Peter Schiff - EuroPacific Capital

  1. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Friday, March 10, 2017
    With his widely followed, and positively reviewed, address to Congress last week, President Trump showed how easy it could be to unite Washington around a big-budget centrist agenda on health care, immigration, taxes, infrastructure and the military. But the continued accusations surrounding his campaign’s alleged Russian connections, and the President’s conspiratorial responses, have insured that the battle lines have only hardened. However, anyone with even a casual concern with ballooning government debt should take notice just how easily both parties in Washington would agree to vastly expand the gushing red ink if a political truce can be brokered. Those fears should galvanize around the newly-issued Republican replacement for Obamacare.  If such a monstrous bill could successfully navigate Congress, we would find ourselves stuck deeper in a deficit deluge than we can possibly imagine.  
     
    Obamacare attempted to rewrite the laws of economics by preventing insurance companies from charging high-risk customers more than low-risk customers. But to make this work without bankrupting the companies, all agreed that the young and healthy would need to be forced to buy insurance.  The flaw that doomed the law was that the penalties for not buying were too low to actually motivate healthy people to buy.  Consumers were charged just a few hundred dollars per year to forego insurance that would have cost many thousands. Given that they could always decide to get insurance in the future, at no added cost, the choice was a no-brainer. Without these healthy people keeping costs down, insurance premiums have risen alarmingly. 
     
    Ironically, the Supreme Court noticed this flaw as well. In sustaining the Law’s constitutionality, Justice Roberts argued that the relative lightness of the penalties was insufficient to compel anyone to buy insurance and, as a result, he considered them to be a “tax” that could be voluntarily avoided rather than a coercive penalty to force commercial activity. (Presumably had the tax been high enough to actually work, it would have rendered Obamacare unconstitutional – see my 2012 commentary).
     
    However, the Republican replacement plan, which removes all taxes on individuals who don’t buy insurance, and all penalties on employers who do not provide insurance to their employees, will actually make the problem far worse.
     
    The only reason healthy people buy health insurance is that they know that if they wait until they get really sick no insurance company will sell them a policy.  The same principal holds true for all insurance products.  You can’t buy auto insurance after you get into an accident. You can’t buy life insurance at a reasonable cost after your doctor has given you six months to live. The fact that your car is already wrecked, or your arteries already clogged, are pre-existing conditions that no insurance company would be expected to ignore. 
     
    Allowing voters the low-cost option to buy health insurance after they actually need it is very popular. It’s like promising motorists they can stop paying their monthly auto insurance premium and just buy a policy after they have an accident.  If the government were to require this, all auto insurance companies would quickly go out of business (unless they were bailed out by the government).
     
    Obama’s solution was to use the penalties to force healthy people to buy insurance before they actually needed it.  As the years wore on, the relatively low cost of the subsidized exchange plans and the availability of those plans to anyone proved popular.  However, the mandates and penalties, as well as skyrocketing premiums for non-subsidized policies, were clearly unpopular.  
     
    The Republicans have taken the “brave” political approach of keeping the parts that are popular (subsidized access, pre-existing conditions waivers, expansion of children’s coverage until age 26) and jettisoning those that are not (the mandates and the penalties).  The new plan pretends to offer a replacement to the Obamacare penalties by allowing insurance companies to charge a 30% increase to the premium for those who come back into the system after having previously allowed their coverage to lapse. But the problem here is that the premium increase is far too small to force anyone healthy to buy insurance. In fact, it is so low that any healthy person currently insured may decide to drop coverage.
     
    The effect of this law, were it actually enacted, would be the death of the health insurance industry.  As the law removes the requirement that larger employers provide insurance, I believe that big companies would look to self-insure employees for routine care.  For example, employer and employees could pay into a common risk pool that would set their own deductibles and co-pays. For employees who incur medical charges in excess of the cost of an actual policy, the pool could provide funds to pay for outside insurance at the increased 30% premium. As a result insurance costs would be encountered only if there is a need.
     
    Self-employed individuals would only buy insurance if the total cost was less than the tax credit provided by the new plan.  If they can’t find such coverage, they would likely buy a new form of insurance that this law may create: A policy that would pay for health insurance premiums if the user ever got sick enough to need them.  Such insurance would be very cheap, as the maximum exposure to the insurance company is only 130% of the premium for a standard health insurance policy.   
     
    In the end, the only people buying health insurance would be those who can buy it for free using their tax credits and really sick people for whom insurance premiums are cheaper than their medical bills.   But as insurance companies lose money on the latter group, they will be forced to raise their premiums on the former.  This puts us right back in the box we are stuck in with Obamacare.
     
    As premiums soar well above the amount of the tax credits, more people will drop out.  Unless the amount of the tax credits rises substantially, which will cost a fortune, all health insurance companies will eventually go out of business.  The end result will be socialized medicine, only it will be Trump not Obama that gets the blame.  It seems to me that this would be a political loser for the conservative cause. I would rather we go down in flames with Obamacare as then, at least, we will have a chance at a free market solution that could actually work.
     
