Bud Conrad: Japan Is Forcing Us out of the Eye and into the Storm

Chris Martenson: Welcome to another podcast with Chris Martenson. I am your host and today we are talking with Bud Conrad, Chief Economist for Casey Research. We are big fans of the operation Doug Casey has built and Bud is doing great work there. Bud holds an engineering degree from Yale and an MBA from Harvard. And is also the recent author of the book, Profiting from the World’s Economic Collapse. So today, he and I are going to discuss his vision for where the economy is headed and what impact he expects the unfolding developments in Japan to have. Welcome Bud, it's great to have you here today.

Bud Conrad: I am looking forward to our discussion, Chris.

Chris Martenson: Oh me too, me too. So you and I share something of a background. So I say “Chief Economist” and I know a lot of people are thinking you’re a traditional economist, but you and I share a nontraditional approach to this and I think the alignment is that both of us understand systems and look at this as a systems issue; and we understand the role of energy and the economy put together. Why don’t you talk a little bit about your background, if you could?

Bud Conrad: Yeah, that is a great place to start. I have long worried about how our economy worked as a sort of amateur. I had a whole career in the computer industry, starting with IBM and ending with Tandem, a company acquired by Hewlett Packard. But I decided to take – it was something that I would call a personal love – to understand how the world works. How is it that these paper system connect up to each other and how should we protect ourselves from what looks to be the destroying of the purchasing power of a currency. And I applied my engineering kind of look to create a systems approach, to understanding how things all connect up. There is a chapter in my book, Chapter 6, that tries to make a bigger picture model of how these all hang together. But of course, in today’s crisis, one wants to understand how the political system affects the economic system and the point of all this is to say: I am not a traditional economist who has had a formal education that I think really limits an understanding of how all these things hang together.

Chris Martenson: Right, so this is exactly the view I have – much of traditional economics tries to find that perfect equilibrium point. There is one in their minds. If you just pull the right levers and dump enough money in, something happens. And if we get to the right amount of joblessness at three to four percent, you have the right amount of economic growth, also at three or four percent – that there is something that we can do to twist things around and get to a point of equilibrium and I’m fundamentally opposed to that idea. I think that we live in a very dynamic world. It's a world of exponential growth. If there is any sort of an equilibrium at all, it's a state of constant change, is how I see it. And the fundamental thing that we are addicted to at this point is growth. As long as our debt supply is growing, as long as our money supply is growing, as long as our economy is growing, everything works reasonably well. But there might be a wrinkle in that story. Do you talk about that?

Bud Conrad: Yeah, of course. They say “Trees can’t grow to the sky” – expediential growth can’t go on forever. You know traders and the marketplace sort of know this intuitively. George Soros writes a book called, The Alchemy of Finance, including the theory of what he calls reflexivity, which I call feedback loops, which is when things start to move, they pendulum in one direction. It will go right past equilibrium very fast, meaning the vertical position. In fact the fastest, going to the extreme. And currency trading, which was his experience is a good example, where things oscillate and move beyond what they could be. People often talk about bubbles. We just experienced some pretty big ones in our own stock market and real estate. And of course, we get to this business of unsustainability too, when you move things forever. And the key one behind this that is great in your book and I think that it's wonderful you focused on it, Chris, and it's Chapter 2 in mine, is the creation of debt. What has happened is that we have had an egregious creation of debt, mostly around mortgages, private debt that grew to an extreme that couldn’t be sustained. It was obvious in 2004 and certainly very obvious by 2006 to me that this couldn’t go on forever and of course, we did have the terrible collapse of particularly housing that we are still facing and of course, the stock market too. When you look at charts historically of debt growth in the private sector and overlay debt growth in government sector, you realize that as the people stop borrowing to buy more houses, the government has now stepped in to do borrowing and paper over the last crisis.

In other words, we’ve gotten from a position of too much private debt to too much public debt. They have  – by throwing a combination of guarantees of something like ten trillion dollars, papered over the problem of our private sector no longer growing, into government debt growing and creating what I’ve called, “the eye of the storm” that we’ve been in, in the last recovery since March 2009. And the government can print out money for a while to make things feels better, but then the government basically loses confidence or people lose confidence in the government and government debt, just as we lost confidence in Goldman Sachs and private mortgage securitization-types of debts. 

