AMA 37 – Debt Ceiling Increase Means Profit for Investors!

 

Jason Hartman talks with Daniel Amerman about the likely results of the recent multi-trillion dollar increase in the debt limit. Dan is a Chartered Financial Analyst with MBA and BSBA degrees in finance. More at: http://jasonhartman.com/radioshows/. He is a financial author and speaker with over 25 years of professional experience. Years of studying the costs of paying for over $100 trillion of US government retirement promises, as well as the costs of cashing out an expected $44 trillion of Boomer pensions and retirement accounts, have convinced him that too many promises and too much paper wealth chasing too few real resources will likely lead to substantial inflation in the years ahead, with potentially devastating implications for many savers and investors. A problem that will also apply to many other nations.

Mr. Amerman spent much of the 1980s as an investment banker helping Savings & Loans and others try to survive the effects of the last major bout of inflation in the United States. There is a basic economics principle that much of the public is unaware of inflation doesn’t directly destroy the real wealth of goods and services, but rather, redistributes the rights to that real wealth (a principle which unfortunately will likely destroy much of the investment wealth the Boomers plan on enjoying in retirement). The author worked with the effects of billions of dollars of such wealth redistributions, and saw how there was not only a loser for each dollar of wealth redistributed but a winner.

Narrator: Welcome to the American Monetary Association’s podcast. Where we explore how monetary policy impacts the real lives of real people, and the action steps necessary to preserve wealth and enhance one’s lifestyle.

Jason Hartman: Welcome to the podcast for The American Monetary Association. This is your host, Jason Hartman and this is a service of my private foundation, The Jason Hartman Foundation. Today we have a great interview for you, so I think you’ll enjoy it. And comment on our website or our blog post. We have a lot of resources there for you, and you can find that at AmericanMonetaryAssociation.org or the website for the foundation which is JasonHartmanFoundation.org. Thanks so much for listening and please visit our website and enjoy our extensive blog and other resources there.

Start of Interview with Daniel Amerman

Narrator: Welcome to the American Monetary Association’s podcast. Where we explore how monetary policy impacts the real lives of real people, and the action steps necessary to preserve wealth and enhance one’s lifestyle.

Jason Hartman: Welcome to the podcast for The American Monetary Association. This is your host, Jason Hartman and this is a service of my private foundation, The Jason Hartman Foundation. Today we have a great interview for you, so I think you’ll enjoy it. And comment on our website or our blog post. We have a lot of resources there for you, and you can find that at Americanmonetaryassociation.org. That’s Americanmonetaryassociation.org. Or the website for the foundation which is jasonhartmanfoundation.org. Thanks so much for listening and please visit our website and enjoy our extensive blog and other resources there.

Jason Hartman: It’s my pleasure to welcome back to the show Daniel Amerman. I’m a big follower of his work, I met him about three years ago and we had him on the show quite a while back. He talks about turning inflation into wealth, and with all this talk in the news about the debt ceiling and the huge, huge fiasco related to that, I thought it would be a good idea to have Dan back on the show to talk about that in terms of current events and also to talk about some derivatives as well. Dan, welcome. How are you?

Daniel Amerman: I’m doing really good Jason. Thanks for having me.

Jason Hartman: Good, well it’s a pleasure to have you back on the show. So what are your thoughts on this whole debacle with the debt ceiling? I have a feeling I know what they might be, but I’ll let you tell the listeners the at the same time I hear it.

Daniel Amerman: What we’re seeing with the deficit limit was more or less just a surface cover up of the symptom of the problem. And what I mean by that is that when we look at the deficits themselves, they’re not the problem of course. It’s not the deficit limit being 14.2 trillion or whatever the number was. But the problem is the astronomical rate at which the US is racking up new debt.

Jason Hartman: Well I think it was John Boehner who said that the problem is not the debt ceiling, it’s the debt.

Daniel Amerman: Oh absolutely.

Jason Hartman: And I thought that was a perfect, simplistic way to put it, but it’s absolutely true.

Daniel Amerman: Absolutely. And to really understand what’s going on, at the same time we have all this discussion about jobs and unemployment. Which is very appropriate. And as you may have seen, I believe the number that just came out was there were more layoffs in the last month than we’ve seen in the last sixteen months. So things appear to be getting worse then. But the real problem is what happened in 2008 not having been fixed yet.

