Many writers of investment books approach the topic of saving and investing without any clear economic theory. Value investors often share the sentiments of fund manager Peter Lynch, who said, "If you spend 13 minutes a year on economics, you have wasted 10 minutes." From the other end of the methodological spectrum, MBAs trained in efficient portfolio theory look disdainfully on any suggestion that investors should at times be entirely in cash as "market timing".
In contrast to both schools, author and investor Peter Schiff approaches the issue from a top-down macro-economic view. Schiff believe that the most important issue facing investors over the next few years is a series of macro-economic crises that will impoverish most Americans.
Schiff’s book Crash Proof: How to Profit from the Coming Economic Collapse is really two books in one. The first is Peter Schiff’s analysis of the US economy, incorporating both theory and historical examples. The second consists of his strategies for surviving and even prospering.
It is not possible to approach macro-economic questions without an economic theory. A sound economic theory may not yield any useful insights for investors, but a false one is almost certain to mislead. A problem with macro investment literature is the generally poor economic foundations of most of their authors. Harry Dent, for example, shares the Keynesian-macro belief that consumption, not savings, drives economic wealth. Louis-Vincent Gave, Charles Gave, and Anatole Kaletsky believe that capital accumulation is a money-losing proposition for firms. The reader of Crash Proof is fortunate that Schiff incorporates Austrian economics in his approach.
The Further Reading section contains titles by Rothbard, Mises, Hayek, Hazlitt and J.B. Say. And unlike some authors who cite these thinkers without understanding them, Schiff displays a grasp of their thought and its application to investing.
This review will focus on Schiff’s economics. I will not say much about his investment advice. While his advice could be implemented through the investment firm of your choice, Schiff discloses that he is the founder of a brokerage firm offering investment accounts following the book’s recommendations. Schiff believes that his firm provides advantages in executing these strategies. After reading the book, I believe that his investment recommendations follow from his economics (right or wrong) and not the other way around. And by publishing his ideas in a book, an investor could implement these strategies with or without Schiff’s help.
Another common economic fallacy is we don’t need to save because our assets are going up in value. Schiff disputes this as well:
Savings? Who needs savings when you own stocks that can only go up in price and a home that gains equity every year? Let the dismal scientists worry that stock values or home equity might simply be the result of inflationary bubbles created by an irresponsible Federal Reserve, or that when the bubbles burst, all that will remain are the debts that they collateralized.
Schiff understands that savings are necessary to fund economic growth:
It is important to remember that in market economies living standards rise as a result of capital accumulation, which allows labor to be more productive, which in turn results in greater output per worker, allowing for increased consumption and leisure. However, capital investment can be increased only if adequate savings are available to finance it. Savings, of course can come into existence only as a result of [consuming less than one earns] and self-sacrifice. [pp. 6—7].
Schiff skewers another commonplace fallacy: that Americans provide the "engine of growth" in the world economy by consuming what others produce. Consumption creates demand for other products, but the point that is missed by most financial writers is that demand must be funded by supply. Unfunded demand created by printing more paper is simply a drain on the productive efforts of others.
The world no more depends on US consumption than medieval serfs depended on the consumption of their lords, who typically took 25 percent of what they produced. What a disaster it would have been for the serfs had their lords not exacted this tribute. Think of all the unemployment the serfs would have suffered had they not had to toil so hard for the benefit of their lords.
The way modern economists look at things, had the lords increased their take from 25 percent to 35 percent, it would have been an economic boon for the serfs because they would have had 10 percent more work. Too bad the serfs didn’t have economic advisers or central bankers to urge such progressive policies. [p. 14].
One area where Schiff may be on less firm ground is in his analysis of the US trade deficit, which he sees as evidence that Americans are living beyond their means and making up the difference by borrowing from foreigners. For example,
"The shift from manufacturing to services caused growing trade deficits." [p. 9]
We are financing that consumption [the trade deficit] not with money we have saved but with money we have borrowed, mostly from the same countries we’re importing from. [pp. 28—29].
