A toothpaste factory had a problem: it sometimes shipped empty boxes without the tube inside. This was due to the way the production line was set up, and people with experience in designing production lines will tell you how difficult it is to have everything happen with timings so precise that every single unit coming out of it is perfect 100% of the time. Small variations in the environment (which can’t be controlled in a cost-effective fashion) mean you must have quality-assurance checks smartly distributed across the line so that customers all the way down to the supermarket don’t get pissed off and buy another product instead.

Understanding how important that was, the CEO of the toothpaste factory got the top people in the company together, and they decided to start a new project in which they would hire an external engineering company to solve their empty boxes problem, as the engineering department was already too stretched to take on any extra effort.

The project followed the usual process: budget and project sponsor allocated, RFP, third parties selected, and six months (and $8 million) later it had a fantastic solution – on time, on budget, high quality, and everyone in the project had a great time.

They solved the problem by using high-tech precision scales that would sound a bell and flash lights whenever a toothpaste box weighed less than it should. The line would stop; someone would walk over and yank the defective box off of it and press another button when done to re-start the line.

A while later, the CEO decides to have a look at the Return On Investment of the project: amazing results! No empty boxes ever shipped out of the factory after the scales were put in place. Very few customer complaints, and they were gaining market share. “That’s some money well spent!” he said, before looking closely at the other statistics in the report.

It turned out that the number of defects picked up by the scales was zero after three weeks of production use. It should have picked up at least a dozen a day, so maybe there was something wrong with the report. He requested an inquiry, and after some investigation, the engineers came back saying the report was actually correct. The scales really weren’t picking up any defects, because all boxes that got to that point in the conveyor belt were good.

Puzzled, the CEO traveled down to the factory and walked up to the part of the line where the precision scales were installed.

A few feet before the scale was a cheap desk fan, blowing the empty boxes out of the belt and into a bin.

“Oh, that,” says one of the workers, “One of the guys put it there ’cause he was tired of walking over every time the bell rang.”

Author Unknown.

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Budget:

‘The way to deal with sequestration is put revenues on the table.” That is third-ranking Senate Democrat Charles Schumer of New York’s coded way of telling congressional Republicans that if you want to prevent the budgetary devastation of the U.S. military, you’ll have to break your promises to voters and agree to major tax hikes.

After the presidential and congressional elections this November, a lame-duck Congress will address an impending fiscal calamity.

Without action, the Bush tax cuts once again are set to expire at the end of the year and some $110 billion in indiscriminate, across-the-board spending cuts will take place automatically. House Speaker John Boehner is already wisely demanding “cuts and reforms greater than” any debt limit increase.

Heritage Foundation senior fellow and former Treasury Department tax economist J.D. Foster recently warned that on New Year’s Day, “some $494 billion in tax hikes will crash down on America’s taxpayers and economy” — not just the expiration of the 2001 and 2003 tax cuts that gave us a boom and cut unemployment to under 5%, but “a jump in the payroll tax rate,” “the return of the death tax,” ” a bigger, badder” Alternative Minimum Tax, and the tax hikes for ObamaCare.

The ObamaCare 3.8% surcharge goes into effect in 2013, “not just on wage and salary income, but all income, thus breaking the historical link between Medicare and labor earnings,” Foster recently noted.

“This link has been sacred to the left for decades, but it apparently wasn’t enough to stop them from breaking it to hike taxes,” he said.

This is a gift-wrapped campaign present for Mitt Romney and all those running for Congress this year who believe in prosperity and fiscal responsibility.

Why is America faced with a fiscal mess that already has Lockheed Martin and other defense firms last week distributing “digital countdown clocks” warning that automatic Pentagon cuts will mean the loss of over 1 million jobs — at a time the U.S. suffers an 8.1% jobless rate?

And why is Ernst & Young telling its clients not to depend on a whole series of business tax breaks, including bipartisan relief for corporate R&D?

The answer is a spending spree during two years of absolute rule by Obama and a Democrat-controlled Congress, which left our children and grandchildren with a $1.3 trillion deficit and a $15.7 trillion national debt.