What I mean by that is if you go back to 2007, we were in a situation where the private economy was 65% of the total economy. And of that approximately 9.4 trillion was the private economy. And that fell to 8.1 trillion in a very fast implosion kind of associated with the events of September 2008. Which was a drop of about 14%.

Jason Hartman: In the private economy. Now, I assume you’re going to talk about the government economy as well.

Daniel Amerman: Absolutely. You can’t understand any of this as long as you fall for the illusion that is usually presented in the financial press that there’s one economy. Because that’s what enables the deceit. The way we usually read about the economy is a sum of both the private and the public sectors.

Jason Hartman: Right, and the public sector has been increasing so quickly it’s scary.

Daniel Amerman: It’s at a fantastic rate and it’s worse than most people understand. What happened was the private economy fell by 1.3 trillion. In effectively a period of months, which by itself is depression with a capital P. But we did see that happen because simultaneously the total spending by federal, state and local governments rose by 1 trillion dollars. So when we look at the two separately, we see this fantastic fall in the private economy, we see this fantastic surge in the public economy, but between the two it was only a small drop.

And the heart of the problem that we run into is that the private economy has never rebounded. So if you look at these current approximate deficit levels, these fantastic levels of about 1 ½ to 1.6 trillion dollars, and one way I like to explain that is if you took every household in the country and they ran a monthly deficit of a thousand dollars a month, that’s equivalent to what’s going on in the federal deficit right now.

So as long as we have the federal government creating an extra trillion dollars a year on top of what was already a problematic deficit of about 450 billion a year in 2008, then we’re going to be at this extraordinary level of government spending. And probably the best way of presenting this that I’ve worked out, and this is part of an article of mine that will be coming out tomorrow, is that if you compare the ratio of the private economy, that’s what pays for everything is the private economy, to the public economy… in 2007 there was a dollar and eighty six cents in private economy for every dollar in government spending.

By 2009 that had dropped to a dollar and thirty four cents in private economy for every dollar in public spending. So we went from a little bit shy of two dollars in private economy for every dollar in public spending to not that much of a dollar in private economy.

Jason Hartman: And I believe the federal government’s share of the GDP now is somewhere around 20%, isn’t it?

Daniel Amerman: I don’t even look at the federal government because you have accounting games that go on there. Because what happens is the federal government essentially creates or borrows money and then it passes the stake to the local governments. Without which the crisis would have been much worse.

Jason Hartman: Right, right. It kind of reminds me of how Enron used to use SPVs or special purpose vehicles, and that’s really what happens. It goes both ways, where the federal government sends money to state governments but then it also takes money from them in the course of unfunded mandates and regulatory burdens and so forth, so it’s really hard to keep track of. You’re absolutely right.

Daniel Amerman: It’ really federal spending but it’s not shown in the federal budget because it’s kind of a transfer, so to speak. And then what makes it much worse than that is the amount of Federal Reserve spending that’s entirely off the balance sheets never even authorized by congress and so forth. But the way I prefer to look at it is total government spending federal, state and local compared to the total economy. And it was 35% in 2007, it jumped up to 43% by 2009 and it’s still at 41%.

Jason Hartman: Oh my gosh. That is a mind boggling number. This is what socialism looks like, or maybe communism almost. That’s crazy.

Daniel Amerman: It’s a pretty amazing number but it’s very hard. If you don’t understand that number, you’re not going to understand what’s going on with the economy or the deficit limit, the hidden depression and so forth. I wrote an article at the end of last year, beginning of this year called The Hidden Depression. It’s gotten a lot of circulation. And what I did there was I took a look at what’s really gone on with unemployment, which is something that most people are just not aware of. What the government has done has taken unemployment and then split it out into three separate boxes and those boxes are never added together.

Jason Hartman: I’ve talked on the show many times about the discouraged workers falling off the unemployment rolls, I’ve talked about underemployment, I’ve talked about independent contractor employment… And I know that one first hand because back when I owned a traditional real estate company that I had sold in 2005 to Coldwell Banker, I had many independent contractors working for me and Dan, I can tell you they show up as employed but I promise you some of those people, a year would pass by and they wouldn’t receive a check.

