Jim Rickards and Alex Stanczyk, The Gold Chronicles October 2018
*Cyberwarfare Update – Chinese embedding hacking chips onto server mother boards used in American Industry and Department of Defense Systems at the factory level
*Why infrastructure will be most likely targets for cyberwarfare
*How cyber financial-warfare versus financial systems, stock markets, banks is an evolving and real threat
*How physical gold is resilient versus cyber financial-warfare
*IMF Global Financial Stability Report
*How markets are over 90% automated trading, and there are no human market makers available to stabilize falling markets
*Total official gold adjusted upwards for Central Bank buying. Eurozone countries now buying gold may be signaling important shift in Central Bank behavior
*Gold requires no counter-parties to retain its value, all other currencies rely on counter parties
*Game Theory on Future Monetary System Based On A Sovereign Issued Crypto Currency: Permissioned Distributed Ledger sponsored by China / Russia / IMF, Digital Coin tied to the SDR for measure of value, net of payments settled in Physical Gold
Listen to the original audio of the podcast here
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 Alex Stanczyk, and welcome to another addition of The Gold Chronicles. Today is October 18, 2018, and I have with me again my friend and colleague Mr. Jim Rickards. Welcome, Jim.
Jim: Thank you, Alex. It’s great to be here.
Alex: Before we dive into today’s podcast, I’ll mention that you can access an archive of all of our podcasts going back for several years at PhysicalGoldFund.com/Podcasts. If you happen to watch this on YouTube, please take just a moment to subscribe, like the video, and recommend it to friends if you think this information could be valuable to them.
Jim, the first thing we have up is something that over the years you and I have discussed quite a bit. We’ve talked about the concept of full-spectrum warfare, which is the combination of kinetic, financial, and cyber warfare. There have been some interesting developments on the cyber warfare front we should touch on and that is regarding a Bloomberg article published earlier this month. In this piece, there’s a story about Amazon conducting due diligence on a company, vetting a company, because it’s looking at buying the company. When doing this, Amazon started discovering some really disturbing things.
Specifically, they found that the motherboards these companies were using had tiny little microchips, smaller than the size of a grain of rice, embedded in the motherboards that was not part of the original design. As it turns out, these chips were embedded at factories run by manufacturing subcontractors in China.
We’ve talked about cyber warfare before. You’ve talked about it extensively, and I know you lecture about it on a regular basis. If I’m understanding it right, this is taking it to an all new level, because being able to embed stuff at the manufacturing level is huge. U.S. officials are describing it as the most significant supply chain attack known to have been carried out against American companies in history. China makes 75% of the world’s mobile phones and almost 90% of its PCs. These motherboard servers were found in the Department of Defense data centers, in CIA drone operations, and on board Navy warship networks. What’s your take on all this, Jim?
Jim: I certainly share that level of concern. Credit goes to Amazon for uncovering this and Bloomberg and others for putting the story out there. In listening to your introduction and question, the words that jumped out to me were that this is the most significant known attack. Well, what about all the ones we don’t know about? This is news because it was discovered, but it’s been going on for at least 15 years, probably longer. There’s nothing new about China’s efforts to do this.
Going back to 2010, it was discovered that a few lines of code were implanted in the NASDAQ operating system for malicious purposes. It is believed to have come from Russian military intelligence. It’s not clear what it could do, but at a minimum, it could monitor. At worst, it could shut down the NASDAQ with a server switch. This has been going on for a long time now.
I’ve spent over a decade working with the intelligence community, the CIA, on something called CFIUS. That’s an acronym for the Committee of Foreign Investment in the United States. It’s an inter-agency committee housed at the Treasury and composed of the Treasury and other branches of government such as Congress Department, the Defense Department, and Homeland Security. They have the power to review and unwind any foreign acquisition of any U.S. company based on national security grounds.
My role at the CIA was as a lawyer. When a deal would land at Treasury, as either the buyer or the seller, you had to notify the CFIUS via the Treasury that there was going to be an acquisition.
Think of it as a four-part matrix. On the horizontal X axis were degrees of sensitivity, meaning is this an ice cream company nobody cares about or are we trying to buy IBM? On the vertical Y axis, we had another gage as to whether it was a friendly acquisition or an unfriendly acquisition. Presumably, Canada or the U.K. would be on the friendly side and something from Russia or China would be on the unfriendly side.
