Jim Rickards and Alex Stanczyk, The Gold Chronicles April 2017
*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
Listen to the original audio of the podcast here
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.
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