Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles November 2017

Jim Rickards and Alex Stanczyk, The Gold Chronicles November 2017


Topics Include:

*Understanding golds utility value
*First Principles regarding gold
*How wealth is created
*Why wealth can also be viewed as energy
*Defining money
*How money is a form of storing energy (wealth)
*How investments also store, but also leverage energy (wealth)
*Basic energy inputs which create a good or service that the market will pay for can all be calculated mathematically
*Gold is the only form of money or investment that is indestructible and completely immune to the forces of entropy
*How confidence and agreement is a key component of money
*Summary of theories of intrinsic value (total inputs), Marxist surplus labor theory, Menger’s subjective value theory
*Subjective value leads us back to confidence as a key component of money
*Why central banks are accumulating and stockpiling gold
*Greenspan on gold
*How to create your own personal gold standard
*Australia’s institutional market warming to gold
*Probability of Fed interest rate hike in December update
*Power consolidation in the House of Saud


Listen to the original audio of the podcast here

The Gold Chronicles: November 2017 podcast with Jim Rickards and Alex Stanczyk


Physical Gold Fund presents The Gold Chronicles with Jim Rickards and Alex Stanczyk offering insights and analysis about economics, geopolitics, global finance, and gold.


Alex:  Hello. This is Alex Stanczyk, and I have with me today the brilliant Mr. Jim Rickards. Welcome, Jim.

Jim:  Thank you, Alex. It’s great to be with you.

Alex:  Today we’re doing another addition of our Gold Chronicles podcast. In our last podcast, we covered a wide range of topics from institutional allocations in gold to an analysis of how U.S. warfighting policymakers are looking at the North Korea situation, and much more. If you want to hear any of our previous podcasts, the entire archive is available at

Let’s dive into our topics. First, as we often do, will be a discussion on gold. Some of this material may seem a little remedial to some, but a lot of people ask me about these foundational concepts. I continue to find that in the financial professional space, gold’s utility value is widely misunderstood or isn’t understood at all. For purposes of hitting on some of the basic education concepts, let’s break it down into first principles basics.

When I say first principles, that is a method of reasoning where we’re going to start with what we absolutely know to be true. We start with the facts and go from there instead of theorizing about gold being a good investment or a gold standard or anything like that. We’re just going to start with what we absolutely know.

We’ll begin with how wealth is created at its most basic level. A person can expend their labor, i.e., they invest energy. From this, they’re creating either a type of good or service that has value in the marketplace and some entity is willing to buy. A person creates wealth or energy by doing this above and beyond what is required for basic needs. In other words, anything in excess of how we pay for where we live, what we eat, the clothes on our back – basic necessities to survive – that is wealth. One way to look at it is as a surplus of energy. That’s the first part.

Now that we’ve created some wealth, now that we have a little bit of surplus or excess energy, the second part is, what do we do with that surplus or excess energy? You can either invest it or store it in money.

What is money? This is all super remedial, but bear with me. We’re getting to the good stuff here in just a minute. Going back to the basic economics textbooks, money is essentially a few different things – a medium of exchange, a unit of measure, and a way to store value. That last one is what I mainly want to talk about for this segment. Money is a storehouse of value or energy, and this is where gold’s utility value comes into play.

Gold stores value, and that is in fact its utility value. Not only does it store value, it’s the way it does it. Gold stores energy in a form that’s basically indestructible, and that’s the key. I’ll say it again; gold’s utility value is the fact that it stores energy in a form that’s indestructible. Unlike anything else you can invest or store money in, gold doesn’t rely on any external force for that to continue to be true over time. It’s sort of like a battery with no expiration date.

Jim, what are your thoughts on these first principle topics I’ve just talked about?

Jim:  I certainly agree with your articulation of that, Alex. As you know, I covered a lot of the same ground, not everything you just mentioned, but some of the same ground in chapter 10 of my first book, Currency Wars, where I advanced the concept that what you call the battery theory, which I think is a good one, is that money is stored energy. I think we need to separate two things:

  • What is money or how can we think about the definition of money?
  • What is gold’s utility as money?

Obviously, there are many forms of money other than gold. I happen to think gold is a particularly good form of money that has been around for a long time, and I expect it will reemerge in the near future as a preferred form of money. Let’s talk about money first and then come to gold and its utility.

I think money is stored energy. The three things you mentioned are the classic economist definition of money. Economists don’t agree on much, they like to disagree, but this is one of the things they all agree on. I’ve never heard too much dissent. There’s a three-part definition of money:

  • One is store value, which you mentioned.
  • Another one is unit of account, just a way of counting things, “How much do we make? How much do we have?” etc.
  • The other one is a medium of exchange, meaning we can use it to get other things.

Of those three, the unit of account is probably the least important. It’s not unimportant, but anything could be a unit of account such as soybeans, jellybeans, baseball cards or Bitcoin for that matter. Bitcoin is a unit of account, it’s how many Bitcoins you have, and so forth.

Unit of account is an easy one, but medium of exchange and store value are really the heart of it and much more difficult. Medium of exchange really depends on confidence. I lecture quite a bit around the world on money, and one of my slide presentations shows ten forms of money. You’ll see gold and silver, but also digital, credit card, Bitcoin, beads, feathers, and shells. I make the point that all of those things have been money at one time or another, and some of them still are. People will say, “Well, it’s not backed by anything.” My point is, yes, it is. It’s all backed by one thing, and that is confidence.

Forget about intrinsic value and what’s behind it, we’ll talk about that in a second. It’s backed by confidence. Paul Volcker said something I completely agree with, and it goes like this:

  • I have something I think is money.
  • You also think it is money.
  • We both think that somebody else over there thinks it’s money.
  • I give it to you for goods or services.
  • You’re confident that you can give it to somebody else for goods or services.
  • They’re confident that if they take it, they’ll be able to spend it as well.

Again, it could be feathers as it has been in certain indigenous tribes around the world. Maybe it was a small community and it didn’t last too long, but there was a time when clamshells and feathers were money.

It’s all based on confidence. The question is, how do you gain confidence, and what could destroy it? That’s how I think about money. When I think about gold, it has gained confidence over thousands of years and is almost impossible to destroy.

I have some grandchildren in the five- to seven-year-old range. They’re great because they’re curious and inquisitive about everything. If I show them a gold coin, they have an instinctive, natural, “Oh yes, that’s…” They just get it. Picasso said if we grew up painting like children, we’d all be like Picasso. I think if a lot of our PhD monetary economists could understand the intuitive appeal of gold a little bit better, it would have a greater role.

Gold is a very good form of money in the sense that it maintains confidence. Right now, people have confidence in the U.S. dollar, but we’ve seen so-called fiat currencies come and go. I don’t know who’s that confident in Bitcoin. It’s an interesting speculation for a lot of people, but I’m not sure it has much confidence behind it when push comes to shove.

The third thing we mentioned is store of value, and that gets to your battery metaphor. I view it as a form of stored energy, and that’s important, because you can then use physics and dynamic systems analysis, energy equations, and energy mathematics to begin to understand money.

How do you get money? One way is by working. What do you do when you work? You don’t have to be out digging pipeline ditches in the winter. You can be a writer, a lawyer or any white-collar profession, but you’re spending time, effort, and energy whether it’s brainpower, physical power, gas in your car to get to work or electric lights in the office. Whatever it is, you’re expending energy, and they give you money, whether it’s fees, royalties, a paycheck or whatever it is.

Now you have money. You’ve in effect stored up the energy that you exerted in acquiring it. You can then release the energy by hiring someone to work for you. To get your house painted, you hire the painter, the painter comes in and works hard, and you give that person the money. The money that you have has stored up the energy you used to acquire it, and then you can release energy from third parties by spending or investing it.

It fits that battery metaphor. Energy comes from somewhere whether it’s burning oil, natural gas or the sun, it goes into a battery, it’s stored there, and then it’s released later on to run a light bulb or power a tool, whatever it may be. That’s more than a metaphor, it’s actually an exact parallel.

The store value is it stores up the energy spent acquiring it, and it can release energy for your own goods and services. The medium of exchange, basically spending it, depends on confidence, and the unit of account is a little less important, but yes, you can use it to account with.

With all those things said, what is the utility of gold as a form of money compared to other forms of money? Here, we get into the economic history of value. David Ricardo was one of the first – if not the first – economists in the early 19th century to really wrestle with the theoretical concept of value.

There have been big markets since ancient Greece and Rome, and for that matter in the Bronze Age, so markets are nothing new. People have been exchanging goods and value all along, but Ricardo wanted to understand it on a theoretical level. He said the way you value something is to figure out all the inputs. What were the raw materials? What was the energy used to acquire it? How much labor was involved, etc.? Add them all up, and that was the value. That’s the theory of intrinsic value. You hear that a lot when people are talking about money, saying it has no intrinsic value. Let me come back to that, but Ricardo was the author of this theory of intrinsic value.

About 30 years later, Karl Marx came along and agreed with Ricardo but believed that intrinsic value comes from labor and capital. The capitalists owned what he called the means of production (the factory, bank, railroad or whatever it might be), and labor worked for them to receive a wage.

Marx’s critique was that capital captures the surplus value of labor. In other words, labor doesn’t get its fair share; the capitalist gets more than his fair share. That surplus labor theory is his critique of capitalism. Of course, that led to communism, so basically, Marx took Ricardo’s theory of value, which was intrinsic value, and created the surplus labor theory of value, but it was still relying on intrinsic value.

Now come forward another 30 years, and we get to University of Vienna, 1870s, and Carl Menger, the father of Austrian economics. He said, “Nonsense. The whole intrinsic theory/surplus labor theory of value is all nonsense.” He created what’s called the subjective theory of value.

Menger said something is worth basically what other people think it’s worth. That’s a subjective thing that can vary over time and was the basis for markets and price discovery. Like I said, we’ve had markets throughout the history of civilization, but again, the theoretical basis for the role of markets, the benefit of capitalism and what we call price discovery, is that it allows people to explore bids, offers, and preference curves, and subjectively value things.

That’s been the prevailing view on economics ever since. Whether you’re a Keynesian or in the newer Keynesian consensus or a monetarist or an Austrian – all schools of economics – we now agree that Menger’s subjective theory of value is the right way to think about it. When people say a currency doesn’t have intrinsic value, I say, “Who cares? So what?” I compliment them on their firm grasp of Marxian economics, but I say it’s a completely irrelevant concept that’s been discarded as part of the theory of economic history. It plays no role in how we think about value each day, and the subjective value really prevails.

This brings us into the 21st century. When we talk about subjective value, we’re back to the first thing I mentioned, which is confidence. Currencies rise and fall because you lose confidence in the issuer, you lose confidence in the central bank or you gain confidence by its performance in a crisis.

This is one of my critiques of Bitcoin. I get beaten up on social media and Twitter all day long because of my critique of Bitcoin. People say, “You’re a Neanderthal, you’re a dinosaur, you don’t understand technology.” In my snarkier moments, I remind them that I was writing code before they were born, so I understand the code and the technology perfectly well. I’ve read the technical papers, and I’ve actually been at the IBM SLA private laboratories where they’re working on something that’s going to blow existing forms of blockchain away. It’s called Hyperledger Fabric version 1.0. It was released last summer and is now being adopted by the Linux Foundation

Putting that aside, I get the technology, but I wonder whether the techies understand money in the terms we’re talking about right now. One of the things I point out is that Bitcoin has never had a stress test. It was created in 2009 after the last crisis. I’ve lived through a series of crises, whether it’s the mid-’80s emerging markets crisis, the ‘87 crash down 22% in one day, the Mexican Tequila Crisis in ‘94, certainly the LTCM crisis in ‘97-’98, the dotcom crash, the mortgage crisis of ‘07, and the financial panic of ‘08.

When you see enough of these things, you get a feel for them and see them coming. Bitcoin hasn’t seen any of that, yet it’s had a lot of adoption from millennials. I love millennials, I have three millennial children. I think they’re some of the brightest, most creative people on earth, but we all know what we know – let me put it that way. If you’ve never lived through a panic as an adult or an investor or someone with something to lose, you’re not acquainted with that sick feeling in the pit of your stomach when you’re watching markets go down and they seem to have no bottom.

Bitcoin has never been through a panic, a recession or a liquidity crisis. I’ll leave aside all the many other technical difficulties, because we don’t have time today to go through them, but that’s one thing in particular I would caution the Bitcoin fans. You’re dealing with something where confidence in it has never been tested. All the other forms of money we’re discussing, despite their strengths and weaknesses, have been stress tested one way or another.

When you take everything we’ve just discussed, gold has enormous utility for the reason you mentioned. I’ve studied the amazing physical, chemical, and atomic properties of gold. First of all, it’s an element, atomic number 79. It’s practically indestructible. You can blow it up with high explosives, but even then, all you do is spread the atoms around, they fall to the ground, and someone will dig it up 10,000 years from now. You can’t actually destroy it.

Alex:  Right, gold molecules are still gold molecules, just in smaller pieces.

Jim:  Exactly. As you know in the gold refining process, historically they’ve used mercury, and now they use cyanide. The reason they use cyanide is because it dissolves everything except the gold. Through the milling process, you get a fine powder containing gold and other stuff. That’s reduced to a liquid, you pour in some cyanide, all the other stuff dissolves, and there’s the gold. Gold’s indestructibility makes it possible to extract it from the ore.

Gold has more than stood the test of time, and people have confidence in it. I say it’s not a form of money today in the sense that central banks and finance ministries hate it. You won’t find any international monetary elites who have a kind word to say about gold, but then I say, “If that’s true, why does the IMF have 1000 tons? Why does the United States have 8000 tons? Why does Germany have 3000 tons? Why have Russia and China tripled their gold reserves in the last ten years – China probably more so – if it has no utility as money?”

The answer is, of course it has utility, but the elites don’t want to talk about it. They want to scoop up the gold for themselves and leave everyday citizens and investors out in the cold.

Alex:  Yes, they hate it and they don’t hate it. It comes down to, “Watch what they do and not what they say.” They’re saying on one hand that it’s useless – think back to Bernanke’s testimony before the congressional panel when he was basically saying we keep it because of tradition – but at the same time, the facts are, central banks around the world are stockpiling it. They’re not getting rid of it.

Jim:  If I had a printing press that could print money and I had a monopoly position such as the Federal Reserve, I probably wouldn’t want people to look at the competition either. We’re not in that position, so we can be objective and analytical. Yes, do as I do, not as I say.

Interestingly, the one global leader who has been candid about this is Vladimir Putin who is acquiring gold hand over fist. Russia is an interesting case study. It’s a petro state, I think the number one oil exporter in the world. In 2014, the price of oil collapsed. That continued through 2015 into 2016 before it stabilized, and Russia’s reserve position crashed along with it.

I’ll use round numbers. Their reserve position went from approximately $500 billion to a little over $300 billion. They lost 40% of their reserves or $200 billion.  That entire time, they not only did not sell an ounce of gold, they continued to acquire it at a rate of 5 – 10 and sometimes as many as 30 tons a month, which you know is a lot of gold.

They were selling treasuries, euros, German debt, and whatever they needed to create liquidity in Russia and deal with their balance and payment outflows. They never sold gold, and they kept buying more. That was Elvira Nabiullina who is the head of the central bank of Russia and my favorite central banker. It was clearly greenlighted by Putin; that would not have been happening if Putin didn’t want it to. Despite the stress, they continued to buy gold, so clearly, it is a monetary asset.

The other case study is our friend Alan Greenspan. I think a lot of our listeners know that going back to the 1960s and early ‘70s, Greenspan was a strong, outspoken advocate for a gold standard, gold as money. He was a bit of an acolyte of Ayn Rand at the time, and since retiring as head of the central bank and head of the Fed in 2007, he’s been out on the speaking circuit saying kind things about gold. He occasionally shows up at gold conferences where I’m sometimes invited to speak, etc.

I said, “That’s interesting. Before you were a central banker, you loved gold. Since you retired as a central banker, you loved gold. It’s only when you put on your central banker clothes…” But even then, when all is said and done, you won’t really get this in Sebastian Mallaby’s biography of Greenspan. I like Sebastian’s kind of definitive biography, but you won’t get this in his book. If you look at the price of gold during Greenspan’s tenure as chairman of the Fed, it traded in a narrow range.

It started to spike up after ‘02, but that’s because of Greenspan’s famous episode between ‘02 and ’07 when he kept rates too low for too long. He did that because he was worried about deflation, and gold, as we know, had a fabulous run in those years. If you leave that episode aside and look at the ‘80s and ‘90s, gold traded in a pretty narrow range. It was between $200 – $400 an ounce with ups and downs, but did not break out to the upside or the downside outside of that range. It’s almost as if Greenspan was on a shadow gold standard saying, “If gold gets a little pricy, maybe I’ll tighten a bit. And if it gets a little low, maybe I’ll ease off a bit.”

My view is that he was operating on a shadow gold standard even when he was Fed Chair, but he just couldn’t say so.

Alex:  He understood it, right? I’ve got his quote right here in front of me. Fed Chairman Greenspan wrote in his article Gold and Economic Freedom:

“Gold and economic freedom are inseparable. In the absence of the gold standard, there’s no way to protect savings from confiscation through inflation. Gold stands as the protector of property rights. If one grasps this, one has no difficulty in understanding the status antagonism towards the gold standard.”

Jim:  I absolutely agree. That’s a brilliant and succinct statement. People lament the fact that we’re not on a gold standard today, and my answer is, “What are you waiting for? Put yourself on a personal gold standard. Why are you waiting for central banks in countries to reinstitute a gold standard or use gold as a reference for a monetary policy?” You can take dollars, euros or yen today and go buy all the gold or whatever allocation you want. I call that putting yourself on a personal gold standard. You don’t have to wait for governments to lead the way.

Alex:  Yes, very much so.

One more quick thing on the uniqueness and utility value of gold, then we’ll move on to our next topic. We were talking about how gold really doesn’t rely on any external force for it to continue to have value, basically because it’s indestructible. As long as humans agree that gold has value, it completely resists entropy and is indestructible. Something I was thinking of is this little Twitter exchange the other day when somebody tweeted at you, “Jim, AI systems won’t be using gold,” and you quipped back, “Gold won’t be using the power grid.”

I thought that was hilarious and precisely the point. I would even take it a step further than saying it’s not just good money. Let’s do a thought experiment. Here’s a little challenge for you. Can you think of any form of storing wealth, whether it be an investment in stocks, bonds, companies, real estate, Bitcoin or anything, that is not subject to entropy over time?

What I mean by entropy is everything else requires human effort and interaction in some way or another to maintain. Bitcoin requires electricity, the Internet, computers. Companies and fiat-issued currencies require maintenance. All of this requires human will and interaction to resist the forces of entropy, otherwise they slowly self-destruct over time. The only thing that doesn’t do that as far as I know is gold. Can you think of anything, Jim, to invest in that’s not subject to entropy over time?

Jim:  No. In fact I agree with that. Even silver. I’m a friend of silver and have it alongside of gold, because it has some form of utility. Think about a real crisis maybe where Kim Jong-Un has detonated an electromagnetic pulse weapon in the high atmosphere of the United States or the power grid goes down. The power grid could go down for reasons that have nothing to do with North Korea or EMP weapons as we saw in 2003. In that world, the ATMs don’t work, your credit and debit cards don’t work, you can’t do online banking payment systems, you can’t even fill up your car with gasoline because gasoline pumps require electricity, etc.

Civilization has a very thin veneer and lasts about three days. Three days is when you run out of food and water, and then society quickly devolves into looters and vigilantes as we’ve seen. I’m not talking about the Wild West, because we’ve seen this in the days after Katrina, in Puerto Rico very recently, and really all over the world. Gold will be money, there is no question about that. If you’re out to get a couple days’ groceries, an ounce of gold might be a year’s worth of groceries. If you don’t want to sit there with a file and chip off a little piece, a one-ounce silver coin is probably the right amount to go get your family a couple days’ worth of groceries. Some say, “People won’t accept it,” but I say, “Of course they will. Are you kidding?”

One of the ironies of the Puerto Rico tragedy after Hurricane Maria was that a lot of the shelves were stripped bare because people had bought stuff in advance, but there were some places that had stuff on the shelves –  water and food – but nobody had any money. Like I said, the ATMs didn’t work.

The Federal Reserve system is 12 regions, each of which have a certain piece of territory. Boston is the first district, and Puerto Rico is under the second district, which is the Federal Reserve Bank of New York. Bill Dudley, as President of the New York Fed, had responsibility for Puerto Rico, so he chartered planes and flew pallets of bills, like $100 bills, to Puerto Rico as fast as possible. They passed them out through tellers and loaded up the ATMs when the power came back, because they were literally out of money. Again, there were stores with provisions that people desperately needed, yet they literally didn’t have a way to pay because credit and debit cards didn’t work, etc.

I dare say, if you walked in with five ounces of silver and said, “Give me $100 worth” of whatever, that merchant would have gladly taken it. In even more dire circumstances, even more so. Having said that, silver is not as scarce or robust gold. Gold is the best, and so I think you’re absolutely right about the uniqueness of gold.

Alex:  Yes, and silver still interacts with oxygen, it oxidizes over time.

Jim:  Yes, which gold doesn’t. Gold is the most inert thing anybody can think of.

By the way, I just returned a couple of days ago from an extended trip in Australia where I did about 20 one-on-one consultations. It was a pretty grueling three days meeting with six or seven a day of the top hedge funds and institutional investors in Australia. I met with about half of the money in Australia in terms of big banks and insurance companies. I can’t mention the names of clients, but you get the point.

I detected kind of a warming up to gold, and you don’t usually hear that in the institutional investor world. Unfortunately, I can’t get a pulse in the United States, because Americans are going to be the last to know. Russia and China are easy. They get gold, they’re stockpiling it. The same is true in Europe, Austria, and elsewhere around the world. I think people have a good understanding of gold, but definitely not true in the United States or Canada.

I was finding in Australia people who might not have even wanted to talk about it before. In my consultations, I would cover U.S. politics and fiscal policy. When I go abroad and people say, “We really don’t understand U.S. politics,” I say, “Well, don’t feel bad, neither do Americans.” I take them through my main topics, and then people say, “Talk to me about gold.” I would, and I was definitely detecting some interest, so that’s another good sign.

Alex:  Very good.

On to our next topic. Jim, in our last podcast, you placed the likelihood of the Fed raising interest rates in December at about 20%. I think that call surprised a lot of people. Has your view on this changed since the last time we discussed it? And if so, why, or why not?

Jim:  I’m hanging in there, but let’s be fair to the other side. I’m no stranger to out-of-consensus forecasts, as you know. I was running around between March and June 2016 saying that the UK would leave the EU at a time when that was considered extremely unlikely, and that happened. I was running around in October 2016 saying Trump would win, and he did. The great thing about doing TV is you have the video tape, so if someone says, “You never said that,” here’s the tape, have a look.

Alex:  I remember that.

Jim:  Thank you. Beginning in December 2016, I said that the Fed would raise interest rates in March 2017 at a time when the market gave it about a 30% probability. That 30% probability prevailed all through January and February. I was saying they would raise, the market was saying they wouldn’t. The market didn’t believe the Fed, they were calling it a bluff, etc.

Suddenly, over the course of about three days at the end of February 2017, the Fed started to panic. They were like, “Hey, we know we’re going to raise rates, but the market doesn’t believe us, so we have to signal.” Yellen, Dudley, Fisher, and Brainard, the four horsemen, went out and gave speeches that were incredibly blunt. They said, “Wake up, we’re going to raise rates.” The market got the message, and the probability went from 30% to 90% in three trading dates and converged on my forecast. You can see this on a chart, it’s one of those hockey stick charts.

As I say, I’m no stranger to being out of consensus, and I’m not uncomfortable with it if I have confidence in the model. Having said that, I’ve never been more out of consensus, because I’m giving it a low probability. Maybe I’ve increased it from 20% to 30%, but I’m still way below 50%. The market is actually at 100%, not 90% or 95%. The market has 100% chance of the Fed’s raising rates in December.

Let’s see how it plays out, but it does have a lot of significance. I won’t belabor it, but let me just spend a minute on the analysis. My baseline scenario is that the Fed is on a path to raise rates four times a year. Twenty-five basis points every March, June, September, and December like clockwork through 2019 to get rates to 3.25%. They’re doing it not because the economy is strong or because there’s that much inflation on the horizon, they’re doing it to raise rates so they can be ready to cut them again in the next recession. The finesse is, can they do that without actually causing the recession they’re trying to cure?

I realize I ran through that quickly, but people can play it twice. That’s the big picture, the scenario. However, there are three pause factors. Many quarters – September 2017 was one of them, and the first seven meetings in 2016 were another example – there are many times when the Fed does not raise rates. So what are the conditions under which they do not raise rates despite the baseline scenario that they will?

First is a disorderly market decline. That’s what happened in January 2016 when the market dropped 10%. The Fed did not hike in March and June of that year in response to that. The second one is if job creation dries up. That’s not much of a factor, because job creation has been strong. It has come down from 250,000 a month to 100,000 a month, but that’s still more than enough to absorb new entrants into the labor force, and unemployment is 4.1%. As far as that’s concerned, it’s mission accomplished. The Fed’s not even thinking about employment except as it relates to the other part of the dual mandate, which is price stability. So market disruption is one, but it’s not present today, and evaporation of job creation is another, but that’s not present either.

The third pause factor that is present is disinflation. The Fed has a goal of 2% inflation as measured using very specific metrics, which is personal consumption expenditure deflator core year-over-year. I realize that’s a mouthful, but they’re all important. It’s PCE, not PPI or CPI, but PCE. It’s specifically core, meaning it excludes food and energy, and it’s year-over-year not month-over-month or quarter-over-quarter. The Fed told us that, so that’s not guesswork.

They have a 2% target. Last December and January, that number came in at 1.9, which is why I said they would raise rates in March even though the market didn’t believe them. Since then, it’s been flat or down nine months in a row. It’s come down .6% and is currently at 1.3%. That was the most recent reading. This is a flashing red light to the Fed saying, “Hey, Fed, you’re moving substantially and rapidly away from your goal. You’re causing the problem with your rate hikes and strong dollar which is deflationary.” There are a lot of voices saying, “Don’t raise rates.” Neel Kashkari, President of the Minneapolis Fed, Charlie Evans, President of the Chicago Fed, and Lael Brainard, who is on the Board of Governors, are all no votes coming up.

I didn’t break into a safe and steal any secret plans here. Based on that and the most recent readings and sticking to my model, I would say the Fed will not raise rates in December. Having said that, there’s one more reading before the meeting. The meeting is December 13th, and the next and final pre-meeting PCE core year-over-year comes out November 30th. For our listeners, 8:30 a.m. Eastern Time, November 30th, check it out and see what the number is. I’m a good Bayesian, so if I get new data, I’ll plug it into the equation. If the probability goes up, it goes up. I’m not going to ignore the evidence.

If it’s hot – and by that I mean 1.6% – 1.7% – that will first of all be close to two. Secondly, it will validate Yellen’s belief that all this other disinflation was transitory. At that point, I’ll join the crowd, throw in the towel, and say, “Okay, they’re going to raise rates.” But that’s not what I expect. If it’s weak, meaning 1.4% or certainly 1.3% or less, that’s going to be the last nail in the coffin, and my expectation is the Fed will not raise rates.

From a market perspective, this sets up a very interesting trading opportunity that I call an asymmetric trade. An asymmetric trade is when a certain outcome is completely priced. The market is not sitting there saying, “50-50, we don’t know, it could go either way.” The market expectation is so high that the event is completely priced into markets, which means that if it happens, nothing happens. If something is priced in and then happens, nothing else happens to the market, because you already priced it. That’s what markets are supposed to do, they’re supposed to discount the future.

On the other hand, if it doesn’t happen, you have a violent, sudden repricing as market expectations get adjusted. The beauty of that is, “Heads I win, tails I don’t lose,” meaning it’s not that you’re going to make money both ways, but you could make a lot of money one way and not lose or get hurt the other way. So, what’s priced in right now? As I said, there is a 100% expectation the Fed is going to raise rates on December 13th. What does that mean? It means strong dollar, weak euro, weak yen, weak gold prices, higher bond yields, and lower treasury prices.

What happens if the Fed doesn’t raise rates? What happens if that PCE number is weak, meaning 1.3% or less? What happens if my analysis if correct and they don’t raise rates? Suddenly, every one of those trades is going to reverse. Gold is going to skyrocket, the euro is going to go from 1.17 to 1.20, yen is going to go from 1.12 to 1.10, gold is going to go from 1270 to 1300 plus, and the dollar index is going to come down. All these markets are going to – probably within hours – adjust to this new reality of the Fed not being able to raise rates.

I wrote a column the other day and said if you were on Mars last week, you didn’t miss anything. Gold just went sideways and has been a little bit boring. There was a little activity over the course of the day Thursday when it ran up and then fell off a cliff with one of those paper gold dumps, but last week it started and ended the week around 1275. Right now, it’s a little bit higher than that, but not much. This is what I mean by gold is not doing anything right now, and neither is the dollar index or the euro. They’re all just sitting there waiting for Guido Menzio or more accurately waiting for Janet Yellen and the FOMC. They priced in an outcome. They can’t do it anymore, because they priced in a 100% chance, so they’re just going to sit there and go sideways absent some geopolitical shock. Now if that inflation number is weak and the Fed doesn’t raise rates, then it’s going to be a wild couple of days in early December.

Alex:  We are bumping up against our time limit, and there is one other thing I wanted to quickly cover. Moving into the realm of geopolitics, we usually like to talk about something that’s going on around the world, and more importantly how it affects global economics and markets. The most recent thing since the last time we talked, Jim, is the chaos going on right now over in the House of Saud. It appears to be chaos from the outside, but maybe it’s all very well under control.

About a week ago, we started hearing news of sweeping changes taking place in Saudi Arabia. Senior ministers were being fired, dozens of princes and other wealthy businessmen were being arrested, and assets from all of these people were being frozen. I saw one estimate as high as $800 billion USD’s worth of assets have been frozen.

Apparently, only hours before all of this started happening, King Salman decreed the creation of a new anti-corruption committee headed by the Crown Prince, heir apparent, Mohammad bin Salman. MBS is what a lot of people refer to him as for short. This committee has the power to investigate, arrest, ban people from travelling, and freeze assets of anyone it deems corrupt.

One article I read claimed that the purge against other members of the royal family is unprecedented in the kingdom’s modern history, and that family unity, which guaranteed the stability of the state since its foundation, has been shattered. Jim, what are your thoughts on this? What does this mean for regional politics, and how does that then go on to affect the rest of the world?

Jim:  Alex, that’s a very good, succinct summary. This is one of those topics we could spend hours on or could write a book on it. We don’t have that much time, but I’ll try to do the short version of it. Since the founding of the kingdom under King Abdulaziz, he had about 75 children by multiple wives. Forget the sisters, because women don’t play a role in their culture – unfortunate, but that’s just the case. Among the 30 or so brothers, who were mostly half-brothers, they had a succession.

The succession of the kingship in Saudi Arabia did not go from father to son but from brother to brother. The problem was most of them died or at this point they’re in their 80s and not mentally or physically fit, etc. They’re almost to the point where there are only a handful of possible kings, and it has to go to the next generation.

That begs the question, which son of which half-brother is going to be the successor versus some other son of some other half-brother? That jockeying, that sort of house of cards if you will, has been playing out for decades. It’s getting very intense now because of the demographics, because they’re all going to die, and so they have to do something.

It’s been decided by King Salman that his son, Mohammad bin Salman (bin means son of, so Mohammad, son of Salman), is going to be the new king, and they gave him the title of Crown Prince as the second in line. That doesn’t sit well with some of the other princes and their children. They also have all these kingdoms where you find multiple armies. There’s the regular army, then there’s like a national guard which is an internal army, then there’s a police force which is a paramilitary, and then there are personal bodyguards.

Who’s in charge of which? They not only arrested a lot of these princes, but one prince’s bodyguards decided to fight it out. They got in a firefight, and the son of former King Fahd was killed. It’s getting nasty over there. And of course, ice-nine, my theory of freezing accounts when you need to control a situation, is operative as it was in Cyprus, Greece, Catalonia, and a lot of other places around the world.

To cut to the chase, this is a pattern we’ve seen before in Putin’s Russia and Xi Jinping’s China, which is when you want to assert your power, you use the judicial system. This is not objective or fair at all, but it’s under your control to arrest your enemies on grounds of corruption.

The thing you must understand is that they’re all corrupt. Everybody in Russia, China, and Saudi Arabia is corrupt. That’s not the point. The point is, are you with me or against me? If you’re with me, I will ignore your corruption up to a point. If you’re against me, I will use the corruption to round you up and put you in jail.

The best statement of that was from Lavrentiy Beria who was the head of the NKVD secret police under Stalin. His motto was, “Show me the man, I’ll give you the crime,” meaning, as John Lennon said, “Everybody’s got something to hide except for me and my monkey.” You can pretty much bring up anybody on charges as Paul Manafort found out the hard way, so you use these corruption justice tools as a cloak to round up your enemies and disable them.

Will there be pushback? I think MBS may have pulled this off sufficiently fast and callouslesly to have done it successfully.

I was in Riyadh for a few days, and when I left, it was like getting out of jail. The Ritz Carlton there is probably the fanciest Ritz Carlton in the world, and they’ve turned it into the world’s most luxurious prison, because they needed a place to put all these princes. They couldn’t put them in regular jail, so they surrounded the Ritz Carlton with guards, put paramilitary men in black in the lobby, and put all the princes in the suites upstairs under house arrest. I guess if you had to be under house arrest, there are worse places to be.

Let’s see how it plays out, but he’s moved quickly and ruthlessly. That’s the way you have to do it. You can’t have half measures, because you’d give the other side time to rally their forces and push back. Meanwhile, we see escalating tensions with Iran, and Saudi Arabia has some cards to play on Lebanon. I think the best thing we can leave our listeners with is that this is not over, and it’s part of what’s giving a little bit of a lift to the price of oil.

Alex:  We’re out of time. Jim, once again, I greatly appreciate the discussion with you. It’s been invigorating. Until next time, thanks a lot.

Jim:  Thank you, Alex.


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The Gold Chronicles: November 2017 podcast with Jim Rickards and Alex Stanczyk


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Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles October 2017

Jim Rickards and Alex Stanczyk, The Gold Chronicles October 2017


Topics Include:

*Bullion Bank Scotia Mocatta
*How the Chinese are assembling strategic LBMA and Gold industry focal points of control
*Allianz Chief Economic Advisor Mohamed El-Erian on gold
*Why Central banks cannot control market volatility forever, and gold will return as a key safe haven hedge
*Currency Market Volatility
*Typical institutional portfolio allocations in gold
*Why increased weighting of institutional portfolios to gold could have an impact on USD gold price
*Janet Yellen’s Legacy
*20pct Chance of a Fed Rate Hike in December, market is currently pricing in an 80pct chance of a rate hike
*How the Fed is making decisions based on broken models
*Next pick for Federal Reserve Chairman
*Analysis of 6 hrs spent with HR McMaster, US National Security Advisor to the President, and Mike Pompeo, Director of the CIA on topics of US National Security
*Determining probability of a kinetic war with North Korea
*Key quotes “Prevent…by military means if necessary”, “last chance to avoid severe consequences”, “we are running out of time”, “accept and deter, is unacceptable”
*20pct Probability of Regime change in NK, 20pct Kim Jong-Un backs down, 60pct United States goes to war
*Inside view of Trump – good or bad decision maker

Listen to the original audio of the podcast here

The Gold Chronicles: October 2017 podcast with Jim Rickards and Alex Stanczyk

Physical Gold Fund presents The Gold Chronicles with Jim Rickards and Alex Stanczyk offering insights and analysis about economics, geopolitics, global finance, and gold.


Alex:  This is Alex Stanczyk, and I have with me today the brilliant Mr. Jim Rickards. Jim, welcome.

Jim:  Alex, it’s great to be with you.

Alex:  In our last podcast, we covered a lot of different topics. We talked about everything from technical mountain climbing to training with Navy SEALs as well as the mindset required when making assessment of counterparty risk. For those who are interested, you may access our entire archive of podcasts on our website at

Let’s dive into our topics here. The first one we want to talk a little bit about is gold. There’s an interesting bit of gold industry news this morning. It turns out that Scotiabank is in the process of selling its bullion bank, ScotiaMocatta.

For those of you not familiar with it, ScotiaMocatta is a market-making member of the LBMA. There are five full market makers of the LBMA that include the usual suspects such as Citibank, Goldman Sachs, J.P. Morgan, HSBC and UBS AG.

There are another eight called two-way market makers of which ScotiaMocatta is one. These bullion banks handle OTC trades in gold valued into the trillions of dollars. ScotiaMocatta traces its origins all the way back to one of the first bullion banks. It was founded by a gentleman named Moses Mocatta in 1671.

The rumor floating around is that the Chinese are being courted for the deal. I found it interesting to note this morning that Zero Hedge called the Chinese the world’s dumbest money because of this. To me, however, it lines up with an ongoing, long-term pattern of Chinese state-run banks buying LBMA strategic assets.

For example, they bought some of the largest vaults in New York and more of them in London. If they buy ScotiaMocatta, it’s going to be the second market-making member of the LBMA controlled by the Chinese. What do you think about all that, Jim?

Jim:  I think it’s a very big deal and agree with you in terms of the implications. I hadn’t seen that particular news yet this morning, but I’m familiar with the LBMA, the institutions you mentioned, and the set up.

Yes, it’s a big deal. Step by step, China – if not taking over the gold market – is at least putting a pretty big stake in the ground in terms of its ability to not only compete but participate in the market making side-by-side with London. They’re going to steal the business from London.

I think they’re probably more than halfway there, because they have the Shanghai futures exchange, which includes a gold futures contract, and they have the Shanghai Gold Exchange, which is spot gold where you take gold in and get money or go in with money and buy gold. Their banks are among the largest gold dealers in the world.

I mentioned in a prior podcast that I was in Shanghai not long ago and met with two of the four biggest gold dealers in China, ICBC and another one of the top Chinese banks, and got some firsthand information from them. As the largest gold producer in the world, they generate more than twice as much as the next highest producer. They produce about 450 – 500 tons a year versus the next closest at about 250 tons a year. They’re also the largest gold buyer in the world as we’ve learned from our friends in Switzerland, the refiners who sell the gold. So in every respect, they’re the big foot.

It reminds me of the 1980s when I was in the U.S. government securities market as General Counsel and Chief Credit Officer at one of the largest securities dealers. The Japanese were the biggest customers. All the banks, the so-called primary dealers, were U.S.-owned with some owned by the UK or a couple of other countries, but the Japanese were the biggest customers. They did not have any primary dealers.

I said, “Wait a second. We’re the biggest customers, so we think we want to own some of the dealers. We want a front row seat. We don’t want to just be on the receiving end of bids and offers; we want to be actual market makers and insiders that deal directly with the Fed.” That was kind of understood, so within a couple of years, they ended up with five primary dealers.

China is similar. If you’re going to be the biggest customer, you don’t want to just be a customer; you want to be a dealer or a market maker. You don’t want to be disadvantaged; you want the inside price and don’t want to pay commissions, spreads, and so forth. That’s exactly what they’re doing.

Alex:  I have to agree. Another interesting item in the gold space is something Mohamed El-Erian recently went on record with. For those not familiar, El-Erian is the Chief Economic Advisor of Allianz, a multi-trillion-dollar global finance titan. Some of you may know him from PIMCO that manages about $1.6 trillion where El-Erian was the CEO and Co-Chief Investment Officer. Allianz is the owner of PIMCO.

In an interview, El-Erian said that central banks can’t stay in the business of repressing financial volatility forever, and that gold will return as a safe haven hedging instrument. I thought that was an interesting comment. Jim, what’s your take on that?

Jim:  I agree with that. You gave a brief overview of El-Erian’s resume, and you’re exactly right. As one of the largest financial institutions in the world, Allianz is a huge institution. They deal primarily in insurance rather than banking, but they have banking-like functions and own PIMCO, the world’s largest U.S. government bond investor. They also deal directly with the Federal Reserve.

But El-Erian is more than that. I put El-Erian in the category of the global super elite meaning he’s on G20 committees, he’s at the IMF World Bank meetings, and he’s a regular at Davos. He’s a really smart guy, but apart from having these important advisory roles in the institutions you mentioned, he is one of a handful of people alongside Christine Lagarde, Larry Summers, Bob Rubin, David Lipton, and others who really call the shots in the international monetary system.

I always date myself with these examples, but there was an old marketing campaign in the 1980s for a broker long gone called EF Hutton. The punchline was, “When EF Hutton talks, people listen.” Well, when El-Erian talks, I listen, because he is a true insider. He’s not just talking his book at Allianz; he’s actually conveying something that is no doubt in the air, as I put it, among the elites. So, I’d put a lot of weight on that. I think it’s very significant.

I think he’s right. Where are you going to go if they have to keep a lid on bond prices because governments are going broke and on stock prices because we can’t afford another meltdown?

I’ve actually observed the volatility in the currency markets. People keep saying, “Where’s the volatility?” I say, “Look at the euro/U.S. dollar cross rate.” The euro/U.S. dollar cross rate has had seven moves of 20% or more in the last ten years.

Again, people say, “Where’s the volatility?” I point them to the currency market, because the U.S. dollar and the euro are the two leading global reserve currencies. The U.S. dollar has the bigger share at about 60% and the euro is closer to 30% in terms of global reserves, but the two of them together are 90% of global reserves. They’re both supposed to be stores of value, and they both have PhD central bankers, so why should they be moving 20% against each other? There’s the volatility.

It is because central banks are fighting the currency wars but using bank policy to suppress volatility in the stock market, the bond market, and elsewhere. Something has to give. The best way to understand this – and this is a metaphor, but it’s also the same science – is to imagine two tectonic plates similar to the San Andreas Fault where a pacific plate and continental plate are butting up against each other.

You can see the San Andreas Fault and actually stand on it. I’ve done this out in the desert near Palm Springs where my guide took me to the San Andreas Fault. The point being, the day I was standing there, nothing was happening. Well, that’s fine, but it doesn’t mean it’s stable. It’s not moving that day, but it’s dynamically unstable. Eventually the pressure builds and builds until it snaps.

That’s what I see happening in financial markets and I think what El-Erian was referring to. When this snaps, there’s going to be an enormous run to gold. Based on what we talked about earlier with the Chinese acquiring dealer positions, exchange positions, and so forth, there’s not even close to enough gold to satisfy all the existing paper claims let alone future paper claims, so you would expect a very significant price spike.

Alex:  The idea of institutions moving into gold has always been interesting to me based on the amount of gold in the typical institution portfolio according to certain individuals who are professional money managers or pension fund managers, etc. Shayne McGuire owns a very large pension fund, and in his book called Hard Money, he says that amongst his colleagues, they’ve typically got less than 1% weighted allocation to gold. His opinion was that if institutions moved more towards even a 2% – 4% allocation to gold, that would significantly drive the price just from that alone.

Jim:  That’s exactly right. I know Shayne, he’s a great guy. He was part of a group that was instrumental and successful in getting UTIMCO, the University of Texas Investment Management Company, to do an allocation of gold. One of the big drivers who lobbied hard for that was Kyle Bass, a very well-known hedge fund manager and trustee at UTIMCO. They did buy $500 million worth of gold, which is a lot of gold, but it was still a tiny part of the overall portfolio. This is a huge, multi-billion-dollar portfolio involving the entire university system endowment and other state contributions.

I always recommend 10% gold for personal portfolio allocations and get a lot of pushback on that. People say, “Jim, you’re the guy saying gold is going to go to $10,000 an ounce. Why wouldn’t you have 100%?” The easy answer to that is you shouldn’t be 100% in anything, I don’t care what it is. That’s just not prudent. I think 10% is fine although some people say 5%, and that’s fine.  If nothing happens to gold, or it goes sideways or down a little bit, you’re not going to get hurt with a 10% allocation. If it goes anywhere near what I’m expecting, then that will be enough to in effect insure the rest of your portfolio.

You can debate 10% or 5% all day long, but in fact, the institutional allocation is about 1.5%, not even 3%, and that’s not evenly distributed. It’s not as if every large institution has 1.5%; it’s more the case that some have 5% and some have 0%. Most institutions have zero, so with any kind of move at all, there’s not enough gold in the world at these prices to meet that kind of demand. They’ll get their gold, but at much higher prices, and there’s no reason for investors and our listeners not to position accordingly today. You can definitely see this coming.

Alex:  Moving on, the next topic is going to be the Fed. Janet Yellen seems to be having a hard time coming to grips with the fact that inflation numbers in the U.S. are actually in a downward trend. Her response – besides blaming it on a series of different issues – is that all of this is transitory. It’s also not looking like she’s going to be reappointed, and that has to be weighing on her mind.

Jim, why does the Fed keep getting this wrong? And where do we go from here? Where do they go from here?

Jim:  It’s a great question, and you’re exactly right. Probably the hardest thing for any of us, whether your Janet Yellen, me or anyone else, is to admit you’re wrong. You have a model, you worked hard, you did the math, you studied, you went to school, you did all this stuff, and it turns out that everything you believed is just wrong. That’s the situation she’s in.

The biggest thing they’ve got wrong is the so-called Phillips curve. For the benefit of listeners, Phillips curve is just a curve, a relationship or a distribution between a couple of factors. The basic idea is that there’s an inverse relationship between employment and inflation so that as unemployment goes down, inflation goes up, or as unemployment goes up, inflation goes down.

The theory is that as unemployment goes down, labor markets get tight and it becomes more difficult for companies to find workers. If I’m putting up a construction site, starting a new company or expanding my plant, I want to hire people, but they’re all working already. I can’t find anybody, so what do I do? I bid up wages. I offer to pay them more, and they’ll come work for me.

The theory continues in that if the economy can only grow in real terms (historically, we would have said 3% – 3.5% or today under the new normal maybe it’s 2%) and we start bidding up wages 3% – 5% to get the workers, anything over the maximum real rate of growth has got to be inflationary. If I pay you more than real growth, then you’re going to go out and spend the money and bid up prices of other things. It’s inflationary.

That’s the theory, but it is complete garbage and nonsense. It doesn’t work that way and there’s plenty of evidence to the contrary. Going back to the late 1970s, we had high inflation but we also had high unemployment, and we had back-to-back recessions in 1980 and 1981. We had a worse one in 2008, but prior to 2008, the worst recession since The Great Depression was the one in 1981 – 1982.

Those were the days in the late ‘70s and early ‘80s of 13% interest rates and 15% inflation along with high unemployment. They had to come up with a new word for it called stagflation. Weak growth was stagnation and rising prices was inflation, but here we had both which wasn’t supposed to happen, so they called it stagflation.

We have the opposite situation today. Unemployment is extremely low. It’s the lowest it’s been in at least in 17 years, and maybe we’d have to go back even further than that. We’re down to about 4.2% which we haven’t seen in a very long time, and yet inflation is low. In fact, not only is inflation low, it’s falling. We have disinflation although we’re not quite to the point of deflation.

These two examples completely refute the Phillips curve, so you would think that Yellen would just throw in the towel and come up with a new model, but she can’t do it. She’s been doing this too long. She’s ideological, overly academic, and detached from the real world. If I want to put on my behavior psychologist hat, this is what’s called cognitive dissonance, and she just can’t come to grips with it.

You’re right, Alex, about her list of factors. I wrote a column recently called Janet Roseannadanna, and it was a reference to the TV character Gilda Radner played in the late ‘70s called Roseanne Roseannadanna. The schtick was she would have this long list of complaints like, “Oh, my stomach hurts. I can’t get out of bed.” The punchline at the end of it was, “It’s always something.”

I applied that to Yellen. When prices kept going down, she first said, “There’s a cell phone price war.” Then she said, “Medical costs are government administrators, so they’re not responsive to monetary policy.” Then she said, “The strong dollar is lowering import prices,” and on and on. She gave a long list of reasons, but all of it was to deny the fact that the prices were going down.

Having said that, the upshot of all this is my forecast that the Fed will not raise interest rates in December, which is very out of consensus but also very bullish for gold. Using hedge fund futures and implied probability, the consensus forecast right now is that there’s an 80% chance of an interest rate hike in December.

My model gives it about a 20% chance. What I expect is that as we move down the timeline over the next two months between now and the December meeting, the markets will get the wakeup call and converge on that 20% level. When you have an expectation of a rate hike and the Fed doesn’t hike, that’s ease relative to expectations. That kind of easing is very bullish for gold.

Alex:  Very good. You heard it here first. This is pretty typical of Jim Rickards. He looks at things and connects dots that typically the markets are usually catching up to a month or two after the fact. I suspect that this is probably going to turn out no different.

