing very aggressively in new industries and technologies. Fifteen years from now, China will probably be dominantly solar power, solar cars, solar energy, they’ll be energy independent. So in those respects, China has a plan, they have a plan for how they’re going to grow their economy and how they’re going to become the dominant global economic superpower and technological power. And if their bubble doesn’t implode some time in the next five years or so, they very well could achieve that global dominance in technology, and economically as well. And then who knows what threat they might pose to the rest of the world? It’s hard to say.

Stig Brodersen  40:40  

So, Richard, I would really like to talk about the impact on currencies because some of the things that we’re seeing here in Asia right now is that the Chinese more and more are requiring the neighbor countries to make the business transactions in RMB. Whereas previously, it’s been USD. It’s not only exchange rates, we’re seeing a big shift. We’re also seeing more and more countries starting to learn Chinese. We see more and more countries that doesn’t even have Chinese as like the first language speaking Chinese to each other as the trade language in Asia. Do you think the agenda of a project like the “One Belt, One Road” is not only trade, but really also a more… It’s a superpower policy so to speak?

Richard Duncan  41:26  

Yes, I I think that’s certainly a part of it. Yes, it is. But in terms of conducting the trade in renminbi, many people are concerned that renminbi is going to overtake the dollar and replace it as the key international currency. Well, that’s not going to work because what is required of the key international currency is that there is a lot of it in the global economy, and there’s not a lot of renminbi in the global economy because overall it has a very large trade surplus, let me say. 

So, US on the other hand has a very large trade deficit. And so every year that throws out well about 500 billion new dollars that get thrown out into the global economy and accumulated by the US trading partners. China’s not throwing out any renminbi into the global economy in that way, because they have a big trade surplus. So that’s not going to work. And furthermore, countries that accumulated RMB, would have to invest them in RMB denominated assets. I don’t think a lot of people would be very keen to invest in Chinese government bonds. In fact, as you can see, the Chinese themselves are very keen to get their money out of China over the last couple of years.

Preston Pysh  42:35  

We talked with a gentleman named Jim Rickards, I don’t know if you’re familiar with Jim. But Jim, he’s written a couple New York Times bestsellers on a lot of this currency type situations. And one of the things that Jim talks a lot about is the special drawing rights from the IMF potentially being a solution to some of this, in that maybe in the next crisis whenever the credit would contract that you might see the IMF kind of come forward and try to act as that global peg to currencies in order to try to maybe alleviate the rough waters if maybe that’s the best way to describe these currencies in each different part of the world. And that the SDR could serve as that purpose. Do you agree with that idea? Do you see that that could potentially work? Or is that not something that could potentially be a solution?

Richard Duncan  43:24  

Well, so the SDR, special drawing rights, it’s essentially IMF money or money that the IMF can create from thin air, the way that central banks can create their own money from thin air. And all the members of the International Monetary Fund are allocated special drawing rights in proportion to their ownership stake effectively in the IMF. 

Now, in my first book, “The Dollar Crisis,” which came out in 2002, I anticipated this global economic crisis. I didn’t know when it would happen. I actually called for this for the IMF at that time to issue special drawing rights to provide global liquidity when the crisis struck. And actually, that happened. When the crisis struck in 2009, the IMF increased the number of special drawing rights by a factor of 10. There weren’t very many special drawing rights in existence to start with. But I think they ended up creating the equivalent of $300 billion of SDRs, which did help alleviate the liquidity shortage in the global economy at that point. But there’s no way the US is going to allow the IMF to issue enough new IMF money that it actually undermines the dollar standard itself.

Preston Pysh  44:38  

All right, Richard. So I want to give you the opportunity to tell our audience where they can learn more about you tell them about your newsletter that you send out because there’s no way anybody could listen to this and not realize how insanely smart you are. So please tell them where they can learn more about you.

Richard Duncan  44:55  

Okay, thank you very much. I produced a video newsletter called Macro Watch. And every couple of weeks I upload a new video, which is a PowerPoint presentation, usually about 20 minutes long and usually with 30 or 40 charts that you can download on different subjects describing how the global economy really works. Now, it’s not like the economic textbooks told us now that money is no longer gold backed. The global economy works in a very, very different way than it did before. So that’s what I focus on and I hope your listeners will check it out. They can find it, if they will Google RichardDuncanEconomics.com or if they Google Macro Watch, and they can sign up for my free blog. Or they can subscribe to Macro Watch. One year subscription costs $500. But if you use the discount coupon code “Podcast,” you can subscribe for $250 and then you’ll have access to all of the archives 32 hours of archives now, including two courses called “Capitalism in crisis,” and the second one is called “How the economy really works.”

Plus, you’ll also get the next 24 macro watch videos over the next 12 months. 

Preston Pysh  46:12  

So there you go, guys. If you want to get a masterclass on how macroeconomics works, Richard’s offering up a 50% discount off of his courses on a site so we highly endorse anything Richard puts out because it’s of the highest quality. We can’t thank you enough for coming on the show, Richard. This conversation was just fantastic. Always so insightful, and we just really appreciate it. 

Richard Duncan  46:35  

I enjoyed talking with you guys. twice now. Let’s do it again. 

Preston Pysh  46:39  

You bet.

Stig Brodersen  46:40  

All right, guys. That was all the Preston and I had for this episode of The Investor’s Podcast. We will see each other again next week.

Outro  46:46  

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