Bill Bonner on the Failing US Bond Market, the Coming Hyperinflation and the End of the Dollar Reserve System

The Daily Bell is pleased to present another exclusive interview with Bill Bonner (left).

Introduction: Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his 3rd New York Times best-selling book, Mobs, Messiahs and Markets, offering concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning.

Daily Bell: Let's get an update from one of our favorite hard-money mavens. Where is the world today? Recovering?

Bill Bonner: No, there is no recovery possible or desirable. That is, the world is not going back to the naive bubble of the '05 – '07 years. And no one should or would want it to. It's moving on – to a new bubble. The US consumer sector is de-leveraging. Household debt is at its lowest level in 6 years – thanks largely to mortgage defaults.

But at the same time, the feds are desperately trying to releverage the whole economy. They're having success in two areas. Business loans are still down from 2009, but they're moving up. Corporations are able to borrow money merely in order to make payouts to shareholders. In other words, capital is changing hands ... from the fools to the knaves. Typically, private equity hotshots are borrowing money at low rates so they can pay themselves off. The underlying business is weakened with debt; but nobody seems to care.

Daily Bell: Any other areas of growth?

Bill Bonner: The other sector of the economy that is leveraging up in a big, and I mean in a really big way, is government. Here again, the money goes from the fools to the knaves. Government squanders the money in all the usual ways, while the lenders believe they will get it back. Both can't be right. My guess is that the lenders will be wrong. They are making a bad bet. There is no recovery. They will not be repaid.

Daily Bell: How about the particulars. Will the EU hold together?

Bill Bonner: Yes, the EU will probably hold together. It could always shuck off the periphery states if it had to do so.

Daily Bell: Where is Germany headed?

Bill Bonner: I have no opinion on Germany. Except that it is a relatively solid economy, selling things to people who want to buy them. Not a very original business model, but not a bad one.

Daily Bell: How about the PIGS?

Bill Bonner: Eventually, someone, somewhere, somehow must suffer the PIGS debt. They cannot repay it. So, someone else must – either the bondholders or the taxpayers or the whole society. Most likely it will be all of the above.

Daily Bell: Will the Greeks will devalue eventually?

Bill Bonner: They will eventually default and restructure.

Daily Bell: Even the Irish?

Bill Bonner: Yes.

Daily Bell: There is a lot of anger against the EU. Was it anticipated?

Bill Bonner: Everyone believes that some combination of political will and technical competence can make these problems go away. They can't. Debt does not disappear. It can be hidden. It can be delayed. However, it can be put onto someone else. But it is still there. The EU has tried desperately to make the debt vanish. People are disappointed that it hasn't.

Daily Bell: They believed an economic crisis would force a political union. That doesn't seem to be the case. Why?

Bill Bonner: Different countries have different interests. They can get together in the upswing of a credit expansion because they all seem to do better as a result. But in the downswing each tries to grab a bigger share of a diminishing pie. It is a fight for survival, not a love-in.

Daily Bell: The Germans won't stand for an EU bailout of British and French banks. Will the British and French taxpayers provide the bailout?

Bill Bonner: Probably. German banks have a lot of exposure to periphery state debt too. And everyone in a position of authority has the same interest – to slip the losses onto the taxpayers, without them realizing it. The losses won't go away. They won't disappear. They can't be paid. So someone must suffer them. The idea will be to manage and "share the pain." There will be some restructuring ... some write offs ... and a lot of obfuscation. As long as interest rates can be held at such low levels, the problem can be put off because it costs so little to service the debt. Meanwhile, inflation even at fairly low rates wears away at the real weight of the debt. Problem delayed, problem solved. That's what they have in mind.

Daily Bell: What if these banks flounder? Double dip? Won't that split the union asunder as well?

Bill Bonner: If the banks go down (and they should) it will trigger a short panic. In crisis mode, politicians will look for scapegoats and miracle cures. But letting the banks go down would strengthen, not weaken, the euro. It would ultimately probably strengthen the EU too.

Daily Bell: What will they do to try to save the union? How do you negotiate when the German and PIG positions are so polarized?

Bill Bonner: This might be a good thing. They may not be able to work out a coordinated fraud at taxpayers' expense.

Daily Bell: Let's move on the Chinese miracle. The Chinese have been throwing the kitchen sink at price inflation with little or no result. What can they do to damp it? We think it's futile.

Bill Bonner: The Chinese only have the illusion of control. The Chinese economy will blow up.

Daily Bell: They've even been trying price controls. Who's running the show? Are they really that economically illiterate?

Bill Bonner: No ... no ... they're not economically illiterate. That's the problem. They're economically sophisticated. They've learned all the claptrap of the economics profession in the last 50 years. They think they can use it to control the economy. So did Japan, by the way. It was only a quarter century ago that people thought Japan had the magic. Back then Japan's economy was not so much managed as guided by MITI, its centralized industrial planning board. Foreign economists so admired the work of the planners that they urged the US, Britain and other nations to follow the Japanese example. They were unaware the biggest successes in Japan came in industries where entrepreneurs and businessmen had been able to ignore MITI. In the auto industry, for example, MITI told Honda and Toyota to stay out of the US market. It was too competitive, said the planners. But Japanese automakers went in anyway – with spectacular results.

