Lead-Lag Live

Richard Duncan on the Evolution from Capitalism to Creditism, Global Credit Bubbles, and Economic Interventions

• Michael A. Gayed, CFA

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What if our entire understanding of capitalism is fundamentally flawed? Join us on a journey through history as we explore Richard Duncan's compelling argument that capitalism has evolved into what he terms "creditism." Starting from the collapse of the gold standard during World War I and leading through key events like the Great Depression and World War II, Richard provides an eye-opening historical analysis that shows how government intervention has become a cornerstone of our modern economy. Understand how significant changes in monetary policy during the 1960s and 70s, especially the severance of the dollar-gold link in 1971, have shaped the financial landscape we navigate today.

Ever wondered about the dangers lurking in our credit-based economy? Richard Duncan delves deep into the precarious nature of credit bubbles and the potential catastrophic consequences if they burst, as warned by Austrian economists like Ludwig von Mises. We also cover the government's pivotal role in staving off economic disasters during the 2008 financial crisis and the 2020 COVID-19 pandemic through aggressive deficit spending and monetary interventions. Additionally, we discuss the global implications of this credit-driven system, touching on how globalization, inflation, and geopolitical tensions like the war in Ukraine are intertwined with the Federal Reserve's and other central banks' policies worldwide. Don't miss this insightful episode that challenges conventional economic wisdom and offers a comprehensive understanding of our current financial system.

The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.

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Speaker 1:

my name is michael guyad, publisher of the lead lag report. Join me for the rough 40 minute time frame. Here is mr richard duncan. Uh, richard, you and I have done, I think, got two or three spaces in the past. I know a lot of people are familiar with some of your work, but do a brief intro on yourself. What have you done throughout your career, where are you located and what are you doing currently?

Speaker 2:

All right, okay, well, thanks, michael. Nice to see you again. Thanks for having me back on. So I started my career in Hong Kong in 1986 as a securities analyst doing research on the Hong Kong listed companies, and since then I've lived in Hong Kong, singapore, thailand a few times. I've been a securities analyst, an economist, a strategist. I worked for the World Bank in Washington for a couple of years. I was the global head of investment strategy for ABN Amro Asset Management, based in London for a couple of years and along the way I've written four books. The first one was written about 22 years ago, it was called the Dollar Crisis, and the most recent one came out a couple of years ago. It was called the Money Revolution.

Speaker 1:

And now my business is Macro Watch, a video newsletter, and now my business is Macro Watch, a video newsletter, so I named the interview to tease out we never had capitalism, or from capitalism to creditism. Creditism is a hard word to say. I got kind of tongue-tied on that, but I think we should level definitions for those that are listening and watching, because I think a lot of people think that what we have currently is capitalism.

Speaker 2:

What is the real definition of capitalism and what in the world is creditism? Okay, well, so capitalism more or less reached its highest form in the 19th century, but under capitalism the government played very little role in the 19th century. But under capitalism the government played very little role in the economy. Gold was money and market forces more or less determined what happened in the economy. I mean, that's a very simple version, but those are the basics. Everything started going wrong in World War I. That was the beginning and the end for capitalism, because during World War I, all the European countries went off the gold standard. They didn't have enough gold to fight the war, so they started creating a lot of paper money and issuing a lot of government debt that they used to buy weapons and fight the war. That they used to buy weapons and fight the war and that destabilized the global economy.

