Game Plan

by Kevin D. Freeman

  In discussing the implications of a currency collapse, George Soros told Der Spiegel in 2011, “The euro exists, and if it were to break apart, all hell would break loose.”85 Now imagine that happening to the dollar.

  It doesn’t take much to imagine. We are already on the brink.

  *Renminbi (“People’s Currency”), abbreviated RMB, is the formal term for Chinese currency. The yuan is the basic unit of the currency, as the pound is the basic unit of sterling. There is no term for American currency analogous to renminbi; we speak in terms only of the unit of currency, the dollar.

  CHAPTER THREE

  Making It Personal

  Let’s say America experiences an economic attack. How will it affect you personally? What will it mean for your job, your real estate values, your 401(k), your savings? What will it mean for your children’s future?

  In this chapter, we’ll examine the broad economic issues and show how they have direct, personal, and potentially devastating effects on everything each of us holds dear. We’ll detail the effects on workers, entrepreneurs, business people, consumers, investors, families, and taxpayers. This is not an academic exercise. We are anticipating an attack that is very much a possibility.

  And most people won’t see it coming until they feel their wallets get lighter.

  In 2008 only a small percentage of Americans had even heard of credit default swaps, let alone invested in them. Unfortunately, ignorance is no protection. Most Americans were paying their mortgages, unaware that a housing crisis would sink the economy. Yet because the housing bubble burst and the stock market crashed, millions of Americans lost their jobs. Since the 2008 collapse, reliance on food stamps has risen 70 percent. Almost fifty million Americans—one in five—receive them.1 Put another way, the number of persons on food stamps exceeds the population of twenty-four states plus the District of Columbia.2 Even though the federal government spends $1 trillion a year on anti-poverty programs—more than on Social Security or defense3—poverty is increasing, with almost fifty million citizens at or below the poverty line.4

  Then there’s unemployment. According to a study from the Center for American Studies, fewer native-born Americans have jobs now than had jobs in the year 2000; the entire net job creation of the country has gone to immigrants, including illegal immigrants. Nonetheless, our leaders are seriously talking about the legalization of another twelve million immigrants. “The economic problem facing America right now is not too few workers, but too many unemployed workers,” lamented Senator Jeff Sessions, a Republican from Alabama. “The Senate immigration bill [proposed in 2013] massively increases the supply of lower-skilled foreign workers, which would produce lower wages and higher unemployment. . . . [P]olls clearly show the American people don’t support such an approach.”5

  The unemployment rate more than doubled over the course of the crisis. According to the Bureau of Labor Statistics, from December 2007 to October 2009, the unemployment rate jumped from 5 percent to 10 percent. BLS reported, “The employment decline experienced during the December 2007–June 2009 recession was greater than that of any recession of recent decades. Forty-seven months after the start of the recession that began in November 1973, for example, employment was more than 7 percent higher than it had been when the recession started. In contrast, 47 months after the start of the most recent recession (November 2011), employment was still over 4 percent lower than when the recession began.”6

  With a miserable job market, millions of Americans have dropped out of the labor force. In the ten recessions prior to 2007, it took an average of twenty-five months to recover all of the lost jobs. Peter Ferrara writes for Forbes, “[U]nder President Obama, by April 2013, 64 months after the prior jobs peak, almost 5 1/2 years, we still have not recovered all of the recession’s job losses. In April 2013, there were an estimated 135.474 million American workers employed, still down about 2.6 million jobs from the prior peak of 138.056 million in January 2008 [emphasis in original].”7

  Worse still, the official unemployment rate understates how bad the jobs situation really is. In the summer of 2013, the real unemployment rate—counting those who are underemployed or who have dropped out of the labor force entirely—was near 18 percent.8 The U.S. labor force participation rate remains the lowest it has been in over three decades. As the Associated Press reported in April 2013, “Even Americans of prime working age—25 to 54 years old—are dropping out of the workforce.”9

  The recession of 2007–2009 hit just when the economy seemed robust. Shortly before the financial crisis, both the IMF and World Bank were celebrating tremendous gains and predicting further strong growth. The IMF’s World Economic Outlook published in April 2007 predicted an average world growth rate of 4.9 percent, to continue for two years as the global economy enjoyed its largest boom since 1970. The Global Economics Prospects Report predicted something similar, with the World Bank suggesting future “strong global performance” and “very rapid expansion in developing countries, which grew more than twice as fast as the advanced economies.”10

  Nobody is predicting robust economic growth now. The economy remains weak. So what happens if we suffer an economic attack in a down economy? That’s the prospect we face today.

  Panic

  In Unrestricted Warfare, Colonels Qiao and Wang aim at producing “social panic, street riots, and a political crisis.” There are those who have downplayed such risks, but the threat of Chinese hacking remains grave. Retired Lieutenant Colonel Timothy Thomas, a student of Chinese strategy, cites Unrestricted Warfare and asks,

  If I had access to your bank account, would you worry? If I had access to your home security system, would you worry? If I have access to the pipes coming into your house? Not just your security system but your gas, your electric. . .?

