January 12th Gold Chronicles topics:
*What happens if the Fed does or does not raise rates in 2015
*QE4 Early 2016
*China coming debt crisis – Trillion dollar ponzi scheme
*Gold second best performing currency of 2014
*Gold and dollar acting as safe havens
*Gold becoming harder to mine, mining companies cant simply mine as much more as they would like
*Chinese show no evidence of letting up on gold purchases
*How gold will behave in a Japanese style inflation
*In a massive deflation, the government can always raise the price of gold
Listen to the original audio of the podcast here
The Gold Chronicles: January 12, 2015 Interview with Jim Rickards
The Gold Chronicles: 1-15-2015
Jon Ward: Hello, I’m Jon Ward on behalf of Physical Gold Fund. We’re delighted to welcome you to our first webinar of the New Year with Jim Rickards in this series we’re calling The Gold Chronicles. Jim is an investment banker and an investment advisor based in New York, and he also serves on the Investment Advisory Committee for Physical Gold Fund. He is the author of the New York Times bestseller Currency Wars: The Making of the Next Global Crisis and most recently The Death of Money: The Coming Collapse of the International Monetary System, also a New York Times bestseller. Hello, Jim, and welcome.
Jim Rickards: Hi, Jon. How are you?
JW: I’m great, thanks. I’m looking forward to today’s webinar where we also have with us Alex Stanczyk of Physical Gold Fund. Hello, Alex.
Alex Stanczyk: Hi, Jon. It’s great to be here, thanks.
JW: Alex will be looking out for questions that come from you, our listeners, so let me just say that your questions today for Jim Rickards are more than welcome.
Jim, in this first webinar of 2015, let’s take a look forward. Why don’t we start with the Federal Reserve? They made it clear they’d like to raise interest rates. But they’re holding back for now, in what looks like a push-pull going on here. Let me ask you two related questions. What happens if the Fed does raise rates? And what happens if it doesn’t?
JR: It’s unfortunate that we have to be spending so much time on the Federal Reserve. You’re right; it is the place to start and is the key to understanding a lot of what’s going on in markets. Nothing is more important, but I wish that weren’t true. I wish the central banks could go back to just being boring, opaque, marginal institutions that took care of money supply and acted as a lender of last resort instead of these monstrosities that seem to manipulate and invade every corner of every market in the world. But unfortunately, that is what we have. When you manipulate the dollar and dollar interest rates, you are directly or indirectly affecting every market in the world – equities, gold, real estate, other commodities, junk bonds, corporate debt, etc. So it is the biggest question, but I wish it were otherwise.
Let’s take your two scenarios: What if they raise rates? What if they don’t? I’ll address both of those directly but would like to spend a minute on the background to help our listeners hopefully understand what’s behind the debate. The Fed has certainly signaled that they intend to raise rates, there’s no question about that. That is what the Fed has signaled and what the markets expect. Securities around the world — equities, bonds, etc. — are priced as if the Fed were going to raise rates. I’ve never seen anything more trumpeted and more advertised in my career, and there’s good reason for that. The last time the Fed raised rates was 2006. In terms of cutting rates, they hit bottom in late 2008 when they got to zero, and they’ve been at zero ever since. It’s been six and a half years at zero, but you have to go back two years before that to find the last time they raised rates, so it’s going on nine years at this point. That’s a long time without a rate increase, and maybe people forget how nasty they can be.
I was in the markets in 1994 when the Fed raised rates, and it was a wipe out. That’s when we had the bankruptcy of Orange County, California, and other dealers went out of business. There was a bond market massacre. The same thing happened in 1987. A lot of people recall the crash of October 1987 when the stock market dropped 22 percent in a single day. In today’s market, that would be the equivalent of over 3,000 DOW points. Imagine the market dropping not 300 points, which would get everyone’s attention, but 3,000 points. That’s what happened in October 1987. But before that, in March of 1987, there was a bond market crash. The bond market crash preceded the stock market crash by about six months.
These things can get nasty and I could say it’s been a long time since the last one. That’s why the Fed is talking so much about it. You have to go all the way back to May 2013 when the Fed was still printing money and buying bonds (long-term asset purchases as they call it) when Bernanke, chairman at the time, first started talking about maybe beginning the taper. They didn’t do anything. They didn’t cut purchases and they didn’t raise rates — they just talked about it — and still the market threw a taper tantrum fit. We had the actual taper through the course of 2014. Now the taper is over, QE3 is officially over, so this thing has been really advertised for two years.