Another thing I was reminded of while you were talking about Janet Yellen basically being in an echo chamber coming from academia, etc., is the many conversations we’ve had regarding PhD economists. I don’t want to make it sound extreme, but it’s almost like a religion. It seems like a dogma to me.

I recall when you had spoken about Copernicus. All the scientists of the day believed a certain thing, but they were all wrong. Copernicus was right. Their models were wrong, but it was dogma they were clinging to because of the echo chamber they were in.

Jim:  I don’t want to be 100% categorical about PhD economists, because there are a few good ones out there. My friend Gail Fosler, based in Washington, is really good on business cycles. I thought the best economist was John Makin who was a friend of Gale and I. Sadly, John passed away a couple of years ago, but boy do we need him now. John had an uncanny ability to call business cycles.

That said, there are a couple of economists I’m fans of, but not many. Basically, I consider PhD in economics to be a disability when it comes to understanding the economy. Of course, right now as we record this, we’re in the midst of the final beauty contest for the next Chairman of the Fed.

I think our listeners know about the five finalists. Would Janet Yellen be reappointed? Would President Trump pick Jay Powell who is a governor now and already on the board? Plus, there are three outsiders: Gary Cohn, head of the National Economic Council, Kevin Warsh, former governor (he has a couple of appointments and is also Chief Economist to Stan Druckenmiller’s family office which was formerly Duquesne, one of the most successful hedge funds in history), and the last one is John Taylor, professor at Stanford University and author of the Taylor Rule, which is a formula for setting monetary policy.

I’ve said for the better part of the year beginning last January that it’s going to be Kevin Warsh, so I’m sticking with that, but they set up these betting markets. It’s an interesting horse race, because not a month ago, Warsh was leading, but then it’s like, “Here comes Seabiscuit.” Suddenly Jay Powell shot ahead because Steve Mnuchin, Secretary of Treasury, got on his side. Then John Taylor met with the president. The president interviewed all the candidates, and apparently it was a great meeting. Trump loves John Taylor, and that gets leaked by the West Wing, so all of a sudden John Taylor’s odds are up. Gary Cohn was ahead last summer but fell back after criticizing the president publicly – not a good idea if you’re looking for a promotion. No one really thinks Janet Yellen is going to be reappointed.

It’s a horse race. We’ll know literally within days, because apparently the president is going to make this decision before he heads off to Asia in early November. My forecast is Kevin Warsh. I’ve said this since last January, and there’s good reason to believe that’s true, but we’ll see.

One of the things I like about Kevin is that he’s not an economist, he’s a lawyer. Maybe I’m showing some bias because I’m a lawyer myself, but he’s also an MBA and an investment banker, so I’m not saying he walked out of a law firm. He’s got plenty of financial chops, and he was on the board of governors already. He was not the Chairman, but he was there in 2008 – 2009 during the worst of the financial crisis. He was part of Ben Bernanke’s inner circle in dealing with the crisis. Whatever you think of what Bernanke did, Warsh was there on the front line.

I know from my own experience in 1998 with Long-Term Capital Management when I negotiated that bailout, we were hours away from shutting every stock and bond market in the world. That’s how dangerous it was and how close it came. When you’re in that position, you actually get to see the whites of their eyes, so to speak. You know how dangerous it is, all the things that are going wrong or could go wrong or almost went wrong, and how close the world can come to hitting a wall at 70 miles an hour.

Warsh had that experience in 2008, not just as an academic or a market participant, but as a true insider. If it happens again – which we all know it will – I find that when lawyers turn to economics, they tend to be very good at it, because legal training is all about problem solving. It’s a benign form of brainwashing. I had six years of law school, because I got a second law degree, but no one goes through three years of law school without your brain coming out a little different at the other end. It’s kind of like a North Korean reeducation camp. They train you to look at both sides of every problem and force you to keep an open mind, and that’s valuable in economics.

The problem with Yellen is that she looks at things one way and is not good at balancing different views. I consider that a disability. I think Warsh would be a great choice or the others, too. I know Jay Powell from working with him when I was in Wall Street and he was at the Treasury. I don’t know John Taylor personally, but there’s every reason to believe he would be a great choice. Whether it’s Powell, Warsh or Taylor, there are three good choices on the table. Again, my expectation is Warsh.

Alex:  That brings us to our last topic which I’ve been looking forward to discussing with you, Jim. Yesterday, you attended a meeting with a select group of people where I understand you had access to H. R. McMaster, the U.S. National Security Advisor, as well as Mike Pompeo, Director of the CIA.

Among the topics the meeting dug into was U.S. national security interest issues. Jim, what are your key takeaways from this meeting?

Jim:  Yes, I was in Washington yesterday and spent six hours over the course of the day from late morning to late afternoon with Mike Pompeo, Director of the Central Intelligence Agency, and General H. R. McMaster, National Security Advisor to President Trump.

They’re two of the big four. I would say the other two would be Rex Tillerson, Secretary of State, and Jim Mattis, Secretary of Defense, who advise the president on matters of war and peace.

I talked a few minutes ago about the bailout of LTCM, and I’ve had other big challenges in my career, but I have to say that this is the hardest problem I’ve ever worked. I’m talking about North Korea and the prospects of war and peace; it’s absolutely the hardest problem I’ve ever worked. There are a lot of moving parts and partial information which is always true in intelligence work. You never have all the information. If you did, it would be easy. The challenge of intelligence analysis is reaching solid conclusions or estimates with partial information.

I concluded some months ago and did a series of interviews in August and September saying we would be in a war with North Korea by early to mid-2018. Whether it’s a preventative war, which means you’re trying to stop them from developing their program, or a preemptive war which means, “Hit them before they hit you,” that’s an interesting distinction. Either way, the U.S. would start it. We would attack North Korea, it would be bloody and messy, it would not be a walkover, it would not be shock and awe. It would be a really bad situation, and it was coming.

I subscribe to Bayesian statistics and mathematics among disciplines such as behavioral psychology, complexity theory, and others. One of the things you do as a Bayesian is to update, so as I went through the months of September and October, I said, “Okay, I have the hypothesis, I tested it, I’ve given it this probability,” but you get new information every day. The new information goes into the equation and updates it, so you have to keep an open mind. You have to do exactly what I said Janet Yellen doesn’t do, which is to be nimble and flexible and willing to say, “You know what? Here’s what it was, but new stuff came in. I’ve updated, I’ve lowered the probability, and I’m now in a different place.”

You have to be willing to do that. John Maynard Keynes famously said, “When I get new facts, I change my mind. What do you do, sir?” That’s a good rebuttal for people who call you a flipflop. I’m not a flipflopper, but I’m willing to update.

The point is, I said, “What if I’m wrong? What if I got this wrong? What if I’m missing something?” so I reached out to some CIA analysts and other people. It’s like you’re not quite sure if they handed in their badge or not, but as one guy put it, “They still send me pictures and ask me what I see,” so I reached out to people who are very plugged in including CIA operatives, subject matter experts, scholars, and people very immersed in the field. What I was hearing consistently is (to quote Steve Bannon), “They got us. It’s too late.” It would have been nice to stop this capability six or eight or two years ago, but they’ve got nuclear armed missiles. Whether they’re reliable ICBMs, they’re at least intermediate range missiles. Whether they have ten of them, they have at least one they can use, launch on warning, etc.

It’s too late. If we launch this attack, they’d lob one over Tokyo or Seoul. The poor Japanese, I don’t know why they’re the ones always getting nuked. We dropped two bombs on them, and North Korea is getting ready to shoot another one. The casualties would be too high, the costs would be too high, so we’re going to have to engage in a long, drawn-out policy of deterrents and containment not unlike what we went through with the Soviet Union during the Cold War.

I was hearing this a lot as well as updated information. One expert said, “They don’t have to test a missile in space to ruggedize it. They can put it in a wind tunnel with a rocket engine at the other end, and that gives you all the heat and vibration you want.” I said, “You know more about wind tunnel testing missiles than I do. That’s an interesting bit of information.” And I kept going.

Until the night before I went into this meeting with Pompeo and McMaster, I had come around and said, “Yes, maybe Bannon was right, they got us. There’s not going to be a preemptive war.” My takeaway was that there’s going to be a war, it’s just a different kind of war. If we don’t attack North Korea because they can nuke us, they’re going to attack South Korea and rely on their nuclear deterrent to keep us from doing anything. At that point, we might as well fold up our tent in the Western Pacific.

That’s how I went into the meeting with Pompeo and McMaster. Six hours later, I walked out and said, “We’re going to war,” because I heard it straight from the horse’s mouth.

I have to say as an aside, apart from the substance, I cannot tell you how refreshing it was to hear top policy makers speak in their own words for hours on end. It wasn’t being filtered by CNN or the Washington Post. They’ll cover it by throwing in a quote here or there and fill up all the space between the quotes with their own spin, fake news, and everything.

There’s another side worth mentioning. Both of them were extremely complementary to President Trump. They said, “He’s got our back.” When you’re a three-star general, that’s a major statement. When you say someone’s got your back, you mean he’s got your back. Same thing with the Director of the CIA. They’re running assets, paramilitaries, clandestine operations, spies, people in denied areas, and people risking their life every day, so when you say, “The president has got our back,” that’s a major statement.

They said, “He’s giving us all the authorizations we need.” That has to do with when you run cover ops, and you must get something signed by the president. They actually do it in physical copy. They drive it over to Langley, the director puts it in a safe in his office, and then goes and does all kinds of hair raising stuff. If he gets called out, he just opens the safe and says, “Look, that was authorized by the president.” They don’t want a replay of what happened with the Church Committee in the 1970s. Trump has been very willing to sign those authorizations, they’re conducting the ops, and they’re preparing militarily.

Getting back to our point, I’m going to read some exact quotes from when I was at the meeting and took notes. I have them in front of me. Here’s a quote from Mike Pompeo, CIA Director:

“The president has made it clear that he will prevent North Korea’s ability to hold America at risk, by military means if necessary.”

The two key parts of that sentence are “prevent,” meaning they’re not going to get there, and “military means if necessary,” meaning war.

By the way, Pompeo put a date on it of March 20th, 2018. Why do I say that? He said five months, and yesterday was October 19th, 2017. Those are his words, not mine. He didn’t say the war starts in exactly five months, but he said:

“It would be imprudent to assume it would take more than five months for North Korea to gain the capability.”

Waiting more than five months risks them having the capability we’re trying to prevent, and therefore, war would come on March 20th if not sooner.

Another exact quote from Pompeo was:

“Trump has instructed the CIA to ‘prevent Kim from having the capacity to threaten the United States.’”

Again, the key word is “prevent.” Now let me turn to McMaster, National Security Advisor. I’ll quote him as saying:

“This is Kim’s last chance to avoid severe consequences.”

That was a reference to the ongoing diplomatic efforts. He’s like, “If Kim wants to verifiably give up his weapons development program, or if diplomacy bears fruit, we can avoid it. Absent that, no, it’s coming.” I also quoted McMaster saying:

“We’re running out of time.”

That’s consistent with Pompeo’s five months. Here are the two most important quotes from McMaster. He said:

“Accept and deter is unacceptable.”

Just to shorten that, “Accept is unacceptable.” “Accept” meaning accept North Korea as a nuclear arm power, and “deter” meaning deter them from using their power. No, he said, “Accept and deter is unacceptable,” meaning we’re not going to pursue a policy of deterrence and containment. We’re going to prevent Kim from building the nuclear arsenal, which is what Pompeo said.

A final quote is in reference to the April 6th, 2017, meeting at Mar-a-Lago between Xi and Trump. Again, an exact quote:

“China has a great deal of coercive power on North Korea. What’s worse, that or war?”

In other words, China is really putting the screws to North Korea. That feels bad if you’re Kim, and maybe it’s uncomfortable for China, but the quote, “What’s worse? That or war?” means war is the alternative. I was stunned, because we’re so used to Washington figures’ elliptical speech, euphemisms, buzzwords, saying nothing. Here we have two serious guys.

Pompeo has had a military career. He was first in his class at West Point. You might say, “First in class at West Point, that’s pretty good,” but he was also first in his class at Harvard Law School and Editor in Chief at the Harvard Law Review. So, I’m like, “Wait a second. If you told me you were first in your class at West Point, I’d be impressed. If you told me you were editor of the Harvard Law Review, I’d be impressed. If you told me you were both, I’d be blown away.” Well, that’s Mike Pompeo.

McMaster has a highly decorated, distinguished military career. Again, as a three-star general, he’s been in the fight in more ways than one and is a totally serious player. They were blunt, they were candid, they were unambiguous. We’re heading for war.

The only other talk I heard that I found interesting and factored in was assassination. It’s not a funny topic, but Pompeo made a funny remark. Someone asked him, “Would we be engaged in the assassination of Kim Jong-un, a kind of regime change without a war?” Pompeo replied:

“I don’t want to comment on that, because in case an accident should befall him, I wouldn’t want anyone to think that was a coincidence.”

It was very elliptical. In other words, “I get it. It’s illegal for the United States Intelligence Services to assassinate anybody, but that doesn’t mean somebody else couldn’t do it if we asked for a favor.” So, you take my point.

I also talked to a CIA operative who told me that he’d been working on a program for a device to cause Kim to have an unfortunate accident. It was a device that is not being employed because it would have been too much collateral damage, but it told me that, as we say in Wall Street, “They were working the order.”

Here’s my lineup right now:  I would give a 20% probability to regime change, meaning Kim has an untimely death and some changes there. I would give a 20% probability (that’s probably high, but I’ll say 20%) that Kim gets the message, backs down, stands down, and we avoid a war because he gives up his program. I give a 60% probability to war started by the United States preemptively or preventatively before March 20th, 2018, and I give a 0% chance to, “We just live with it. They get the weapons and we don’t do anything, we just contain it.”

Again, four possibilities, and I would give them probabilities of 20, 20, 60 and 0 in that order:

  • A regime change including assassination
  • Kim stands down
  • We go to war
  • We accept a nuclear-armed North Korea

So, I’m back where I started, but at least I can credit myself for questioning my own assumptions and incorporating a lot of contrary views.

Alex:  Regarding the second category, Kim stands down, I read a really interesting article recently. I had not known this about North Korea, but apparently the entire country has this situation where they basically worship him and his now passed father. It was a really amazing article that indicated there’s one city over there – I think it’s Pyongyang – that’s essentially dedicated to the worship of these two individuals.

It’s kind of like the U.S. is the boogeyman that Jong-un has constructed as the great enemy of the people. They’re all unified behind that idea, so him backing down sounds like a tough scenario.

Jim:  I agree with that, Alex, and that’s why I put a 20% probability on it. I was like, “Eh, should it be 10%?” You never want to be 0% or 100%, because that’s just not good science, but I was stretching to 20%. The only reason I got there was because the likelihood of war that I was hearing was so clear and unambiguous that maybe even Kim gets the message? That’s why I gave it a little higher probability.

Maybe he will stand down, but I agree with you, that’s the hardest thing for him to do. They have an official ideology called Juche. It’s not quite communism, it’s kind of totalitarianism, but it incorporates exactly what you just described, which is the cult of the individual and the personal worship of the Kim family.

You referred to his father, and that’s right, but you really need to go back to the grandfather. Kim Jong-un is the third generation. It goes back to Kim Il-sung who is the founder of this Kim dynasty. What’s interesting is that Kim Jong-un reminds me more of his grandfather than his father.

If you go online and dig out some pictures of the grandfather when he was about 30 years old, there’s a striking resemblance to his grandson Kim Jong-un. He acts and looks more like his grandfather than his father.

The Korean War is not over. I’m talking about the war that was fought from 1950 to 1953. It’s not over, there was never a treaty. There was an armistice, which is just an agreement to stop shooting, but it’s not more than that. It’s an agreement to stop shooting, meaning you can change your mind and start shooting anytime you want, so this war is not over.

Kim Jong-un considers it unfinished business. I’d say his top priority is personal and regime survival, and the second priority is the reunification of the Korean Peninsula on his terms. He’s pursuing both, and he thinks the way to get both is with nuclear weapons. I heard it from the National Security Advisor, who sits right down the hall from the president, that it’s not going to be allowed to happen.

My expectation – and I would price and organize portfolio accordingly – is that we will be in a shooting war with North Korea before the end of March 2018.

Alex: Here’s a question about Trump. The sort of narrative going on right now in the mainstream media is that Trump is dangerous, he makes bad decisions, and the people close to him are always trying to contain him in his bad decisions. What feeling did you get about that when talking to Pompeo and McMaster? Did you get the impression that they’re trying to run around containing the president, or do you get the feeling that they are confident he is making good decisions here?

Jim:  It was more the latter. I was trying to pass along specific quotes that had to do with war and peace, but as I said, this was six hours. Pompeo said the president asks great questions.

By the way, Pompeo personally briefs the president every day. There’s a document called the PDB, the President’s Daily Brief, that is compiled overnight on a daily basis by the CIA and is top secret. I’ve seen them; they come in a nice leather binder. Someone gets in a car and drives from Langley to the White House which is a pretty short drive. They have copies for seven or eight people who get it. Obviously, that includes the Secretary of Defense and Secretary of State, but it’s not widely distributed because it’s highly classified. They walk in and brief the president.

The Director of the CIA doesn’t have to do that. If you’re on a career path in the CIA, one of the prestigious jobs is the briefer, meaning you’re the person who gets to brief the president. The president doesn’t have to take the briefing; sometimes they’ll take it once a week or twice a week. Obama was famous for not taking these briefings, for blowing it off.

Alex: Wow.

Jim: Obama did not get briefed by the Director. Trump is the opposite. He takes it every day, and he gets briefed by Mike Pompeo personally. We were in Langley in Northern Virginia just a few blocks from the White House, and Mike said, “I’m here every day, and I brief the president personally. The president asks great questions. He challenges us. If he has a doubt about something, he makes us go back and look at our assumptions. If there’s room for improvement, we make the improvement.”

I got the sense of a good dialog, mutual respect, good interaction, a process working the way it’s supposed to work. I didn’t get the sense that Pompeo did adult supervision in a daycare center which is how Senator Corker put it.

Same thing for McMaster. Again, when a three-star general says, “He has my back,” that’s an expression of confidence and a relationship of deep trust. That’s not an expression of someone who doesn’t think well of the person or feels he’s got to rein them in.

Trump is Trump, and Trump is not going to change. People say, “Why doesn’t he stop tweeting?” He’s not going to stop tweeting; 70-year-old guys don’t change. It’s not going to happen. To an exterior audience, Trump can be vulgar, shoot from the hip, ostentatious, name calling, a little bit egocentric, a little bit spoiled. Yes, that’s all true. I’m not going to dispute any of that, but so what? That’s not the substance of what we’re talking about.

We’re talking about war and peace. As I said, I heard from two of the big four, and what I heard were complements, respect, and a good, mutual working relationship. I did not hear an adversarial relationship or one where they felt they had to run a kindergarten.

Alex:  That’s good to know. Wrapping it up with this, the comment of, “He’s got our back,” is incredibly important and very close to my heart.

About a month ago I was doing some training in Colorado where I spent time with some former Navy SEALs, and we were talking about how a lot of people in the military think. During one of the downtimes, one of them said to me that they just didn’t feel like some of the former administrations cared. The military felt like they were expendable, that they were possibly going to be thrown into combat situations and torn to pieces, and that these administrations just didn’t really care.

He said something that struck me like a blow. He said, “What could be worse than a generation of Americans growing up, and the leadership of America doesn’t have their back; they’re willing to throw our lives away? What could be worse for a free nation than that?” That was like, “Wow, good point.”

Jim:  That’s very powerful, Alex. I’ll add to that briefly and say that I’ve traveled quite a bit in my career. I used to go to places that I would not go back to today without an armored car and a platoon or something. In the early 1980s, I walked unarmed by myself in the streets of Khartoum and Omdurman in Sudan. I walked the streets of Karachi in Pakistan, Lahore, which is in Northern Pakistan closer to the frontier, and I felt completely relaxed.

I knew there were bad people around, but Reagan was president, and I felt like, “You won’t mess with me, because I’m an American and Ronald Reagan has my back.” I wasn’t in the military, so it’s not like I could call in a helicopter evacuation. I just felt that in general they knew you were an American, and they weren’t going to mess with you because somebody was going to mess with them.

I haven’t felt that since. As we got into the ‘90s, and certainly during the Obama administration, I wouldn’t go back to Karachi without an entourage. It’s too dangerous, and I don’t think they do have your back. Having said that, it’s a new administration. You’re exactly right about the depth of feeling and importance of that and how it affects everything you do.

I’ll mention two more things on Pompeo and McMaster. Now I’m putting words in their mouth a little bit, but everything I said earlier were direct quotes. I heard disdain from Mike Pompeo for General Clapper, former Director of National Intelligence. To be clear, Pompeo did not use Clapper’s name. He used the phrase “formers,” meaning former Director of CIA and former Director of National Intelligence. We all know who they are, John Brennan and James Clapper.

I had some interactions with Clapper myself, and let’s just say I’m not a fan. I’ll leave it at that. Again, that’s something you don’t get from the media.; you only get it from being in the room. Pompeo made a disdainful remark, and I heard the same thing from McMaster. He said, “Wishful thinking is not a strategy.” Then in a separate part of the conversation – I’m paraphrasing here, because I don’t have the exact quotes in front of me – he said, “We didn’t have a strategy, we had a fantasy,” referring to our approach to North Korea.

I would add that to this clear message of no more wishful thinking, no more fantasy, no more hoping for the best. It will be Kim stands down, he’s removed or we go to war.

Alex:  Jim, I appreciate your time today. It’s been a great discussion, and I very much look forward to doing it again next month.

Jim:  Me too, Alex. Thank you.


You have been listening to The Gold Chronicles with Jim Rickards and Alex Stanczyk presented by Physical Gold Fund. Recordings may be found at You can also register there for news of upcoming interviews with Jim Rickards and other world-class thinkers.


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The Gold Chronicles: October 2017 podcast with Jim Rickards and Alex Stanczyk


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Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles August 2017

Jim Rickards and Alex Stanczyk, The Gold Chronicles August 2017


Topics Include:

*Gold allocations according to some of the worlds foremost professional money managers
*North Korea Update
*How Congress is deadlocked and why it may affect the debt ceiling and budget
*Why “Wealth Management Products” in China pose a potential threat to global markets
*How liquidity can be frozen by governments at any time
*”The Myth of August”


Listen to the original audio of the podcast here

The Gold Chronicles: August 2017 Interview with Jim Rickards and Alex Stanczyk


Physical Gold Fund presents The Gold Chronicles with Jim Rickards and Alex Stanczyk offering insights and analysis about economics, geopolitics, global finance, and gold.


Alex: This is Alex Stanczyk, and I have with me today my friend and one of the smartest men I know, Mr. Jim Rickards. Welcome, Jim.

Jim: Thank you for that introduction, Alex.

Alex: Jim, with everything going on lately, gold briefly punched through the $1300 USD per troy ounce ceiling at the London Open. Ray Dalio, one of the world’s most respected hedge fund managers who manages money for governments as well as some of the world’s largest sovereign wealth funds, recently recommended a 5% – 10% allocation to gold. Do you have any thoughts on gold before we dive into the rest of our topics?

Jim: Gee, 5% – 10% allocation, where have we heard that before? Ray is the most successful hedge fund and alternative fund manager in history, certainly in the Hall of Fame along with George Soros, Bruce Kovner, Stan Druckenmiller and a relatively small handful of others.

I had occasion to meet him since we live nearby, and I have a lot of respect for Ray, but he’s come around to exactly what we’ve been suggesting to listeners all along, 5% – 10%. I personally recommend 10%, but that’s kind of season to taste depending on your risk appetite.

People say gold is risky or doesn’t have a yield or they’re nervous having it in their portfolio. I just look at people and say I would be nervous not having it in my portfolio. I can’t imagine going to bed at night, waking up in the morning, and not having an allocation to gold.

People disparage it in a lot of different ways, and in fact, they always want to put words in your mouth. I’m out there a lot giving presentations, doing podcasts like this one, with my book, The New Case for Gold, and people make comments like, “Jim Rickards says the world is coming to an end. Sell everything, buy gold.”

I have never said that, and I don’t believe that. The world is not coming to an end. We may go through some tumultuous changes with some severe stress in the international monetary system, but we’ve seen that many times over the last 100 years. It’s nothing new. When that happens, you’re going to want gold.

I wouldn’t go 100% in anything, including gold, cash or any other asset, but if you do 10% in gold, that leaves 90% in everything else. I’m often asked, “What about the ‘everything else’?” There’s room for cash as a good asset in tumultuous times as well as land, real estate, and museum quality collectibles. I invest in private equity, and I’ve invested in some technology startups and some natural resource startups, particularly in the water space.

Diversification is obviously important, but if you don’t have 10% in gold (I’ll echo Ray Dalio and say 5% – 10%), you’re driving without insurance. If things get bad, that’s the first thing you’re going to want to get, and you’re going to find that you can’t get it.

Alex: Indeed. Now let’s get into some of our subjects. On our last podcast, we discussed disinflation, slowing of the U.S. economy, Fed tightening into weakness, Fed’s new pet theory, and North Korea. That’s our first topic today.

We first started covering North Korea back in our April podcast, and since then it’s gone from being on nobody’s radar to what one whitepaper described as the world’s biggest tinderbox. As a quick recap for those not familiar with the back-story, we first started talking about North Korea’s weapons capability in our April podcast. If you want to hear it, it’s available on our podcast page at Physical Gold Fund Podcast.

Jim, you had been on a major news station and said that the North Korea threat was escalating and the U.S. would be at war with North Korea in short order. This was met with huge skepticism. An hour later, North Korea launched an ICBM test missile. Next, North Korea conducted a series of ICBM tests. U.S. intelligence has confirmed they can fit a miniaturized nuclear warhead into a missile-sized payload. Intel estimates that they’re sitting on up to 60 warheads at this time.

On Tuesday, August 8th, President Trump made the comment that North Korea had best not make any more threats to the United States or they would be met with fire and fury like the world has never seen.

On August 9th, North Korea revealed its plans to strike Guam with four nuclear missiles, and the green light to do so would come from Kim Jong-un. Current estimates are that it would be a 14-minute flight time for a North Korean missile to reach Guam.

For those who are not familiar with Guam, it’s a U.S. island territory in Micronesia used as a forward staging area for projection of U.S. sea and air power. It’s home base to a number of U.S. nuclear attack submarines. These aren’t the ones that fire nuclear missiles vertically. They hunt other submarines as their primary role, but they can also launch Tomahawk land attack missiles and provide insertion options for U.S. Seal teams.

Also located on Guam is Andersen Air Force Base, home to the U.S. 36th Wing. It includes Intelligence aircraft, fighter interceptors, and importantly, acts as one of only two critical forward airbases for U.S. long-range bombers in the Pacific. So, it’s a pretty important installation.

On August 10th, the U.S. Air Force, in an unprecedented move, transferred all three main bomber types in the U.S. arsenal to Guam. That included B1 Lancers, B2 stealth bombers, and B512 Stratofortresses.

As of now, North Korea has backed down on the threat regarding Guam, but the fact remains that they’re continuing to develop capabilities in defiance of the world asking them to halt their nuclear weapons program.

Jim, let’s game theory a bit. Where does it go from here?

Jim: First, Alex, that was a fantastic summary. As you know, I’ve been to the Pentagon many times for briefings on different topics. Your summary feels like I just sat through a Pentagon briefing, because that was very thorough. I don’t have a lot to add to that in terms of logistics other than to say I’ve been to Guam and Saipan on the Northern Marianas in the area you described, and yes, it’s U.S. territory.

Even before the ICBM test there was the Hwasong-12 and other tests more in the intermediate range. Then they made a big breakthrough with this intercontinental ballistic missile which has a much further range.

I was very disturbed when newspapers were publishing maps showing concentric circles from Pyongyang showing the range of the missiles to give readers an idea of how far they can go. I saw one that said, “We’re not worried, because it can’t reach Los Angeles,” but I looked at the map and saw that it covered Guam and Alaska.

The last time I looked, Alaska was a state and Guam a U.S. territory. I don’t understand this view that if it’s not a densely populated city – which of course we should care about – it’s somehow not a threat to the United States. It certainly is, and you’re right, Guam is U.S. territory with a lot of Americans living there.

The point is, this escalation has continued. Now, this has been going on for 25 years. We may have been warning listeners about it ahead of the pack, so to speak, months ago, but this threat has been escalating since the mid-1990s with Kim Jong-un’s father.

Bill Clinton did a deal with him in which we released some sanctions in exchange for promises to discontinue the program. They immediately broke that deal. Then George Bush did a deal with them whereby he also gave some section relief, and they immediately broke that deal. So, their track record is that they lie, they buy time, they get concessions, and they keep building the missiles.

The Obama administration essentially did nothing for eight years, so this thing’s been kicking around since the mid-‘90s. I do think the Trump administration deserves credit for clarity, saying, “Okay, that’s it.” The best line I saw was, “We’re not going to negotiate our way to the negotiations. If you want to come to the table and talk to us, we’ll meet with you, and we’ll tell you right now that what you must do is verifiably discontinue your weapons programs. What do you get in exchange for that? Let’s talk.”

Obviously, there would be sanctions relief and maybe even integrate the North Korean economy into the global economy. They’re actually very rich in natural resources. It’s an interesting country. They could be a commodity-driven exporter and have a decent economy, but they’re completely cut off.

That’s the back-story. For the recent sequence of events, let’s go back to August 8th – 10th when the stock market went down about 1.2%. That’s when this rhetoric was dialing up exactly as you described, Alex. Kim Jong-un was talking about attacking Guam, Trump was saying this’ll be met with fire and fury, Kim Jong-un was saying, “I’m waiting for the battle plans, we’re launching at Guam,” etc.

The weekend of August 12th and 13th, a lot of national security officials went on television. General H. R. McMaster, who’s the National Security Advisor, Rex Tillerson, and others gave interviews, but they dialed it back by saying war is not imminent. By the way, you have to agree with it; war is not imminent. If there’s a high probability it’s coming in early 2018, is that imminent?

Not in the sense that someone’s going to launch an attack tomorrow, but that’s close enough for investors to start thinking about it if they cared, and I certainly think they should. Yes, I’ll buy the fact that it’s not imminent. They dialed down the rhetoric, and then Monday, Kim Jong-un seemed to respond in kind. He said, “I’ve got the battle plan but I’m not ready to launch yet.”

By his standards, that seemed a little bit conciliatory. And then Trump made a statement saying, “We welcome this progress, and maybe we can do some basis for talking.”

Suddenly, stocks take off, it looks like the threat’s over, and everyone is dialing down, but that is not how I read it at all. Kim Jong-un actually said, “I will not launch at Guam if the United States engages in acceptable behavior,” or stated in the negative, if they don’t engage in unacceptable behavior.

That was a very specific reference to a joint U.S./South Korean military exercise that is conducted periodically. These military exercises have very long engagement periods. There’s a big one they’re going to launch on Monday, August 21st that lasts for about a week, I think August 21st to 28th. It has a lot of moving parts involving all branches of the military.

What Kim Jong-un was saying is, “I won’t launch at Guam if you call off that exercise.” That’s what he meant by the U.S. not engaging in bad behavior. You don’t have to read between the lines very much to see that’s what he meant.

Well, we’re not going to call off the exercise, because the U.S. is not going to be bullied or threatened. This exercise is long planned, and we’re going to go ahead and do it. The minute we do, we have now broken the condition on which Kim Jong-un was reframing, so, my expectation is he will test one of these systems.

Here’s where it gets really interesting. You talked about the miniaturization, Alex, and there are a lot of technologies you have to master to be able to do this. You have to get your hands on some uranium or plutonium and enrich it which is very demanding technologically. You have to build missiles to have a certain range which is demanding technologically. Then you have to miniaturize the warhead so you can fit it on the missile.

A nuclear device that would just detonate, create a chain reaction, and be a nuclear explosion could be the size of a truck. That’s called a device. It’s not necessarily weaponized, because it’s hard to deliver unless you get it small enough. And then finally, you have to ruggedize it. ICBMs go to space and come back into the atmosphere under a lot of stress, heat, and vibration, and it must survive all that.

One by one, Jong-un mastered all these technologies, and it looks like he’s getting to the final two: miniaturization and ruggedization. That comes from testing. But there’s one more thing he’s doing where I think he gets very dangerous. He has a submarine, and there’s reason to believe he will release a submarine-launched ballistic missile.

That’s different from an ICBM, because you can move submarines around. The U.S. has been betting on Terminal High Altitude Defense (THAD) defense, where we can shoot down these missiles with some degree of accuracy. No one wants to rely on that because it’s not 100%, but it’s better than nothing.

However, you can move a submarine to create a trajectory where you’re evading the THAD missile batteries, number one. Secondly, you can move that submarine within range to where it would support an intermediate range ballistic missile attack instead of an ICBM.

It’s a total game changer and possible that that’s what he’s going to do. He also might detonate a nuclear device to perfect that technology. That’s not a missile launch, that’s a nuclear detonation. Any one of these things is highly provocative.

My expectation is that the U.S. will go ahead as planned with this war game. Kim Jong-un intended all along to do the test knowing the U.S. would do this, and he’d put this marker down to make him look like the good guy. But of course, he’s not a good guy, and he’ll do something extreme. If he doesn’t aim a missile in the vicinity of Guam – which would practically be an act of war – it could be the submarine launch test or a nuclear explosion. That’ll get Trump going again, and then we’ll be right back where we were on August 8th.

This threat is not going away. People dialed it back a little bit last weekend, but I think it’s coming back at us, and the stock market is extremely vulnerable. You don’t have to reach hard to find people who think it’s overvalued, so we don’t have to belabor that. I’m not the stock market guy, but go to anyone from Robert Shiller to Warren Buffet or any well-respected voice on that topic, and you’ll hear universally that the stock market is overvalued and headed for a fall.

The question is, when? The answer is, it could be any time. It takes a catalyst, and this could be the catalyst. On top of the terror attacks we’ve seen in Spain on Thursday and Finland on Friday, there seems to be no end to it. That was enough to get the stock market heading in the wrong direction in the course of Thursday and Friday. Let’s see what happens, but I think stocks are vulnerable to this kind of shock. The market has not priced it in, and I do think it’s coming, probably next week.

Alex: This reminds me of many conversations you and I have had regarding complex systems and critical states, and that really is just a shift of psychology. It’s simply human nature. After a while, people become apathetic towards things, and sometimes it takes unfortunate events to shake and wake people up. That’s what we’re looking at.

We will continue to monitor what’s going on with the North Korea situation, and if there are important updates, Jim and I will probably discuss it again in a future podcast.

Our next topic is the debt ceiling and so-called government shutdown.

This subject has been discussed many times. Personally, I’m kind of disgusted with the fact that we have to do this versus proper fiscal management at the government level, and I know I’m not alone in this. The United States is now sitting on $19.974 trillion in debt. That is $165,851 per taxpayer. It’s a reality we must deal with on a regular basis now.

Treasury Secretary Mnuchin has written a letter to Congress asking them to raise the debt limit no later than September 29th. Jim, what’s your take on all this?

Jim: Good luck with that. You’re absolutely right, Alex, in terms of the backdrop.

Let’s sort it out for the listeners. There are two big but separate deadlines converging on September 29th. The way the media reports it is by throwing words around that tend to get mashed together in a lot of readers’ or listeners’ minds; however, they’re separate and they’re converging like two meteors hitting earth at once.

One is something you mentioned, which is the debt ceiling. This has to do with the borrowing authority of the U.S. Treasury. Is the U.S. Treasury authorized to borrow money to pay the bills of the United States covering everything from Social Security, Medicare, Medicaid, operations of government, military, you name it. The whole budget is around $500 billion a year. That’s the deficit.

The budget is well over several trillion, but that must be authorized by Congress. Until it’s authorized, the Treasury is running on fumes. It sounds strange, but the Treasury has a bank account at the Fed and other banks that is no different from your bank account or mine.

If we have money in the bank and spend it with no income, that account goes to zero. Your checks then bounce and you can’t spend any more money. Believe it or not, that’s the situation the U.S. Treasury is facing. It is running out of cash. They have new cash coming in all the time from tax collections, but it’s going out in terms of payments. They can run negative cash flow and draw it down.

That’s the situation the Treasury is facing. They need Congress to authorize an increase in the debt ceiling so they can borrow more money so they can pay the bills. It’s that simple. The problem is that Congress is not really functional right now and is not inclined to do so. This is because the Republicans have a majority of the House and Senate but can’t agree among themselves.

By the way, this is a replay of Obamacare. I don’t want to get into the weeds in terms of the healthcare debate, but I think a lot of listeners know that the Republicans came into Washington with control of both houses of Congress and the White House and said they were going to repeal Obamacare. They didn’t do it and they’re not going to do it, because they couldn’t agree among themselves. They didn’t need Democratic votes, but they did need to agree, and they couldn’t do that.

The same thing is playing out with the debt ceiling. There are members of what’s called the House Freedom Caucus that say, “We’re not voting for the debt ceiling increase unless we get some conditions.” They want to defund Planned Parenthood, there’s an issue around sanctuary cities, and around money for the wall. The White House wants money for the wall, and there’s an Obamacare fix. It’s not the repeal of Obamacare, but Obamacare was running out of money, and that is a separate appropriation that has to get through.

So, there’s a bunch of stuff standing in the way of this vote. Now, you could say, “Okay, to heck with Republicans. Let’s just get moderate Republican votes and some Democrats.” Well, the Democrats are sitting there, notably Nancy Pelosi, who said, “Why should we help you guys? You’ve run us out of town, you’ve ridiculed us, you’ve called us every name in the book, you don’t want to work with us on anything else, you don’t like our agenda. Why should we give you any votes?”

Even though the Democrats in general favor raising the debt ceiling because they like all these programs and spending money, they’re not inclined to vote for two reasons: 1) Why should they help Republicans? 2) They don’t want all these riders attached that I mentioned. If you put defunding of Planned Parenthood in a debt ceiling vote, you will not get one Democratic vote, so, it’s not clear where the votes are coming from.

Let me shift gears for a second and talk about another event, which is the budget. The budget is different than the debt ceiling. The debt ceiling is borrowing to pay your bills, whereas the budget authorizes all government spending that gives rise to having to pay your bills in the first place.

The U.S. is on a fiscal year running from October 1st to midnight on September 30th. While most of us are December 31st, New Year’s Eve, the U.S. government celebrates New Year’s Eve on September 30th.

This year, September 30th happens to be a Saturday when banks are closed and the government is not working, so it’s really September 29th which is a Friday. September 29th is D-Day in terms of keeping the government open, and there are two ways to do it:

  • You could pass a real budget which is kind of what you were saying, Alex. Are we mature enough to actually do that? The answer is no.
  • The other thing you can do is called a CR or continuing resolution. It’s basically a vote by Congress that says, “We agree that all the agencies can keep spending whatever they were spending before. We’ll get back to you later about new spending, new programs, terminations, and all those things, but for now, keep spending.” That’s what a continuing resolution is.

Here’s the thing. That’s a hard stop on September 29th for the reason I mentioned. The debt ceiling doesn’t have to happen at the end of September; it can happen at any time. In years past, I’ve seen this happen in March or other times of year. It just so happens by coincidence that it looks like the Treasury is going to run out of cash on September 29th this time.

As I said, you’ve got yourself two asteroids striking the earth. One is the budget authorization in the form of a continuing resolution, and the other one is the debt ceiling increase in the form of authorizing the Treasury to borrow money. They don’t have to happen at the same time, but they are happening at the same time and are subject to the same dysfunctions. In other words, the issues I mentioned, e.g., the wall, Planned Parenthood, Obamacare fix, and sanctuary cities, pop up in the debt ceiling debate and also the continuing resolution budget debate. There is no consensus on any of them. Again, it’s not clear where the votes are coming from.

Just to add another layer of intrigue here (or dysfunction is probably a better word), it’s not clear if the White House is so afraid of a government shutdown. In a government shutdown, nonessential workers stay home, the military is still on duty, the TSA still works at airports, the Post Office is still open, but there are a lot of government functions that do shut down including popular ones like national parks and monuments. They’re the ones that are going to be most visible.

The White House might like that. Remember, the White House is not exactly Republican. They kind of are and they aren’t. Jared Kushner, Ivanka, and some others seem more like Democrats, but Trump is very hard to categorize. I wouldn’t call him a conservative Republican at all. He’s a nationalist, a Trumpist, a capitalist. He’s a lot of things, but I wouldn’t call him a conservative Republican.

Trump is just as eager to fight with the House Freedom Caucus and Mitch McConnell as he is with Nancy Pelosi and Chuck Schumer. He might say, “What we need is a good government shutdown. Let’s show the American people just how dysfunctional we are, just how immature we are,” etc. Again, I don’t want to take sides in that debate. My role is simply to warn listeners that these two things are coming together. I don’t see how they’ll get resolved.

On top of everything we just mentioned, it takes time to do these things. There’s something called the legislative calendar. Don’t think for a minute that Congress works seven days a week or even five days a week. They tend to show up Monday night and leave Thursday afternoon to go back to their districts on the weekends, so they probably work about three days a week, not to mention holidays. Their idea of the Labor Day weekend is a ten-day recess. Most of us are happy to get an extra day off, but they’ll take ten days for Labor Day.

The point is, the legislative calendar only shows 11 working days between now and what we’re talking about, the September 29th train wreck. It takes members of Congress 11 days to find their way to the bathroom.

They have a lot of other stuff on their plate. They have judicial appointments, they need to reconfirm the new FBI Director, there is some cat and dog legislation on Obamacare, and we have a national security crisis with Korea not to mention all the sound and fury about racism in Charlottesville. Again, I don’t want to get into the weeds here, but that’s obviously adding to the dysfunction.

Put this all together with the possibility that the White House might not mind a train wreck. The fact that there is probably a train wreck coming anyway due to the shortness of time, degree of difficulty, and the lack of consensus, we could have a government shutdown. I think we will have a government shutdown on October 1st effective midnight September 29th, and I think this debt ceiling crisis is going to go right up to the deadline.

That doesn’t have a date certain; September 29th is an estimate for that. Imagine you’re running a bond portfolio – a big one, like a pension fund or something – and you’re saying, “Is the United States going to pay me the interest due?”

By the way, there is a big outflow on October 1st because it’s the first day of the month. With Social Security, welfare programs, and benefit programs, that’s one of those days when the outflows are greatly and excessively inflows. People tend to pay their taxes in April, and by October, you’re running on empty.

This is a mess on top of all the other serious national security, terrorism, and other problems we described. It’s one more reason, in my view, why investors should be over-allocated to gold right now and also have some cash.

Alex:  When you’re discussing the schedule of how these politicians work, I’m over here shaking my head thinking, “Ah, the good life.” Hopefully, someday we’ll be able to rein that situation in.

Moving on to our next topic, as you and I have talked about many times, the world economy is heavily interlinked, and many of our listeners are professional money managers, so oftentimes, we will discuss what is going on in other jurisdictions.

Today, I’d like to talk a little bit about China. There is this disturbing trend going on over there where the banks are slowly becoming the majority, or I should say, the larger share of the investor base plus these things called wealth management products or WMPs.

From our discussions and what I’ve looked at in the past, the entire scheme of the WMP structure seems questionable to me. What are the risks and the potential spillover effects for the global markets?

Jim:  The risks and the spillover effects are huge. We’ve had a taste of this a couple times recently. Just about two years ago on August 10, 2015, China did a shocked evaluation of their currency, the Chinese Yuan. The markets didn’t see it coming, and even the elites, the IMF, the U.S. Treasury, and others did not see it coming. China had their own reasons for doing it.

That caused a shock in U.S. stock markets. Go back and look at a chart from August 10th to September 1st when U.S. stocks fell about 11%, and it was worse than that. It wasn’t just that they went down 11%, but it looked like there was no end in sight. It happened to be from peak to trough an 11% drawdown, but when it was down 10%, we didn’t know that it was going to turn around at 11%. It could have gone down 20%. Think about where you were on August 31, 2015, maybe taking the kids back to school, on vacation or getting ready for Labor Day weekend. Investors had a sick feeling in the pit of their stomach. It felt like there was no bottom.

Then the Fed rode to the rescue, and that was when we were going to have the liftoff in interest rates in September. They pushed the liftoff back to December, got involved in forward guidance happy talk, and the problem went away, but it was pretty bad there.

The second time was December 2015 when China did a stealth evaluation. They learned their lesson on the shocked evaluation, so they were doing it in baby steps, but again, the U.S. market reacted badly from January 1st to February 10th, 2016. It again fell 11%.

There you have two examples of what is called in-state contagion. That’s a good word. The IMF uses the word “spillovers” when one bucket spills over into another bucket. Pick your metaphor, but to say that the U.S. markets are isolated, immune or pristine relative to the Chinese evaluation or the natural market events is false. We have two examples of stocks almost spinning out of control based on Chinese actions, so let’s come back to the WMP.

I’ll take a minute to explain what a WMP is. It stands for wealth management product and is a simple concept. As a middle-class Johnny saver, you’re not a Princeton or an oligarch, but you and your spouse have a good job and have some savings.

You walk into the bank and the bank officer says, “We have two products. You can make a bank deposit and we’ll pay you 2% interest or you can buy a WMP and we’ll pay you 7%.” Most people think about that for two seconds and say, “I’ll take the 7%, thank you very much,” and they do.

What gets lost in translation, even in Chinese, is that these wealth management products are not bank products. They’re not liabilities of the banks. They’re off-balance sheet special products very much like CDOs.

Banks take the money people put into the WMPs, bundle it, and buy junk bonds or equity in real estate, state-owned enterprises, bankrupt companies, speculative land deals, ghost cities, and you name it. They’re out there buying all this garbage, so they look like these Lehman Brothers CEOs from the 2006, 2007, 2008 period, which of course, almost brought down the world.

They don’t really tell that to the customer. I’m sure there is some disclosure somewhere in the fine print that no one reads. I’ve seen interviews with everyday savers, people walking out of a bank, and a reporter says, “What did you do with your money?” “I bought a WMP.”

They’ll say to the person, “Don’t you know that’s not the equivalent FDIC insured, that’s not a bank liability, and it’s not guaranteed by anybody?” Some people don’t know that, but some people say, “I know that, but Beijing will bail us out.”

Alex:  That is the attitude in China, absolutely.

Jim:  I’ve been to China several times. I’ve been out in the boondocks of China, I’ve met with provincial Communist party officials, and I’m very frank with these guys. I was having tea in an office near one of these ghost cities, and I said to one these guys, “Can you build seven cities here?” As I’m looking at them, they’re all vacant. Every building I’m looking at it is vacant, and he did it all with debt.

I said, “How are you going to pay back the debt?” He replied, “We can’t pay back the debt. That’s impossible. Beijing is going to bail us out.” You hear this over and over from government officials to a man or woman on the street.

Be that as it may, these WMPs are Ponzis, and I don’t just throw that word out there lightly. Let’s say I bought a two-year WMP two years ago, I go back to the bank, and it’s maturing. They say, “Okay, Mr. Rickards, we can roll your WMP over into a new two-year WMP.” I might say, “Fine, I’m collecting my 7% interest,” but Bernie Madoff investors collected their interest also. They just didn’t know that their money was gone.

But what if I say, “My kid is going to college in the States so I need the money,” and I cash out my WMP? They have invested in these junk assets, so they can’t really cash out the WMP. What they do is sell a new WMP to the next person who walks in the door, take that money, and give it to me.

The new person is happy because she’s getting 7%. I’m happy because I got my money back. Meanwhile, the money isn’t there. You must sell the new ones to pay the old ones, and what you really hope is that the old ones roll over so your net inflows are positive and you don’t have net outflows. This is a Ponzi.

By the way, the Chairman of the Bank of China in an interview said, “It’s a Ponzi.” I quoted this in my book, The Death of Money. It happens to be my analysis, but it’s not just my analysis; we have it on record from China’s officials.

That’s where we are. We know that all Ponzis fail eventually. They collapse and cause a panic. That’s coming, but it doesn’t have to be tomorrow. This Ponzi can walk for a long time. Madoff ran his Ponzi for 20 years. The guy is spending the money on himself, losing it in other things, but convincing investors that it’s all good. As long as you pay the coupon, sheep will feel good about it.

I saw an article, a chart, and analysis last week showing that the amount of WMPs is going down. This was taken as a positive by the analysts who said, “This is great. China is finally stepping up to the plate. They’re finally getting things under control. It’s good that the leverage in the system is going down. Isn’t this wonderful that the WMPs are going down?”

I said, “No, that’s a nightmare. That’s like Bernie Madoff saying, ‘My assets under management are going down.’” If you don’t have the money and you get into negative cash flows or net outflows in a Ponzi… If it was a real product that was wisely invested and you saw it going down, you might say to yourself, “That’s good. There’s more liquidity in the system. They’re reducing leverage. They’re not acting as crazy on real estate.”

