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 third New York Times best-selling book, Mobs, Messiahs and Markets, which offers 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: Thank you for sitting with us down with us again. We interviewed you last September, and you were not especially upbeat about Western economies generally. Let's get right to it. Where are we today? Is it inflation, or are we moving into a deflationary depression?

Bill Bonner: It's clearer today that the West is deleveraging and that it's continuing.

Daily Bell: Define deleveraging, please.

Bill Bonner: It's a natural phenomenon that comes after a great credit boom. First there's credit expansion in a business cycle, because people want to live better and they tend to test the limits of the credit. So they borrow more and more and more, until they have borrowed too much. Now usually there are mechanisms in place to prevent people from borrowing too much. This is why business has credit checks and other safeguards. But once in a while, you have a situation where those barriers disappear. Then you get people doing things that they shouldn't be doing, and that's what happened in America between 1980 and 2007, a nice long stretch of 27 years in which credit just got greater and greater.

Daily Bell: People were borrowing for consumption?

Bill Bonner: People were certainly not borrowing for investing purposes. This is an important distinction because if you borrow money to build a factory, then you can get the income from the factory to pay the debt off. But if you borrow to buy breakfast, there's no income. You've started the day nutritiously, but you have no way of paying your debt back. This cycle is well known in the financial world. It happens occasionally when you get a central bank like the Federal Reserve that is overly committed to the idea of encouraging people to borrow money. Also when you get a development in the global world, say China for example. The US consumer was committed to consuming. The Chinese, generally, were committed to developing cheap exports. They were willing to take American money and to hold it so Americans would never really have to settle up.

Daily Bell: It doesn't happen very often.

Bill Bonner: When it does, you get this kind of extraordinary explosion in debt; it's just a freakish thing. On the other hand it is perfectly natural because it is just natural that people want to live as well as they can. Americans had that desire, and the Chinese had the wherewithal. So Americans bought sub-prime mortgages, million-dollar trailers on the California coast, huge McMansions on credit, credit, credit. The credit itself then distorted the price structure. Eventually, you could buy a house with no money down, or even 110% of the mortgage. Everybody starts doing it and everyone is competing for houses. Eventually, the prices of collateral are going down. Now aren't you smart because you bought a house for 100% of the mortgage and didn't put down any money? The house went up 20% and you made $100,000, or maybe you made more.

Daily Bell: It's not sustainable.

Bill Bonner: Well obviously there is something strange about that. Eventually you get to the stage where the whole thing starts to go bad. Now we are on the downside – the other side of that mountain where the amount of debt is actually falling, destroying credit. All of a sudden you can't pay those debts, you send the keys back and, hey, the debt is destroyed. That's what has happened.

Daily Bell: Yes, the boom was fueled, as you've pointed out, by credit – a result of money creation, we would argue. How does Keynesian economics keep its mesmerizing hold over the political and economic elite?

Bill Bonner: How does it keep its hold? Well it's very useful to people who want to tell everyone else what to do. The real gem of Keynesian economics, the real insight, is as old as the hills. It's in the Old Testament where Joseph told the Pharaoh his people were going to have seven lean years; he said, "if you want to get through those seven lean years you better save for seven years so you have grain."

Pharaoh listened, and the people had grain. So Joseph was a genius and the Pharaoh was genius. Now Keynes came along and said same thing. He said government ought to save money during surpluses, during good times and then it would have money in the bad times. Well asking modern Western governments to save money is like asking a St. Bernard to save sausages; it's not going to happen. They don't do that.

The people that run governments have a very simplistic idea of how economies work. They believe that they can manage demand and keep economies on track. That was Keynes's idea. You are either encouraging demand or dampening demand. You only dampen demand when you perceive price inflation. Otherwise, you can continue to increase demand, which is what they are doing.

It's a tool. Unfortunately it's not the right tool, and it doesn't work. But from their standpoint, it's the only tool they've got; they are big shots and they're important. They're all geniuses, especially the central bankers. They're going to show off, and that is what they are doing.

Daily Bell: What is the future of central banking generally? Is central banking discredited?