There’s a reason for that. The reason rates were at zero in the first place is because the Fed was trying to pump up assets. They wanted banks and other borrowers to go out, borrow cheap money, buy houses and stocks, bid up the price of assets, and create the wealth effect. Hopefully, that would make people feel richer, they would spend more money, and the economy would get on a self-sustaining path. That didn’t happen. The asset prices did go up, but the wealth effect did not kick in and the economy is still very weak. The Fed did not get the kind of 3.5 to 4 percent growth they were really hoping for when they started all this. I think if the Fed had it to do it over, they never would have gone down this path or at least not stayed on it this long.
They had encouraged everyone to borrow money and lever up and do maturity mismatches (borrow overnight in the repo market and go out and buy some risky asset like stocks or other assets). Because of that, they wanted to give people lots of warning — hey, we’re going to raise rates. If I’m a dealer, I can borrow money overnight in the repo market and go out and buy a 10-year note, which until recently was about 2 percent. I have zero cost to funds and I make 2 percent of my 10-year note, but I can leverage that trade 10-to-1 because I can get more than 90 percent margin in the repo market. A 2 percent profit levered 10-to-1 is a 20 percent return on equity, so with a government security as my asset, it’s not like I have to go buy some junk bond.
As long as rates were at zero, it was pretty easy to make 10, 20, or even 30 percent returns on equity with a highly leveraged trade. You say that sounds a little too easy; what’s the risk in the trade? Well, there’s no credit risk in the trade because you’ve got a treasury bill as your asset. The risk is that they may raise short-term rates while you’re sitting there with overnight money holding a 10-year note. All of a sudden the overnight money gets to be more expensive, the trade is upside-down, and you’re losing money. The Fed was saying we encourage everyone to do these crazy carry trades, do these maturity mismatches, make a lot of money, and rebuild the bank balance sheet. The time will come when we’re going to raise rates, but we’re going to give you years, literally, to get out of the trade or wind it down or hedge it. Anybody who’s caught out, shame on them, as you can’t say you weren’t warned.
The Fed wants to raise rates to normalize things. They’ve been talking about it for almost two years because they want to give people plenty of warning, but the markets don’t listen so well, at least there’s always somebody who doesn’t get the message. As I look around, there’s still a lot of leverage in the system, enormous leverage in the stock market, enormous leverage in various carry trades around the world. Chuck Prince, then CEO of Citicorp, said prior to the last world financial calamity that you have to keep dancing as long as the music’s playing. There are some people who literally either won’t listen to the Fed or don’t believe them, etc. and are still going to be in these trades.
The short answer is I expect a lot of market disruption. I think this might throw the U.S. economy into a recession because the economy is fundamentally weak. Some people have been smart enough to get out of these carry trades, at least based on the Fed’s warnings, but some people have not and will get a rude awakening. They may have to unwind those trades quickly, and we may see a lot of liquidity pressure. We’re seeing it anyway, by the way, based just on the talk. Imagine the reality of the Fed actually raising rates for the first time in eight years.
I think we’ll have a very bumpy ride and it won’t be soft landing. Beyond that, the whole idea that the Fed would raise rates was based on a forecast that the economy was getting stronger and we sort of achieved self-sustaining growth. But nobody in economics, nobody on Wall Street, nobody on the buy side, nobody in academia, nobody I’ve seen anywhere has a worse forecasting record than the Fed. I don’t say that out of spite or to try to embarrass anyone; it’s just a fact. Year after year after year they produce these very high growth forecasts, and every year they’re wrong. They’re not just wrong by a little bit; they’re wrong by orders of magnitude. So when the Fed says, well, we think the economy is healthy enough for a rate increase, that’s the first sign that it’s not. Now besides that, there’s a lot of data. We’re seeing auto loan defaults go up, real wages are stagnant to down, labor force participation continues to be very low, our trade deficit is getting worse partly because of the strong dollar, emerging markets are slowing down, and China and Europe are slowing down. I think it’s nonsense to believe that somehow we would be closely coupled on the way up but somehow the rest of the world is going to go down and the U.S. won’t be affected by that.
Growth is weak, so not only would I expect some disruption from the rate increase simply because people don’t listen or they’re greedy or they stay in the trade too long, but I would say the Fed’s got the economy wrong and they’re going to increase rates into a very weak economy. I would expect probably for the U.S. economy to come close to a recession, more deflation, and probably some disruption in equity markets. The one market that might rally actually is the bond market. Ten-year notes are still pretty attractive based on everything we see.