It would be a good thing if it wasn’t a Ponzi, but people forget that it is a Ponzi. When you see assets in a Ponzi going down, that means the run on the bank has started and this fire is about to spin out of control. To me, that’s one of the scariest indicators I’ve seen and one more reason to expect that China is about to implode.

Just to be clear, nothing is happening in China until either the end of this year or early 2018. The reason for that has nothing to do with economics and everything to do with politics. There is a national Communist party, Congress, that hasn’t set the exact date, but it’ll be late October or early November when President Gee is going to be anointed, if you will, as the big G, the big man, the most powerful Chinese leader since Mao Zedong. He doesn’t want to rock the boat ahead of this party Congress, so no crises are going to break out in China between now and November. They can back that up because they still use firing squads if they have to.

Once we get past the party Congress and Gee has achieved his power goals, we’re into 2018, and yet two plus two does not equal five. I think you’re going to see some of these chickens come home to roost.

If you asked me, “How does this play out? What do they do?” I would expect a maxi-devaluation of the currency, because devaluation of the currency solves the capital outflow problem. You can reopen the capital account, because people are not as anxious to get their money out. Once you steal their money, you can’t steal it twice, so they say, “I might as well sit here. I’m not sure how to get my money out.”

I would expect a maxi-devaluation to boost exports and export-related jobs and cure the capital outflow issue. For right now, they’re squashing everything, so don’t look for drama from China before the end of the year. I would look for a lot of drama in the next year.

Alex:  You mentioned that they all believe the government is going to bail them out if there are problems. That reminded me of my many trips to China talking to money managers, government officials, and others.

Before 2015, I made a trip and talked to five of the largest fund managers in China. They all said the same thing – they weren’t concerned about the banks or the markets. Then in June of 2015, I’m sure you remember there was the Chinese stock market crash.

The government basically froze everything and told them, “You can no longer trade. You’re not allowed to sell.” They were even going so far as to making criminal investigations into fund managers who were selling positions during that time, and they locked down liquidity.

You’ve mentioned something like that in terms of Ice-Nine in your recent books. That’s a big deal right now. The prevalent question on the mind of every professional money manager I talk to nowadays is, “What’s the liquidity like?”

Adding to that, keep in mind that secondary markets, stock markets, etc. can get shut down by governments at any time. If things are going badly, it can happen, and if you’re frozen out of markets, be super careful.

Jim:  I had a conversation with an investor just the other day and pointed out that on October 19, 1987, the major U.S. stock market indices, which is now referred to specifically as the Dow Jones Industrial Average, fell 22% in one day. Not a month or a week, but one day.

In today’s Dow points, a 22% drop would be 4,000 Dow points. Not 400, which would be a really bad day. The other day it was down 275 and everybody was all spun up. Four hundred would dominate every headline. Imagine 4,000 Dow points.

The person I was talking to said, “Yes, but they wouldn’t let that happen. They’d change the rules. They have circuit breakers and would close the Exchange.” I said, “You’re right. They would close the Exchange.”

You tell me. Which makes you feel better: a 4,000 point drop or a closed Exchange? At least with a 4,000-point drop, I can still trade or get out at a price. I might not like the price, but things are still transacting. If you shut the market, that’s Ice-Nine.

My thesis was that when you shut one market, the demand for liquidity moves to another market, probably money market funds, and you have to shut that down. Then it moves to another venue, which would probably be a run on the bank, and you must shut the banks down, etc. It spreads, so, I wouldn’t be too glib or sanguine about the fact that you can close the Exchange, which you can, because then you should say, “What’s the next move?”

As far as the Chinese bailout is concerned, the fact is, Beijing will bail them out. What drives me crazy about Wall Street analysis is they’ll say, “Yes, but Beijing will bail them out,” and I’ll say, “But what does that mean?” It’s going to cost $1 trillion to do this bailout we’ve been talking about.

Chinese has approximately $3 trillion in reserves. About $1 trillion of that is illiquid. It’s real money. I’m not saying it’s fake wealth, but it’s in the stock market, it’s in hedge funds, it’s in private equity. Try getting your money back from Henry Kravitz. He’s not going to give it to you, at least not until your seven years or whatever are up.

Take $1 trillion off the board because it’s there and it’s illiquid. Then there’s another trillion that has to be held in liquid form as a precautionary reserve to do this bailout. If you use that money, then you don’t have the money you need to do the bailout.

That means there is really only $1 trillion in reserves in China that is not already spoken for either in the form of illiquid assets or precautionary reserve. When the reserves were going in 2016 at a rate of $50 billion a month, you’re broke in a year.

China is in a much more precarious situation than people realize. You can’t just throw the $3 trillion number around without thinking about how much of that is already spoken for (the answer is $2 trillion). That’s why I expect the devaluation would be the answer, because that does solve the capital account problem.

Alex:  If you’re the Chinese government, why would you blow your dry powder on trying to prop everybody up and bail everybody out? As they’ve already proven, you can just shut it down and threaten people with criminal investigation if they try to trade.

Jim:  I think that’s right.

Alex:  Obviously, you and I have been banging the table on why you need to take a hard look at physical gold for a long time. I think these are all reasons that you have some of the smartest money managers in the world, like Ray Dalio, talking about it.

Moving on to our last topic. Jim, in our private discussions, you’ve mentioned something to me called The Myth of August. For our listeners, would you elaborate on what that means?

Jim:  The Myth of August started as kind of a fun thing with me, although it’s not fun in the sense of the specific events I use to illustrate it. Here we are two-thirds of the way through August, so there isn’t too much time left but plenty of time for fireworks.

The idea is, August is a very popular vacation month. As the last month before kids go back to school, it’s a great time at the beach or the mountains, etc. From Europe to North America to around the world, a lot of people take their vacations in August. Everyone, at least in my part of the world, are in the Hamptons, the Jersey Shore, Cape Cod, or wherever. Offices empty out, whole industries, publishing is almost practically shut down, and nothing happens. It’s just quiet. We all come back to work and are rocking and rolling on Labor Day. That’s the myth.

The myth persists, yet the reality is quite different. Look at the things that have happened in August. They’re not just newsworthy; they’re among the most momentous events in history and financial history. Most famous, tragically, is what Barbara Tuckman, a great writer and historian, called the guns of August, which was the outbreak of World War I.

Even in more recent times, on August 15, 1971, Richard Nixon ended the gold standard. It was August 7, 1990, when Saddam Hussein invaded Kuwait and George Bush, 41, said, “This will not stand.” We sent troops to Saudi Arabia, airlifted them in to the Land of the Two Holy Places, as the Muslims say, literally the next day, which gave rise to Al Qaida.

It was August 1998 when we had the double embassy bombings in Kenya and Tanzania, and Bill Clinton responded with cruise missiles. August 1998 was also the famous Russian default which led straight to the global financial crisis meltdown involving Long-Term Capital Management. As their General Counsel, that landed in my lap, and I negotiated that bailout.

August 1991 was the Solomon Brothers trading scandal when Solomon, the largest U.S. bond dealer in the world, almost went bankrupt which would have started another financial crisis. Warren Buffet came in as a white knight, bailed them out, and the Treasury backed off in the threats against Solomon. The crisis did not go further, but it certainly had the potential to do so.

August 1991 was also a Russian coup. Some crazy KGB guys kidnapped Mikhail Gorbachev. Remember that one? I think the coup was busted because they got drunk on vodka, so their situation awareness was not the best, but they did kidnap the General Secretary of the Communist Party in an attempted coup. And we had Hurricane Katrina in 2005.

I don’t need to belabor it, but I’m very wary in August. A lot of very nasty things have happened. We’re in the home stretch here, just about ten days left, so hopefully it’s quiet, but given everything we mentioned at the beginning of the podcast about North Korea, I’m not so sure it will be quiet.

If the U.S. goes ahead with this military exercise, which I expect, and Kim Jong-un responds with some kind of test, whether it’s a submarine-launched ballistic missile, nuclear device or an ICBM aimed at Guam, which I also expect, then we’re not going to make it out of August without a financial earthquake. Let’s see what happens, but I wouldn’t put my feet up quite yet.

Alex:  I think these are all good reminders.

Revisiting the whole liquidity thing, many people are heavily invested in what you and I call paper products that require some kind of counter-party to perform. In a recent paper, the IMF said that gold is the only financial asset you can buy that does not require a counter-party for it to have and retain its value.

I wasn’t going to share this, but I’m going to mention that I had a conversation earlier this week with the head of a trading desk who has 15 people under him. They’re running a lot of money as one of the largest financial houses in the world. If I mentioned the name, everybody would immediately recognize it, so I’m not going to say who this person was.

In a candid moment of discussion, he mentioned to me that they are pretty nervous about this kind of stuff. They listen to our podcasts on a regular basis and don’t miss one, so thanks guys. We appreciate the support.

He mentioned that if it were up to him in regard to all the paper investments – in other words, the ones with the counter-party risk and the ones that rely on exchanges to trade, etc. – he’d sell it all right now.

Jim:  Personally, thank you if you’re listening, and thank you and your team for joining us.

The one thing I would say, Alex, is there is a name for restorative value that does not have counter-party risk. It’s called money. People say, “I have money in the bank.” No, you don’t. You have a bank deposit which is an unsecured liability of an occasionally solvent financial institution. Even a Federal Reserve note, if you read it, says, “Federal Reserve note.” Where I went to law school, that means it’s a liability, which it is.

People don’t think hard about what money is. They take a lot of things for granted and assume it’s money when it’s not; it’s something else.

Again, to go back to where we started, people say, “I’m nervous about buying gold.” I say, “I’d be nervous if I didn’t have any.”

Alex:  That wraps up today’s podcast. Jim, thank you for your time. The discussion has been invigorating. We covered some really great material, and I very much look forward to our next one.

Jim:  Thank you.


You have been listening to The Gold Chronicles with Jim Rickards and Alex Stanczyk presented by Physical Gold Fund. Recordings may be found at You can also register there for news of upcoming interviews with Jim Rickards and other world-class thinkers.


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The Gold Chronicles: August 2017 Interview with Jim Rickards and Alex Stanczyk


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Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles July 2017

Jim Rickards and Alex Stanczyk, The Gold Chronicles July 2017


Topics Include:

*US war with North Korea still on the table
*Commentary on physical gold
*Why gold stores value over long periods of time
*Institutional Money Mangers views are shifting towards concerns over insuring portfolio assets will have liquidity under market stress
*The critical mistake in due diligence when investing in gold funds
*3 Factors which would cause the Fed to pause its rate hiking schedule
*Inflation vs Disinflation
*Slowing Economy and Fed Policy


Listen to the original audio of the podcast here

The Gold Chronicles: July 2017 Interview with Jim Rickards and Alex Stanczyk


Physical Gold Fund presents The Gold Chronicles with Jim Rickards and Alex Stanczyk offering insights and analysis about economics, geopolitics, global finance, and gold.


Alex:  Hello, this is Alex Stanczyk. Welcome back to another podcast of The Gold Chronicles. I have with me today Mr. Jim Rickards. Hello, Jim.

Jim:  Alex, how are you?

Alex:  Excellent, thank you very much. We covered quite a few topics on our last podcast including the risk in cryptocurrencies. We also talked a little bit about the G20, Syria, and North Korea.

On the topic of North Korea, you’ve been saying for several months now that at some point, the U.S. will go to war with North Korea to eliminate the risk that Kim Jong-un might actually nuke a U.S. city. You even mentioned it live on Bloomberg at one point in the last few weeks. The staff there was skeptical of the idea; however, an hour later, North Korea test-fired its first ICBM.

Jim:  That was one of those amazing coincidences. I wouldn’t have said one thing differently if I had known about the test in advance (which of course I didn’t). Whether it was happening or not, I wouldn’t have said one thing differently.

They say it’s good to be smart and better to be lucky, and sometimes things converge in a way that that plays out. Yes, it’s a serious subject. Literally, I was on the air live with Bloomberg Asia, interestingly.

Bloomberg has a 24-hour cycle. They don’t have separate networks for their different regions. They just keep going, so it was 7:00 at night where I was in Montreal, 7:00 AM in Hong Kong and Singapore. We were live on the air, and with two billion people in Asia, it was potentially a big audience.

That’s exactly what I said. It was with a great interviewer and a cohost. I always say it’s not the anchor’s job to make me look good; that’s my job. They’re there to hold your feet to the fire, and there was a fair amount of skepticism.

I was very categorical about the march to war. Then literally minutes later, the news broke that they had just fired an ICBM. People weren’t sure it was an ICBM when it went off although it looked like one. Subsequently, that was verified by a number of sources. It was certainly not a good development.

When I do these interviews including our podcasts, I’ll put them out on Twitter to try and expand the audience a little bit. I can see some but not all of the clicks while Bloomberg will obviously see more than I do.

That interview got more clicks than anything I’ve ever done outside of a couple things that just went super viral. Normally, if you get 1,000 or so views, that’s pretty good interest. This one went off the charts at over 6,000 views in 24 hours, which is a lot for a TV interview. That definitely got a lot of attention.

What was interesting was that my cohost, a very well-established, reputable money manager, was sort of disparaging gold, and I was taking the pro-gold side.

Then I went into the thing about North Korea to which he said, “Well, if we’re going to war with North Korea, you would definitely want to own gold,” as if we weren’t going to war. Again, not an amusing exchange, not an amusing topic, unfortunately, but my point was, “We’re going to war.”

It was a really good example of the cognitive dissonance or denial and complacency of professional money managers. It’s like, “Oh, yeah, if we’re going to go to war with North Korea, I’d load up on gold.”

Well, we are. It’s happening in front of your eyes. You can see it with a six-months to one-year lead time, so why don’t you get some gold now at an attractive entry point? What are you waiting for?”

The answer is they always wait until the first shot is fired. Gold will be, who knows what, $500 or $1,000 an ounce higher. Then they’ll run out and buy some at $1,375 – $1,400 an ounce when you can back up the truck right now and buy it for $1,240. I never understand it, but it is what it is.

Alex:  Yes, that’s pretty typical. For our listeners, if you haven’t heard our previous two podcasts when we talked about the North Korea situation in depth, I recommend you go check them out as well as the last one we just did when we talked quite a bit about the risks in cryptocurrencies, which I think people are starting to explore further.


For today’s topics, we’re going to begin with a few thoughts on physical gold. We’re also going to discuss the U.S. economy, what the Fed is watching in terms of its metrics, Fed policies in terms of easing or tightening, and we’re going to wrap up with some discussion on a little-known problem in the Chinese financial markets.

Beginning with physical gold, I recently returned from a family vacation where we spent some time panning for gold in the Black Hills of South Dakota. Jim, as you well know, panning for gold is a labor-intensive process. Our little group of seven people spent about four hours moving earth.

We would dig buckets of earth out of these massive tailings piles left over from the gold excavation operations in the Gold Rush back in the 1870s. A tailings pile is leftover dirt that they sifted through looking for gold. The thing was, the screens they used to find the gold had huge holes in them. Back then, they expected to find gold nuggets of much larger size than we find today.

Our tailings pile made up the entire side of the riverbed we were on. Even with all of the time and energy we expended – again, there were seven of us working for four hours doing this – we ended up with less than a gram of gold.

Some of this reflects the concept of what’s called high grading, which means that all of the super-high ore deposits in history have mostly already been discovered. In everything we’re doing in mining operations today – I’m talking large-scale mining – it’s not uncommon for a large-scale operation to move a ton of earth to find just 1 – 1.5 grams of gold.

The point I’m trying to make is that gold is actually stored energy. The energy cost of extracting gold from the earth is now, and has always been, considerable. I contend that, along with physics, these are the two primary reasons gold retains its purchasing power over thousands of years.

Jim, you do a bit of panning yourself in your top-secret personal location. I’m not going to ask you to divulge where that’s at, but tell me a little bit about your experiences there and why gold’s physical properties make it ideal for storing value over millennia.

Jim:  I should make it clear that I do it for fun and to teach my grandchildren a little bit about where gold actually comes from and how scarce it is. We do it as a recreational thing. I’m not trying to pay my property taxes with my gold output.

You, at least, had the benefit of tailings where there was some reason to believe there was gold around. I pan in an area where there is gold, but certainly not in commercially viable qualities. It’s also a very environmentally sensitive place, a very green place, which is a good thing. It’s unimaginable to me that anyone could ever get a permit to open a mine.

There are old mines from the 1850s in my vicinity. There is gold in them thar hills, as they like to say. In fact, this area was affected by Hurricane Irene in 2011, and there was a bit of a gold rush. People were buying gold pans from the local stores and, believe it or not, running down to parking lots of shopping centers where the earth had literally been stripped off the face of the surrounding area, and it drained into these lower-lying areas. There were mud piles and water caches and so forth. People were panning for gold in these parking lots and finding some.

There is gold there, and I find it. A gram would be a lot to me, but if we found a couple flakes, that would be good. We do it for fun. It does underscore the point you were making, which is that this is a known goldmining area, at least back in the 19th century, and it is extremely scarce.

I recently visited commercial goldmining operations up in Northern Quebec where they have real goldmines with real development. There’s a lot of drilling going on and equipment moving in, but even there, you’re exactly right. It takes a ton of ore – rock and earth and so forth – to get maybe a gram if you’re lucky. That would actually be quite high, because it’s usually measured in fractions of a gram. That’s how scarce it is.

It would be one thing if you could just say, “I’ll get a gram of gold per ton of ore,” in any place you dug up, but you can’t. What I’m talking about, as you said, is a high-grade location. Those locations are few and far between and seem to be getting scarcer.

The other point I would make about goldmining output is that we’re talking about very long lead times.

Gold had a magnificent run in one of the great bull markets in history from 1999-2011. I’ll use round numbers and say it went up from about $200 an ounce, maybe $199 an ounce at the low, to almost $1,900 an ounce. That was 1,000% gains, ten times your money, in a relatively short period of time. Then it had a measured correct. It came down about 50%, which is interesting.

I think I’ve mentioned my conversations with Jim Rogers in past podcasts. He’s one of the great traders, period, but particularly one of the great commodity traders of all time. He was cofounder of the Quantum Fund along with his partner at the time, George Soros.

Jim told me he’s bullish on gold. He owns gold, he holds gold, but he’s never seen a long-term bull market that didn’t have a 50% correction along the way. He said that’s just the way it is. You get to $1,900, and gold’s back down. The interim low or cycle low was $1,050. That was just over a 50% correction if you use $200 as your baseline or starting point. It’s been going up over 20% since then. It looks like that is behind us and we’re on to bigger and better things.

Here’s my point. You can only imagine the gold rush fever that was going on in 2010/2011 not just in Canada but around the world. People were investing, capital was easy to raise, a lot of mines were opening up, etc., but a lot of that was priced at $1,300-1,400 an ounce, or not really feasible when gold went down below $1,100.

You can well imagine the gold fever that was going on when gold was soaring up to $1,900 an ounce. If your production costs were $1,100, $1,200, $1,300 an ounce, you could get financing, you could bring marginal properties back into production, etc.

When gold went down to $1,300 by April 2013, then even lower by 2015, those mines were suddenly not economic. There were a lot of bankruptcies, a lot of projects were called off or halted in midstream, other projects went bankrupt, and so forth. There was no – or at least very little – exploration mining going on in 2013, 2014, and 2015 as the price was treading water.

What’s happened now, with the price back up at $1,250 and a good upward trend, is that mining fever is picking up again. But you can’t just pick up where you left off.

If you’re talking about a greenfield, which is you have an attractive opportunity (you get the mining rights or you lease it, you start exploring, you start drilling, you do your feasibility studies, you get your financing and stuff), that takes 5 – 7 years before you can bring ounces onto the market. With some opportunities, the time horizon is shorter than that, because you’re maybe stepping into the shoes of somebody who went bankrupt at a much lower price point and you pick up where they left off or there are some mines that were never shut down.

As far as new production, we’re in a trough right now. It’s going to take years to get production up close to where it was in terms of capacity if you even could. We all know that demand is sky high as we see in Russia, China, India, and elsewhere, and supply is tight.

Alex, you and I have been around the world. Whether it’s meeting refiners, miners, vault operators or dealers, we hear the same story everywhere. It’s amazing. It’s really, really hard to fulfill orders or get your hands on gold.

The technical setup on the physical side could not be better. Of course, we have our old friend, the COMEX. Anyone can sell 60 tons of paper gold with a phone call to a broker with no actual gold involved. That’s happened occasionally, but that will fade in time.

Alex:  Yes, I totally agree.

To wrap up our gold commentary, I’d like to make a quick observation. I’ve noted a continual shift in the views of institutional money managers when it comes to what they’re allocating to. When they’re evaluating the risk in the ability to get liquidity on their assets, it’s starting to become a big concern. This makes sense, considering the fact that very little has been learned from the past couple of crises.

I was recently looking at your latest book, Jim, where you were talking about this concept that Wall Street is basically still clinging to the notion that net exposure is what matters, when gross exposure is where the risk really lies. Wall Street hasn’t come around to this view yet.

For any financial professionals and money managers listening to this podcast, if you’re conducting due diligence on gold funds, one area I would encourage you to look into specifically is how those funds are buying and selling their gold. That’s the Achilles heel. I think you’re going to find that they all do it through banks, which is, in our opinion, a big mistake.

Jim:  They are either doing it through banks, which leaves you very vulnerable, or they’re buying paper gold and expecting to be able to convert it to physical gold. The big gold banks are the members of the London Bullion Market Association (LBMA). There aren’t that many. I don’t know the exact number, seven or eight, but they’re familiar names such as Goldman Sachs, HSBC, and a few others.

When they sell gold – and again, you must read the contracts carefully – they do it on what’s called an unallocated basis, which means all you really have is paper price exposure. They don’t have the actual gold. They might have 1 ton of gold and sell it 20 times over. They’re short 20 tons of paper gold backed up by 1 ton of physical gold.

What happens if the longs – the holders of the 20 tons of physical gold – all show up on the same day and say, “I’d like to convert my unallocated to allocated, and I’d like to take physical delivery. I’m sending my Brinks truck, and they’ll be there in 15 minutes”?

There’s no way they can satisfy those deliveries, no way. What they would do is essentially terminate those contracts and send you a check for the price differential. You would get your paper profit up to that point.

This is the conditional correlation Wall Street does not seem to understand or at least does not want to understand. The world in which the holders of the 20 tons of paper gold all call up on the same day to take physical delivery is a world where gold’s going up $200 – $500 an ounce per day, stocks and other paper assets are crashing, and there’s blood in the streets as they say. There’s a panic.

When you most want your gold is when you will least be able to get it if you don’t already have it. That’s why I’ve always encouraged those who want exposure to gold to have physical gold in safe, non-bank storage. You won’t have to worry about delivery or fine print and contracts. You’ve got your gold.

Obviously, make sure you’re dealing with a reputable fund or provider or a fund that’s backed up 100% by physical gold with no delay. I’m not saying there’s anything dishonest about any of this. What I’m saying is that people don’t read the contracts or, if they do, they assume that they can convert when the time comes. They’ll find out the hard way that they can’t.

With some of ETFs, you buy a share of an ETF, and that’s a secondary market transaction. You’re not buying gold; you’re buying the GLD share on the New York Stock Exchange. When the seller sells to a buyer, that has no impact on the amount of gold in the ETF itself. That only happens when one of the authorized dealers chooses to issue new shares. They have to buy gold, deliver it, and then they get some new shares so they can expand the floating supply of shares, if you will. But there are leads and lags in that process. They can issue the shares, and then it can take up to 28 days or so to deliver the physical gold.

The point is, whether it’s the ability to terminate a contract on other force majeure clause or a mature adverse change clause, the ability to delay acquisition of physical gold, the possibility of closing banks, the possibility of futures exchanges order and trading for liquidation only, there’s just a whole long list of things that can go wrong. None of them are a substitute for physical gold.

Alex, we talked earlier about my Bloomberg interview when I was on with a money manager. It was supposed to be a pro-gold/anti-gold debate with him against gold and me for it, but it turned out that when we talked it through, he said, “We’re not totally anti-gold. We allocate from time to time. We’re in and out of it the way we’re in and out of other things. We’ll occasionally take up to a 5% allocation.”

I said, “That’s interesting, because I’ve never recommended more than a 10% allocation.” I’ve said put 10% of your investable assets in physical gold, not 50% or 100%, but 10%. I said, “If you’re occasionally a 5% guy and I’m a 10% guy, we’re actually not that far apart. This is a bit of a phony debate, because we both see a role for gold in portfolios.”

Institutional exposure is 1%. Whether you’re with this money manager, who occasionally does 5%, or whether you’re with me and I recommend 10%, they’re both a far cry from 1%. If the world of institutional investing even moved from 1% to 2% or 3% –  forget 5% – 10% – there’s not enough gold in the world, at these prices, to satisfy that demand.

Alex:  Again, I totally agree.

Circling back around to the risk part of clearing gold through banks, my perspective as a manager of a physical gold fund is that if I’m a gold fund that has gold assets and there are investors needing liquidity so they want to sell gold assets, to me the biggest risk is if their prime broker is a bank. That’s no different to me than what just happened in China recently with their stock markets melting down or what happened in the 2008 global financial crisis.

If I was a hedge fund and my primary dealer was a bank and that bank was frozen up or locked up or unable to trade for whatever reason, I’m basically frozen out of the market. In my view, that’s a very bad place to be.

Jim:  That’s exactly what we’ve seen. Lehman Brothers was the most famous example to file for bankruptcy on September 15, 2008. There were billions of dollars of frozen accounts where the accounts were fully paid up, fully margined. Those securities, instruments, physical gold, whatever it was, were owned by the client and simply in safekeeping at the broker. But all the accounts were frozen. We saw that with MF Global as well. These things do happen in the real world.

Alex:  Our next topic is the slowing economy. Contrary to optimistic thoughts, there’s still a strong concern that the economy – I’m talking globally – isn’t getting better overall.

The average person and sovereign governments are continually going further into debt right now in order to make ends meet. The U.S. national debt is approaching the $20 trillion mark. Who would have ever thought that would happen? Other countries are continuing to pile on the debt, as well. The compound annual growth rate in global debt over the last 15 years is around 6%.

Jim, what are your thoughts about whether the economy is slowing or strengthening in the short to medium term?

Jim:  The evidence is very good that the economy is slowing. The best thing you can say about the economy is that it’s weak. The worst thing you can say is that we’re on the edge of a recession and may actually be in a recession before the end of the year.

This was a completely predictable consequence of the Fed’s blunders by raising interest rates in a weak environment. The Fed is always in the process of making a mistake. It’s just that they keep making different mistakes at different times.

Let me unpack that a little bit and talk about what’s going on. In past podcasts, we’ve talked about my basic Fed model and my modal forecast for Fed activity. I won’t go into that in great detail, because we have done it before, but here’s the short version of it.

The Fed is on track to raise interest rates four times a year from now until the middle of 2019. It will be 25 basis points each time in March, June, September, and December. That times four, 1% a year through the middle of 2019, will get interest rates up to around 3.25%, which they would consider normalized. That would be a normal interest rate environment for this late in the business cycle.

However, that path is subject to three pause factors. Yes, they’re set to raise four times a year, but there are three reasons why they wouldn’t raise, three very specific pause factors.

One is if you see job creation dry up so it’s below 75,000 a month – not 150,000 or 100,000 or even 90,000, but below 75,000 a month. That might cause them to pause. The second factor is strong disinflation, moving away from the Fed’s 2% inflation target. The third factor would be a disorderly stock market decline.

I emphasize the word ‘disorderly.’ If the stock market went down 10% over six months – 2,000 Dow points or 200 points in the S&P – the Fed could care less. If it went down 10% in two weeks, they would care, and that would cause them to pause. That’s the difference between disorderly and orderly. It happens in a very compressed period of time.

If you see job creation dry up, strong disinflation or a disorderly stock market decline, the Fed will not raise the rates; they will pause. If you don’t see any of those three things, they’re going to raise rates.

This is the easiest Fed I’ve ever seen to forecast. It’s actually very straightforward. Why more people don’t get it, I don’t understand. Why Wall Street doesn’t get it and they get all spun up over some recent Reserve bank president like Jim Buller making a speech or something – I know Buller. He’s a nice guy, but his speech is irrelevant to monetary policy. I just gave you the model to forecast Fed policy.

I said this a few months ago, but I’ll repeat it for the listeners: The Fed is not going to raise rates in September. There’s a July meeting coming up, but they’re certainly not going to raise in July. There was never any significant chance of that.

They’re not going raise rates in September, and they’re not going to raise rates on November 1st at their next meeting. For December, I would put it way below 50%, so if I had to call it right now, I would say they’re not going to raise rates in December. They’re done raising rates for the year. I’ll update my December forecast as we go along, but right now it’s very clear that they’re not going to raise rates in September.

I just said they were going to raise them in March, June, September, and December. Now I’m saying they’re not going to raise in December. Why is that? Which one of the pause factors applies? The answer is disinflation.

It’s not job creation, because job creation is still strong. Over the past year and a half, it’s trended down from way over 200,000 to the low 100,000 range with a lot of volatility in there, but that’s still good enough. The stock market is reaching new highs every day. That’s not a reason for the Fed to pause.

The reason is disinflation, the second of the three pause factors. Where do we see that? I said that the Fed has a 2% inflation target, but there are dozens of inflation measures such as CPI, PPI, PCE, deflator core, non-core, and trim mean. Without getting too technical on all those, there are many ways to measure inflation.

The one the Fed uses – and this is the one you need to watch if you’re trying to forecast policy – is core PCE (Personal Consumption Expenditure) deflator year-over-year. It’s not month-over-month, quarter-over-quarter, non-core, etc. but core PCE deflator year-over-year. That’s the one they watch, and they want it to be 2%.

Note the time series of the data. In February, it was 1.8%. The Fed’s looked at that and said, “See, we told you it’s going to 2%.” In March, it came down to 1.6%. In April, it came down to 1.5%. In May, it was 1.4%. We don’t have the June data yet, because it won’t be out until the first week of August.

Based on data from other inflation metrics – not the ones the Fed bases policy on, but important ones nonetheless including PPI and CPI that both show downward trends – they’re at higher levels. They’re running hotter than PCE core year-over-year, but they are showing a downward trend.

Based on that data, there’s every reason to think that the PCE core year-over-year will be at best 1.4%, maybe even 1.3%, and maybe lower. That’s a big deal. That is moving in the wrong direction from the Fed’s 2% goal, and it’s moving very strongly. Most important of all, it’s moving persistently.

What was Janet Yellen saying about that in March, April, and May? I always remind readers that I don’t have secret data. We’re all looking at the same data. The only thing that separates us are our models and analytical tools and maybe different ways of looking at things.

Yellen is looking at the same data, but what was she saying in March, April, and even May, when this was coming down? She was using the word ‘transitory.’ “Well, yes, I see it, but I don’t really believe it. It’s not going to persist. They’re temporary factors,” etc.

One time it’s oil. Well, oil is not part of the core. It’s part of the overall index but not part of the core index. If oil is going down, it does have ripple effects in other parts of the economy, so there might be reason to believe that. If you think prices are going back up, which I don’t, that might be the reason to call it transitory, but that has persisted.

There’s a price war in telecommunications carriers, your cell phone carriers like T-Mobile, Sprint or AT&T. There’s a price war going on there. They actually referred to that as transitory, but I don’t know if it’s transitory or not.

I think she has the Gilda Radner problem. Remember her character Roseanne Roseannadanna from Saturday Night Live? Her punchline was, “It’s always something.” That’s Yellen’s problem. She can look at one factor and say it’s transitory, but it’s always something. There’s always something coming along. It could be healthcare, etc.

This is persistent. She threw in the towel recently in her Humphrey-Hawkins testimony to the House of Representatives a week ago Wednesday when she acknowledged and said words to the effect that it might not be transitory. She didn’t quite come out and go full Monty and say, “Oh, no, it’s moving in the wrong direction. We have a problem.” She didn’t say that in so many words, but she was as explicit as she ever gets about the fact that this is now a problem. They hit the pause button to see what happens.

Interestingly, the Fed doesn’t move on a dime. I just gave you four data points (February, March, April, and May PCE core) that would be very bad for the Fed. You say, “The June number is going to come out in early August. What if it goes up? What if it goes up to 1.6%?” That will not be enough to get them to raise rates in September.

The reason is it takes a long time to get Yellen to turn, but it takes just as long to get her to turn back. In other words, she’s now flicked the switch. She’s in “Disinflation is a problem. We need to pause” mode. She won’t reverse that based on one data point.

Again, if she sees June, July, August and it’s trending, then maybe she’s back on track for a December rate hike, but we’ll see. As of now, September is completely off the table. By the way, I said that a while ago. We told our listeners that even in the last podcast a month ago, and now I see a lot of economic analyses have come around to that conclusion.

This is a reaction to the fact that they had four rate hikes. They raised them in December 2015, December 2016, March 2017, and June 2017. They put four rate hikes on the table, and I would argue strongly that they began the tightening in May 2013.

The so-called liftoff or first rate hike was December 2015. “Jim, what are you talking about? What do you mean they started in May 2013? That was two years before the liftoff.” The answer is there are a lot of ways to tighten. You can do it with forward guidance or with tapering.

That’s what they did in May 2013 when Bernanke gave the famous taper talk. We practically had an emerging markets currency and stock market meltdown. Then in December 2013, they started the taper that persisted through November 2014.

In March 2015, Janet Yellen removed the last bit of forward guidance. They had been including the word ‘patient’ in their statement meaning, “We’re going to be patient about raising rates,” which means, “We’re not going to raise rates until we give you a heads-up.” They took that out, and that was the heads-up. Then they didn’t actually raise them until December 2015.

That whole sequence of warning about taper, starting the taper, staying through the taper, and moving forward guidance were all tightening moves. I remember people saying, “Tapering is not tightening because you’re still printing money.”

Yes, but if you’re printing less money than you were the month before, that’s a form of tightening. It’s not extreme tightening, but at the margin, if I’m printing $80 billion a month and I go down to $40 billion a month, which is what they did in stages, that’s a form of tightening. You can’t say that expanding QE is ease but somehow contracting QE is not tightening. That’s just illogical and also not empirically correct.

Here’s the key, Alex. Our friend, Milton Friedman, reminds us that monetary policy operates with a lag that can be 18 months to two years. If you start tightening in small ways in 2013 and aggressively in 2015 and 2016, you should expect the economy to perhaps go into a recession in late 2017. Here we are, right on time.

The Fed is always the last to know. They’re going to try to undo the damage by pausing, but that will probably not be enough. If we go into a recession, they’ll have to throw the whole show in reverse, which means actual rate cuts and getting back down to zero then QE 4.

This is extremely bullish for gold. I know we talked about gold earlier in the podcast before we switched to the Fed, but when people talk about gold going up or down, what they’re really talking about is the dollar price of gold.

I think of gold by weight. That’s the right way to think about gold, because I think gold is money. For those who think of gold in terms of a dollar price, well, the dollar price of gold is just the reciprocal of the strength of the dollar. A strong dollar means a lower dollar price for gold as we saw in 2012/2013. A weak dollar means a higher dollar price for gold, and that’s what we’re starting to see now.

The dollar has come off the top, but when the Fed switches to ease along the lines I just described, when we get to September, they don’t hike, and perhaps they offer some forward guidance and say, “We’re not going to hike in December,” this will weaken the dollar. That’s very bullish for gold.

My advice to gold investors is that you’ve got a great entry point here. Don’t wait until it’s back up over $1,300. You might still want to buy then, because it’ll go even higher in the long run, but it’s a great entry point right now and a very good reason to buy gold based on this Fed forecast.

I’ll mention Lael Brainard who’s also a member of the Board of Governors and voting member of the FOMC. He gave a speech before Yellen’s testimony. Yellen testified on July 13th, but Brainard gave a speech on July 11th. It’s a little bit technical but absolutely fascinating and indicates that the Fed still doesn’t get it.

Alex:  Speaking of policy lag and how that affects the value of the U.S. dollar, you just mentioned that the U.S. dollar and the U.S. dollar gold price is basically an expression of U.S. dollar buying power.

There’s a common point of confusion here considering that central banks have injected something like $15 trillion U.S. dollars of currency into the economy over the last decade, but it really hasn’t shown up in price inflation. The area where we’re seeing inflation is in financial assets.

If you talk to Austrian economists, for example, they will tell you that asset price inflation is actually the precursor to consumer price inflation. That could still be in the cards. If we see that, it will definitely be an expression of the loss of buying power in the U.S. dollar.

Jim:  I study Austrian economics and think it has a lot to offer. I don’t consider myself an Austrian economist. I consider myself a complexity theorist and a few other branches of science that I bring to capital markets. That’s how I understand capital markets.

The Austrians have a lot to offer. Asset price inflation certainly can be a precursor to consumer price inflation. I wouldn’t rule that out. If they keep going, eventually it will be, but asset price inflation results in bubbles. If bubbles burst, you have financial panics. You could have deflation in nominal space, but a financial panic would mean a major run to gold as a safe-haven asset.

Maybe other things would be collapsing. Maybe even consumer prices would be coming down in a recession or a financial panic, which they would, but gold and treasuries would be going up as safe havens.

I remind people that the greatest period of sustained deflation in American history was the Great Depression from 1929-1933. Yet in the Great Depression, gold went up 75% from $20 an ounce to $35 an ounce. The best-performing stock on the New York Stock Exchange was Homestake Mining. It rallied when the market was going down from top to bottom over 80%.

Gold is a funny thing. Because it is money, it can perform very well even in environments when everything else is falling apart, because people want money.

Alex:  Exactly. We are out of time. We did have on the agenda for today a certain disturbing trend that’s going on in China, but we’re going to have to leave that for our next podcast.

As always, I appreciate you being on with me. It’s been a great discussion that I think our listeners are going to enjoy very much.

Jim:  Thank you, Alex. It’s great to be with you.


You have been listening to The Gold Chronicles with Jim Rickards and Alex Stanczyk presented by Physical Gold Fund. Recordings may be found at You can also register there for news of upcoming interviews with Jim Rickards and other world-class thinkers.


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The Gold Chronicles: July 2017 Interview with Jim Rickards and Alex Stanczyk


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Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles June 2017

Jim Rickards and Alex Stanczyk, The Gold Chronicles June 2017


Topics Include:

*In depth look at potential risks of cryptocurrency
*Why cryptocurrencies are still in their infancy and are not yet comparable to gold, US dollars, or other currencies
*Why ICO’s and crypto currencies are not protected from government regulation or enforcement
*How most cryptocurrency ICO’s are not compliant with international AML/KYC reporting frameworks
*Which tools regulators have for enforcement of breaches in regulation and why cryptocurrencies are not beyond regulatory reach
*How a distributed ledger works
*How Bitcoin mining works
*What is an Initial Coin Offering
*Trustless dis-intermediation still has chokepoints that regulators can act against
*SWIFT transfers
*Tax implications of cryptocurrency ownership
*G20 Update
*Syria Update
*North Korea Update

Listen to the original audio of the podcast here

The Gold Chronicles: June 2017 Interview with Jim Rickards and Alex Stanczyk


Physical Gold Fund presents The Gold Chronicles with Jim Rickards and Alex Stanczyk sharing insights and analysis about economics, geopolitics, global finance, and gold.

Alex:  Hello, this is Alex Stanczyk. Today I have with me Mr. Jim Rickards. Jim, welcome back to the podcast.

Jim:  Thanks, Alex. It is great to be with you.

Alex:  We have a number of different subjects today including cryptocurrency. We’re also going to talk about the G20, Syria, and North Korea.

Let’s start with cryptocurrencies. We have listeners who are interested in crypto but are not what I would consider seasoned crypto-enthusiasts. For the portion of the audience who are not highly technical, there’s a desire to know more about crypto in terms they can understand. We’re going to discuss that a bit today.

I would like to lay down a few thoughts to set a foundation for the topic. First of all, this is not about cryptocurrency bashing. I personally like the idea of a distributed ledger; it’s fascinating technology. The potential for the blockchain technology is quite interesting.

This also isn’t about whether gold is better than cryptocurrency or vice versa. The truth is, crypto is still in its infancy. It does not yet come close to gold in terms of practical application.

Gold’s market cap is in the neighborhood of $7.4 trillion as of the last estimates we received from our sources. Other currencies, Global forex for example, are multiple times this in size. All crypto combined is sitting at a market cap of about $112 billion. While the technology has great potential, cryptocurrencies themselves have a long way to go before global markets take them seriously as a money alternative with any depth and liquidity.

There’s been a lot of buzz surrounding crypto that, from my perspective, does not take into account the reality of the global regulatory landscape we live in today. For example, because it’s crypto or because it’s an ICO (Initial Coin Offering), if this ICO is in a country outside the U.S., there seems to be this belief that it’s somehow protected from regulatory reach.

One of the things I want to talk about today is that this is either a lack of understanding of how regulatory enforcement works on a global level, or possibly there may be a little bit of confirmation bias going on that’s blinding people to how things really work.

I want the listeners to keep in mind that I’m not pretending to be any kind of technical expert on cryptocurrency. What I’m addressing is what appears to me to be gigantic, gaping holes in the attention given to regulatory compliance and this idea that crypto is somehow beyond the reach of government.

Jim, I’m going to be asking you for your input on this in a moment. But for now, let me just add a little more foundation.

Right now, ICOs are popping up like crazy. It’s kind of like the Wild West. An ICO is a brand-new cryptocurrency people are pouring money into. My observation is that the majority of these ICOs may not understand the legal implications of what they’re doing in the area of what regulators could view as issuance of securities or, with a lot of them, being in noncompliance with international AML/KYC frameworks such as FATCA, CRS, and IGA. FATCA is the Foreign Account Tax Compliance Act, an intergovernmental treaty framework the U.S. has pushed. CRS is an OECD framework, and IGA is put forward by the UK.

These things all need to be taken seriously. There’s a host of regulatory bodies from several countries that are monitoring what’s happening in crypto. Even if they’re not aggressively pursuing enforcement actions, they’re well aware of activity in the space.

From the U.S. specifically, the regulators who have potential oversight are the SEC, the CFTC, and particularly the FinCEN. FinCEN stands for the Financial Crimes Enforcement Network.

All it would take would be for crypto to be classified as a primary tool for terrorist financing, and then all kinds of risks start to open up. I want to be clear here that I’m not suggesting crypto is a primary channel for these kinds of activities. What I’m saying is that if a regulator such as FinCEN claims that it is, that’s all it’s going to take for this to have serious potential repercussions.

At this point, some people who are familiar with crypto might make the argument that, just like gold, if it’s used in total isolation, it works, which I grant is true, but not for any serious liquidity. For example, you can bury gold in the backyard, but in serious quantity, who are you going to sell it to later and expect it to remain secret or safe during such a transaction?

With crypto, you can avoid digital exchanges by going point-to-point directly. You can try to avoid interfacing with anything that touches USD transactions. In doing so, your world of potential transactions and, importantly, options for liquidity and size diminishes substantially if an actor tries to take this isolation route.

Jim, considering that regulators could take the view that ICOs are acting as noncompliant financial services entities, what are your thoughts in this area in terms of the tools regulators bring to bear on U.S. dollar transactions in cryptocurrency or other risks you see here?

Jim:  Thanks, Alex. That was a great introduction. The first thing I would say is that this is a huge topic. We say, “cryptocurrencies,” “blockchain technology,” “initial coin offerings,” “safe contracts” or “smart contracts,” and the various uses and legal regulatory regimes which I’ll talk a little bit more about.

Each thing I just mentioned is a big topic in itself, and they all fall under the banner of crypto. For those not familiar, this all originates with a certain kind of technology, a certain protocol called the blockchain.

Blockchain is basically a recordkeeping, a ledger. Right now, certainly for hundreds of years but still true today, if you bought a property from somebody, you’d show up at the closing (or your lawyer would) and the seller would have a deed. They would sign it over to you, and you or more likely your lawyer or a clerk or somebody would go down to the town hall and hand that to the town clerk.

The town clerk would literally write it down. Maybe they’d type it in a ledger, a land record, and put a stamp on it. They would give it back to you or mail it back to you so you could put it in your safe-deposit box. That deed would be your legal document representing your title to that land.

Think about all the steps I just described. The fact that there’s paper involved and it’s got to go through many hands: lawyer, clerk, the town clerk, back to you, buyer, seller, etc. It’s legally binding and recognized by the courts. It’s the way things are still done today.

These are public records. You can go to the town hall on your own and pick out a lot number and a block number. (That’s usually how they’re categorized, e.g., Block 22, Lot 15.) You could look it up, find out who owns it today, and who they bought it from all the way back to whoever, maybe the Revolutionary War for that matter. That’s an example of a ledger and a recordkeeping method to establish title.

The blockchain does a couple things. First, it’s completely digital, so forget the paper side of it. Second, it’s heavily encrypted with what’s called military-grade encryption, which is (at least as far as I know) unbreakable. If there’s any way to break it, I promise you, it is the most closely held secret of any government in the world.

People are certainly working on it all the time, but for all practical purposes – again, as far as I know – it’s unbreakable unless you give away your key. You have a certain alphanumeric code that is your key. As long as you keep that private and don’t give it away, then you’re the only one who can unlock the encryption.

It’s heavily encrypted; it’s digital; it’s virtually free to move it around. Most importantly, it’s distributed. ‘Distributed’ means that this ledger resides on thousands, millions, or potentially tens of millions of computers and servers all over the world.

That’s a big deal, because if there were a fire in the town hall and all those paper records I just described were destroyed, you’d have a heck of a time recreating all that. But if you literally blew up a computer that had this ledger on it, it wouldn’t matter. The same ledger exists on all these other computers. It’s the community as a whole that verifies it.

If one party says, “I own this certain asset” (it could be Bitcoin or any other asset which we’ll talk about in a minute) and the whole community says, “No, you don’t. We all have the same ledger, and we see that this went to a certain party from A to B, and Ms. B is the owner,” that’s that.

You have the benefit of digitization, encryption, and distribution. These three very powerful tools are the blockchain technology. Now, what can you do with blockchain technology? One thing – and this has been done – is to create a cryptocurrency. Bitcoin is the most famous or best known, but there are many of them out there.

I was involved with one working group, and we identified 90. That was some time ago, so I am sure there are many more than that. Some of them have larger amounts in circulation, larger followings, if you will, than others. Greater liquidity is the way I think about from an economic perspective, but they’re all out there.

How do you get some of this currency? How do you get a Bitcoin? Well, you can sell something and accept Bitcoin payment. I have a store on my website, The James Rickards Project, that accepts Bitcoin. You could pay me in Bitcoin for one of our goods, etc.

You can sell things for Bitcoin, and you can go buy a Bitcoin. You can take dollars or euros for that matter and go to a Bitcoin exchange (exchanges are popping up all over) to buy Bitcoin.

You can also mine them. The word ‘mining’ obviously is a reference to, or at least an analog of, gold mining. Of course, it’s nothing at all like gold mining. I’ve been in gold mines, and it’s one of the grittiest, most physical business you can imagine.

You have to drill cores and walk around in remote areas that are either freezing, equatorial swamps, or deserts. It’s a nasty business with all kinds of machines, backhoes, and all that stuff. Gold mining is a very hands-on, gritty business.

Mining Bitcoin or any cryptocurrency is quite the opposite. It takes massive computing power. To simplify it, the Bitcoin protocol is basically solving very difficult math problems that take a lot of number crunching, a lot of computing power, and a lot of energy.

By the way, one of the criticisms of Bitcoin is that the amount of energy being sucked up to create Bitcoin, to do this mining, is itself a waste. We’re burning a lot of coal somewhere in the atmosphere, or nuclear power or some other things people don’t like, to generate electricity so Bitcoin miners can go about their work. I’ll just leave that as an aside.

Some big Bitcoin mines are, at this point, a very large warehouse-sized facility with lots of servers and processing power going on. Some are being put in Iceland, because it’s cool in Iceland, and you generate a lot of heat with that much computing power. Also, energy is relatively inexpensive there, because they have geothermal and a couple other things. That’s the kind of Bitcoin mining.

These math problems I described get harder. Every time somebody mines a Bitcoin, the next problem gets a little bit harder. It grows exponentially to the point where the last few Bitcoins that ever get mined, the amount of processing power that goes into it, is going to be enormous.

As a miner, if you solve the problem, you get Bitcoin. That becomes your reward. I haven’t verified this myself, but I heard from third parties that today it costs about $1,000 to mine a Bitcoin. Bear in mind, we’re pretty far down the road with these things. Originally, it would have been far less than that. Now the Bitcoin are selling on exchanges for between $2,000 – $3,000. It’s volatile.

