Casey's Chief Economist on the Eye of the Storm
Source: Bud Conrad interviewed by Louis James, International Speculator (5/5/10)
For our first foray into the deeper regions of someone else's mind, we've decided to have a talk with our chief economist, Bud Conrad.
For our first foray into the deeper regions of someone else's mind, we've decided to have a talk with our chief economist, Bud Conrad. That's in part because Bud's thinking is a critical ingredient in the analysis that drives our investment decision-making here at Casey Research. It's also, quite frankly, because Bud has just published a book that we think is a must-read for anyone trying to come to realistic grips with today's tumultuous economy. We may be biased, but we think Bud's book is an important resource for understanding and investing.
After reading this interview, you can decide for yourself if you agree.
L: I'm sitting in Las Vegas, Nevada, with Casey Research Chief Economist Bud Conrad, who's just delivered a spellbinding talk, the opening salvo of our first 2010 Crisis and Opportunity Summit. But, oddly enough, Bud is an engineer by training. . .So, the first question is, Bud, how the heck did you wind up being our chief economist?
Bud: Thanks, Louis, it's great to be speaking with you here at a conference where so many interesting and important ideas are being discussed. But yes, let's start with an introduction. My background was in electrical engineering, the undergraduate degree I got from Yale. I worked a whole career in the computer industry. So my approach to the way the world works, in terms of systems and analysis, is what you might call highly analytical. I mean that in the sense of starting with the data and trying to figure out how all the parts and pieces fit together into a system.
L: It's a deeply empirical approach. You're always saying, "What do the numbers say?"
Bud: Yes, and it's quite different from the traditional way most economists are trained, right up through the top levels of Ph.D. economists. I think that tradition is intellectually bankrupt. It's why economists have, for the most part, been unable to foresee the big inflection points in the economy and why they seem unable to do anything but predict a return to the way things were before any major turning points.
So I think I have something to bring to the economics community. That's why I took a year and a half to work on and publish my book, which is full of my ideas on how the world economy works. Being based on my electrical systems analyst approach, it's full of things like feedback loops and other factors that cause systems to move beyond equilibrium and cycle back and forth in a more dynamic process that's not unlike what electrical circuits do.
L: Okay, but let's come back to the book later. How did an electrical engineer become an economist?
Bud: Well, I've always had an interest in investing, and I've always had a fundamental interest in how things work. As early as 1978, I looked at the financial system of the United States and thought that it would fall apart. At one point, I worked for TRW and was told to go look at X company to acquire, and that company was providing a new thing: online charts. I asked the owner, who was considering selling the company to TRW, if he made a lot of money selling his charts. He said, "No, I make money by using the charts to find ways to invest in silver."
L: [Laughs] I begin to see the connection.
Bud: So I asked him how he invested in silver, and he explained commodities futures to me. I invested about $2,000 and made about $100,000 during the precious metals bubble of 1980.
L: Wow! You realized that?
Bud: Yes, and I've been hooked, watching the markets you specialize in, ever since, even though my career was in computers. I've spent the whole time since then watching and learning, and trying to figure out how to predict these big economic events that impact our investments so strongly.
L: That explains a lot. I remember when you first started with us. You met Doug Casey at a conference in San Francisco and gave him some interesting charts—so interesting, we couldn't ignore them. You were the "chart guy." And anyone who's been to one of your presentations knows you like to pack about 100 charts into 50 minutes. Now it all makes sense; you got started with a big chart-based success. No wonder you value charts as tools so highly.
Bud: Sure, but charts are just a way of presenting data to make it easily digestible. It's about the numbers. I'm not a chartist in the sense of what technical analysts do. I consider myself a much more fundamental analyst. The focus is not on looking for trends in charts, but on trying to understand how systems work, in order to predict what they will do in the future.
L: And like a typical engineer, you had to take it apart and tinker with it. That makes perfect sense—we're glad to have you with us, Bud. Your perspective really adds value to our organization, and your work has been an essential tool in our efforts to look forward. So, let's talk about that. Where are we going? What's the big picture your systems analysis paints for the future?
Bud: I start by looking at society's growth—and decline. I look at our situation today and try to look for parallels with other societies, to see if they can give us any ideas on where we may go. I think the most important historical comparison is to the Roman Empire; it lasted many generations, grew to great strength in its day, and then declined. I see parallels between that and the growth and decline of Western civilization, which appears to be headed for the wings as Asia prepares to take over the mantle.
L: Asian barbarians at the gates. . .Hm. So, where do we stand? Where in this cycle are we?