Now, that’s if they raise rates. Let’s flip that around and talk about what happens if they don’t raise rates, because that was the other part of your question. Very, very few people expect this, but I actually don’t think they will raise rates. I’ve been saying that for about six months, and more people are jumping on board that bandwagon recently. I did a bunch of interviews in the fall where I said I did not think the Fed would raise rates in 2015. We can debate 2016 — that’s still pretty far away — but let’s just talk about 2015.
My view is the Fed will not raise rates, and more people are coming over to that view. If you go back six months just to last summer, the debate was the Fed’s definitely going to raise rates in 2015: the only question was would it be March or June? I was one of those saying they won’t do it. Well, here we are in January and nobody is talking about March. Even Janet Yellen said they weren’t going to raise them in March, so now you have your April people and your June, July people, but you’re hearing more and more people say maybe it won’t be until September. Bill Gross recently said he expects it in December. Tell me the difference between December 2015 and January 2016 — not much of a difference.
We’re starting to hear a lot of doubt about whether they will, in fact, raise rates. My view that they won’t is based on what I expect the data to show. I don’t have a crystal ball and I’m not sitting inside the Fed boardroom overhearing the chitchat. I’m basing this on what the Fed itself says. They say that the decision is data-dependent. If you look at the data, it’s coming in weak. I know we had this gangbuster third-quarter GDP, but there’s a lot of noise around that and it doesn’t appear to be sustained. It looks like the fourth quarter will certainly come in a lot weaker and first quarter 2015 may be weaker yet. We’re still not seeing any pulse in the thing that Janet Yellen pays so much attention to, which is real wages. Real wages are stagnant.
Remember that the Fed has a dual mandate that consists of trying to reduce unemployment (or create employment, depending on how you want to put it) and price stability. Sometimes those things are in conflict and they have to roll the dice on inflation a little bit in order to create jobs or other times they have to stifle job growth in order to damp down inflation. You can’t always do both of them at once, but sometimes you can. What’s the one piece of data where both parts of the dual mandate come together? One thing you can look at that tells you something about both is real wages. If real wages are going up, that’s a leading indicator of inflation, but it also tells you that the labor market’s pretty healthy because employees cannot get a raise or demand a raise from their bosses or their companies unless the labor market’s tight.
Real wages is the number one thing Janet Yellen is looking at. Guess what? They went down; they’re still going down. There doesn’t seem to be anything indicating, at least as far as the data is concerned, that they should raise rates. I think this is just the result of bad forecasting. They always forecast stronger growth than we actually get, and by the time they catch up to the reality of their forecast, they find out that we’re nowhere near what they expected. This is interesting because the market is set up for a rate increase. What if they don’t? I think we’ll get to the summer, the data will be lousy, the Fed will make it clear that they’re not going to raise rates anytime soon, and “patience” will just turn into more “patience”, using their new favorite buzzword. (They seem to come up with new buzzwords every six months or so!)
Once it becomes clear that they’re not going to raise rates, I think the markets might say that maybe they can never raise rates. We did QE1, QE2, QE3 part 1, QE3 part 2, then they promised to raise rates, and then they can’t do it. It wouldn’t surprise me to see QE4 in early 2016. What may happen then will be very interesting, because the stock market could actually rally on that. It won’t be rallying on fundamentals; it will be rallying on cheap money. The market’s expecting tightening. If they get ease, at least no rate increase and the possibility of more reason to form a QE4, markets might even rally. I’m not a big stock market bull, but if the Fed doesn’t raise rates — and my expectation is they won’t — you might actually see stocks higher at the end of the year than they are now based on more free money. I think by then the inflationary expectations will start to ratchet up, and that’s probably good for gold as well. It could be one of those periods in the second half of this year when gold and stocks go up together for the same reason, which is it’s apparent that the Fed has no way out of this dilemma.
JW: I’d like to pick up on one element you mentioned right at the end there, and that’s the dimension of inflation. Would you spell out how you see the impact of this trajectory you are forecasting on inflation?
JR: This goes back to literally the first couple pages of my first book Currency Wars which came out in 2011, and nothing has really changed my view since. The way to understand a global economy is we have inflationary and deflationary forces going on at the same time. They’re pulling against each other exactly like two really strong teams pretty evenly matched in a tug of war. I’ve used that metaphor before but I think it’s a good one. At the beginning of the tug of war, not much happens. You have one strong team pulling one way, another strong team pulling the other way, and nothing is moving. There’s enormous tension being exerted on the rope, a lot of force involved, but nothing happens right away. Eventually one team wears out the other, the losing team collapses, they get pulled over the line, and the outcome becomes clear, but it’s not clear at the start.
