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INC.: Such as?
SALVIGSEN: The long-term U.S. Treasury bond is the only investment that can really benefit if interest rates go down to the median rate of return of the past 200 years. The long bond will be in demand, so it won't hurt to move into it early on. There are three other forces that are going to have to buy that same piece of paper. The Social Security Administration, which has built up incredible surpluses -- those funds must be invested in Treasury obligations. The same thing for the FASB [Financial Accounting Standards Board's] 87 financial disclosure rule coming next year, which will cause the private pension-fund system to move more into safe bonds. Then there's the aging of the yuppies.
INC.: What influence will they have?
SALVIGSEN: As yuppies get older they'll go for bonds like they went for Reeboks. Yuppies are responsible for putting all this debt on the books. They bid up the price of housing, and they used a lot of credit. Like anyone else, as yuppies pass into midlife over the next 15 years, that same generation has to get out from under borrowed money and the illiquid assets it is paying for, and consolidate into liquid assets that are income producing. We don't think that can be a smooth adjustment. Because to whom will they sell their five-bedroom barns, if the population behind them is smaller and the older people want smaller dwellings?
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INC.: In your scheme of rolling depressions, couldn't business in general stay healthy while certain sectors suffer setbacks and recover? Perhaps you don't have so bleak a view as it sounds at first.
SALVIGSEN: That's true. It's not nearly as bleak as the word depression implies -- as long as the debt liquidation rolls through the economy sector by sector. What would make it bleak is if all the sectors entered a rolling depression at once. Then you would have a real debacle, such as the 1930s.
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INC.: Otherwise, what?
SALVIGSEN: You can appreciate the rolling-depression setting by noting what happens when banks decide to loan a sector a lot of money. In the Farm Belt, they loaned the farmers all the money they needed for whatever reason -- tractors with air-conditioners and tape decks -- in the early '80s. It seemed safe. How could they miss? People need to eat; we'll feed the world. Brokerage firms were accumulating farmland to sell to their investors. When you step back, it was ridiculous. How could people afford to eat with wheat at $6 a bushel, when they couldn't afford to eat at half that price? You saw what happened: the farmers got killed. So then banks wouldn't loan to the farmer anymore, and they had to find another sector. Where did they loan the money in '81 to '84? To the Oil Belt. Capital rushed to Houston and Dallas, and there was building all over the place. Then energy got killed. It's easy to determine who will get it next: the sector that is attracting the capital. Since we hit the wall in 1981, every time a sector attracts capital, that sector gets killed.
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INC.: To wit, Wall Street?
SALVIGSEN: I don't think anyone who lives in the Northeast would argue that there are not excesses on Wall Street. BMWs are the tape-decked tractors. What is the easiest loan to take out right now? A home loan. Not in Houston, but where the financial sector is prospering -- in Manhattan, and Boston, and Chicago.
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INC.: What would precipitate a full-scale depression?
SALVIGSEN: A depression in the classical sense means you have a net credit liquidation for the whole system. So far this decade, you've had credit liquidations in the farm and energy sectors, but consumer borrowing and government borrowing offset them. So the aggregate debt load has continued to climb. At some point you run the risk of undergoing a national liquidation.
That probably gets triggered more by policy error than anything else. Everybody says you can't have a depression because nobody will let you. Except you've had about nine of them so far, and somebody let them happen.
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INC.: What is your worst-case scenario for the public?
SALVIGSEN: A worst case would follow from a mistake in policy in the middle of an average recession. Stopping credit growth too quickly would be such a mistake. If the feds raised taxes and raised the discount rate, and shrunk the money supply even more than they have already, there is a possibility of a cataclysmic event. With this much debt, it is very hard to judge how much you pull on the string before the string pops. Even a midsize recession at this point would be brutal, with all this debt. People with debt will find themselves without an income; businesspeople with a lot of LBO debt on the balance sheet will find themselves without the cash flow they've been counting on to service the debt.
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INC.: How about if we're already liquid?
SALVIGSEN: Another worst case that people don't appreciate is when interest rates go down from here without the stock market going up. You'd be amazed at how few can benefit from that scenario. Especially large pools of money like private pension funds, endowment funds, the state pension systems, and so on, which are obliged to pay out a lot of money in the future. If they're not protected, that also will be catastrophic, because they won't be able to meet their actuarial obligations. The actuaries have predicted -- incorrectly -- that if interest rates go down, stocks will go up, and everything will be protected.