Bill Bonner: I think it will be discredited when the dollar is discredited. We are now in this period that started in 1971, in which the dollar standard, as a paper money standard, is on the way out. It's not going to last forever. My guess is it won't last for another 10 years. We're in a period of orderly deleveraging, but when this period comes to an end we will probably see a period of disorderly deleveraging, which will mean the end of the money system. This will severely discredit the central banks and the larger money system.

Daily Bell: So one way or another the economy is continually headed down?

Bill Bonner: This economy is probably headed down for years. Deleveraging takes a long time. If you have currently, 350% GDP in debt in the US, if you add in the unofficial debt, the unfunded liabilities of the government, you are talking about a debt that reaches beyond 600% of GDP. So, in order to get that debt down to a more reasonable level you have got to pay off and foreclose and default and all that takes a lot of time.

Daily Bell: The Internet has exposed Keynesianism, and shown clearly that it doesn't work, along with many other government policies and plans. Are you worried about government attacks on the Internet as a result?

Bill Bonner: I am not, but maybe I should be. I am just not alert to them. I am more worried about Google attacks on the Internet. You know, so much of the world now depends on Google for transmitting information and making contact with other people. If the people running Google or Facebook decide they don't want somebody doing something, or saying something, they can wield an enormous amount of power to shut those people down. I don't think it will happen, but I don't know.

Daily Bell: Unfortunately, they don't wield enough power to shut down bad government programs – or wars, either. Is Afghanistan America's Germanic disaster, putting it within a Roman context?

Bill Bonner: Oh, that's an interesting question!! You are taking about the Battle of Totenberg Forest. No, that was a huge disaster, but that was not even near the end of Rome's decline. That was a much earlier disaster, which established the limits of Roman power. They took Roman armies across the Rhine into Germany and those darn Germans attacked them and wiped them out. Two legions! After that the Romans decided to stay on the other side of the Rhine. That was the limit to the Roman Empire. We are not at that stage. We are way, way beyond that stage. We are not establishing the limits of US power. I think those limits have been reached. Now we are probably going to see US power diminishing. I don't know what to compare Afghanistan to. It's just a border securement; the Romans did that for years, just draining away capital and wasting money. Eventually it led to the ruin of the Empire.

Daily Bell: All right. Speaking of empires, what is going to happen to the EU?

Bill Bonner: Most people say the EU will fall apart, but I don't think so. I think the EU is fundamentally solid. I think the euro is more solid than the dollar because the dollar is a piece of paper backed by the US Government and the US government seems bent on actively destroying the dollar. Nobody in the EU seems determined to destroy the euro, so I believe the Euro-zone will hold together. There's a lot of time and a lot of money invested in it. As a result the periphery may fray. Maybe Greece, Ireland and Portugal among other countries, may spin out of the EU. But the real danger is the banking system, which could collapse, causing a worldwide financial catastrophe, and so on.

Daily Bell: Are the tribes of Europe going to continue to rebel?

Bill Bonner: Yes. Hungary's leaders recently came out and said they are not going to stick with the EU austerity plan. I would expect you will see that in Greece and other places too when the pain really starts to set in. Ireland is an interesting case, because the leadership and people went along with the austerity measures, though it is apparently not doing much good. They are finding that even when they cut back, their deficit actually goes up because the economy shrinks. That is the danger Keynes warned about. You can't cut spending because if you do the economy is going to collapse and that does seem to be true (laughing).

Daily Bell: Will there be a gold backed euro?

Bill Bonner: Well, I think after this period, looking ahead, after the system really does collapse, the powers-that-be will look around for some better way, some better money, to reconstitute confidence. Usually, historically – over thousands of years – we see that means gold. And it would not surprise me, therefore, if they find gold again.

Daily Bell: Right now, the fallback seems to be some sort of IMF currency. Will the IMF succeed at making SDRs the world's reserve currency?

Bill Bonner: I don't know. I don't know enough about the mechanics of the SDR.

Daily Bell: Where does China stand in all this? What game are the leaders of China playing if any?

Bill Bonner: I don't think they are playing a game. First, they have an economy that is booming. So they're going to assert their place in the world. They have kind of historic view of who they are and what place they should have. I think that view is very difficult for us Westerners to understand, and we should make some effort to understand because I think they are going to be forcing it on us. I think what they say is what they will do.

Daily Bell: What are they saying? Do the Chinese expect the demise of the dollar as the world's reserve?