    The government has a very poor track record with containing the cost of a service when it gives consumers money to buy it. Think student aid and college tuition.   Plus the plan is constructed in a way that makes it ripe for potential abuse.  Whenever the government is giving away money, people always game the system to get it.  Think about the wide-spread fraud in welfare, food stamps, disability, and even cell phone credits. Trumpcare will be no different. Many people will buy catastrophic plans with extremely high deductibles just so they can pocket the difference between the tax credits and the costs of the plans.  If they actually incur a medical condition that results in a high out-of-pocket expense, they can just switch their coverage to one with a much lower deductible.  Such a switch may even be possible without the 30% premium for lapsed coverage. 
     
    If Trump and the Republican leadership can push this monstrosity through, despite the obvious mathematical shortcomings, look for them to make similar efforts on infrastructure and defense spending. All this adds up to uncounted trillions in new debt, and a giant step closer to the utter bankruptcy of the nation. But the real danger lies in the possibility that the law is voted down by conservative Republicans and Trump turns instead to Democrats.
     
    In contrast to the former mission statement of the Republican Party, Trump believes that government solutions can work as long as they are “smart.”  The opening weeks of the Trump presidency were dominated by combative rhetoric, conservative and pro-business appointments, and nationalistic executive orders. And while this approach sent Democrats and the media into convulsions, it solidified the loyalty of Trump’s political base, and allows him to pivot toward the center if he wants. If he could peel off some “Red State” Democrats, he would be in a position to enact some of the biggest spending increases that the country has ever seen, even if fiscally conservative Republicans bolt.
     
    If those conservatives defeat the new health care bill, Trump could look to partner with Democrats in a heartbeat. Of course, to get that support, he would have to make the current bill even more generous. Let’s hope that his self-inflicted wounds continue to prevent such an unholy alliance.
     
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  2. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Wednesday, January 18, 2017
    There is much we don’t know about how the Trump presidency will play out. Will the Wall get built? Who will pay for it? Will it have at least some fencing? Will repeal and replace happen at exactly the same time? Will Trump throw a ceremonial switch? Will there be a Trump National Golf Course in Sochi? It’s anyone’s guess.  But of one thing we can be fairly certain. President Trump is very likely to preside over the largest expansion of Federal budget deficits in our history. Trump has built his companies with debt and I’m sure he thinks he can do the same with the country. His annual budget deficits are likely going to be huge. This development will make a greater impact on the investment landscape than most on Wall Street can imagine. 
     
    In the past half-century, Republican presidents have been the going away winners at the deficit derby, a fact that should make any true conservative blush. The sad truth is that annual deficits exploded under Ronald Reagan and George W. Bush, and generally contracted under Bill Clinton and Barack Obama (despite the latter's distinction of having added more total debt than all previous presidents combined.) Some of the explanation is just luck of the draw, some walked into office in the midst of recessions they didn’t create. But the better part of the explanation is baked into the political dynamics.
     
    Democrats want to raise spending and taxes. Republicans want to cut spending and taxes. But whereas Democrats have generally succeeded on both of their missions, Republicans have just succeeded in one. (Actual spending cuts require politically difficult choices that are much harder to vote for than perennially popular tax cuts). This puts a giant thumb on the Republicans budgetary scale.
     
    Like prior Republicans, Trump has promised to cut taxes, on both corporations and individual taxpayers…even the wealthy. But unlike prior Republicans, he has not paid a word of lip service to spending cuts. He has promised to spend now, and spend big. Trump just doesn’t do the austerity thing. It’s for losers.
     
    In addition to fronting the cost of building the 2,000 mile Wall (accounts receivable has a reliable address in Mexico), Trump plans big increases in military spending, both on active military and on our veterans. His reboot of Obamacare has yet to be presented, but as he has promised that no one will lose coverage, not even those with pre-existing conditions, we can be sure that Trumpcare won’t be cheap. But his big project will likely be his promised $1 trillion plus infrastructure spending plan. Most importantly, he diverges from most Republicans by promising no structural changes in Social Security and Medicare, the entitlement leviathans that are the sources of the vast majority of Federal red ink.
     
    To aid him in these budget-busting efforts, Trump will have the benefit of a compliant Congress in which his own party controls both Houses. Most Republican senators and representatives now seem eager to jump aboard the Trump train and will likely pass anything he sends to the Hill. Those who resist should prepare for the kind of political hardball that we have rarely seen in this country (I’m talking to you Lindsay Graham). If Republicans couldn’t hold the line on Obama, how will they do so with Trump and, politically, why would they even want to? Grandstanding against Obama’s big deficits, even to the point of forcing a government shutdown, did not play well politically. Standing up against Trump will involve considerably more risk with Republican primary voters. 
     
    Even if none of Trump’s taxing and spending plans come to fruition, the United States would still be on the threshold of a sobering era of debt expansion. The age of trillion dollar plus annual deficits began in 2009 when the financial crisis tripled a very large $458 billion deficit in 2008 into a record smashing $1.4 trillion in 2009. Three more trillion-dollar deficits followed. But since 2009, excluding a small increase from 2010 to 2011, the deficits have declined steadily. By 2015, they had decreased to $438 billion, slightly below where they were before the crisis began. (Of course these smaller deficits exclude hundreds of billions of additional debt that is borrowed off budget.) These developments have caused many to conclude that budgetary issues are no longer at the top of the agenda.
     