Bud: I think we've just about peaked. That's sad to me, being a product of Western civilization, but I think it's an important perspective to keep in mind as we look at the size of the problems we face. It tells me the current situation is a much bigger and longer-term problem than most economists believe or are willing to say. We did not just experience a typical business cycle bust period such as we've had many times since World War II. I think we're into a major change, handing off the baton of new economic growth to Asia.
Bud: There are some parallels that, though simplistic, seem to apply. American culture has changed from what it was for my father's generation. He told me: "Work like hell, and be honest with all your associates." Kids today ask only what the latest thing on the iPod is. It's a very different society. It's not one that has faced scarcity and values work and production. Today's America is all about enjoyment; the focus is partying, friends, self-indulgence. Las Vegas didn't exist in my father's day as it does today.
You see the same transition in Roman history, with the society starting out close to its agrarian roots, working hard to build their empire, but then changing to debauchery in the later years, with the famous Roman orgies and throwing people to the lions in the circus for sport. It was horrific and brutal, and the empire ended up being torn apart by endless internal warfare, which left it vulnerable to its barbarian attackers.
L: Watching the news these days and knowing that most Americans are now net recipients of government largesse, I wonder at times if the powers-that-be have not found a more effective form of bread and circuses to keep the people distracted.
Bud: I worry that we're moving in that direction. Our society is becoming much more oriented towards war—America spends half of all the money spent worldwide on military expenditures. That's typical of what an empire does when trying to maintain a crumbling position in its later stages. England did similar things, even as they came closer to passing their mantle of World Empire over to the United States.
There are still many good things about our culture, and some optimistic things happening in the Western world, so I'm not ready to abandon it, but I think we've hit our limit. We should be open to the fact that we can't be the top dog forever.
L: Okay, so is all of this just context for understanding, or are there chains of cause and effect from your observations on the decline of the American Empire that explain and predict what's going on?
Bud: There are two main ideas I want to focus on in answering that. The first can be summed up by the title of our Crisis and Opportunity Summit: Out of the "Eye of the Storm." The global economy is in the blue-sky center of a huge hurricane, the leading edge of which has just passed over us. We had the tempest winds of a credit collapse from overleveraging the private debt sector, particularly into housing—that collapse was a disaster, sparking the worst recession we've had since World War II. It now looks like things have recovered; blue sky overhead.
L: But anyone paying attention can see the dark cloud swirling around us. . .
Bud: Yes. Unless, of course, their economic training or their most heart-felt wishes prevent them from seeing it. The so-called recovery is simply the direct result of government spending. Private debt dried up and remains greatly reduced, but the government has stepped in with government debt. So, instead of the private sector buying houses with money they didn't have, we now have the government spending money it doesn't have.
There were bellwethers of the original credit crisis. We were writing about the coming credit crisis before the collapse of Lehman Brothers. Just last week, we heard the loud peals of a new warning bell, this time for a sovereign debt crisis. It looks different in detail but similar in structure, as Greek debt looks close to being repudiated.
There's a promise of bailout by the EU, just as, in some sense, Bear Stearns was bailed out by guarantees that came with the Fed's backing of their takeover by JPMorgan. Bailing out Bear Stearns didn't fix the credit crisis, and I doubt bailing out Greece will stop the sovereign debt crisis. It leaves the whole system under great stress, and it will get much worse if Portugal, Italy, and Spain follow Greece.
And those could be just the beginning cracks. Look at the parallels to Lehman Brothers and the others that had to be merged out of existence. The whole government debt system could fail in a spectacular way if people lose confidence in paper money entirely. The current financial order of the world is very much in the balance.
The trailing edge of the storm, once the eye passes from overhead, will take the form of a sovereign debt crisis, like the credit crisis of 2007/2008, but based on governments having too much debt.
L: Those are pretty high stakes, Bud. What do you say to the skeptics who argue that the government has always been able to stimulate the economy back into health before, to "prime the pump," as they say, with government spending that gets the private economy going again?
Bud: Let's look at the numbers. The Fed spent $1.5 trillion last year to support the mortgage market and therefore housing. The U.S. Treasury increased the deficit by $1.5 trillion last year, which adds up to $3 trillion in spending to try to fix our economy. The government is reporting that economic growth has turned positive again, by 3% of GDP. GDP is about $14 trillion, so that means we got about $400 billion in growth for about $3 trillion spent. Yes, there is a little blue sky. If you blow $3 trillion, the party will go on a little longer, but they're still spending trillions and we're only getting billions back for it.