Bill Bonner: I think they don't expect it any time soon, but I think it is certainly a concern of theirs. I think they're kind of stuck because they hold so many dollars. What they will do eventually I have no idea.

Daily Bell: They seem to be having trouble with price-inflation. Is the Chinese economy doomed to increased price-inflation or even hyperinflation.

Bill Bonner: I don't know what it is doomed to. I would say more likely it's doomed to a crash. We only have a couple of examples in history of big economies that have the kind of growth China has seen. The biggest example is the US in the 1920s. We know how that ended.

Daily Bell: What do you think about Barack Obama?

Bill Bonner: He seems like a nice enough guy, but he's totally out of his element, totally out of his depth. Would somebody else be better? I doubt it. I think it's kind of a hopeless situation. This is not politics, anymore; this is economics. He's doesn't know anything about it. He has advisors who don't know anything about it. If the Republicans get into office, it won't make a darn bit of difference. They have the same stupid advisors, the same ideas and they are ideologically in the same trap.

Daily Bell: A lot of what the US is doing today to respond to the economic crisis has to do with bailouts. Western governments have been amazingly proactive with bailouts. Have we seen the end of them?

Bill Bonner: No, I think we are seeing a pause in the bailouts. I think governments are committed to bailouts. The too-big-too-fail scenario is alive and well. So my guess is there are other bailouts coming.

Daily Bell: So much money sloshing around in the economy has had a positive effect on the prices of gold and silver. Where are gold and silver headed now? Will prices continue to go up?

Bill Bonner: Gold and silver are heading down in my view. We are in a period of deleveraging. Deleveraging affects gold prices as well as silver prices, usually. So if I am right about the deleveraging and if the deleveraging is calm and orderly as it was in Japan during that country's "Lost Decade," then we will probably see somewhat lower gold and silver prices, at least for some time. Of course, it could become disorderly, which would be messy.

Daily Bell: Where are commodities headed, generally?

Bill Bonner: Same story. They are headed down because of deleveraging. But I think they are headed up because of increased demand. A nice, wishy-washy answer.

Daily Bell: Is there going to be a war in Iran?

Bill Bonner: I have no opinion.

Daily Bell: What inspires you to write? Do you have another book in the works?

Bill Bonner: I do have another book in the works and I might have two books in the works, I'm thinking about it. That's what I do; it's how I earn a living.

Daily Bell: Closing remarks? What would you like to say about this past year?

Bill Bonner: I think the world's picture has changed in a subtle way in the last year, maybe for the better. What I see is that the likelihood or the ability of the world to get through this period of price-deflation in an orderly way has gone up. And if you had asked me a year ago, which you did, I probably would have said, gee something terrible is going to happen because the government's going broke, the private sector's going broke, etc.

All this is still true, but interestingly, because the recovery didn't work, the savings rate has gone up. We are getting this kind of soft meltdown, this calm, orderly, deleveraging, debt-destruction cycle. It could happen that we end up just like Japan, which is just what I predicted 10 years ago, and I was wrong because it didn't happen, but maybe I was just 10 years too early.

Daily Bell: That's a great observation. If the deleveraging is quick and brutal, you have a scenario where everything collapses quickly. A slow deleveraging is less destructive to the current economic structure, but it certainly presents a Japanese slow-growth or no-growth scenario.

Bill Bonner: We do seem to be falling right into the Japan trap. The US government is spending and trying to offset a shrinkage in the private sector and funded it via savings, in this case savings of much of the world. The rest of the word is saving, and the US happily steps up and borrows the world's savings and converts it to boondoggles. That's the Japanese formula, in a sense. It is certainly true that the central banks would find this sort of scenario preferable to others, such as a collapse or hyperinflation. As long as they can finance this Keynesian response to a credit deleveraging, I say that we are on track for a sort of soft-meltdown.

Daily Bell: A very interesting perspective as usual. It has been a pleasure to speak with you again. Thank you.

Bill Bonner: You are welcome. Thank you.

It is interesting to see Bill Bonner's evolution as regards his perspective on inflation and deleveraging, as he is one of the most astute observers on the financial scene. When he we interviewed him previously he was focused on price inflation because of the size of the financial bailouts; now he seems to have come to the conclusion that deleveraging of prices (price deflation) is the sustainable trend.