    But, as a result of the failure of Republicans and Democrats to achieve any kind of agreement on long-term budgetary reform, the six-year run of declining deficits has come to an end. The 2016 deficit was more than $100 billion wider than 2015. This marks the first year since 2009 that the deficit increased from the prior year (except for a minimal .001% expansion in 2011 over 2010). This is just a down payment on things to come.
     
    The Congressional Budget Office (CBO) - the closest Washington comes to actual objectivity - issues long-term budget assumptions. Except for a relatively small dip from 2017 to 2018, the CBO sees continuous deficit expansions every year through the end of the next decade, culminating in continual $1 trillion deficits every year starting in 2024. (8/23/16 CBO report) That’s the good news. The bad news is that in making these projections, the CBO has to make some very rosy assumptions. The most egregious of these is that the U.S. economy will avoid recession for the entirety of the next decade.
     
    Over the past century we have seen a recession, on average, every 60 months (based on data from National Bureau of Economic Research and Bureau of Labor Statistics). According to current figures, the economy has been in expansion for 92 consecutive months. This means that the current expansion is already 50% longer than average. Expecting it to last for nearly 18 years is completely without precedent.  I believe it will be sooner rather than later that we will have another recession, which will greatly enlarge the deficits. History is clear on that point. The Great Recession caused the deficit to triple. Even the mild recession of 2001 turned a $236 billion surplus into a $157 billion deficit in just two years. The next recession I expect to work similar magic. But, in addition to being blind to recessions, the CBO was also blind to Donald Trump.
     
    In making its projections, the CBO simply assumed that the taxing and spending laws currently on the books would remain unchanged. The projections do not account for any tax cuts or spending increases. As mentioned previously, Trump has virtually promised to do both in the first year of his presidency. If he is successful, we could return to trillion dollar deficits much sooner than the CBO thinks. A recession could push the red ink well into record territory.
     
    The graphs below chart the prices of gold and the dollar versus annual budget deficits since 1990. The data shows clearly that after a few months of lag time, the price of gold has followed the long-term expansion and contraction of deficits, while the dollar has moved in the opposite direction.
     
     
     
    Of course, who on Wall Street has picked up on these macro trends. In fact, one of the biggest issues currently being discussed is how the U.S. economy will deal with a perennially strengthening dollar. They are assuming that the Federal Reserve will be raising rates and that the economy will be expanding under the Trump stimulus thereby strengthening the dollar and attracting flows from abroad. This type of “trees grow to the sky” thinking is similar to Clinton-era assumptions that the national debt would be repaid by perpetual budget surpluses, or the feeling earlier in this century that real estate prices could never decline.
     
    To make these assumptions, Wall Street must ignore the obvious ramifications of big deficits, in particular the need for the Federal Reserve to step up and buy all the new debt that the Trump administration will have to issue. The last time the government had to find buyers for more than a trillion dollars per year of debt, it relied on foreign central banks. Eight years ago, the vast majority of Treasury debt was purchased by China and Japan (and, to a lesser extent, Saudi Arabia, Russia and other emerging nations in Asia and Latin America). But as the debt surge persisted, the real heavy hitter became the Federal Reserve itself which, through its Quantitative Easing (QE) Program, bought more than half a trillion dollars of Treasury debt per year from 2009 to 2014.
     
    But there can be little expectation that the foreign buyers will be returning for a repeat performance. Currently, both China and Japan are looking to draw down foreign exchange and are engaged in active selling of U.S. Treasuries in order to keep their currencies from declining against the dollar (Scott Lanman, 10/18/16, Bloomberg). What’s more, Donald Trump is likely to engage in aggressive trade wars that may certainly discourage other foreign central banks from supporting our debt issuance.
     
    Also, bond analysts are now convinced that the 35-year plus bond bull market, which began in 1980, finally topped out in July of 2016, when European and Japanese yields sank deeply into negative territory and yields on the 10-year Treasury hit 1.36% (Peter Boockvar, 9/19/16, CNBC). Since then bond prices are down significantly across the board.  If this trend continues, it will discourage private buyers from making the jump into Treasuries. In other words, the Fed may be the only game in town when it comes to financing future deficits in a new bond bear market.  
     
    This would mean that the QE programs that many had assumed to be a thing of the past can return with a vengeance, becoming the signature program of the Trump era. When this reality sinks in, you may witness the dollar begin a long and steady decline from its current decades-high strength. At the same time, gold, gold stocks, commodities and foreign stocks could finally enter a turnaround.  
     
    Ultimately, I expect years of dollar decline to culminate in a crisis, with the dollar plunging in value, as the world abandons it as its primary reserve currency. The last time the dollar was on the brink of collapse it was saved by the financial crisis of 2008. Next time we will not be so lucky!
     
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    To order your copy of Peter Schiff's latest book, The Real Crash (Fully Revised and Updated): America's Coming Bankruptcy - How to Save Yourself and Your Country, click here.

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  3. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Thursday, December 22, 2016
    The optimism that has followed the election of Donald Trump has pushed the Dow Jones Industrial Average to the threshold of 20,000, a level that will be both a nominal record and a symbolic milestone. Although this is not the way most observers had predicted that 2016 would play out, most on Wall Street have become extremely reluctant to look a gift horse in the mouth…or to even look at him at all. The impulse is to jump on and ride, and only ask questions if it pulls up lame. But if this year has proven one thing, it is that predictions made by the consensus should not be trusted.
     