Daniel Amerman: Yeah that’s been one of the unfortunate side effects is the sheer number of real estate agents who’ve fallen far below the poverty line.

Jason Hartman: And when people try and compare, like Paul Krugman for example, he tries to compare the unemployment rate now and he goes with the official numbers more often than not to the great depression, and back in the great depression people either had a job or they didn’t. It was much more clear. You worked in industry then or you didn’t work. Nowadays there’s this huge gray area of all this self-employed and independent contractor type people.

Daniel Amerman: The issue is when you take a look at those numbers, though, what we do with it or don’t do, which is if you look at official what’s known as U3 unemployment, that’s right now about 9.1% expectation is the next time it comes out it will be about 9.2%, which is bad but it’s a recession level of unemployment rather than say a depression level.

If you go to what they call U6 which is as high as the government goes in its estimates, that includes both discouraged workers and involuntary part-time workers, that’s the engineer that has a part-time job working at McDonalds that the US government now counts as being fully employed. That takes you up to about 16.2% right now. But where the heart of the issue comes in with the deficit and with the debt, is this artificial and very inefficient economy that the government has tried to create to cover up that implosion of the private economy.

If they stopped running those deficits, then the real state of the economy becomes true in an instant. And right now the deficits are running about 10% of the total economy, which is a fantastic number. 10% economy is based on a bankrupt economy borrowing what it can’t pay back, or else just flat out creating the money through the Federal Reserve and effectively funding Treasury bond purchases. If that government deficit spending disappeared, and 10% of the economy disappeared, at the very least without including multiplier effects, we have another 10% unemployed right there.

And that would take us to 26% of the economy, which is greater than seen in the very depths of the great depression. But it’s just split out into these three boxes of official unemployment, the unemployed who aren’t counted to their discouraged or involuntary part time, and the people who have jobs only because the government is creating money at a fantastic rate.

Jason Hartman: And unfortunately the government, although it can be an employer, it’s a terribly inefficient employer and a terribly inefficient, if you will, broker. It doesn’t create anything and when you send it money, it largely wastes the money.

Daniel Amerman: It does. It’s a very ineffective source. But that’s not even the biggest problem. The biggest problem that I see is that we’re engaged in a cover-up. Essentially, we’re taking these massive fire hoses worth of created or borrowed money, and we’re blasting it at the economy in a very ineffective manner to create a semblance that has more employment than we have right now. But we’re not fixing what really needs to be fixed.

Jason Hartman: So what needs to be fixed?

Daniel Amerman: Which is the private economy. And all that we’re doing by spending these fantastic sums in order to cover it up, is we’re bringing forward the day when we collapse the value of the dollar. And once the value of the dollar collapses, that real unemployment that’s been there the

whole time comes out. The only difference being that you’ve wiped out everyone’s savings in the meantime.

Jason Hartman: Well, here’s the thing that I really wrestle with when it comes to a dollar collapse or just further debasement of the dollar. It’s the big issue of compared to what? Compared to what? Gold, silver, the Swiss franc? There is no place really in the world that precious metals are truly used as a currency. The Swiss franc is sort of a symbolic currency in a way almost in that it’s not widely traded.

And so the dollar’s a disaster, I couldn’t agree more. But the problem is, what else are you going to do? When you have the size of the US military that’s rapidly using up its resources unfortunately, it just seems like the US although it’s a poorly managed house, it’s a poorly managed house in a neighborhood of homes that are inferior largely. Am I wrong? Please debate it with me!

Daniel Amerman: Oh, no. Your heading into an area where I have been in the years we’ve known each other in strong disagreement with some of the other people that ride in this area. Because what they recommend is effectively shorting the US dollar against other currencies. And this is a great way of generating a lot of brokerage commissions in the short term. But the problem is that we’re actually in pretty good shape compared to Europe at the moment. They’ve got even worse problems than we do. And it’s a very dangerous strategy to try to do that as well because the central banks are liable to intervene at any time. And when regulators intervene they can very deliberately punish investors and speculators.

Much like what happened with silver. Not too long ago when there was a four margin call raises in a very short period of time that temporarily knocked $6 off the price.