We had a quadrant or what we call a four-part quad chart. The lower left would be a friendly acquisition of something nobody cared about. For example, the U.K. wants to buy an ice cream company; fine, go ahead. In the upper right would be an unfriendly actor (say Russia or China) trying to buy something extremely sensitive such as a computer telecommunications company. Those almost always got a no. The hard ones were the upper left and lower right where we had either had an unfriendly buyer or a sensitive technology and we had to think about it.
The Treasury would outsource the national security review to the intelligence community. The intelligence community did not have yes or no authority to say the deal could or could not go through. We would simply collect the intelligence and report back if there was a threat here or there. It’s actually quite similar to corporate due diligence except using more sources and methods that we don’t have to go into now.
When I was doing this, mostly during the Obama administration, the attitude was that they wanted deals to go through. They were not oblivious to national security. Of course, they cared, but the attitude during the Obama administration and even earlier – I’ll say including the Bush administration – was to find a way to let the deal go through. That meant entering into what are called mitigation agreements. A mitigation agreement is basically saying, “Yes, we know you’re China, and we know it’s a sensitive technology, but if you agree that none of your Chinese directors can be on the board of a U.S. target, and if you do classified information or classified projects, nobody outside the U.S. can be involved in that, and if you’re open to inspections… We had a list of things that would appease the government, and then the deal would go ahead.
Personally, I was never comfortable with that. There was very little enforcement and very little after-the-fact inspection. I felt it was a much too relaxed attitude. Again, I was just helping with analysis and was not a decision-maker, but my personal view, which I expressed privately, was that we ought to be a lot stricter on those. At the time – and this was included in the 2008 Financial Crisis – we were mainly focused on the financial sector in December 2007. The crisis came to a height, a panic, in September 2008, but the crisis actually began in the summer of 2007. By December 2007, there was a lot of distress, and all these foreign sovereign wealth funds came along and bought big chunks of the U.S. banks. It was essentially bailout number one, if you want to put it that way, as opposed to what happened in October 2008, which was bailout number two.
Abu Dhabi bought Citigroup, and the Government Investment Corporation of Singapore and Temasek and Kuwait Investment Authority all went around and snapped up big chunks of the U.S. banks. If you go back and look at those deals, they were all held below 10%. Nine percent to 9.5% was usually a comfort level that could have a financial impact but not too much governance power, and we were comfortable with that. We took a close look at all those deals.
What has changed, and I think changed for the better, is that the Trump administration has now weaponized CFIUS. We’re telling China flat out, “You cannot buy any sensitive U.S. companies at all.” You saw this when an affiliate of a Chinese company went to buy Qualcomm. That deal was shot down, and a lot of deals are getting shut down. Walway, forget it. Walway couldn’t buy an ice cream company let alone a technology company in the United States.
I don’t know if metastasized is the right word, but this has now certainly spread into a broader effort by the United States to contain the Chinese government, and we’re kind of in a new cold war. This is going beyond just the national security implications of M&A, which is where it starts, and broadened into an effort to prevent China from getting all this technology or overtaking the United States’ critical sectors, etc.
The chips story you mentioned is a very important story, but I’m just trying to put it in a broader context. This is an all-out financial and technological war between the United States and China. At least so far, it’s not kinetic war, but you can’t rule that out. And let’s not forget the Russians, because they’re pretty good at this also.
The idea of an embedded chip or code is something we’ve been concerned about and warned about for years. Again, this is an example that has come to light, and that’s good, but who knows how many chips, how many lines of code, how many embedded back doors and portals are already in all the stuff we use every day. At a minimum, it’s a massive invasion of privacy, but worse than that, we could have major gaps in national security.
What’s interesting is that the U.S. is just as good at this as China. We’re probably better than the Chinese, but they don’t buy that much stuff from us, so our opportunity to kind of turn the table on them is limited. We’re really good at surveillance, we have a better satellite network, we’re better at picking up microwave transmissions, and we have pretty good eyes and ears on this, but we’re not as good as they’ve apparently been by being able to pull off embedding these chips.