    Back in the earlier part of 2016 the mood was decidedly darker. At that point most people believed that the Federal Reserve would be raising rates throughout the course of the year. While such hikes had been anticipated (and delayed) for years, most took comfort in the belief that the economy would be expanding nicely by the time the Fed actually pulled the trigger. But in late 2015, the already tepid GDP growth seen in the prior two years seemed to be decelerating. Investors also concluded that Hilary Clinton was a lock to win the election, thereby assuring that the anti-growth policies of the Obama years would continue. Many looked at these developments and concluded that the sins of the past decade, in which the Government and the Federal Reserve had used unprecedented levels of fiscal and monetary stimulus to prop up the economy and the stock market, had finally caught up with us. As a result, the Dow Jones shed more than seven per cent in the first two weeks of the year, its worst start on record.
     
    But the year comes to an end amid a cloud of Trump-fueled bullishness. The markets fully embrace an unapologetic capitalist, and his team of billionaires, who promises to cut taxes, rewrite trade deals in America’s favor, take a machete to anti-growth regulations, repeal Obamacare, and return America to its former industrial might. Many are making parallels to the Reagan Revolution in which a maverick anti-establishment Republican took charge in Washington and ignited an economic boom, a stock market rally and a surge in the dollar. But to make this comparison, boosters must jump over a more telling comparison to the last Republican president elected, George W. Bush.
     
    The parallels to W. are striking. Both lost the popular vote, and will have taken office following the tenure of a two-term Democrat who had presided over a furious stock market bubble and a surging dollar. In the 4 years prior to Bush's election, the Dow Jones had surged approximately 60% and the dollar index had risen approximately 19% (1/2/97 to 12/29/2000). For Trump, the numbers are 48% and 24% (1/2/13 to 12/21/16). Then, as now, the U.S. was seen by investors as the only game in town. Clinton's second term was rife with global crises that both created safe-haven flows into the dollar and caused the Fed to backstop U.S. financial markets with cheap money (at least cheap by the standard that existed at the time). Both will have come into office promising tax cuts and regulatory relief following eight years of Democratic reign. As a result, the market gains of the Clinton and Obama years were expected to continue under their Republican successors.
     
    But the optimists did not anticipate that the big, fat, ugly bubble that inflated during Clinton’s second term, would burst early in Bush’s first term (although the air started coming out of that bubble while Clinton was still in office). Given the ensuing recession of 2001, it can be argued that the only reason Bush was reelected in 2004 was that the Fed was able to inflate an even bigger, fatter, and uglier bubble in housing that postponed the pain until the financial crisis of 2008. That is where the similarities will likely end, as Trump will likely not be that lucky.
     
    One of the pillars of dollar strength under Clinton was eight straight years of deficit reductions, culminating with a massive $236 billion budget surplus in 2000 (Congressional Budget Office). While the surplus did require some accounting smoke and mirrors and a stock market bubble to create, it nonetheless marked a significant achievement. At that point, many economists had assumed that the U.S. debt problem had largely been solved and that the country would ride a wave of permanent surplus. The only problem most could envision was a shortage of Treasury bonds once the national debt was fully repaid. No one is to worried about that “problem” now.
     
    Similarly, Trump is taking charge at a time when official budget deficits have fallen consistently since 2009 (albeit from astronomically high levels). But 2016 is projected to be the first year since 2009 in which the deficit will have risen, significantly, from the prior year. The Congressional Budget Office sees a return to perpetual $1 trillion plus annual deficits in the early part of the next decade (The Budget and Economic Outlook: 2016 to 2026 report, January 2016), even if we have no tax cuts, spending increases or recessions over that entire time. Under the Trump presidency, we are likely to get all three.
     
    If a recession comes early in Trump’s presidency, it will be no more his fault than the 2001 recession can be blamed on Bush. A sharp pullback has been years in the making. Firstly, there is simply the issue of timing. On average, the U.S. has experienced a recession every 60 months or so since WW II (based on data from National Bureau of Economic Research and Bureau of Labor Statistics). The current expansion is already 90 months old, or 50% longer than average. Sooner, rather than later, it will have an end date. Recessions completely reshuffle the budgetary deck, causing government outlays to rise and revenues to fall simultaneously. The swings can be dramatic. The 1981-1982 recession resulted in a 61% increase in Federal red ink. The recession of 2001 turned a $236 billion surplus in 2000 into a $377 billion deficit in 2003 (then a record). The Great Recession of 2008-2009 caused the $458 billion deficit in 2008 to more than triple to $1.4 trillion in 2009. Rest assured, the next recession can cause a similar catastrophe to the government’s finances.
     
    Trump’s election was predicated on his intention to buck traditional Republican policy of fiscal restraint. He has promised tax cuts for people and corporations and massive $1 trillion plus spending binges on infrastructure and the military. Of course the argument goes that these moves will stimulate growth thereby raising tax revenue to pay for both the cuts and the spending. The same arguments were made by George W. Bush in 2001 when he cut taxes, increased spending, and pushed through a temporary tax holiday to encourage corporations to repatriate money held overseas. Deficits soared anyway. The only real question is will the recession arrive before or after Trump’s fiscal policies kick in. If the events happen simultaneously, the budgetary implications will be hard to fathom.
     
