Why the Meltdown Should Have Surprised No One

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Henry Hazlitt Memorial Lecture, Austrian Scholars Conference, March 13, 2009. An MP3 audio version of this lecture is available for download. You can also watch the video. Transcript provided by Jennifer Lewis.

Introduction by Joseph Salerno

It is my great and distinct pleasure to introduce the Henry Hazlitt Lecturer, Peter Schiff.

Schiff, president of Euro Pacific Capital, is familiar to everyone who has watched financial coverage in the last year. He is famed for being the most vocal financial economist to have perfectly predicted the crash.

He also happens to be a dedicated student of the Austrian school. He is the author of the prophetic Crash Proof and, most recently, The Little Book of Bull Moves in Bear Markets.

Whenever he speaks about finance and economics, he also seeks to teach sound economic theory, writing for publications such as the New York Times and the Washington Post. Today he will speak on the relationship between theory and practice in financial markets.

Peter Schiff

I just looked at the topic for my speech about thirty seconds ago before I walked in the door. But apparently I’m talking about why is it that people didn’t see this coming, or should people have known that this meltdown was coming.

I don’t know. Is there anyone in this room that was surprised by the economic meltdown? Does anybody think it’s over? Anybody? Raise your hand if you think it’s over.

And does anybody think that the government solutions are going to work or that they’re going to help? Is there anybody? One. All right. So, I guess there’s really no reason for me to speak here. I don’t know that I’m going to tell anybody anything they don’t know. But, if you want to indulge me, I guess I could talk about it a little bit anyway.

But I don’t know why so few people seem to understand what was going to happen. I guess when you’re living inside a bubble, it’s very difficult to actually see what’s going on, from your point. But I lived through two of them, because I’m a stockbroker. I lived through the NASDAQ bubble.

And to me, at that point in time, it seemed pretty obvious what was going on, in 1997, ’98, ’99. It seemed obvious to me that these companies that people were touting couldn’t possibly be worth the prices that people were paying. Yet nobody seemed to be able to figure that out back then.

Everybody seemed to be living in this new era, and the Internet had captured everybody’s imagination. To me, I couldn’t see the difference between the Internet, really, and a catalog or a telephone.

People were saying that everybody’s going to buy everything on the Internet. Why? Why aren’t people just shopping by telephone? Or why aren’t they just buying everything in a Spiegel catalog? It didn’t seem that it was any different.

And I knew that the valuations they were putting on a lot of these companies, I knew they’d come out with a company, maybe it’d be Doorknobs.com, or whatever it was.

And you’d say, "Well, gee, even if they sold every doorknob in the world, they couldn’t possibly be worth the multiples that they’re trading at." And of course they didn’t even make any money selling them.

And the whole idea behind so much of the e-commerce was just nonsense. The idea that it was more cost effective to individually FedEx items to people, as opposed to letting them show up and buy them and put them in their cars and leave. There’s no way.

There are certain items that lend themselves to online sales, but most items didn’t, but it didn’t matter. Everybody was going public.

And people were getting rich, but none of the people were getting rich because the businesses were successful. The people were getting rich because suckers were buying their stock.

The guy that started eToys lived in my apartment building in downtown Los Angeles. And I started my company, Euro Pacific Capital, about the same time he started his. He made a lot more money than I did, but he didn’t make a profit.

He never made a profit. But he made a lot of money because he found people to buy into his idea. And at one point, eToys was worth more than Toys "R" Us.

I remember when I was trying to get clients, back when I was starting out at Euro Pacific Capital, and I was trying to get people to buy foreign stocks.

And I remember one country I was active in was New Zealand, and I remember trying to convince people who owned shares of stocks, like Yahoo, why they should sell their Yahoo and buy a stock in New Zealand.

I would point out that Yahoo was worth twice the entire country of New Zealand; every stock they had, all the real estate.

I’d say, "What would you rather own, this entire country?" The dividend yield on the New Zealand stock market was over a billion dollars a year. That was the dividend yield. Yet Yahoo was trading for more than twice the value of that whole stock market.

I said, "What would you rather own, this company that just got started a couple years ago, or this whole country? And you could take all the dividends." No. No one cared; they wanted Yahoo. But it was just all nonsense, but nobody saw it.

Of course, after the Internet bubble burst, everybody was talking about how crazy it was. And the politicians were ready to throw people in jail and they vilified Wall Street. But it didn’t last very long.

The whole thing was, in a year or two, we just moved right from that stock-market bubble, almost seamlessly, into the real-estate bubble, and nobody could see that there was any similarities.

There was one. Somebody recently put together another one of those Peter Schiff videos. There was one that somebody made, this "Peter Schiff Was Right" video that was on YouTube that I know about a million three hundred thousand people have seen.

But someone else put together a CNBC version of that recently and I happened to watch it. And there was one particular clip he put on with me and Mark Haynes, and I’m talking to him about this impending collapse and the economy and the real-estate market.

And Mark Haynes just says to me, he says, "Peter, bubbles are like a once in a lifetime occurrence, we just had one." He said, "Do you expect me to believe that we have another one within ten years?"

And he was just incredulous that there could be another bubble so close to the stock-market bubble. But, of course, they were really interrelated. It was almost like the same bubble, because we never really had the fallout from the bursting of the NASDAQ bubble.

We simply replaced one bubble with a bigger bubble, and we postponed the consequences of the unwinding of the imbalances until right now. And, of course, we’re still trying to postpone it.

But I think, at this point, the damage has been so great and the problems are now so huge that I don’t think there’s another economic rabbit they can pull out of their hat at this point. We’re just going to have to face it now.

And, basically, what happened is, why did we have a stock-market bubble?

We had a stock-market bubble because the Federal Reserve was too easy; they were too loose in the 1990s. Interest rates were too low, we created too much money, and that fed the investments in the stock market.

And we had a lot of malinvestments. Companies were created that never should have existed. They were created not because they could generate a profit, but because they could go public, because investors wanted these stocks. It didn’t matter that they couldn’t make money.

So what did they do? They took land, labor, and capital; they took all the factors for production, and they combined them in ways that actually destroyed value.

But it didn’t matter, because these companies got financing. The Fed made the financing cheap, so they were able to flourish. They were able to flourish despite the fact that they were losing money. The saying used to be, they’d lose money on every sale but they’d make it up on volume.

And, so, but as long as they could raise money. And when I was working at Euro Pacific Capital, I would see deals and people would send me prospectuses on new companies they wanted to fund.

I remember one I got from a small Internet company that was, I don’t remember. They were — I don’t know if it was a browser or whatever they were, or a service where you go on the Internet, a provider. I don’t even remember what they did.

But it was a small start-up, and they had their prospectus and they were coming around looking to raise money. And they were trying to raise, I don’t know, five or ten million dollars. They weren’t public yet. But they were selling a little small piece of their company, so they were valuing their company at about fifty million dollars.

Now, these guys were in their twenties. They probably started the company less than a year ago. I remember saying, "Well, how could you possibly think your business is worth fifty million dollars?"

I said, "You have no assets, you’ve got no revenues, you’ve got no customers. It’s like, you don’t have anything. I could recreate your entire business from scratch myself for next to nothing. And yet you want me to pay you five million dollars to get five percent of this thing? Why would I do that?"

And all they kept telling us, "Well, you don’t understand, we’re going to go public, and you’re going to make a lot of money."

And I said, "You think you’re going to find people to pay even more than this in a public offer? How are you ever going to make any money?"

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Peter Schiff is president of Euro Pacific Capital and author of The Little Book of Bull Moves in Bear Markets and Crash Proof: How to Profit from the Coming Economic Collapse.

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