Washington, DC -- (ReleaseWire) -- 02/21/2015 --BENNETT: Charles Hugh Smith is here. Charles is an author and financial columnist. His financial commentary regularly appears on Financial Sense and David Stockman's Contra Corner. His web site Of Two Minds is listed as number seven on CNBC's top alternative financial web sites list. He's also an author of seven novels. He's got a strong opinion regarding Greece and its impossible stand off with the EU and why Americans need to be paying attention. Charles, welcome to Financial Myth Busting.
SMITH: Thank you, Dawn. Glad to be here.
BENNETT: Austerity has severely harmed Greece's economy, cutting the GDP by 26 percent from their pre-crisis peak. Is one nation's austerity another nation's reform?
SMITH: Well, we would like to think so and it can be but it's not necessarily so. I think that like a lot of the things that our government tried to do here in the U.S. after the 2008 financial crisis, they were attempting to reform broken systems, but a lot of us feel that those reforms were superficial and really didn't fix what was broken. So I think that's the same thing going on in Greece from what I gather. I have not been in Greece personally to report from the ground, but from what I gather, their tax system is still broken. They still have a very corrupt economy. So, those kinds of major problems that make an economy inefficient and unproductive are still there.
BENNETT: Do you think Greece's position is that Germany is the cause, of not just Greece's economic collapse, but also the economic crisis in the Eurozone?
SMITH: I think it's fair to say that a lot people blame Germany, and the flipside of that is that a lot of German people might blame the Greeks for over-borrowing, but neither is correct, Dawn. In my view, what's really going on is the Euro was a failed idea from the start. Let me use a household analogy to describe why. It's sort of like the Greek and the less productive economies in Europe that joined the Euro, they got the credit card of their rich cousin because the Euro slapped one value on every nation's economy and so a nation like Greece was able to borrow at rates that were nearly as low as their rich cousin Germany, but they didn't have the economy to support that debt. In other words, it was really obvious. They don't have the same productivity, they don't have the same huge export engine, they don't have the same efficiencies in governance and the way the economy works that the Northern European countries have.
It was inevitable that when you give your poor cousin an unlimited credit card with low interest rates, guess what? They're going to run it right up to the max. That's exactly what Greece did. So the problem is that the currency market exists as a market. In other words, what does the market do? The market has price discovery. It discovers the price of virtually everything: risk, credit, profit, streams. It prices all that stuff and normally what should happen is a country with lower productivity like Greece, their currency would be low and so that would mean that imports were expensive for the Greeks because their currency was weak and their exports would be cheap for other countries, and that's basically how it works if you have independent currencies. But when you slap one currency on a bunch of different countries with completely different economies, then you get this ridiculous imbalance.
So in my view, Greece is hanging on to the Euro, but the Euro is basically a concrete life preserver, it's dragging them right down to the bottom.
BENNETT: You're arguing that that the Greeks should actually leave the euro and then go back to the drachma, but then peg their drachma to the dollar. Isn't that like pegging your currency to another sinking currency?
SMITH: I'm kind of a fish swimming upstream here in alternative financial media, if you will, but I've been calling for the dollar to strengthen against other currencies for the past four years.
BENNETT: Short term or long term?
SMITH: I'd say out to ten years. Beyond that, we don't know, but currencies are like any other commodity. If there's a huge over-supply, then the price drops, and if there's a shortage, then the price goes up. And believe it or not, there's actually a shortage of U.S. dollars in the global economy for a lot of different reasons and so that's why the dollar's strengthening, and also, people look at—national health, if you will. It's sort of like that your currency is a thermometer reading on your national economy. Despite of all of our many well-known problems here in the States, our economy still has a fair amount of really solid things compared to other nations. There's still a trend to innovate here. There's still a possibility of solving problems on the local level. We still have a lot of resources. So compared to China, Japan, or the Eurozone, we actually are looking pretty solid.
BENNETT: What is your take on the de-dollarization that's going on worldwide? There are bilateral agreements happening, with China, for example, to do business in the renminbi; and OPEC is moving to the renminbi and the ruble, even gold and silver, instead of the OPEC dollar. How do you explain that with your theory?
SMITH: I think that that all the de-dollarization is definitely a trend, and from the point of view of those people pursuing that, we can perfectly understand that they're tired of the dominance, if you will, of the U.S. dollar, and therefore of the U.S., in the global economy. They are trying to bypass that dominance to benefit themselves. But to really answer, we have to break down what money does, and this is any kind of money, whether it's gold, silver, dollars, bits, you name it. It works as a transactional device so we can exchange goods and services using this money without having to barter or figure out the price. It makes transaction easy and then it also acts to store value. So the dollar plays both roles. What I see a lot of people missing in the de-dollarization, is you can get rid of the Dollar to transact, you can buy oil with renminbi and so on, but that is not really the same as using money as a reserve. That's why, when we talk about the U.S. Dollar being the world's reserve currency, that's the currency that countries tend to hold to prop up their own money and their own credit expansion.