    Investors who are basking in the Trump victory should take a hard look at what happened to the markets during the Bush presidency. In mid-2008 (just a few months before the financial crisis sent stocks plummeting), the S&P 500 was just 17% above the level when Bush was elected nearly eight years earlier. The dollar, in particular, took a beating under Bush. In August 2008 (right before the dollar rallied temporarily as a result of the panic), the dollar index had fallen by 19% since his election. The opposite occurred in gold. In November of 2000, gold was at about $370 per ounce, close to a 20 plus year low. In August 2008, it was more than $920, down significantly from it's high of almost $1,100 hit earlier that year.
     
    Also, for all the optimism about the U.S. stock market and pessimism abroad, it was foreign markets that delivered for investors. From Bush’s election to mid-2008, just before the global financial crisis sent stocks reeling around the globe, developed foreign markets were up 80% (priced in U.S. dollars) while emerging markets were up a staggering 300% (priced in U.S. dollars). Even if you include the huge losses in the back half of 2008, by the time Obama was sworn in, developed markets were down less than 3% from the time of Bush’s election, and emerging markets were still up about 80%. (In contrast, the S&P 500 was down almost 27%).
     
    The 2001 Recession, which was triggered by the bursting of the dotcom bubble and the September 11 attacks, came very early in Bush’s first term. Fortunately for W., the Federal Reserve was able to support the economy by bringing rates down from more than 6% to just 1% (Federal Reserve Bank of St. Louis) (which helps explain the swift collapse of the dollar). As a result, the 2001 recession was the shortest and mildest on record. In doing so, however, the Fed blew up an even bigger bubble in real estate, the bursting of which created a far bigger recession in 2008, propelling Obama into the White House.
     
    But can the Fed ride to the rescue this time around? Given that rates are practically zero and the Fed is choking on trillions of dollars of assets that are permanently held on its balance sheet, the answer is clearly no. All the Fed will be able to do is launch the mother of all QE programs, perhaps in the form of a massive helicopter drop. But the bad news for Trump fans is that the result will not be a housing bubble like the one that bailed out Bush, but a wave of stagflation that will make Trump a one-termer. The nightmare scenario is that once again tax cuts and deregulation take the blame, allowing Bernie Sanders or a socialist candidate to ride another populist wave, only this one headed far left, into the White House of 2020.
     
    Subscribe to Euro Pacific's Weekly Digest: Receive all commentaries by Peter Schiff, John Browne, and other Euro Pacific commentators delivered to your inbox every Monday!
     


    To order your copy of Peter Schiff's latest book, The Real Crash (Fully Revised and Updated): America's Coming Bankruptcy - How to Save Yourself and Your Country, click here.

    For in-depth analysis of this and other investment topics, subscribe to Peter Schiff's Global Investor newsletter. CLICK HERE for your free subscription.

  4. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Thursday, November 17, 2016
    The election of Ronald Reagan in 1980 provides the best recent precedent for the unexpected triumph of Donald Trump (in my opinion, the other post-war Republican takeovers of the White House --Ike in ’52, Nixon ’68, and W. in ’00 – did not constitute a real break from the status quo.) As many people expect great changes from Trump, it is worthwhile to look at what the Reagan Revolution actually wrought. 
     
    Both Reagan and Trump were better known to many as entertainers rather than politicians, both came from outside the Republican mainstream, and both engineered hostile takeovers of the Party. During the 1970s, the Republican Party was dominated by “Rockefeller Republicans,” the Ivy League-educated liberal Eastern elites. Reagan was the Western heir apparent to Barry Goldwater, the deeply conservative standard-bearer who went down in flames in 1964. In 1976, the brash Reagan had the nerve to challenge incumbent Republican President Gerry Ford in the primary, thereby weakening him in the general election, which he ultimately lost to Jimmy Carter. While Reagan was simply too conservative for the Rockefeller wing, Trump’s various positions are similarly inconsistent with much of the mainstream neo-conservative orthodoxy. Both candidates also capitalized on a weak economy as a catalyst to encourage voters to cross traditional party lines. Many of the rust belt ”Reagan Democrats” came home to Trump.   
     
    While books have been written about the cultural and political legacy of Reagan’s presidency, harder facts can be found in his budgetary record. Despite the economic revival that his tax-cutting and deregulation tendencies delivered, the national debt ballooned as it never had for any other peacetime President. Although the fiscal imbalances have gotten significantly worse since Reagan left office, the Gipper gave plenty of cover for future Republican presidents to run up red ink. President Donald Trump, the self-proclaimed “King of Debt”, now appears to be perfectly positioned to test the limit of how much debt the world’s largest economy can issue. 
     
    Leading up to the election of 1980, Reagan and the conservative economists who supported him, warned that Federal debt, which had risen to approximately 26% of GDP, had grown too heavy to bear (data from Congressional Budget Office, July 2010) Reagan brought the spirit of Milton Friedman into the Oval Office, and his campaign was based on a clear intention to roll back the nearly 50 years of socialist government expansion that had occurred since Roosevelt’s New Deal.
     