Let’s put that in the broader context you mentioned, Alex, which is cyber warfare. Part of this is preparation for a cyber war, but cyber war is a broad category and could include a lot of things. At the low end is surveillance information. Think about what spies used to go through spending years cultivating a resource in a foreign country, then hoping that resource could get access to a few papers, pull out a Minox camera, take a few pictures, and pass them along without anybody getting caught. That was the old way of doing it. Now we’re hacking into systems, tapping into systems, monitoring communications, and all that.
Intelligence gathering is better than it’s ever been, but that only goes so far. Then comes the analytical side. Okay, I got all this information, but what do I make of it? What do I think is going to happen next? What’s my estimate?
Cyber warfare can go right to any form of critical infrastructure. That would include hydroelectric dams, nuclear power plants, transportation networks, communication networks, gas stations or ATMs. When we think of anything electrically powered that we rely on, it’s probably a pretty long list, and you could just start shutting that down collectively. Or worse, if you’ve got control of the operating system of a huge hydroelectric dam, what about opening the floodgates and flooding communities downstream killing hundreds and thousands of people who had no warning and were suddenly caught in a horrific flood? What about shutting down airport networks? That kind of thing is all on the list of targets you could attack.
It is warfare. Just because it’s cyber doesn’t mean it’s not destructive. When we think about kinetic warfare, what happened in World War II? Waves of bombers were sent up. They flew all night over Germany, tried to drop bombs on the targets, the German Luftwaffe was up there trying to shoot them down, and we had fighter escorts. The casualty rates and damage were high, and the bombsites weren’t that good. If they were aiming for a bridge, they were lucky if maybe one bomb in a hundred would hit the bridge.
Why was that done? To degrade the critical infrastructure of your opponent. If you took out a bridge or a refinery or a railroad hub – and railroads were a big target – you slowed down their economy and ability to fight the war. What if you could do that without a bomb? What if you could do that with just pure cyber warfare? It’s the same thing. In other words, it’s not the means, it’s the objective. The objective is the same, which is to shut down your enemy, but if the means switched from kinetic to cyber, then it’s so much the easier, so much less expensive, and you don’t have your own casualties.
Within the realm of cyber warfare there’s a subset called cyber financial warfare. Just to step back for a second, I was involved for quite a long time with financial warfare. When I started doing this around 2003, one of the things I warned about was, for example, take a power like China with basically unlimited funds. What if they took $50 or $100 million dollars, which is not a lot of money to them, and started a hedge fund in disguise in a place like the Cayman Islands, the British Virgin Islands, Malta, Macaw or all the places where hedge funds are usually formed? They had a network of these, but it wasn’t apparent from the outside that it was a network all working for China, and they traded and traded. If you long and short the same stock, it’s not a smart way to make money, but you’re not going to lose any money other than the transaction cost.
They would gain trust and credit lines. Then one day on a signal from Beijing, they would start flooding the market with sell – sell Apple or Google or Facebook – and just take the market down destroying trillions of dollars of Americans’ wealth. By the way, don’t do that on a sunny day; do that on a day when the markets are already down a thousand points. It’s what’s called a forced multiplier. Then we would come up with ways of looking for these hedge funds and all that.
What if you didn’t need a hedge fund or an actual party with financing and credit lines and an ability to do this? What if you could hack your way into an entry system at Morgan Stanley, Goldman Sachs, Citi or any other major bank and do the same thing? You would basically mimic orders by sending out the same wave as sellers I just described and take down the market, but it wouldn’t involve any actual transaction. It would be spoofing or phony transactions that you did because you hacked into their operating system. It would be discovered eventually, but it might be too late.
For people to say this could never happen, just go back a few years to Night Trading. Night Trading was a legitimate broker/dealer with an automated order entry system that went crazy. It started doing exactly what I just described. In their case, they were putting in all these sell orders and taking the market down. Nobody could find the kill switch. They were running around Night Trading at 9:30 or 10:00 in the morning saying, “How do we shut this thing off?” They lost almost $500 million dollars in a couple of hours before the New York Stock Exchange finally shut them down from their side even though Night Trading could never find the kill switch on their side. That happened by accident. Imagine if you were trying to do it on purpose and knew exactly what you were doing.