The problem, I think, is that the government has made so many promises to make people feel good—not only for the short term but for the longer term—that we are past the "point of no return." The government's debt will never be paid off. As people realize this, they will question whether they should loan any more money to the government, and that means that interest rates will go up—and that rising interest rates will create a feedback loop, a vicious cycle of rising rates and more borrowing that will ultimately destroy not only the dollar but paper currencies throughout the world. They are all based on nothing but confidence.
I call that the world's largest confidence scam ever carried out in human history.
L: You're talking about financial Armageddon. That's a big prediction, and a hard pill for many to swallow. Can you give us some facts and figures to back this conclusion up? How do you convince someone who can't conceive of the U.S. following the path of Mugabe that this could really happen?
Bud: I can't help whether or not people want to face reality, but the fact is that paper money is worthless. The only reason it's accepted as money is because of laws that have forced people to use it for so long that most people have forgotten what real money is, and that bank notes were meant only to represent real money on deposit in some bank somewhere. You and Doug have talked about that in past conversations. It became a convention to accept paper as money when it was redeemable in gold, and we've carried on with that convention, even though Nixon closed the gold window in 1971.
As is so well documented in Ken Rogoff and Carmen Reinhart's book, This Time Is Different, people are kidding themselves if they think the U.S. dollar can't fail. Currencies fail all the time. Currency collapses have been documented throughout history, averaging about one per generation. This is a regular occurrence, and we're about to see it in the U.S.
L: So, what you're saying is that the question should not be, "Can it happen here?" but rather, "Why shouldn't it happen here, when it happens everywhere else?"
Bud: Nicely put. But let's get back to the numbers. We're sitting here on a $12 trillion national debt, a $1.5 trillion deficit last year, probably a $1.5 trillion deficit this year, and a new health care package that we're promised will save money but that includes no incentives to save money. On top of this, we have an aging demographic trend, with promises galore in the form of Social Security and Medicare. . .If you discount that future spending back to the present, we have a $75 trillion unfunded pension liability.
If the U.S. government were a private company, that liability would have to be on the books and funded. The government simply mentions in passing, from time to time, that it has unfunded mandates that have to be dealt with at some future time. That's not surprising, because there simply are no good answers to the problem. The only way those obligations can ever be paid is through greatly inflated dollars. These numbers are just too big to paper over. This is not like past recessions, which the government has stimulated away. . .
L: Thereby causing the next boom in the so-called boom-bust business cycle.
Bud: I think we're on a trajectory that will, within our lifetimes, cause the dollar to lose its purchasing power to the point that it will have to be replaced with something else.
L: Given what I could get for my dollars in Europe last week, it seems that the dollar is already well on its way to revealing to the world that it's as worthless as any other lie printed up by governments.
Bud: Yes. . .You know, a perennial question at investment conferences is the inflation/deflation debate. And I always wonder how the deflationists even get time on the stage. Deflations are very rare. We've had some deflation in Japan recently, as they've had a strong currency and a very positive trade surplus. But, historically, the periods of inflation always greatly outnumber those of deflation, because the incentives for governments to inflate money supplies are always present.
Governments can print up more money, and they get to spend it first, while it still holds its previous value. The money spreads out through an unaware population, diluting the value of the currency units already in circulation, almost always causing price inflation, but the government has already benefitted from its spending.
We are certainly now in a system where the incentives are for us to have inflation. There are many ways of looking at the value of the dollar, with the simplest being to look at its purchasing power within our own country. Using CPI for that, the dollar is worth about a nickel, compared to what it was worth when the Federal Reserve was founded. A large part of that loss of value happened in the 1970s, when the country was dealing with the large deficits that came out of the Viet Nam war, though that cause was partially masked by the effect taking five to ten years to show up in earnest. That, combined with the energy crises of 1973 and 1979, drove the prices of lots of things much higher.
L: And CPI being the government's estimate for U.S. price inflation, we can take that as a best-case scenario. I just looked, and the government says it takes $21.98 today to buy what one dollar bought in 1913, so, your round figure of a nickel is right on target.
Bud: This brings us to the second main idea I wanted to focus on in this interview. We've talked about government spending, deficits and inflation, but there's a second issue that has nothing to do with the government, and that's the state of the planet itself and its resources. Specifically, it took about 100 million years for nature to lay down the fossil fuel deposits that have become our major source of energy. We've used up approximately half of that resource in 100 years. Harnessing that store of wealth has allowed our species to grow from 1.5 billion people to 6.5 billion people and create a life of abundance for so many of them today.
L: Most people think of wealth as being things like houses and cars, not untapped resources in the ground. . .