Speaker 2:

The United States stayed on the gold standard. World War I started in 1914, but the US didn't join until 1917. And in the meantime the US sold Europe all the European belligerent nations a lot of war materials and weapons and received an enormous amount of gold from Europe in those first 1914, 15, 16, and into 17 as well, and all the gold entering in the US at that time. That really was the foundation that sparked off the roaring 20s, because we had so much more gold than we did before. That allowed the banks to expand credit through fractional reserve banking. So there was enormous credit boom all during the 1920s. And then in 1930, that credit bubble blew up and banks started failing in very large numbers. And at that time the government, the policymakers they still believed in laissez-faire and capitalism and the rules of capitalism demanded that market forces be allowed to work. So that's what happened Market forces were allowed to work. Unfortunately, market forces resulted in the economy collapsing by 50% in nominal terms. Unemployment shot up to 25%. A third of all the banks failed. There was no deposit insurance, so everyone lost their money. We went into a 10-year depression. The depression didn't end until World War II started. They didn't do quantitative easing, they didn't have enormously large budget deficits to try to end the depression. They just let market forces work and they did, and that meant a 10-year depression and the depression only ended when World War II started. And when World War II started, then the government had extraordinary spending on the military and the war. Government debt expanded astronomically and that government borrowing and spending in part financed by money creation by the Fed. That's the thing that ended the depression. But of course the government at that point took over complete control of the economy. They took over production, distribution, labor and prices. There were price controls and so the government had complete control over the economy at that point. And well, the good guys won that war. But afterwards we never went back to a sort of a capitalist system where the government was not involved and in fact things deteriorated from there.

Speaker 2:

Things were fine in the late 40s and 50s. Truman and Eisenhower more or less played by the rules of capitalism. The government's budget was more or less balanced. Most of the time the Fed didn't create a lot of money. But starting in the 1960s that changed. The government started running very large budget deficits and the Fed started creating a lot of money to help finance those budget deficits at low interest rates. And by 1968, up until 1968, the Fed had been required by law to back all the money that it created with dollars sorry, to back all the dollars it created with gold. And they were able to do that up until 1968. But in 1968, they got to the point where they didn't have enough gold left to issue to create one more dollar. And so at that point, congress just threw in the towel and said okay, we're changing the law, the Fed doesn't have to have any more gold to back dollars anymore, any more gold to back dollars anymore. And that is the spark that, I believe, launched the money revolution, as I call it in my most recent book. That was 1968.

Speaker 2:

Afterwards, the Fed was free to create as much money as it pleased, and just a few years later, in 1971, president Nixon reneged on the United States' pledge to allow other countries to convert their dollars into US gold, and so, after 1971, there were absolutely no longer any links whatsoever between dollars and gold, and that changed everything in a number of ways. Let me list them. That's when capitalism started evolving into creditism, first of all, of course. After that, the Fed was free to create as much money as it dared, and at first it took a slow, but, as you can see, in recent years, there have been a few years when the Fed has created more than a trillion dollars in the space of 12 months. That would have been entirely impossible if we'd continued to back money with gold. Of course, kevin Kennedy Jr, another important thing that changed at that time was.

Speaker 2:

Up until then, international trade had to balance, because it's very easy to understand why If one country had a very large trade deficit with another country, that country was required to pay for its trade deficit by sending gold to the other country, and gold was money. So if they had big trade deficits for a number of years, their money supply would have shrunk very sharply, they would have had an enormous recession, unemployment would have skyrocketed and they simply would have just had to stop buying things from other countries because they were running out of gold and trade would come back into balance. So trade always balanced when we were under a gold standard or a Bretton Woods system. But as soon as that ended, it didn't take the US long to realize that it could start buying things from other countries that didn't have to pay with gold anymore. It could just pay with paper dollars or, more realistically, treasury bonds denominated in paper dollars, and there was no limit as to how many of those the government could create. So by the mid-1980s the US was running a current account deficit more or less the same as a trade deficit. That was 3.5% of GDP For a big country. Nothing like that had ever happened before, and by 2008, the US current account deficit was 6% of GDP. It was $800 billion in that one year alone, and altogether since 1971, the cumulative US current account deficit has been $15 trillion Now.