A trade deficit as such is not necessarily a problem. All that a trade deficit means is that the deficit country is importing capital. If the imported capital is used to fund the development of the productive structure within the country, then the resulting financial claims are supported by production. Schiff’s view of the trade deficit could be correct but it does not follow from the mere existence of a trade deficit. To prove this, he would need to provide more evidence than he does that the imported capital is wasted.
Economic historian Sudha Shenoy has broken down some of the data to arrive at the conclusion that US trade in the private sector is balanced for the years she looked at (up to 2002), and that the trade deficit results entirely from government over-consumption. Her articles are also worth studying in full (see: The Case Against Neo-Protectionism, The Division of Labor is World-Wide, and u2018Is America Living Beyond its Means?’ — Is That the Right Question?) For another contrary view that directly addresses some of Schiff’s points, see articles (1 2 3) by economist Robert Murphy on Mises.org.
Schiff shares the skepticism of most Austrians toward central banking and inflation. How many investment books contain a section called Fiat Money: Why it is the Root of our Economic Plight? As he points out, central banks create debt not backed by any production. Schiff correctly identifies inflation as an expansion in the quantity of money. He argues that "demand created by inflation is artificial because it does not result from increased productivity" [p. 70].
This underlying economic principle is known as Say’s Law or Say’s Law of Markets…the supply of each producer creates his demand for the supplies of other producers. This way, equilibrium between supply and demand always exists on an aggregate basis. [p. 70—71].
His discussion How the Government Obfuscates the Reality of Inflation is excellent. Schiff soundly refutes a series of scapegoats for inflation used by government economists: cost-push inflation, the wage-price spiral, and inflation expectations. A sidebar [p. 93] explains that inflation not caused by economic growth, either.
He follows with a discussion of the politically manipulated inflation measurements. "Core inflation", for example, is often cited as evidence of low inflation; however, it is computed from the same data as the CPI excluding food and energy, as if price increases in food and energy don’t count. A section is devoted the questionable practice of substitutions in the basket of goods used to compute the CPI. Substitutions allegedly better reflect actual consumer spending, but in practice, as Schiff points out, they adds a bias to the CPI because things that people consume less of due to their higher prices get removed from the basket, and lower-priced substitutes get added, so the adjustments impart a bias to the CPI computation.
The underlying reason for manipulating the CPI is for the central bankers and their political allies to avoid taking the blame for the inflation that they have created:
If you really want to see the effects of inflation, just look around you. The prices are rising wherever you look, yet the CPI, the PPI, and the PCE say otherwise. That is because the indexes do not measure how much prices actually rise, but how much the government wants us to think they rise. [p. 78].
Schiff is particularly good on the deflation issue. The deflation bogey is frequently raised by Wall Street economists as a justification for further central bank inflation. According to this way of thinking, deflation is supposed to be even worse than inflation, and we should be thankful that we have the Fed to artfully charting a course between the two terrors.
Schiff dismisses this nonsense:
Deflation, which we technically define as the opposite of inflation, meaning that in deflation the supply of money contracts, is erroneously defined by government and Wall Street as falling consumer prices. Using that false definition, what is wrong with falling consumer prices? Aren’t lower prices, in general, beneficial and conducive to better living standards? Why would it be a problem if food became less expensive, or if education or medical care became more affordable? What is so bad about being able to buy things at cheaper prices? Why does the government have to save us from the supposed scourge of lower prices?
Furthermore, contrary to popular belief, falling prices are actually a more natural phenomenon in a healthy economy than are rising prices. Manufacturers recover their costs and gain economies of scale that result in lower consumer prices, which lead to greater sales, higher profits, and rising living standards. In fact, it is the natural tendency of market economies to lower prices that makes them so successful. (p. 79—80)
It is commonly alleged by Wall Street economists and central bankers that people will stop spending if prices are falling, and that business firms will not be able to make profits. Schiff takes apart these fallacies as well:
The usual fears about falling prices…simply don’t make sense. Unless an economy is in a total free fall, people don’t stop buying in anticipation of lower prices. …
Nor does the argument that corporate profits suffer from falling prices hold water. Profits represent margins, which exist independent of prices, and what is lost in dollar sales is gained in volume.