The natural state of the world is deflation, and we’re seeing a lot of visible signs that this has been true for years. There are three main reasons why the world wants to deflate. The first one is demographics. Work forces are aging, people are retiring, they’re spending less and saving more or there are just fewer people around in places like Russia and Japan. It’s not a question of birth rates slowing down; the population is actually declining. China’s population with the one-child policy has leveled off. The only reason the U.S. has some population growth is because of demographics, but more and more of our baby boomers are turning 60 every day. So demographics is one thing.
The second thing is technology. I don’t need to belabor this, but I think we all understand that we’re all more productive with computers and technology and the Web. But this means that people who used to hire an assistant or a couple of staffers don’t need them anymore, so that’s a driver for fewer job gains and is deflationary.
The final addition to those two reasons is de-leveraging because of the excessive debt which we’re still working our way out of. I know it seems like a long time since the financial panic of 2008, but in fact there was so much debt in the system and there still is. There’s been a lot of de-leveraging in the private sector, private balance sheets, but that’s been accompanied by increased leverage in the public sector. All we really did was substitute government debt for private debt to some extent because of the bailouts. What that means is that the system is still pretty highly leveraged and has a tendency to de-leverage.
With demographics, technology, and de-leveraging, we have three deflationary forces. On the inflationary side, we have money printing by all the central banks. We’ve talked about the Fed quite a bit, but the ECB, the Bank of England, the Bank of Japan, and People’s Bank of China are all leveraged just as much as the Fed, some more than others. The People’s Bank of China has printed more money than the Federal Reserve in the last five years. So you’ve got the inflationary force of money printing by central banks offsetting the deflationary force that we just mentioned — demographics, technology and de-leveraging — and these two powerful forces are fighting against each other. Right this minute deflation is winning as we see in oil prices, commodity prices, gasoline at the pump, and in a lot of indicators everywhere. But the central banks have not stopped trying, because central banks have to have inflation. There are reasons having to do with managing sovereign debt, tax collections, and bank balance sheets. We could spend the whole hour just on why central banks have to have inflation, but they do.
What does it mean when central banks and governments have to have inflation but they’re not getting it because the natural state of the world is deflation? It means they have to try harder. If they printed all this money and it hasn’t worked yet, then they probably have to print more, which is one of the reasons I don’t expect them to raise rates in 2015 and may even come back with QE4. This is very, very difficult for investors needless to say. If I told you that we’re going to have inflation, you would know what to do; you wouldn’t need much investment advice. You’d buy some gold or art or hard assets or get out of cash, etc. If I told you there was definitely going to be deflation, likewise you would know what to do: cash, bonds, and certain other things that do very well in deflation.
The problem is that we have both. One can prevail for a short period of time, but the other one never really goes away. I think the best way for investors to deal with that is to have a balanced portfolio, a diversified portfolio that has a combination of all the things I’ve just mentioned. You’re not going to win on all those trades, but you’ll win on a lot of them and at least you won’t get wiped out on the wrong side of a tidal wave when it comes. A barbell approach is some mix of inflation protection in the form of gold, fine art, land, energy assets, and some mix of deflation protection in the form cash and high quality government bonds. By the way, Warren Buffett has exactly that kind of portfolio. He’s buying railroads, oil, and natural gas to hedge inflation, but he’s got $55 billion of cash to hedge deflation. I think that’s the right approach. It’s not as sexy as putting all your chips on one side of the table, but it’s a lot more prudent, because we don’t know how this is going to turn out and you need to be prepared for both.
JW: Looking beyond the U.S. for a moment, Jim, there are murmurings of a coming credit crunch in China. Do you think that’s likely? And if so, what are the global implications?
JR: I think not only is it likely, I would say it’s already here and is being finessed by the central bank. Real estate prices are in full-scale decline. We know they’ve conducted a trillion-dollar Ponzi scheme under the name of wealth management products or WMP. We’re not talking about the multi-billionaire oligarchs and we’re not talking about peasants. We’re talking about the rising middle-class Chinese person, which numbers in the hundreds of millions. When they go down to the bank to make a deposit from their savings, they basically get zero or a very low interest rate, the same as in the U.S. But then the bank will say, “We’ve got these wealth management products that are paying 5, 6, or 7 percent.” Of course a lot of people think 6 percent sounds a lot better than zero, so they take the wealth management product.
What they don’t realize is that these wealth management products are structured products not that different from our mortgage-backed securities or CDOs, collateralized debt obligations, etc. They are not guaranteed by the bank. A lot of people think they’re guaranteed by the bank because they buy them in a bank office, but they’re not guaranteed by the bank. The money goes to these real-estate projects which are being used to build empty apartments and office buildings in empty cities, stadiums, train stations, and everything else. I’ve been to China and seen this first hand. I know a lot of the listeners have heard about it or have seen pictures, but you actually have to go there and get some mud on your feet out in some of these construction sites. It’s amazing what’s going on.