BENNETT: I understand where you're going with this, but to be the international reserve currency of choice, you have to have a strong political system and a strong economic system. Are you saying that those two elements in the United States are stronger than anyone else's right now, and you think for the next 10 years, it's going to be that way? Or do you think de-dollarization is happening because people see weakness in both of those elements in our country?
SMITH: I think that—and again, this is just an opinion, it's a very squishy thing because currencies are valued by so many different factors. It's really complicated, but I would say that they want to de-dollarize because we're too strong, that they don't want to be dominated by the U.S. dollar. And it's interesting, we, as Americans, we know our own problems very intimately. We know they're huge. We know we're not solving them. We're not taking care of our own debt crisis. We're not taking care of our own lopsided political system. But the American people and the American economy, despite all these problems, are still quite productive and we are quite adaptable. If you compare our system of governance, with all of its problems, to a command economy like China—the Chinese are just pouring out of their own country. Anybody with any money is just fleeing as fast as they can and we all know, they're buying houses in the U.S. and Canada because they know their system is corrupt and rotten to the core and you could say, our system is corrupt and rotten the core, but we're still way more adaptable than in other countries that are stuck in a system that's failing and there's really not a lot of empathy or cultural values that support the reform they need to get through the next ten years.
That's the basic answer, that despite all of our promise, we still have this engine of ingenuity and innovation and it's of course under a lot of pressure from all the problems that we have, but it's still a lot bigger and more powerful than the innovation engines in other countries.
BENNETT: So, the Greeks, are they not adaptable enough? Do they not have enough ingenuity? You've argued in some of your writing that it would be impossible for Greece, in the event they want to stick with the EU and the euro, to even pay off a tiny bit of their debt in euros. If you tie that back to the United States, we have a much larger economy than Greece but our debt is just massive. I don't know how we're going to escape that either.
SMITH: Right. I think you mentioned the key point in asking me whether we're talking short term or long term and so I should specify that my throwing up the idea of pegging the new drachma to the dollar was a short term thing. It's interesting, Dawn, I don't know how many other countries use other currencies. I don't know anybody in Asia that uses the Chinese renminbi for their currency. I don't know anybody on the Eurasian subcontinent that uses the euro, but there's a lot of countries that use the dollar for their own currency: Ecuador, Panama, East Timor. In other words, when a country gets into real problems, then switching to the dollar or pegging to the dollar provides some stability because everybody in the world knows what a dollar's worth and they know that they can wake up at least in a short term and find that their dollars are still worth what it was last week, in general. It's not going to suddenly devalue by 50 percent like the Russian ruble.
BENNETT: There's no real way to know, though, is there? And the other thing is, maybe Russia will standardize, perhaps not 100 percent tie it to a gold standard, but possibly 16 or even 32 percent. That's going to change the game for everybody.
SMITH: Right. Dawn, it's always hard to find a right context for these big questions but I try to start with the basics. So the Greek economy, as you said, is taking a huge hit to GDP. It's now about $240 billion. That's their GDP annually. That's less than half the GDP of the county of Los Angeles.
So Greece is a very tiny economy on a global scale and it's really tiny compared to the U.S. economy. I think that gives them inflexibility. That's why they need to exit the euro. As of right now, they're in prison essentially. They can't really earn the money in the Eurozone that Germany can, but their debt is denominated in Euros so their debt is I believe worth 300 billion, and that's a lot of money given their economy. So if you look at—what's the strength of capitalism? The strength of capitalism is a couple of things, we all know. Creative destruction which is when a business or a model fails, and you scrap it. You write it off and you move on. And the other one is the adaptability of seeking out of other models or other businesses that can succeed. This is the beating heart of capitalism. So I look at it and I go, "Gosh, Greece has got to get back to that because that's their only hope."
BENNETT: You think, then, that Greece's only hope is to leave the EU? What people are calling the Grexit?
SMITH: Yes, and I think that the Greek people—and I actually do have a Greek friend who I discuss this with, and his family is middle class and university educated. And he said that in his view, a lot of Greeks are just afraid of leaving the Eurozone because they fear more instability, because they know their economy's weak. But the problem is how do you force people to reform?
SMITH: That's the problem and we can look around here in the U.S., and any state and any city or any county, nobody reforms anything until it's in crisis mode, right? It's just kind of human nature. We have to be pushed against the wall. So the Greeks have basically had this credit card with the Eurozone and it hasn't benefited them. It has run up all this debt. Did they build some new infrastructure that really strengthened their economy? And what it turns out is it was mostly lost to political graft, like for example, the Greek military bought a bunch of weapons they have no need for that cost billions of dollars and what was the purpose? Well, so that somebody could collect a hundred million dollar bribe. If you have a system that broken, you've got to start over somewhere. They have to be pushed against the wall to implement the reforms they need.