Bud: Humanity is wealthy because it has access to the energy needed to make those things that are visible signs of wealth. So it's a major problem to have used up half of our main supply; it means we won't be able to increase production in the future. In such a situation, we face much higher prices, which acts like increased friction in a mechanical system, slowing everything down. It will also lead to conflicts over natural resources.
L: But there's unconventional oil and gas, tar sands, shale oil, coal bed methane, etc., so it's not that there won't be any more oil, but that it will be there in a permanently higher price context.
Bud: Not entirely. One of the biggest unconventional oil sources is the oil sands, but the problem there is energy in vs. energy out. It takes a lot of energy to scrape those tar sands out of the frozen Canadian wilderness, so the net energy you get is much less than with conventional oil. It is a viable source and we will use it, but it's not enough to overcome the drop-off in conventional oil production, which has reached a plateau over the last six years. I believe that's the "peak" of oil production predicted over 50 years ago by Hubbert, and none of the alternatives will be able to keep oil production increasing, and that spells big trouble.
Look, the West has shown the world a lifestyle that's a lot of fun. Those who do not yet enjoy that standard of living aspire to rise to it, and that would take a lot of energy. If those in China alone aspired to rise only to the standard of living in Mexico, they'd have to use roughly as much oil as the U.S. currently uses. The U.S. uses about a quarter of the world's oil production for about five percent of the world's population—clearly an unsustainable situation. I think we're going to see more and more conflict over resources, and I think that's why we are in Iraq, why we're sending more troops to Afghanistan. We want to maintain our lifestyle, and we want "our" oil.
That's my belief. I'm scared as hell that the world is much closer to the brink of WWIII than most people want to believe as they sit at home watching reality TV and American Idol.
L: So. . .you're not just talking about financial Armageddon, but Armageddon Armageddon. Do you think modern civilization itself could collapse and bring on a new dark age, or does the world "merely" go through a painful and possibly violent transition and then emerge into a new, stable, but different social order?
Bud: That's the crux, isn't it? Which direction will society go? Frankly, I don't know.
L: I don't think anyone really can, and I know I'm asking you to gaze into a crystal ball, but what's your hunch, as a systems analyst looking at this disintegrating, unsustainable system?
Bud: My feeling is to agree with people like Doug Casey, who says it's going to be even worse than he thinks it's going to be. And here's a key point: I think it's going to get worse before it gets better, because not enough people realize how bad it is.
In particular, I'm thinking of the financial system here. The government has decided to create a commission, with no power, no budget to speak of, no subpoena authority, no real legislative capability, to look at the budget and report—after the next election. That's not bullish for anything positive happening on the budget problem.
On the energy side, the American ability to maintain oil supplies, or to make sure the other guy doesn't get it, is extremely limited. China wants oil. Russia has oil, but not enough. I believe there will be a shooting war over resources. I don't know when, nor how bad, but I believe it will happen.
L: Back on the financial side, a huge amount of inflation seems baked in the cake at this point, because we have price destruction in certain asset classes, particularly real estate, masking the government's inflationary policies. That means they'll keep on causing inflation, thinking that they are getting away with it, and will only realize they've gone too far—way, way too far—after it's too late.
Bud: I agree, that's a very important point. But I don't want to be all gloom and doom—I do also see hopeful signs all around me. Literally. From my home in Northern California, I can ride my bike up the hill and see Google, Cisco, Sun Microsystems, Intel, Yahoo. . .I can't quite see Oracle, because it's a little way up the Bay Shore freeway. There are some wonderful things going on in this valley, and I think this, broadly understood as technological innovation, is what can save our future.
New technology is particularly needed in the case of the energy problem I brought up. We're going to run out of fossil fuels, but if we can figure out ways to make nuclear fusion, wind power, solar power, electric cars, etc. economic, an empty tank of fossil fuels doesn't have to be the end of the road. New technology is the answer to the issue of scarce resources. Ultimately, it's the only way to deal with the reality of what our planet is and what its limitations are.
My own background was in computers. I saw the computer revolution, the Internet. . .In the early days of the Internet, I edited an article in which the author said he didn't think the Internet would ever be used for commercial applications because it's unsafe and no one would give credit card information online, etc.
L: That sounds like the IBM guy who said back in the 1940s that he thought the global market for computers was about four.
Bud: Yes, exactly. But the Internet is so recent—I still know the people who said these things. That just shows how fast new technology can transform life these days. And it is revolutionary. Personal computing and the Internet have greatly increased human productivity, making it cheaper, faster, and better.