When people do want to redeem them, they just sell a new one to the next sucker in line. Maybe they get their money back if they were smart enough to cash out, but then the bank just sells it to the next person and uses that money to replace the original investment. There are over a trillion dollars of those, and that’s starting to implode. Real estate prices are going down. China has $4 trillion in reserves so they’re in a good position to bail it out, but it’s still very costly in terms of how that’s going to play out. On that point, I think a credit crunch in China is happening in slow motion and we need to watch it.
It’s important for listeners to understand there’s a credit crunch going on all over the world, partly because of the strong dollar. We now have two sets of borrowers out there who are starting to go into pretty deep distress. One is in the energy sector. A lot of people know about this obviously with the price of oil going from $100 to about $45 today; we’ll see where it levels out. A lot of money — we’re talking trillions of dollars — was borrowed on the assumption that oil would be over $80 a barrel. Some of these projects were priced out with oil well over $100 a barrel. With oil at $45, $50, and even as high as $60, those projects are not profitable and a lot of those bonds are going to default.
In addition to that, we have trillions of dollars of emerging markets’ corporate debt. I’m not talking about sovereign debt; I’m talking about companies in places like Mexico, Brazil, Indonesia, Turkey, South Africa, certainly Russia, and elsewhere that borrowed dollars. Remember, they’re not central banks, so they can’t print dollars, and a lot of their business is conducted in their local currency. It could be Turkish lira or Russian rubles or Mexican pesos, so they don’t even necessarily earn dollars. Some of them do if they’re exporters, but a lot of them don’t. Yet they’ve got these dollar liabilities, and the dollar is getting stronger. This means they need more of their local currency to convert to dollars to pay off the debt, so that debt just got a lot more onerous. That’s if they can even get the local currency. Some of these central banks may run out of hard currency.
Russia is a prime example of that. Russian hard currency reserves are probably enough to pay off their sovereign debt, but they’re not nearly enough to pay off the corporate debt beyond the end of 2015. I’m not saying this is a crisis that’s going to hit us in the face tomorrow as it could actually take a year to play out. Even a guy who’s in the process of going bankrupt might have a little cash in the bank to pay interest for six months or whatever. Eventually, if the price of oil doesn’t correct, and these natural resource exporters don’t start to make more dollars, and the economy continues to stall out, which it looks like it is, they’re not going to be able to pay this debt. We could be looking at trillions of dollars of defaults from energy-related debt and emerging-markets debt. That’s bigger than subprime was in 2007. The entire subprime market, including what’s called Alt-A or alternative A, which is a kind of subprime, was about $1 trillion total in 2007.
I’m talking about a market that’s closer to $10 trillion, so it’s 10 times bigger. It’s not all going to default, but even a default rate of 10 or 15 percent means losses bigger than subprime. We’re starting to see it already show up in swap spreads, credit spreads. It reminds me a lot of what happened in 1997 and 1998 where that didn’t happen overnight but took over a year to play out. It started in Thailand in June of 1997. Who knew that it would end up in a hedge fund in Greenwich, Connecticut, by September of ’98, 14 months later, but that’s what happened. I was at Long-Term Capital Management at the time, the hedge fund in question. I had a front-row seat on that fiasco, so I know what it looks like and how it feels. It has that feel right now. We’re not at the acute stage, but it does look like we’re at the beginning stage. I think the credit crunch in China is a big deal, but I’m seeing a credit crunch all over the world with early signs of distress and spreads widening. We could be at the beginning of something that, as I say, may take a year to play out, but it does have that kind of dangerous look and feel to it.
JW: Let’s take a moment to look at gold. It turns out that December 31st saw the price down slightly from the start of the year. Does that make 2014 a bad year for gold in your view?
JR: I think of gold as money. I know a lot of people think of it as a commodity and some people think of it as almost an industrial import or collectible. There are a lot of ways to think about it, but I think of it as money. Whenever I’m asked a currency question – and I get quite a few, as you can imagine – people ask: What’s the value of the dollar? What’s the value of the euro? What’s your forecast for Japanese yen? Or whatever… And I always ask them the question: Compared to what? Because none of these things exist quite in a vacuum. They’re all priced in terms of something else. When we talk about the value of a euro, we’re really talking about the dollar value of the euro or the dollar-euro cross rate. One thing I know from sixth-grade math is the dollar and the euro can’t both go up against each other at the same time. It’s a zero-sum game. If one’s up, the other one’s down.