Jason Hartman: Well actually, with silver though we went from about $50 down to about $35.

Daniel Amerman: I’m sorry, I was off a digit there. It was 16, after a few days was about 34.

Jason Hartman: Right, right. And that was in a period of just what? A week or so. I remember when that happened. It was a real calamity.

Daniel Amerman: Yes, absolutely. And it was because the regulators changed the regulations in a deliberate attempt to destroy the speculators. So that’s an issue currency speculation as well. Now, when you say what really happens when you have a high rate of inflation, what happens is the savers get devastated. The average person gets devastated. Someone who has been for decades leading a productive life, working hard, making a net contribution to society…

Jason Hartman: Saving money.

Daniel Amerman: Setting that money aside as they’ve been told to do, and inflation takes it all away. And that’s where the real damage is done. So the place that I’ve been recommending people focus their efforts on are not complicated international plays where everybody’s in trouble and it’s hard to say what will happen at any one time with the exchangers and the traders in the markets and so forth, but the simple domestic plays where the more the purchasing value of the dollar in your savings is destroyed, the more you own real wealth grows.

Jason Hartman: And what are those plays? I know that you and I are both, or at least you were, and I haven’t talked to you in a while, a fan of using long term fixed rate debt to have that debt become debased by inflation. I actually coined a phrase around that, and I don’t know if you use this one too, but I call it inflation induced debt destruction.

Daniel Amerman: Yep.

Jason Hartman: And when I read your work Dan, and I’ve been following you for a long time, I’m just in so much agreement with what you say. It’s amazing. Sometimes I recommend that people read your work and follow your work, and of course we’re going to ask you to give out your website for the listeners, and then they send me back one of your articles and they say Jason, this is exactly what you’ve been saying and I go I know, Dan is like my kindred spirit. It’s amazing.

Daniel Amerman: Well let me get a little more, maybe I could use a little bit of a metaphor to answer that. What I really like is the combination of a hard asset that generates a cash flow, because when you have a hard asset that generates a cash flow unlike let’s say cash or silver, you can borrow against it if it’s considered to be a reliable cash flow. And you can usually borrow against it. At the height of a credit crisis you can’t, but typically you can borrow against it.

And think of it in these terms. Let’s say that you’re in a valley, and you know a flood wave is coming down the valley and the floor of the valley is covered with sand and around you are all these other savers and baby boomers and so forth, and everyone is building their sand castles out of their savings and conventional investments in dollar terms. And you know that what’s going to happen is an almost inevitable result of what’s going on with debt and the deficit and social security promises and so forth. It’s going to be this wave of inflation coming through and it’s going to knock away all the sand or a good piece of it.

Now, for me the ideal strategy is you get yourself this great big boulder that’s not going anywhere. And you pay for not all of the boulder, I don’t recommend that people take chances, particularly at the time, I’d say, listen, leveraging too far or anything. .But with a controllable debt burden that you’re very comfortable even in a very poor scenario that goes on for years where you’re going to have enough money coming out of that property to cover the debt service and the mortgage, you more or less surround that boulder with sand, the sand is the prudent level of debt that you took on to buy the boulder in the first place.

The title wave or flood wave, whatever you want to call it, comes down the valley, it wipes out the sand castles all around you and it washes the sand around your boulder away. And what you’re left with is a much bigger boulder exposed than what you started with.

Jason Hartman: Ah, that’s an interesting metaphor. And what you’re saying is that the boulder is a piece of income property, it’s a piece of rental real estate, right?

Daniel Amerman: It has two things in common. One of them is it’s a tangible asset, and one of them is that it generates a cash flow. And because it’s a tangible asset while there’s never absolute guarantee, the odds are it’s going to maintain its value to at least some extent if we do have a high rate of inflation in the future. And because it generates a cash flow, if you borrow prudently against that you have the money to pay the debt on an ongoing basis as that debt is wiped away. So that’s a pretty potent combination. And then you’re left with both the asset, most of the value of the debt’s been wiped away and you have that ongoing cash flow coming in as well.