Spending cuts, budgetary reform with teeth, and tax reform are the obvious solutions to our fiscal ills.

But Obama and congressional Democrats refuse to do anything to defuse the economy’s ticking fiscal time bomb before the November election.

Romney and congressional Republicans should be asking every day between now and the election: Why, aside from politics, are we waiting?

Published at Investors.com May 15, 2012.

FAIR USE NOTICE:This site contains copyrighted material the use of which has not always been specifically authorized by the copyright owner. We are making such material available in our efforts to advance understanding of environmental, political, human rights, economic, democracy, scientific, and social justice issues, etc. We believe this constitutes a ‘fair use’ of any such copyrighted material as provided for in section 107 of the US Copyright Law. In accordance with Title 17 U. S. C. Section 107, the material on this site is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. For more information go to: http://www. law. cornell. edu/uscode/17/107. shtml

I must confess that I’d been a gold bear for many years. When I reevaluated my position, I surprised myself when my conclusions made a 180-degree turn. On average gold has an 18-to-20-year life cycle, which implies the bull run will run until 2018-20. The cycle doesn’t necessarily mean a huge run-up, but it does mean there should be very little downward pressure. The other factor that is encouraging is how most gold cycles, when there are strong signs of upward movement, terminate with an even larger and steeper rise near the end of the cycle. If history is a guide, we should therefore expect the most dramatic phase of the rally to occur six to eight years from now.

My longstanding macro view has been that as debt became unsustainable, a severe deflation period would ensue. That argument still holds. However, I did make some unsubstantiated assumptions that because of the severity of this debt cycle, the deflation cycle would be deep and long. As it turns out, that has never been the case. On average deflation has an 18-month window. It is during times of strong contraction that cash outshines all other investments. I also believe that gold will experience a downturn as well, but not as steep as most other assets, and that it should recover quickly as governments re-inflate their economies.

Risk of Confiscation
Pondering future scenarios, it seems likely to me that gold will be one of the best investment vehicles. However, there are two scenarios that could be disheartening to gold owners. One has to do with confiscation, or placing government restrictions on ownership or price. If you are inclined to believe this worse case, I would suggest you hold your gold investments overseas in the most stable of countries. In the end, though, if you invest early enough, with the price of gold below $3000, there is little chance of losing. The second scenario will not fare as well. If we have total collapse of world economies gold might not be an easily bartered commodity. Barring that last scenario, gold should be the top investment choice till 2020.

More immediately, perhaps next year, I expect major defaults to play out that will go unremedied by world banks and governments that are either disinclined to step in or unable to do so. All lenders will quickly retrench, just like the banks did four years ago. This time, however, would-be rescuers will make clear that there will be no safety-net and no subsidy for interest or principle. New government rules will be enacted in an attempt to stabilize the financial system. Real write-offs will be placed on ledgers; no more issuing of bonds and government bailouts. No winners, whether lender or borrower. A forced period of across-the-board austerity will be put in place. For the masses, there will be a global depression that will last for more than a decade. For the economies of the world, it will be much briefer. Businesses will quickly do what they have to do to survive and then thrive. Just as nearly everyone has been flabbergasted by the way corporations have sustained strong earnings over the last four years, they will underestimate the ability of companies to adapt in a more severe economic downturn.

The Normalcy Trait
The reason gold has not already taken off has to do with a human psychological trait that clings to the notion that everything will be as it was. It’s called the normalcy trait, and it makes it hard for us to acknowledge that drastic, unwelcome change can occur. This of course assumes you have lived in a stable environment all your life. That was why Jews clung to the notion that Hitler’s regime would be short-lived, and that its citizens would not attack one another. While most can understand the logical conclusion to this debt crisis, we still cling to the notion that somehow it will end without much change in our lives. We can see the datapoints and the almost irrevocable conclusion, but somehow manage to skirt reality and accept that our lives will continue in the “normal” way they always have.