Most investors think of the dollar price of gold. When they say gold is up, it would be a day like today — gold’s up about $18 an ounce today, a pretty strong day. Gold is volatile and has its up days and down days, so when people say gold’s up, what they really mean is the dollar price of gold is up. If they say gold is down, what they really mean is the dollar price of gold is down. Looking at 2014, was it a bad year for gold? Not at all. It was down slightly — a little over one percent in terms of dollars — but it was up against every other major currency in the world. Based in euros, gold was up; based in Japanese yen, gold was up; based in Chinese yuan, gold was up; based in pound sterling, gold was up. In other words, gold was up measured in every major currency in the world — Canadian dollars, Australian dollars, New Zealand dollars, Singapore dollars — name one. Gold was up in every single currency except U.S. dollars.
I realize that most of our listeners are U.S. dollar-based investors so that’s how they think about it, but it’s important not to get too gloomy and to understand that gold was down a little bit in U.S. dollars. Another way to think about it, gold was the second-best performing currency in the world ahead of all the others except it was down slightly in U.S. dollars. It certainly beat the heck out of bitcoin. Bitcoin was the worst performing currency in 2014, the Russian ruble was second, and everyone else was somewhere in between. Gold was second best and dollar was the best.
To me this is not really a gold story; it’s a dollar story and a very, very strong dollar. One way to think about it is that considering the dollar’s strength against the euro, the yen, and other major currencies, it’s amazing that gold held up as well as it did. Gold barely went down against the dollar, so that really means gold and the dollar are harnessed together at least for the time being, pulling away from all the other world currencies. This tells me it’s a safe-haven trade. The dollar has a bid because of capital flight from around the world, people unwinding carry trades and emerging markets, getting out of China before it collapses, getting out of Russia before getting arrested or worse, getting out of emerging markets because all those economies are slowing down, and trying to get into dollars. When you do that, you can buy the U.S. dollar in the form of our stocks and bonds or you can buy gold, which a lot of people think of as a dollar-denominated asset.
Gold stayed very close to the U.S. dollar throughout all of 2014, down a little bit but not much, just about one percent, but gold and the dollar together pulled away from all the other currencies. To me, this is a strong dollar story, and gold actually did pretty well. I would say it had a very good year in 2014. Even though it was down slightly against the U.S. dollar, it was up against everything else. That trend seems to be continuing although if anything, gold is actually starting to leave the pack a little bit right now.
JW: Thank you, Jim. And now we do have some questions from our listeners. Here’s Alex Stanczyk with those questions.
AS: Thanks a lot, Jon. Just a brief housekeeping item. This webinar is being recorded, and we will post the recording at Physical Gold Fund on the podcast page.
Our first question is by e-mail from Ted G. He’s asking, “If the price of gold goes up, don’t they just mine more?”
JR: In the long run, yes, but in the short run, no. The reason is that you can’t just turn the mine on. It’s not like throwing a light switch. Gold mining is a very capital-intensive, long-horizon business. They have to identify a likely vein, do feasibility studies, geology studies, get environmental permits, and raise money, a lot which is borrowed. You have to get out there with your equipment, and a lot of these gold mines are in difficult locations. I realize some mines have already been dug out and they just closed them so they can reopen them with a little bit less effort than I was just describing, but it’s not a simple thing to do. With gold’s volatility, if gold goes up, it doesn’t mean reopen the mine the next day. You want to see it stay there for a year or two years. Of course, in a world where maybe interest rates are going up, these capital costs could be going up as well.
The basic answer is in the long run, yes, a much higher price of gold at a sustained level will cause more mining and more output, but that can take years. It’s not something that’s going to change the price of gold in the short run, not at all. I know a little bit about gold mining, but I’m not a geologist, but beyond that, all the reports I’ve seen and read say that I don’t want to get into “peak gold”, so to speak. I have seen a lot studies that say it’s just getting harder and harder to find. I was in South Africa recently and spoke to people there who said, yes, we’re still mining gold, but the quality of the ore is going down. We have to keep going deeper and deeper. Some of these mines are over a mile or more deep, not a couple of hundred yards. It seems to be getting scarcer and harder. It’s not something that can happen very quickly.