And the coming biotech revolution is even more exciting. I'm not that kind of technologist, but it is truly revolutionary that we've cracked the code and mapped out the entire human genome. It's staggering to think we can direct the evolution of mankind.
L: We know how to turn genes on and off—we've got a map, and we know how to use it. I think we're very close to one of those pivotal "This changes everything" moments in history.
Bud: It's amazing. And it's extremely positive news for medicine. The new biological approach to medicine is a completely different way of doing things than the mostly chemical approach of current medicine, handing out pills all the time. The biological approach uses living organisms to potentially regenerate broken body parts. I said earlier that we have a huge healthcare problem, courtesy of the Obama administration. That's so, but we may have completely new ways of doing things in the not-so-distant future that could help greatly.
If America can emphasize and encourage technology, especially in energy, medicine, and computation/communication, that's the salvation of humanity—and not just the U.S. That's the wave of the future we should invest in.
In contrast, if the government focuses on building bridges and railroads we don't need, just to create employment, we won't be any better off.
If you value American preeminence in the world, then investing in technological innovation is the way to go. And you improve the human situation while obtaining returns on your investments, if you bet correctly.
L: This conversation is a sort of distillation of Casey Research itself; you're talking about Armageddon and the hope for humanity, crisis and opportunity. So let's talk more about the broad investment implications of what you're saying. What should people do, Bud?
Bud: Well, perhaps the most obvious thing is to buy oil. Invest in anything sound that will benefit from higher oil prices. The prediction I made last year that I'm most proud of is when I said, when oil was trading at about $40 a barrel, that it would double. Guess what: it did. That call shocked many analysts who'd lost sight of the forest for all their detailed modeling of the trees. But looking at the bigger picture, I saw the limits on oil production and that society needs and would use and would be willing to pay much more for oil. I was right—and I think it's still going much higher.
L: You made a call on gold last year as well, and you nailed it. Gold was around $900 in late 2008, and you said it would go to $1,150 by the end of 2009, and it hit $1,200.
Bud: I did, but that was an easier call, and it wasn't as dramatic—I didn't call for a double in the price of gold—so I find that less impressive, though it was a very accurate call. So, in addition to investing in oil, gold is one of my main long-term investments. The reasons are obvious, when you look at the corruption of our whole financial system. But you and Doug have talked a great deal about why people should invest in gold, so I won't repeat all of that.
L: So, oil, gold—what else?
Bud: The obvious one is that if the dollar is collapsing, interest rates on dollar instruments will have to go up dramatically before the collapse is complete. So the third main strategy I recommend to investors is to invest in rising interest rates. There are many ways to do that, but the details are probably more than we want to get into in this conversation. We discuss how to best invest in all three of these areas in The Casey Report and more specifically in Casey's Energy Opportunities for oil and in Casey's Gold and Resource Report for gold.
L: And, there's more on all of this in your book, including, as anyone who's seen you give a presentation—or now has read this interview—would expect, a gazillion charts.
Bud: I have to say that the book is a different product from what most people do when writing a book to make money, or fame, or for vanity's sake. Mine was an intellectual process of trying to organize and express on paper all my new ways of thinking about economics, all collected in one volume, hopefully to enable readers to grasp the method, the insights, and the conclusions in a useful way. I try to explain all these systems, how they work together, and how they drive certain outcomes, like the prices of oil and gold and interest rates and agriculture.
It was disastrously difficult, personally, to get it all done, but having done it, I'm proud to say that the book contains many of my ideas and enough data to think of it as a reference work. But I also hope it's a little more exciting than a reference tome; I make some near- and long-term predictions, predicated on the crises I see unfolding.
L: Sounds great—I look forward to seeing how your predictions work out.
Bud: I guess you're not alone in that. The book has sold out at Amazon and is, as we speak, #1 in three category rankings and #24 in the overall Amazon rankings.
L: That's fantastic. People need to understand how these things work, and I had no idea you were reaching so many of them. You could actually be making a more positive contribution to that future of mankind you speak of than you know. Congratulations.
But if your book is sold out at Amazon, where can people get it?
Bud: You can still order it at Amazon, though it may be a while before they deliver, and they have electronic versions for the Kindle, of course, that you can have instantly. You can also get it at Bordersand at Barnes & Noble at the moment. It is not yet in most physical stores, but they can order it for you.
L: Great. Well, thanks a lot for your time, Bud. It's always interesting talking with you.
Bud: You're very welcome.
If you want to hear Bud's riveting speech at the just-concluded Crisis & Opportunity Summit, we are now making the entire Summit—more than 15 hours of audio plus charts—available on CD.