  Maybe nobody’s been killed yet, but I don’t want you having the ability to hold me hostage. I don’t want that. I don’t want you to be able to blackmail me at any point in time that you want. . . . I wonder what would happen if none of us could withdraw money out of our banks. I watched the Russians when the crash came and they stood in line and . . . they had nothing.11

  Of course, there are many who attempt to argue that China’s rise is not merely harmless but beneficial. China, they assert, wants to be a cooperative player on the world stage. Unfortunately, this view doesn’t square with the facts. It reflects the success of Chinese propaganda rather than China’s actual intentions. The Chinese have two stories—one for international consumption and one for their own planning. Their military literature “give[s] you both versions,” says Colonel Thomas. “They give you a model that says, ‘There will be no way we’ll ever fight [the U.S.], we’ll work on cooperation.’ A chapter later, ‘There could be a time where if pushed hard enough, we’ll have to do something and there will be a battle.’”12

  Lest you imagine that the aggressive stance of Unrestricted Warfare is somehow out of the Chinese mainstream, the same views were expressed in the Communist party journal Qiushi in 2011: “Of course, the most important condition [for economic warfare] is still that China must have enough courage to challenge the U.S. currency. China can act in one of two ways. One is to sell U.S. dollar reserves, and the second is not to buy U.S. dollars for a certain period of time, which will weaken the currency and cause deep economic crisis for Washington.”13

  The threat is not a matter of Chinese bluster. Our own Congressional Research Service published a paper on the danger of China’s suddenly reducing its holdings of our debt:

  A potentially serious short-term problem would emerge if China decided to suddenly reduce their liquid U.S. financial assets significantly. The effect could be compounded if this action triggered a more general financial reaction (or panic), in which all foreigners responded by reducing their holdings of U.S. assets. The initial effect could be a sudden and large depreciation in the value of the dollar, as the supply of dollars on the foreign exchange market increased, and a sudden and large increase in U.S. inte
rest rates, as an important funding source for investment and the budget deficit was withdrawn from the financial markets. . . . However, a sudden increase in interest rates could swamp the trade effects and cause (or worsen) a recession. Large increases in interest rates could cause problems for the U.S. economy, as these increases reduce the market value of debt securities, causing prices on the stock market to fall, undermining efficient financial intermediation, and jeopardizing the solvency of various debtors and creditors. Resources may not be able to shift quickly enough from interest-sensitive sectors to export sectors to make this transition fluid. The Federal Reserve could mitigate the interest rate spike by reducing short-term interest rates, although this reduction would influence long-term rates only indirectly, and could worsen the dollar depreciation and increase inflation.14

  There would be a “deep economic crisis” for Washington, producing considerable turmoil on the streets of America. George Soros predicts that the next financial crisis will produce “riots, a police state and class war for America.” He adds, “It will be an excuse for cracking down and using strong arm tactics to maintain law and order, which, carried to an extreme, could bring about a repressive political system, a society where individual liberty is much more constrained.”15 His words echo those of the People’s Liberation Army. “I am not here to cheer you up,” Soros says. “The situation is about as serious and difficult as I’ve experienced in my career. We are facing an extremely difficult time, comparable in many ways to the 1930s, the Great Depression. We are facing now a general retrenchment in the developed world, which threatens to put us in a decade of more stagnation, or worse. The best-case scenario is a deflationary environment. The worst-case scenario is a collapse of the financial system.”16

  Soros, in the view of Colonels Qiao and Wang, understands financial warfare better than anyone else. In the history book about twenty-first-century financial warfare, they say, Soros will be the “main protagonist.” He is undoubtedly right about one thing: the next wave of attacks could result in a deflation, hyperinflation, or total collapse, depending on how events play out. And, the vulnerability is greater than ever before.

  Could Deflation Destroy Us?

  George Soros says that deflation might be the best of the bad outcomes. What would that feel like?

  The Great Depression is an example of severe deflation. According to a report published by the Federal Reserve Bank of San Francisco, “Between 1929 and 1933, real gross domestic product per capita plummeted by nearly 30 percent and the unemployment rate soared from about 3 percent to over 25 percent. The consumer price index (CPI) plunged by nearly 25 percent, with the rate of deflation exceeding 10 percent in 1932.” But that’s not the end of the story: when the CPI turned around, unemployment remained extraordinarily high, a “surprising” combination.17 The cycle seemed impossible to break.

