In Mid-January I received a request from Angel Martín to do an interview for the Spanish newspaper “Libertad Digital”.

Dear Mish,

I am a follower of your blog. I work for the economics section of a Spanish classical liberal online newspaper,, with a strong Austrian flavor in economics. We have published exclusive interviews to people such as Jim Rogers, Marc Faber, Antal Fekete, Robert Higgs, or Gerald O’Driscoll.

We plan to open a new newspaper, called Free Market, and exclusively limited to economic and financial issues. It would be a great honor to have an interview with you in the opening of the website (on your predictions for 2011, your perspective on Spain and the European debt crisis, and so on). What do you think about it?

Thank you very much for your time.
Best regards,

Angel Martin Oro

Interview Questions and Answers

I was happy to oblige “Libertad Digital”. Here is the interview in Spanish: “No confíen en gobiernos o bancos centrales: son los culpables de la crisis”

Here is the interview in English.

Q: What is your general prediction for 2011? Will the crisis be over at the end of this year?

A: I covered many specific topics for the US and global markets in my post Ten Economic and Investment Themes for 2011

My general long-term thesis is the US will go in and out of deflation for a number of years just as Japan has done.

Stocks are richly price and historically are poised for no gains for another 10 years. That is not a prediction for 2011 as timing is very difficult. However that equity warning is similar to one I made in 2006-2007.

Q: On Europe, what is your view of the European Bailout Funds? Should sovereign states go bankrupt? How could this be done? Will the European Monetary Union and the Euro survive?

A: The Euro is likely to survive, but I can see things that could cause the member group to shrink. One thing I am certain of is there will be haircuts on sovereign bonds. What cannot be paid back won’t. Eventually Ireland and Greece will default.

However, it is important to step back and understand just who is being “bailed out” here. It is certainly not Ireland. It is bondholders of Irish debt that are being bailed out. Those bondholders are UK banks, German banks, French banks, and US banks in that order. The person footing the bill is the average Irish citizen.

Those Irish citizens should not stand for it and they won’t. I made my suggestions for the next Irish Parliament in my post Irish Government Collapses, Six Cabinet Members Resign, Election March 11; How To Negotiate Haircuts

Prior to that, I talked about Ireland on numerous occasions. In general, this is how I see the IMF’s “Trojan Horse Bailout of Ireland”

That comic is from To Ireland With Love

In that post I noted how Iceland came out of its crisis by forcing haircuts on bondholders. Ireland should do the same.

Q: In the United States, is the banking system healthy now, after the Paulson’s Plan and the government interventions? Or do you expect more turbulence and troubles coming from the US banks?

A: The entire global banking system is technically bankrupt. There is $40 trillion in US denominated debt that cannot possibly be paid back. European banks are in no better shape.

That is what the sovereign debt crisis in Europe is all about. Look at Japan. It has a debt-to-GDP ratio of 200%. Yet, Japan’s demographics could not be worse. The Japanese people were savers, but the government squandered it all and 100% more in foolish efforts to defeat deflation.

The US is making the same mistake. Bernanke is crowing now, but US unemployment is still near 10% (if you believe the reported numbers). I don’t. Unemployment in the US is higher.

Q: What about China and the emerging economies (India and Latin America)? Will they be able to sustain such outstanding growth rates?

China is overheating. It has the world’s largest property bubble. I talked about that a number of times recently. Here are a few links.

Shanghai Prepares for Property Tax to Curb ‘Speculative’ Buying; China Addresses Symptom NOT Problem

“Consensus Nonsense”; Is the Yuan Undervalued? Who Wins a Currency War?

China Secretly Buying US Treasuries Via UK Accounts? Trade Deficit Math; “Hot Money” Math

Q: Many people, since 2008, have feared high inflation as a consequence of the expansionary monetary policy of the FED. However, this has not taken place yet. Why were they wrong? And also, will 2011 be a year of very high inflation as some predict?

Fears of rampant inflation in the US are misguided. Yes, the Fed is “printing” but so is China, the ECB, the UK and for that matter everyone else. China is the real culprit regarding commodity prices and inflation.

It’s important to have an understanding of what inflation is. Here is my definition: “Inflation is a net expansion of money supply and credit, with credit marked-to-market”.