I guess it’s like gold mining. If I can mine gold for $800 an ounce and sell it for $1,200 an ounce, I can make some money. If I can mine Bitcoin for $1,000 and sell it for $2,000 – 3,000, obviously I can make money doing it. That’s the currency part of it.

Now, let’s talk a little bit about Ethereum and ICOs. I said there are many cryptocurrencies other than Bitcoins. These initial coin offerings are groups of developers not unlike any Silicon Valley startup. In San Francisco, San Jose, Silicon Valley, New York or anywhere in the world associated with Silicon Valley, you can find teams of developers. Maybe some of them have experience at one of the big, successful startups whether it’s PayPal, Uber or some of these new apps they’re working. You name it, there’s an app for it, of course.

They need to fund themselves, because they have salaries, overhead, rent, equipment costs, etc. no different than any other startup. The traditional way is to meet with venture capitalists, ask your mother or family and friends, knock on doors or do a private placement. There are traditional ways of funding any startup.

More recently, we’ve seen what they call crowdsourcing or crowdfunding where you throw it out there on a certain Internet site and get people to give you money. With original crowdfunding, they’d give you a T-shirt, a ticket to a movie if they could produce a film, whatever it might be.

These ICOs are really nothing more than crowdfunding or crowdsourcing. Here’s how it works: If I choose to subscribe to one of these, I send in hard dollars, $100 or $1,000 or whatever. In return, I receive one of these coins. They also call them tokens or some name like Dow and Mastercoin, for example.

I’ll get one of these coins or maybe a bunch of them because I put a lot more money in. What do I get for my coin? Here’s where it gets interesting. In a normal startup, I’ll sign a subscription agreement, send my money in to the promoter, and I’ll get shares, units, limited partnership interest, LLC member’s interest, stock, or something.

It goes on the ledger (a capitalist will say a cap table). From then on, I’m an equity holder. If the company fails, my equity goes to zero, tough noogies. If it succeeds, maybe I just bought into the next Google at $1/share and someday it’s at $1,000/share. That’s why people do it hoping for those big gains.

With the coin or token I get, it’s not really a share. I don’t get any voting rights or dividends. That’s where I’m jumping ahead a little bit to the regulatory regime you talked about, Alex, and where the securities laws get tricky.

If I’m the creator, the programmer, and the developer of this, I can define the token any way I want. It’s certainly possible that a token could walk and talk like a share of stock. The minute you tie the value of the token to the success of the enterprise, it’s probably a security.

For purposes of application of the ’33 Act and ’34 Act securities laws (the ones we’re familiar with in the U.S.) and similar securities laws in Europe, the UK, and Japan, the definition of a security is a little bit technical. It’s usually tied to some stake in the success or failure of the enterprise and defined as the earnings of the enterprise.

What if my token says, “No, Jim, you don’t get any stock. You get no votes. You have no equity in this thing. What you do get is to use the app for free,” or “You get to sell it to somebody else,” or “If the app is successful, you’re going to get certain privileges,” or “You can intersect something you’re doing with what we’re doing so these things are compatible in certain ways.”

I realize I’m being a little vague right now, but the area is vague, because there are a lot of ways to do this.

I might create a token that looks just like a security, in which case, unless I follow the private-placement rules 506(b), 506(c) and some other laws, I could be breaking the securities law if I’m not careful.

On the other hand, if the token is not much more than a token and the person buying it is hoping for the best – that the token becomes more valuable because they’ve got a front-row seat on the next new app and can sell it to somebody else – it might not be a security. It’s some kind of property right, it’s some kind of speculation, but it might not be a security. This is very new, very grey.

I can imagine traditional securities lawyers pulling their hair out over this trying to figure out what it is. I was involved in the very early days of the swaps market. Swaps and derivatives are commonplace today, but going back to the late ‘70s and early ‘80s when these things were literally being invented, I was international tax counsel at Citibank. We knew how to write them, but we didn’t know how to treat them in terms of tax treaties.

If you paid a swap payment, was that interest? Was it a dividend? Was it insurance premium? You could argue that it was any one of those things. We were operating in a grey area and have a lot more clarity around that today, but it’s the same thing with these ICOs.

What are these apps you’re funding used for when you buy a token in an ICO? One of the big applications today are what are called safe contracts. Because transfers through a distributed ledger are both encrypted and irrevocable, if not un-hackable or at least sufficiently widely distributed that they’re reasonably safe, it’s considered to have the potential to solve a trust problem in any transaction.

Go back to cavemen and cavewomen and imagine you just killed a mastodon. You’ve got some fresh meat, and I just picked a bunch of berries. We want to barter. I want to give you some berries, and you’re going to give me some of the mastodon meat. Well, what if I give you the berries first and you run away or you give me the meat first, and I run away? It might start a war or whatever.

It’s the “who goes first?” problem that applies even in modern times. Maybe in the 19th Century I’m going to buy something from you, I hand over the money, and you don’t deliver the goods. You keep my money and don’t deliver the goods, or vice versa.

This happens on a much larger scale when you’re doing multibillion-dollar corporate takeovers. How do you handle all that? The answer is that through centuries of law and contracts, precedent and court cases, enforcement, and other things, we have developed tried and true ways of dealing with all these problems.

If the buyer and seller are remote and not face-to-face for a simultaneous exchange, you can use an escrow agent. You can use insurance, a third-party bank or a lot of different trust counterparties to solve that problem.

I worked on one of the biggest problems like this in history when we were obtaining the release of the Iranian hostages in 1979/1980. Iranian militants broke into the U.S. Embassy and took a bunch of Americans hostage around the time of the Ayatollah Khomeini and the Iranian Revolution after the fall of the Shah.

Because it was sort of spontaneous, they hadn’t really thought through where a lot of their money was. It turned out that a lot of it was in U.S. banks, so all that money was immediately frozen.

After a year or so of negotiations, the U.S. obviously wanted the hostages back. Iran had gotten enough propaganda value out of it, and they wanted their money back. The U.S. was not going to pay ransom, but took the attitude that, “It’s not really ransom; it’s your own money that we’ve frozen. We’ll just be giving it back to you if you give us back our citizens.”

That was the deal, but the problem was neither the Iranians nor the United States (there were other Western banks involved, but I’ll just say the United States) trusted the other enough to go first.

The U.S. said, “If we send you the money, you guys are going to take it, keep the hostages, and poke a stick in our eye.” The Iranians thought the same thing, “If we release the hostages, you Americans will never give us the money. How can we trust you?”

We solved that by saying, “The obvious way to solve it is to get an escrow agent.” You give the money to the escrow agent, he sits on it, observes the release of the hostages, and when the hostages are released, the money is forwarded to, in this case, Iran. They’re no longer trusting the United States; they’re trusting the escrow agent.

Then the problem was, who in the world was trusted by both sides? Who could the U.S. trust enough to send the money to in the first place, and who could the Iranians trust enough to know that they would get the money if they released the hostages? It turns out, the answer was Algeria, the Central Bank of Algeria. They were sufficiently Western and sufficiently Islamic that both sides were happy.

It’s a long story and an interesting one, but my point is, that’s how difficult it can be to solve this “who goes first?” problem in any exchange. With Ethereum and some of the apps being developed under some of these initial coin offerings, that problem is solved through the protocol.

That is, if I pay you, there is going to be some verification that you ship the goods. When that happens, you automatically get paid. You’re no longer relying on me to send you the money. You know the money is waiting for you once you ship the goods.

These are called safe contracts. A lot of people are working on apps for those. I question whether they’re not solving a problem that doesn’t exist in the sense that Amazon does quite a bit of business. When I use my credit card to buy something on Amazon, I don’t really worry that I’m not going to get my merchandise. If I don’t, I know I can get the credit card charge reversed.

It would be rare if that were not true, so I don’t consider there to be much of a problem. If there’s an improvement on that, maybe Amazon would buy the technology. Who knows? This is just an example.

I realize I’m going on at length here, but I’m trying to make the point that there’s the blockchain technology, there are cryptocurrencies, and there are ICOs issuing coins or tokens that could be currencies but are really property rights of some kind, hard to define, in a new app. The apps themselves are performing these kinds of ledger or safe contract role.

I don’t want to mush it all together, because I think there’s too much of that. People are kind of glib in the conversation, but I think it’s important to make all these distinctions so we’re not just throwing the word crypto around without a lot of content. We should know exactly what we’re talking about.

Alex:  I think the idea with the whole trust lists thing is that it removes intermediaries. In particular, it removes banks as intermediaries and the focal point of control of the transactions.

That’s one of the things I was trying to get at here. Any of these cryptocurrencies you’re transacting in are cross-rate or cross-currency. In all forex, there’s a cross-rate. Either it’s USD/RMB, it’s USD/CHF (Swiss francs) or it’s USD/gold, for example. That means you’re converting these cryptocurrencies in and out of other types of currencies, and this is where your risk is at. This is where there is potential for regulators to control that.

Jim, talk a little bit about how SWIFT works and how anything that’s done, really in U.S. dollars, how that happens and how regulators can use that.

Jim:  Let’s say I’m Deutsche Bank, the biggest bank in Germany. A lot of my business is in euros, but I deal in all major currencies. You’re sitting in New York and are Citibank, one of the biggest banks in the United States.

I have to send you $2 billion, because my dealers bought foreign exchange from your dealers or we had a bunch of transactions or customers wanted a little money. Whatever it is, I want to send you $2 billion. How do I actually do that?

One thing you don’t do is go to the ATM, get a bunch of cash, put it in FedEx, and send it. That’s obviously ridiculous, so we can cross that off the list. I could send you some kind of commercial paper, negotiable instrument, by courier, but that’s slow and pokey. It wasn’t so long ago that that’s the way things were done.

The way they do it now is to send a message through SWIFT (Society for Worldwide Interbank Financial Telecommunications). They don’t consider themselves a payment system, and they’re certainly not a bank or a financial institution. They compare themselves to the phone company and say, “We handle message traffic. To get in SWIFT, you must agree to abide by all the protocols of SWIFT.”

As Deutsche Bank, I want to send Citibank $2 billion. I would do that by sending a message through the SWIFT system. Think of SWIFT as a giant digital switchboard. They have forms that can all be done online that go by the name MT (Message Traffic). There’s an MT101, MT102, 202, etc., lots of different kinds.

Here’s the thing about SWIFT. Assuming I’m an authorized participant, you’re an authorized participant, we both have the right protocols and passwords, we go on and fill out this MT form, somebody hits “Send” and Deutsche Bank just sent you $2 billion. That’s irrevocable. I can’t say, “Whoops, sorry, I pushed the wrong button,” or, “Oh, gee, I filled out the form.” Too bad; that’s on me now. If I actually do that (mistakes do happen), the bank must call the other bank to explain what happened. Maybe they can sort it out, maybe they can’t, maybe there’s a lawsuit. Who knows?

SWIFT says, “We have nothing to do with it. We’re not your referee or your escrow agent, we’re just the phone company. We connect the switchboard, and the message goes through.” That’s the way things are done today. It’s rather efficient and certainly a lot better than the way it used to be, but it still takes a lot to maintain SWIFT.

SWIFT is subject to government intervention and government control. It’s rare, and they don’t like it, because they like to keep out of politics. Obviously, there could be all kinds of squabbles among all the SWIFT members. They don’t like to get in the middle of that. However, there have been several instances most famous of which was in 2012/2013, right in there.

As part of U.S. sanctions on Iran because of the Iranian nuclear weapons and uranium enrichment programs, Iran was kicked out of the SWIFT system. The board of governors or the supervisory board of SWIFT said that Iran could not use the system. SWIFT didn’t really want to do it, but there was pressure put on them for that reason.

That was a big deal. Iran could ship oil, which they do, but they could not get paid in dollars, euros or any other hard currency through the SWIFT system, and they had no other way of doing it.

They could get Indian rupees deposited in an account in an Indian bank if they wanted rupees, but it’s kind of limited in terms of what they could do with that. They couldn’t transact in dollars, euros or anything else anybody really wanted.

Iran did workarounds, such as barter, and gold was a big part of it. They could put a bunch of gold on a plane, fly it to somebody and unload it, and there’s payment. There’s nothing digital about it and no way to interdict it other than shooting the plane down, but then the gold would just land on the ground. That’s the great thing about gold – it’s pretty much indestructible.

The point is, that was a real burden on Iran. It brought them to the negotiating table and led to an agreement under the Obama administration. I don’t want to do a deep dive on the agreement, but those financial sanctions were very effective. Today, North Korea is the one that’s kicked out. Again, it is rare and SWIFT doesn’t like to do it, because they like to keep out of politics.

The blockchain – particularly for applications created on the Ethereum platform –  offers the kinds of transfers I’m describing with no trusted counterparties, no heavy infrastructure.

A lot of people are looking at this. JP Morgan is working on it, Blythe Masters (formerly head of commodities trading) is in a joint venture or enterprise with some other founders looking at it, Marc Andreessen, the Winklevoss twins, other major banks, the IMF, and Russia are all looking at it.

There’s good reason to be enthusiastic about the technology. I’ve voiced a lot of concerns, reservations, and some criticisms of various things going on in crypto and immediately get branded as, “You’re a Neanderthal, you’re from the Stone Age. What’s wrong with you? Baby Boomers, you don’t get it,” etc.

The fact is, I’ve been studying this for years. I’ve read the technical papers, and I do keep up with it. I’ve been involved, for example, by working with the U.S. Military in interdicting the use of cryptocurrencies by ISIS. I’ve seen ways this stuff can be interdicted, which I can’t really discuss in any detail since some of this information is classified. The point is, there’s more there than maybe some of the fans want to believe or tell themselves.

I’m not technophobic at all. Like you, Alex, I find it fascinating. I try to learn about it, but I’m not a cheerleader, either. I don’t get the pompoms out and say, “Go buy this stuff.” I think for people who do, it’s maybe self-interested, because if you own some, you probably want the price to go up. I would say Bitcoin doesn’t have a price; it has a cross-rate to other forms of money.

That aside, there’s a lot of self-interest and trolling involved. There are people who are a little overly enthusiastic and don’t see the dangers in all this. That’s why I think it really does pay to be thoughtful.

Alex:  I agree. At the end of the day, what it comes down to is that any cryptocurrency that’s going to interface with another currency, for example if it touches the U.S. dollar ecosystem, that’s the chokepoint. Any wire transfer or transfer that’s sent in U.S. dollars around the world goes through an intermediary bank in New York City. Well, that is on U.S. soil, and they have complete control of that.

There’s a big difference between regulation and enforcement. Ultimately, lawmakers can pass any law they want, but if it can’t be enforced, it doesn’t really have any teeth. The reason banks and financial services entities all over the world are complying with extra-sovereign regulatory oversight is that the enforcement tools regulators have at their disposal do have teeth. Anyone who thinks that cryptocurrencies are outside the reach of that, aside from these direct transactions we talked about, are fooling themselves. By the way, this oversight compliance is costing them billions of dollars.

Jim:  Right.

We’ve touched on securities law, counterterrorism, any money laundering, the Financial Crimes Enforcement Network (FinCEN), and all the things you mentioned, but there’s another 500-pound gorilla in the room, which is our friends at the IRS. A lot of people don’t realize that if you could go out and buy a Bitcoin for $200 – it’s shot up so much, but it wasn’t long ago you could get one for $200 – and today it’s worth $2,000, you can use it to buy something. You don’t even have to cash it in for dollars. You can buy a plane ticket or just about anything with Bitcoin.

In my example, you just had an $1,800 gain you have to put on your 1040 income tax return. Bitcoin is some kind of property. I query whether it’s a capital asset or not, but it doesn’t matter. It could be an ordinary account or capital gains, but you have a $200 basis, $2,000 of value of proceeds, and an $1,800 gain. You must put it on your tax return and pay the tax.

How many Bitcoin users are actually doing that? I don’t know the answer, but I’m guessing it’s not that many. All those who are not are tax evaders, at least if you’re U.S. citizens. If you’re a citizen of another country, that may be different, but for U.S. citizens at least, it’s got to go on your tax return. That’s the law. If you don’t do it, it’s intentional, willful, and possibly a felony. They didn’t get Al Capone for murder or bootlegging but for tax evasion.

Now, is there enforcement? I haven’t heard of much, but the IRS is a funny organization. They’ll see things like this and lie in wait. They’ll sit there and say, “Why chase after a couple of little guys? It’s all new. Why don’t we just wait and let it build up for years. Let the amounts involved get into the billions and then go scoop them all up at once.” They’d need a test case or some probable cause, but they’d serve a subpoena on the major Bitcoin exchanges and demand all their books, records, and identities of all counterparties. It would be resisted and end up in court where they’d probably get a court order enforcing that.

Well, suddenly the exchanges are giving up all this information. The Bitcoin fans might say, “So what? I’ve got a digital wallet. All they’re going to do is get a code they can’t crack.” Maybe, maybe not. The point is, you can kind of go from there. They can start to find purchases or they can subpoena the sellers. If it happens to be Amazon, they’re not a rogue organization, so they’re certainly going to comply with a subpoena. On and on it goes.

I’m not saying this is easy or happening tomorrow morning, but I’m saying we’ve seen this before. I was a tax lawyer, and one of my favorite cases in law school was when the IRS tried to impute the income of a house of ill repute, but the brothel didn’t keep any books and records.

Their defense was, “You can’t prove how much income we had, so you can’t assess us.” The IRS got the laundry bill, looked at how many times the sheets were cleaned, figured out the going rate, and came up with an income. The judge said, “That’s good enough for me in the absence of anything else.”

The IRS does not let the absence of information stop them. They will come up with the worst set of facts for you and put the burden of proof on you to prove otherwise. They’re pretty resourceful in that way. That’s another pitfall for the young crypto community to bear in mind.

Alex:  We have a little bit of time left for a couple of other subjects, so let’s move into geopolitics. The G20 has a meeting coming up on the 7th and 8th in Hamburg, Germany.

There was a recent article that portrayed Germany and China linking up as globalization partners. I’m going to read a quote from a professor at the Chinese School of Journalism and Communication who is a Fellow for the National Academy of Development and Strategy of Renmin University:

“In the global context of increasing uncertainty due to the U.S. and Britain’s actions of antisocialization, isolationism, and nationalism, the G20 can forge ahead for more stable, more sustainable, and more responsible global economy only if the two groups of countries unite.”

Jim, what’s your take on this, and is there anything else happening regarding the G20 that you think is important to note right now?

Jim:  Yes, I do, Alex. As you mentioned, it is coming up July 7th and 8th in Hamburg, Germany. G20 stands for “G” or “group” of 20 nations although it’s more like 24. They invite Norway, Spain, and a couple other hitters plus some multilateral participants: the IMF and the European Union. I call it “G20 and Friends.” They get about 30 key players at the table.

The leaders meet once a year. They used to meet twice a year, but as we get further away from the crisis, they’ve dialed that down to once a year. There are G20 meetings throughout the year at levels below the leadership or the President, if you will. The central banks, finance ministers, and other technical working groups meet a couple of times a year. The G20 never sleeps. Their work goes on around the clock even though these big summits only happen once a year.

A lot of people shrug and say, “What the heck does the G20 mean? It seems like a boondoggle.” I disagree. I have a long section in my book, The Death of Money, about the G20 where I make the point that it’s really the board of directors of the global economy. Think of the highly integrated, connected, densely networked global economy we have because of globalization and some of the things we talked about earlier such as digitization and so forth. It has a central bank, which is the IMF, and the IMF has a board of directors, which is the G20.

It’s actually a very powerful organization even though they don’t agree on every little thing. They have a rotating presidency. This year, it’s Germany, so that’s why the meeting is in Hamburg. Last year, it was China with the meeting in Hangzhou in September. The year before that was Turkey and so forth as it moves around.

This one in July is a very important one. You mentioned China and Germany. President Xi Jinping of China and Chancellor Angela Merkel of Germany are probably the two leading globalists, or pro-globalist, figures. They don’t have much else in common since China is communist and Germany is a pretty healthy democracy, but at least they are the two leaders who still espouse a traditional globalist view.

It’s funny, because they claim to love free trade, yet Germany and China have the largest trade surpluses relative to GDP of any major economy – embarrassingly large. The point being, they say they like free trade, but truthfully they like a rigged game that favors their exports whether it’s the GP or the GP1 at various points in time.

Anyway, we’ve got these two big globalists, Merkel and Ji, holding hands, and we also have the two most powerful nationalists, who are Trump and Putin. I think that’s going to be the big story coming out of G20.

This is the first face-to-face meeting of Trump and Putin. Of course, you can’t go online, turn on the TV or radio or pick up a newspaper without hearing, “Russia, Russia, Russia,” “Russian collusion,” “Russian interference with the elections,” “Hillary lost because of Russia,” and all this other nonsense. America seems to have a Russia paranoia or fixation going on.

Some of that, at least in my view, is attributable to the fact that if you’re a globalist, you really want to keep Trump and Putin separated. You really want these guys at each other’s throats, because they are the two most powerful nationalist leaders in the world. If the two of them ever do set out a common agenda or strike up a good working relationship, that’s going to give a powerful boost to the anti-globalist nationalist forces.

You’ve got the two leading globalists, Ji and Merkel, and the two leading nationalists, Trump and Putin, who are going to be meeting on the sidelines. The G20 has a formal agenda and formal plenary sessions with a class photo and all that stuff, but a lot of the most important action happens on the sidelines in these little bilateral and trilateral meetings where two or three leaders go off to the side and work on some deals.

These are busy people. It’s not like they see each other all the time, so this is a good opportunity for that. BRICS (Brazil, Russia, India, China, South Africa) always have a minisummit on the sidelines of the G20. They do have their own BRICS summit at a different time of year, but since they’re all in the G20, it tends to be a good opportunity for a little BRICS summit.

The other bilateral relationship I’m watching is called Mackerel, after the fish, involving Emmanuel Macron and Angela Merkel. Macron and Merkel mashed together gets Mackerel. Despite some early warnings, it looks like Merkel is in pretty good shape for the election on September 24th and appears to be cruising to reelection as Chancellor. Although he’s a lot younger, Emmanuel Macron was just elected as the President of France in a very convincing way.

Their mantra is More Europe. I think this is the friendliest, most productive, potentially most important period of Franco-German relations going back almost to Konrad Adenauer and Charles de Gaulle. You’d have to go back to the ‘50s and early ‘60s to find greater Franco-German cooperation.

Alex, you know from prior podcasts that I’m very bullish on Europe and the euro. I have been and still am. When a lot of economists – Paul Krugman and others – were running around with their hair on fire saying Europe is falling apart, I was the one saying, “No, they’re going to stick together. Greece is not getting kicked out, and Spain is not going to quit. The euro is strong and getting stronger.” Things have played out exactly along those lines, but that doesn’t mean it’s all good.

There are some problems and reforms needed in the European Union. They need unified banking regulation, which they’re getting, but above all, they need unified fiscal policy. They’ve had unified monetary policy since the Maastricht Treaty in 1992 and the rollout of the euro in 1999/2000, but they need unified fiscal policy.

Germany has not wanted to backstop that until Merkel saw some kind of fiscal discipline. It goes by the name ‘austerity,’ but she would call it ‘prudence.’ She’s saying, in effect, “Germany is not going to underwrite Greek debt, Spanish debt, Italian debt or Portuguese debt unless we see some evidence that all you countries are getting your house in order in terms of debt-to-GDP ratios and deficits as a percentage of your GDP.”

That’s been happening in a very positive way, so now I think Germany is ready to take the next step. There’s been some talk about a fiscal parliament, common fiscal policy, a euro-zone finance minister, and a unified budget.

These are all very significant advances that will solve the problem of the euro once and for all, because you’ll be combining fiscal and monetary policy the same way we do in the United States. It looks like Macron is in favor of all that, and he’ll find a willing partner in Merkel. That’s a big deal too.

So, I’m watching the Trump-Putin relationship, China and Germany, which you mentioned, always keeping an eye on the BRICS, and I think Mackerel will be another thing well worth watching.

Alex:  It’s going to be interesting to see how this all plays out. We have just a few minutes left for two quick topics we want to hit. Let’s move on to Syria. A few days ago, a U.S. F/A-18 Hornet, which is a first-tier fighter bomber, shot down a Syrian Su-22 that had dropped some bombs near the American-backed fighters south of Tabqa.

The American commanders on site indicated that the aircraft was shot down in compliance with standard ROE (Rules of Engagement) and that they had notified Russian forces prior to engaging the aircraft. They do that to mitigate any chances of accidental escalation.

Afterwards, a statement from the Russian Ministry of Defense warned that any aircraft or objects in flight west of the Euphrates, which includes Coalition and American aircraft, would be followed by Russian air-defense systems as targets.

I reckon the whole situation over there is confusing to most. There are so many forces in place, so many different factions, so many different motivations. I know this is a huge topic, but just in a few minutes, would you talk about your view on the events, the players, and possible outcomes?

Jim:  Obviously, this is serious. During the Cold War, Russia (the Soviet Union at the time) and the United States were armed to the teeth with thermonuclear weapons and intercontinental ballistic missiles and also commanded control systems that could have completely destroyed life on the planet. Somehow, we got through that time with no Russian or American ever firing a shot at each other.

Sure, there were lots of other wars with allies, proxies, and so forth (Vietnam, Angola, Cuba) and there were revolutions and assassinations. I’m not saying there wasn’t bad stuff going on. There was, but there wasn’t a single time when Russians and Americans shot at each other. That was not by accident. It was because the two sides knew that the first shot could escalate and end up destroying the planet. Nobody wanted to go there.

I think those lessons are still understood, but what you’re describing, Alex, is a little scary and dangerous. There’s good reason to believe that some of this is posturing. Shooting down a Syrian jet is not posturing – somebody got blown out of the sky on that one – but the Russian complaints may be just to hold up their end and show some support for Syria.

This is going to get worse, though. Right now, Russia and the United States have a common enemy, which is ISIS. The Russians support Assad, we support the rebels. We support the Kurds, the Turkish want to destroy the Kurds. There are a lot of conflicting cross-currents, but the one thing everyone agrees on is to destroy ISIS.

What happens when ISIS is destroyed? The threat will never be completely wiped out, because they’ll just go underground and conduct terror. However, in terms of a state or holding territory, they’re not quite mopping up in Mosul, but that’s getting close to being done. Then Raqqa is next and then cleaning up the Euphrates River Valley.

At some point, ISIS won’t exist as a state. Then the U.S.-backed rebels and Kurds on the one hand and the Russian-backed Syrian army on the other are going to be face-to-face in the battle for Damascus.

This is a good example – North Korea is another one; Ukraine is another one – of why the Russians and the U.S. should be talking to each other, improving relations, building bridges, and opening lines of communication. Instead, we’ve got this Washington DC beltway circus of Hillary’s whining about why she lost the election, which is nonsense, and for some reason, if you talk to the Russians, you’re colluding to beat the Democrats.

We should be talking to the Russians every day. I like to say that it’s smart to talk to the Russians, but it’s dumb to lie about talking to the Russians. I don’t know why Jared Kushner couldn’t fill out his forms correctly. There’s been a lot of amateurish work and inexplicable bad behavior by some Trump administration officials for no good reason, because we should be talking to the Russians.

Hopefully, we’ll get past some of this hysteria, build bridges to Russia, and help to alleviate some of the tensions you’re describing.

Alex:  Yes, I very much agree.

Our last item is North Korea. Recently, there were exercises in South Korea involving over 100 F-16 fighters. Also, U.S. F-35s have been deployed to South Korea, and there have been several defense briefings in Guam where they station a lot of the B-52s for power projection in that theater.

On our last podcast, you said something that really struck me. You expect that the U.S. will be at war with North Korea by 2018. What are your current thoughts on what’s going on in North Korea?

Jim:  There’s no change in that assessment. I pointed out that in March 2003, we jumped off on the road to Baghdad and invaded Iraq. I’ll use General James Mattis, today’s Secretary of Defense, as an example. At that time, he was commandant of the 1st Marine Division. In 2002, he was told, “Get ready. We’re going into Iraq. Get your guys ready.”

The point is, you don’t go to war overnight. There’s at least a year, perhaps longer, of preparation. Now, just because you start the preparation doesn’t mean you pull the trigger. To me, 2017 looks like 2002 in Iraq. We’re going to try sanctions, diplomacy, and engaging with allies.

Notwithstanding that, the orders have been passed to get ready, particularly the Navy, the Strategic Air Command, certainly other special operators, and others. We’re on the path to war, and I expect it in 2018.

The only question is, what could change that outcome? There are really only two things:

  1. Kim Jong-un gives up his nuclear programs and missile programs in a verifiable way. I don’t expect to see that happen, because he thinks that’s essential to his own survival.
  2. Somehow Russia and China put enough pressure on North Korea to get them to do it anyway. I don’t see Russia doing that partly for the reason we just discussed, which is that the U.S. is barely talking to Russia. That’s too bad, because there are issues of war and peace at stake.

As far as China is concerned, Trump sent a tweet the other day. I sent a tweet in response saying, “This is the most important tweet the President has ever sent.” I’m paraphrasing because I don’t have it in front of me, but he said, “It looks like China is not having much success changing North Korean behavior. Too bad, but at least they tried,” or words to that effect.

He wasn’t overtly, blatantly criticizing China, but in a pretty clear way he was saying, “Okay, I gave you guys a chance. You didn’t do anything, so time’s up. Now we’re going to turn on North Korea ourselves.” That’s how I read it, and I think that’s the right interpretation.

China has not been able to do anything, we’re barely talking to Russia, and Kim Jong-un will not be deterred. We’re not going to risk Los Angeles, based on his good intentions, if he ever has any. The only thing left to do is to go in and take it out.

Some people have pointed out that they have a lot of antiaircraft capability. The significance of Guam is that long before fighter attack aircraft and other forces get into theater and long before the Nimitz-class aircraft carriers get within range of North Korean anti-ship missiles, we will have suppressed all of that with our long-range bombers, the B-52s and the B-2s.

I think the war will start out of Guam using very heavy bombing before we then come in with carriers and some of the smaller, nimbler aircraft.

Alex:  Unless doctrine has changed since I was in the military, that’s standard procedure. They’ll gain control of the battle space, particularly the air space, first, and then move from there.

Jim:  Right.

Alex:  Jim, I appreciate the discussion today. It’s been very insightful, as always, and I look forward to doing it again next time.

Jim:  Thank you, Alex.

You have been listening to The Gold Chronicles with Jim Rickards and Alex Stanczyk presented by Physical Gold Fund. Recordings can be found at You may register there for news of upcoming interviews with Jim Rickards and other world-class thinkers.


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The Gold Chronicles: June 2017 Interview with Jim Rickards and Alex Stanczyk

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Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles May 2017

Jim Rickards and Alex Stanczyk, The Gold Chronicles May 2017


Topics Include:

*Forecast for June 13th, 14th FOMC Meetings
*Cryptocurrencies – bubble or bull market?
*Update on IMF SDR’s
*Fed’s plan to normalize the balance sheet
*Expecting confluence of rate hikes and tightening monetary conditions to create recession and force easing by end of 2017
*Why North Korea has to be taken seriously
*Forecast for war with North Korea by 2018
*Trump, Russia, and media bias
*Physical gold market flows Q1 2017
*Dangers of the mirage of portfolio diversification and conditional correlation (Scholes)
*Why todays portfolios are at risk in the same way as LTCM
*Gold price behavior during liquidity crisis
*Liquidity in the gold market


Listen to the original audio of the podcast here

The Gold Chronicles: May 2017 Interview with Jim Rickards and Alex Stanczyk


Physical Gold Fund presents The Gold Chronicles with Jim Rickards and Alex Stanczyk offering insights and analysis about economics, geopolitics, global finance, and gold.


Alex:  Hello. This is Alex Stanczyk and I have with me today Mr. Jim Rickards. Hello, Jim, and welcome.

Jim:  Hi, Alex. How are you?

Alex:  Excellent. Thank you.

We are recording this podcast heading into the Memorial Day weekend. For those of you not from the United States, Memorial Day is a U.S. holiday honoring those who have fallen during military service going all the way back to the American Civil War, so we want to take a moment to acknowledge soldiers who have fallen on the battlefield.

Now let’s dive right into our podcast with an area our listeners are always interested in. We have another series of FOMC meetings coming up on June 13. In the event that I don’t talk to you on a podcast before then, would you make some comments about that and what you think you see happening there in terms of rate raises, etc.?

Jim:  The Federal Open Market Committee (FOMC) is the subset of the Federal Reserve Board members and Regional Reserve Bank presidents who set interest rate policy.

They always hold two-day meetings with the next one being June 13 and 14. The second day of the meeting, the 14th, is when the fireworks happen, so they’ll be in a conclave locked in the boardroom at the Fed Building on Constitution Avenue. When they come out, they’ll issue a kind of press release or statement that covers whether they raised rates or not. I’ll tell you right now that they’re going to raise rates 25 basis points, so we can already see that coming.

This is a significant meeting because it’s one where Janet Yellen has a press conference. The FOMC meets eight times a year, but only four of those have a press conference associated with it where she’ll sit sometimes for two hours and take reporters’ questions. That gives her an opportunity to expand on the statement with the new ‘transparency.’ They say we like to do communications, and obviously they overcommunicate, but be that as it may, this is her chance to signal whatever she wants about the economy and what the Fed is doing.

A lot of these questions are planted. I’m not denigrating the press; I think they do a great job, but reporters like Steve Liesman, CNBC, and others – I shouldn’t pick on Liesman – have certain questions they know the Chairman wants to hear because it gives her a platform to explain what they’re doing. This is one of those press conference meetings where they tend to do big things such as announce new policies or reaffirm existing policies.

We know they’re going to raise interest rates. I guess a different way to put the question is what would it take for them not to raise interest rates? Bear in mind it’s less than three weeks away at this point, so it’s really hard to imagine. When the May Jobs Report comes out next Friday, June 2nd, it would have to be below 75,000 or even negative or something to throw the Fed off their game. No one expects that. I don’t know what the number is going to be, but whether it’s 200,000 or 100,000 (that’s a big range and a lot of jobs), any of those numbers north of 75,000 puts the Fed on track to raise.

There’s not much inflation data coming out. Even if we saw a bad print in the inflation data, meaning it was disinflation, these inflation numbers are coming in below expectations. I do expect that and think disinflation leaning towards deflation has the upper hand now causing those numbers to get weaker, but that’s not going to be enough to throw the Fed off because they’ll use the word ‘transitory.’ Even if we get a weak number, they can say, “It’s only one month. We think it’s going up for all these other reasons like unemployment is slow, Phillips curve, etc., so we’re not going to pay much attention to it.” Even that won’t throw them off.

The only other thing in the model that would cause the Fed to ‘pause’ – that’s the operative word – on their rate-hiking path would be a severe drawdown in the stock market that looks disorderly and scary. Even if the stock market went down 5%, let’s say 1,000 Dow points or 100 S&P points, the Fed absolutely would not care. Even if it went down 10% or 15% over three or four months, the Fed wouldn’t care about that.

If it went down 7% or 8% like in three days’ trading sessions where it looks scary kind of the way it did in August 2015, that might be enough to get them to pause, but even then, I would say it would have to be a pretty rough ride. Ruling that out, I think they’ll dismiss weak inflation numbers as transitory, and job creation doesn’t have to be great, it just has to be good enough, and that’s really the important thing. They’re going to raise rates in June.

The model I just described is what I’ve been using for several years with very good results. Last December, we forecast that they would raise rates in March. By March, everybody knew they were going to raise rates in March, but if you look at the Fed Fund Futures implied expectation of a rate hike through the months of January and February up until the last couple of days of February, the considered wisdom of the market crowds, all the participants, were giving it a 28% to 30% probability. We were at 80% and 90% and indeed, they did raise it.

The model we’re using is the one I just described, which is the Fed will raise rates four times a year, 25 basis points per time from now until the middle of 2019, to get rates to about 3.25%. It will be like clockwork unless one of three things happen: a disruptive stock market, a severe disinflation that looks persistent and not transitory, or job growth well below 75,000 or even negative. If you don’t see those three things, they’re going to raise, so it’s an easy forecasting model.

Alex:  The model and forecasts on what the Fed is going to be doing have been really great. We’ve had some feedback and commentary from professional money managers on that as one of the things they always like to pick up on in particular from this podcast.

Jim:  One thing that’s unique about the model is that it’s completely different from what you hear from Wall Street economists, mainstream economists, commentators, bloggers, you name it. It’s a very different model. It’s not a complicated model; it’s very simple as I just described. The reason it’s different is that people are looking at the Fed raising rates and the minutes of the May meeting released a couple of days ago making it clear that they’re going to raise rates. The market is assuming that raising rates is related to a stronger economy – they equate that to a stronger economy. It’s one of the reasons stocks are going up, because they rely on regressions and correlations. They think that in the 38 business cycles since the end of World War II, every single time the Fed raised rates was because the economy was getting stronger.

That data is true and that correlation exists, but it’s not true this time. For the first time since 1937, the Fed is raising rates into weakness, and they know it. Why are they raising rates? The answer is they must get rates to 3% or more before the next recession comes so they can cut them 3%, because that’s how much it takes to get out of a recession. If you don’t have interest rates at 3% – 3.25% before the next recession starts, you’re not getting out of the recession, because they can’t cut them enough. They would have to have to go back to QE4, and they know it.

This is all a long-winded way of saying they should have raised rates in 2010 – 2011. They didn’t because of Bernanke’s cockamamie QE experiments, which is evidence that they didn’t help at all. What it did do is prevent the Fed from normalizing interest rates. That brings us to where they’re going with this. Just because they’re raising rates, I don’t take that to mean the economy is strong. In fact, there’s a lot of evidence that the economy is weak, but they’re doing it anyway for different reasons.

Alex:  Let’s move on to cryptocurrencies. This is a controversial topic in some circles right now, because some people I consider to be very smart believe that cryptocurrencies are in a huge bubble right now. What do you think about this?

Jim:  They’re definitely in a bubble, there’s no doubt about that. If you do have any doubt about it, I recommend something you can do at home. Just get the latest bitcoin chart. Ethereum is another one that’s performing the same way, but bitcoin is the leader in this. The bitcoin chart is going vertical right now from $1,000 per bitcoin to $2,000 per bitcoin in about a week or less.

Now get a NASDAQ chart from 1998 – 2000 and a Nikkei 225 chart (a Japanese stock index chart) from 1988 – 1990. Take the Nikkei chart, the NASDAQ chart, and the Bitcoin chart and overlay them. It’s the same chart. They look exactly the same with one difference, which is that the other two – Nikkei and NASDAQ – both crashed and lost 80% of their value in a very short period of time, most of it in months and then all of it within a year. Bitcoin hasn’t crashed yet, but this pattern of increases and the rate of increase, the second derivative of the rate of increase skyrocketing, is completely characteristic of bubbles.

Having said that, there are two things I know about bubbles. Number one, they can go on a lot longer than you think. It’s easy to say, “It’s a bubble; it’s going to crash.” What’s not so easy is knowing when it is going to crash. I have no interest in owning them or being part of this madness, but I wouldn’t short it. I don’t know if you can short bitcoin. Maybe Goldman Sachs would write you a derivative, the new big short, but I don’t think you can short it, which is interesting.

It just occurred to me that one of the reasons it’s going up so much is because there’s no short interest. If the stock market behaved this way, there’d be somebody, Jim Chanos or Kyle Bass or somebody, who would be shorting the heck out of it. There’s no short interest in bitcoin as far as I know unless someone’s extending credit, which makes this even crazier. That’s one of the reasons it’s kind of feeding itself.

I just arrived back east this morning from San Francisco. As always in San Francisco, you end up meeting with engineers and the Silicon Valley crowd. I talked to one very seasoned guy who has a young team of engineers working for him doing some apps and things. He said, “One of my guys came in the other day and said, ‘I went out and I bought some bitcoin. I paid $1,000.’ He bought four or five, and maybe put $4,000 or $5,000 into this. ‘It’s already up to $2,000, I doubled my money.’” He couldn’t be happier although he probably never heard of bitcoin until a few weeks ago, but that’s the kind of mentality you get.

Here’s the point. You can say it’s a bubble, that’s easy, but you don’t know when it’s going to end. It can go on a lot longer than you think. The other side of that is when it cracks, it cracks hard and fast, and you’re kidding yourself if you think you can get out. If you bought it for $1,000 and sold it for $2,000, lucky you, nice job and well done. But that’s no way to invest, it’s no way to make a living.

The reason is you have to think of these things on a risk-adjusted basis. You can’t just look at returns. Let’s say you had a whole bunch of money, hired me as major money manager, and I said, “Okay, leave me to it.” I go to Las Vegas, go to the roulette table, and I put all your money on red. It comes up red, I double the money, and I come back to you and say, “I doubled your money, I’m taking my 20% management fee or performance fee, and here’s the rest.” You think I’m a genius, “Jim’s the smartest guy in the world. He’s got a 100% return, and net of fees, I got an 80% return.”

No, I’m not. I’m an idiot. The point is, I could have lost all your money. If you don’t know how I do it or if you just look at the return (in my example, I doubled your money) but you don’t know how much risk I took, you think I’m a great money manager because I doubled your money. But on a risk-adjusted basis, I’m a complete idiot because I could have lost all your money.

When you get into bitcoin, yes, it could go up. Could it go up to $4,000? Just to be clear, I’m not predicting that at all, but I’m not going to say that can’t happen. It could happen. When is it going to crack? $2,500? $3,000? $3,500? $4,000? I don’t know, but I do know it will crack. It will crack hard, and I wouldn’t want to be around when it happens.

Alex:  Let’s dig into another topic area. I understand you recently had some new insights into IMF special drawing rates. Another way of saying that is SDRs. You plan to include these insights in your next book that’s upcoming. By the way, this is the first hint. I knew you were probably working on another book but recently had a first hint that this was going to be coming, so I’m looking forward to that. Without giving away the secret sauce of what this is all about, can you share anything about this?

Jim:  Yes, it will be in a new book. I’m not talking much about it because the publication date right now is October 2018, so we’re more than a year away, which is good, because it’ll take me that long to write it. As you know, Alex, you don’t just write a manuscript, hand it in, they print it up, and they send it to the bookstores. With my publisher, and this is one of the things I like about them because they’re very high quality, it takes four or five months, sometimes longer, for not just proofreading and normal editing where there’s a back and forth with your editor, but also for what they call copyediting. Copyediting is the person who decides what’s capitalized and whether it’s a comma or semicolon and all that stuff. I just keep writing and hope someone else can figure it all out. Then comes legal and then binding. There’s a lot to it.

This book is going to come out in October 2018, so there’s not much to talk about right now, but I did have a one-on-one conversation at an apartment in New York with former Treasury Secretary Tim Geithner. I had some quotes from him in my second book, The Death of Money, indicating some very favorable impressions of SDRs. Geithner is one of the people who knows more about SDRs than anybody.

We went to the same graduate school, the School of Advanced International Studies in Washington (SAIS), which is intellectual boot camp for the IMF. About one-third of each class goes to work for the IMF, for the World Bank, so there’s a very close affiliation there. We received similar training although my class studied gold because I was the class of ‘74. Gold had been abandoned by the time Geithner came along, but we had the same background and training. Unless you have that specialized training, it’s hard to really get your mind around SDRs.

He said some very favorable things, and I quoted him on that. In the last crisis that started in the spring/summer of 2007, it peaked and backed off and peaked and backed off, and then finally it went completely thermonuclear on September 15, 2008, with Lehman Brothers. There was an emergency issuance of SDRs for the first time in 30 years. The last time they had issued SDRs was in the early 1980s and then none at all until August of 2009.

It went pretty much unnoticed, because you have to be a bit of a geek to see that happening. I was certainly attentive to it, but in analyzing a future financial crisis, which again, is kind of like the bitcoin bubble, you can see it coming and estimate the magnitude, but timing and specific catalysts are more difficult.

What are the central banks going to do? When we talked about the FOMC raising interest rates in June, one of the things we didn’t talk about that was in the minutes of the May meeting is normalizing the balance sheet. The Fed did not just take interest rates to zero and hold them there for seven years. They expanded their balance sheet from $800 billion to $4.5 trillion basically by printing money and buying bonds.

They still have the $4.5 trillion on their balance sheet. Not only did they not normalize interest rates, they’re about a third of the way to normalizing interest rates. Using the Taylor rule, interest rates should probably be 2.5% – 3%. They’re at approximately 1%, so they have a little way to go. At least they’ve started, but they haven’t taken any steps to normalize the balance sheet, so they’re now talking about that also.

The way they’re going to do it is not by dumping bonds. The Treasury bond market is big but it’s not that big. They’re not going to sell a single bond. What they are going to do is let them run off, let them mature. Let’s say you bought a five-year note five years ago. Sometime in the next month or so it’s going to mature. The Treasury sends you the money and, just as when the Fed buys bonds, they pay for it with money that comes from thin air. The same is true in reverse. When the Treasury sends the Fed money to pay off the bonds, the money disappears. It reduces the money supply.

The Fed is just going to sit there. This happens now anyway, these bonds mature all the time, but the Fed then takes the money and buys a new bond. They’re not expanding the money supply; they’re maintaining the money supply and buying new bonds all the time to maintain the balance sheet. What they’re going to do is stop that reinvestment. They’ll take the money, the money will disappear, they won’t buy a new bond, and little by little, the balance sheet will run off. They’re going to do this very gradually. They have all this jargon and use words like ‘background.’ They say this is going to run on background, and steady Eddie, and we’ll be transparent about what we’re doing, and no one is going to notice. It’s just going to happen, and over my estimate of seven or eight years, the balance sheet would get back down to $2 trillion. Arguably, that’s a normalized balance sheet.

Again, that assumes no recession, which is a false assumption. We are going to have a recession in the next several years, but the Fed doesn’t really deal in reality. In Fed world, there’s no recession, there are no recessions, and they’re going to run the balance sheet off over seven or eight years.

This is called QT. Everyone knows about QE, quantitative easing, and this is QT, quantitative tightening. That’s what happens when bonds mature, the money supply is reduced, you don’t buy new ones, and the balance sheet shrinks. It’s like watching paint dry or holding an ice cube in your hand and watching it melt. It happens very slowly, but it does happen.

The interesting thing about this is the whole time the Fed was doing QE to the tune of taking the balance sheet to $4.5 trillion, they told us that this was stimulative. By buying intermediate-term securities, they were keeping a lid on the middle of the yield curve, it helped mortgage rates and that helped stock prices and home prices and all that wealth effect, and they let people borrow because that’s all collateral and they’d spend more money. This was the story, but none of it was true. The wealth effect was weak or invisible or maybe even negative this time around. They did create asset bubbles, so they were good at that, but not much good at stimulating the economy or at least returning to trend growth on a sustainable basis. That did not happen.

We were supposed to believe that it was somehow stimulative and when they do it in reverse, it’s not supposed to be contractionary. I don’t understand that at all. If you reduce the money supply, that’s a tightening of financial conditions, that’s contractionary. I’m not saying by itself it’s going to put the U.S. economy into a depression. We’ve been in a depression since 2007, so they’re kind of hitting the economy with a double whammy. They’re raising rates, which we already talked about, and I’m guessing probably before the end of the year, they haven’t said but maybe as early as September, they’re going to start reducing the balance sheet. My estimate is for every $50 billion of balance sheet reduction, that’s equivalent to one 25-basis-point rate hike. Like I say, you can’t have it both ways. You can’t say printing money is expansionary but making money disappear is not contractionary. Sure it is.

We’re going to get hit with rate hikes and tightening monetary conditions, reduction of the money supply. The economy is weak to begin with, so my estimation is that this will cause a recession later this year, probably by the summer. It will become apparent, but the Fed will be the last to know. A lot of people will see it before the Fed, but maybe by August/September when that happens, the Fed is going to have to pivot and do a 180.

I said earlier that they’re going to raise rates four times a year – March, June, September, December – like clockwork for the next three years unless something bad happens. The bad things are what I mentioned – the stock market falls out of bed, job creation dries up or you see disinflation. I think you might see all three.

We might see strong disinflation. The PCE core deflator is the Fed’s preferred inflation metric, which after about six years has finally gotten to 2%. They were hoping the whole time to get it to 2%, it finally got there, and it immediately headed south down to around 1.7%, give or take. If you see that going to 1.5%, 1.4%, 1.3%, and job creation falls below 75,000, maybe we even start to lose a few jobs or get a negative GDP print, and then the stock market wakes up and says, “Whoa, we’re way out over our skis here. We invested in this Trump trade, and we thought the Fed raising rates was a sign of a good economy. It turns out the economy stinks, we’re in recession, and Trump’s not delivering on any of his promises,” boom – there goes the stock market.