Then again, perhaps my slanted, cynical outlook on life has overdramatized the possible scenarios that lie ahead. I surely hope so, but just to be safe I will be hedging my bet with gold.

Written by Rick Ackerman and published on Rick’s Picks May 14, 2012.

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Many countries are now debating the causes of the global economic crisis and what should be done. That debate is critical for how we explain the crisis will influence what we do.

Broadly speaking, there exist three different perspectives. Perspective # 1 is the hardcore neoliberal position, which can be labeled the “government failure hypothesis”. In the U.S. it is identified with the Republican Party and the Chicago school of economics. Perspective # 2 is the softcore neoliberal position, which can be labeled the “market failure hypothesis”. It is identified with the Obama administration, half of the Democratic Party, and the MIT economics departments. In Europe it is identified with Third Way politics. Perspective # 3 is the progressive position which can be labeled the “destruction of shared prosperity hypothesis”. It is identified with the other half of the Democratic Party and the labor movement, but it has no standing within major economics departments owing to their suppression of alternatives to orthodox theory.

The government failure argument holds the crisis is rooted in the U.S. housing bubble and bust which was due to failure of monetary policy and government intervention in the housing market. With regard to monetary policy, the Federal Reserve pushed interest rates too low for too long in the prior recession. With regard to the housing market, government intervention drove up house prices by encouraging homeownership beyond peoples’ means. The hardcore perspective therefore characterizes the crisis as essentially a U.S. phenomenon.

The softcore neoliberal market failure argument holds the crisis is due to inadequate financial regulation. First, regulators allowed excessive risk-taking by banks. Second, regulators allowed perverse incentive pay structures within banks that encouraged management to engage in “loan pushing” rather than “good lending.” Third, regulators pushed both deregulation and self-regulation too far. Together, these failures contributed to financial misallocation, including misallocation of foreign saving provided through the trade deficit. The softcore perspective is therefore more global but it views the crisis as essentially a financial phenomenon.

The progressive “destruction of shared prosperity” argument holds the crisis is rooted in the neoliberal economic paradigm that has guided economic policy for the past thirty years. Though the U.S. is the epicenter of the crisis, all countries are implicated as they all adopted the paradigm. That paradigm infected finance via inadequate regulation and via faulty incentive pay arrangements, but financial market regulatory failure was just one element.

The neoliberal economic paradigm was adopted in the late 1970s and early 1980s. For the period 1945 – 1975 the U.S. economy was characterized by a “virtuous circle” Keynesian model built on full employment and wage growth tied to productivity growth. Productivity growth drove wage growth, which in turn fuelled demand growth and created full employment. That provided an incentive for investment, which drove further productivity growth and supported higher wages. This model held in the U.S. and, subject to local modifications, it also held throughout the global economy – in Western Europe, Canada, Japan, Mexico, Brazil and Argentina.

After 1980 the virtuous circle Keynesian model was replaced by a neoliberal growth model that severed the link between wages and productivity growth and created a new economic dynamic. Before 1980, wages were the engine of U.S. demand growth. After 1980, debt and asset price inflation became the engine.

The new model was rooted in neoliberal economics and can be described as a neoliberal policy box that fences workers in and pressures them from all sides. Corporate globalization put workers in international competition via global production networks supported by free trade agreements and capital mobility. The “small” government agenda attacked the legitimacy of government and pushed for deregulation regardless of dangers. The labor market flexibility agenda attacked unions and labor market supports such as the minimum wage, unemployment benefits, and employment protections. Finally, the abandonment of full employment created employment insecurity and weakened worker bargaining power.

This model was implemented on a global basis, in both North and South, which multiplied its impact. That explains the significance of the Washington Consensus which was enforced in Latin America, Africa, and former Communist countries by the International Monetary Fund and World Bank by making financial assistance conditional on adopting neoliberal policies.

The new model created a growing “demand gap” by gradually undermining the income and demand generation process. The role of finance was to fill that gap. Within the U.S., deregulation, financial innovation, and speculation enabled finance to fill the demand gap by lending to consumers and spurring asset price inflation. U.S. consumers in turn filled the global demand gap.

