Editor's Note: An earlier version of this story incorrectly indicated that stocks had stagnated on an inflation-adjusted basis.
"Hear Me Now, Believe Me Later," was the title of two separate and prescient pieces penned by Pomboy, an economist and founder of the MacroMavens research boutique. One, published in March 2006, foretold the disastrous costs of the housing bubble. The second, somewhat later, laid out the consequences of the bubble's "financial echo." Today, Pomboy predicts something more draconian: the demise of fiat money—currencies that aren't backed by anything other than government decrees that they have value.
We checked in with her last week, as central banks around the globe weighed more easing and as Fed chief Ben Bernanke described to Congress the headwinds facing the U.S. economy, including the automatic tax increases and spending cuts set for year end, called the "fiscal cliff." With the Fed being the biggest buyer of Treasuries, Pomboy thinks the 40-year-old fiat system will crack within five years.
Barron's : What don't investors anticipate today?
Pomboy: That the Fed will be a presence in the Treasury market for a long, long, long time. Some believe that, with another round of quantitative easing, we move forward, emerge from the morass, and the need for further intervention will dissipate. But the Fed is really the only natural buyer of Treasuries anymore. It will have to continue to monetize Treasury issuance at the same time all the other major developed economies—from the Bank of Japan to the Bank of England to the European Central Bank—are doing the same. Pursue that to its natural conclusion, and you see the inevitable demise of fiat money. To look at our policies and not be concerned about the risks to our currency would be dangerously naive.
One step at a time. When is the next round of QE?
You recently wrote an entire piece about the importance of the Bank of Kazakhstan. Why?
Economics is so dull! You have to inject a little levity when you can. We know that the Bank of China, India, and major emerging-market economies have been slowly diversifying out of their dollar reserves into hard assets. When you get to the point that the Bank of Kazakhstan is thinking: "We really need to figure out a way to diversify out of dollars," it is a pretty profound statement about the quality of the dollar. Here in the U.S., it doesn't seem like any investor is concerned about the risk of the demise of fiat money. I'm sure most people think I should be fitted for a straitjacket.
The real urgency for QE is not the economic outlook, but that the Fed has made itself the only natural buyer of Treasuries; during QE2 they were 61% of the market. At the peak of the housing bubble and globalization nirvana, foreigners absorbed 82% of Treasury issuance; today, it's 26%. While we are enjoying a short flight-to-safety bid, courtesy of Germany's Angela Merkel and the euro-zone crisis, that's not a sustainable financing strategy. Now people are paying for the privilege, after inflation, of owning that paper. We have over $1 trillion annually in Treasury issuance, and our foreign creditors are buying $300 billion. That's being absorbed by the flight-to-safety bid, as hedge funds cover short positions and bond managers extend duration.
Our creditors have limited diversification choices, too.