The only way is down

This is my latest book review for the Financial Times.

Those with a weak heart might best avoid reading The Real Crash. In it Peter Schiff, an investment and economic commentator, makes a strong case that the real economic turmoil is yet to come. So far we have only seen the tremor before the earthquake.

He argues from a free market perspective that the US’s economic plight is much worse than generally appreciated. Only a dramatic shrinking of government can set the country on the path to a genuine recovery. The one upbeat note is that it is possible for investors to protect themselves against the impact of the imminent crash.

Schiff starts with an examination of what he considers to be the basis of the US’s current economic weaknesses. He challenges the notion that consumer spending drives prosperity. Mainstream commentators fail to see that it is production, driven by investment, that is the basis for genuine affluence.

Of course, in the short term it is possible for individuals to use borrowing to enable them to consume more than they produce. But in the medium and longer term any debts accrued have to be repaid.

If the gap between production and consumption becomes too wide, as Schiff believes it has in the US, the consequences are bound to be damaging. Hyperinflation and a debased currency are likely to be the ultimate result.

In the US, the government has for many years played a central role in inflating a huge credit bubble. Most notably the Federal Reserve has kept interest rates artificially low and pumped massive amounts of liquidity into the system.

Rather than accepting the need for recessions, which Schiff sees as necessary to bring the economy back into balance, the authorities have sustained one bubble after another. Short-term expediency has trumped monetary prudence.

The bulk of the book analyses different areas of state activity, arguing that most of them should be cut or at least dramatically reduced. For example, Schiff favours taking an axe to income tax, social security and publicly funded education. He also advocates a return to the gold standard, in which the value of the dollar is pegged to the precious metal, as a way of ensuring monetary discipline.

Schiff believes that everyone, not just the rich, would benefit from limited government. For instance, its involvement in medical provision, in programmes such as Medicare, pushes up costs enormously.

A privatised medical system would, he says, be better for the poor, as it would be far more affordable. There would also be more scope for charities to help the most deprived.

In the final section he outlines an approach to protect investors against the expected economic crunch. Schiff likens his strategy to a stool with three legs: high-quality, dividend-paying stocks in the right sectors; liquid and relatively non-volatile investments such as cash and foreign bonds; and gold and gold mining stocks.

The free market case is more coherent than liberals (in the popular US sense) and, indeed, many conservatives allow. Too often they prefer to dismiss it, rather than examine it in a balanced way.

It is a pity that The Real Crash did not devote more than two chapters to develop the argument about the US’s underlying weaknesses. Since it is the edifice on which Schiff’s case is built, it could have done with more substance.

More fundamentally, there is the possibility of an alternative explanation for many of the trends he identifies. Perhaps it is not big government that has weakened the economy but the reverse. An underlying economic atrophy has propelled the authorities to intervene more – and to extend credit – to maintain economic momentum.

After all, the long-term trend across the developed world has been for public spending to increase hugely from the late 19th century. Western capitalism seems to have lost much of the vitality it enjoyed in its earlier days, when it more closely approximated a free market.

This is not to deny that politicians are often short-termist or that debt has reached staggering levels, but these problems could at least partly be expressions of more deep-rooted weaknesses in the productive economy.

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‘The Real Crash: America’s Coming Bankruptcy – How to Save Yourself and Your Country’, Peter D. Schiff (St Martin’s Press, 2012, $25.99)