“Deflation is a net contraction of money supply and credit, with credit marked-to-market”.

That last phrase “marked-to-market” explains the US stock market rally nicely. Credit never expanded, but Bernanke reignited the junk bond market and bonds banks were holding went from “priced for bankruptcy” to “good as gold”.

This happened even though credit card debt, consumer loans, home equity loans, and consumer debt in general still continue to contract.

This helps explain the recovery in financial assets but not the real economy or jobs. In contrast, prices are soaring in China along with unsustainable levels of credit expansion. Those who focus on prices as well as those who focus solely on money supply both miss the boat.

Greenspan ignored rapidly expanding credit in the housing bubble years. China is doing the same now.

In China, credit is expanding at 35% a year with GDP rising less than a third of that. That is a distinct sign of an overheating economy. India is in the same inflation boat with China.
Australia is dependent on commodity demand from China.

It should be easy to see what happens to Australia when China slows. Notice I said “slows”. There is a good chance China crashes. Moreover, Australia faces a double whammy because its property bubble is starting to implode now.

Those paragraphs should explain how interconnected and unbalanced the global economy is.

Q: What is your view on the Spanish economic troubles? As an investor and analyst, would you trust the current Spanish Government?

A: At first glance, Spain’s woes appear similar to US and Ireland (housing bubble and property speculation) and dissimilar to Greece. However, all of the countries just mentioned are alike in regards to problems with public unions. In the case of Greece, public unions and unsustainable pension problems are the overriding concern. In other countries it is private sector debt. Thus, all of the countries have the same problems; it’s just the order of importance of the problems that differs.

I see no reason to trust any governments or central banks. The Fed took illegal actions and so did the ECB. Jean-Claude Trichet broke every major promise he ever made by cutting interest rates to nothing and by buying sovereign government bonds. Buying bonds was against the Maastricht Treaty. Germany has done things that are arguably against its constitution.

There is even a power struggle at the ECB now as Trichet’s term expires. Axel Weber is the leading candidate but he was against Trichet’s bond purchases. I suspect they may declare an emergency and keep Trichet on beyond his term.

Greece lied to the EU to gain admission. Japan’s policies over the last two years have been a disaster. Are we supposed to believe Spain? Italy? Any central bank? Why?

Q: Since the minimums of March 2009, the US and European stock markets have risen more than 60 %. What would you expect for the foreseeable future?

A: I have a saying: “They don’t know and neither do I”. However, as I stated above, equities are hugely overpriced here. Expect Long-term gains to be minimum and most likely negative.

Q: Finally, what are your recommendations for policy-makers to get out of the financial and debt crisis as soon and healthy as possible? And even more importantly, what must be done to avoid future crisis like this one?

Everyone likes to blame lack of regulation. However, I like to point out that regulation created Fannie Mae, regulation empowered the big three rating agencies, regulation gave tax breaks to homebuilders, Greenspan openly endorsed derivatives, etc. I can go on for hours regarding the failure “of” regulation.

In a free market, there would have been no Fannie or Freddie. Nor would there be 30 year mortgages. The first thing a decent regulator would do is shut Fannie and Freddie down. Instead we just guaranteed their debt.

If you want to see just how screwed up the credit rating agencies in the US are, please read Time To Break Up The Credit Rating Cartel

That is another clear case of government screwing up a perfectly workable system.

I am not against all regulation, however. Regulation that protects property rights and prevents fraud is fine. Glass-Steagall should not have been revoked. It provides a wall to prevent some forms of fraud. However people use Glass-Steagall as a scapegoat. It would not have stopped this crisis at all.

Finally, it is important to understand the root cause of this mess: Fractional reserve lending and the Fed (and central bankers in general). Note too, that it was regulation (legislation) that created the Fed. Together the Fed and fractional reserve lending are the driving forces that allow unmitigated creation of debt. They are all guilty. However, the Fed and the People’s Bank of China are the worst.

The result of central banker sponsorship of credit is bigger boom and bust cycles of increasing amplitude. Unfortunately, there will be another crash as the global imbalances and root causes of this mess have not been addressed.

Mike “Mish” Shedlock
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