And now, we are about to enter a era where the question of sovereign debt and currency difficulties will take over from the private debt-types of problems that we saw with Lehman Brothers. It's kind of complicated, but to simplify this we went through a crisis that became a terrible storm. I think we went through the eye of the storm and I think we are coming out the other side with things like what we have seen in Greece, Ireland, and Portugal, as government debt problems. I think our own government is very close to having that. We are past the point of no return on the amount of debt the government has already taken on and it's taking on even more debt.

Chris Martenson: Right. So I see this as sort of – there’s a nested set of things occurring here. Some people I think mistakenly say, “I think the crisis happened in 2008 and then we had some responses in 2009.” And so they hold that narrow view of saying, look there was a little bit of transference from the private side of debt accumulation to the public side and when things get better we will just of maybe shift that back again. But if we widen up a little bit and go back, we could actually start to source this problem, maybe five years ago or ten or twenty. In fact, I see this thing as really we’re living in extraordinary times. This is a moment where we might have to face several generations of excessive debt accumulation and consumption and it's a painful process of adjustment. What you are calling “the eye of the storm,” can I characterize that as really an effort to dodge the pain of having to face up to whatever length of period of overconsumption?

Bud Conrad: Absolutely. I will put a few more basic points on it. The original currency idea is to have exchangeability for something of value. In other words, gold or silver – we had a bi-metallic system. We became the only country standing pretty much after WWII and the world based its currencies on our currency. We based our currency, saying we would stand behind $35/ounce Bretton Woods system – up until 1971, when we couldn’t everybody for all the dollars we had printed up. Nixon went off the gold standard. We based then kind of on a face that US Treasuries would be a backing for our currency and it seems odd to have paper backing paper. But when we got to QE1, the Federal Reserve buying up toxic waste as the backing of our currency is absolutely to the point of insanity. That toxic waste mortgage-backed securities are now the backing of the issuance of paper currency to the tune of a trillion and a half dollars, leaves one just shaking their head.

Chris Martenson: Now, hold on – are you suggesting that the dollar bills in my pocket are now backed by a subdivision in Las Vegas?

Bud Conrad: [Laughs] Perfect.

Chris Martenson: I just wanted to clear that up. [Laughter]

Bud Conrad: And it really is. I think I always go back to the fable that the emperor has no clothes. For some reason, by convention we have continued pass these paper slips around with President’s picture on them. Or more importantly today, just digital bits in a computer somewhere, started by the Federal Reserve, but anyway as the credits and values of our wealth. Of course, it's a scoring system and therefore has some relative value in our continuing acceptance. But it's one of passing one hot potato to the next. It's all a sham in some “real sense,” because all the currencies in the world are paper money. My long-term view of that system is that it will collapse, as have all fiat currencies forever, usually about once a generation for a major society and fortunately the dollar has lasted the second longest currency on the planet, only after the British pound. But I think all of them are vulnerable to major long-term inflation that will destroy them – and I am claiming that within my lifetime. That basic bias about the value of the dollar affects all my vision about investing, in the sense that I think the paper and financial system collapses for real, when enough people stand up and say, you mean the emperor doesn’t have any clothes on? It will happen and the question is what are the trigger events that bring some of that about? And we are seeing events around the planet, just as we speak. 

Chris Martenson: So if every generation or so paper money sort of gets away from the handlers and becomes worthless – that is really a process of disconnection between the amount of money that is created and the underlying assets that are backing it, the productive economy, the things that are being truly being produced. So if that is a normal sort of a rhythm that happens throughout history, let’s turn our attention for a second to what happens when something a little bit bigger happens, which is if we agree that it's really the goods and services that undergird the value of a dollar or any currency: what happens when the master resource, the one without which no goods and services can be produced at all – and I am talking about energy now – what happens when we can throw some real prudent adult-sized concerns and questions about the ability of the energy infrastructure to continually grow? That’s going down I am convinced with peak oil and now with this nuclear event in Japan. I think we have to scrap a whole lot of ideas around how much nuclear power we are going to be adding into the mix over the next few decades. We put those two pieces together and I see an energy shortfall and I see massive money printing happening. So when we talk about the gap between what’s real and how you value it – that is your money – I feel that we are in an accelerating process for that gap to widen. How do you see it?