Daily Bell: What happened?

Bill Bonner: When the Japanese economy blew up in 1989, the planners were on the case immediately. Instead of allowing the crisis to wash out excess capacity and the bad debt that accompanied it, they propped up the whole system with zero interest rates and huge deficits. Companies that should have de-leveraged or gone broke, were allowed to stay in business – indefinitely. Banks that carried the debt of zombie businesses were never forced to clean their cupboards. Why should they, when the cost of storage was so low? These policies effectively meant that the correction was stymied. The private sector was never purged of its mistakes. Instead, the errors were refinanced at ultra-low rates.

Daily Bell: And the public sector?

Bill Bonner: The public sector in Japan is also feeble and zombified. Japan owes twice its GDP in central government debt. At the current rate, the total will be three times GDP by 2020. Already, the debt dwarfs Japan's ability to pay; it is 20 times tax revenues. At least, in heading towards debt equal to 300% of GDP, Japan won't go broke; it can't ... it's already broke. Japan is trapped by its own central planning in an endgame that threatens to be even more punishing and upsetting than the nation's 21-year on-again, off-again slump.

Daily Bell: Similarities to China?

Bill Bonner: China is not Japan. But its economic model is very similar – export your way to prosperity. And where Japan's central planners merely gave bad advice, up until the blow-up in '89, China's central planners have more authority. They continue to direct massive amounts of cash and credit into expanding China's export capacity, apparently unaware that their number one customer is having a hard time paying its bills.

US interest rates have been trending down for at least 28 years, while US debt and deficits grow rapidly. An uptick in US inflation and interest rates could be disastrous for China's pile of dollar reserves, while an intensifying correction in the US and Europe would be disastrous for its export industries. The only thing that will work for China is a continuation of the status quo ,which is extremely unlikely. Rates are near zero in the US and Japan, while sovereign debt soars. This can't continue forever ... though Japan shows that it can go on long enough to drive short-sellers crazy. Nations can remain insolvent longer than you can remain rational.

In short, the Chinese economy depends on the health of the economies of Japan, Europe and the US – all of which, with the possible exception of parts of Europe – are following unsustainable financial models.

Daily Bell: Eventually they'll hit a wall, won't they? Either they freeze the monetary velocity with high rates or they end up with sky-high real estate and food prices. Either way it's not good for the Chicoms is it?

Bill Bonner: Look out! We're going to find out if central planners really can run an economy. Of course, we already know the answer. FA Hayek explained it theoretically in his book "The Fatal Conceit." And then, the Soviet Union very generously ran a 7-decade real-world experiment that proved he was right.

The problem, if I may simplify, is that you can never know what anything is worth unless you allow people to buy and sell freely. And if you can't know what something is worth, you can't make sensible investment decisions. You end up allocating capital to the wrong places, which leads inevitably to massive bust-ups.

Daily Bell: Is that what they've been doing?

Bill Bonner: As might have been predicted, the authorities' efforts to smooth out the business cycle has led to some of the most violent ups and downs ever experienced. One year, oil is worth $150 a barrel. Next year, it is worth $35 a barrel. Two years later, it is back to $100. How can businessmen make intelligent decisions when the price of energy whips around so much? They can't. Instead, they make mistakes.

Most central planners acknowledge that they can't improve on the price mechanism as a source of information. But they nevertheless maintain that they can improve the performance of an economy by controlling the price of short-term credit. They use their control of interest rates – not to mention fiscal policy – to block the downside of the business cycle. Sharp discounting of asset values and deflation are counteracted quickly. The only acceptable price movements were to the upside. Corrections are suppressed ... the problems are amplified. Eventually, markets always have their way. It is just a matter of time until China's compounding mistakes catch up to her.

Daily Bell: Let's move on to the Middle East. What's going on there in your view? Are these revolutions spontaneous?

Bill Bonner: They seem to be.

Daily Bell: There's a lot of evidence that the US – State Dept, CIA etc. – is helping organize these youth movements around the world. Why would that be?

Bill Bonner: Unlikely. The US is extremely conservative.

Daily Bell: We believe the US is trying to generate a series of Islamic republics so as to further the phony war on terror. Al Qaeda isn't doing the job anymore. Comment?

Bill Bonner: That is giving the US State Department and the CIA a lot of credit for strategic thinking. It is unlikely that they are that focused. They are bureaucrats with many different views ... most of them misguided and wrong.

Daily Bell: Is America headed for a recovery or another recession?