Speaker 2:

This is enormously important for a number of reasons. First of all, by allowing the United States to buy things from other countries, especially low-wage countries, that put downward pressure on US wages. It was very disinflationary, so the inflation rate fell from 14% in 1980 down to the low single digits in most recent decades and that allowed interest rates to fall to very low levels. William Greenblatt, and also In this environment, the government was able to borrow and spend on a much larger scale than it had been before. For one reason because it didn't overstimulate the economy. Stimulate the US economy that we would have full employment, full industrial capacity utilization and pretty soon we would get upward pressure on prices. Workers would demand higher wages. There wouldn't be enough factories to create more cars and so the overstimulation from the government, large budget deficits and large government stimulus. That would lead to high rates of inflation, a wage push spiral of inflation, like we saw in the late 60s and early 70s. But once we started buying things from the whole world. We no longer had a closed domestic economy. Suddenly, we had a global workforce that was about 24, 25 times larger than the American workforce, and most of these people were earning 90% less than in the low-wage countries, at least like China and Vietnam. Today, bangladesh, india, is coming into this picture, so this allowed the government to have larger and larger budget deficits and use those budget deficits to stimulate the economy and make it grow faster than it otherwise would have, and to get away with this without having high rates of inflation. The Fed could jump in and create a lot of paper money and just finance the government debt by creating money and buying government bonds, like we saw so dramatically after 2008 and again in 2020. And so this?

Speaker 2:

Meanwhile, it wasn't just US government borrowing that took off, it was the borrowing of all the sectors of the economy. We started to have an explosion of credit. Household sector borrowing skyrocketed. The borrowing and lending of the government-sponsored enterprises like Fannie Mae and Freddie Mac they skyrocketed. All the sectors of the economy started borrowing and borrowing more. The more they borrowed, the force that gave them more money to spend with, to consume with and to invest, and this drove economic growth.

Speaker 2:

So we've just hit a milestone this quarter. It first went through $1 trillion in 1964. So from $1 trillion in 1964 to $100 trillion a hundredfold increase in credit in just what 63 years. And this changed everything. Credit became the main driver of US economic growth and US demand became the main driver of global economic growth. And since the, for instance, the ratio of total debt in the US, or total credit to GDP, went from about 130% in 1950 to about 180% around 1980, up to 360% by 2008. So every year the credit was growing faster than the economy. The credit growth was making the economy grow. Without the credit growth, the economy wouldn't have grown.

Speaker 1:

But maybe before you get back to that, because the way you were framing things brought up a few questions of mine I want to ask you Okay, so it's all credit-driven, credit has to keep on expanding and expanding. Um, that immediately makes me think it's a ponzi scheme that just requires more and more with every iteration. But let's go beyond that, because I don't think it's as simple as saying it's a ponzi scheme and it's all negative. I mean, I've seen the same charts you've seen on what happened post 1971. There were a lot of really good things in terms of economic activity and growth that took place afterwards, aside from the explosion of debt. So what are the let's balance it out what are the pros and cons of such a credit heavy based system?

Speaker 2:

Okay, right, well, so the main thing that I want people to understand is that you know, this system just evolved. We went from. It evolved once money stopped being backed by gold. No one planned it, it's just. It was sort of the natural evolution of things. And now here we are.

Speaker 2:

So the problem is, if credit contracts like it did in the 1930s, then we will go back into a new Great Depression. Can you imagine what a collapse of $100 trillion of credit would look like? It would be worse than the Great Depression. So that's the point. Everyone needs to understand the Austrian economist who always talked about credit bubbles and how they lead to disaster in the end. Well, they were right when Ludwig von Mises wrote about that in 1912 and earlier. They were exactly right. But here we are. We have this enormous credit bubble. Our economy now drives and works on credit.