These three different perspectives make clear what is at stake as each recommends its own different policy response. For hardcore neoliberal government failure proponents the recommended policy response is to double-down on neoliberal policies by further deregulating financial and labor markets; deepening central bank independence and the commitment to low inflation; and further limiting government via fiscal austerity.

For softcore neoliberal market failure proponents the recommended policy response is to tighten financial regulation but continue with all other aspects of the existing neoliberal policy paradigm. That means continued support for corporate globalization, so-called labor market flexibility, low inflation targeting, and fiscal austerity.

For proponents of the destruction of shared prosperity hypothesis the policy response is fundamentally different. The challenge is to overthrow the neoliberal paradigm and replace it with a “structural Keynesian” paradigm that repacks the policy box and restores the link between wage and productivity growth. The goal is to take workers out of the box and put corporations and financial markets in so that they are made to serve the broader public interest. That requires replacing corporate globalization with managed globalization; restoring commitment to full employment; replacing the neoliberal anti-government agenda with a social democratic government agenda; and replacing the neoliberal labor market flexibility with a solidarity based labor market agenda.

Managed globalization means a world with labor standards, coordinated exchange rates, and managed capital flows. A social democratic agenda means government ensuring adequate provision of social safety nets, fundamental needs such as healthcare and education, and secure retirement incomes. A solidarity based labor market means balanced bargaining power between workers and corporations which involves union representation, adequate minimum wages and unemployment insurance, and appropriate employee rights and protections. Lastly, since the neoliberal model was adopted globally, there is need to recalibrate the global economy. This is where the issue of “global rebalancing” enters and emerging market economies need to shift away from export-led growth strategies to domestic demand-led strategies.

The critical insight is that each perspective carries its own policy prescriptions. Consequently, the explanation which prevails will strongly impact the course of economic policy. That places economics at the center of the political struggle as it influences which explanation prevails.

As of now, the economics profession is split between the hardcore and softcore neoliberal positions. However, that can change under the pressure of an ugly reality that produces mass political demand for change, as happened in the Great Depression of the 1930s which provided an opening for Keynesian economics. The only certainty is change will be politically opposed as powerful elites and orthodox economists have an interest in preserving the dominance of the existing paradigm by ensuring their explanation of events prevails.

May 9, 2012.

Written by Thomas I. Palley, from his recent book From Financial Crisis to Stagnation: The Destruction of Shared Prosperity and the Role of Economics, Cambridge University Press, 2012. A 20% discount is available using this link. [Select country location (top right hand corner) & enter code "palley2012" at checkout].

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The Gold Report: David, you have talked and written about the effect of government-funded, debt-fueled spending on the stock market. What will be the real impact of quantitative easing?

David Stockman: We are in the last innings of a very bad ball game. We are coping with the crash of a 30-year–long debt super-cycle and the aftermath of an unsustainable bubble.

Quantitative easing is making it worse by facilitating more public-sector borrowing and preventing debt liquidation in the private sector—both erroneous steps in my view. The federal government is not getting its financial house in order. We are on the edge of a crisis in the bond markets. It has already happened in Europe and will be coming to our neighborhood soon.

TGR: What should the role of the Federal Reserve be?

DS: To get out of the way and not act like it is the central monetary planner of a $15 trillion economy. It cannot and should not be done.

The Fed is destroying the capital market by pegging and manipulating the price of money and debt capital. Interest rates signal nothing anymore because they are zero. The yield curve signals nothing anymore because it is totally manipulated by the Fed. The very idea of “Operation Twist” is an abomination.

Capital markets are at the heart of capitalism and they are not working. Savers are being crushed when we desperately need savings. The federal government is borrowing when it is broke. Wall Street is arbitraging the Fed’s monetary policy by borrowing overnight money at 10 basis points and investing it in 10-year treasuries at a yield of 200 basis points, capturing the profit and laughing all the way to the bank. The Fed has become a captive of the traders and robots on Wall Street.

TGR: If we are in the final innings of a debt super-cycle, what is the catalyst that will end the game?

