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Doing the Wrong Thing

How the US Federal Reserve is making the economic mess worse...

PRESIDENT and chief global strategist for Euro Pacific Capital, Peter Schiff is one of the harshest critics of US central bank the Federal Reserve, says Hard Assets Investor.

In this interview – originally published on IndexUniverse.com – the vociferous Dollar bear asks what excuse the Fed will need for its next dose of quantitative easing.

Olivier Ludwig, managing editor IndexUniverse: What's your take on the latest goings on in Europe?

Peter Schiff, president Euro Pacific Capital: Well, Chancellor Merkel seems to be saying: "We're not going to print money, the ECB is not the Fed and won't be the lender of last resort, and that these governments have to cut spending." She's also saying it's her intention for the Euro to be the strongest currency in the world.

If she's going to stick to that, then there's no quantitative easing, no bailout, and Italy and France or Greece or Spain – everybody in Europe – is going to have to cut back on government spending.

That would be a very positive thing for Europe. Because if they did the opposite thing we did, it's the right thing to do. And if they want to have the world's reserve currency, they can have it, at least for a while. They can take the economic mantle from the US, and that is going to plunge us into the economic abyss.

Ludwig: So what is the US doing?

Schiff: We're doing the wrong thing. We're doing exactly what Merkel is saying Europe is not going to do.

Ludwig: So what does the near-term pain look like in Europe from where you sit if we take Merkel at her word?

Schiff: The near-term pain is for people who are collecting checks from the government. The near-term relief is for the people who are paying the taxes. They're going to see a stronger currency, lower prices and a more vibrant economy.

I don't think there's a lot of short-term pain associated with cuts in government spending. I think the pain is already there. If they cut government spending, it's going to be a big positive.

Ludwig: On this side of the Atlantic, with the Fed, what's your outlook? Do you see a QE3?

Schiff: I think QE3 is going to happen – if it's not already here in disguise. They will officially acknowledge it. The government just revised downward its estimate for third-quarter growth from 2.5% to 2%. I think we're relapsing into recession because we never really fixed our problems – we just added more debt and more government.

I think the Fed will be looking at oil prices, which will be well over $100 a barrel shortly. We'll be seeing record-high gasoline prices seasonally, and probably we'll see heating oil prices the highest they've ever been in the wintertime.

The Fed will unfortunately react to this thinking: "Oh no! We need cheaper money because higher energy prices are going to be a drag on the economy." But, of course, the higher energy prices result from all the cheap money.

So I think we're going to see more easing and more pain, which means higher gas prices, higher food prices and a weaker Dollar.

Ludwig: So, when does the Fed have a change of heart?

Schiff: It'll take a crisis. We're not going to do it differently until there is no other choice, until there is a full-on sovereign debt crisis where US Treasury prices, long term, are really under pressure and the Dollar is falling fast, and prices are really soaring.

That's when the Fed will potentially do the right thing. But as long as it can delay doing the right thing, it will. And that ultimately means that doing the right thing will be that much more painful for the economy because of how long the Fed will have delayed.

Ludwig: "Predictions are hard, especially when they're about the future," as the saying goes, but how long before a long bond Treasury auction goes quite poorly?

Schiff: Most likely, we'll make it through 2011, but in 2012 or 2013, it's a better-than-even-money shot that that's when it's going to happen. Is it possible that it could be delayed? Yes. Politically, it's going to be interesting: Is it going to be before the next election or after it? That could certainly impact the election itself if it were to happen before.

Ludwig: Are you inclined to short Treasurys?

Schiff: Yes, I think Treasury prices are going to go down. It's a question of when. But I think they're going to get clobbered. I also think the Dollar is going to fall because I think the Fed is going to try to stop the bond market from falling initially by printing more money.

But eventually, the Fed has to let prices fall, because, remember: The big problem with the US economy is that interest rates are too low. They need to be much higher. We'll never have a solution to our problems; we'll never have legitimate economic growth or job creation until the Fed lets interest rates go up.

The problem, if they allow them to go up, means that a lot of banks will fail, real estate prices fall more, people lose jobs, government has to cut spending. So, a lot of painful things will have to happen when interest rates go up. But, until we do any of that, we don't have any recovery.

Ludwig: Are you shorting Treasurys right now?

Schiff: I've been shorting Treasurys for years. It hasn't really worked out. So, I don't really short them, but I short them for clients.

Ludwig: When you take in the market craziness lately – up 200; down 300; up 100; down 200 – what's the best game plan? Is it all about precious metals and commodities?

Schiff: Well, Gold Prices are going to keep on rising; commodities prices are going to keep rising – all a result of a falling Dollar.

And if we see some really big cuts in European spending, that's going to really clobber the Dollar, as a lot of the money that's been going out of the Euro and into the Dollar starts going the other way. And if the Europeans pull this off and get some of those cuts, some of these central banks – China and Japan – are going to want to buy Euros and dump Dollars.

Ludwig: What do you make of all this talk of China slowing down, struggling with a real estate bubble in eastern China? And it looks like demand for things like copper is falling.

Schiff: The problem over there is the Dollar. They're trying to prop up the Dollar so that they can keep exporting to a group of people that can't afford to buy their products. That's what's screwing up the Asian economies – the subsidies to the US

They have to come to terms with the fact that we're broke and we're not a good customer. And they have to stop propping up our currency and allow their own citizens to enjoy a stronger currency to consume their own production. But as long as the world is trying to sell merchandise to Americans, it's going to create problems. We're poor. We can't afford all this stuff. So they have to lend us some money and that creates a lot of problems.

Ludwig: Well, it's like the drug addict and the drug dealer – both sides are invested in this sick narrative, no?

Schiff: Yes. But the Chinese have already lost a lot of money. And the minute they stop [buying Treasurys], their losses will stop. We have benefited from the relationship in that we've been able to consume things that we couldn't have otherwise afforded.

But during all these years that we've been consuming for free, our industry has decayed, and so our economy is now hollowed out. So it's going to be very difficult for us to get back to a real economy once we can no longer rely on charity from countries like China.

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