Speaker 2:

If we do anything that causes it to contract, for instance, in 2008, when the financial bubble started blowing up, then we already had an enormous bubble. Back then, the private sector started defaulting. And what happened? Fannie Mae and Freddie Mac could repay mortgages. Fannie Mae and Freddie Mac went bankrupt. They were enormously large international players in the capital markets, the financial markets and all of the US banks started going bankrupt. So what was the government to do? If they had just pursued the laissez-faire method, as we did in 1930, then all of the banks would have failed. None of them could have survived, and if the government didn't intervene, that means everybody's savings in those banks would have been destroyed and the economy would completely have collapsed. We're talking about sort of a return to the dark ages type scenario. So it was only the trillion dollar budget deficit, year after year, after 2008, financed with paper money creation by the Fed. The Fed created three and a half trillion trillion of paper money between 2008 and 2014 and used it to buy a lot of the bonds that the government was selling to provide this stimulus money that kept the economy from collapsing. And hey, that worked. We didn't collapse into a new Great Depression. There was no fall of Rome. We are still here, we have a higher level of government debt, but we survived. We didn't collapse into a new Great Depression. There was no fall of Rome. We are still here, we have a higher level of government debt, but we survived. And the same thing happened again in 2020.

Speaker 2:

Once COVID hit and people were locked down and couldn't go to work. It wouldn't have taken long for these people without government support stimulus checks how would these people have paid their mortgages, their credit card bills and their card-ons? They wouldn't have. They couldn't have, and so therefore, once again, all of the banks would have failed and without government intervention, there again, everyone's savings would be destroyed.

Speaker 2:

So everyone needs to understand that our economy is very different than it used to be. And yep, the Austrians were right Credit leads to bubbles, but the problem is is here we are living on top of this bubble. If we do anything that makes the bubble pop, then we are essentially going to spiral into something worse than the Great Depression. That's what everybody understands. The Austrians are right, but their policy response now would ensure that we are completely doomed. So that's the main message If you try to balance the government's budget, then government spending will drop.

Speaker 2:

Government's budget, then government spending will drop. Therefore, I think the deficit this year is expected to be $1.9 trillion. Right, that would take $1.9 trillion out of the economy. So consumers and businesses would have $1.9 trillion less, so they would spend less and therefore the economy. There would be less consumption, less investment and the downward spiral would begin. Corporate banks would begin, the firing of employees would begin, and it would just be a vicious spiral downward. Return to some sort of Austrian economic laissez-faire Garden of Eden and expect to have some sort of happy outcome. That is the certain way to the destruction of our civilization.

Speaker 1:

It seems to me that the elites are not that naive to any of that, but, of course, as long as they can kick the can down the road, it doesn't matter, because somebody else will deal with it. Um, what do you think about all this? Um, debt forgiveness, right, that's. That's kind of happening to me. These are all precedents, whether it's on the college loan side or so. I think one of Biden's policies is should he get reelected for giving medical liabilities, medical debt, is that sort of a pathway to a bigger reset on a credit-based system?

Speaker 2:

Well, the debt forgiveness for the students is just more debt on the back of the government, so that's not a reset of anything. It just moves one person's debt to the government's debt, so that doesn't reset the amount of debt that we have. So the bad news is we have an enormous amount of debt now. The government debt is about 120% of GDP. That's higher than it was at the end of World War II, but this is still only half the level of Japanese government debt to GDP. Japanese government debt to GDP is about 260% of GDP. They blew past where we are 25 years ago, so we can probably keep the. You know you mentioned kicking the can down the road. So we can probably keep the. You know you mentioned kicking the can down the road. Then absolutely let's keep kicking that can as far as we can, because otherwise, when the can stops moving, that's essentially when we all die. Our economy collapses and every you know if the economy collapses, the government revenues will collapse. That will mean the government won't have money for things like social security, medicare, the military. We won't be able to fund our military bases around the world. So we're essentially talking about societal collapse and global international geopolitical chaos in that environment. So, yes, I am in the can-kicking camp. Let's kick the can.

Speaker 2:

For a long, long time, this has been working now since 2008. It's worked twice and there's no sign that it's about to stop working anytime soon. But let's think about this. You can think about this. Okay, that it's about to stop working anytime soon, but let's think about this. You can think about this, okay, it's like we've gone up in a big hot air balloon and now we're getting afraid because we're quite high above the ground. Well, the solution here is not to turn off the hot air and suddenly crash back down to earth and die. The solution here is to keep the balloon in the air and try to come up with some solution before the thing crashes. And so we have time ahead of us. And so it seems to me, since we have to keep the credit expanding, the private sector can't keep growing its debt indefinitely, but the government sector can keep growing its debt indefinitely.