Bud Conrad: Boy, right on – almost – you don’t need to interview me, because you got it nailed in my view, Chris. Let’s add a few more just background pieces. Your book nicely points out the wonderful chart I have used in talks about the finding of oil on the planet by decade. You have nicely made a chart in your book, which will be coming out pretty soon that says how much oil we have found in a decade compared to how much we are using in the decade. And up through the 1960s we were finding significantly more oil than we were using. Those times were when we were finding reserves to eventually produce. Right now, we are finding about a third as much oil as we are using. That is clearly unsustainable. And if you look at the big picture, I usually give a talk, which I title, They aren’t making any more dinosaurs, based on the basic concept that natural fossil fuel sources of energy were laid down over a period of a hundred million years and we just used up about half that supply in the last hundred years, which is obviously using it a lot faster than the dinosaurs are rotting – and we just combusted it. Oxygen combines with hydrocarbon and breaks it down into the atmosphere – and that’s the end of it. It doesn’t come back. It's not like growing food, where you come back and plant a crop next year: this is gone. We will never have those complex hydrocarbons for constructing plastics or food or petrochemical feedstocks and all the valuable things that they could be, because they are nice molecules for chemical processes, because we just burn them up. A little bit of an aside, but the big picture point-of-view; having used up that half of the planet’s fossil fuels and in this case, oil particularly in a hundred years, one questions the future of humanity.

I think you and I Chris, have lived in probably the most abundant time for humanity as all that energy has given us the wealth and the ability to create things that never existed. I came through the computer industry. I love what we have done with telecommunications and electronics. Steve Jobs grew up in the house across the street from where I raised my kids. Maybe he went to the same high school a little sooner than my kids, but I love the iPad that I purchased in the store, waiting in line last spring, and I haven’t gone to an iPad II, but all of this depends on having a source of energy to take the work off of the backs humans, horses, or animals to grow our foods for example. At the turn of the century, my dad was growing up on a farm in Ohio a turn of the century ago, fifty percent of the people on the planet were cranking out food in our own country. Now, three percent of the people provide the food by driving tractors and having mechanization and having hybrid seeds and fertilizer – all of which depend on this energy source that has given us this abundance. And the reason I went into all that elaborate is to suggest that the life of the future, if we are intent in fact as I think, are likely to not be able to increase of quantity of energy produced, will limit the increase wealth to spread around our human existence. In other words, our lifestyles probably will not grow for our children the way they did for us in terms of abundance. We have to face some real limitations of what the personal wealth and living styles will be as we go forward, because of this very fundamental limitation of nature – that the planet can only support so many human beings. We are not sure what that level is, but I don’t think it's infinite growth anymore.

Chris Martenson: And I think that narrative is just creeping in at the edges. I mean for me, it is central to my life and for the people who happen to subscribe to that it is central. But it is still not mainstream yet and this is my chief concern. So if we turn to Japan for a second: I am really concerned about the implications for the global economy that are embedded in the Japan story. And my concerns kind of go like this – I don’t think the world is prepared for the world’s third largest economy to violently shift from being a net exporter of both goods and more importantly, liquidity and funding, to a net consumer of both. So I mean just think about – Japan has been like this – if it has been emanating anything for the past two decades it’s been to spend yen like crazy and it's been taking their trade surpluses and recycling those back out. There’s been a flow that has been established that is now about to shift in the other direction. And when we look at things that we just don’t fundamentally know about – we don’t know what six hundred trillion dollars in derivatives, most of them interest rate-linked, and a lot of them forex linked – we don’t know how those are going to behave with some sort of an insult like I am talking about.

And as well, there is a deeper story under this. Kind of like when the Deep Water Horizon blew up, yes we said oh, okay so there’s a primary story, which is about oil and oil exploration and risks, but there was a deeper story, which was about the limits of technology. And I think some people are still wrestling with this internally, oh what does this mean that our best efforts can sometimes be forted? That’s not the story that we want to be hearing right now. 

So when I look at this, I am looking at Japan now as potentially a point of recognition at which a couple of things come due. One is that we can’t – our growth story for next year is kind of shredded, but maybe something larger is shredded. Maybe the longer growth story, maybe it's not next year, maybe it's the year after that. And then also, there is going to be some really violent perturbations as those capital flows reverse and the liquidity flows reverse. There are eddies standing up and swirling, where there used to be just a nice comfortable stream. And there is an element of all of this being just slightly out of control of the fiscal and monetary authorities. In Japan, I can see that also spreading. It's like a Greece-like awareness moment, but on a much larger scale. What are your thoughts there?

