This is Part VII of our multi-part series of questions and answers with Robert Prechter, the world's foremost authority on Elliott wave analysis. (Excerpted from an hour-long June 19, 2010, interview with Jim Puplava's Financial Sense Newshour.)
...Jim Puplava: This brings me to an interesting question. Right now, the government spends about four trillion, and they take in close to two trillion in revenues. Every dollar they spend, 43 cents is coming from debt. Then we have $54 trillion in total debt as a country and another equal amount of unfunded liabilities. Social Security this year is paying out more than it takes in, and we have problems with Medicare. Despite the fact that these programs are going broke, we just added a new healthcare entitlement. Can you have a situation -- let me just throw this one out because I’m dealing with my own state of California, which I think will be bankrupt. California has a habit of putting all these initiatives on the ballot. We want this, we want that. And the initiatives get passed, but then we block the tax increases to pay for it. People like the entitlements that they get, but they don't want to be taxed to pay for them, and even some of these Tea Party people, if you told them, “OK, this is a situation we're in: We're broke. We can't afford these entitlements. And I know you paid into Social Security, and I know you are entitled to Medicare, but we're not going to be able to do that. We just don't have the money to pay for it.” Do you think that will change social mood? In other words, we've got these looming, big deficits on the horizon, with these entitlement programs that are over 60 percent of the government's budget. How does that get resolved? Do you see a politician looking at the people and saying, “Look I'm going to give it to you straight; here's the situation we're in?”
Robert Prechter: No, not a chance. They'll run it into the ground. Governments always do that. The Soviet Union was a disaster from the day it started, but the rulers didn't give up until they squeezed every penny out of the entire country and it was a wasteland. A lot of people in government know that they're heading towards complete bankruptcy. Certainly the state governments, which can't print their own bonds willy-nilly and can't print their own money through the Fed, know this, and yet they're doing it anyway! They're all going bankrupt, and they're flat broke. They're not only broke, but they are indebted up to their eyeballs. You can't pay interest on debt or the principal on debt if you're broke. Every possible solution simply sucks more money out of the economy.
Everybody always talks about the federal government spending more money as “stimuli.” It's ridiculous. Every dollar the government spends is a drag on the economy. It has to come out of someone else's hide: either by direct payment from the taxpayer or by borrowing the money, which means it can't be lent to a private business. The more the government spends and the more the government borrows, the weaker the economy gets. The weaker the economy is, the less chance it has to pay off the principal and interest that the debtors owe. If public servants’ behavior were any different, then the outcome may be different. But studying world history tells you that governments always take from the economy until it's completely destroyed. It's sad, but it's pretty predictable. You don't see someone coming into California and saying, “Let's clean all this up. Let's cut the budget by 60 or 70 percent and start paying our bonds off so we're completely out of debt in 15 years.” It's easy to do, anybody could do it. But they won't.
JP: I want to move on to the public. The public got into the stock market game late -- in the late ’90s, especially after '97 with the tech boom. They got their clocks cleaned in the correction, the bear market let’s say, from 2000 to 2002. Then they moved their money over into the real estate market and from real estate, they got back into the stock market. They got their clocks cleaned again. Now for the last seven consecutive months, the public is moving into bond funds: junk bonds, corporate bonds, Treasury bonds. Is this another recipe for disaster?
RP: You read my mind. On several recent TV interviews, I went through that exact list. Now everyone thinks that they don't want stocks; they don't trust stocks anymore. They don't want commodities; they got creamed in the oil market. They don't want real estate; they can see that that's not going to recover for 20 years. So what are they buying? They're loading up on bonds, especially municipal bonds and corporate bonds, many of which are junk. They think they can get their 6½ to 8½ percent yield. This is going to be the biggest disaster of all of them, because we're headed down the road to complete debt collapse. They're putting money into these instruments, and one day the debtors are going to announce, “We're sorry; we can't honor any of these IOUs.”
The people who've invested in these things are going to realize that instead of that 100,000 dollars or million dollars or 50 million dollars that they thought they had in safe places in municipal debt, in corporate debt, they're going to have zero. One by one, these debtors are going to give up on paying any part of it. They're just going to default or go bankrupt. This is another thing that happened to some degree in the early 1930s. There were counties and cities that declared bankruptcy; their debt was no good anymore. It certainly happened to some corporate debt.
This time the situation is 20 times worse than it was in 1929-1930. We’re heading into a much bigger collapse. So I agree 100 percent: The last thing you want to do is what everyone else is doing. This is why ever since Conquer the Crash [first edition: 2002 -- Ed.], I've been very, very consistent in saying that you want the safest possible cash and cash equivalents. That means cash notes, Treasury bills -- not even Treasury bonds -- and certainly no municipal debt, no corporate debt, and no foreign debt, except maybe for Swiss money market claims, which are the equivalents of T-bills; in other words, none of the things that people think they find attractive. They find bonds attractive because they think they have a yield. That yield is actually, in the end, going to come out of the principal.
JP: I find it almost astounding in looking at the monthly inflows in municipal bond funds, because we know next year the top tax rates under the Bush tax cuts expire, so people are saying if you're going back into a 40 percent tax bracket, buy muni bonds. I saw an advisor who was addressing some of these issues that you and I have been talking about, about municipal debt problems and the fact that they can't print their own money, and he was talking about, well, in a fund or in an ETF, you're diversified. But if you own 200 bonds in California, and California goes bankrupt, what good is the diversification?
RP: That was the argument that they used to sell people a bunch of crummy mortgages: “Oh yeah, they're all individually no good, but you put them together and you're fine, you're diversified.” So that doesn't work for me. It's a bogus argument. It's a great way to sell the worst stuff you’ve got.
If you're a financial planner, you're probably telling your clients to make sure you have a lot of different types of bonds. There's some value to diversification in certain restricted situations. For example, when I say I think people should be completely in cash, I would like them to be in several different forms of it. That's a safe way to diversify. The people who really believe that municipal bonds are the place to be are being prudent when they say, “OK, you should have different ones just in case I'm wrong about one of them.” What these people are missing is that the problem isn't going to be just one city or one state. It's systemic. The only state that I know of that doesn't have a serious debt burden is Nebraska, because they have a law against it.
[Part VIII is now posted. Topic: gold and hyperinflation]