Speaker 1:

But the government sector can keep growing its debt. So I've got on the screen a slide you sent from a deck you messaged me with. What I'm hearing from you is that the end result is that we're still going to see a lot more of an increase in Fed holdings. Right, I mean this dip that we've seen in the assets of the Federal Reserve. Right now we've got $9 trillion or so. That's just momentary. You're going to see a resumption higher.

Speaker 2:

I think that's right. I think we will. There's been some quantitative tightening that has taken them. It peaked at $9 trillion of total assets. Now it's down to something closer to $7.2 trillion. So they actually have destroyed something like $1.8 trillion through quantitative tightening. But it's very interesting, even the Congressional Budget Office is projecting that the Fed will once again have to expand its holdings of treasury securities over the next decade. So, yes, we're going to see government debt continue to grow and we're going to see the Fed's balance sheet continue to grow in order to support the growth in the government debt, to finance that debt at low interest rates. But all of this requires globalization to persist, because only as a result of globalization can the government get away with so much stimulus and so much money printing.

Speaker 2:

We had a sharp spike we didn't have any inflation after the crisis of 2008. The highest inflation we had then was 3.8% in 2011, despite the $3.5 trillion that the Fed created at that time. But after COVID, the Fed created roughly a similar amount of money, but this time we had a spike of inflation up to 9% on the CPI. Well, why was that? It was primarily because of the global supply chain bottlenecks. We get most of our manufactured goods now from Asia, and Asia was locked down. The shipping was disrupted and so there was a lot of demand and it was impossible to get the supply from Asia to the US. And then, on top of that, the war in Ukraine began. Russia invaded Ukraine. That caused oil and food prices and metal prices to spike again. So we had two big rounds, two very big blows to globalization. But now, for the most part, those have been worked out, and as they were worked out, the inflation rate dropped very quickly from 9% Now it's back to 3% on the CPI. It wasn't really the Fed that had so much to do with bringing the inflation rate down, in my opinion, because the Fed was trying to slow the demand by pushing up interest rates, which would make the economy slow, which would result in higher unemployment, less consumption. But none of that happened. The unemployment rate is still very low. Consumption has been very strong. So it wasn't the supply that slowed, it was just the supply chain. Bottlenecks allowed the demand to start flowing again.

Speaker 2:

So it's crucial that globalization survives. If we have a collapse of globalization, then we'll be right back where we were in the late 1960s, where a lot of government stimulus and a lot of money creation by the Fed would lead to very high rates of inflation because we would once again have a closed US domestic economy, and so that is a real concern, because I've spent most of my career in Asia and I've been a major beneficiary of this expansion of the US current account deficit. I've watched Asia develop economically. I lived here through the miracle years.

Speaker 2:

It was incredible to see as China was transformed from a very poor developing economy into now the second most powerful country in the world, quickly approaching becoming the most powerful country in the world if we're not careful. And all of that was the result of the US current account deficit, but that meant that there was no inflation in the US. Now you know, we may be leading this age of globalization, be leading this age of globalization, and if we do, then we will return to a period of potentially double-digit inflation and double-digit interest rates, which would cause a collapse of wealth, and the collapse of wealth would cause a collapse of the economy. So the protectionist trend that we are living through there's a real chance it's going to become worse, but if it does, the impact on the US economy and the global economy will be very severe.

Speaker 1:

And, to be clear, all these dynamics in the US are found everywhere, right? I mean there's no single country that doesn't have some elements of the creditism, credit-based dynamic.