DS: I think the likely catalyst is a breakdown of the U.S. government bond market. It is the heart of the fixed income market and, therefore, the world’s financial market.

Because of Fed management and interest-rate pegging, the market is artificially medicated. All of the rates and spreads are unreal. The yield curve is not market driven. Supply and demand for savings and investment, future inflation risk discounts by investors—none of these free market forces matter. The price of money is dictated by the Fed, and Wall Street merely attempts to front-run its next move.

As long as the hedge fund traders and fast-money boys believe the Fed can keep everything pegged, we may limp along. The minute they lose confidence, they will unwind their trades.

On the margin, nobody owns the Treasury bond; you rent it. Trillions of treasury paper is funded on repo: You buy $100 million (M) in Treasuries and immediately put them up as collateral for overnight borrowings of $98M. Traders can capture the spread as long as the price of the bond is stable or rising, as it has been for the last year or two. If the bond drops 2%, the spread has been wiped out.

If that happens, the massive repo structures—that is, debt owned by still more debt—will start to unwind and create a panic in the Treasury market. People will realize the emperor is naked.

TGR: Is that what happened in 2008?

DS: In 2008 it was the repo market for mortgage-back securities, credit default obligations and such. In 2008 we had a dry run of what happens when a class of assets owned on overnight money goes into a tailspin. There is a thunderous collapse.

Since then, the repo trade has remained in the Treasury and other high-grade markets because subprime and low-quality mortgage-backed securities are dead.

TGR: Walk us through a hypothetical. What happens when the fast-money traders lose confidence in the Fed’s ability to keep the spread?

DS: They are forced to start selling in order to liquidate their carry trades because repo lenders get nervous and want their cash back. However, when the crisis comes, there will be insufficient private bids—the market will gap down hard unless the central banks buy on an emergency basis: the Fed, the European Central Bank (ECB), the people’s printing press of China and all the rest of them.

The question is: Will the central banks be able to do that now, given that they have already expanded their balance sheets? The Fed balance sheet was $900 billion (B) when Lehman crashed in September 2008. It took 93 years to build it to that level from when the Fed opened for business in November 1914. Bernanke then added another $900B in seven weeks and then he took it to $2.4 trillion in an orgy of money printing during the initial 13 weeks after Lehman. Today it is nearly $3 trillion. Can it triple again? I do not think so. Worldwide it’s the same story: the top eight central banks had $5 trillion of footings shortly before the crisis; they have $15 trillion today. Overwhelmingly, this fantastic expansion of central bank footings has been used to buy or discount sovereign debt. This was the mother of all monetizations.

TGR: Following that path, what happens if there are no buyers? Do the governments go into default?

DS: The U.S. Treasury needs to be in the market for $20B in new issuances every week. When the day comes when there are all offers and no bids, the music will stop. Instead of being able to easily pawn off more borrowing on the markets—say 90 basis points for a 5-year note as at present—they may have to pay hundreds of basis points more. All of a sudden the politicians will run around with their hair on fire, asking, what happened to all the free money?

TGR: What do the politicians have to do next?

DS: They are going to have to eat 30 years worth of lies and by the time they are done eating, there will be a lot of mayhem.

TGR: Will the mayhem stretch into the private sector?

DS: It will be everywhere. Once the bond market starts unraveling, all the other risk assets will start selling off like mad, too.

TGR: Does every sector collapse?

DS: If the bond market goes into a dislocation, it will spread like a contagion to all of the other asset markets. There will be a massive selloff.

I think everything in the world is overvalued—stocks, bonds, commodities, currencies. Too much money printing and debt expansion drove the prices of all asset classes to artificial, non-economic levels. The danger to the world is not classic inflation or deflation of goods and services; it’s a drastic downward re-pricing of inflated financial assets.

TGR: Is there any way to unravel this without this massive dislocation?

DS: I do not think so. When you are so far out on the end of a limb, how do you walk it back?