Jason Hartman: Now, in an inflationary environment, where at the same time you have credit destruction though and higher unemployment, the debt will be wiped away, the debt on that income property will be wiped away which is great but what happens to the value of that property, Dan? Vis a vi other assets? Maybe I don’t want to say value, or maybe you want to distinguish the value in real terms and nominal terms, you’re welcome to do that. But maybe I don’t want to say value, maybe I want to say price of the property. I’m not sure which. It’s a complex question.

Daniel Amerman: We don’t have nearly enough time to cover this, but my own background is in institutional finance. Years ago, besides financing many billions of dollars’ worth of real estate, I also used to structure what were known as synthetic securities. And it’s how in real terms the major wealth in the world is actually invested. And a problem in the personal finance world is that people focus on what you were just talking about which was asset value, and the institutional world at the highest levels takes a different perspective, and it focuses not on the value of the asset but the value of the differential. You’re actually indifferent to the value of the asset. All that matters is the difference between the value of that asset and the value of the debt that was taken on to finance it because that represents your equity portion.

So if let’s say the value of your asset drops 40%. If you take a conventional personal finance perspective you say that’s a disaster scenario! My gosh, look at what just happened to me there. But let’s say that we’re looking at this in inflation adjusted terms, and that’s what really matters and that’s the approach I take when looking at all investment alternatives, is I do something few people do because most investments can’t handle it. You look at everything in terms of after inflation and after tax. That’s a deadly combination for a lot of investments, but when you take a look at that perspective and you say if in inflation adjusted terms, the value of that hard asset fell by 40% but the value of the debt used to finance it fell by 80%, then you haven’t taken a loss, you’ve taken a fantastic gain. You’re playing the differentials.

Jason Hartman: Exactly. Playing the differential. It’s really an arbitrage. And one of the things that’s really interesting…

Daniel Amerman: It’s a hard arbitrage for people to understand, think in just asset terms. It’s hard to get your mind around that it’s okay if your asset plummets and as long as your liability plummets more in real terms.

Jason Hartman: Absolutely, and that’s a really good way to put it. It is amazing to me in working with real estate investors that I find sometimes people are complaining but they’re actually winning and they should be celebrating, but they just don’t know how to properly keep score, do they?

Daniel Amerman: And the point of the matter is, as you and I have talked for quite a while, and in fact the real estate scenarios that I was running and still run call for substantial deflation in real estate. And what I would show to people that’s still very true today, is if they bought a property and it went down sharply in market value in the first several years, that it could be one of the best things that could happen to them long term. So long as that property is throwing off the cash flow to make the payments. Because as long as it does that, really with property, and I’m not a flipper and I don’t think you are either you’re working with long term values there. If you’re not approaching this from a short term flipping perspective where the play is all in the dollar value, what happens there is that if you’re playing for the long term what matters in the short term is not the value of the property so much.

Because really, when you look at the total amount of debt and so forth and look at a variety of other factors that I’ve discussed in my books and DVDs, there’s a very high chance that we have a high rate of inflation coming ahead of us and that’s going to risk those property values regardless of what’s happening with real values right there. The key is what your short term coverage is coming from. And right now we’re looking at falling the vacancy rates, we’re looking at rising rents, we’re having more and more people enter the rental market. So if we’re comparing the size and the likelihood of our cash flow coming in versus the cash flow coming out, we’re already if you’re focusing on that factor in a very positive real estate market even today. But people don’t see that.

Jason Hartman: I know they don’t.

Daniel Amerman: People see the asset value falling, and they’re saying oh I’m getting annihilated here. No, you’re not. Not if you’re in there for the long term. It’s just a strategic opportunity to acquire even more real estate, you could argue.

Jason Hartman: Yeah. Real interesting. Well Dan, let’s wrap up on a little discussion about derivatives. Because you made a prediction back when I met you and attended your event back in 2008 in New Port Beach. And that prediction has largely come true, hasn’t it?

Daniel Amerman: It has. It has. And it kind of introduced a principle that I think has really worked out well. I used to, and I hope you don’t hold it against me, this was back in the 1980s, I was one of the leaders in structuring derivate securities. And I found an honest living after that point. But I understand very well how they work because I used to create them.

And what I had predicted to you in early 2008, well before the crash in September, was that the derivatives market was almost inevitably going to be destroyed, that it was going to crash. Or at least would attempt to do so. I was one of the minority of people that were talking about that.