We could see all this. Everything I’m describing is based on I’ll say a conditional forecast. My expectation is that some of these conditions will fail and that by September, they’ll have to go back to easing mode. How do they do that? They’ll probably still be reducing the balance sheet, so I estimate they’ll stop raising rates in September, and they’ll use forward guidance to take a pause, so you’ll be hearing about ‘pause.’ They’ll raise in June for sure, pause in September, and then we’ll see about December and how it plays out.

This is what happens when you manipulate the economy for eight years. You can’t get out of it. You can’t un-manipulate the economy, because the economy is completely dependent on Fed policy and signaling and expectations and herd behavior and everyone following the Fed. They just can’t get out of it.

Alex:  It sounds to me like 2018 and 2019 are shaping up to be pretty interesting. As you mentioned, the Fed has announced it’s not going to be reinvesting government debt. It’s basically going to let that roll off the balance sheet. From 2018 to 2019, I think that number is going to be close to $1 trillion. In addition to that, I’m going to share some information in a little bit when we start talking about the physical gold market that will dovetail into that. It’s going to create some interesting conditions for our space in particular.

Jim:  I completely agree with that and am interested in hearing more on your analysis, Alex, but 2018 is when we will go to war with North Korea. That’s not on the calendar for 2017 unless Kim Jong-un is even crazier than we think. The story is well-known, so I don’t know why people are not more attentive to it. He’s out to build an intercontinental ballistic missile (ICBM) capable of reaching Seattle, Los Angeles, San Francisco, not to mention all of China, Japan, South Korea, and Taiwan. They’re not there yet, but they’ve tested more complex intermediate-range ballistic missiles that have some of the multi-stage technology and liquid fuel that you need to have in an ICBM, so they’re getting there and are making steady progress.

Sometimes these missiles go off course, they wobble or they blow up on the launch pad and people laugh them up like ah, they’re idiots, they don’t know how to launch a missile. But they don’t think of it as failure; they think of it as a learning experience. Every so-called failure is a way to learn something to make the next one better. Recently, the tests have been succeeding and have produced better results, so they’re making progress in miniaturization.

They have the fissile material, the uranium, and the plutonium. They’ve mastered the enrichment cycle but need to weaponize that, because you can’t just put a truck-sized device on a missile. You have to get it down to the size of a grapefruit or a basketball, but it looks like they’re just about there on that and a couple of other pieces of technology. All this is coming together faster than analysts estimated. The four-year estimates I was reading about six months ago have now turned into three-year and in some cases two-year estimates. That’s what he’s doing.

It is crystal clear that the United States will not let this happen. We are not going to sit here and let him perfect this technology, put a warhead on a missile, test it in some credible way, and say, “I can now nuke Los Angeles. You guys better hope you can shoot it down. I’ll send up 10 and your success rate in shooting down or intercepting ballistic missiles is probably 50% if you’re lucky (which is pretty darn good, by the way), but that means five of them go through and I just killed 10 million Americans. Don’t mess with me.” That will be his message. We’re not going to let that happen. We’re not going to put ourselves in that position. We’re not going to gamble with Los Angeles.

One or two things must happen: Either he must voluntarily give up this program or we’re going to destroy it militarily. I see no signs that he’s voluntarily giving it up, because he thinks differently about it. What he’s saying is that the guys who had nuclear programs and gave them up – Muammar Gaddafi and Saddam Hussein – are both dead. Libya and Iraq had a nuclear program. They gave them up and they both got killed. One was shot in the eye, and one was hanged. The guys who didn’t give up their program are the Iranians, and they’re still standing.

Kim Jong-un looks at this and thinks, “Well, this is simple. If you give up your program, you get killed, but if you don’t give up your program, your regime survives.” From his point of view, he’s going to keep the program. The other reason he wants to keep it is he sells the technology to Iran for gold. They’re not moving dollars through the global payment system. They’re putting physical gold on planes and shipping it either to North Korea or some of it is held in custody in Russia. The point is, he’s not giving up the program, and we’re not going to let him go too far; therefore, war is inevitable.

President Trump, Defense Department Secretary Mattis, and Secretary Tillerson are now conditioning the battle space. You don’t just go in guns blazing; you prepare. That involves diplomatic efforts and preparing the American people. When Trump basically invited the entire Senate, 100 Senators, to come over to the White House a couple of months ago, they boarded buses up on Capitol Hill and took them down to the White House. A lot of people made light of it, but that was getting buy-in from the Senate. Trump is saying, “We’re getting ready to do this when I share what we see and how we’re thinking about it,” Nikki Haley is bringing it up at the United Nations, and Trump’s talking about it with our NATO allies.

All the pieces are in place. This feels like Iraq in 2002. We invaded Iraq in March 2003, but the preparation was in place in 2002. I look for that war in 2018 after a year of warning and preparation, last clear chance, etc., so we all know what that’s going to do to the price of gold.

Alex:  I thought it was interesting the comment you made about when they’re developing this weapons programs and have failures, that people tend to laugh about it and say it’s not a serious thing.

A lot of people don’t know that the same technology needed to fire an ICBM, an intercontinental ballistic missile, is essentially the same technology that’s necessary to put objects into orbit. You talked about the rate of success for shooting down things like that. They’re moving at about 6.951 miles per second. These things are really cruising along, and to figure out how to do that is no easy thing.

People forget that even in the U.S. space program, it wasn’t like success after success. There were a lot of failures on the road. I think you’re right, there’s an incredible threat that they are continuing to develop and move along.

Jim:  I remember in the late 1950s and early 1960s when the U.S. was trying to catch up with the Russians. We had the Mercury Redstone program, then the Gemini program, then Apollo, and then the Space Shuttle and all that. In the early days of testing rockets for Mercury Redstone, the American rockets used to blow up on the launch pad. One didn’t work and they would try it again, but as I say, these were all learning experiences. You’re exactly right.

Not to pile on, but the Pentagon announced yesterday that they’re considering shooting down a missile with a missile as a test. What we would do is fire one of our missiles, then there’d be an antimissile battery, and their job would be to shoot that missile out of the sky as a demonstration that we can do it. The message to Kim Jong-un is: “Don’t waste your time.” Now that’s a high-stakes gamble, because what if we shoot our missile and our antimissile misses? We’re controlling the whole thing, so hopefully they rig it in our favor, but even if it hits, which hopefully it does, I think anyone who is fair-minded about it would say, “Your success rate is never going to be north of 50%.”

Alex:  Continuing in this vein of geopolitics, there is a hot topic I don’t really consider a hot topic, but the media seems to be making a big deal out of it. There’s this idea that Trump improperly shared intelligence with the Russians. Is this an issue? Is it a nonissue? Is the media blowing this up or is there real substance here? What do you think?

Jim:  The media is definitely blowing it up. I’ve heard people saying, “Trump leaked information to the Russians.” First of all, the President can’t leak anything. The President can reveal information or share information. He’s the Commander in Chief and can do whatever he wants with that intelligence. The President has the last word on what’s classified or declassified or shared with anybody. The President revealed information, but he didn’t leak information.

You do see the word “leak” used a lot, but that’s just incorrect and in the fake news category. Let’s come back to what he did do, which is he revealed some sensitive intelligence to the Russians that would otherwise have been classified. Good idea, bad idea – that’s debatable. A lot of people say that’s a horrible idea, he gave up sources, we can’t trust the Russians, they’ll tell the Syrians, etc.

That’s an argument I’m not dismissing, but the other side of the argument is, if we’re getting ready to confront China and getting ready for war with North Korea, we better have the Russians at our side. We better make friends with the Russians, because there are really only three countries in the world that count. I hate to break it to the Brits and Germans and a lot of others, but China, Russia, and the United States are the only three countries that really count. They’re three of the five biggest by land mass, among the five or six biggest by population (Russia is a little smaller by population), and the biggest in energy output, but most importantly, in military capability and nuclear arsenals, they’re the three superpowers in the world.

In any three-handed game, be it poker or Risk, it’s always two against one whether that’s explicit, implicit, behavioral, whatever. The oldest joke in poker is if you’re at a poker game and don’t know who the sucker is, you are the sucker. In the old board game, Risk, you’d start out with five or six players, quickly get down to three, and then two of them would one way or the other gang up on the third one, wipe them off the board, and then turn around and fight each other to see who won. That’s just how you play a three-handed game.

If we’re going to confront China, which we are, we better be friends with Russia. We don’t want to be confronting Russia and China at the same time. We don’t want to be in a war in North Korea and some kind of shooting match in the South China Sea without having a relationship with Russia, because they’ll just roll through Ukraine, parts of Central and Eastern Europe, maybe roll up the Baltic. You want to fight a war in Korea and the Baltics at the same time? The Pentagon’s worst nightmare is the two-front war. Going back to the ‘70s, we used to be able to fight what we call two-and-a-half wars. Two-and-a-half wars meant we could fight a war in the Pacific or Asia, a war in Europe, and a half a war somewhere else, maybe Africa or Cuba or someplace like that. Today, we’re lucky if we can do one-and-a-half wars, but we can’t do two wars.

This was the thinking behind Trump’s people. Jeff Sessions, Jared Kushner, Mike Flynn, all of them reaching out to the Russians during the transition and meetings with the ambassador was about getting relations with Russia back on track so we can prepare to confront China.

Where it blew up is they all lied about it. This is idiotic in my view. I don’t see why you have to lie about it. What I just described can be taken right out of Henry Kissinger’s book, New World Order. This is balance of power politics 101. If you’re going to mix it up with China, you better have Russia. So, we should have been talking to the Russians.

My view is that talking to the Russians is really smart and lying about talking to the Russians is really dumb. The reason Flynn got fired and Jared Kushner is now reportedly under FBI investigation and Jeff Sessions had to recuse himself is because they all lied and misrepresented one way or another their contacts with the Russians. That was just stupid, in my view, and I don’t know why they were hanging their heads about it. I would have been up front and say, “Hey, it’s a dangerous world. If you think Putin’s a thug, well, meet President Xi Jinping of China.”

China has more human rights abuses, they have firing squads, they have slave labor, they have child labor, they killed 25 million girls in the one-child policy. None of these people are particularly nice. If you want to pile on Putin, fine. He’s a bad actor, he’s a killer, but that’s the world we live in. All I know is if you’re going to confront China, you want to build bridges to Russia. I think that was a smart policy by Trump.

It’s blown up for two reasons. Number one, his people mishandled it by hiding in the shadows, in the bushes, and lying about it. Then, two, it fed into this separate, completely ridiculous narrative that somehow Putin won the election for Trump. Did the Russians use sources, methods, operatives, hacking, and other tools to influence public opinion in the United States maybe in a way that disfavored Hillary and favored Trump? Of course they did, absolutely. We do that to them. You don’t think we were in Ukraine working actively to depose the pro-Russian of Ukraine? This is how the game is played.

That comes as no surprise, but beyond that, the idea that we were seeking to improve relations doesn’t strike me as odd or problematic or uncalled for, but boy, did they mishandle it. Now they can’t even be seen in public with a Russian, which is too bad.

What’s interesting is that coming up on July 7th and 8th in Hamburg, Germany, is the G20 meeting. That’ll be the first face-to-face meeting between Trump and Putin, so that’s certainly going to get a lot of attention.

Alex:  Basic diplomacy is what it comes down to.

Jim:  Yes, basic diplomacy. With intel sharing, again, he’s the Commander in Chief if he wants to tell the Russians something. By the way, this faux outrage is laughable. You and I have a background in intelligence. Intelligence gets shared all the time. The Jordanians pick up some pocket litter from a prisoner and give it to the Israelis, the Israelis share it with us, or we get something from the Turks and we slide it to the Israelis. Intelligence operators trade intelligence the way kids trade baseball cards. They swap it around all the time, usually for some quid pro quo, because intelligence is usually a two-way street. This idea that somehow he uniquely and clumsily revealed some hypersensitive stuff is just nonsense and a good example of media bias.

Alex:  Yes, I agree. Now let’s discuss physical gold for a little bit. I’m going to give a brief snapshot on what’s going on in the physical gold markets for the year up until now. After that, we can get into some material from your last book, The Road to Ruin. I want to ask for your commentary on how that dovetails into gold.

Right now, gold flows are still going west to east. This is no news to anybody on this podcast, but it’s continuing. U.S.-based gold funds have been pretty flat as of late. In Q1, Germany and the UK actually led the investment in gold funds. We’re talking as much as six times as much capital was invested in gold through Germany and UK as was coming from the United States in Q1.

In addition to that, export data has shown us that India is basically back on top of the stack in terms of gold flow from Switzerland, so they’re taking more right now than Hong Kong and China combined. We’re talking from Switzerland, not all sources. They’ve been the top destination from January through April.

Overall though, Asia is accounting for about 74% of Switzerland’s total gold exports, which means it’s still a one-way street in terms of physical flow. If we look at China specifically, in Q1, Chinese gold imports were up something on the order of 64.5%, and their domestic production is actually dropping. The premiums so far this year have skyrocketed unlike anything in the last two to three years.

And then finally, here’s something I found to be quite interesting. Our sources are projecting that mining production is going to start dropping off after 2018. This is sort of a combined consequence of very sharp cuts in capital expenditure for new production.

Total CapEx for companies in the HUI index, for example, declined by about 65% between 2012 and 2016, and there really haven’t been any new significant discoveries. Adding that to what we were talking about a little while ago in terms of the Fed balance sheet rolling off, the deflationary effect, and the fact that it looks like mining capacity is going to start dropping off, is an interesting scenario.

Let’s talk a little bit about systemic risk. I’d like to read an excerpt from your book, The Road to Ruin. For those who don’t know, Jim was the chief counsel for Long Term Capital Management and negotiated the Long Term Capital Management bailout with Wall Street and the Federal Reserve at the time. This excerpt is about that time during the crisis period and looking at how things were constructed:

“LTCM had 106 trading strategies involving stocks, bonds, currencies, and derivatives in 20 countries around the world. From the outside, the trades seemed diversified. French equity baskets had low correlation with Japanese government bonds, Dutch mortgages had low correlation with Boeing’s takeover of Lockheed. The partners knew they could lose money on a given trade, yet the overall book was carefully constructed to add profit potential without adding correlation.”

In the next paragraph it says:

“This diversification was a mirage. It existed only in calm markets when investors had time to uncover value and cause spreads to converge. However, there was a hidden threat running through all 106 strategies that Scholes later called conditional correlation. All the trades rested on providing liquidity to a counterparty who wanted it at the time.”

Jim, what are your thoughts on what you’re seeing and how portfolios are constructed today? Do you see similar risks that apply? Maybe not necessarily the exact same vehicles but in terms of how the portfolios are constructed versus systemic risk. And what are your thoughts on gold and how it factors into this?

Jim:  I absolutely do, and let me expand on that briefly. By the way, the Scholes you mentioned in that excerpt is Myron Scholes, winner of the Nobel Prize in Economics in 1997, and one of our partners at Long Term Capital Management. I worked in the same office with Myron for six years.

Yes, that conditional correlation was meaning it’s not normally there, but it’s there when you least expect it, and it’s what takes you down. I definitely see this happening again. Having lived through the Long Term Capital experience in 1998, I had a front row seat. I saw the PNLs every day, I knew all the positions, I negotiated the bailout, I talked to the banks, the Treasury, the Fed, so really, almost no one knew about it better than I did. Not because I was the head trader, the risk manager, but because I wrote all the contracts and then had to unwind them all and do the bailout.

I was a lawyer and am still a lawyer technically, but at the time I was acting in a legal capacity. That’s why I did the bailout. For years afterwards, I was very unsatisfied with my understanding of what had happened from a risk management point of view. I spent a decade studying physics, complexity theory, network theory, graph theory, applied mathematics, behavioral economics, every field I could find to help explain what happened, which I ultimately did, and then was able to move forward from there and build new models that worked much better.

Beginning in 2005, I ran around warning about the next crisis. I didn’t say, “On September 15th, 2008, Lehman Brothers is going to file for bankruptcy.” I wasn’t that granular, but I didn’t need to be. I could just look at the macro and see the size of the balance sheet, the fact that they had gotten rid of derivatives regulation so you could trade derivatives on anything, the fact that Basel II had basically gotten rid of serious capital constraints and banks could do valuate risk as their capital measure, the FCC getting rid of the 15:1 leverage ratio on certain assets, they repealed Glass–Steagall so banks could act like hedge funds.

Every single thing they did between 1999 and 2005 was the opposite of what you would have wanted to do if you wanted to make the system safer. I was lecturing at the Kellogg School at Northwestern at the time and the School of International Studies, and I did a lecture with the Applied Physics Laboratory. I have all those old lecture notes, and I said this system was going to blow up and it’s going to be worse. Sure enough, that’s what happened.

I see the same thing happening again. Now, it’s always the same and it’s always different. Let me explain what I mean by that. Every financial panic is the same. The best description I’ve ever heard of a financial panic is everyone wants their money back. People think they have money that’s not really money, so you’ll hear them say, “I’ve got money in the stock market. I’ve got money in the bond market. I’ve got money in real estate.”

No, you don’t. You have stocks, bonds and real estate. You don’t have money. If you want money, you must sell that stuff and get the money. And guess what? When you do, everyone else is going to be selling at the same time, the prices are going to be plunging, there’s going to be fear, blood in the streets, and your so-called money is going to be disappearing.

That’s what happens when people want to liquidate assets and get out. They want to do it all at once. It feeds on itself and they want their money back – real money, not dollar-denominated assets that are melting before their eyes. That’s what a financial panic is, and that’s what I mean when I say they’re all the same behaviorally.

But they’re all different, because there’s a different catalyst every time. In 2007, there were the subprime mortgages. I can’t imagine subprime mortgages being a problem now. We barely even have subprime mortgages.

There were $1 trillion of them in 2007, and then $6 trillion of derivatives on the subprime mortgages, slightly better but still pretty junky mortgage. So, it’s not a problem now. The banks are tough, the regulators are tough, the down payments and credit standards have gone up, so the next problem is not going to come from the mortgage market.

Could it come from Chinese credit? It probably won’t come from bitcoin, that’s too small and will get ugly when the time comes. It could be emerging markets, currency crisis, a Chinese credit crisis or the U.S. stock market suddenly crashing because they wake up and realize that none of what Trump said he was going to do has actually happened. Look at how the stock market went up between November 8th and March 1st: 15%. It has gone sideways since then with a couple of highs, but pretty much sideways. But 15% on those three months based on Trump’s promises of tax cuts, Obamacare repeal, the wall, infrastructure spending – not one of those things have happened and may not happen this year or even next year, because it’s an election year. Let’s see how it plays out.

I understand the difficulties, and I’m not blaming Trump. I’m just saying that the market priced a lot of good things that haven’t happened, meaning it’s very vulnerable to repricing, and that could get disorderly. So, it could come from a lot of different sources.

There’s $100 billion more leverage in the system, or more debt, I should say. There’s leverage all over the place when you count derivatives. So, the scale of the system, the concentration of assets, the use of leverage, the use of nontransparent derivatives, all of those things are worse than they were in 2008. That by itself would tell you that the next crisis will be exponentially worse and beyond the ability of the central banks to cure, because as we said earlier in the podcast, they haven’t normalized the balance sheet yet.

But there’s something worse than that. Worse than saying this is a bigger, badder replay of 2008 is the rise of robo-investing and passive investing, indexing in ETFs. I’m not talking about high frequency trading. That has its own dangers, but passive investing. Here’s why.

You have passive and active. Passive is just, “I’m going to buy the index and go take a vacation.” Whatever the index does, it does, because you can’t beat the market, you never have better information, you’re never fast enough or smart enough, so just track the market. Even if it goes down, it’ll come back and I’ll make money in the long run. This is the Warren Buffet, John Bogle, Jeremy Siegel mantra.

But there are a certain number of active investors who wake up. Whether they’re hedge fund mavens like Stan Druckenmiller, Kyle Bass or Ray Dalio who have incredible track records or even others who maybe don’t have such good track records but they’re trying, these are the people who engage in what’s called price discovery. They’re taking money, committing capital, taking a view, engaging in transactions to see where the value is by buying, selling, holding, and seeing how it works out. Maybe they have tight stops and they buy something, it blows up in their face and they get out of it, but that’s what’s called price discovery.

Think of price discovery as a healthy body. Active investing is a healthy body, and passive investing is a parasite that jumps on the back of the healthy body and sucks it dry, because that’s what passive investors do. Well, a small parasite on a large creature will carry on. The creature won’t die and the parasite will thrive. What happens when the parasite gets to be bigger than the creature? You have more and more passive investing on less and less active price discovery, active capital commitments. That is an inverted pyramid and is a highly unstable situation. That’s what’s new – the passive investing piece is now I believe larger than the active investing piece and getting larger all the time.

What that means is that when the psychology changes and people want to bid, the number of active traders out there will say, “Yes, I’ll take them, I’ll buy them,” the way the old New York Stock Exchange specialists used to do. As a specialist, your job was to buy when everyone else was selling and sell when everyone else is buying. You took the other side of the market, and that’s how markets maintained some liquidity. It wasn’t foolproof, but it worked pretty well for almost 200 years.

That’s gone. It’s long been gone in the stock market. I talked to Steve Guilfoyle, his nickname is Sarge, and he’s the Head of Floor Operations at the New York Stock Exchange. I was down on the floor of the stock exchange with Sarge when he said, “Jim, there is no liquidity down here. Don’t let anyone tell you otherwise.” I said, “I kind of thought that, but hearing it from you, I know it’s true.”

Even for the upstairs traders and the hedge funds, there are fewer and fewer of them, so things are going to go “no bid” so fast it’ll make your head spin. That’s going to make this crash worse.

Gold is where you want to be, but not 100%. The listeners know I recommend 10% of your investable assets in gold. There’ll be a flight to quality that will start out in treasuries. In the early stages of a panic, a lot of people sell gold. The reason they sell it is interesting. It’s not because they don’t want the gold, because they wish they had more. They sell it because it’s liquid.

Alex:  Yes, exactly.

Jim:  That’s contrary to everything I said. I said everything becomes illiquid. Gold can go up and down, but I’ve never seen it go illiquid or “no bid.” People sell gold not because they want to but because they have to.

But that passes quickly, and then it’s just, “Hey, get me some gold. Where is the gold?” Gold goes up, and Treasury bills go up. There may come a time when Treasury bills hit the wall because you’re like, “Wait a second, I’m getting out of everything else into Treasury bills, but is that a smart idea?” If the central bank is tapped out and people are losing confidence in the United States and the dollar, then maybe not. So, then the demand for gold goes up even more.

It’s obvious that’s how it plays out. A lot of people say, “Call me when that happens, Jim. Call me the week before, and I’ll sell some stocks and buy some gold.” My answer is twofold. Number one, I’m not going to know the week before. I’ll see it coming using the models I’ve developed, and I’m actually warning you about it right now on this podcast, but it’s not like I’m going to know the exact minute or the day. I won’t; I just prepare for it in advance.

What I say to those people is, “What are you waiting for? You know this is coming.” Beyond that, even if I could pinpoint it a little bit, when this hits and you go out to get your gold, you might not even get any. There might not be any available. There’ll be a price, you’ll be able to watch it on TV, but you won’t be able to get the physical gold. Again, one more reason to get it now.

Alex:  Let me add a little bit to that, and then we’ll wrap this up. One thing I found interesting in what you were just saying is that the common thread there is always liquidity. I was in Minneapolis recently meeting with some money managers, and it’s interesting how often that question comes up. “How liquid is it? How liquid is gold?”

I’m saying this for the benefit of our listeners who don’t understand how deep the gold markets are. It’s basically a $7 trillion market cap. If you took all the above-ground gold in the world, it’s worth about $7 trillion. Annually, we see tremendous liquidity and depth. For example, China and India alone are consuming close to 3000 tons a year, and the amount of liquidity that’s available is pretty high.

The other thing you mentioned is that gold will initially drop down because of its liquidity properties. It’ll sell off a little bit. That’s exactly what happened in the 2008 financial crisis. It went down initially with everything else, but it ended up 6% on the year, which was the only asset in the world that did that.

Jim:  Right.

Alex:  That about wraps up our time. Do you have anything you want to add about that last part there?

Jim:  My advice is pretty much unchanging, which is to allocate 10% of your investable assets to gold. In defining investible assets, I always say take your home equity and your business equity. If you’ve got a pizza parlor or an auto dealership or you’re a doctor, a lawyer or a dentist, whatever, you’ve got some business equity. Put that and your home equity to one side, because you don’t want to be betting with that. Whatever you have left are your investable assets. I recommend 10% of that for gold. If nothing happens to gold, you’re not going to get hurt with a 10% allocation, but if the kind of scenarios I’m describing do happen, it may be the winner that protects your losses against the entire rest of your portfolio.

Alex:  Jim, I appreciate your time. This has been a great discussion as always. I look forward to doing it again next month. Enjoy your weekend, and thank you for being on the podcast.

Jim:  Thanks, Alex.

You have been listening to The Gold Chronicles with Jim Rickards and Alex Stanczyk presented by Physical Gold Fund. Recordings may be found at You can register there for news of upcoming interviews with Jim Rickards and other world-class thinkers.


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The Gold Chronicles: May 2017 Interview with Jim Rickards and Alex Stanczyk


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Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles April 2017

Jim Rickards and Alex Stanczyk, The Gold Chronicles April 2017


Topics Include:

*Commentary and analysis of military action in Syria in response to what appears to be nerve gas attacks on civilian population
*US President Trump authorized release of 59 Tomahawk Land Attack Missiles targeting Shayrat airbase
*Discussion of the USS Carl Vinson carrier group deployment towards the north west pacific in the vicinity of North Korea
*What triggers cause countries to go to war in history
*Are current events a series of unfortunate mis-calculations
*Discussion of North Korea’s nuclear weapons capability
*When analyzing potential threat, there are two factors: Capability, and Intentions
*How US policy regarding nuclear weapons programs has possibly sent the wrong message to Kim Jong-Un
*The intersection of kinetic, cyber, and financial warfare, and role of fiat payment transfer systems as opposed to gold
*Why the US will never allow North Korea to achieve inter-continental ballistic missile technology
*Why the level of intensity of military action that may be used versus North Korea could be substantial
*How the US could target specific Chinese banks for removal from the USD global payments system if China fails to cooperate on North Korea
*Sources indicate that China has moved the Peoples Liberation Army to the border between China and North Korea along the Yalu river
*Commentary on upcoming FOMC rate hikes, and the formula Jim uses to predict a change of course for the Fed

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The Gold Chronicles: April 2017 Interview with Jim Rickards and Alex Stanczyk


Jon:  Physical Gold Fund presents The Gold Chronicles with Jim Rickards and Alex Stanczyk – insights and analysis about economics, geopolitics, global finance, and gold.

Alex:  Jim, welcome to today’s podcast.

Jim:  Thanks, Alex. It’s great to be with you.

Alex:  The last podcast we did was a touch on the gloomy side, and this one – sadly – may not be much brighter. There are several serious events happening in the world today that could escalate quickly, and it feels to me that the U.S. is heading towards a war footing.

As you know, there has been widespread video footage of what appears to be attacks on civilian populations in the Syrian city of Khan Shaykhun. Hospital staff in Turkey where some of the victims were taken said that the symptoms are consistent with sarin gas, which is a deadly nerve agent.

On a personal note, I believe you know I’m a combat veteran. Back before Desert Storm, I went through a safety briefing as we were steaming into the Gulf. The briefing was on the effects of sarin gas. In my opinion, I consider it up at the top of the list of the worst ways to die.

Trump responded to this by authorizing TLAM (Tomahawk Land Attack Missile) strikes from two U.S. Navy guided missile destroyers, the USS Porter and the USS Ross. These two ships commenced firing at 03:45 local time and deployed 59 TLAMs. The missiles were fired at Shayrat Airbase where it’s believed the gas airstrikes were launched from. They targeted runways, hangars, ammo depos, the control tower, and radio installations.

This represents a pretty serious escalation for the United States, and it’s the first major test of Trump exercising military authority.

Russia has indicated it’s not so pleased with this and have stated so publicly. They responded by committing an additional navy frigate, a couple of corvettes, and support ships to bolster the fleet already on patrol in the Mediterranean.

What is your view on all of this? What do you think the potential scenarios are here, and what are the ramifications going forward?

Jim:  Alex, I am as fascinated by the details you just provided as I’m sure our listeners are. I’m a strategic and geopolitical analyst, but I don’t claim to be a military expert in the sense of true expertise to know those systems, so that’s a great introduction.

I happen to be involved in some business development with another veteran, a retired lieutenant colonel army ranger with a lot of experience in the Middle East. He was in the wars in Afghanistan and Iraq.

After that gas attack in Syria became known, he e-mailed me and said of all the threats in the world, of all the things you have to confront and ways to possibly die, he said that is the worst. It certainly confirms your analysis of the horrific nature of this. These attacks in the Middle East and really around the world are all pretty horrific, but I guess if there’s a scale of horrific-ness – if that’s a word – then this is high up there.

I’d like to take a step back. I don’t really see the Syrian situation as an escalation so much as a response – a very specific, very narrowly focused response to the gas attack. Now, we know back in maybe 2011 but I think 2012 there were some prior gas attacks.

There had been several going all the way back to Saddam Hussain in Iraq prior to 2003. Both dictators, Saddam and Assad, used chemical biological weapons and gas attacks in the past, so these have been occurring for a while. This certainly wasn’t the first one.

But President Obama drew the famous red line and said in effect, “If you use gas, there will be a price to pay.” He wasn’t specific about what it was, but clearly, military action was implied. Assad did use the gas, and Obama did nothing. Instead, they got into a long negotiation, etc.

I don’t want to rehash that history since listeners are familiar with it, but the point is, this opened the door to a lot of things. It really was the beginning of the rise of ISIS and of Russian intervention in Syria.

Russia has always had ambitions and some access to warm-water ports, but since then, they’ve built two major ports. Russia is a big country with a big coastline, most of which is frozen much of the year, so the significance of warm water and the ability to get vessels in and out of Mediterranean ports is a big deal.

They built an airbase and put in Spetsnaz special forces, so they’ve got a big footprint in Syria, as does Iran. With Obama’s actions, that was basically the United States saying, “We’re checking out; we’re out of here.”

There’s an old saying in both physics and geopolitics. In physics, it’s ‘nature abhors a vacuum.’ In geopolitics, it’s ‘power abhors a vacuum.’ It’s the same thing, which is when you create a vacuum whether physical or political, it’s not like nothing happens. What happens is something else rushes in. You may leave, but something else is coming in.

Once the U.S. checked out of the Middle East, it didn’t mean peace, love, and understanding in the area; it meant that somebody else was going to come in. That somebody else was Russia and Iran.

Now let’s flash forward. Assad used chemical weapons again, but this time when he crossed the red line, Trump struck back. Just to pick up on the escalatory dynamic, the question is, “What happens if Assad uses chemical weapons again?” You can’t rule it out.

I would expect Trump would strike again except this time with more force and against more targets. I believe there were six airbases, and he disabled one, so he has five to go. Maybe they’ll take out two, three or all six the next time. That would essentially ground the Syrian air force and eliminate what’s left of Syrian air power. Syrian air power is not a threat to U.S. air power; it’s just a threat to its own people, but of course, that’s what Trump is trying to stop.

Let’s see what happens. Secretary of State Rex Tillerson is in Moscow as we speak meeting with Lavrov and Medvedev. It’s not clear if he’s going to meet with Putin, but I’m sure there are plenty of back-channel communications going on whether the U.S. and Russia can come to some kind of joint arrangement on the future.

This all remains to be seen, but for now, I don’t think the U.S. is going to do more. We do have boots on the ground in Syria. When people ask, “Does this mean boots on the ground?” the boots were already there but not in Damascus or the places we attack. They’re special forces – special operators as they’re called – working with Syrian rebels and other forces including Turks and Kurds to defeat ISIS and particularly in preparation for the battle of Raqqa, which will be one of the big events of 2017. Raqqa is the de facto capital of the Islamic Caliphate or the Islamic State. That’s what ISIS is all about.

There’s going to be a lot more fighting in Syria. The U.S. is involved, we do have boots on the ground, but we’re certainly not going to send a Marine expeditionary unit in to liberate Damascus or take out Assad. That will be done through diplomacy, but we certainly have a very tense situation subject to escalation.

If it was a chess game, Assad made his move, Trump made his move, and now it’s Assad’s turn. Let’s see what he does. Hopefully, he got the message and this is the end of chemical weapons, but we’ll see.

Again, Syria is critical, so I’m not diminishing the importance of that at all, but I think we have a much more dangerous situation in North Korea. That’s what I’m focused on, Alex.

When I look at gold and stocks and other markets, they have many drivers. Geopolitics is one of them plus all the normal fundamentals in supply and demand – economic things we talk about on this podcast all the time. But sometimes geopolitics comes to the fore. It’s always there in the background, but when you look at day-to-day movements particularly in gold, you say, okay, we have a couple of things.

We have physical supply in demand as we’ve talked about in the past. We have Federal Reserve interest rate policy, because gold famously has no yield. Of course, my answer to that is it’s money; it’s not supposed to have a yield.

Money has no yield. If you want yield, you have to take risk and you’re in the world of investing. When it comes to money, whether it’s a dollar bill in your pocket or a gold coin, it’s not supposed to have a yield because it’s a medium of exchange.

That said, gold does compete for investment dollars with interest-bearing investments. As interest rates go up, that can be a headwind for gold – not always, but it can be. So, you have the monetary vector and geopolitics.

You basically have three vectors:  basic supply and demand, monetary policy, and geopolitics. All three can be pointing up at the same time or down or you can have a mixed bag. Right now, geopolitics is certainly a big driver, but in my view, the driver is North Korea more so than Syria although Syria does have that kind of potential.

Alex:  Speaking of North Korea, President Trump has ordered a U.S. carrier group to steam in the direction of the northwest Pacific in the vicinity of North Korea. The carrier group consists of the USS Carl Vincent (a Nimitz-class nuclear powered aircraft carrier), a Ticonderoga-class guided missile cruiser, two Arleigh Burke-class guided missile destroyers, and an unknown number of submarines.

North Korea’s response has been a threat of nuclear attack on the United States. That’s not anything new; they’ve been saying that for a long time now. And also, they’re warning that their nuclear capability – if we can call it that and is of a much greater concern in my opinion – is targeting U.S. military bases in South Korea.

Trump’s comments regarding China’s role in theater were that it would be better if China solved the North Korea problem themselves. He tweeted out that if China decides to help, that would be great, but if not, we will solve the problem without them.

Do you see this simply as strong talk, or given the action in Syria, do you think Trump is prepared to back that up? What does it mean for the overall Korean theater? And as a follow-on, how does this affect the rest of the world?

Jim:  I followed it closely and don’t see any of this as just talk or even strong talk. I think it has real potential to spin out of control and do something; certainly a possibility of nuclear war with Korea and maybe something much worse as I’ll talk about in detail.

By the way, I’m not sure if all the listeners know about your own military background and expertise, and I appreciate that rundown of the elements of the aircraft carrier strike force.

Reuters is a great news service; I use it all the time because it’s very reliable. They published something on this and illustrated what’s in a strike group, what these vessels look like, and so forth. These kinds of infographics are very popular and useful. Jane’s Defense Weekly and all the other military publications have graphic silhouettes of aircraft or vessels. Well, Reuters had the Arleigh Burke-class destroyer and the cruiser backwards. They had the cruiser in the destroyer column and the destroyer in the cruiser column.

As you know, cruisers are a little boxier and destroyers are more lean and mean. They’re both very potent; anything with cruise missiles onboard is a potent vessel. But it just goes to show that even the experts can get it mixed up, so we’re always glad to be the beneficiary of your expertise, Alex.

Let’s talk about North Korea. The thing about wars is that most of the time, they don’t happen because anybody thinks it’s a good idea; they happen because of strategic miscalculation. Sometimes wars are started on purpose. The Islamic State just wanted to go out and kill people and start a war, so they’re ones who I don’t think are very strategic; they’re just doing whatever they can to inflame tensions and start wars.

Sometimes that happens or it’s a quick land-grab, etc., but often wars – particularly big ones – start through a series of miscalculations. There’s no better example of that than World War I. I’ve studied World War I very closely. There have been a number of times I picked up a 700- or 800-page book on World War I and got about a third of the way through it before I just threw it down and shook my head. I couldn’t finish it or I had to at least put it off for a while, because it just made no sense.

The history is good. You can understand the history, you can follow the chronology, you can learn about the battles and all that and you’ll know what happened, but there is really no good answer to why it happened.

For example, in early June 1914 when tensions were high, if you had sat down with the crown heads of Europe including Franz Joseph, emperor of the Austro-Hungarian Empire, Kaiser Wilhelm II, emperor of the German Empire, Tsar Nicholas, emperor of the Russian empire, and the Sultan in Istanbul, Constantinople, the Ottoman Empire  and said, “I’ve got a good idea. Why don’t we start a war that will kill 20 million people, cause all four of your empires to collapse, put every one of you either in a grave or in exile in the next five years, bankrupt France and England, and destroy Europe as a world power. Who thinks that’s a good idea?” I don’t think you would have had very many takers.

Yet that is exactly what happened. The war started, 20 million were killed for no real discernible reason, all four of those empires collapsed, all four of those emperors were dead or in exile in a matter of years, and European power has never been the same.

It shows that there was no strategic calculation, foresight or real understanding of what they were doing. They just got caught up in an escalatory dynamic. Everybody thought the war would be short, that they would win, etc., and none of that turned out to be true.

It was the same thing with the Iraq war in 2003. All Saddam Hussain had to do was let the weapons inspectors in. He didn’t have weapons of mass destruction although he definitely had in the past. This is not debatable; it’s all very well established. He did have a nuclear weapons program and chemical and biological weapons programs.

It’s all well documented that Hussain used those chemical weapons, but he had given them up by the time 2003 came around. His WMD was one of the famous reasons for invading Iraq, but it turned out he didn’t have those.

Some do question whether he had stockpiles of chemical and biological weapons that were moved across the border into Syria in the weeks and months before the U.S. invasion, and whether perhaps some of those weapons are the very ones being used by Syria today.

I’ve spoken to people with top secret and beyond security clearances trying to probe that a little bit but haven’t been able to get good answers. If you don’t get a straight answer, it tells me that maybe it’s true, but I can’t prove that. It doesn’t matter. The point is, by the time we got to Iraq, those weapons were gone and the evidence was clear that he had given up his nuclear ambitions in the early 1990s. There were no WMD in Iraq; that’s just a fact.

The question is, if Saddam didn’t have any WMD, why didn’t he just let the inspectors in? Remember, Bush 43 said, “If you let the weapons inspectors in, we won’t go to war.” Saddam didn’t, we did go to war, and he ended up hanged. After fighting, hiding, being captured, and put on trial, he ended up hanged. He didn’t let inspectors in because he didn’t believe it. He thought Bush was bluffing. He said, “You guys will never be dumb enough to come in here. Besides, I’m your checkmate against the Iraqis.” He wanted to pretend he had WMD so that the Iraqis wouldn’t mess with him, but he got it wrong.

I spoke to one of the few people who interrogated Saddam Hussain after he was captured, before he was hanged, while he was a prisoner and available for interrogation. I was told that he just miscalculated.

The point is, really bad things happen not because anybody thinks it’s a good idea but because they simply miscalculate. Now take that historical background and bring it over to Korea. Are we witnessing a series of possibly tragic miscalculations? I think the answer is yes.

Let’s start with Kim Jong-un, the leader of North Korea.

I’ll distinguish for the listeners the difference between a nuclear device and a nuclear weapon. A nuclear device is when I take fissile material, create a controlled chain reaction, have some detonators, let it explode, and I get an atomic explosion. This can be detected with seismographs, intelligence sources, and other technical means.

There’s no doubt that North Korea has that. They’ve detonated a number of these nuclear explosions. They have highly enriched uranium and plutonium, which is fissile material. An atomic bomb can be made out of either highly enriched uranium or plutonium. It’s estimated that they have enough for 10 weapons.

They’ve mastered the enrichment cycle, have fissile material, and shown they can blow it up. That’s all pretty bad, but the next step is to weaponize it. Can they take that fissile material and put it in the form of a weapon that furthermore could be put on a warhead or missile?

These devices are the size of trucks. You could put it on a truck and drive it around, but where are you going to go with that? They can’t, so they have to weaponize it. They have to do something else, which is they have to ruggedize it.

‘Ruggedize’ means to strengthen for better resistance to wear, stress, and abuse. Even if they have something that’s a weapon that will work and detonate in a warhead, they have to shoot it into space. There is enormous stress during the liftoff phase, then it goes into space, and then it must re-enter the atmosphere. It needs a heatshield. It has a very rough ride before it reaches the target, so they have to weaponize and ruggedize it.

The evidence is that North Korea is very far along in that. I won’t say they’ve mastered it, but they’ve put some models on display which experts have looked at and said, “Yes, it looks like they know what they’re doing.” Who knows exactly where that is, but no reason to think that they’re not pretty far along.

The other thing they need is a missile that can reach a target. They can get South Korea because they have fairly reliable short-range missiles. The next step up is intermediate-range missiles that’ll go out maybe 500 to 1000 kilometers and be capable of reaching all of Japan and parts of China.

That’s been hit or miss – no pun intended – but they do seem to have nearly mastered that technology. They still have times when it blows up on the launchpad or it launches, goes off course, and lands who knows where.

It’s not clear how much of that is imperfect technology on their part and how much might be sabotage on our part. Let’s hope it’s the latter. Actually, let’s hope it’s both, but they seem pretty far along in intermediate-range missile capability.

The last leg of that triad is an intercontinental ballistic missile. This is the one that could hit Los Angeles or a lot of big cities in the United States. It’s much longer-range, has to go into space, and come back again. It doesn’t go into orbit, it’s kind of a suborbital ballistic path, but it’s very long range. They have not mastered that although they’re trying and making good progress.

So, where do we stand? They have the enrichment cycle, the fissile material, and the ability to create atomic explosions. They have short-range to intermediate-range missiles and are working on miniaturization, weaponization, ruggedization, and ICBMs.

They’re not that far away and seem to be making very good progress. They are probably four years at most, maybe three years, from being able to fire an atomic weapon at Los Angeles and kill 3 or 4 million Americans. That’s the capability.

Whenever you do this strategic analysis, you have to look at capabilities and intentions. If you know the capability, then all the talk in the world doesn’t mean anything if you can’t do it. If you do have the capability, you still have to ask about intentions. India has nuclear weapons and missile capability, but do they intend to strike the United States? Nobody thinks that.

It’s a combination of the two, capability and intentions. They’ve come very far down the capabilities path and are getting dangerously close to being able to nuke L.A.

Now let’s talk about intentions. Kim Jong-un has stated his intention to attack the U.S. with nuclear weapons. I see no reason not to believe him. He doesn’t quite have the capability yet, but that’s a dangerous combination.

What is he thinking? It’s impossible to know. One line of analysis I’ve read recently, which is not reassuring, is that he’s actually crazy. It’s probably the worst possibility when you have a crazy guy with nukes.

Maybe he’s one of these people who’s very cagy, not crazy but acts crazy to keep everybody off guard, something called strategic ambiguity. Going back to World War I case history, it’s the confusion about other people’s intentions that causes strategic miscalculation. Jong-un is looking around the world and saying a couple of things.

Let’s look at different nuclear weapons programs in rogue states. Iraq was working on nuclear weapons programs. Again, they didn’t have them when we went in, but they were working on them as evidence clearly shows. They gave it up, and Saddam Hussain got hanged. Gaddafi in Libya was working on a nuclear weapons programs. He gave it up and he got a bullet in the eye. The lesson is, if you have nukes and you give them up, you get killed.

The Iranians are working on a nuclear weapons program and they’re still standing. Kim Jong-un’s takeaway is, “If you work with the United States and give up your nukes, you get killed. If you keep your nukes, they don’t mess with you.”

It’s a totally bad message and major blunder the U.S. foreign and military policy has created in three cases – Iraq, Libya, and Iran – where if you work with us and give up your nukes, you get killed, but if you keep them, we don’t mess with you. That’s the wrong message, but it’s what we sent, and that’s what Kim Jong-un has internalized, so he’s saying, “All right, I’m going to keep going on the program.”

I’ve done a lot of work on North Korea. It’s an illegitimate regime, a brutal regime, a thuggish regime run like a crime family. They actually sent a cable to their embassies saying, “All you embassies, we don’t have the money to pay for you, so you have to pay your own bills. We suggest you do it with criminal rackets like counterfeiting or drug smuggling in diplomatic pouches.”

It’s run like the mafia with the same ethic of the mafia, which is basically to kill anyone who looks at you cross-eyed including your own family members. That’s the best way to understand what’s going on there.

The first thing Kim Jong-un is thinking is to keep going with the nuke program because the U.S. won’t mess with him. If he actually perfects it meaning he has reliable ICBM technology, miniaturization, and all the things we just talked about, he’ll think, “You definitely won’t mess with me. If you do and you don’t disable the whole program, I will send a nuclear missile to Los Angeles and kill millions of Americans, so good luck with that.”

The second thing he’s thinking is, again, being illegitimate – how to keep this thing going. How do you keep any racket going? Well, the main way you keep the racket going is to pay your people, but how does he earn hard currencies? He’s been shut out of the banking system; he’s been de-SWIFTed.

As a quick footnote on that, SWIFT is fundamentally the central nervous system of the international banking system. It’s a message traffic system run in Brussels where all the big banks in the world exchange money. When Deutsche Bank is sending a billion dollars to Citibank, it goes through SWIFT. When someone is exporting an oil tanker and waiting to get paid however many hundreds of millions of dollars for the cargo, that goes through SWIFT. Whether it’s dollars, euros, Swiss francs, yen, etc., all that message traffic goes through SWIFT.

In 2012 during what I call the first Iran-U.S. financial war, we worked with our allies to what we call de-SWIFT Iran or kick them off the SWIFT payment system. They could ship all the oil they wanted but couldn’t get paid.

North Korea is the second country to be de-SWIFTed. It’s a pretty extreme remedy much like cutting off oxygen to a patient in an intensive care unit; they’re probably going to suffocate. That’s what’s happened to them.

There are ways around that, however. They can use front banks. Maybe a Chinese bank is willing to send message traffic, wire transfers really, on behalf of North Korea without disclosing the beneficial party.

You’re supposed to disclose. There are forms – MT201s and so forth – where you put the sender, recipient, account information, amount, currency, all that stuff. There’s a line at the bottom for beneficial holder if you’re acting as an agent for somebody else.

Leaving it blank is one kind of fraud. The Chinese might leave those blank for North Korea and the Russians. I just saw the other day that the Malaysians have been doing something similar.

Be that as it may, the U.S. obviously knows this as part of our intelligence gathering. Going back to the escalatory dynamic, what we’re saying to the Chinese banks is, “If you front for North Korea, we’re going to kick you out of the U.S. payment system.” That’s a big deal, because these Chinese banks obviously need access to the dollar payment system.

That’s really putting the screws to North Korea. I’m sure that’s what was discussed in part between President Trump and President Xi at the Mar-a-Lago summit a few days ago behind closed doors which is, “We’re about to get serious, and we will put pressure on you directly if you don’t help us.” Trump has been tweeting about this. He leaves out the details, you can only do so much on Twitter, but it’s pretty clear what’s going on.

As another aside, the way North Korea gets money to pay their people is by selling weapons to Iran. North Korean scientists are further along than the Iranian scientists. Iranians have the enrichment cycle down, and they’re under a lot of scrutiny. Their missile program is coming along, but the North Koreans seem to be further along than the Iranians with all the technological items I mentioned – weaponization, ruggedization, miniaturization, ICBMs – so the North Koreans are selling their technology to the Iranians. That’s a separate story I’ll save for another day, but they’re getting paid in gold.

This is why there’s very strong physical demand for gold. Something that has emerged that I’ve written about for one of the think tanks in Washington is what I call the axis of gold involving Iran, China, Russia, and Turkey, and I would include North Korea as an auxiliary member.

The story of Russia and China acquiring gold as an alternative to the dollar, to build up their reserves as insurance against inflation, and all the reasons any investor might want gold, which all apply, is a big story. We’ve talked about that a lot in the past, but there’s another reason, which is to avoid sanctions or interdiction.

Physical gold is not digital, you can’t hack it, you can’t erase it, you can’t interdict it. It doesn’t go through SWIFT. You just take the bars, put them on a plane, and fly them to Shanghai, Pyongyang, Moscow, Teheran or wherever they happen to be going. You need very good intelligence to know where it is, and even then, are you going to shoot down a plane? Probably not, so that gold gets around.

It’s how these guys are paying each other outside of the message traffic system that is de facto controlled by the United States. There’s a big demand for gold coming from that vector. North Korea is getting gold they can use to bribe people and pay them off or to buy other things.