Bill Bonner: Neither. It is in a Great Correction of the credit expansion that began after WWII. This will continue for many years to come and probably lead to enough excess money-printing by the feds to create a hyperinflationary blow-up. This will be the end of the monetary system that was set up – almost unwittingly – in August 1971. More than that, hyperinflation will shake the foundations of modern political, social and economic institutions, and probably bring many of them down. The social welfare state, for example, was invented by Germany's Iron Chancellor Otto von Bismarck more than a century and a half ago. In their late, degenerate form, they depend on delivering benefits in the present while pushing the costs – in the form of national debt – onto future generations. A bout of hyperinflation will make this model inoperable, because governments will be unable to finance further huge deficits at low rates. It will also mark the end of Keynesian interventionism, as it will be obvious that central financial planning doesn't work.

Daily Bell: Why has Bernanke been so relentless about money pumping?

Bill Bonner: He believes he has to fight the Great Correction.

Daily Bell: Putting everything together it is as if the powers that be are pushing and shoving toward maximum chaos. Can it all be coincidence or is there a purpose behind it? Out of chaos a new world order and a single currency?

Bill Bonner: Hm-mm. Again, this presumes more of a grand design and more control than the 'powers that be' actually have.

Daily Bell: Given all the uncertainty where would you be investing now?

Bill Bonner: In gold and silver. Both remain good investments.

Daily Bell: Give us your best peek into the crystal ball. Where will the world's economy be in a year? Better? Worse?

Bill Bonner: Impossible to say. But the risks are greater than the potential rewards. There is too much debt in the system. It makes the whole system vulnerable to a breakdown. There's more downside, in other words, than upside. That said, tomorrow is usually like today. So, most likely, the world economy will stumble forward, with low growth, bubbles in some sectors, and pockets of prosperity as well. Keep in mind though that you don't make any money by betting on what is likely to happen. You make money by betting on things that may even be unlikely, but underappreciated.

Daily Bell: What might be underappreciated?

Bill Bonner: What is underappreciated now is the risk in the US bond market. Investors are lending at less than four percent interest, for 10 years, while the real rate of consumer price inflation – including fuel and food – is probably around eight percent. They're losing money already. And a move back to "normal" interest rates would be devastating to bondholders. Sooner or later, the bond market is going to collapse. Will it happen this year? I can't say. But it is best to be prepared.

Daily Bell: Great stuff. Thank you again for your time and insights.

If we have any differences with one of the most insightful minds in the hard-money investment business, it would have to be on the issue of premeditation. Mr. Bonner sees the "big picture" and believes it is too big for meaningful power elite manipulations. We look at what is taking place and wonder how it can be other than deliberate.

Of course, this does NOT mean that each gambit attempted by the Anglosphere – each war, each fear-based promotion, each dominant social theme – has the requisite effect. In the 20th century many of them did. In the 21st century, many of these attempted manipulations are failing and floundering.

Global warming had a good run of almost 50 years. But a year ago, thanks to "Climategate," the dishonesty of the numbers was exposed and the public consensus fell apart and has never been put back together. The elite renamed the promotion; it's called climate change now, and is lurching ahead without much success. But as we have often pointed out, a hallmark of elite promotions is that the Anglosphere won't let them die, even if they have actually ceased breathing. The elites animate the corpse, prop it up, and insist it is alive. This is another problem – for them, not for us.

The Afghanistan war is not going well. The Pashtun–Taliban should have been pacified by now, instead they continue to gain safe-haven within Pakistan's borders; try as it might, the US cannot prevail on Pakistan's military and intelligence leaders to route them out. Tensions continually rise. Pakistan is not even attending the upcoming US/Afghan summit, though it has been invited. The current distrust was brought about by the capture and subsequent release of a CIA contractor who gunned down two Pakistanis on the street. On the heels of this incident came the subsequent drone killings of some 40 elders on the Pakistan border. Pakistan and Pashtuns alike claim the meeting in which the elders were participating had to do with a local business dispute; Pentagon drone handlers say the meeting was a terrorist gathering.

The European Union, another long-term power elite project, is having the same credibility problems as the Afghan war. The EU leaders meet and meet and announce solution after solution but the bond market doesn't agree, and the Sovereign Debt crisis rolls on. Lately, the EU has pinned its hopes on a closer political union between the EU's various nation states. In practice, this means the EU will be keeping a close eye on Southern PIGS budgets and expenditures. While this may seem to be an inevitable trend, the entire process may grind to a halt if the Irish eventually vote on the process – as their Constitution seems to demand. This time round, one would have to think that the Irish will not be bullied into changing a "no" vote into a "yes" vote through the convenient if questionable gambit of holding an additional referendum.

There is more, much more; we write about it regularly. Who knows what the future holds? Bill Bonner seems to believe it will be a rocky ride; we tend to agree. Our take however is that one reason things may get a lot worse before they get better is because the powers-that-be are attempting to sustain a growing amount of failed promotions. The elite in our view seeks chaos, but not so much chaos that the events cannot be guided and smoothed into shape. When chaos overwhelms the system even elites lose control. That may be happening now.