If you see a run-up in the price of gold, the mining output is not going to change it in the short run. Over a five-year horizon, some gold might come on stream, but bear in mind that demand for physical gold is voracious. The Chinese show no evidence of letting up, not just the Chinese government but also the Chinese civilian population and people throughout Asia, India, and elsewhere. Yes, maybe over a very long period of time gold mining output could go up a little bit but the demand seems to be right there. Although gold is volatile, I’m not saying it’s going to go up a lot. I certainly expect that it will go up exponentially, meaning 300, 400 or 500 percent in the face of a new financial crisis, which I do expect. But leaving that to one side and simply talking about the steady state, I would expect gold to trend higher based on some of the factors we talked about earlier in the call, and mining output is not going to change that in the short run.
AS: The next question comes from Judson R. which I’m going to paraphrase a little bit. Judson says, “Jim, you have made good points about the merit of gold under most scenarios. However, there is one scenario that I have never heard you address, and that is what to do about Japanese-style deflation. So how would gold perform in a multi-decade Japanese-style deflation?”
JR: I take that to mean what if Japanese-style deflation came to the United States, and I think that’s not farfetched. I actually think the U.S. is Japan. We’re seven years into a depression. Japan’s been in a depression for approaching 30 years at this point, about 27 years, but I think the U.S. is in that rut. As I said earlier, central banks cannot tolerate deflation, and it’s not just a preference; it’s existential because there’s too much debt. The United States gets out from under its debt by buying inflation. We basically steal the money from creditors by making the money worthless. We say, China, we owe you $2 trillion. Fine, we’ll print it up. Here’s your $2 trillion. Good luck buying a loaf of bread. That’s a little bit of an overstatement, but I think listeners take the point that historically we get out from under these debt burdens by inflating the dollar and making the dollar worthless, which hurts the creditors — but too bad. At least that’s the way the United States government thinks about it.
But there’s more to it than that. Tax collections are a big deal. Gas used to be $4 a gallon but now it’s $2 a gallon. Let’s just say you use 100 gallons a week in your pickup truck or whatever. At $2 a gallon and 100 gallons a week, all of a sudden you’ve got $200 more in your pocket than you did before the price of gas went down, but the government can’t tax it, right? There’s nothing about a lower price of gasoline that changes your tax bill, you still owe what you owe, so you’re getting the equivalent of a $200-a-week raise in the form of a lower gas price and the government can’t tax it. The government hates it when you get a raise they can’t tax. That’s the asymmetry.
If I gave you $200 more in your pocket in the form of a pay increase or if I gave you $200 more in your pocket in the form of lower gasoline prices, an economist would say it sounds like it’s the same thing. It’s not the same thing to the government. If I give you a raise in your paycheck, I’m going to tax it, but if it’s a lower gasoline price, I can’t tax it. This asymmetry is another reason governments favor inflation. They want inflation to prop up the banks because it’s easier to tax those gains and it’s the only way to pay off the debt.
The listener’s question was what happens if you get persistent deflation. It happened once before from 1929 to 1933. Actually, it started in 1928 before the crash in 1929. The U.S. had about 30 percent deflation over that five-year period, and guess what happened. The price of gold went up 75 percent. In other words, because of all the reasons I mentioned why governments need inflation, if governments need inflation and they’re not getting it through money printing or QE or Operation Twist or currency wars or forward guidance or all the bag of tricks the Fed has, governments can always get inflation just by raising the price of gold.
We won’t see the government arbitrarily raise the price of gold in the short run because they want to pretend this problem doesn’t exist, but if they get desperate enough and actually do get into a Japanese-style deflation, don’t be surprised if the government takes steps to raise the price of gold. Nothing happens in a vacuum. If gold goes up, guess what, everything else goes up – silver, oil, copper, bread, wheat, beef, everything goes up. That’s why they do it. The government doesn’t increase the price of gold because they’re nice guys and want to enrich gold investors. They do it to cause inflation. If we get real long-term, persistent, deep Japanese-style deflation that just won’t go away, don’t be surprised to see the government raise the price of gold. They did it before, and actually it’s been done many times but most famously in 1933 when the price of gold increased 75 percent. If you go back and look at the New York stock exchange prices during the Great Depression when it dropped 90 percent, the one stock that went up was Homestake Mining, a gold miner.
AS: This next question is coming from Juha M. I’ve actually heard this said before about you, Jim, in that sometimes people refer to you as an “insider”. In other words, you come from the pedigree and the league, so to speak, of people who have very high positions either in government or among hedge funds, etc. Here’s Juha’s question: “Considering that you’re an insider, why did you write your books Currency Wars and Death of Money, and how have other insiders reacted to your books, for example, people from the Fed, Pentagon, etc.?”