    But when Reagan came to Washington he was confronted by a strong Democratic majority in the House of Representative led by House Speaker Tip O’Neill, a skillful and forceful defender of big government. Reagan soon discovered that the political price was always very high when government expenditures are being restricted. And so, Reagan decided to move on the tax cuts (a perennial political winner) but never really got around to the spending cuts. As a result, the 26% debt to GDP ratio that he inherited when he came into office expanded to 41% by the time he left. (data from Congressional Budget Office, July 2010) This was not the complete conservative victory for which his backers had hoped.
     
    Trump comes to office with similar expectations for significant changes. The good news for him is that he will face far fewer restrictions than Reagan had to face. Most importantly, both houses of Congress are now Republican. The Supreme Court is currently split along ideological lines but is likely to swing conservative after Trump’s appointment to the open Scalia seat.
     
    On the taxation side, Trump has proposed cuts in personal and corporate tax rates that could likely sail through Congress. How much these moves will add to the deficit depends on how much growth they generate in the economy. Such predictions are very hard to make. But if the tax cuts are assured, the growth is not. However, there is no need to make algorithmic predictions on the budgetary implications of spending decisions. They are what they are, and their impact is immediate. Trump plans massive increases in Federal spending, initially in the form of a trillion dollar infrastructure spending over ten years, and billions to build his border wall and pay for his planned deportation force. On the spending side, Trump could likely get whatever he wants, and more. Had a smaller infrastructure spending plan been proposed by President Hillary Clinton, it would have likely been voted down by “fiscally hawkish” Congressional Republicans. Such scruples could fall by the wayside when the spending requests come from a Republican President.
     
    Although the years of trillion dollar plus deficits we experienced during the first Obama term have been pared down to the $500 -$700 billion dollar range, the Congressional Budget Office’s Summary of The Budget and Economic Outlook, 1/19/16, currently predicts that we will officially return to trillion dollar levels by 2022. (In truth we are already there. Over the last 10 years the actual expansion of the debt has averaged $1.1 trillion per year, about $300 billion more than the average deficit of $790 billion over that time). (TreasuryDirect; usgovernmentspending.com) The CBO’s  projections are based on no unplanned spending increases between now and 2022, steady GDP growth in the 2% to 3% range, and no dip into a recession (even though the current expansion is already far longer than the typical postwar expansion). Given this very optimistic set of assumptions, and Trump’s announced plans on taxing and spending, we should absolutely expect a massive expansion of the Federal debt over the next four years. The more difficult question is how it will be financed. 
     
    When making a comparison to Reagan, it is important to realize that he financed his debt expansion the old fashioned way: He sold long-term government debt to private investors. In the early 1980s, savings levels in the United States were much higher than they are today. The average American actually had money in the bank. And those with the means to invest were less inclined to dabble in stocks than they are today (there was no eTrade to make the process easy and transparent). The stock market had essentially made no gains between 1966 and 1980, (Dow Jones Industrial Average data) so investors could be forgiven for having given up faith. Bonds were a bigger part of the mix up and down the investment spectrum. And those investors who stepped up to the plate to buy those 30-year bonds in 1981 to finance the Reagan deficit ended up making some of the best portfolio decisions.
     
    It seems impossible to believe in our current low interest world, but in 1982 the U.S government sold 30-year bonds with a 14% annual coupon. That’s right, a guaranteed, principal-protected, 14% annual return for 30 years. Investors today could only dream of something so magical. Of course inflation was higher back then (partly because the government hadn’t yet figured out how to recalibrate the Consumer Price Index), but even at its worst, inflation rose only to approximately eight percent. (InflationData.com) This means that buyers of those 30-year bonds were getting a real rate of six percent above inflation. But it just gets better from there.
     
    Over the course of the Reagan presidency inflation and interest rates came down steadily. This meant that those investors who bought in 1982 would see their real rate of return increase every year. By 1988 inflation had come down to 4%, so those bonds offered a real yield of 10%. The falling inflation strengthened the value of the dollar itself. So in relative terms Americans holding those bonds were seeing a real increase in purchasing power of their principal relative to the falling prices of imported goods. Also, in an environment of falling interest rates investors holding 30-year 14% bonds could sell those bonds before maturity for more than they paid. That’s because even at a price above par the bonds would still offer higher yields to maturity than newly issued bonds. But despite the premium, investors were better just to hold them till maturity. Purchasing Treasury bonds in 1982 was an investment in America’s future, but it also happened to turn out to be the deal of the Century.
     
    Think about how different it would be today for investors making a similar choice to finance the Trump deficits. 30-year bonds are currently being offered at a rate of just under 3%. If you believe the government inflation figures of just about 2%, this means that your effective yield is about 1% (pre-tax). If inflation is even slightly higher, the real yield could be negative. And in 30 years there is plenty of time for inflation to go, much, much higher. If it does, these bonds would be all but guaranteed to deliver less purchasing power than their original cost, even if held to maturity.
     