It can be used it to buy imports, and they like luxury goods. The North Korean military leaders, intelligence assets, and the people Kim Jong-un has to keep happy like their fancy watches and fancy cars as much as anybody. You can import that stuff with gold, so there’s a gold trade going on there.

Kim Jong-un has two big reasons to keep his program going:  1) He believes that if he perfects it, the U.S. won’t mess with him and he can perpetuate his regime, and; 2) He can sell the technology for gold to keep his people happy and protect his regime. He’s like the Godfather sitting up there.

The problem is, the United States is not going to allow him to nuke Los Angeles. He might say, “I just want the capability so you guys won’t mess with me,” but the answer is, “No, you’re not going to get the capability.”

You can’t gamble with Los Angeles. You can’t even take a 1% gamble with Los Angeles. You can’t even take a fraction of 1%. This is something Dick Cheney called the 1% doctrine, which meant that when the risks are existential, you can’t take even a minute fraction of 1%. You can’t make that bet; you have to eliminate it.

Kim Jong-un is on a course to get the weapons, and the U.S. is on a course to prevent him from getting the weapons. Each side misreads the intentions of the other. Now, here’s where it gets really interesting and I think war could be imminent:  How do you actually root out this program?

There’s an old saying, If you shoot the king, don’t miss, meaning if you try to assassinate a leader – shoot the king, in other words – and you miss, you’re dead. They’re going to come back to you.

This is what happened with Hitler and the Wolf’s Lair plot when they actually got a briefcase bomb two inches from Hitler. It blew up, but the briefcase had been moved behind an oak panel at the last minute. Hitler was injured and wounded but not killed. Of course, that was bad news for all the perpetrators, because they all got killed.

If you shoot the king, don’t miss, so if we, the United States, are going to take out the North Korean nuclear program, we must get it all. We can’t leave them with any fissile material, any missile launch capability, any reactors, etc., because they’ll just come back and get us.

There are ways to do it. I’ve been talking about the ICBM in Los Angeles as the existential threat, but they could unleash a military barrage on Seoul. I’ve been to Seoul a number of times, and it’s very close to the North Korean border.

It would be nicer for them if they were down around Busan or someplace further away, but they’re not. They’re well within artillery range. I’m not talking about bomber range; I’m talking about artillery range of the North Korean border, and they will be massively bombarded. Then North Korea could use even their short-range missiles to attack U.S. bases in Korea and the region.

Even if they can’t reach L.A. because we hit them before they can get the ICBM, they can easily kill a lot of Americans in the region. That’s exactly what they’ve threatened to do and have the capability of. If we hit them, we have to take out everything, or else the retaliation on us, the South Koreans, probably the Japanese, and others will be pretty horrendous. So, if you shoot the king, don’t miss.

What does it mean when I say don’t miss? The North Korean stuff is underground buried in mountains and heavily fortified. We do have GBUs (bunker buster bombs) and have been working on that, but if we give them more time and let them burrow in deeply and dig more tunnels, we might have to use tactical nuclear weapons.

Now, atomic weapons. I’m switching back and forth between atomic and nuclear weapons to distinguish between Hiroshima-type bombs and thermonuclear devices, which North Korea is not even close to getting. Russia and United States have them.

Atomic weapons are the kind used in Hiroshima and Nagasaki. August 1945 was the last and only time these weapons were used in warfare, but obviously, they’ve been tested up until the 1960s.

There are some smaller-yield, tactical nuclear weapons called sub-nuclear, which are pretty powerful. They get up to a certain critical stage and unleash a lot of energy. I don’t want to get too technical on all this, but the point being, those are obviously more powerful than the bunker busters.

Will we have to use those to wipe out the North Korean program to make sure if we shoot, we don’t miss? All I know is the more time that goes on, the more likely that becomes. If you’re the United States and are saying “We don’t want to use tactical nuclear weapons, because that crosses a separate red line that gives Russia permission to use them elsewhere,” then you’d better act sooner rather than later.

Here’s the dynamic:  Kim Jong-un is on a course where he says, “I’m keeping my nuclear weapons to perpetuate my regime and so that the U.S. won’t mess with me.” The U.S. is on a course that says, “We have to take out your program sooner rather than later because it’s an existential threat.” That’s a recipe for war sooner rather than later.

My view is we’re on that course. This is not saber-rattling or bluster or talk. Just to connect the dots all the way back to Syria, Trump has shown that he’s decisive and is willing to shoot.

Not to be glib, but when you have a forward-deployed military with as much weaponry, technology, and capability as the United States, the generals don’t totally mind taking out a Syrian airfield. In some ways, it’s target practice.

Again, I’m not being glib; I’m just saying that when you have all this stuff, you have to use it every now and then to make sure it works, and you know that very well. So, the military is primed. They had a nice live-fire exercise in Syria. Trump has shown he’s decisive. We’re on a collision course with North Korea.

To cut to the chase, this is one of the drivers of gold right now with physical gold prices in particular in addition to the other things we mentioned. I think the gold market and the smart money has this figured out. Institutional investors and retail, unfortunately, are usually the last to know, but I think some of the hedge funds, some of the sovereign wealth funds, and some of the big players are going to gold because they see this happening.

Alex:  This has brought up a couple of different thoughts we should talk a little more about. One is you had mentioned that kicking China out of SWIFT is a potential move on the chessboard. This seems to me to be a pretty extreme action. What I’m wondering is could it backfire and the blowback of that be cause for an acceleration of seeking alternatives to SWIFT? In other words, looking for other ways to transfer money around or looking at gold as being the axis of gold you mentioned.

Gold is a two-edged sword here in that it’s the only form of money I’m aware of that governments are unable to control. Gold is completely fungible. Even though a gold bar has serial numbers on it and may be tracked in certain systems, you can take it out of those systems, melt it, recast it into a bar, and sell it anywhere in the world as completely untraceable.

What do you see there? Could that be an accelerant to moving away from the U.S. dollar as a form of transaction globally?

Jim:  Just to be clear, Alex, I don’t foresee kicking China out of SWIFT. I think that’s the equivalent of using tactical nuclear weapons, so I don’t think that’ll happen. To be more specific, what I was talking about is the United States kicking certain Chinese banks out of Fedwire, which is the U.S. dollar payment system.

There are two major payment systems. One is the U.S. dollar payment system completely controlled by the Fed and the U.S. Treasury operating through Fedwire. Even if you’re a smaller bank or a foreign bank and you’re not in Fedwire, you can’t move dollars around without going through a correspondent bank that does.

The U.S., whether through OFAC or other sources, tells our banks “This Chinese bank is on the list because we think they’re fronting for North Korea. All of the banks in the world are not allowed to move dollars through our system for that bank.” It’s targeted kind of like Syria.

Alex, you have a military background, I do a lot of strategic work, and we both obviously have a financial background. It’s interesting to note how we’re moving back and forth between kinetic war and financial war. These are not simply metaphors.

I just led a seminar for the Advanced Strategic Art Program at the U.S. Army War College. It was really an honor to be invited. When I say “college,” don’t think of undergraduates running around in blue jeans; the U.S. Army War College is graduate-level instruction only. There is no undergraduate division.

The people in my seminar – about 15 of them – were mid-career officers, so majors, captains, lieutenant colonels, all with brilliant academic backgrounds. It was a handpicked group, and the quality of the students at the U.S. Army War College is pretty high to begin with.

This was a select group of people who have been identified for their potential as strategic thought leaders, so these will be the future generals and end up in the National Security Council, cabinet level, under-secretary level positions, NSA, etc. Really the crème de la crème of strategic leaders.

I was invited in to do a financial warfighting seminar at the historic 69th Regiment Army in New York. The U.S. Army War College is in Carlisle, Pennsylvania, but this group came to New York because they were meeting with other financial people.

After my lecture, their next guest lecture was Secretary Geithner, so we had a little fun talking about that. I said, “You’re going to get a very different view of the world from Secretary Geithner than you got from me, but that’s okay. That kind of diversity is good.”

This is exactly what we were talking about, how the lines between kinetic and financial and cyber and financial are being blurred. They’re all part of the battlespace.

To come back to this, just as we targeted one airfield and not six in Syria, so the U.S. can target one bank, not 20, and one payment system, not all of them. So, China as a country will not be de-SWIFTed, but certain Chinese banks may be kicked out of the U.S. payment system if they’re carrying water for North Korea. I do expect that.

Having said that, your bigger point is absolutely correct that this has been well vetted. Russia and China are building up their gold reserves and are starting to do business in each other’s currency. If Russia ships energy to China, they’re willing to get paid in yuan; if Russia then wants to buy certain technology exports – it could be iPhones for that matter –-from China, China is willing to take yuan back or rubles, etc. They’re already getting away from the dollar, but they’re also building payment systems.

One of my favorite central bankers in the world, Elvira Nabiullina, head of the Central Bank of Russia, recently announced that if Russia were de-SWIFTed, they would kind of shrug and say, “No big deal. We have other alternatives good to go.”

I don’t see Russia and China getting de-SWIFTed, but one of these alternatives, as I mentioned, is gold. In Russia’s case today, their reserve position is about $400 billion. China is in a whole different league at about $3 trillion of reserves. I’m using dollars as a numéraire, but it’s not all in dollars. That’s the point. Some of it is in euros, some of it is in each other’s currencies, and increasing amounts are in gold.

Take Russia, for example. If their reserve position is $400 billion, they don’t spend it all at once. It’s $5 billion here, $10 billion there, a billion here, a couple of hundred million there to settle payments and payment obligations with trading partners or if their own corporations need access to hard currency. Gold is a part of that. If Russia owes some money to China, put some gold bars on a plane, fly it to Shanghai, done.

I was recently in Shanghai and met with two of the five biggest physical gold dealers in China. They’re banks, of course. One of the things I asked them was, “I have pretty good information that the People’s Liberation Army moves the gold around in armored columns and so forth. Why is that? Why don’t you guys move the gold around? Can’t you get some armored cars, Brinks or whatever?”

They just looked at me and said, “We’re not allowed to have guns.” I said, “Oh, right, you don’t have a second amendment. In the U.S., you’re allowed to have guns.” You can’t very well be in the business of having an armored car business if you can’t have guns, so that’s one reason. There are multiple reasons, but that’s one reason they use the PLA, because they’re the only people who are allowed to have weapons.

The government, the PLA, and the banks are all working hand in glove. This system is very far along, so again from the gold investor’s point of view, rising geopolitical tensions is one reason to have physical gold.

Consider the efforts of Russia and China and others to build alternatives to the dollar payment system. The euro has its issues. You can switch from dollars to euros and Swiss francs, which is what Iran did. When we kicked Iran out of the dollar payment system in 2012, they said “No big deal.” They just switched to euros. “We’ll ship the oil, pay us in euros or pay us in Swiss francs.”

It was only when they were de-SWIFTed and couldn’t transact in euros, Swiss francs, yen, and other hard currencies that they came to the bargaining table and started talking to Obama about their nuclear program.

Russia and China aren’t going to wait for that. They’re not going to be vulnerable to that or held hostage. In addition to all the other reasons we mentioned, this is a very strong demand vector for gold, which is it’s the one thing you can’t freeze, seize or interdict.

Alex:  Going back to something we were talking about earlier, you mentioned reading about World War I and the reasons countries go to war. You also mentioned Kim Jong-un acts a little crazy sometimes, and it’s possible that instead of being crazy, he’s just acting this way to keep people off guard.

It occurs to me – and this is complete speculation and opinion on my part – that Trump maybe does a little bit of the same thing. If that’s true, what we have is two individuals who act a little crazy, but at the end of the day, they’re playing with very serious stakes and both of them to some degree or another have a need to prove that what they’re saying is the truth and should be taken seriously.

That seems to be a pretty volatile mixture. What do you think about that?

Jim:  I agree completely that it’s volatile and unpredictable. I wouldn’t overdraw the parallel, meaning Trump is pretty smart in my view. He’s not crazy. When we say he acts crazy, what we really mean is that he acts in an unpredictable way. That can be a good thing. Keep your opponents and adversaries off guard. People will never know what’s coming; it forces them to pay attention and listen to you.

I would describe Trump as situational, mercurial. He has certainly shown his ability to do a 180 and not look back. There’s no better example than Chinese currency manipulation. Remember during the campaign he said, “China is a currency manipulator. They’re stealing our jobs, and when I’m president, on day one, I’m signing an executive order declaring China a currency manipulator.”

Bearing in mind that that’s not the president’s job; that actually comes from the Treasury Department. The Treasury Department can take instructions from the White House if need be, and it’s twice a year (April and October) that currency manipulator label comes out in a report required by Congress.

The April report is coming out in a matter of days. The best information is that China will not be declared a currency manipulator, nor did the president do anything on his first day in office, nor has he mentioned it very much recently. The reason is obvious, which is he’s now engaged in dialog with China and needs their help on North Korea.

Alex, you mentioned the deployment of the aircraft carrier strike group to Korean waters which is a very big deal. The best information not verified from multiple sources but from at least one reliable source is that China has mobilized the People’s Liberation Army to move them to the Yalu River on the Chinese side of the North Korean border. That has echoes of the Korean War when General MacArthur miscalculated Chinese intentions with regard to crossing the Yalu.

Whether this is a pincer movement where you have ground troops on the Yalu River and sea forces in Korean waters ready to strike on land, sea, and air if Kim Jong-un doesn’t back off, that’s possible.

It’s a very interesting scenario. The last time we mixed it up in Korea, it was the U.S. and the South Koreans versus China and the North Koreans. The next time, it could be South Koreans, U.S., and China versus the North Koreans. That would be an interesting twist, but that’s only one possibility.

Another possibility is that China is kind of signaling the U.S., “Don’t attack North Korea, because we’re sitting there on the border. We’ll come back into Korea and stabilize rather than destabilize the regime.”

I think it’s probably the former rather than the latter, but you can’t rule anything out. All I know is that you have dangerous escalation occurring on land, sea, and air with U.S. and China boxing North Korea in from a couple of different directions.

Again, this is all about these potential miscalculations. I think Trump knows what he’s doing. He has reversed course. That’s a way to understand Trump, not as crazy but as I say, situational, mercurial, a little unpredictable.

Kim Jong-un is another case. Whenever you have to say to yourself, “Is the guy actually crazy or is he just acting crazy?” listen to your own question. What’s the difference between a guy who is crazy and one who acts crazy? The fact is some crazy people act pretty sane, like serial killers and others.

I don’t know, but here’s what I do know:  You cannot gamble Los Angeles on getting the right answer to that question. You have to treat him as perfectly capable and having the intent to start World War III, and you have to stop that before it happens.

Alex:  Let’s turn to economics as we wrap this up. The next FOMC meeting is scheduled for three weeks from now. What track is the Fed on in terms of raising interest rates, and what are the factors we need to be watching that could impact this process?

Jim:  We have just a couple of minutes left, and that’s something I could probably talk for an hour on without pausing for a breath. We don’t have time for that, but I’ll give you the short version.

Fed policy is the gift that keeps on giving. There’s never a time when we run out of things to say on the Fed, so maybe we will make that a big topic in the next podcast. Here’s the quick version: The Fed will raise rates four times a year – 25 basis points each in March, June, September, and December – every year from now until the middle of 2019 until they get to 3.25%. That’s the baseline scenario and what they’re going to do.

There are three reasons why they won’t actually do it in a particular case. Assume they’re going to raise them in June, September, and December 2017, and March 2018. They’re going to keep going unless one of three things causes them to pause.

‘Pause’ is the key word and the one Dudley used the other day not by accident. ‘Pause’ is one of those buzzwords that means we don’t raise at a particular meeting, we might pause for one meeting, and we might pause for two meetings.

In 2016, they paused for seven meetings. They raised them in December 2015 but did not raise them again until December 2016. There are eight meetings per year, so that was a seven-meeting pause. These pauses can be pretty long.

‘Pause’ means one of three things has happened, and we’re going to stop raising rates until the situation is rectified. So, what are the triggers for a pause?

One is if job creation falls below 75,000. Even 100,000 – which these days is considered a weak jobs report – will not cause the Fed to pause. If you don’t see that, then they’re still going to raise.

The second one is disinflation. The Fed believes it has achieved its inflation targets or will shortly. Their preferred measure is PCE price deflator core year-over-year. That’s about 1.8% right now, but their target is 2%, so they’re just about there. If you see that back off and go down to 1.5, 1.3, etc., then that’s another reason for them to pause.

The third reason is the stock market falls out of bed. Anything short of a 5% drawdown, they don’t care. If the stock market Dow goes down 1000, the Fed absolutely doesn’t care, but if it goes down more than 1000 points, it starts getting closer to 10%, it looks disorderly meaning it could just feed on itself and create a panic momentum, then they will pause. But that’s it. So, look for those.

Going along with the job point I mentioned, if GDP completely falls out of bed and goes negative… By the way, we’re close to negative right now. The forecast for first quarter looks like maybe six-tenths of 1% or certainly below 1%. So if you see job creation below 75,000 or GDP going negative, if you see a disorderly rout in the stock market of between 5% and 10% heading south, or if you see disinflation where PCE core deflator year-over-year starts going significantly back down to the 1.5% area, or certainly any two of those, then the Fed will pause.

Right now, I don’t see those things happening. I have them raising rates in June, and I’ll take September one step at a time, but if those things don’t happen, then they would raise in September.

Here’s the problem:  The Fed is raising rates for the wrong reason. Historically, there is a high correlation between Fed rate hikes and an expanding economy. That makes sense, right? The Fed sits there, they watch the economy grow, unemployment goes down, labor markets get tired, inflation picks up, the whole thing is getting a little hot, the Fed thinks they must cool it down, so they raise rates. And then the same thing in reverse. They raise them too far, the economy cools down, unemployment goes up, inflation cools down, and they say, “Gee, we better cut rates.”

That’s the normal business cycle. The Fed does not lead the business cycle; they follow it. They raise rates when the economy is hot, and they cut rates when the economy is cool. Pretty simple.

That is not what’s going on right now. The market thinks it is, which is one of the reasons the stock market is going crazy, but that is not what’s going on. What’s going on is the Fed is raising rates exactly as I described. They’re playing catchup because they failed to raise rates in 2010, 2011, and 2012 when they should have.

Bernanke skipped a whole rate hike cycle in the early 2010s because he was doing all these nutty experiments with QE and ZIRP, zero interest rate policy. Now the Fed has to catch up. Why? Because they have to cut rates to get out of a recession.

We could be in a recession any time. How do you cut rates 3% if they’re only 1%? The answer is you can’t. You have to get them up to 3% or 3.25% so you can cut them again to get out of a recession.

The Fed is doing this very strange finesse where they’re raising rates not into strength but into weakness, and they’re raising rates to prepare to cure a future recession without causing the recession they’re trying to cure. That’s the finesse.

I don’t think they’re going to do it. They are going to try, but I don’t think they’re going to pull it off. I think they’re actually going to cause the recession. We talked about Trump flip-flops, but the Fed could flip-flop as early as this summer.

I do look for the June rate hike, but by then it could very well be the case that they’ve thrown the U.S. economy into a recession, you see one of these factors I mentioned, and they have to pause by September. But let’s take that one step at a time.

The pause is bullish for gold because it’s monetary easing, but even the rate hikes don’t seem to have stopped gold because of the geopolitical factors we mentioned. Also, these are nominal rate hikes. Gold investors need to focus on real rate hikes. As long as inflation is ticking up, then the real rate is actually going down even as the nominal rate goes up.

We’ll leave it there. I know that’s a lot to unpack, but listeners can always play the recording back and hear it again. I hope that’s helpful.

Alex:  I’m sure it will be.

Jim, we’ve covered a lot of ground on today’s podcast. This has been a great discussion I’ve enjoyed a lot. I want to thank you as always for your time and insight. I appreciate it and look forward to getting together with you again next month.

Jim:  Thanks, Alex.

Jon: You have been listening to The Gold Chronicles with Jim Rickards and Alex Stanczyk presented by Physical Gold Fund. Recordings can be found at You can register there for news of upcoming interviews with Jim Rickards and other world-class thinkers.


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The Gold Chronicles: April 2017 Interview with Jim Rickards and Alex Stanczyk


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Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles March 2017

Jim Rickards and Alex Stanczyk, The Gold Chronicles March 2017

Topics Include:

*Commentary on FOMC and Rate Hike
*How VAT may enable a revenue neutral solution to allow Trumps fiscal and tax cuts plan
*One of the dangers to VAT is that it is prone to a creeping rise in the tax rate
*Scenarios for consumer reactions to VAT perceived as price inflation
*How increasingly fragile markets combined with highly leveraged financial services institutions are leading to amplified risk levels for the entire financial system
*Market fragility from Jim’s view is a function of system scale – if you double the size of the system the risk increases exponentially
*The system has not deleveraged since 2008, but has increased leverage and concentrated in an even fewer number of banks
*The derivatives market is approaching one quadrillion dollars in size, approximately ten times the size of global GDP
*Nation debt levels, debt ceiling, comments on the math of servicing the increasing debt burden in consideration of the debt to GDP ratio
*The first $20T of US Government debt is treasury debt, with a debt to GDP ratio of about 105%, and it does not include contingent liabilities such as social security and Medicare
*If counting contingent liabilities, it brings the US debt number to more than $100T, and the debt to GDP ratio closer to 1000%
*The most likely path out of the current debt for the US is inflation, which means inflation is ultimately required and likely


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The Gold Chronicles: March 2017 Interview with Jim Rickards and Alex Stanczyk


Jon:  Hello, I’m Jon Ward on behalf of Physical Gold Fund. We’re delighted to welcome you to the latest podcast with Jim Rickards and Alex Stanczyk in the series we’re calling The Gold Chronicles.

Jim Rickards is a New York Times bestselling author, Chief Global Strategist for West Shore Funds, and the former General Counsel of Long Term Capital Management. He is currently a consultant to the US Intelligence Community and to the Department of Defense. Jim is also an advisory board member of Physical Gold Fund.

Hello, Jim, and welcome.

Jim:  Hi, Jon. It’s great to be with you.

Jon:  We also have with us Alex Stanczyk, Managing Director of Physical Gold Fund. Alex is an expert in the physical gold industry dealing with the logistics chain from refinery to secure transport and vaulting. He has lectured globally to investor, institutional, and government audiences on the role of gold both in the international monetary system and in investment portfolios.

Hello, Alex, and over to you.

Alex:  Hi, Jon. I’m excited to be here and looking forward to today’s conversation.

Jim, you just recently got back from South by Southwest. Before we jump into this, do you have any interesting insights you’d like to share from this event?

Jim:  You’re right, I just flew in from Austin the other day. It was my first time at South by Southwest although it’s been going on for a long time and has a great following. It’s an interesting mixture. They have expanded the menu, so now they have a film festival for a few days, then they switch to tech and interactive for a few days, and then they finish up with music, which is the root of South by Southwest – that’s how it all began.

It’s a mixture of techno geeks, spring break partiers, music producers, and talent. They block off all the streets, so it’s a little like a street fair similar to New Orleans at Mardi Gras.

The highlight for me was being able to participate in the launch of a new media platform along with a number of other participants who were there. I actually got to play a few hands of Texas Hold’em with Phil Hellmuth. For listeners who may not know, Phil is the 14-time world champion of poker. It was like sparring in the ring with Muhammad Ali back in the day. People could not have been nicer, and we had a lot of fun, so I certainly enjoyed that and met a lot of other great folks.

Phil did have some interesting insights. As a world champion of poker, you’d obviously figure him to be a smart guy with great intuition and a very sharp, incisive mind. We talked a little bit at lunch before our poker game about efforts to create algorithms that could beat him or anybody at poker, basically poker-playing algorithms.

There’s a long history of that with IBM trying to beat Garry Kasparov, world champion at the time in chess. I had occasion to talk to Garry about it. He knew his days were numbered although he actually defeated a couple of IBM programs, and finally they came up with one called Blue Gene that was able to beat him.

I had lunch with him before that contest, and he said, “I’m going to beat them next time and they’re going to beat me the time after that, because I can sort of reverse engineer what their developers are doing.” Of course, there’s nothing random in chess. It’s a deep game, but it’s kind of a mechanical game in the sense that there is a “finite” number of moves and results, although I’d put that in quotation marks as it’s quite a large number.

Poker is different than chess because you have more of an element of luck. Phil said to me that he’s been playing some of these algorithms, and he beats them routinely. The reason is that nothing in artificial intelligence has been able to come close to a poker player’s intuition about fear, spotting a weak hand or understanding when the other guy is bluffing. These are things that no amount of automation is quite up to yet.

I found it an interesting insight, and you know me, I obviously carry that over to the gold and financial markets with all the high-frequency trading and automated trading. I think 90% or more of trading on the New York Stock Exchange these days is completely automated.

The ability to – as Phil put it – smell fear in markets and human nature’s herding instincts crowding in and then everyone trying to go for the exits at once, those are the things you can’t automate. Investors always need to bear that in mind. I think there are some lessons there for gold investors and investors in other assets as well.

Alex:  I have to agree with that entire element of being able to spot what’s going on with the crowd and just sense that. I’m not sure we’ll be able to teach machines how to do that, but it’s definitely an interesting topic.

Let’s turn our attention now to markets and the recent FOMC meeting. Your track record of predicting U.S. Fed moves is one of the best there is. As you are aware, the Fed just hiked interest rates. It seems the FOMC is divided in its views, though. Members of the Fed such as the Atlanta Fed don’t really see eye to eye with Yellen’s narrative.

We know that the Fed does not have the best record for forecasting the economy. Talk to me a little bit about why this matters and what you think the Fed is going to end up doing moving forward for the rest of the year.

Jim:  I have been able to call Fed moves with a lot of accuracy going all the way back to September 2013. That was not long after the famous taper talk by Ben Bernanke in May of 2013.

At the time, they were nowhere near raising interest rates, but he said, “We might begin to reduce our asset purchases.” In other words, reduce money printing. Although he didn’t do it in May, he just said, “We’re thinking about it.” Well, by September, the entire market was poised for that move, but I said it wouldn’t happen. It didn’t then and finally did a few months later.

The same thing happened in September 2015 with the market poised for what they called liftoff, which was the first interest rate hike. That was long after they had finished the taper, so there was no more money printing. They were still printing money to roll over maturing assets, but they weren’t expanding the balance sheet. That ended in late 2014 and took all the way until September 2015. There was a lot of expectation about liftoff; again, I said they’re not going to lift off. They didn’t, and that happened once more three months later. The first rate hike was in December 2015.

Then in late 2014, I was saying they would not be able to hike rates in all of 2015. Meanwhile, the markets were predicting March, June, September, and December for rate hikes. Through eight meetings, it was no, no, no, they didn’t hike rates. It was finally clear in December 2015 that they would.

About three months ago, in December 2016, I called for the most recent hike on March 15th and the market expectation in Fed funds futures contracts as implying a probability of a rate hike. That’s the wisdom of the crowds. The considered judgment of all market participants had it at 28% December and 30% through February. I was forecasting 75%, 80% and basically leaning clearly to a rate hike.

Suddenly, in the three trading days February 28th to March 2nd, the probability skyrocketed to 50%, then 80%, then 90%. By Fed day, March 15th, everybody was at 100%. That was easy, but there were two months there when the markets were 30% and I was 75% – 80% before we all converged at 100%.

Here’s what I would say about that:  I don’t have a crystal ball. It’s not like I’m doing some mumbo jumbo to figure this out, and I’m absolutely not smarter than my peers or the other people doing this. I know a lot of the quants and PhDs and friends on Wall Street who are all pretty smart.

All I have is a better model that is unbelievably simple. It’s not like you need IBM’s Watson to do your processing for you. As I’ve said all along – and we have discussed this many times – if you have the wrong model, you’re going to get the wrong forecast every time. If you have the right model, you have a much better chance of getting the forecast right.

So it’s really just about the model. I’m always happy to explain that to our listeners, because the thing is, the model works. It is your best guide to what’s going to happen with the Fed moving forward.

Of course, that has implications for the price of gold. There’s some extent – not perfect by any means, but some extent – to which the price of gold is correlated to the value of the dollar, and that in turn, ties to interest rates. So if you can get the Fed forecast right, you can at least have some insights into what’s going to happen with the price of gold.

Alex:  Let’s talk a little bit about Trump’s fiscal plan and how this is going to work in terms of tax cuts he wants to make, etc. We’ll keep in mind his fiscal plan as it’s already been outlined, as well as we’ve recently been reminded that the U.S. government is now dealing once again with the so-called debt ceiling. This is an issue that keeps coming up and doesn’t seem to be going away.

You’ve recently suggested that perhaps VAT may be a way for Trump to cut taxes and get the fiscal program he wants. VAT is an acronym for value-added tax and is pretty common in Europe.

Would you briefly explain what VAT is, and do you consider Trump’s plan doable if VAT is made into law?

Jim:  I’d be happy to do that and also talk about the impact of it, but to properly address that question, it has to be put in a broader context of the global economy – or if not the global economy, at least the U.S. economy which is a big part of the global economy.

VAT or value-added tax is very common around the world. The United States is the only major economy that does not have a value-added tax. The Treasury has wanted one forever going through Republican and Democratic administrations for decades.

Part of my background before I started doing more economic work and writing was spending the first ten years of my career as international tax counsel for Citi Bank, one of the world’s largest financial institutions. I had experience as a tax lawyer, so I’m pretty familiar with the ins and outs of this.

You can think of value-added tax as kind of a sales tax, but there’s a little more to it than that because there’s a value chain. They start with raw materials and inputs, then they sell to a manufacturer, then they sell to a distributor, then they sell to wholesale, then they sell to retail, and then retail sells to you and me. You actually apply the VAT at every step in this whole chain only on the portion of the value that you added. That’s why they call it a value-added tax.

There’s a wholesale element to it, but it’s basically a sales tax. Every time you sell your goods, whether you’re in the intermediate stage of the value chain or the end stage, you charge the value-added tax for the increase in the value relative to what you paid. It’s kind of like a super sales tax.

The reason the Treasury loves it is that it generates a ton of revenue and it’s also easy to sneak up on people. Maybe it would start at 3% or 4% (I’ll make up a number), and the next thing you know, it’s 5%, then it’s 7%, then it’s 8% like state sales taxes. I think our listeners have experience with state sales taxes that seem to only go one way, up and never down. Be that as it may, it’s a great revenue raiser and a way to pick people’s pockets.

The reason this is important is that it plugs into Trump’s bigger-picture fiscal plan. Getting back to the stock market and ultimately to the gold market, his fiscal plan is to cut taxes and add $1 trillion of infrastructure spending. The third leg of the stool is regulatory reform, but let’s leave that to one side for a moment although I think that’s positive for the economy.

Basically, he wants to cut taxes and spend more money, which implies bigger deficits. Congress is saying, “Hold on. We’ll consider the tax cuts,” but they have to be what they call revenue neutral, which just means that if you’re going to cut them in one place, you have to raise them someplace else.

What kind of tax cuts does Trump want? As Trump would say, they’re huge or amazing. He wants to cut the individual tax rate from roughly 39% to 33%, the corporate tax rate from 35% to maybe 25%, and he wants to bring back offshore earnings at maybe some favorable rate, 15% let’s say. All of this would cost the Treasury money relative to what they think they would get in a static projection.

The question Congress is asking is, “If you’re cutting those taxes, where are you going to raise taxes to make up the difference so that we don’t have larger deficits?” Think about that for a second. If it’s revenue-neutral and doesn’t increase the deficit, where is the stimulus?

Consider the whole idea of John Maynard Keynes as an economist. I’m not a Keynesian in terms of deficits as far as the eyes can see, but if you believe in Keynesian stimulus, you’ll say, “When the economy is as weak as it is now, deficit spending might be a good thing,” but if your tax cut is revenue-neutral, then there’s no additional deficit spending, so it’s hard to see where the boost is coming from.

It’s actually a little worse than that, because you have this concept of the marginal propensity to consume, which varies depending on total income and wealth. The issue is if you get an extra dollar in your pocket, what are you going to do with it? Are you going to spend the whole dollar, are you going to spend nothing and stick it in the bank, or are you going to spend 50 cents?

When you cut income taxes from 39% to 33%, that benefit mostly goes to people making $250,000 all the way up to $1 billion a year. They’re the ones in that tax bracket. Throw on a value-added tax or even something else called the Border Adjustment Tax, which is the other one that’s in the running that is highly regressive, meaning you’re taxing people who can barely get by.

If you have to go to the store and buy food for your family or you have to go buy clothing at Costco or you have to do any kind of shopping at all and you’re paying the value-added tax, then you’re paying that tax even though you might be poor or you’re just marginally getting by.

Whereas let’s think about those making $1 million a year, a pretty rare category. For people in that category, if they get a tax cut, are they really going to spend much more? Probably not. The people making that kind of money probably have three cars, five TV sets, two houses, and they take nice vacations already. Are they going to buy another house or take another vacation? Maybe, but probably not. They’re probably going to invest the money or save it.

The point is, if you cut taxes on people with a low marginal propensity to consume, they’re not going to spend a lot more, and if you raise taxes on people with a high marginal propensity to consume, meaning it really comes out of their pockets so maybe they spend less, that’s a headwind for the economy. That actually hurts what’s called aggregate demand; it hurts the economy.

So now you have two things going on. One is you’re revenue-neutral, so there’s no Keynesian multiplier or Keynesian stimulus. There probably wouldn’t be much of one anyway, but now you’re going to get none if you’re revenue-neutral. Plus, it’s not neutral in terms of consumption; you’re actually hurting consumption.

Now, there are advocates for them long term, but short term, this is going to basically cause the economy to slam on the brakes. I don’t understand why the stock market is so euphoric over Trump’s plans, because when you look at them, it’s hard to see where the stimulus is coming from.

The stock market does look like a bubble to me. That doesn’t mean it can’t go on. One of the lessons of bubbles is that they go on a lot longer than you think, so I’m not predicting that the bubble is going to burst tomorrow, and I’m not saying people should run out and short stocks. What I’m saying is we’re well into bubble territory.

As a very simple example, in early November right after the election, the stock market (I’ll use Dow Jones) went up a thousand points based on the Trump fiscal plan and tax cuts. Then in December, they came out with some more detail about the timing, and it went up another thousand points on the tax cuts. And then in February, around the time of the President’s address to Congress and they had more details along with Secretary Mnuchin adamant about getting it done by August, the stock market went up another thousand points.

I’m looking at that and saying, “Hey, you just rallied three times on the same news.” There aren’t going to be three tax cuts; there’s only going to be one tax cut, but the market rallied three times on the same news. That’s bubbly behavior, and it looks like the market is way ahead of itself.

There’s a lot more to say, but I’ll wrap it up there. Some of this reality – meaning the stimulus is not going to be as great as expected, the impact of the tax cuts are not going to be as great as expected, and the whole thing is going to take longer than expected – is going to be a bit of a wakeup call for the stock market and could combine with other things to give us a serious correction, maybe down 10% or so by the summer.

Alex:  I have a follow-up question to the VAT topic. Instead of consumers looking at it and thinking it is additional tax, is there a scenario where VAT could be perceived by consumers as prices of things going up? Could this be some sort of psychological trigger that could accelerate the velocity of money or an inflationary-inducing kind of effect?

Jim:  It could be, and that’s a very good question. In fact, prices will go up. I’ll leave it to the people at the Commerce Department to sort out how they want to define inflation, but if you have something that’s $100 and you slap on 5% VAT, suddenly it’s $105.

The talking heads and people on financial television will tell you, “Oh, don’t worry about it. It’s not inflation; it’s only a tax,” but I’m not sure the average consumer would think of it that way. If they’re paying $105, that’s 5% inflation overnight.

There are other weird consequences such as we’ve seen in Japan, which is if they announce an effective date, you might actually get a short-term boost in consumption. That would be good short-term for the economy, because everyone will run out and buy stuff before the effective date. If they said “This is in the bill that’s going to pass Congress with an effective date of September 1st,” you might see everyone at the end of August shopping like crazy to beat the sales tax or value-added tax.

That did happen in Japan, but it’s only a Kool-Aid high. It’s a short-term boost, because the day the tax comes into effect, the economy falls off a cliff. All you did was bring the entire aggregate demand forward to get ahead of the deadline.

It’s still early days since this bill has to wind its way through Congress, but I know the value-added tax is getting a lot of consideration and always has.

I spoke to top people at the tax section of the American Bar Association. These people are career professionals, they’re lawyers who talk to the Treasury on a regular basis about policy. One of those top people said to me a couple of years ago during the Obama administration, “The Treasury has given up reforming the internal revenue code. It’s just too much of a mess. The only way they see that we can keep the U.S. from going broke and raise revenue is with a value-added tax, with a VAT.” That’s the default position.

With the Trump administration and Congress saying you have to be revenue neutral and Trump committed to income tax cuts, there’s no way to square that circle without a big revenue raiser, and VAT is the biggest thing out there. We have to keep an eye on it. It may be coming, but it can have these weird effects of bumping inflation.

There are offsetting forces, and that’s what makes it tricky. On the one hand, sticker shock at the counter might give you an inflationary mindset. On the other hand, if everyone is running around spending before the tax and then not spending after the tax, that can actually be deflationary if aggregate demand drops and the economy runs into a brick wall.

The problem with all this is it’s not difficult to define theoretical outcomes based on what we know, but because these things are behavioral and psychological – what I call emerging properties of complex dynamic systems – basically we’re manipulating behavior and shouldn’t be surprised if we get some very bad results.

Alex:  I had a really interesting conversation with a friend of mine whom you also know named Ronnie Stöferle. He manages a fund out of Lichtenstein called Incrementum. Our conversation was around this idea of fragility in markets. It seems clear to me, and to observers like Ronnie and other people I consider to be very smart, that the markets are becoming increasingly fragile.

If we can pick up on a comment you made in a recent interview, you said that companies most vulnerable to financial turmoil are those that rely heavily on high leverage and financial engineering to produce returns. You included banks in that category, and you forecast some potentially dire outcomes and consequences to this.

For those of our listeners who are new to these concepts, touch on why these are legitimate concerns and more likely to play out than not.

Jim:  You’re right; I do know Ronnie very well. He’s a great guy and very astute market analyst. I call him an Austrian for the 21st century, meaning he’s a follower of Austrian economics but he’s followed a lot of recent development in economics and theoretical approaches to it. He brings that Austrian mindset but with a lot of really good, up-to-date technology. I think he is one of the sharpest commentators and fund managers out there.

Let’s address the issue of fragility and the impact of leverage by starting with leverage. Leverage is a pretty simple thing to understand. It means borrowed money that could be derivatives, off-balance-sheet contracts, futures and options which have embedded leverage, or it could be outright borrowed money.

It means you get more of whatever you’re betting on. If I buy a stock for cash and it goes up 10%, I made 10% at least on a mark-to-market basis. But if I buy stock on margin, borrow half the money, and it goes up 10%, I don’t owe any more debt. I owe the original debt, so I actually made 20% because I only had 50% equity. My 10% return becomes a 20% return if I bought it with half borrowed money, because I’m making the same amount of profit on half the investment, so obviously that gets a higher return.

Naturally, it works in reverse. You can lose twice as much money. If you leverage ten to one, you can lose ten times as much money.

What leverage does in any form, whether it’s outright debt, a note, or a derivative contract of some kind, is just amplify your return. Depending on the amount of leverage, you’ll make twice as much or ten times as much or a hundred times as much, and you can also lose just as much.

If you’re on the losing side of a highly leveraged trade, a very bad thing happens, which is you go bankrupt. In other words, if I have $1 million and I leverage it ten to one so I have a $10 million bet with $1 million of equity and $9 million of borrowed money, if my $10 million bet goes down 10%, I’ve lost 100% of my equity because I’m leveraged ten to one in that example.

It only takes relatively small market moves to completely wipe out your equity and force a bankruptcy. This is what was happening in 1998 and 2008. It happens to individual firms along the way. You see people making these leveraged bets over and over. That’s the impact of leverage.

Now you get into something called contagion. The IMF likes to call it spillovers, but it’s the same thing. You make a big leveraged bet, and if you win, it’s nice because you make a lot more money – everyone likes that. But if you lose, you don’t just lose more money, you actually wipe out your equity and go bankrupt, so you walk away from the table.

Let’s presume you have trading partners. The thing about trading and capital markets (money markets, stocks, bonds, etc.) is that as Paul Simon once said in a song, one man’s ceiling is another man’s floor. One firm’s mark-to-market loss is somebody else’s mark-to-market gain.

If the loser goes bankrupt and the person on the other side of the trade who had the gain goes to collect his winnings and the guy is not there, it’s like he won at the casino, took his chips over, and somehow between the table and the cashier, the casino shut down and went bankrupt. He’s basically sitting there with a bunch of plastic or rubber chips and can’t get his money.

Now the guy on the right or winning side of the trade might find that he’s in financial distress, not because he made a bad trade, but because he had a bad credit by doing the trade with a person who’s no longer there.

This is exactly what happened with AIG in 2008. AIG had all the losing bets. Goldman and Citi Bank and many others had the winning bets, but when they turned to AIG to collect, AIG was practically bankrupt and couldn’t pay. The government had to bail out AIG, not because they loved AIG, but because they said, “If we don’t bail out AIG, all these other firms, starting with Goldman, are going to go bankrupt.”

That’s how the danger spills over or there’s contagion. Think of it as like a disease where one person infects another and it just gets worse. All of a sudden, we go from individual hedge funds, small institutions, and individuals to some dealers going bankrupt, then they have a clearing broker who goes bankrupt, and next thing you know, it’s threatening the solvency of the entire futures exchange or derivatives exchange or banking system as a whole. That’s how it spins out of control and fragility comes in.

That’s well understood, meaning people have observed that many times. Credit officers try to prevent it by not permitting that much leverage, but they never get it right. So much of it is hidden, so much of it is off balance sheet, so much of it migrates to new ways.

The regulators are always fighting the last fire. After 2008, they were very determined to make sure we didn’t have another housing credit crisis. I don’t think we’re going to have another housing credit crisis because it’s extremely difficult to get a housing loan right now. But how about dollar-denominated emerging markets debt? How about the high-yield market? How about various forms of derivatives? How about buyout loans that corporations take out to buy back their own stock or pay dividends?

There are a whole host of other areas where this problem could emerge. Just because regulators went around and cleaned up the mortgage market doesn’t mean they have a good handle on all those other things.

Let’s burrow down inside the off-balance-sheet commitments of a major bank where we get into things like asset swaps. An asset swap would be if I want to borrow money but the person I’m dealing with only takes high-quality collateral, let’s say treasury notes, and I have a bunch of garbage corporate bonds on my books. I go to a mutual fund or a pension fund and say, “I’ll swap you my corporate bonds for your treasury notes on agreement to swap back.” It could be one week, one month, an overnight trade or whatever, but I’d give a whole bunch of corporate stuff as collateral and they’d give me treasuries.

Then I turn around and pledge the treasuries to the first guy who didn’t want my corporate junk but he will take the treasuries. I’m swapping corporates for treasuries so I can do another deal where I post treasuries as collateral, get some other line of credit, and add some more leverage on top of that.

This asset swap is an off-balance-sheet transaction; it’s invisible unless you know where to look. What started out as a two-party trade between the bank and the counterparty turned into a three-party trade between the counterparty, the bank, and the pension fund in my example. Instead of two assets being swapped, you get three or four.

This goes on all the time. All these conversion futures, asset swap futures, and off balance sheets are expanding, and this is where we now segue into complexity theory and how I really think about markets.

To Ronnie’s point that markets are getting more fragile, I think that’s right, but I would say they’re always fragile to some extent. The question is, how do we think about the risk? How do we measure it?

The way I think about it is in terms of systemic scale. Scale is just a fancy, more technical word for the size of the system. The point is the risk of the system. I’ll define risk as the worst thing that can happen, so what’s the biggest meltdown, the biggest collapse, the most contagion, the 2008-type of event? What’s the biggest disaster that can happen in the system?

Intuition says if I double the size of the system, I probably double the risk. If I triple the size of the system, I probably triple the risk, although the value-at-risk jockeys, risk managers on Wall Street, wouldn’t even say that. They’d say no, you can double or triple the system and increase the risk not at all or very little, because it’s long-short, long-short, long-short. In other words, you’re pairing off all these trades that net out to a small number, and it’s only that small number that really reflects the risk.

This is complete nonsense for the reason I mentioned earlier. That way of thinking about risk is fine when nothing bad is happening, but the minute something bad happens, you don’t get to pair off, because there are two different counterparties, and now you’re worried about the counterparty of your winning trade.

You’re stuck with the losing trade. The winning trade that supposedly pairs off from a market risk perspective all of a sudden has the guy going bankrupt. The market risk converts into credit risk, so you still lose and go bankrupt yourself. That’s why value at risk has no capacity to deal with it at all.

Leaving that aside, the value-at-risk people would say risk is very little. The people using intuition would say you double the system and the risk. The fact is, if you double the system, you don’t double the risk; you increase it exponentially by perhaps a factor of ten or even more.

As we see these off-balance-sheet relationships, derivatives, outright leverage, and hidden asset swaps all grow, think to yourself, the system is not just getting riskier; it’s getting exponentially riskier.

We’re at a point now where the biggest banks are bigger than they were in 2008 with a higher percentage of total banking assets. The off-balance-sheet exposures are larger. The amount of debt in the world is significantly larger.

The notion that we deleveraged the system since 2008 is nonsense. We’ve not only increased the leverage – meaning the debt and the derivatives – but we’ve concentrated it in fewer and fewer hands. This makes it even more dangerous and more likely that one party in distress is going to take down the entire system.

What I expect based on very good science – not just my gut but you can actually see it unfortunately in front of your eyes – is a new collapse coming that is far worse than what happened in 2008. I think that’s Ronnie’s point, and I agree completely.

Alex:  This reminds me of a quote I heard that went along the lines of financial services today consisting of the dark art of shuffling and reshuffling the same paper assets over and over again in order to generate larger and larger returns.

On a scale perspective, give people an idea of how big this has gotten, the derivatives market. How big is this in dollar terms, and how big is it compared to everything else?

Jim:  It’s getting close to a funny number that is called $1 quadrillion at notional value. It’s a little bit lower than that, a little over $700 trillion, but is converging in on $1 quadrillion. $1 quadrillion is $1000 trillion, so take a second to get your mind around that.

That is approximately ten times larger than global GDP. Global GDP, the entire value of all the goods and services in the world, is approximately $70 trillion and the gross notional value of derivatives is approximately $700 trillion, so derivatives are ten times larger than global GDP.

Think of global GDP as the real economy, real stuff that we buy or make and sell, services we provide, etc. The derivatives are ten times that. Going back to what I said earlier, when you throw ten times leverage on something, it only takes a 10% drawdown to wipe you out.

A 10% drawdown on the gross notional value of derivatives would wipe out the entire global economy. Those losses would be larger than the total output of the world. That’s a pretty daunting thought.

Now take the second point I made, which is that it’s not linear, meaning when you scale up the system, the risk grows exponentially. This would be like an extinction-level event in archeology, geology, cosmology, and biology when all those sciences converge in different ways and have what is called an extinction-level event like when a comet or an asteroid hits the Earth and causes massive tsunamis, volcanic eruptions, black clouds, freezing temperatures or ice ages with a very high percentage of all life on Earth killed. There would be a few survivors, remnants, and then little by little, over millions of years, we would claw our way back to some kind of life. This is what happened to the dinosaurs and has happened more than once throughout history.

We could be looking at an extinction-level event in capital markets.

Alex:  The thing that is really concerning to me – and I’m sure others have thought of this, too – is the people who are driving these airplanes, so to speak. All of these derivative books are managed by human beings. What comes to my mind is that human beings are not infallible, as you well know. My question is, do these people actually know what they’re doing?

You had a front-row seat to a situation where the smartest guys in the room were running big money, and they could do no wrong. What is your view on that? Do they know what they’re doing? What is the chance that they don’t know what they’re doing, and that could really lead to some bad results?

Jim:  You’re right; I was Chief Counsel of Long-Term Capital Management. We had 16 PhDs in finance from Harvard, MIT, University of Chicago, Stanford, Yale, Colombia, and some others – what I call the usual suspects. Two of them won the Nobel prize. It’s an interesting mix. They were basically the biggest brains in finance.

We even had complaints from deans of some graduate schools of finance that we were depriving academia of the next generation of scholars because we were hiring so many top-flight PhDs to come work for us.

There was no shortage of brainpower, but they absolutely did not understand risk or any of the things we’ve been discussing on this call. I wasn’t particularly focused on it at the time I was there as a lawyer making sure the contracts got done, making sure compliance was good, and negotiating deals. I knew what was going on and saw all of the contract flow, but I was seeing it from a lawyer’s perspective instead of the financial risk management perspective.

