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Famed Broker Warns: Worry About America, Not Europe


Peter Schiff believes that if we don't practice austerity soon, we will soon be experiencing hyperinflation and the collapse of the US dollar.

Forget all the woes in Europe, and start fretting about the US instead.

That was the advice dished out by investment guru and Euro Pacific Capital CEO Peter Schiff at his firm's second annual Global Investor Conference, held Thursday at the Sofitel in New York City.

Giving his opening address, Schiff noted that the eurozone crisis has given people an impression that the US is doing relatively fine, since the dollar is rising and GDP has gone up. Thus people have been buying dollars and Treasuries, thinking that those are safe havens, when they are actually not.

"I hear a lot of people say: If it weren't for Europe, things would be much better. I think they got it backwards. The only thing we've got going for us right now is the European crisis. It's because people are so worried about Europe that money is flowing into our bond market and to the dollar," Schiff said.

The 49-year-old likened people's appetite for US Treasuries to the hype for the Facebook (FB) IPO, saying that "a lot of people who wanted to buy Facebook wanted to because they were convinced they could flip it to a greater fool," only to realize after the IPO that there were no more greater fools.

"People are buying dollars and Treasuries and they think it's safe. But what happens when they actually take a closer look at what they own and decide that they don't want it anymore?" he questioned.

The picture Schiff painted of the American economy and the weight of the federal debt was a grim one. He noted that the 2% GDP growth the US notched up was achieved with 5x the amount of GDP growth.

"If you're an analyst and you're looking at a corporation and you see the assets went up, but the liabilities went up 5x as much, would you be impressed by the asset growth?" he quipped, adding that at some point, our borrowers will want their money back.

"The idea is that we're not going to pay it back. When bonds mature, we're just going to borrow money from the people whom we owe it to so we can repay it. And where do we get the money to pay the interest? We borrow that too, from the same people who loaned us.

"That's a great plan, until it falls apart. That's the plan that Bernie Madoff had," he said wryly.

Worse still, Schiff said that the national debt was actually much larger than we think, because contingency liabilities like Social Security, government pensions, and Medicare have to be accounted for. So do mortgage guarantees and student debt guarantees, because statistically speaking, there will be a percentage of those that will not be paid up.

"The government guarantees $100,000 in student loans for somebody who majored in social anthropology. There's a pretty good chance that student's not going to pay, so the government might have to cough up some money," he said.

The only thing that is holding the precarious US economy together now, he asserts, is the Fed's continued 0% interest rate policy.

"I hear people saying all the time that quantitative easing, 0% interest rates, they were the training wheels on the economy and we needed those training wheels for a while. But now that the bike is riding along nicely, we can take the training wheels off and the economy can go on its own. No! That's not the truth. The fact is the stimulus isn't the training wheels. The stimulus is its only wheels. The economy is rolling on stimulus. And the Fed knows if they take the training wheels off, then the bike falls over and we'll be right back in recession."

What will happen if the Fed raises interest rates? Schiff presented a thought experiment with JPMorgan (JPM), with its recent $2 billion-and-counting trading losses, pointing out that the firm would lose a lot more money if interest rates spiked. He added all the big banks like Citigroup (C), Bank of America (BAC), and Morgan Stanley (MS) would not survive a big increase in interest rates.

That was why, he argued, in the Fed's recent bank stress tests, it didn't mandate a test for a scenario in which interest rates went up.

"Why didn't the Fed ask the banks: 'Why don't you run these scenarios: What about a bursting of the bond market bubble, and interest rates spiked way up?' Why not stress test that and see how the banks balance sheets respond? They didn't do that because they knew the banks would fail that test.

"Banks make money by borrowing from the Fed at practically nothing, and lending it to the Treasury. They also make loans, but they're not getting money from depositors. Who puts money in the banks? The return is zero! So they get their money from the government. But if the fed funds rate went up to 5%, 6% or 7%, how much money would these banks lose? The positive carry would go negative, and their cost of funds would skyrocket," he elaborated.

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