Yet under the guise of "price stability", generally defined as annual price rises of 2—3 percent, the government robs its citizens of all the benefits of falling prices and uses the loot to buy votes, thereby trading the rising living standards of their constituents for their own reelection.
His discussion of the business cycle is clearly Austrian. In a section title The Classical and Correct View of Business Cycles, we find:
According to the classical economists, like Ludwig von Mises and Friedrich A. von Hayek of the Austrian school, recessions should not be resisted but embraced. Not that recessions are any fun, but they are necessary to correct conditions caused by the real problem, which is the artificial booms that precede them.
Such booms, created by inflation, send false signals to the capital markets that there are additional savings in the economy to support higher levels of investment. These higher levels of investment, however, are not authentically funded because there has been no actual increase in savings. Ultimately, when the mistakes are revealed, the malinvestments, as Mises called them, are liquidated, creating the bust. Legitimate economic expansions, financed by actual savings, do not need busts. It is only the inflation-induced varieties that sow the seeds of their own destruction.
This flies in the face of modern economic thinking that regards the business cycle as the inevitable result of some flaw in the capitalist system and sees the government’s role as mitigating or preventing recessions. Nothing could be further from the truth. Boom/bust cycles are not inevitable and would not occur were it not for the inflationary monetary policies that always precede recessions.
Economists today view the apparent overinvestment occurring during booms as mistakes made by businesses, but they don’t examine why those mistakes were made. As Mises saw it, businesses were not recklessly over investing, but were simply responding to the false economic signals being sent as a result of inflation.
While I would quibble with Mises and Hayek being identified as classical and Austrian, as if they were the same thing, his coverage of the Austrian business cycle is sound. Schiff does not make the mistake of many writers and analysts quoted in the media of characterizing it as an over-investment theory.
Schiff forecasts a stock market crash, the bursting of the real estate bubble, and the collapse of the dollar. For the first two of these, his reasons are the over-valuations of these asset classes, runaway credit expansion and the moral hazard created by bailouts. His argument for the collapse of the dollar is tied very closely to his view of the trade deficit, which I have called into question above.
His investment recommendations consist largely of foreign stocks, which have higher earnings yields and pay better dividends than US stocks; gold and gold mining; and cash or liquid short-term bonds to preserve purchasing power until after bubbles have burst, when the money can be put to work at much more favorable valuations.
Schiff’s book falls in a long line of gloom-and-doom forecasts offering advice on how to profit from them. Many of these books even have titles containing the words "how to profit from the coming u2018X’." A search on Amazon.com for those words shows a number of titles including the coming Y2K computer crash, the coming hyperinflation (1985) and the coming currency recall (1988).
While it is possible to see unsustainable trends playing out, some of them take many years to reach the breaking point, and in the meanwhile, there can be very long counter-trend movements. While bubbles burst, getting the timing right is difficult. It is possible to be right but wrong about the timing for a long period. While there were a number of bears in the late 90’s who correctly called the stock market bubble, many of them were wrong for several years until being vindicated.
I recall reading a column by a prominent financial reporter in which she heaped scorn and ridicule upon gloom-and-doomers because they had been wrong for an entire year, so they rolled out the same forecasts for the next year. Her point was, when are they going to just admit that the economy is in great shape, is growing, and that their whole bearish worldview is out of step with reality?
My purpose in bringing up blown forecasts is not to suggest that anyone forecasting a crisis is always wrong. Crises do happen. In recent years, a number of countries have had their currency collapse or defaulted on foreign debt. Recall the Asian contagion, the Mexican peso crisis, the Russian ruble crisis in 1998, and the Argentine banking crisis. America is not inherently immune from such a crisis. The laws of economics so ably demonstrated by Schiff apply to America as well as to other places. And I believe that Schiff does as good a job as anyone making the case that the trends that he examines are unsustainable, excepting possibly the trade deficit.
I enjoyed the book and it is one of the better examples of economic writing among investment books. I recommend it for anyone who wants an analysis of current economic and investment trends from an Austrian viewpoint. While I am in general agreement with Schiff’s forecasts, time will tell whether the crises are imminent or whether we are due for an extended period of grinding sideways.
Robert Blumen [send him mail] is an independent software developer based in San Francisco.