It all blew up, and we brought the thing in for a soft landing in the sense that we got the Wall Street rescue money. Wall Street didn’t rescue us; they rescued themselves.

Going back to what I said earlier, we had $1.3 trillion of swaps on the books. This was one hedge fund in Greenwich, Connecticut. It wasn’t like JPMorgan Chase, but even our hedge fund had $1.3 trillion of swaps. If we had failed, if we had filed for bankruptcy, I would have just slept in the next day and caught up on my sleep after the whole bailout drama, but Wall Street would have been left with all the losses. They put in capital to keep us going so they could collect on their bets, so they bailed themselves out.

That group absolutely did not know what they were doing. Unfortunately, things aren’t much better. I look around at the central banks, the FOMC, monetary research staff at the Board of Governors in Washington or the Federal Reserve Bank in New York, and other central bankers around the world. What I discover is that these people got the same PhDs from the same schools as my former colleagues. In fact, they were associates.

I believe the PhD advisor on at least a couple of the partners at Long Term Capital was Stanley Fischer who today is the Vice Chairman of the Federal Reserve Board. It’s a club, they all know each other, they taught each other, they all believe the same thing. It seems impervious to new learning. They know what they know.

The short answer to the question is, no, these people do not know what they’re doing.

There’s no better example than around this time last year when Jamie Dimon had an annual letter to the shareholders of JPMorgan Chase. Around April or so, they come out with their annual report that always includes a letter from the CEO.

He was discussing events from the year before, from 2015. We were in the aftermath of the London Whale fiasco when they lost billions of dollars because of that derivatives trader. Based on what had happened, Dimon was saying this is like a 15-standard-deviation event (I forget the exact number), this is something that should only happen once every three billion years, it was so rare, etc. I read that and didn’t know whether to laugh or cry. It was certainly an embarrassment to Jamie Dimon.

All that jargon about three billion years comes from an understanding of risk management based on what’s called a normal distribution of risk. Sorry, but risk is not normally distributed. If you look at the time series of movements in any capital market be it stocks, bonds, commodities, and certainly gold, the degree of distribution is not normally distributed. It’s distributed in accordance with what’s called a power law or a power curve.

It’s not a dry academic argument about the shapes of two different curves. Those curves are just graphical representations of two completely different systems that function in totally different ways with different shocks and different outcomes to be expected.

That’s a scary example from the head of practically the biggest, most powerful bank in the world that shows they really don’t understand risk.

However, there are some people who do and are going along with this because they personally enrich themselves. In other words, if your understanding of a system is that you can pull the wool over someone’s eyes, this is anywhere from highly immoral and unethical at best to just outright illegal depending on who’s doing it and how.

I do believe there are people in capital markets who, even if they don’t comprehend exactly how risk works, recognize that the standard models understate the risk, which means they can go around selling garbage to their customers who won’t understand it.

It’s like signing up for fire insurance, they’re pouring gasoline in the basement getting ready to light a match, and then the insurance is no good when the fire burns the house down. That’s kind of how they operate.

There are also some people who do get it but they’re like me; they’re writing books, they’re doing commentary, they’re practically yelling that the system is ready to implode. If you’re not actually running the Federal Reserve, then you try to have impact, but it’s a challenge.

I think most of the policymakers have no idea what they’re doing, some do but they’re kind of in it for the money because they can enrich themselves, and others do but they’re not in a position to change policy except through influence such as writing and speaking.

Eventually things will get straight. The question is, how much more damage will we have in the meantime?

Alex:  I can tell you from personal experience that I concur. I’ve seen a large number of former and current Wall Street traders and people who have run large companies in financial services go to gold and buy gold for the very reasons you’re talking about.

The financial media and a lot of people in positions of credibility in financial services may not talk a good game about gold – probably because they don’t make any money selling it – but at the same time, I have seen them go to it for the very things we’re discussing.

Let’s shift our attention now to the national debt and where that’s at, how it gets serviced, what are the outcomes, and what are the solutions. National debt is sitting right around $20 trillion, and the debt ceiling has been a big deliberation lately.

Depending on how you work the numbers, I’ve read that there’s as much as maybe $10 trillion of additional deficit that’s probably going to end up happening because of spending that’s basically already been approved and is on the books.

You recently said that real economic growth is simply a matter of how many people are working and the productivity of those workers. What is the productivity of those workers? Demographic trends are what they are; there’s not much we can do to change those forces.

In much of the developing world, we have an aging workforce that is not being replaced with the same number of younger workers. Combined with the fact that productivity has been stagnant and not really growing sufficiently to service the increasing debt burden, we have a math problem here that does not seem to have a plausible solution.

We’ve discussed over time that certain structural reforms could help with this, but there’s no political will to do so, and therefore one more reason for people to get their financial house in order.

The way I look at it is time is growing short, maybe too short for systemic changes to be made, so why do people need to be paying attention to this, and what should people be studying to better prepare?

Jim:  One of the points you raised, Alex, is that this is a math problem. We are so spun up today in ideology, left versus right, elites versus everyday people, Republicans versus Democrats, progressives versus nationalists, take your pick. Everybody is yelling and screaming at each other, everybody is upset, and nobody is getting along, but the thing about math is that it has no ideology; it’s just numbers. You can look at this deficit problem very clinically. It doesn’t matter if you’re a Republican or a Democrat; these numbers are going to eat you alive if you don’t do something about it.

Let’s just look at a couple of relationships. Throwing out a number of $20 trillion in national debt is important, but a debt in isolation doesn’t tell you very much. You have to compare it to your ability to pay, meaning that I look at the debt-to-GDP ratio.

Here’s a very simple example:  Let’s say you make $30,000 a year and have $100,000 on your credit card. You’re probably going to go bankrupt, because you can’t service $100,000 of debt at the exorbitant credit card interest rates with a $30,000 income. Now let’s say you make $5 million a year and have $100,000 on your credit card. No problem; you can probably just write a check and pay the whole thing off. The point is, you cannot look at the $100,000 of credit card debt and answer the question of whether that’s a bad thing or an okay thing without understanding how much income the person has to service it. The $30,000-a-year person is probably going broke while the $5-million-a-year person is probably just fine.

When you say $20 trillion of debt, I immediately look at it in terms of the GDP. Now that ends up being a scary number. I’ll go all the way back to when Ronald Reagan was sworn in as president in 1981 and our debt-to-GDP ratio was 35%. I can’t recite the numbers off the top of my head, but it doesn’t matter. The numbers are a lot smaller, and what matters is the ratio of 35% I just mentioned.

Reagan was actually a big spender contrary to his conservative credentials. He took the debt-to-GDP ratio up to 55%, which is a 60% increase. If you throw 20 percentage points on top of 35% to start and get up to 55%, that’s a 60% increase in the debt-to-GDP ratio in the eight years of Reagan.

Having said that, we got something for the money, which is we won the Cold War. Reagan spent it on a 600-ship navy and Strategic Defense Initiative – the so-called Star Wars. He at least spent the money on a lot of good things, and the Soviet Union collapsed, so we won the Cold War. I would say yes, he spent a lot of money, but we fought a war, won it, and got something for the money.

In the years of George H. W. Bush and Bill Clinton, the debt-to-GDP ratio did not go up a lot. It went up a little bit, 60%, 61%, and came back down again. Believe it or not, Clinton actually banged out a couple of surpluses at the end of his administration, but it remained pretty constant in that 60% level.

Now, 60% is a big deal, because that’s considered the outer limit of the danger zone. If you look at Europe and the Maastricht Treaty and what the members of the European Monetary Union (the so-called Eurozone) commit to, they say they’re going to keep the debt-to-GDP ratios below 60%. They haven’t all done it; Greece is off the charts at about 120%, but nevertheless, they’re held to that 60% standard, and that’s how Angela Merkel measures it.

Kenneth Rogoff of Harvard and Carmen Reinhart who was at University of Maryland and might be at Colombia now are two of the leading monetary scholars and economic historians. They have looked at this closely, done a ton of research, and they think the danger zone is 90%.

This would mean that 90% debt-to-GDP is the place where more debt doesn’t help you. More debt doesn’t give you any bang for the buck but actually retards growth, and it makes it more difficult to pay off the debt. You start to look more like the person with $100,000 credit card debt making $30,000 a year.

Guess where we are today? We’re at 105%. By any definition whether Angela Merkel’s definition or the Rogoff and Reinhart definition, we are way in the danger zone. This simply means that Trump does not have the degree of freedom Ronald Reagan had.

Trump wants to be a big spender. He wants to rebuild the military and do infrastructure – bridges, tunnels, airports and new roads. We all love all that stuff, don’t we, but he doesn’t have the fiscal space – the running room – that Ronald Reagan had. Not even close.

In fact, he’s highly constrained, and Congress is going to insist that tax cuts be revenue-neutral. Where are you going to get the stimulus for all this spending that everyone keeps talking about?

The $20 trillion is just the tip of the iceberg. That’s treasury debt. Those are bills, notes, and bonds where we owe you the money and you get some contractual right. That doesn’t count contingent liabilities or include Medicare, Medicaid, social security, veterans’ loans, federal home, farm loans, student loans, food stamps. These are all conditional and contingent liabilities the U.S. government has piled on.

If you do that, multiply it by ten, and we don’t have a 105% debt-to-GDP ratio; we have a 1000% debt-to-GDP ratio. There’s $103 trillion of these contingent liabilities.

I’ve heard mainstream economists say, “You don’t have to count that, because we could always change the law.” Really? You think you’re going to get rid of social security? Technically you can change the law, but that’s just wishful thinking and is absolutely not happening in the short run, because Trump says he’s not touching entitlements.

How do we get out of this? Notionally, there are four ways out. One is growth. You could grow your way out of it if you held the debt constant or it didn’t go up very much and you grew the economy faster than the debt was growing. That would lower the debt-to-GDP ratio and is exactly what the United States did from the end of World War II until around the time of Ronald Reagan as I just described.

But that gets back to what is the source of growth? It is simply expansion of the labor force times productivity. How many people are working? How productive are they? Like the old song by Peggy Lee, Is That All There Is? That’s all there is – working force times productivity.

The problem is, if your working force is growing about 1.5% a year and your productivity is about 1% a year or a little bit more, you multiply one by the other and get a number that’s less than 2%. But how much is the deficit going up?

Today we’re in a sweet spot where the deficit is going up around 3% to 3.5% of GDP, but projections that just came out of the CBOE show that we’re past the sweet spot. That number is going to start to go up to 4% and ultimately 5% and 6%.

Let’s be generous and say your economy is growing 2% and your debt is growing 3% or 4%. Your debt-to-GDP ratio isn’t going down; it’s going up. It’ll go up from 105 to 106 to 110. You’re on the path to bankruptcy just like Greece.

What can you do to increase the labor force? One of the big ways to do it is immigration. By the way, people are not having enough kids. I’m going to leave that debate to others, but the fact is demographically, indigenous population is not growing. We’ve been relying on immigration.

What’s Trump doing about immigration? He’s building a wall through Mexico. Again, I don’t want to jump into these policy debates. You could be pro-wall or anti-wall, knock yourself out. I’m just saying that this approach to immigration is not going to help the U.S. expand the workforce.

Then beyond that, you can say, “Let’s get people off the couch. Let them stop eating Doritos and watching Final Four basketball and get back in the workforce.” Really? Check out the opioid epidemic. There’s more to it than that, but this is devastating. There are a lot of reasons to think that we’re not going to be able to grow the workforce more than about 1% if we’re lucky.

Productivity is declining, and economists are not sure why. That’s an interesting debate for another day, but those are just the facts. So, it doesn’t look like we’re going to grow our way out of this. Growth is a good way out, but it’s not happening.

The other thing we can do is simply default on the debt and say, “Hey, we’re not paying you.” That’s not going to happen. Why should it? We can print the money, so why on earth would we default on debt denominated in a currency that we can print? You wouldn’t do it, so that’s not going to happen.

The only thing that’s left is inflation, and that’s what they’re trying to get. The irony is that we have a central bank that’s been trying for eight years to get inflation, and they can’t do it. It’s a pretty sad thing when the central bank wants inflation and can’t get it.

Inflation is the traditional way out, but we’re not getting the inflation. We look like Japan; we are Japan. I said that in my first book, Currency Wars, and even before that. In 2009/2010, I said we are Japan.

Ben Bernanke scurried around in the 1990s and early 2000s as a private economist and as a member of the Federal Reserve Board and later Chairman yelling at Japan, “You’re messing this up, you don’t understand how to use monetary policy,” really bashing the Japanese. Yet he went out and made every single mistake the Japanese made. We are Japan and will stay that way as far as the eye can see. It’s a slow-motion train wreck that sneaks up on people.

One of the reasons I own gold is because it’s kind of immune. If we have inflation, gold will do just fine. If we have a catastrophic collapse, again, gold will do just fine.

Maybe that’s a good place to wrap up. We’ll drill down on gold the next time, but gold is your insurance.

It’s been a pretty gloomy call, but it’s always a pleasure to talk with you, Alex and Jon, and our listeners. We’ve covered a lot of systemic risk and market risk, we’ve talked about leverage, derivatives, complexity theory, and the debt-to-GDP ratio. All of these things seem to be pointing in very bad directions, and they are. That’s not being a pessimist; that’s just being realistic and trying to do some good analysis.

The solution to all of them, at last for the individual, is to get some insurance through gold. I recommend a 10% allocation of physical gold. If you don’t have that much, start your allocation today and try to get there. Don’t use paper gold. Get either gold in storage – which is, of course, what Physical Gold Fund offers – or for smaller accounts, go get some coins and bars and put them in a safe place.

Alex:  Very good. I want to thank you, Jim. It’s been a great discussion today, and I really appreciate it. As always, it’s very insightful, and I look forward to doing it again next time.

Jon:  Indeed. Thank you, Jim Rickards, and thank you, Alex. It’s always a pleasure and an education sharing this time with both of you.

Most of all, thank you to our listeners for spending time with us today. Let me encourage you to follow Jim and Alex on Twitter. Jim’s handle is @JamesGRickards, and Alex’s handle is @AlexStanczyk.

If you’ve enjoyed this podcast, please recommend it to your friends. If you’re watching on YouTube, please click “like” and “subscribe.” If you’re listening on iTunes, please give us a rating and a review.

Goodbye for now to everyone, and we look forward to joining you again soon.


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The Gold Chronicles: March 2017 Interview with Jim Rickards and Alex Stanczyk


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Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles February 9th, 2017

Jim Rickards and Alex Stanczyk, The Gold Chronicles February 9th, 2017

Topics Include:

*Golds role as an international alternative to the United States Dollar
*How financial warfare between sovereigns works
*Strategic view on changes to sovereign gold reserves
*China is slowly shortening the maturity structure of its US Treasuries and letting them run off the books versus selling
*Analysis of projected Trump policies; deep dive into some of the inconsistencies and potential scenarios
*Trump may be able influence the appointment of as many as 4 or 5 members of the FOMC
*Currency Wars are alive and well, new rounds of devaluation are starting
*Helicopter money and price inflation
*Are capital markets complex systems, and why it matters
*Why traditional models such are VaR are old science that may no longer apply to markets
*Specific criteria used in physics to identify a complex system
*Triffin’s Dilemma and gold


Listen to the original audio of the podcast here

The Gold Chronicles: February 9th, 2017 Interview with Jim Rickards and Alex Stanczyk


The Gold Chronicles: 2-9-2017:

Jon:  Hello, I’m Jon Ward on behalf of Physical Gold Fund. We’re delighted to welcome you to the latest podcast with Jim Rickards and Alex Stanczyk in the series we’re calling The Gold Chronicles.

Jim Rickards is a New York Times bestselling author, Chief Global Strategist for West Shore Funds, and the former General Counsel of Long Term Capital Management. He is currently a consultant to the US Intelligence Community and to the Department of Defense. Jim is also an advisory board member of Physical Gold Fund.

Hello, Jim, and welcome.

Jim:  Hi, Jon. It’s good to be with you.

Jon:  We also have with us Alex Stanczyk, Managing Director of Physical Gold Fund. Alex is an expert in the physical gold industry dealing with the logistics chain from refinery to secure transport and vaulting. He has lectured globally to investor, institutional, and government audiences on the role of gold both in the international monetary system and in investment portfolios.

Hello, Alex.

Alex:  Hello, Jon. It’s great to be here. I’m very excited about today’s podcast. This is a new format where we’re recording directly, so we’re going to dive right in.

Jim, you recently collaborated with some of the nation’s leading experts on economic security and contributed to a report published by the Center on Sanctions and Illicit Finance. Would you talk about gold’s role as an international money alternative to the United States dollar?

Jim:  I’m happy to, Alex. The report you’re referring to was just released, and you’re right, it’s the Center on Sanctions and Illicit Finance – CSIF, we call it. It’s part of a larger Washington think tank called the Foundation for Defense of Democracies. It has quite a distinguished setup of scholars, advisors, boards of directors, and so forth.

They have a website, so everything we’ll be talking about here is publicly available. I encourage listeners who are interested to go to the Center on Sanctions and Illicit Finance at the Foundation for Defense of Democracies, FDD. You’ll find it easily.

Our release was a new report geared to the transition. I was one of the contributors out of a number of other contributors and editors involved. We started working on this last summer not knowing whether Hillary Clinton or Donald Trump would win the election. My own view was that Trump would win. It was proposed as a transition document to help whichever administration came in to understand these linkages.

To help our listeners understand it, just picture a simple Venn diagram – two big circles. Think of one circle as defense, intelligence, national security, diplomacy – all those aspects of national security broadly defined. The other circle is global capital markets that include stocks, bonds, commodities, derivatives, obviously gold, foreign exchange, etc.

Imagine these two circles intersecting so they converge and there’s some overlap. That overlap where national security issues and global economic issues come together I’ll call “geo-economics” for a word. That’s really my specialty and the area this group and I work in.

That area is getting larger and larger. It’s difficult to think of a national security issue today that is not also an economic issue. Going back to the Obama administration, there were a lot of confrontations with Russia, North Korea, and others. Going back even further through the Bush and Clinton administrations where for whatever reasons the United States did not want to use military force but did not want to be uninvolved or let countries do whatever they wanted, we used economic sanctions.

Nobody wanted to start a war in North Korea, but we wanted to put economic pressure on them to stop their nuclear program. Nobody wanted to start a war in Iran, but we wanted to put economic pressure on Iran, again with regard to their uranium enrichment program. Then there were kind of rogue states like Syria where we would use economic sanctions to try to make it more difficult for the regime in power.

This whole area of economic warfare, financial warfare, includes an even more specialized part called cyber financial warfare using cyber techniques, which can affect any part of critical infrastructures. It could affect dams, hydroelectric plants or the power grid, etc., but we would aim it specifically at banks, stock exchanges, financial message traffic systems like SWIFT, etc., in an effort to disrupt the economy.

Kinetic warfare involves bombs, tanks, and things that shoot or explode – physical force. The purpose of kinetic warfare is usually to degrade the economic power of your opponent. In World War II and wars, we bombed railroad depots, pipelines, and factories not only to attack military forces but also to degrade the economy.

If you can do that with sanctions and cyber financial warfare, you can skip the bombs and get the same effect using other 21st-century cyber financial techniques. That’s what our center does. We just released this report that will go to senior officials in the Trump administration, but it was really a bi-partisan approach calling attention to this.

My particular contribution was a section I wrote involving gold. I thought that’s where I could make the biggest contribution, because even though there were a lot of scholars, as you and our listeners know, I still regard gold as money. I regard gold as the foundation of the international monetary system, but that’s a bit of a minority view.

Most people – certainly mainstream economists, central bankers, and others you talk to in the economics profession and policymakers – think gold is kind of a joke. They’re like, “Yes, we have some, but as Ben Bernanke said, it’s a tradition,” or “We don’t think it plays any role,” or they’ll quote John Maynard Keynes saying it’s a “barbarous relic.”

We all know the rap on gold. I went through this in my book The New Case for Gold, where I took these objections one by one, deconstructed them, refuted them, and showed that they don’t hold up. We’ve talked about that on prior podcasts, so I don’t need to repeat that whole analysis. But it’s fair to say that most economists and analysts don’t like gold very much, and yet I think about it quite a bit not only in monetary terms but also in strategic terms.

Since this was for the new president, it will go to Trump’s cabinet members and others, so I thought it was a good opportunity to inject gold into the discussion.

Here’s the point I made, and this is all obviously factually based. There’s something I call the axis of gold. I presently include four countries, although I could include others perhaps over time. They are Russia, China, Iran, and Turkey. We probably need to include North Korea in some ways, but let’s just start with those four.

What do I mean by the axis of gold? Number one, they are all acquiring massive amounts of gold. We spent a lot of time in the past talking about the Russia/China story. Russia has tripled their gold reserves in the last ten years from around 600 tons to 1800 tons in round numbers. China has done likewise officially, but unofficially we estimate that they have even more gold than they admit. China has gone from about 600 tons to 800 tons that they acknowledge, but my estimate is they probably have 3000 or 4000 tons, perhaps more off the books in the State Administration of Foreign Exchange. So, the Russia/China story is pretty well known.

Less well known is the Iranian story. We have even less information on Iran than we do on China, because Iran is an outlier and a bit of a pariah in the international financial system. There’s not a lot of gold mining output in Iran. There is in China, by the way. China is the largest gold producer in the world from a mining perspective, producing – at least for the time being – about 450 tons a year. That’s more than twice as much as the next closest country.

Iran is not. Iran gets their gold from abroad. Where? A lot of it comes in from Turkey, trans-shipped through Turkey. Some of it is smuggled in from Dubai right across the Strait of Hormuz.

I’ve been to Dubai a number of times. The smuggling boats, called dhows, are down in the waterfront called the Baniyas Road, and they’re all lined up. You see boxes full of HP printers, Sony TVs, Apple iPhones, and all that, but who knows what’s inside the boxes? There is probably a fair amount of gold in there.

They fly it in from Turkey, they smuggle it by boat from Dubai, and they recently got billions of dollars of gold courtesy of the United States of America. Our listeners are familiar with President Obama’s efforts to induce Iran to sign a deal that would in theory defer their uranium enrichment program for ten years and slow down their effort to become a nuclear power. I don’t want to spend a lot of time on the deal itself, because there are enough critics out there, and our listeners can find out all they need to know about that.

Part of the deal is that the U.S. would release some funds we froze years ago that were owned by Iran and also provide other money that could look a little bit like a ransom for some hostages. Leaving that aside, the amount was well over $10 billion.

Over $1 billion was in the form of cash. When I say cash, I don’t mean a wire transfer; I mean physical bank notes. We couldn’t give them U.S. dollars, because Iran doesn’t want dollars. They’re pretty much out of the dollar system. We actually had to call the central bank of the Netherlands and do a swap with them. They sent large-denomination euro notes to Iran, because they’ll take euros and other forms of money, including gold.

Included with these ransom payments was billions of dollars of gold. We don’t know the exact amount as that’s never been disclosed, but you can think of it as several hundred tons, perhaps more. So, they’re all accumulating gold.

Why are they doing this? They’re doing it for a couple of reasons. One is to insulate or protect themselves from U.S. dollar inflation. The U.S. has an unmanageable, non-sustainable debt problem approaching $20 trillion of debt.

That wouldn’t be so bad if the economy was growing fast enough to pay it, but it’s not. Our annual deficits are over 3% of GDP and our growth is around 2%. If you grow your deficit faster than your economy is growing, you’re going broke. You may be going broke slowly, but you’re heading down the same path as Greece.

Also, the Trump administration is talking about $1 trillion of critical infrastructure spending over and above the existing deficit. All of this looks completely unsustainable, but there is one way to deal with it, which is inflation. If you can generate enough inflation, the real value of the debt goes down and you end up paying it with cheaper dollars. You just print the money and pay it off.

What single entity has the most dollars in the world? The answer is China. They have well over $1 trillion of U.S. treasury notes that are vulnerable to devaluation through inflation. China can’t dump those. The treasury market is big but it’s not that big, and China knows it. If they tried to do it in a malicious way, the president could stop them with one phone call.

What they’re doing is letting it run off little by little. They shorten the maturity structure. Every month that goes by, a certain number of these treasuries mature. China just gets the money, but they don’t have to sell anything. They don’t have to dump them; they just kind of run off. It begs the question, what do you do with the money? One of the things they’re doing is buying gold.

Some people have speculated that they’re trying to come up with a gold-backed yuan. I find that highly improbable. There are many reasons why the yuan is not ready for prime time or it’s not in a good position to be a global reserve currency even though the IMF says it is. I think the IMF bent the rules to do that for political reasons.

The yuan is not ready. They don’t have a bond market, they don’t have rule of law, they don’t have repos, futures, options, dealers, auctions – all that plumbing and infrastructure needed to run a bond market so that people who have your currency have something to invest in. It just doesn’t exist and won’t for at least ten years, perhaps longer.

They don’t have enough gold to back their currency. The People’s Bank of China has printed more money than the Fed. People like to beat up the Fed about printing money – and they should. They printed close to $4 trillion since 2008, but the People’s Bank of China has printed even more with less gold than the United States. So, they’re not ready for that.

What they are doing is creating a hedge. Let’s say that there is no inflation and the dollar is stable. I don’t expect that, but let’s just assume it’s true. The dollar price of that gold might not do very much, but China will be happy because they’ll get their treasury securities paid off in real dollars.

On the other hand – and I think this is far more likely – we inflate the currency. We say to China, “Hey, China, here’s your $1 trillion. Good luck buying a loaf of bread, because we printed all the money.” China could shrug and say, “Yes, maybe our treasuries are worth less because of inflation, but our gold is worth more.”

Without dumping a single treasury and while continuing to have a substantial investment in U.S. dollars, the physical gold acts as a hedge so that if we resort to inflation (which in my view, we will), the gold will be worth more and their wealth will be preserved.

By the way, that’s a reason for every investor to have an allocation of gold. I recommend 10%, but people can do more or less according to their personal preferences. If nothing else, gold is good if the monetary system collapses, it’s good in a panic, and it always preserves wealth in the long run.

There are many, many reasons to have gold in your portfolio, but one of the most obvious that people get is inflation insurance. I like to say if it’s good enough for China, it’s good enough for me. I do recommend savers and investors allocate some of their portfolio to physical gold for that reason. That’s exactly what China is doing.

Russia is doing something similar, but I think Russia is more aggressive. They’re actually looking for ways out of the dollar payment system, maybe create a ruble zone. The ruble is also not ready to be a global reserve currency, but it could be an effective regional reserve currency meaning something that trading partners would accept.

Those trading partners would include places like Kazakhstan, Belarus, Crimea is part of the Russian Federation now, and Turkey, which is a major trading partner of Russia. That could be an effective inflation hedge as I described in the Chinese situation, but it’s also a form of wealth.

Iran is not very plugged into the global payment system. They’ve been in and out of SWIFT, and some of the sanctions are starting to ease up, but now the Trump administration is slapping them back on again.

Obama put them on through the end of 2013 to get Iran to the bargaining table. Once Iran came to the bargaining table to talk about the uranium enrichment program, Obama started to alleviate the sanctions, which he did to a great extent although not completely. Now that Trump is in, he is slapping sanctions back on again, because Iran is violating the agreement with missile testing.

This switching back and forth between sanctions and gold and dollars and missiles I hope makes my point that the geopolitical and the economic are converging and are very closely related.

For Iran, it’s an alternate form of wealth. Gold is fungible, it’s non-digital, you can’t hack it, you can’t erase it. If you take it to a refinery, even if you receive bars with serial numbers on them and assay stamps on them, big deal. Melt them down and make your own bars with your own new serial numbers. It’s an element; it’s atomic number 79. It’s completely untraceable. You can turn gold in one form into gold in another form. It’s still gold, but in such a way that it can’t be traced.

Iran’s motives are a lot more nefarious, and I talked about Turkey also. Turkey has confronted NATO and the United States. They’re somewhere between Iran and Russia in terms of looking for alternate stores of wealth on the one hand, but also thinking about what happens if they get kicked out of the financial system. How can they conduct trade and suddenly bounce payments?

Now let’s introduce North Korea. North Korea might be the most dangerous spot in the world. We certainly hear about confrontations in eastern Ukraine, the South China Sea, and the Senkaku Islands off of Japan. There are enough hot spots to go around, but North Korea may be the most volatile, the most dangerous.

North Korea is obviously testing intercontinental ballistic missiles. They don’t have one that works consistently yet, but they’re getting better at it and are moving in that direction. When they fire a missile and it fails or blows up or falls into the sea, everyone says they failed, but in their minds, they didn’t fail; they learned something. They are a learning organization, so failures are not really failures; they point to something that can be improved, and then you do better the next time.

They’re weaponizing their uranium and plutonium, making it smaller. They’re increasing the distance of their missiles. They’re not there yet, but they’re getting closer to being able to fire a nuclear missile at Seattle and kill millions of Americans.

We’re not going to let that happen, which means that the U.S. is set up to attack North Korea with air power, bunker buster bombs, and maybe something even more powerful than that to degrade and destroy their weapon systems, their enrichment programs, and their missile testing systems.

In the meantime, North Korea is going down this path. Why are they doing that? Well, 98% of their people are practically eating bark off of trees. They’re starving and suppressed, but a very small elite live fairly well with a lot of luxury goods. That’s how Kim Jong-Un bribes his own military commanders, spy chiefs, elites, and others – with Western goods and money.

How do they get money? They’re not integrated with the international monetary system, so one of the ways is gold. Why are they developing these programs? Do they really want to attack Seattle? You can’t rule it out, but what they really want to do is sell it to Iran to use against Israel, and Iran pays for it with gold.

If you were to do a dollar-denominated wire transfer payment from Iran to North Korea, it would be frozen by the United States. It wouldn’t go through. All dollar payments have to go through a U.S. bank or a member of what’s called Fedwire, a wire transfer payment system the United States controls. We would see that payment, stop it, and freeze it.

But if I put gold on a plane and fly it from Tehran to Pyongyang and unload it to pay for my missiles, that’s completely untraceable. It’s non-digital, there’s no message traffic, there’s nothing. You don’t even know what’s in the plane. It could be tourists or it could be gold, or both. It probably is both, because you don’t want to shoot it down and kill the tourists.

These countries are now using gold to settle payments between themselves for weapon systems and other illicit transactions in ways that are non-traceable, cannot be interdicted, cannot be hacked, cannot be frozen, etc.

That was the point I was making in the CSIF report. If you are the incoming Secretary of State or Secretary of the Treasury – you’re Rex Tillerson or Steve Mnuchin – and you have to deal with this in addition to all of the normal sanctions relief you may or may not be familiar with, you certainly have to come up that learning curve pretty quickly. There’s a new kid in town which is gold, and this axis of gold as I describe it is using gold to preserve wealth, get out of the payment system, and actually settle transactions including illicit arms transactions between and among themselves.

That’s in the report. I hope the listeners will go find it online at Center on Sanctions and Illicit Finance, CSIF, Foundation for the Defense of Democracies.

Jon:  Thanks, Jim. That’s a fascinating outline.

I’m wondering, Alex, if you have any thoughts about Jim’s insights here.

Alex:  Jim, it’s interesting that you mention that gold is being used in these ways and that it’s a relatively new method of doing it. You’re a student of history just like I am, so you know that this is a repeat of what has happened in the past. Gold has been used for thousands of years as international money, and I think that’s what you’re getting at.

If you look at central bank managers or governors of central banks or former chairs of central banks among the elite financial crowd, many of them don’t look at it as money, or at least they don’t say that when they’re in office. I found it interesting that recently the former Governor of the Reserve Bank of India, after getting out of office, did say that gold was in fact the best international money, and former Federal Reserve Chairman Alan Greenspan said the same thing.

Jim:  Yes, we’re seeing more and more comments like that. I’m always fascinated by central bankers, and Alan Greenspan is a classic case. Before Alan Greenspan became Chairman of the Federal Reserve, he had a lot of positive things to say about gold going all the way back to the 1960s including through the 1970s and early 1980s before he was appointed Fed Chairman.

After leaving the Fed, he has given a series of public speeches where he had positive things to say about gold. The only time he didn’t have anything nice to say about gold was when he was Chairman of the Federal Reserve.

It’s almost as if you take that job and automatically shut up about gold, which tells you something right there, that it probably is important but they just can’t talk about it. Greenspan is an interesting case of a guy who has spoken candidly and favorably about gold before and after he was Fed Chairman but not during.

Jon:  Speaking of Greenspan, let’s turn our attention to the U.S. for a moment. The opening weeks of this new administration have hardly been uneventful, and I welcome your thoughts on the likely impact on the markets of the Trump White House.

We’re spoiled for choice. There are so many factors here – Trump against Janet Yellen, trade wars, banking deregulation. Perhaps you could pick the factor with the most immediate significance and take it from there.

Jim:  That’s actually a very tough question. First of all, you’re right; there’s no shortage of information or proclamations that are coming out of the White House about economic policies, whether it’s an actual executive order, pending legislation, a speech, or a tweet. We all wake up and read the President’s tweets to find out what’s going on. There’s a lot of stuff out there, and a lot of it is very significant.

Donald Trump has given some interviews. He said, “I go to bed around midnight or 1:00 and I get up at 5:00.” It’s like, “Okay, that’s four hours of sleep,” and he’s full of energy. He’s working 20-hour days. You hear stories about him calling generals at 3:00 am.

I think he’s driving his staff crazy, but he seems to have more energy than any of the people around him, and they’re all struggling to keep up. This is one of the most hyperactive administrations ever. You probably have to go back to Franklin Delano Roosevelt in 1933, but even then, I’m not sure they got as much done in 20 days. You always hear about the first 100 days of FDR, but this has only been 20 or 21 days of Trump and they’ve already turned the world upside-down, so there’s plenty to say.

I’d like to step back from that for a second and make a higher-level observation. Look at Trump’s individual statements; not just the President, but some of his cabinet appointees, members of Congress, people he’s working with, people on his staff, etc. Taken individually, there’s a lot of merit in many of them. I don’t agree with all of them, but who cares, that’s just my opinion. But a lot of them have merit.

Most of us think that cutting taxes is good because it’ll free up money for consumption and private spending or building infrastructure. It’s a good idea because our bridges, tunnels, and airports are falling apart, reducing regulation is a good idea, and so forth.

Individually, they sound like good ideas, but when you look at all of them, they don’t add up. There are some big contradictions and inconsistencies, and that’s what I’m focused on. It’s not so much a matter of being right or wrong; it’s just that if two things contradict each other, then there’s going to be a train wreck somewhere along the way.

Let me be very specific about what I mean by that. During the campaign, Trump complained that Janet Yellen was holding interest rates too low for too long. That’s probably true. I said they should have raised interest rates in 2009. I didn’t get much agreement at the time, but with hindsight, they skipped an entire cycle.

They wouldn’t be so desperate to raise them now during a period of weak economic growth and the late stage of a business cycle (which is not when you’re supposed to raise interest rates) if they had done their jobs and raised them in 2009 or 2010. But they didn’t. They missed a whole cycle and now they’re playing catchup, probably at the worst possible time.

They think two wrongs make a right, but they don’t. It’s just two wrongs. They should have raised them and then didn’t. They should not raise them now and they will, so they’ll probably mess up both times. They’re desperate to do that, but they did hold them too low for too long.

They probably had a good opportunity to raise rates last September 2016, but they did not do so because they were trying to help Hillary’s chances in the election. Trump has been critical of that. At face value, Trump wants higher interest rates.

There are two vacancies on the Board of Governors right now. These seats were left unfilled by Obama to help Yellen because he thought Hillary would win and she could fill the seats.

Oops, they’ve made a mistake there, because they didn’t foresee that Trump would win, and now Trump gets to fill those two vacancies. He’s going to have two Fed governors right off the bat. I would expect those announcements. There are some behind-the-scenes discussions with a couple of names being floated that I’ve heard about. We’ll see what happens, but I would expect those sooner rather than later.

Beyond that, Yellen’s term as Chairman expires next January. He’s clearly not going to reappoint her, so he’s probably going to pick somebody by December. They have to be confirmed by the Senate and ready to go by the time Yellen actually leaves in January.

There’s another governor, Dan Tarullo, whose role is regulatory matters. He’s not a monetary thought-leader in the way some of the others are, but he’s pretty strong on regulation. Trump will clearly appoint someone else to do the regulatory role, so I would expect Tarullo would leave because why would he stay if someone else just took his job?

So, Trump may get four appointments: the two vacancies – Tarullo and Yellen – and there are others coming out. Trump may get four or five out of seven seats to fill by the end of this year. That’s extraordinary and means that Trump can remake the whole Board of Governors.

He complained that interest rates are too low. Is he going to fill those seats with hawks so they’re going to raise interest rates? Well, hold on a second. Trump has also complained that the dollar is too strong; he wants a weaker dollar.

He accuses China and Mexico of currency manipulation. He also accused Germany and Japan of currency manipulation. Germany doesn’t have its own currency, they use the euro, so you have to point the finger at the ECB. Be that as it may, Trump has painted with a very broad brush and said that Mexico, Germany, Japan, China, and others have cheap currencies and that’s how they promote exports and cost Americans jobs.

This is currency wars 101. It’s what I wrote about in my first book, Currency Wars, a few years ago. I said at the time that they would continue for a long period of time, meaning 15 or 20 years. That book came out in 2011, so I’m not the least bit surprised that here we are in 2017 and not only are we still talking about currency wars, but they’re actually more urgent than ever because Trump is the President and he’s making a point of it.

Take everything I said in the last five minutes. Trump complains that interest rates are too low and he might appoint hawks, but he thinks that the dollar is too strong and he wants a weaker dollar. What happens when you raise interest rates? It makes the dollar stronger. It pushes in the opposite direction from a weaker dollar, which is what Trump says he wants.

There’s a basic contradiction there. You can’t have it both ways. You can’t have hawks raising interest rates and a cheap dollar at the same time, because higher rates make the dollar more attractive, money comes in, and the dollar gets stronger. That’s one problem.

Let’s take another issue called the border transaction adjustment or border transaction tax. This is something designed to promote exports and reduce imports, which would in theory reduce the U.S. trade deficit, help growth, create U.S. jobs in our export industries, and perhaps make it more attractive to manufacture in the United States instead of Mexico and China. This has been pushed by Peter Navarro, Dan DiMicco, Robert Lighthizer who is the designated U.S. trade representative, and some of the other inner circle members of Trump’s team.

What does it mean when you put tariffs on? You would tax imports with something like a tariff, and the cost of imports would not be tax deductible. If you’re a U.S. manufacturer and import components, you can’t deduct whatever you spend on those imported components from your taxes. In effect, it increases the cost of imports to a U.S. taxpayer.

Likewise, if you export items, the revenue from the exports is not taxable income. You don’t have to pay any tax on that. So, you lose your tax deduction on the cost of imports, you get a tax exemption on the proceeds from exports, and the combination of the two promotes exports and hurts imports. It acts like a tariff on imports. In effect, that’s what it is.

There’s another identity in economics, which is that savings equals investment in the aggregate. What happens when U.S. domestic savings are less than our investment which they are right now?

The United States spends more on investment, whether it’s housing or capital goods or other forms of infrastructure or long-term goods, than we save. The U.S. doesn’t save enough. Where does the difference come from? It comes from abroad, from overseas.

Foreigners invest dollars in our economy, and that’s how we make up the shortfall between domestic savings and investment. Where do foreigners get the dollars? They get it from running a trade surplus with the United States. They sell us stuff, we give them dollars, they take the dollars, and invest it back here.

There’s an identity there which is the shortfall between domestic savings and investment, which is exactly equal to the trade surplus of foreigners with the United States. It just has to be, because that’s where the dollars come from. They don’t come from Mars.

When you increase the cost of imports – in other words, when you put a tariff on or you do something like this border tax adjustment we talked about – and you increase the cost of exports, if that were the only thing happening, it would reduce our trade deficit. But then where would the foreigners get the money to make up the investment gap in the United States? And they have to.

The way that works out is that is that the dollar gets stronger. The stronger dollar offsets the impact of the tariffs. My imported goods could be French wine, a nice German pair of skis, a Japanese car, Chinese textiles, clothes you buy at Costco from Thailand, whatever it is. If the price of that goes up because of tariffs, the dollar has to get stronger so that the real price doesn’t change at all. In other words, the stronger dollar offsets the impact of the tariff. That’s how you adjust this global savings versus trade surplus identity that I described.

I’ll skip the economics lecture, but the bottom line is that all things being equal, tariffs make the dollar stronger because that’s how you offset the impact of the tariffs and maintain the foreign trade surplus that gets invested in the United States.

Once again, there’s a contradiction. Trump says he wants a weaker dollar, but tariffs would actually make the dollar stronger. There are other solutions including a collapse of investment so that you close the savings/investment gap by shrinking investment, but that would just throw the U.S. economy into a recession and nobody wants that.

Once again, we have Trump calling for a policy of tariffs or border tax adjustments on imports that would make the dollar stronger, yet at the same time, he wants the dollar to be weaker.

The reason I’m going through this in a lot of detail is to make the point that taken individually, these policies may have something to offer or they may not if you disagree with them, but collectively they don’t add up. Something is going to break.

What I expect is that the solution to this tariff savings shortfall issue I just described is inflation. If the dollar just gets stronger, that is by itself deflationary, but what if you generate inflation through easier monetary policy, i.e., we run larger deficits? The Fed accommodates the deficits. Well, that is what helicopter money is.

We get inflation. Now you may find that the nominal value of imports is going up, but the real value isn’t, because a lot of it is just inflation. You’d have a stronger dollar from imports, but you’d have a weaker dollar from monetary policy, and on net, you’d probably get inflation through higher input prices that would feed through the supply chain, etc.

Once again, I come back to gold. I can describe all this and give an economics lecture on it, but I can’t predict exactly how it’s going to turn out. I can tell you that not all these things will happen, because they contradict each other. The tariff thing flies in the face of a weak dollar. The Fed hawks fly in the face of a weak dollar, so you’ll probably get Fed doves, weaker dollar. You’ll probably get tariffs too, but they’ll solve that with inflation, and all roads lead to gold.

This is why gold is going up. Gold has gone up 10% in the past seven weeks from the middle of December until now. This is because expert traders look at the issues I’m describing and say, “There’s only one way out of this. There’s only one way to get to debt sustainability. There’s only one way to have larger deficits if that’s what Trump wants, which is inflation.”

People are getting ahead of that. Smaller investors should understand that this move in gold is not a normal blip or volatility; it’s actually being driven by a very fundamental understanding of the contradictions in Trump’s economic policies.

A lot of people remember election night when the returns were coming in and it became more and more apparent that Trump was going to win. Initially, the price of gold was soaring up to about $1330 to $1340 an ounce. It was a huge surge, and then it just hit an air pocket and went all the way down to I think a low of $1150 in mid-December.

Why was that? One reason was because in a very public way, Stan Druckenmiller sold all of his gold. Prior to the election, Stan Druckenmiller was one of the biggest bulls on gold. He acquired a very large gold position, some paper and some physical. Duquesne Capital is his family office/hedge fund. It’s not an open hedge fund; it’s a family office at this point.

When Druckenmiller saw that Trump was going to win, he said, “I was buying gold because I was worried about Hillary. Now that Trump won, I dumped all my gold.” People found out about that and said, “If Stan’s out of gold, I’m getting out of gold.” People sold their ETFs, this whole thing got a momentum, and gold went all the way down to the $1150 range, as I said.

Well, guess who’s back? Stan Druckenmiller is now buying gold. Now that the Trump train and the Trump euphoria are over, he’s looking at these contradictions and saying, “Trump really does want a weak dollar, and he’s in a position to get it because of his Fed appointments. A weak dollar means a higher dollar price for gold, so it’s a great price to buy gold.” He’s back in the market. Other people are getting tuned into this, and that is why gold is rallying. I would expect the rally to continue.

Alex:  One of the things I’m hearing you say, Jim, is that basically all roads right now are leading to inflation, which also means that all roads are leading to gold as well.

I’d like to turn for a moment and talk about some core concepts. When I say core concepts, I mean the type of thing that you and I have discussed for years now and many of the regular listeners of our podcast are aware of. For people who are new to this podcast and the things we talk about, I recommend you go back and take a look at Jim’s first book, Currency Wars, and bring yourself current.

One of the most interesting things we’ve discussed since I’ve known you, Jim, is your description of capital markets as complex systems, and this is a view I’ve come to agree with. Why are capital markets complex systems? Would you talk a little bit about why that is? And for analysts using measurements such as VAR and other traditional tools, why does this matter?

Jim:  Let me give you a fairly succinct version of that, Alex. As a lot of topics, I could deliver a two- or three-hour lecture on that, and I have, but let me give you the short version.

The question is, are capital markets complex systems? I think that is the most important question in economics today, and here’s why: There’s a difference between complexity and complicated. People use those two words interchangeably, and that’s fine in terms of everyday conversation, but in scientific terms they mean very different things, and I’ll explain why.

The models in use today by central banks, Wall Street, risk managers, etc. fall into one of two categories. One is equilibrium models. These assume that you have efficient markets, good pricing information, people are rational, they’re wealth maximizers, they act rationally, so the economy really works like a well-tuned Swiss watch.

Just in case it gets out of tune, every now and then there’s something economists call hysteresis, but basically something comes along and disturbs the equilibrium. It’s like your watch needs to be wound up because it’s running slow or whatever.

All the central banks have to do is come along, put a little pressure in the opposite direction, tip it back into balance, and then it’s like winding a watch. All of a sudden, it’s running like a Swiss watch again and it’s keeping very good time. An equilibrium model more or less takes care of itself, everything balances out, but just in case it gets out of balance for whatever reason, you can tip it back into balance.

The other model of risk management concerns events in capital markets. When I say events, I mean price goes up, price goes down, normal fluctuation or extreme fluctuation, panics, etc.  That what’s called the degree distribution, which is how you compare the frequency and severity. How often do really severe things happen? How often do really small, little things happen? What’s the extent of both of those things?

Just imagine an X- and a Y-axis, a normal grid, where the vertical Y-axis is the frequency of the event and the horizontal X-axis is the severity of the event. The assumption is that it looks like a bell curve. A bell curve kind of smoothly slopes downward from upper left to lower right where the small events happen all the time, so you have high frequency and low impact. Extreme events happen almost never or at all, so by the time you get way out to the right on the X-axis (the really extreme events), the curve has come down and made a nice soft landing on the axis itself. In other words, the frequency is close to zero.

Extreme events never happen or happen very, very rarely, and common events happen all the time. That’s what’s called a normal distribution also known as the bell curve, and that’s the assumption behind a lot of risk management modeling including value at risk, which is the major model.

You have these two assumptions: 1) equilibrium models, and 2) normally distributed risk. Both of those things are empirically wrong, meaning it’s not just my opinion. You can look at data and the degree distribution of shocks and events in capital markets. You can actually look behind the operation, the system dynamics (capital markets), and see that empirically and analytically, those two models the central banks and Wall Street use do not correspond to reality.

If you have the wrong model, that’s pretty bad. It’s like thinking the sun revolves around the Earth. We all know that the Earth revolves around the sun, but for a thousand years or longer, people thought the sun revolved around the Earth. Try flying to the moon if you think the sun revolves around the Earth; you’re going to fail.

If you have the wrong model, you’ll get bad results every time. This is why central banks, the IMF, BIS, and others never see recessions coming, they never see panics coming, they never see anything like 2008 coming. They never see it coming, because they have the wrong models.

What’s the correct model? This gets back to your question on complexity theory. Imagine we were enrolling in the physics department at the University of Michigan or MIT, some fine school with a professor who knew nothing about economics. We wanted to go into the physics department and study complexity theory, and we were being taught by someone who didn’t know anything about capital markets. What would they teach us? What would they say a complex system is?

They would say it has four main parts or characteristics in determining whether a system is complex or not. The four things are diversity, connectedness, interaction, and adaptive behavior, so DCIA.

Let’s take them one at a time. In any system, you have what are called agents. Agents are the individual actors. An agent could be, in effect, a molecule or an atom if you’re talking about a radioactive element. It could be a person if you’re talking about getting stuck in traffic or trading, buying, and selling stocks. Whether it’s subatomic or at the human level, individual actors in the system are the agents.

The first thing you need is diversity of agents. If everybody acts the same, thinks the same, and responds the same, it’s not a complex system because there’s no clashing, there’s no divergence of opinion. There’s nothing to create unexpected outcomes.

Imagine it’s just a bunch of cave people in a primitive society all living in caves. If every one of those cave people thought exactly the same thing about everything, that’s a really boring system. That’s not a complex system. But if you have different points of view, now you have the beginnings of a complex system.