The Fed is now at the end of a $3 trillion limb. It has been taken hostage by the markets the Federal Open Market Committee was trying to placate. People in the trading desks and hedge funds have been trained to front run the Fed. If they think the Fed’s next buy will be in the belly of the curve, they buy the belly of the curve. But how does the Fed ever unwind its current lunatic balance sheet? If the smart traders conclude the Fed’s next move will be to sell mortgage-backed securities, they will sell like mad in advance; soon there would be mayhem as all the boys and girls on Wall Street piled on. So the Fed is frozen; it is petrified by fear that if it begins contracting its balance sheet it will unleash the demons.

TGR: Was there some type of tipping that allowed certain banks to front run the Fed?

DS: There are two kinds of front-running. First is market-based front-running. You try to figure out what the Fed is doing by reading its smoke signals and looking at how it slices and dices its meeting statements. People invest or speculate against the Fed’s next incremental move.

Second, there is illicit front-running, where you have a friend who works for the Federal Reserve Board who tells you what happened in its meetings. This is obviously illegal.

But frankly, there is also just plain crony capitalism that is not that different in character and it’s what Wall Street does every day. Bill Dudley, who runs the New York Fed, was formerly chief economist for Goldman Sachs and he pretends to solicit an opinion about financial conditions from the current Goldman economist, who then pretends to opine as to what the economy and Fed might do next for the benefit of Goldman’s traders, and possibly its clients. So then it links in the ECB, Bank of Canada, etc. Is there any monetary post in the world not run by Goldman Sachs?

The point is, this is not the free market at work. This is central bank money printers and their Wall Street cronies perverting what used to be a capitalist market.

TGR: Does this unwinding of the Fed and the bond markets put the banking system back in peril, like in 2008?

DS: Not necessarily. That is one of the great myths that I address in my book. The banking system, especially the mainstream banking system, was not in peril at all. The toxic securitized mortgage assets were not in the Main Street banks and savings and loans; these institutions owned mostly prime quality whole loans and could have bled down the modest bad debt they did have over time from enhanced loan loss reserves. So the run on money was not at the retail teller window; it was in the canyons of Wall Street. The run was on wholesale money—that is, on repo and on unsecured commercial paper that had been issued in the hundreds of billions by financial institutions loaded down with securitized toxic garbage, including a lot of in-process inventory, on the asset side of their balance sheets.

The run was on investment banks that were really hedge funds in financial drag. The Goldmans and Morgan Stanleys did not really need trillion-dollar balance sheets to do mergers and acquisitions. Mergers and acquisitions do not require capital; they require a good Rolodex. They also did not need all that capital for the other part of investment banking—the underwriting business. Regulated stocks and bonds get underwritten through rigged cartels—they almost never under-price and really don’t need much capital. Their trillion dollar balance sheets, therefore, were just massive trading operations—whether they called it customer accommodation or proprietary is a distinction without a difference—which were funded on 30 to 1 leverage. Much of the debt was unstable hot money from the wholesale and repo market and that was the rub—the source of the panic.

Bernanke thought this was a retail run à la the 1930s. It was not; it was a wholesale money run in the canyons of Wall Street and it should have been allowed to burn out.

TGR: Let’s get back to our ballgame. What is to keep the U.S. population from saying, please Fed save us again?

DS: This time, I think the people will blame the Fed for lying. When the next crisis comes, I can see torches and pitch forks moving in the direction of the Eccles building where the Fed has its offices.

TGR: Let’s talk about timing. On Dec. 31, the tax cuts expire, defense cuts go into place and we hit the debt ceiling.

DS: That will be a clarifying moment; never before have three such powerful vectors come together at the same time— fiscal triple witching.

First, the debt ceiling will expire around election time, so the government will face another shutdown and it will be politically brutal to assemble a majority in a lame duck session to raise it by the trillions that will be needed. Second, the whole set of tax cuts and credits that have been enacted over the last 10 years total up to $400–500B annually will expire on Dec. 31, so they will hit the economy like a ton of bricks if not extended. Third, you have the sequester on defense spending that was put in last summer as a fallback, which cannot be changed without a majority vote in Congress.