To better understand the points that he is making, we will spend part of this After Thought providing definitions. First of all, what is deflation and is it different than deleveraging or price deflation? Austrian economist Joseph Salerno suggests four processes for deflation, of which the most relevant from our point of view is "hoarding." Hoarding of gold or silver (or cash money in a fiat environment) takes money out of the active money supply. In simplest terms, if someone wants to acquire money in a hoarding environment, that person will have to pay MORE to acquire money (offer more goods and services presumably). This is a market-based definition of deflation.

Is hoarding taking place today? Gary North, another notable hard money economist, argues that in a fiat-money central banking environment, deflation (a contraction of the money supply) rarely if ever exists. Using this perspective, what is going on today (and what we have written about this in past articles without always being precise in our own terminology) is likely more accurately known as deleveraging or price deflation.

How can deleveraging take place absent a contraction in the money supply (real or available money-on-demand according to Austrians)? One explanation would be that over-printing of money so distorted the business cycle that certain prices delinked from the money supply. This has precedent within Austrian monetary theory. A natural disaster for instance may place certain resources in jeopardy. These resources will be bid up (price inflation) and then become less in demand once the crisis has passed (price deflation).

Using this logic, it might be argued that the business cycle itself, mercilessly stimulated by over-printing of fiat money, generated such a boom (especially in housing prices) that the price-inflation that ensued far-exceeded even what might have been expected from the expansion of the money supply. We can see, then, that the collapse of these prices does not necessarily predict a collapse in the money supply. Such a process might more accurately be called deleveraging (as businesses and people spin off devalued assets) or price deflation.

There are other explanations, of course, for the collapse in prices, though they are likely not Austrian. Some may have to do with the collapse of credit (and subsequent lack of payment of interest) but Austrians do not formally recognize credit as money. Some Austrians, in fact, question whether fiat money ever goes away (short of burning the stuff) – and thus the money supply doesn't ever really contract. Thus, what we may be talking about when we examine other definitions of deflation is actually a reduction in the velocity of the circulation of money – which is in turn based on the value that people put on money (as the great Henry Hazlitt has pointed out among others).

It is also important to note that the money supply NEVER conforms to the economic reality in a mercantilist, central-banking, fiat money environment. In fact, there is no direct, quantifiable relationship between money-in-circulation and its price. Central bankers actually tried to diminish money-printing in the early 20th century to conform to economic ups and downs, as we understand it (because that was how the "real economy" worked ), but they were no better at tracking the "downs" than the "ups" of economic output and soon abandoned the idea altogether. Thus, we have a situation where central banks simply stimulate no matter what. They stimulate when the economy is expanding and they stimulate when the economy is contracting. Thus, in a sense, the money supply itself never contracts.

Nonetheless, we have "deleveraging" or "price-deflation," and we will have deleveraging until such time as prices readjust to the actual money supply. Bill Bonner believes this process will take a number of years. We are not so sure of the timeline as he is. We continue to believe that the massive amount of money that central banks have put into play via bank reserves, etc. could circulate sooner rather than later. It is all quite unpredictable, and not necessarily a science. Thus we are not so sure as Bill Bonner (admittedly a maven in this field as we are not) that deleveraging is necessarily a long-term phenomenon.

The re-occurrence of price inflation in no way indicates that the current business cycle or precious metals bull market is winding down from our point of view. In fact, price inflation will mark the final and deadliest leg of this current cycle before it draws to a close. When price inflation does happen, as we believe it must, central bankers will be forced to raise interest rates fast and hard. It will be the final and most intolerable part of this Great Recession. We are not even sure, however, that central bankers have the stomach to raise rates and do the other things necessary to fully damp the velocity of money they have set in play. The amount of pain that may have to be inflicted could destabilize Western society or turn the Great Recession into the Great Depression.

We continue to believe, along with Bill Bonner, that sooner or later the current system, which has lasted in aggregate about 100 years from our point of view, is probably doomed to unravel, at least to some degree. We have suggested that what comes next is some sort of gold and silver based system. Bonner makes a similar point in this interview. Since he is a great deal smarter than we are, we are gratified by his analysis.