But the really essential point as you might recall is I said that wouldn’t be allowed to happen, there wouldn’t be a melt-down. There would be a bail-out that the government would do with the large banks that would require the creation of money without end, that would lead to massive government deficits and eventually to the point where the Federal Reserve was creating money out of thin air to fund those massive deficits, which is exactly where we are today.

And the key point that I’ve been making is that sometimes people get in this mindset where they think well, the whole world’s going to collapse right here. That does happen with society every now and then, but more often you have to anticipate what the counterpunch is going to be from the people holding the power to try to keep from losing that power and losing that wealth. And unfortunately that’s where we’re all stuck in right now. It’s the bail-out rather than the crisis itself that has dominated economic invests for the last three years and still is. And that’s what we need to be investing for.

Jason Hartman: That’s a really good point Dan. Because it seems, and I’ll criticize especially the gold bugs on this one. It seems that they’re always putting forth these disaster scenarios, these society collapse survivalism, etc. I think there is some validity to that, but my criticism is this: that they talk about all of the reasons this will happen and they outline them and they do that very well, but they never talk about the counter punches. For example, with the precious metals people they never talk about GATA and the concept of gold price manipulation. You talked about it in the silver market just a few minutes ago. But there are always countervailing factors and counterpunches that are done specifically by the powers that be that really have a huge impact on these things.

Daniel Amerman: There certainly are. And that is part of the reason that, and I don’t want to knock gold bugs by any means, I have a lot of readers that are heavily invested in precious metals, and I do include some strategies that very heavily involve precious metals. This has been some of what I’ve been doing since you and I have last talked. But the difference is that if you risk everything you have on one vision of the future and that vision doesn’t come true, you just lost everything you have. So what I like to have and what I recommend that people have is a vision where you’re prepared if there is what’s called a societal breakdown, but you’re also prepared if there isn’t.

Because the other big issue that’s been coming out and it’s been a hot buzzword over the last few months, and I don’t know if you’ve read a recent article I did on that or not, it’s financial repression. It’s kind of the other path that we go down. And in some ways it’s the direct opposite of the usual gold approach. And I would say in many cases it looks unfortunately more likely to me in some ways.

We’re going down this approach, meltdown approach. And that is where by law the government, because it has messed everything up, takes ever greater control over money and what can be done with money and so forth. And if we go down that route and you’re in an investment the government doesn’t approve of and you’ve got everything you have in that investment, the government can pull the rug out from underneath you at any time.

Jason Hartman: Well it’s kind of like being a bond holder in GM, right? Look what happened to them. It’s a very good point.

Daniel Amerman: So there’s a really good case to be made for structuring a flexible strategy that handles either melt-down or repression.

Jason Hartman: Very good way to look at it. Well Dan, give out your website if you would so people can learn more. And do you still have your reading course available? I really enjoyed those. Those were fantastic.

Daniel Amerman: The website is www.danielamerman.com and yes I now have a new version of the Turning Inflation into Wealth mini-course available. It’s basically a free book that’s delivered to you at a rate of about two chapters a week once you subscribe.

Jason Hartman: And that is a fantastic course. I love it. I’ve recommended that a lot of my listeners take advantage of that course, and I’d really encourage everybody listening today to make sure they get a hold of that. Dan, thank you so much for being on the show. Any final remarks you’d like to make?

Daniel Amerman: No, I think that took care of it and I sure enjoyed it.

Jason Hartman: Alright, I appreciate it.

Daniel Amerman: Thanks a lot Jason.

Narrator: The American Monetary Association is a nonprofit venture funded by the Jason Hartman Foundation, which is dedicated to educating people about the practical effects of monetary policy and government actions on inflation, deflation, and personal freedom. Our goal is to help people prosper in the midst of uncertain economic times. This show is produced by the Jason Hartman Foundation, all rights reserved. For publication rights and media interviews, please visit www.HartmanMedia.com or email [email protected] Nothing on this show should be considered specific personal or professional advice. Please consult an appropriate professional if you require individualized advice. Opinions of guests are their own and the host is acting on behalf of The Jason Hartman Foundation exclusively.

The American Monetary Association Team

Transcribed by Ralph Jordan

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