Bud Conrad: Oh boy. I wish I could even – I mean we are watching societal collapse there in Japan. I have a couple of email lists. There’s panic in Tokyo. They would like to say, well let’s evacuate Tokyo. You can’t evacuate Tokyo. Twenty million people. You just can’t move them at all. There is no good answer.

Let’s start with the more simple one, rather than get to the financial one which has not completely unfolded enough to say, but the energy piece of this – we really do have a very, very serious problem that we started with here that we are going to at some point, run out of fossil fuels and need an alternative. The most obvious alternative certainly to oil, was coal, but out of fossil fuels was to a new form of energy: nuclear. And we have power plants across the planet, although they haven’t been developed much recently, it looked like a good alternative to the limitations of fossil fuel. I think nuclear, as an energy source, is now dead for a couple decades from this diaster. What that means is, instead of building new nuclear plants to off-load some of the required sources of energy, we will be decommissioning plants and fearful because of what is happening. Right now, it is not clear at all what is going to happen to Fukushima. They cannot get the workers in, because the radiation levels are so high. They are flying helicopters over top, but even the helicopter pilots are getting contaminated by trying to squirt water from a distance. It looks like they are flailing with anything they can think of. At some point, this could match Chernobyl and the flotsam and jetsome is there will be no more nuclear plants.

That puts more demand on perhaps natural gas to provide for – at least in the United States – an electrical powered generation, since we have a pretty good abundance of it and came up with this new fracking system to be able to provide greater supplies of it. I think that is kicking the can to some extent, in the sense that I don’t see us being able to produce growth in energy at the level that the population of a planet, particularly Asia, wants to grow its economies. We cannot meet China’s demands for growth as they industrialize. And there are some great convulsive collapses coming, just through the demands of energy. All of this has been discussed, without discussing – the point I think you brought up and we should do it – the financial piece of it. But just look at the problems of supplying the energy the world demands. We don’t have the resources to do it.

Chris Martenson: Right, so let me just go on that for just a second. China from 2000 to 2009, doubled their energy consumption and of course this is across – 

Bud Conrad: And more than doubled their imports, because they are sizable, but not an overwhelming producer.

Chris Martenson: Right.

Bud Conrad: I think the world trade piece of energy – I am interrupting a little, but the sideline is worth it, because it is an area that most people don’t realize – is net energy exported by these countries that are big exporters is significantly less than the growth of their internal production, because they use it themselves. I am thinking particularly of the Middle East, where population growth is exponential and therefore the net exported energy is not growing by a factor significantly less than the production, which also isn’t growing. I don’t know if you know Jeffrey Brown’s work on –

Chris Martenson: Yes sir, I have met him.

Bud Conrad: – planned export model, you know Jeff?

Chris Martenson: Yep.

Bud Conrad: Okay, I am just inserting that it is worse than we think it is.

Chris Martenson: Well we have the exponential collapse of exports, because it is being eaten from both ends. First, production declines in most countries, with very few exceptions, and then also –

Bud Conrad: Go through the North Sea, Cantarell, yes.

Chris Martenson: Yes and then consumption increases also on a percentage basis, so when you have a percentage decline and production being met on the other side by an increase in consumption, that’s a double exponential whammy to exports, because your exports is the difference between production and consumption. And so the really vital point, to circle back really quick, is around – I know that there are nuclear plant designs today that I am actually reasonably comfortable with, but I happen to live about twenty miles from a nuclear plant that has the exact same design as Fukushima’s. Right? It's one of these GE –

Bud Conrad: – reactor, yeah.

Chris Martenson: Yeah, there it is and it's right at the end of design life and literally the day before the Fukushima incident started, it was recertified by the Nuclear Regulatory Agency and guess what? The people of Vermont are very unhappy with that and it will get contested. Point being that I think even if we build nuclear plants of these new pebble bed designs or other designs as fast as we can, they will probably just be replacing the ones like the one near my house, which I bet now gets decommissioned. So even if we build plants as fast as we can, on a net basis we are probably not looking at – on a best case I think we are looking at zero for nuclear for a long time.

Bud Conrad: That’s the optimistic story and I agree with you. I think we should. I am not as fearful as maybe I suggested that our public will be, after this particular problem unravels and we see what the result is or they have a sarcophagus in Fukushima. I would ask just a little bit though and you said a net zero as a result – if you think about what we need for energy, I think the number is like fifteen trillion giga –