JR: Wow, that’s a good question. I’m usually up in Connecticut but today I’m actually doing this webinar from Washington, D.C. because I have some meetings on counterterrorism finance issues tonight that I’ll be getting ready for after the webinar. I’m not going to call myself an insider, but I do meet with officials of the Federal Reserve, including Reserve Bank presidents and members of the board of governors, and with people in the national security community and at the Pentagon. I’ve been a guest over at the Treasury when they’ve invited me in for seminars and to give presentations behind closed doors to risk management groups, etc.
Suffice to say I’ve had a lot of contacts with the U.S. government which I’m very happy to do. Some of it is consulting and a lot of it is volunteer work. Earlier in my career I happened to spend a fair amount of time in Pakistan involved with Islamic banking, which I wrote about in my second book The Death Money, so I was one of the people called on after 9/11 to help, and I was able to contribute. I did quite a bit of that work as a volunteer and was also very involved in recruiting other volunteers to help out on the national security side. I have to say it was very gratifying that I was never turned down. If I picked up the phone and called a friend on Wall Street or in the hedge fund community and said, could you come down to Washington or northern Virginia and meet with some national security officials, no one ever said no. It’s great to see that kind of patriotic spirit we all applaud.
I spent a lot of time in that milieu with IMF officials and others and became very aware that the insiders, at least the people in the know, always win. They always win because they can see it coming; they’re involved in the decision-making process and know how to get out of the way. It bothered me that everyday Americans are as smart as anybody you meet anywhere and work hard for their money, but you can’t expect a dentist or doctor or lawyer or teacher or fireman or policeman or construction worker or truck driver to have a PhD in economics in their back pocket. That’s unrealistic. I hated the idea that their money could be stolen from them through policy. I understand the policies, but I also felt that there had to be a place for a book that was written in plain English.
If I may say so, what I focused on in my books is PhD-level content but it’s written in plain English. In other words, there’s nothing about my books that’s dumbed down, but it is simplified. When I say simplified I mean you can use plain English and metaphors. You can take fairly sophisticated comments and explain them to people in ways that are pretty easily understood. Some of it’s not even that difficult. When I hear someone talk about something like “sticky wages” or “downward nominal wage rigidity”, I say, oh, you mean people don’t like to take a pay cut. Everybody understands that. Nobody likes to take a pay cut, so why do I have to say “downward nominal wage rigidity” which means exactly the same thing? One is the way you would speak in the faculty lounge at Harvard and the other one is the way we would talk at the bar. I wanted to write a book for all Americans or really people around the world. My first book was in ten languages and my new book is I think up to 6 languages, and we’re still working on foreign sales.
I write these books not for the academic crowd or policymakers but for everyday Americans just to level the playing field. You can be interested in what I have to say or not, but at least I know that I tried to level the playing field and give people some insight into how the elites are thinking. How do my policymaking friends react to the books? There’s a lot of interest. It’s funny, even people who don’t like to think that their conversations are going to be scrutinized like to read about themselves in some way. People are very interested and do read the books. You actually end up maybe getting more invitations because people want to talk to you to see what you’ve been doing or where you’ve been traveling. I do get a lot of speaking invitations around the world, so it’s not just fun but an opportunity to talk to people.
I recently met with the head of the Istanbul stock exchange and a member of the central bank of Turkey, and I was in Korea not long ago and met the head of the Korean equivalent of the SEC, their lead market regulators, so I do have a lot of experiences like that that are opportunities presented because my book is popular. Those are experiences I can use to learn and hopefully offer more. It’s a good process and I’m glad I did it. So that’s a little bit about my motivation and background for doing this.
AS: Thanks for sharing, Jim. It was really great to understand that from you. At this point, I hand it back over to Jon.
JW: Yes, thank you Alex and indeed thanks to you, Jim Rickards. I know you have to get to a meeting but it’s been great having you with us here today. It is much appreciated. And thank you to our listeners. It’s wonderful to have you with us and we appreciate your questions. I’m sorry we couldn’t get to all of them, but they are very valuable and useful questions, and we always welcome those from you.
Just to remind you, you may follow Jim Rickards on Twitter. His handle is @jamesgrickards. Let me also remind you that you can find Jim’s latest book, The Death of Money, at Amazon or any good bookstore, so get yourself a copy if you haven’t already. It was wonderful to hear Jim talk a little bit about the background of the writing of his books.
Goodbye for now to all of you, and we look forward to joining you again soon.
If you would like to ask Jim Rickards a question on Twitter which may be used in a future interview, please use hashtag #AskJimRickards
You can follow Jim Rickards on Twitter @JamesGRickards and Alex Stanczyk @alexstanczyk
Listen to the original audio of the podcast here
The Gold Chronicles: January 12, 2015 Interview with Jim Rickards
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