Speaker 2:

That's right. Creditism has become a global phenomenon. Once the US stopped backing dollars with gold, the whole gold-backed international monetary regime collapsed and all the central banks were free to create as much money as they pleased. So the Chinese central bank and the Bank of Japan, the European central bank they've all created money on a scale of trillions of dollars each and they've used that money in some cases to manipulate their currency in China in particular.

Speaker 2:

China has a big trade surplus. The Chinese manufacturing companies sell their goods in the US. They get paid in dollars. They take the dollars back to China. They want to convert them into the Chinese currency. But if they did that in the free market, that would push up the Chinese currency to a very high level and that would kill China's export-led growth. So to prevent that from happening, china's central bank, the PBOC, and China's central bank, the PBOC, created their own money and used that to buy all the dollars coming into China, and at a fixed exchange rate. So the currency didn't appreciate and the People's Bank of China ended up with about $3 trillion literally.

Speaker 2:

And once they had the dollars, they had to use these dollars. They had to invest them back into US dollar-denominated assets, because they have dollars. If they want to earn any interest on them, they have to invest them in dollar-denominated assets. So they bought a lot of Treasury bonds too. So other central banks now actually own more US Treasury bonds than the Fed does US Treasury bonds than the Fed does. I think the other central banks in total own about $8 trillion of US Treasury securities $8 trillion. Total US government debt is about $35 trillion. So that's a very big chunk $8 trillion whereas the Fed now only owns about $4.5 trillion of treasury securities. So I believe together the Fed and the central banks of the other countries combined own 35% 38% of all US treasury securities. They own them because they created money and with the money they created they bought the treasury securities. So this is a key aspect of creditism. That is completely something that no one on a gold-backed monetary system could have even conceived of before 1968.

Speaker 1:

We only have a couple of minutes, Rich. I could give you that thought, but then I also want you to talk about some of your research and where people can access it.

Speaker 2:

Yeah, so it's important to understand that the economy works in a completely different way now than it did in the past.

Speaker 2:

The government tries to manage the economy through very large stimulus programs. When necessary, the Fed is free to create limitless amounts of money to finance the government debt and globalization has meant that there's been no inflation or very low inflation, and if it persists, then inflation will be low. So this is not the way things worked back in the 19th century when we were on the gold-backed capitalist economic system. So it's important to understand the forces that drive the economy now. They are new and different forces, and so in my work in MacroWatch, in my MacroWatch videos, that's what I focus on Looking at credit creation, forecasting that, looking at Fed policy, looking at government policy in general, looking at the policies of other central banks around the world, and to forecast how that's likely to impact asset prices in the US and around the world US stocks and property, as well as commodities and currencies. So that's what I do with my business now MacroWatch. Macrowatch is a video newsletter. Every couple of weeks I upload a new video.

Speaker 2:

These videos are essentially me doing a PowerPoint presentation discussing something important happening in the global economy and how they'll impact asset prices. They tend to be about 20 minutes long, they have about 40 or 50 charts that can be downloaded and essentially they explain the forces driving the economy and the financial markets in this new post-capitalist age that we live in.

Speaker 1:

And what's the URL on that?

Speaker 2:

the website yeah so Macro Watch was started in 2013. I've created about 100 hours of videos since then which subscribers can access in the archives, and they can find Macro Watch on my website, which is richardduncaneconomicscom. That's richardduncaneconomicscom, and I'd like to offer them a subscription discount. If they'd like to subscribe to Macro Watch at a 50% discount, just hit the subscribe now button and, when prompted, type in the discount coupon code SPACES. That's SPACES, s-p-a-c-e-s.

Speaker 1:

I'm going to try to have Richard on for another podcast because there's a lot of things that I want to ask him and unfortunately, because of the difficulties, we have to keep a little bit short here. But please make sure you follow Richard Duncan, Check out his work as well and hopefully we'll see you next time when we can have a much deeper conversation over a full hour. I appreciate it, Richard. Thank you.

Speaker 2:

Great seeing you again. Take care.

Speaker 1:

Cheers everybody, Thank you.

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Michael A. Gayed, CFA

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