It is a push-pull situation: If you defer the sequester, you need more debt ceiling. If you extend the tax expirations, you need a debt ceiling increase of $100B a month.

TGR: What will Congress do?

DS: Congress will extend the whole thing for 60 or 90 days to give the new president, if he hasn’t demanded a recount yet, an opportunity to come up with a plan.

To get the votes to extend the debt ceiling, the Democrats will insist on keeping the income and payroll tax cuts for the 99% and the Republicans will want to keep the capital gains rate at 15% so the Wall Street speculators will not be inconvenienced. It is utter madness.

TGR: It is like chasing your tail. How does it stop?

DS: I do not know how a functioning democracy in the ordinary course can deal with this. Maybe someone from Goldman Sachs can come and put in a fix, just like in Greece and Italy. The situation is really that pathetic.

TGR: Greece has come up with some creative ways to bring down its sovereign debt without actually defaulting.

DS: The Greek debt restructuring was a farce. More than $100B was held by the European bailout fund, the ECB or the International Monetary Fund. They got 100 cents on the dollar simply by issuing more debt to Greece. For private debt, I believe the net write-down was $30B after all the gimmicks, including the front-end payment. The rest was simply refinanced. The Greeks are still debt slaves, and will be until they tell Brussels to take a hike.

TGR: Going back to the triple-witching hour at year-end, if the debt ceiling is raised again, when do we start to see government layoffs and limitations on services?

DS: Defense purchases and non-defense purchases will be hit with brutal force by the sequester. As we go into 2013, there will be a shocking hit to the reported GDP numbers as discretionary government spending shrinks. People keep forgetting that most government spending is transfer payments, but it is only purchases of labor and goods that go directly into the GDP calculations, and it is these accounts that will get smacked by the sequester of discretionary defense and non-defense budgets.

TGR: I would think to unemployment numbers as well.

DS: They will go up.

Just take one example. According to the Bureau of Labor Statistics monthly report, there are 650,000 or so jobs in the U.S. Postal Service alone. That is 650,000 people who pretend to work at jobs that have more or less been made obsolete and redundant by the Internet and who are paid through borrowings from Uncle Sam because the post office is broke. Yet, the courageous ladies and gentlemen on Capitol Hill cannot even bring themselves to vote to discontinue Saturday mail delivery; they voted to study it! That is a measure of the loss of capacity to rationally cognate about our fiscal circumstance.

TGR: In the midst of this volatility, how can normal people preserve, much less expand their wealth?

DS: The only thing you can do is to stay out of harm’s way and try to preserve what you can in cash. All of the markets are rigged or impaired. A 4% yield on blue chip stocks is not worth it, because when the thing falls apart, your 4% will be gone in an hour.

TGR: But if the government keeps printing money, cash will not be worth as much, either, right?

DS: No, I do not think we will have hyperinflation. I think the financial system will break down before it can even get started. Then the economy will go into paralysis until we find the courage, focus and resolution to do something about it. Instead of hyperinflation or deflation there will be a major financial dislocation, which means painful re-pricing of financial assets.

How painful will the re-pricing be? I think the public already knows that it will be really terrible. A poll I saw the other day indicated that 25% of people on the verge of retirement think they are in such bad financial shape that they will have to work until age 80. Now, the average life expectancy is 78. People’s financial circumstances are so bad that they think they will be working two years after they are dead!

TGR: Finally, what is your investment model?

DS: My investing model is ABCD: Anything Bernanke Cannot Destroy: flashlight batteries, canned beans, bottled water, gold, a cabin in the mountains.

TGR: Thank you very much.

David Stockman is a former U.S. politician and businessman, serving as a Republican U.S. Representative from the state of Michigan 1977–1981 and as the director of the Office of Management and Budget under President Ronald Reagan 1981–1985. He is the author of The Triumph of Politics: Why Reagan’s Revolution Failed and the soon-to-be released The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy.

Written by Karen Roche and JT Long and published on The Gold Report, May 5, 2012.

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