BENNETT: Do you think that the euro is going to collapse if Greece exits?
SMITH: I tend to think that that's highly likely and I know this may be an analogy that seems odd, but it's sort of like a gang. That the Eurozone is a gang and when you try to leave the gang, then what is the gang response? Just trying to beat you up because that indicates the gang is not that great and it's weak. Everyone that loaned Greece money did so under a false pretext, in my opinion. But now they're on the hook and they are going to try to do everything they can to make Greece pay but Greece doesn't have the ability.
Another analogy I use is like back in the subprime mortgage crisis. When foolish lenders would loan janitors making $25,000 a year, like $500,000 to go buy some big mansion. There's no way that somebody earning 25 grand will ever be able to manage that mortgage. It's just impossible. They don't make enough money. Austerity is sort of a fake solution.
BENNETT: Charles, do you fear that a Greek exit will have unexpected side effects that aren't evident to the ECB policy makers? What about other possible collateral?
SMITH: Right. That's an excellent question, Dawn. I think that's the really the question that everybody that's thinking seriously about this issue has. What's that going to do to the rest of us?
SMITH: I think there are two things that we can use for context. One is the idea that the euro is just inappropriate. It's a broken model because it tries to smooth out all the differences between economies that actually need to be differentiated by market discovery of prices, the value of those economies. The other one is that global debt crisis that flared up in 2008, we all know it hasn't been solved. In fact, it's gotten worse. I think globally, you probably know this better than I do, but I believe that global debt has doubled in the last six years. We are trying to solve that debt crisis by adding more debt. That's obviously not a winning proposition.
In that sense, Greece is simply one example of, as we both know, every nation has over-borrowed in one way or the other, whether it's shadow banking or private debt or whether it's government debt. Nobody in the leadership roles of the global economy has figured out how to solve this correctly which is putting a limit on solving debt by borrowing more. That's where the Greek leadership, whatever else we think about them, they have admirably stated that truth.
SMITH: We're bankrupt and they just said, 'We are bankrupt. And it's like "Halleluiah".
BENNETT: Finally somebody said something truthful. Charles, here's my last question—isn't the bigger problem, one that's actually bigger than Greece and Spain, Italy and France combined, isn't it our 9 trillion U.S. dollar carry trade?
SMITH: That is definitely having a huge impact and what that seems to be doing is strengthening the dollar because this 9 trillion was borrowed in U.S. dollars and now that the Fed is no longer printing money through its quantitative easing and the U.S. trade deficit is declining, then the U.S. is actually pushing a lot less money out into the global economy. So now there is a shortage of dollars and that's why people like me say, "The dollar could rise another 50 percent easily and the euro could fall to like sub-dollar.' It could be—who knows how low it could go as people start exiting the euro, because they realized their national survival depends on having their own currency again.
BENNETT: When you borrow in U.S. dollars, aren't you effectively shorting the dollar? So when the U.S. dollar rallies, you have to cover your short or it's going to blow up?
SMITH: That's right. That was a brilliant trade from like around 2010 to mid-2014, because the dollar was falling at value, so you could borrow and pay it back with other currencies. Basically the dollar kept getting cheaper. Now, that is up 17 percent, that trade is reversing and it's causing, as you say, a short-covering rally. But I don't see it changing, for the dynamics are there. The Fed has to end its QE for bunch of reasons and the trade deficit is dropping because the U.S. is producing a lot more of its own energy, regardless of the price of oil. So we're not pushing enough dollars out there to satisfy the need to cover those now catastrophically bad debts.
BENNETT: Charles, what is your strategy for preserving wealth in this environment?
SMITH: Number one, move money out of any currency into the U.S. dollar. I know that sounds weird, given our problems, but that's the reality for the next couple of years. Invest in real businesses in North America that generate a revenue stream.
BENNETT: That's why private equity is doing so well.
SMITH: Yes, and do what you can to create multiple incomes strings for yourself. Don't just depend on one job or one small business. Try to get something else going so that if something else is impacted by recession that you've got more than one lifeline. That's my strategy.
BENNETT: What do you think about gold?
SMITH: Gold plays a role in storing value. It's going to fluctuate like everything else in capitalism but it's never going to zero and that's its value.
BENNETT: Charles Hugh Smith's website, Of Two Minds features both his economic and fictional writing. Thank you, Charles.
All data sourced through Bloomberg
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About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com. She discusses educational topics and events in the financial news, along with her thoughts on the economy, financial markets, investments, and more with her live guests, who have included rock legend Ted Nugent, as well as Steve Forbes and Grover Norquist. Listeners can call 855-884-DAWN a as well as take podcasts on the road and forums for interaction.
She can be reached on Twitter @DawnBennettFMB or on Facebook Financial Myth Busting with Dawn Bennett or email@example.com.