    If interest rates were to rise from the current low levels, as almost every economist and investor assumes they must, the value of long-term bonds will surely fall. In another danger to bond prices, Bloomberg News reports that the new Trump economic team will likely put pressure on the Fed to reduce the amount of bonds on its balance sheet. To do so in any meaningful way will require that the Fed sell off portions of its $4.5 trillion bond stash of holdings into the open market. This could turn the biggest buyer of Treasuries into the biggest seller.
     
    A sustained period of falling bond prices would mean that if current buyers wanted to cash out before maturity, they would likely have to sell for a loss, not the gain that their fathers would have seen with the 1982 bonds. If rates got as high as five or six percent (and I think they will go much higher) those losses could be substantial. As Jim Grant likes to say, today’s long maturity bonds represent return-free risk. Or as Warren Buffet likes to say, it’s like picking up pennies in front of a steamroller.
     
    The risks become greater still when you consider how America's fiscal position is much worse today than it was in 1980. When Reagan took the oath of office America was the world’s largest creditor nation. Today it’s the largest debtor. Our debt was just 26% of GDP then, while today its 105% and projected to go much higher over the next generation...even without Trump's taxing and spending plans factored in. 
     
    But arguing the investment merits of long-term government bonds is a bit pointless in the current age. Real investors gave up on bonds long ago. What little savings Americans still have either stays in the bank, or gets directed to stocks or real estate. The bond market has almost become the exclusive playground of central banks. In Japan and Europe, central banks are sucking up the vast majority of government debt. We did the same during our four years of quantitative easing, and the Federal Reserve’s balance sheet remains swollen.
     
    If under President Trump annual deficits explode, whom should we expect to buy the trillions in debt we will have to issue to pay for it? In the recent past, the big buyers have been central banks in China, Japan and Saudi Arabia. Should we expect those customers to return? We may be in an allout trade war with China, Japan is already pushing its own QE program to the limit (its central bank is currently buying large portions of the Japanese stock market) and the Saudis are struggling with $50 oil. We may need to find new buyers.
     
    But don’t look to Mom and Pop USA. Those investors are tapped out. Don’t look to the pension funds. They can’t meet their numbers with 3% coupons. Don’t look to the hedge funds. They are losing money fast due to bad performance, and their investors expect more nuanced thinking than U.S. Treasuries. What’s more, (in contrast to 1982) the U.S. dollar is currently near generational highs. If the dollar should weaken, holders of dollar-denominated debt will be left holding the bag. When Reagan was elected, the dollar had been beaten down to all time record lows, having lost about 2/3 of its value against currencies like the Deutsche mark, Swiss franc, and Japanese yen. So high yielding, dollar-denominated Treasuries were attractive investments for foreign savers. But the dollar has already risen sharply over the last few years based on expectations the Fed would normalize interest rates. Investors should not be under any illusions that the dollar will experience another continued rally. With so many reasons arguing against buying long-term dollar Treasuries, the Fed may be the only game in town.
     
    Given that, it’s impossible to imagine that the Fed will ever allow interest rates to rise by any significant amount. (Doing so would devastate the value of their bond holdings and raise debt service costs past the point where the government, or most private borrowers, could pay). Already more than $4.5 Trillion of Treasury bonds sit on the Fed’s balance sheet. Look for that number to balloon during the Trump years.
     
    Debt monetization was the term that used to be used by economists to describe the undesirable outcome of a country’s central bank becoming the exclusive financier of its national debt. Inflation and currency devaluation were expected to be the results of this brash approach to fiscal policy. But this will likely be our future under Trump. Investors would be wise to recognize this and to diversify appropriately.
     
    In 2009, when the first Quantitative Easing program allowed the Fed to buy large quantities of Treasury bonds, then Fed Chairman Ben Bernanke pushed back against Congressional accusations of debt monetization by claiming that the purchases should be considered temporary, and that they would be unwound when the crisis passed. Since then the Fed has not sold a single Treasury and has used every penny of interest and principal repayments to buy more Treasuries. Should the Trump deficits force the Fed’s balance sheet into the stratosphere, it will be obvious to all what the Fed is doing.
     
    America was able to survive Ronald Reagan's debt experiments because we started borrowing from a position of relative strength. But the debt took its toll, and we are now a shadow of our former selves. Yet rather than reversing course before it’s too late, Trump may just step on the gas, assuring we go over the cliff that much sooner.
     
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  5. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Thursday, November 10, 2016
    Stunned political analysts are missing the most plausible argument explaining Donald Trump's unexpected victory. The misreading of the American electorate stems from the political class’ acceptance of mistaken (and increasingly insane) economic dogma that has arisen over the past generation. Based on their flawed understanding of economics, the pundits could simply not understand why the electorate had become totally disillusioned.
     
    According to the ideas favored by economists on Wall Street, in government, and in the Federal Reserve, Americans should be enjoying a marginally good economy. Unemployment is low, home values and the stock markets are high, credit is cheap and plentiful, prices are stable, auto sales are robust, healthcare is available to all, and GDP is growing, albeit at levels that are below optimal. These are conditions that would normally favor the incumbent party, and would discourage voters from taking a chance on an unknown who has promised to tear down the entire system. But that is precisely what happened. There can only be two explanations: Either Trump supporters were motivated by hatred strong enough to cause them to vote against their own economic interests, or they understood the economic reality better than the Ph.D.'s. I believe the people got it right.
     