  The same report cites a more recent example—Japan after the boom of the 1980s. “Japan provides recent evidence of what can cause sustained deflation. Core consumer price inflation in Japan averaged a little over 2 percent during the 1980s and the first half of the 1990s. Following the bursting of the Japanese housing and stock market bubbles, the economy tumbled into a lengthy recession, with the unemployment rate rising to nearly 5.5 percent, about three percentage points above its prior long-run average. Nine straight years of core CPI deflation followed.”18

  Some economists, including Gary Shilling, believe that deflation is inevitable. Slowing birth rates, increased saving, and deleveraging, Shilling states, will contribute to the problem. “In recent years, monetary and fiscal stimulus across the world have led to the assumption that serious inflation, if not hyperinflation, is on its way. I believe chronic deflation is more likely.”19 A cycle of falling prices could devastate the economy, leading to cash hoarding, less investment, and less innovation. Rick Newman of U.S. News & World Report points out that deflationary cycles are emotionally driven and difficult to break. They can destroy the lending and credit system that underlies the jobs market. Newman concludes, “Since credit is the lifeblood of capitalism, a sharp cutback in lending and investing is a sure way to torpedo growth or make a recession worse.”20 The biggest problem is that we have already exhausted our bag of tricks—normally, we’d try to inflate the currency by placing the Fed short-term rates near zero. Unfortunately, we’re there already.

  Why is deflation bad? After all, if prices drop and you’re financially responsible, you should be able to buy more. But when deflation continues and people hold out for ever-lower prices, profits drop dramatically. Companies begin to fire employees. You have to rely on your savings. And when those are gone and you can’t get a new job, you’re in serious trouble. People start selling investments and move into anything that might hold value, including bonds that pay little or no interest. Stocks prices drop. The economy plummets.

  And the worst part is that the government typically responds to deflation with enormously increased spending. That means greater debts and deficits. And when people begin to fear that debts won’t be paid back, a new deflationary cycle begins, since people call in their debts and save to prevent new debts from accruing. Cash becomes king, at least for a while. Nothing else seems to hold value.

  The new deflationary cycle will prompt even more government spending—only this time, the government won’t be able to borrow the cash. It will either sell assets, further depressing prices; default on its debt; or print money. At this point, the greenback could be disestablished as the global currency, ultimately destroying savings across America. The price of everything falls first when cash is king. When things get really bad, even the dollar becomes worthless.

  That scenario is becoming more likely each day. The Fed has committed all of its resources to preventing deflation. It has been engaged in quantitative easing for so long that it’s stuck. When it announced the possible tapering of the program, markets freaked out and the Fed backed off.21

  If things got really bad, the Fed would likely become even more aggressive, following the policies of “Abenomics,” named after Shinzo Abe, who began a second term as prime minister of Japan in December 2012. He has made a 2-percent inflation target a top political priority. His directive: “Everything possible” must be done to achieve the goal within two years.

  Abenomics is a response to nearly a quarter century of Japanese economic malaise and deflation. Society has held together primarily because the Japanese people have historically funneled their high personal savings into government debt. It is estimated that the Japanese people have savings of roughly $19 trillion, which they have used to purchase about 90 percent of Japanese government debt. Now Abe wants to get those savings out of the banks and into the system. The central bank is already working on it, vowing to get it done at the “earliest possible time.” Abe’s strategy is stimulus,22 and the Japanese economy has remained stable in the face of deflation and massive increases in Japanese government debt.

  Unfortunately, we do not enjoy similar conditions in the United States. Our savings rate is abysmal by comparison with Japan’s. They are up to their eyeballs in debt as we are, but Japanese debt is held mostly by Japanese. So much of our debt is held by foreigners that deflation would prove more painful, triggering a more rapid government response. The United States simply cannot afford to wait as the Japanese did. We can expect that Ben Bernanke and his successors will follow a massive liquidity strategy when facing signs of deflation. In fact, Bernanke is called “Helicopter Ben” because it is said he would drop money from helicopters if needed to avoid deflation. Bernanke is clear in describing the problem: “The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand—a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending—namely, recession, rising unemployment, and financial str
ess.” He is also clear about his solution: make more money available. Bernanke will be gone in 2014, but the Fed is likely to continue his prescription of “easy money” for a deflating economy.23

  So even if deflation is the best of the bad outcomes, it could nevertheless lead to the worst of both worlds. The government’s response to massive deflation could cause hyperinflation or currency collapse or both, two serious threats.

  The Top-Down Approach

  Now, George Soros may not be right. In the event of an economic attack, we might be able to avoid outright deflation. But that’s not necessarily good news. It could be that our creditors get together and dictate terms for maintaining our debt. These creditors would impose austerity, much as the IMF and World Bank have done in Latin America, Asia, and parts of Europe. That scenario has been playing out recently in Cyprus and Greece. And there are many who think that this imposed austerity is continuing to destroy already downtrodden economies. The IMF itself said that it suffered “notable failures” in the Greek bailout because of its strict austerity requirements.

  But the IMF may have no choice, just as the international community may have no choice. A nation that spends too much, borrows too much, and can’t repay its debts will eventually be called to account. Unlike Japan, our nation is unable to finance its needs internally and routinely turns to other sources like China. One option to prevent debt default is to print money. This is, in fact, what several leading economists as well as Warren Buffett have suggested. Buffett says that we will never “have a debt crisis of any kind as long as we keep issuing our notes in our own currency,” because we have a printing press with which to pay back that debt.24