The second thing is connectedness. We have agents, actors in the system, with different points of view, but are they connected somehow? Can they find each other? If not, then again, that’s really boring. Everyone just sits in their cave and thinks what they think, but there’s no action. But in fact, if you all come out of your cave, sit around a campfire, and get into a discussion at night, now you have connectedness.

The third thing is interaction. We’re diverse, we think differently, we’re connected. Are we doing anything? Are we transacting in any way?

The fourth thing is adaptive behavior, i.e., my behavior affects your behavior, your behavior affects my behavior. We change what we do based on what we observe other people doing.

Again, to go back to the caveman analogy, the diverse cavemen come sit around the fire, they’re communicating, they interact, they all decide to go out and hunt for mastodon the next day. But one caveman goes in a different direction. Everyone else gets food but he doesn’t, so he thinks, “You know what? I better adapt my behavior. I better go with these other guys tomorrow, because that way I’ll get some food for my family.” There’s my caveman example illustrating these four things.

We can take these four things and apply them to physical elements, earthquakes, sunspots, or forest fires. There are many, many examples of complex systems, but let’s take what I just described and apply it to capital markets.

Do we have diverse actors? Of course we do. We have bulls and bears, fear and greed, long and short, leveraged and non-leveraged. We can get ten opinions on every stock or bond or commodity you want to mention, so yes, we have very diverse actors.

Are they connected? Absolutely. We have Thomson Reuters, Dow Jones, Bloomberg, chat rooms, telephones, e-mail, CNBC, podcasts. We are probably overly connected, but we’re certainly connected.

Are we interacting? Big time. Trillions of dollars of stocks, bonds, currency, commodity, transactions taking place every single day, every single minute. We’re transacting and interacting at a massive scale.

Finally, the last question is, do we have adaptive behavior? Well, of course we do. I just gave an example of Stan Druckenmiller selling his gold on election night. As soon as people found out, they went and sold their gold. We have adaptive behavior.

We’re four for four. The four key pillars of complexity theory taught by someone who knew nothing about capital markets, when applied to capital markets, reveal that capital markets are complex systems. They’re not only complex systems, they’re one of the best examples of a complex system you can think of.

It’s an interesting lecture, but what is the significance; what does it mean? The significance is that risk or events in complex systems are not normally distributed. They’re distributed according to a different curve called a power curve, not a bell curve.

It’s not just an argument about the shape of two different curves; those two curves are simply manifestations of events in the real world that have a completely different characteristic, different reaction functions, different frequencies, different severities; everything about it is different.

The minute you go through the looking glass and say, “Capital markets are not complicated systems with normally distributed events; they’re actually complex systems with events distributed along a power curve,” you have entered a completely different risk profile, a completely different way of understanding the world.

That’s what I do in my own analysis. Those are the models I use. The point being that if you’re stuck in the failed, incorrect, obsolete view that risk is normally distributed and systems operate in a kind of complicated equilibrium, you are going to miss everything. You’re going to miss every turning point, every crisis. You’re going to lose money and get wiped out every seven or eight years.

On the other hand, if you can embrace complexity theory, understand it, apply it, and see that the risks are far greater than what Wall Street tells us and that the worst thing that can happen is exponentially greater than what Wall Street believes and that the frequency is a function of scale and the scale keeps getting bigger, which means the frequency of the severe events gets exponentially bigger, you’ll be scared to death. You’ll look at the system we have and say, “It may not break down tomorrow, but actually, it could, and we could get completely wiped out.”

This is another reason to have gold in your portfolio, because gold will withstand these extreme events much better than other kinds of financial assets.

Alex:  Outstanding. I love the caveman analogy. That’s really great. As far as all these indicators most financial professionals are basing what they’re doing on but is really based upon false assumptions, to me it’s like being on an airplane. You have all these indicators, but they’re feeding you information off false data. As you mentioned, that is a pretty scary situation.

We have a little bit of time left and want to go to a question from one of our listeners. We like to do as much listener interaction as possible, so for those of you who want to ask questions for the podcast, you can always submit them by e-mail to us at our website or ask directly on Twitter. We get those, and when we can, we include them.

This is a Twitter question coming from a user by the name of Absolute Hokies. That’s an interesting handle there! In reference to Triffin’s dilemma as it relates to the border adjustment tax, repatriation of funds, and Fed hikes, his question is, “Doesn’t BAT repatriation counter Triffin’s dilemma forces regarding dollar movement? And if so, does a stronger dollar worsen the debt crisis?”

Jim:  That’s a compound question. I spent a little bit of time talking about the impact of border adjustment tax, and what I said was that if you impose it, it’s a kind of tariff. The reaction function would either be a collapse of investment because there wouldn’t be enough of a foreign surplus to fund the investment deficit so investment would collapse which would put the U.S. economy into a recession and be deflationary, or the dollar would get stronger to offset the higher input prices so that the foreign surplus can be just as big and they could fund the investment shortfall.

Either way, you end up with deflation or a stronger dollar. The deflationary impact of a stronger dollar offsets the inflationary impact of the tariff, and so the combination of the two is net neutral. It doesn’t really go to Triffin’s dilemma.

For the benefit of our listeners, Triffin’s dilemma goes back to the 1960s. It was named after a Belgian economist named Robert Triffin who spoke about when a country issues the global reserve currency. That is the situation with the United States, it was then and it is today. Today, U.S. dollars are 80% of global payments and 60% of global reserves, so it’s the dominant global reserve currency.

The world needs dollars to conduct transactions, it needs dollars to pay each other, it needs dollars to hold its savings, etc. Where do they get them? They get them from the U.S. trade deficit. If the U.S. ran a trade surplus, we’d be sucking up all the dollars in the world.

It’s only by running a deficit that we spread dollars around the world. Other countries earn the dollars from us, and then they have dollars to buy oil or things in the United States or invest or whatever they need.

Triffin’s dilemma said if you run the global reserve currency, you also have to run persistent deficits. If you don’t, the world won’t have enough of your currency for commerce to grow. But if you run persistent deficits, eventually you’ll go broke. In other words, the dilemma was that the thing you need to do to supply the world with dollars will eventually cause you to go bankrupt because your deficits will catch up to you.

He said this in 1960, and it’s turning out to be true. It took 55 years to play out and there were a lot of strong dollar/weak dollar episodes along the way, but the bottom line is that what Triffin predicted 55 years ago is playing out today, which is that the U.S. is going broke. Our debt is not sustainable, and we’re getting closer and closer to a dollar crisis every day. That’s Triffin’s dilemma.

Now, the border adjustment tax doesn’t really affect that one way or the other. I don’t want to put words in anyone’s mouth, but I think what the listener was getting at is, if you have a border tax adjustment, doesn’t that reduce the trade deficit and solve Triffin’s dilemma?

The answer is, no. If you get a stronger dollar as a result, the higher price of imports is offset by the stronger dollar, meaning you get more for your buck, so the trade deficit for the U.S. and the external trade surplus in dollars is the same. The exchange rate adjusts to offset the impact of the tariff, so the net effect on the deficit or surplus is the same, and therefore there’s no impact on Triffin’s dilemma.

Having said that, the whole issue with Triffin’s dilemma is coming to a head. The solution to Triffin’s dilemma is not the U.S. trade deficit or surplus; it’s the SDR or special drawing rights. The SDR is a form of world money issued by the IMF, and the IMF is not a country. The IMF doesn’t have a trade deficit or a trade surplus because it’s not a country. It just pulls the money out of thin air.

For foreigners to get dollars from the U.S., they have to earn them by running a trade surplus with the United States. That means we have a deficit; that’s Triffin’s dilemma. But for foreigners to get SDRs, they don’t have to do anything. They just have to wait for a phone call from Christine Lagarde, and she says, “Here are your SDRs.”

The real solution to Triffin’s dilemma is the SDR, but the impact of that is certainly inflationary, which, in my view, is one more reason to own gold.

Alex:  Very good. Jim, I want to thank you for your time. It’s been an excellent discussion. And thank you to all of our loyal listeners.

Jon:  Yes, thank you, Jim Rickards. This is fascinating new material. And thank you, Alex. It’s always a pleasure and an education sharing this time with both of you. Most of all, thank you to our listeners for spending time with us today. Let me encourage you to follow Jim and Alex on Twitter. Jim’s handle is @JamesGRickards, and Alex’s handle is @AlexStanczyk.

If you’ve enjoyed this podcast, please recommend it to your friends. If you’re watching on YouTube, please click “Like” and “Subscribe.” If you’re listening on iTunes, please give us a rating and a review.

Goodbye for now to everyone, and we look forward to joining you again soon.


Listen to the original audio of the podcast here

The Gold Chronicles: February 9th, 2017 Interview with Jim Rickards and Alex Stanczyk


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This Podcast is not an offer to sell, nor a solicitation of an offer to purchase, any security. This Podcast is intended for general education and information purposes only, and may include broad discussions of markets, geopolitics, monetary policy, and geoeconomics. Nothing in this Podcast constitutes investment, legal or tax advice, nor an evaluation of or prospectus for any particular investment or market, including gold. This Podcast should not be relied upon to make any investment decision. You are encouraged to seek the advice of qualified financial, legal and tax advisors before making any investment decisions.

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Transcript of Global Perspectives EP1: February, 2017 Interview with Alex Stanczyk and special guest Brent Johnson


Welcome to Global Perspectives, a new podcast featuring some of the sharpest minds in the world. We delve into the key concerns, opportunities, mindset, and practices of some of the most successful professional money managers, entrepreneurs, and world class personalities today.

This episodes special guest is Brent Johnson of Santiago Capital.

Topics Include:

*Two of the most powerful forces at play in markets today
*Stock and flow of the money supply; Why the flow is so essential
*The key design flaw of the current debt based monetary system
*How continued decrease in the velocity of money can create a compounding deflationary effect
*Velocity of money has been on a downward slope for 16 years which has forced the Fed continue to add to the money supply
*How the Basel III regulatory framework is compounding parking of capital and adding to deflationary forces
*How growth of regulation has created burden on small business reducing competition and raising the cost of entry into markets
*What is “velocity of money” and why it matters to inflation
*Why quantitative easing has led to a situation where inflationary forces could accelerate faster than central banks expect
*How inflation is closely tied to psychology and not just creation of new money
*The case for why zero to negative interest rates are having the opposite effect to what central banks expect
*Trump is a wild card for market psychology
*Why Trump could be highly inflationary
*Global demand for US dollars could push the USD continually higher over the next few years
*Why and how a strengthening dollar could cause its own demise


Listen to the original audio of the podcast here

Global Perspectives: February, 2017 Interview with Alex Stanczyk and special guest Brent Johnson


Global Perspectives Episode 1
Alex Stanczyk and Brent Johnson

Jon:  Hello, I’m Jon Ward, on behalf of Physical Gold Fund. We’re delighted to welcome you to the first podcast with Alex Stanczyk in the series we’re calling “Global Perspectives.”

Alex Stanczyk is the Managing Director of Physical Gold Fund. Alex is an expert in the physical gold industry, dealing with the logistics chain, from refinery to secure transport and vaulting. He has lectured globally to investor, institutional, and government audiences on the role of gold, both in the international monetary system and investment portfolios.

Hello, Alex.

Alex:  Hello, Jon. It’s great to be here. This is going to be a wonderful conversation today with someone whom I’m a big fan of, personally.

Jon:  I’m sure it is. Our guest today is Brent Johnson. He’s the CEO and portfolio manager at Santiago Capital, a hedge fund that focuses primarily on bullion and other metals-related investments.

Brent has been creating and managing wealth-management strategies for high net-worth clients since the 1990s. Early in his career, he was a financial auditor for Philip Morris Management Company, and he went on to serve private clients for Credit Suisse.

Brent recognized early on the need for a robust precious metals solution for his clients, and that’s what prompted him to launch Santiago Capital. Since then, he has attracted a growing following as an expert on gold.

Now, in his spare time, Brent devotes himself to educating the public on financial and monetary issues. His work is often featured throughout the blogosphere, including Zero Hedge.

Welcome, Brent.

Brent:  Hi, guys. Thanks for having me. It’s great to be with you today.

Jon:  Now, Alex, over to you.

Alex:  Okay, thanks a lot. Let me start out by saying, Brent, it’s great to have you on. One of the things that I find interesting about you is that you don’t follow the crowd. There are a lot of different analysts in the space. Interestingly enough (and you’re probably already familiar with this), the common theme that you see amongst analysts in the sector is that they all often parrot each other. I find it curious how that happens. It isn’t so often that you run across someone who has got some original thinking and original content.

You definitely fit that mold. I shouldn’t even call it a mold. You’ve broken the mold. You’re the person who looks at the whole situation in your own sort of way. I’m looking forward to what you have to say on a lot of these different levels.

If you don’t mid, Brent, let’s talk a little bit about your latest presentation. It’s called “Don Yuan.” Can you give us a quick summary of “Don Yuan” and what it means to you?

Brent:  Sure, yeah. Thanks for the nice words you said, by the way. I’m excited to be able to come in and talk with you. I’ve been a fan of you and your work, as well. This is a great opportunity.

As it relates to “Don Yuan,” it’s a play on two of the biggest forces that I see in the world today. It’s not just market forces. It’s political forces. It’s social forces. It’s Donald Trump, “The Don,” and then China and the yuan.

Rather than “Don Juan,” I titled my latest presentation “Don Yuan,” because I really do see those as being the two primary forces right now. It’s kind of a funny play on words, but it’s actually a pretty serious topic when you really get down to it. It’s a very divisive topic, but it’s an important one. That’s a long way of explaining the “Don Yuan” title.

Alex:  I understand. Let’s dig a little deeper into some technical areas that you had mentioned in your other series, “Step into Liquid.” One of the things that you talked a great deal about was stock and flow of the money supply.

A lot of people are familiar with this concept of stock and flow, but they may not understand why the “flow” part of the stock and flow is so essential and why it plays such a big role in your framework of looking at the world.

Can you talk to us about that and about why flow is so essential?

Brent:  Yeah, absolutely we’ll do that, because it’s the key to everything. It’s funny, because I learned of this stuff in college, but I probably just learned it long enough to memorize it to pass whatever test I was taking, and never thought of the real-world implications of it. Then 10 to 15 years ago, I started looking at it closer. Ten years ago, when we started getting into 2007/2008 timeframe, I took a hard look at it. That’s when it hit me.

The stock and the flow goes back to a debt-based monetary system, where money, for lack of a better word, is loaned into existence. The way that our monetary system is designed has a severe design flaw in it. You can argue whether it was done on purpose or whether it was done by accident. We could probably do a whole hour just on that.

Regardless, the flaw is there. The flaw is that in a debt-based monetary system, where money gets loaned into existence, all loans have interest attached to them. If you loan money into existence, then at the end of the year, you need more money to pay the interest than actually exists.

Either the existing money in the system has to be circulating – or the flow, for the lack of a better word, has to be flowing – at a fast enough rate where that money can change hands and satisfy everybody’s interest payment.

If that flow is not flowing at a high enough rate to where the interest gets paid, then loans go into default. It’s like a daisy chain. It starts cascading all the way back to the base money from which that money was loaned into existence to begin with.

You look back, and all the central banks are like this. They’re all based on the same design. For this argument, let’s just look at the United States. The monetary base is around $4 trillion. About $2-2.5 trillion is reserves at the Fed, which isn’t flowing. That money just sits there as the banks’ reserves.

Then there’s about $1.5 trillion of physical currency. That’s money that actually exists. That’s the base money. All the other money is basically digital money, ones and zeroes, that’s loaned into existence and it shows up on a ledger somewhere that says, “You have this money,” etc.

If you look at the total banking system, the banking system has – depending on how you measure it — say $15 to 16 trillion of banking assets. If $4 trillion is base money, then that means there’s $12 trillion of money loaned into existence, and some other assets, etc.

Anywhere from $10 to 12 trillion is loaned into existence. There’s interest attached with that $10 to 12 trillion.

Alex: A lot of interest!

Brent:  Right. If that money isn’t circulating, those loans go into default. You can think of it similar to a collateral account on a brokerage account. If you buy on margin and whatever you buy doesn’t go up, then the equity gets eroded and you have to resupply the collateral, or else the whole account fails.

It’s very similar. If GDP and money velocity are not high enough, there are not enough transactions going on to satisfy all those interest payments. Well, then the Fed has to come in and plug the hole and add money back to the collateral, which is the base money.

That’s the stock and the flow. If you look at the velocity of money, it really started in the late ‘90s, probably around – this would be a great question for Jim Rickards, who I know you’re very close with. It all started around the ’98 crisis, with Long-Term Capital Management, the Russian debt crisis, and the Asian currency crisis.

You can look at the velocity of money. Going back there, it’s been on a downward slope ever since then. Now, there have been a couple times where it’s turned back up for a year or so, but then it’s turned right back down. We’ve been in this downward motion for 16 years now, almost 20 years now.

You can go back, and you can look at the reserves, at the Fed, and the base money, and it’s ramped up since then. There’s a direct correlation. Money is not moving, and they have to continually fill up the collateral. That’s the essence of the stock and flow. That’s the essence of the flow in our monetary system.

The other part of it is if the money is circulating and there are no problems, the interest attached to it, even if it’s just 1% a year, it becomes an exponential system. It doesn’t matter. You can start with the number 1.

Alex:  I agree.

Brent:  If you take 1 x 1.01, year after year after year, it will eventually grow exponentially. It’ll turn straight up. Then you get the inevitable blow-up process that ends with a magnificent crash.

Alex:  That’s the hockey stick on the chart.

Brent:  Exactly. It doesn’t really matter whether or not the money is flowing or not flowing. That design flaw of the money loaned into existence is a catastrophic flaw, and it’s bound to fail.

Alex:  Yes, I agree. We’re not talking about philosophy here. This isn’t about whether this monetary system or that monetary system is a good thing, or a gold standard is a good thing or a bad thing, or whether Keynes is a good thing or a bad thing. We’re talking about math right now.

Brent:  If you believe in math, buy gold. Our monetary system, mathematically, certainly will fail. That shouldn’t really be a provocative statement. It’s just math. You can argue with math if you want to, but you’re going to lose.

Alex:  You’re going to lose, absolutely. I totally agree. That’s something that I think a lot of people don’t realize about our monetary system. I think there are a lot of people caught up in this argument about whether Keynesian is a good thing, whether the gold standard is the way to go, or whatever, all those kinds of things.

I’m not going to argue that one way or another right now. If you just think about the math, that’s really critical. People need to understand that it’s going to change. It’s only a matter of time.

Brent:  Exactly.

Alex:  Let’s move on and talk about regulation. That’s been a big topic for the current incoming Trump administration, and I’m sure for business owners for years now, at least going on a decade, and probably longer.

The amount of regulatory creep that’s been occurring has been getting more and more intrusive, and not just in the United States, but globally. Our fund operates internationally. We’ve done business globally for a long time. We’ve seen the regulatory creep effect there and how that’s affecting things.

What do you think is going to happen as this creep continues to impact the banking system? How does this present a problem?

Brent:  That’s a big topic. There are a lot of different ways it can be a big problem. There’s probably one area that I can focus on that will help explain it in a somewhat simple manner.

If you think back, after all the problems that happened, let’s call it, between 2006 and 2010: the run-up and the real-estate bubble, the explosion of the real-estate bubble, and then all the ancillary negative effects that happened for the couple years after the bubble popped.

The banks did a number of things wrong. We can just leave it at that. We don’t have to get into all that detail right now. They did a number of things wrong.

Alex:  I think everybody agrees, yes.

Brent:  The public bailed them out. Perhaps rightly so, the government said, “Well, we’ve got to go in and do something to make sure this doesn’t happen again.” Like all good government programs, they might even start off with good intentions, but they end up with a really bad result.

One example is the Basel 3 and Dodd-Frank requirements that are now imposed on the banks. It makes sense. The Basel 3 comes from Basel, Switzerland, where the Bank for International Settlements sits, as potentially the central banks’ central bank.

They are trying, on a globally coordinated basis, to establish a framework through which all these other central banks, governments, and monetary authorities can craft a global solution to keep this from ever happening again. Again, it starts off with good intentions.

The way that we can use it as an example is they thought, “Well, we need to make sure that the banks are adequately capitalized so that if we ever have another downturn, they don’t go through this big liquidity event where their capital evaporates and the public has to bail them out.”

In theory, that sounds pretty good. The problem is getting all these different countries to agree on the same thing. Then, of course, politics comes into it. They say things like, “You can hold these different securities on your balance sheet, but they’re all going to have different ratings. Of course, they give their own debt (the country’s debt) a zero-risk rating. You can buy a Greek bond, a Portuguese bond, a US bond, or a Chinese bond, and they’re essentially all given a zero-risk rating, which on the face of it is ridiculous, right? But that’s the rule.

The intention is good. That’s just one example of where banks can now hold risky assets on their balance sheet and say they don’t have any risk at all when, in fact, they’re carrying a lot of risk, especially when you look back.

I don’t know if there’s ever been a country in history that ever paid off its debt without inflating it away. The fact that you take the one entity, which is the government, which has never made good on a debt, and you give it a zero-risk rating, in my opinion, it’s a bit ridiculous. That’s just one example.

Let’s take it a little bit further. The framework for the US is Dodd-Frank. One area in particular that they took a look at was money market funds.

For several years, they have said that by October of 2016, money market funds will have to mark their book to market. Basically, what that means is for a long time, these money market funds were created as a way to provide short-term financing for banks and other big corporations. It’s almost like cash.

People that are invested in it, they kind of assume that it’s cash, so it always just keeps a par value. If you put a dollar in, it shows a dollar on your statement. But in actuality, these are bonds underlying these money market funds. Now, they’re very short-term bonds, but they’re bonds, and there is risk.

Occasionally – especially like in 2008 – there were some failures, and some of these money market funds broke the buck so to speak. They actually printed 99 or 98, rather than 100 cents on the dollar.

Well, in their infinite wisdom, the government said, “We can’t have that anymore. We’ll give you a few years to get on board, but by October 2016, you’re going to have to get these funds to market.”

That was the case for prime funds, which are corporate-backed funds, but not government funds. The government doesn’t have to mark their books to market, because, “We’re the government. We’re never going to default. We don’t have any risk.”

What you saw, the natural progression, is people who didn’t want to take that risk left prime funds, and they moved all their money into government funds. There’s been a big sea change from prime funds to government funds.

Perhaps on one level that’s good, but the problem is that now you’ve got even more people huddled and concentrated in one area – again, government funds – which, in my opinion, have in many ways more risk than a AAA-rated corporate bond does. That’s one example.

Not only that, but a lot of the banks that they’re trying to protect against, they used to get their short-term funding from these money market prime funds. Now that those money market prime funds are gone, they don’t have that competition. There’s no competition between prime funds and prime funds anymore. They’ve lost one area of financing, so the cost of financing has gone up.

You can look at things like LIBOR. If you look at LIBOR between July of last year and October of last year, it almost doubled. A big part of it was because of this movement in the money market funds. Now you’ve got a higher concentration of funds, a higher cost of funds, and a lot of people concentrated in an area that perhaps has more risk than they otherwise think it has.

That’s just one example of how regulatory good intentions end up being long-term bad solutions. That’s probably the easiest way I can explain it.

Jon:  Thanks, Brent. Just talking of concentration, do you have any observations about the whole phenomenon of “too big to fail,” of the largest banks simply getting larger and larger and, in that respect, becoming unassailable?

Brent: It’s really true. You’ve seen these banks get bigger and bigger. I don’t have the market capture right in front of me, but they’re much bigger now than they were in 2008.

If you total up all the fines that the banks have paid between 2008 and 2016, it’s something like $300 billion. Now, name me another industry where that industry can pay $300 billion in fines, still be in business, and still have their profits going higher. You don’t pay $300 billion in fines if you’re treating your customers well. What other industry can do that to their customers, stay in business, and grow? It’s ridiculous.

Alex:  Yes, it’s crazy.

Brent:  On the face of it, it’s just absurd. Another example where this is becoming a problem is that as regulations have gotten more intense and more severe, part of the reason the big banks have gotten bigger is they’re the only ones that can afford to hire the lawyers to comply with all these rules and regulations.

The smaller community banks or regional banks, who didn’t have anything to do with the problems that caused 2008/2009, are the victims of it, because they’ve now had to implement new regulations and procedures, and they’ve had to hire ten lawyers instead of one lawyer, etc. They basically can’t compete against the big guys, so they either go out of business or they sell to the big guys, and the big guys just get bigger again.

Not only that, but then you’ve got a big national bank, perhaps, representing a small manufacturing facility in Dubuque, Iowa. The big national bank has no idea what goes on in Dubuque, Iowa. Maybe they can’t even make that good of a decision of whether that company deserves better credit, worse credit, or a loan.

You’ve gone away from community banks serving small businesses to these mega-banks trying to write rules and regulations that apply, black and white, to everybody, when it’s really a grey world.

I see big problems with all these regulations. I’m a free-market guy. I think the free market solves all the problems. People say, “Yeah, but if you don’t have regulations, then all these banks would have gotten away with murder.”

No, they wouldn’t have. They would have been bankrupt. They would have been gone, and the problem would have been solved. It’s a cute way of looking at it, but I still believe in capitalism.

Alex: This is an area, Brent, where you and I largely agree. The problem, as you explained it, feeds on itself. It’s raising the cost of entry into the market by creating all these regulations, so smaller businesses really can’t compete.

The problem with that, obviously, is if there’s no competition, then there’s nothing that’s going to be keeping these guys honest, if they can get away with it.

Brent:  Right.

Alex:  If we can circle back around to our earlier topic for just a minute, I think that it might be helpful for our listeners to know a little bit more about velocity of money and what it means. Not everybody understands that. You and I, in the industry that we’re in, we get that. We understand what that means.

As far as velocity of money, the last chart I looked at from the Fed, the current velocity of money, it hasn’t been this bad since maybe 1971 or ’72. It’s absolutely horrible. I think sometimes people wonder, “Since the last global financial crisis, we’ve printed up trillions of dollars. Those dollars have been injected into the economy, but we aren’t really seeing inflation.”

All the Keynesians are coming out, going, “Look, money creation doesn’t create inflation after all.” The part they’re leaving out is the whole velocity part. What does that mean? What happened there? We had all these trillions of dollars injected into the system, but we really haven’t seen much inflation. What’s going on with that?

Brent:  There will be people out there that will say, “What are you talking about? We’ve got inflation. House prices have doubled. The stock market has tripled. My Thanksgiving dinner cost me $150, rather than $89.”

I think there has been inflation, and while there has been some consumer price inflation, in general it’s been more asset price inflation than consumer price inflation. A big part of that is, again, the way the monetary system is designed.

The way it’s designed is the central banks give the banks the money. Then the banks give the money to main street. There’s not a system where it goes from the central bank to main street. The mechanism by which it goes to Main Street is loans, that money creation that we talked about earlier.

Again, if you look at all the QE (quantitative easing) that we’ve done, the bailout packages, etc., however you want to define those packages, it was done as a way where the central banks bought assets from the banks. In exchange for taking those assets from the banks, they gave the banks cash.

The banks did not then loan it out into the market, as the central banks were hoping that they would. You can make a big argument. Did they not loan them out because they didn’t want to, because they wanted to keep it for themselves and collect interest on it? They actually get paid by the central bank just to hold onto it.

Or was there no demand? Was the consumer so tapped out that there was no demand for the loans? I think that would probably be a whole other hour-long topic in itself.

Alex:  Yes.

Brent:  Regardless of whatever the reason is, that money did not flow to main street. That is what I was talking about earlier. As velocity fell, the reserves of the banks at the Fed increased. It’s almost a one-for-one correlation.

Now, a lot of people will say, “That’s why we haven’t had inflation. You shouldn’t worry that it’s not inflationary because it’s just in the banks.” Technically, that’s correct, but it’s very disingenuous, in my opinion.

The reserves at the Fed are what the banks use as collateral to make new loans. Even though they haven’t made new loans yet, they’ve got $2 trillion in reserves now that they didn’t have ten years ago. On a 10:1 reserve-to-loan ratio, they need to keep one unit of reserves for every ten they loan out. $2 trillion of reserves could become $20 trillion in new money.

Ten years ago, the monetary base was $800 billion. Now it’s $4 trillion. On reserves of $2 trillion, they could loan another $20 trillion into existence. The total banking system assets right now are around $15 to 16 trillion. They could essentially double the size of the banking system on those reserves that have been given to them in the last ten years. If and when that happens, that would be highly inflationary.

It’s kind of like a dam being built. We’ve had all this liquidity flowing towards main street, but the banks built up the dam. All that flow, all that money from the Fed, is just building up behind this dam. It kept getting bigger and bigger. Now there’s a big lake there. That’s the reserve. It’s become this huge lake.

If that dam ever breaks, or if they ever open the levies on that dam and start loaning it out, that can lead to even higher pressure of that flow coming up. That can lead to even higher inflation, if and when it happens.

I can’t tell you for sure it’s going to happen. I think it is going to start to happen, for reasons that we can get into in a little bit. Those reserves that have been built up, that everybody says, “See, these aren’t inflationary,” they’re the tinder for the inflationary fire that can come later.

Alex:  I totally agree. It’s interesting to me, because when there’s no velocity – in other words, people aren’t spending money and loans aren’t being made – then that creates what you were talking about, that big sucking sound in the flow of money. They have to continually add more dollars to the system to make up for that sucking sound, which is only making this lake bigger.

Brent: Exactly. You touched on the key to everything — the velocity of money. If the velocity of money picks up, then you’re going to have inflation, and maybe this flawed system can go on a little bit longer.

If they cannot get the velocity to pick up, then inflation is not going to pick up, growth is not going to pick up, and we’re going to be back to this deflationary death spiral. It all hinges on the velocity of money.

Alex:  Here’s another interesting aspect of that. What a lot of people don’t realize is velocity is closely tied to psychology.

Brent:  Absolutely.

Alex:  The thing that is guaranteed is that the psychology will not stay the same forever. It’s almost like a perfect setup. The psychology is going to shift at some point. When it does, we’re set up to unleash that gigantic dam.

Brent:  That’s exactly right. In many ways, inflation is more psychological than it is economics or math. It’s just pure psychology. This is where I think the Fed has really gone wrong, and I alluded to this in one of my recent presentations.

What I mean by that is if we go back a year, the Fed raised interest rates in December of 2015 and indicated they were going to raise two or three times in 2016. Well, got into spring of 2016; they didn’t do it. Got further into the spring, and they didn’t do it. Got into the summer, and they didn’t do it. Got into the fall, and they didn’t do it.

They were rapidly losing credibility. Not only that, but in Europe they tried negative rates. In Japan, they tried negative rates. All this talk of they were going to raise three times, and they couldn’t even raise once. They’re like the little boy who cried wolf. They kept saying, “It’s coming. It’s coming. It’s coming.”

In the summer and the fall, the Fed kept saying, “We’re going to go slow. We’re going to slow. We’re not ready yet.” But the market – and maybe that was psychologically driven – started to say, “You know what? Negative rates are ridiculous. Interest rates are at 5,000-year lows. We’re at negative-to-zero-percent interest rates. Do we really want to buy bonds at negative interest rates?”

I think the peak was in August or September. I think Austria issued an 80-year bond at a negative rate.

Alex:  Wow!

Brent:  It’s just absurd. Then there did start to be some growth prospects pick up. Some inflationary signals started to pick up. Then Trump won. Trump’s policies, I believe, are inflationary policies. I believe it for different reasons than a lot of other people believe it, but I believe they are inflationary policies.

In the last 60 days before the last Fed meeting of the year, rates really started to rise. Stock prices started to rise. Inflationary pressures started to rise. I think that allowed them to raise rates. In that way, I think the market front-ran the Fed and allowed the Fed to raise. I’m not sure the Fed wanted to raise, but I think they had to raise. That’s going back to the psychology.

I think for the last two or three years, with the Fed saying, “We’re going to keep rates low,” and other central banks saying, “We’re not only going to keep them low; we’re going to go negative,” this is their ivory tower, some PhD economics department psychology, telling them, “If we lower rates, people will borrow more.”

I think in the real world, the central banks are supposed to be the smartest people in the room. They’re supposed to be the financial geniuses. Well, the financial geniuses are telling me that things are so bad that we’re going to have negative rates. Why would I go take out a $1 million loan and build a new plant? Why would I hire that new person, if all the smart people in the room are telling me things are so bad that we have negative rates? I’m just going to wait, and when things finally get better, then I’ll hire.

I think that low rates and negative rates are actually deflationary, as opposed to the ivory-tower opinion that it’s inflationary. Now that rates started to pick up and the Fed raised, I think the market bailed them out. I think for them to keep this momentum that they’ve got, they have to keep on the raising-of-rates train.

I think if they now go back and say, “Oh, we’re not going to raise anymore. We’re going to slow down,” then they lose all momentum and we go back into that deflationary environment.

From a psychological perspective, if you’ve been sitting on this cash and you’ve been waiting for the time, you haven’t built that plant, you haven’t hired that person, or you haven’t invested in that new project because the rates are low and maybe even going lower, maybe even going negative. You’re saying to yourself, “I’m just going to wait until we get through this and things get a little bit better.”

Now if rates start to rise, maybe on the first rate rise you don’t do anything. But on the second one, you’re probably going to start going, “Maybe things are getting a little bit better.” By the time the third or fourth raise comes along, or by the time the market takes interest rates higher (even if the Fed doesn’t), now that CEO, asset allocator, or investor, says, “Holy cow, things are starting to take off. I need to make a move.” Then you start to see that velocity of money pick up. Then it becomes a self-fulfilling prophecy to the upside.

That’s where I think Trump comes in. I think Trump is such a wildcard that psychologically, he may change behavior in the market. Not because he’s magic and not because he’s our savior. Not because he’s this new-found hope that America is going to be great again.

He’s going to do things differently. Rightly or wrongly, he’s going to do things differently. He’s going to put some policies in place that I think are inflationary. I think if the central bank follows his “lead,” for lack of a better word, and continues this upward projection of interest rates, then we might get some change of behavior, and we might get that velocity of money to pick up. With all those reserves that have been built up, inflation could pick up rather quickly.

Jon:  Brent, can I ask you just one thing about Trump? You mentioned that you, like many people, see his policies as inflationary. I think for most people, they’re thinking about his plans for massive infrastructure spending. But you indicated you had a slightly different angle on this.

Could you explain why you think his policies are inflationary?

Brent:  Yes. This is probably where I start to differ from the typical market observer, or maybe even the typical gold investor, for lack of a better word. I don’t want to speak for anybody else. I’m certainly not trying to put words in anybody else’s mouth, but I think the common view in the precious metals community is one of the main reasons you buy gold is that fiat currencies are fundamentally flawed. The governments will print them to pay for their bad debts, and that currency will be inflated away, so you need to own precious metals as a way of protecting that purchasing power.

Over the long term, that’s certainly a very valid reason to own precious metals. It may be the top reason to own them. That said, I don’t think that it’s the best reason to own gold right now. I think it will be in the future.

Right now, I think that Trump’s policies are inflationary because I think they are going to lead to a stronger dollar. I think we’re going to be in a unique point in time where the stronger dollar leads to higher inflation. I know that sounds a little off or different. Let me explain to you why.

I believe that we’re going to get into an environment where the dollar, gold, and potentially even the Dow are going to rise together. I don’t think we’re there yet, but I think that’s what’s going to happen in the years ahead. But there’s a window of time that we need to go through to get to that place.

I think the strong dollar is here. Now, it may weaken a little bit over the next month or so, or maybe even over the next quarter. I don’t think it will, but if that were to happen, I think it would be a short-term thing.

I did this presentation over last summer. I called it, “Step into Liquid.” It listed all these different reasons that I thought the dollar would get stronger. I’m happy to share that with anybody that wants to see it.

I think the Trump policies are going to make that thesis that I had even stronger. Here’s the reason. Like it or not, the world is still on a fiat system. Like it or not, the dollar, as flawed as it is – and it’s extremely flawed – is still the world reserve currency. It will be the world reserve currency until the moment it’s not.

Regardless of how you view the dollar, institutions, countries, companies, corporations, people who trade, people who import and export, they need dollars to facilitate world trade. If you look at all the dollar debt in the world, we go back to this debt super-cycle. There are hundreds of trillions of dollar debt in the world.

Long story short, I think the supply/demand issue on the dollar is going to push the dollar higher. I’ll get into the reasons why here in just one second. A lot of times, people will say, “Yes, Brent, but they can print the dollar to oblivion. Therefore, they can give out all the supply that way.”

Absolutely true. But right now, they’re not doing it. In fact, they’re doing the opposite. They’re decreasing the amount of money in the world. They’re raising interest rates. They’re sucking all that money back into the US, as opposed to sending it out to the rest of the world. If they change course, then fine. But right now, they are not doing it.

If you go back to the supply/demand issue, like I said, there’s hundreds of trillions of debt in the world. Let me give you a few numbers. If you look just at the US debt, $20 trillion. The Fed owns $2.5 trillion of that. Let’s say it’s $17.5 trillion.

In addition to that, we talked about the loans in the banking system. The loans in the banking system are anywhere from $10 to 12 trillion. Let’s just call it $10 trillion. You put $10 trillion on top of $17 trillion. Now we’re at $27 trillion.

Now, outside the United States, entities, institutions, corporations – however you want to define them, outside the United States – have issued another $10 trillion of dollar-based debt. Put that $10 trillion on top of the $27 trillion we already have. Now we’ve got $37 trillion.

We haven’t even talked about US corporations at this point. So far, we’ve just talked about the US debt, the banking system, and the international entities’ debt. Let’s just use $37 trillion as an example. The average interest rate on the national debt is, I think, 2.25%. At $17 trillion, that would be, let’s say, $300 to 400 billion.

On the other $10 trillion that’s in the banking system, let’s just assume for the sake of argument that they can get the same rate as the risk-free rate of 2.25%, which is ridiculous. But let’s just pretend they can. That’s another $250 billion of interest payments.

Then we take the international $10 trillion. Again, let’s assume they can get the same rate as the US, world reserve currency, risk-free rate of 2.25%. There’s another $250 billion a year. Now we’re somewhere at $800 to 900 billion a year in interest payments alone for the dollar.

That is demand. That is $800 billion of demand for the dollar every year, just to pay the interest. Without the velocity of money picking up, where are people going to get $800 billion to pay the interest payments?

The point is that there’s a lot of demand for dollars. We haven’t even talked about the demand for trade, for new trade, for new businesses. But just in interest payments alone, we’re approaching $1 trillion a year in global demand for dollars.

Now let’s bring that back to Trump’s policies. It’s a combination of Trump’s policies and the Fed. The Fed, when they were providing QE and they were giving dollars to the world that would then either get loaned into the banking system or the banks would use them as collateral to make trades, more dollars were being provided to the world. The spigots were open, for lack of a better word.

Now, rates are going up. It’s costing more money. Not only are we not providing new dollars to the rest of the world, but we are saying it costs more to service the ones that there already are.

Trump is talking about putting up border tariffs, where any goods coming into the US would have to pay some kind of a tax. That means prices are going higher. That means even though the dollar would get stronger, the prices of commodities would go up. Now we’ve got a potentially stronger dollar and some higher prices.

Also, if you think about it, he has said that he would like to build the wall with Mexico, for example. Mexico, they’re not going to want to pay for the wall, but he’s going to try to negotiate tougher treaties with them. Whether he can do it or not, I don’t know, but he’s going to try to negotiate tougher treaties. In other words, he wants to send less dollars to them and more of their stuff to us.

The point is that he wants to provide less dollars to the world and more dollars to the US here. That’s a strong-dollar positive. Let’s suppose rates continue to go up – and I think they might. They might not, but I think for the central banks of the world to have any chance, I think we need rates to rise. That’s the only way to get the velocity of money going.

If rates go up here, and they stay flat in Japan or Europe, or they go even more negative in Japan or Europe, asset allocators should bring more money to the US just to park it in dollars and get some kind of an interest payment, rather than zero interest payment. That alone makes the dollar more expensive.

Then another Trump policy is he wants these corporations, who have these big cash balances, to bring that cash back to the US. The reason they don’t is that right now there is very unfavorable tax treatment. If he says, “Listen, you bring the cash back. We’ll charge you a one-time 10-15% tax on it, rather than the current 40% rate,” I can imagine a lot of people are going to bring that cash back.

That makes the dollar stronger. Then the interest rates go up even higher. More capital is drawn to the US. Not only that, but as the dollar gets stronger, if we go back to the $10 trillion that the international entities own, it’s even harder…

Basically, they took out big loans, and they were involved in currency speculation at the same time, thinking their currencies would appreciate against the dollar. Now it’s gone sideways on them. Now they’re upside down. The dollar is getting more expensive. It’s even harder for them to service that debt. They go into a decline, which makes us look even better on a relative basis, which makes the dollar go even higher.

Alex:  It’s a self-feeding process, isn’t it?

Brent:  You can get into the vicious circle, where the dollar goes higher. Unless the Fed reverses course and starts providing more dollars to the rest of the world, then you get into the situation where the dollar gets even stronger.

Then you think of a place like China, which is going through its own credit crunch, and is one of the biggest owner of treasuries. There’s all this money trying to get out of China. When the money leaves China, China has to take the yuan that’s trying to get out and give them dollars.

The way that they get the dollars to give the people that are leaving is to sell their treasuries to provide the dollars. If they sell the treasuries – and they’re the biggest owner of treasuries – then that pushes yield up on treasuries. Now interest rates are even higher, and the dollar goes higher again.

The point is that there are all these different forces. Because the world still uses the dollar as the world-reserve currency, and because the world still uses dollars to operate, there’s a supply/demand imbalance.

It’s very similar to the gold argument. Let’s say the argument with gold is that there’s not that much out there, and when the world realizes that you need gold, the demand is going to overwhelm the supply.

Then you say, “Yeah, but they can just print more.” You can’t print more gold, but you can sure print more shares of GLD, and you can certainly, out of thin air, create more options and futures contracts on the COMEX.

A lot of times, the gold community will talk about the fact that ETFs and the COMEX provides “paper gold,” which keeps the price from going exponential. Again, that’s a conversation we could spend two hours on.

The same kind of dynamics currently exist for the dollar. They can do that. They could print and provide as much currency as the world needs. But right now, they’re not doing it. Until they start doing it, demand is overwhelming supply, or I think will overwhelm supply.

That’s my whole “Trump is inflationary” perspective. I hope I made sense. I know I was rambling for a long time.

Alex:  No, it makes total sense. Brent, I think you do some of your best work when you’re ranting there like that! That’s a really good argument for a strengthening dollar.

Part of your thesis is that a strengthening dollar is actually going to cause its own destruction at some point, or its own demise at some point. Do you want to talk about that?

Brent:  Yes, right. It’s like taking steroids. It makes you stronger in the short term, but it also might kill you.

Alex:  Right. Explain this. How does this happen? What does it look like when the strengthening dollar causes its own demise?

Brent:  I think it doesn’t happen right away. I don’t think it takes much longer for the pain to start showing up in other places around the world. I could be very wrong on this, but for now, let’s assume that I’m right that rates start to rise in the US, the Fed continues on a path of raising rates, and we start to get a little bit of inflation in the US as a result.

If we take that as an assumption for right now, I think the pain starts to show up in China very quickly. I think the pain starts to show up in emerging markets very quickly. I think it’s not too long in Europe before they start to feel pain as well, because they’ve got a number of problems, Greece and Italy probably being two of the biggest ones, not to mention dealing with Brexit.

What I think happens is the dollar starts to escalate in price pretty quickly. A couple of Trump’s cabinet picks have made comments about how the strong dollar could hurt us short term, and the dollar actually sold off on that news. At one point, he said something like, “It’s nice to have a strong dollar for bragging purposes. For other than that, it doesn’t really do us a whole lot of good.”

There’s all this innuendo that Trump wants a weaker dollar. I think he has more negotiating power with a stronger dollar. I think these foreign countries and these different trade groups, he’s talking about getting us out of these different trade treaties, I think these trade partners are going to start to complain about the strong dollar. I think the IMF will probably start to complain about the strong dollar.

Without some kind of a policy – and not just talk… Trump can say something, and the dollar might trade down for a couple weeks, or a month or so. But unless he actually does something to weaken the dollar, the market is going react and it’s going to rebound.

I think it probably doesn’t take much more than a year or two years before a bunch of the trading partners, the IMF, some of the monetary authorities start to talk about how the strong dollar is not conducive to world trade and world growth. They may even have another Plaza Accord type…

I think without them having some kind of a Plaza Accord type of agreement, or some kind of a coordinated devaluation – everybody devalues against gold or something like that – I think it just goes until the strong-dollar grips the world.

That’s why I say I think the dollar and gold rise together. As these problems start to pop up, I think gold and the dollar will start to rise together as a safe-haven flight to both of those assets. Ultimately, the dollar debts will have to get bigger during all of this as well. For the velocity of money to pick up, debt has to grow.

We’re already way in over our heads on debt. The debt will have to get even bigger. Eventually, people will realize the debts can never get paid off. The currency in which all these debts are issued is going to have to be worthless. That’s when gold separates itself. Maybe at that point, people give up on fiat currency altogether. Then maybe we go from the strong dollar to a weak dollar because people just flee the currency.

That’s how I see it playing out. I would think that in the next 12 to 24 months, the strong dollar is going to start to hurt the global economy. I think initially they will try to do these small half-measures, at best. They’ll try to talk it down. I think eventually they’re going to have to do something more dramatic and permanent in order to combat the strong dollar.

Here’s the great thing about this argument. If I’m completely wrong and they reverse course, and they try to inflate away the dollar right now, I own a lot of gold and I should do very well in that environment as well.

I think it’s my job to try to stay as impartial as possible, and try to figure out what’s going to happen. It’s all about probabilities. Even if I think the probability of something happening is only 1%, I think it’s part of my job to figure out, “We know we think there’s only a 1% chance this is going to happen, but if that 1% chance was to happen, what would have to happen for that 1% to happen?”

I think part of my job is to think through that and focus on that 1%, even though I don’t think it’s going to happen, so if that does happen, I’m not totally caught off guard and I kind of understand the reasons why it’s doing that.

I think that’s one thing I would recommend to anybody. I think sometimes it’s very easy to get caught in an echo chamber. It doesn’t mean that the echo chamber is wrong. The echo chamber that you’re in may be 99% right.

But you don’t learn a lot in the echo chamber. You can learn a lot by listening to that 1%. Even if you vehemently disagree with them, listen to that 1%. Try to figure out where they’re coming from and figure out what kind of crazy scenario would have to happen for that 1% to happen. That way if it does happen, you’re not totally caught off guard.

Alex: Outstanding. You know what, Brent? I think we’ve got a new nickname for you. You are “The Tenth Man.” I don’t know if you’ve heard of the tenth-man principle. The idea there is if there’s a board of directors and the board consists of 11, and you’d be the 11th man. Ten out of the eleven all think one way. It is your duty to disagree and take the opposite position.

Brent:  There you go.

Alex:  I think that’s really great about the way you look at things, and look for things that everybody else really isn’t looking at. This has been a great discussion with you today. I want to be respectful of your time. I really appreciate you taking the time to talk to us about these things.

Brent:  I appreciate you inviting me to come on. I love talking about this stuff.

Listen, I’ve been wrong a lot of times in my life. I’m going to be wrong a lot more times. I like talking to people like you and others that can agree with me on some things and disagree with me on some things. Just talking through it helps crystalize some things, but it also helps figure out where you might be wrong in some things.

I think the one thing I would say is when I really started studying this stuff and really started digging in, the reason that it brought me to gold – and I know you probably agree with this, as well – is that regardless of which way this goes, the flaw in the monetary system exists. That is a fact. It’s a mathematical fact.

Alex:  It’s math.

Brent:  Regardless of which way it goes, whether it goes south because of the deflationary forces, or whether it goes south because of the inflationary forces, gold cannot be deflated away, and gold cannot be inflated away. Gold is a constant. It’s an element.

That is the one part of your portfolio that, regardless of which way this resolves itself, will still be standing at the end of the day. I think that’s why it has to be the anchor of everybody’s portfolio, regardless of which way you think it plays out.

Alex:  Totally agree. Brent, thanks so much for being with us today. We greatly appreciate your time. We’ll have to do it again sometime.

With that, Jon, I’m going to hand it over to you.

Jon:  Thank you, indeed, Brent Johnson, for sharing your insights with us this today, and thank you, Alex Stanczyk. Most of all, thank you to our listeners for joining us in this first episode of Global Perspectives.

Let me encourage you to follow Brent and Alex on Twitter. Brent’s handle is @SantiagoAUfund, and Alex’s handle is @AlexStanczyk. Goodbye for now, and we look forward to joining you again soon.


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Global Perspectives: February, 2017 Interview with Alex Stanczyk and special guest Brent Johnson


You can follow Alex Stanczyk on Twitter @alexstanczyk

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