    In countless commentaries over the last few years, I have argued that the economy has been getting worse, not better, since the Great Recession of 2008. My points were simple. I suggested that the economic signals created by the Government’s deficit spending and the Federal Reserve’s eight year stimulus program were not creating growth but were actually hollowing out the real economy. I argued that prices were rising faster than Washington cared to admit and that inflation was an economic problem for ordinary Americans, not a magic elixir for growth. I argued that unemployment came down only because people either gave up looking for work (and then dropped out of the labor force), or took multiple low paying part-time jobs to compensate for the loss of good-paying full time jobs. I argued that increased workplace regulations, minimum wage increases, and Obamacare would create hostile conditions for small businesses and would stifle job creation. I argued that zero percent interest rates and quantitative easing were simply a benefit for the investor class and did nothing to generate real or sustainable growth (in fact those monetary policies guaranteed stagnation). I argued that these low rates would inflate debt bubbles in the auto and student loan sectors and would set up our economy for years of pain when those bubbles burst.
     
    That is why my gut told me that Trump would win, despite the polls and the widely held belief that a Clinton victory was assured. I believed that voters (who live in reality, not the fantasy world concocted by the elites) would express their dissatisfaction the only way they could, by voting for Trump. Obama came into office eight years ago promising change but delivered more of the same. Clinton’s promise to continue that failed legacy was a loser from the start. The rank and file saw things the way I had, and reacted the way I believed they would.
     
    But just because the electorate has finally noticed the emperor has no clothes does not mean that we are now on the path to recovery. Donald Trump has proven to be a master of identifying the hopes and fears of voters, but whether or not he has the wisdom and courage to do what is necessary to restore the country’s economic health is an open question. While it is true that Trump is less likely to continue with the status quo, no one really knows what path he will follow broadly. His election likely sounds the death knell for Obamacare and for a slew of environmental and workplace regulations imposed by Obama executive orders, but beyond that, it’s anybody’s guess.
     
    He has said that he wants to lower taxes and reduce regulations, which are needed goals, but he has said nothing about the hard work of reducing spending or reining in our country’s runaway national debt. Trump has openly admitted that his business successes have been based on his ability to go deep into debt, and then to emerge, Phoenix-like, on the back of good deal-making, marketing, and braggadocio. He probably thinks he can do the same on the national level. But there the rules are much different.
     
    It is unlikely that he understands the chemicals he will be playing with, nor is it likely that he will rely on the opinions of those who do. It’s clear that his only solution is that we “grow our way out of debt.” This is a gambler’s mentality that is likely integral to his DNA. It didn’t work for him in Atlantic City, and it won’t work for him now.
     
    Our best hope is that the real Trump is actually a lot cagier than his campaign persona. The wisest leader can do nothing if he can’t get elected (a phenomenon with which I have some experience). Trump managed to get himself elected to the most powerful position in the world. Perhaps he has a better understanding of the problems that face us than he let on during the campaign. Perhaps he knows how excessive debt will choke the economy, that entitlement spending will overwhelm us if we don’t enact Social Security and Medicare reform, that unending monetary stimulus will create a zombie bubble economy, and that trade wars will do more harm than good. Only time will tell.
     
    Of particular concern is that Trump fails to understand how American living standards have been subsidized by our trade deficits. Yes, the hollowing out of our manufacturing sector has meant the loss of millions of good American jobs. But it is not the trade deals that are responsible for their loss, but rather the inability of American manufactures to compete in a high cost, high regulation world. And while we have lost jobs, we have nevertheless gained access to very low cost foreign goods and services, without having to expend the resources necessary to produce them. We have been able to consume these things despite the fact that we can’t pay for them in full. For now, the trade deficits are a problem for our creditors, not for us. Of course, they will become a big problem for us if our creditors decide to cut us off. Trade wars may not bring back good American jobs, but they will surely raise prices and reduce choices for American consumers.
       
    For now we should celebrate that the election of 2016 shows that the American public knows that they have been misled, that they are mad as hell, and that they refuse to take it any longer. But as bleak as the picture Trump painted of the current state of the U.S. economy, it was not bleak enough.  Before things can actually get better, they must first be allowed to get much worse.  Decades of government promises to supply voters with benefits taxpayers can’t afford must be broken, starting with many of the promises Trump made himself to get elected.  Rising consumer prices and long-term interest rates can bring this decades-old party to a catastrophic end.
     
    Ronald Reagan was the last Republican president who was swept into office promising great change. He made good on his “Morning in America” promises to cut taxes and regulations. But he failed in his promises to reduce spending. Trump has never even paid any lip service to spending cuts. And while Reagan’s failure to deliver on spending cuts was cushioned by the steady declines of interest rates during his presidency, Trump will not have that wind at his back. Plus the economy of 2016 has far deeper problems than the economy of 1980. Reagan’s morning now looks more like Trump’s midnight.
     
    Trump did not make this mess, but he will likely be in office to clean it up.
     
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    To order your copy of Peter Schiff's latest book, The Real Crash (Fully Revised and Updated): America's Coming Bankruptcy - How to Save Yourself and Your Country, click here.

    For in-depth analysis of this and other investment topics, subscribe to Peter Schiff's Global Investor newsletter. CLICK HERE for your free subscription.