Alex, you’re right. We’ve been doing these podcasts and videocasts for years, and I move around quite a bit, so you never know where I’m coming from. Right now I’m in Washington, D.C. for a meeting tomorrow morning on de-dollarization. Washington is finally waking up to the fact that the dollar is not necessarily permanent unless you take steps to bolster its role. We can’t take it for granted, and that’s something I’ve been worrying about for a long time. It’s good that people are waking up, although it may be a little too late in terms of what Russia and China are doing, but we’ll talk a little bit more about that later.
When talking to people in the national security community and on Wall Street, everybody gets financial warfare – sort of; some better than others. Everybody gets cyber warfare. They understand the example of taking control of transportation or hydroelectric infrastructure. The thing that frightens people the most is the combination: cyber financial warfare. You would go right for the heart of the financial system in cyberspace, and it would be either impossible or extremely difficult to detect and impossible to stop.
This is the most serious threat out there. You brought up the chip story, and I mentioned the other one about NASDAQ. That’s two, but there could be a hundred like it that we don’t know about. It makes a strong case for having some physical assets such as land, gold, fine art, and some cash. I know I sound like a broken record, but I go down this same list because they’re all physical. My rock collection can’t be hacked. If I have a gold coin safe in my bank storage, you can’t hack it. The same goes for land.
Any investor who does not have an allocation to physical assets in safe custody is sitting there on the frontlines of a potential cyber financial warfare and could be wiped out.
Alex: I totally agree. This reminds me of a conversation I had recently with a very prominent commercial real estate developer in the area. I met him in my gym. As we were talking, he found out that I was in the gold industry, and he didn’t quite understand it. I simply pointed out it is the only asset that’s truly uncorrelated. By truly, I mean everything else requires functioning markets, etc., to work, but gold doesn’t.
Jim: That’s right. Again, it has that physical aspect to it. I gave a speech down in North Carolina the other night on some of the topics we’re touching on. Occasionally people say to me, “Jim, you have some money in precious metals. How can you sleep at night?” And I say, “You’re 90% in stocks. How can you sleep at night?”
Alex: Exactly. Moving on, our next topic today is going to be the recent release of IMF’s global financial stability report. Some of the follow-up commentary was that there’s been an increased level of risk among multiple global metrics following its publication. Stocks in the U.S., Europe, and Asia lost 4%, 3%, and 4% respectively over three days. In addition, as the U.S. market retreated, gold held steady, but as the sell-off really started rolling, gold began to rally meaningfully.
Another comment was that a lot of complacency could creep in because we’ve had years of sustained one-directional movement in the stock market. Trading volumes are light.
Something caught my attention that I’ve heard you mention before, so this is a very important point. Liquidity under stress has not been tested in over a decade. What do you think about that?
Jim: I’ll do the last part first and come back to the first part. Liquidity under stress is almost an oxymoron. It has been tested, and there is no liquidity under stress. Let’s start there.
I’ve talked to people about this. I talked to the Director of Floor Operations at the New York Stock Exchange. This guy is on the floor, he’s got one of those brightly colored coats, he’s got his badge, but he has other roles including Director of Floor Operations. As we were standing on the floor of the New York Stock Exchange in a one-on-one conversation, he said, “Jim, there’s no liquidity here. Don’t ever think that.”
Back in the old days, there was a specialist in each stock, and they were a market maker. They had some privileges one of which was they could see the back of the order book. Maybe they knew buyers at this level would go down half a point. If there were a whole bunch of buyers, that was sort of the source of strength. That was their privilege, but their responsibility was to stand up to the market meaning if everybody wanted to sell, they had to buy. If everybody wanted to buy, they had to sell. They didn’t have to go bankrupt in the process, so if they were buyers, they could move the price down a little bit, but they were a source of supply. And, of course, they knew the people behind it.
That system is gone. Over 90% of trading is totally automated. There are no human errors, no using common sense, and no making judgements. Even on the 10% where maybe you’d go over to the booth or the crowd, that’s only ‘normal’ markets. Block trading is automated.
We’re completely computerized not only in terms of bids, offers, and matching systems, but the decision itself to put in the order is automated based on scanners and when the FED releases the minutes. You and I are sitting there reading the minutes while the computers have read it instantaneously and counted the number of words. Did they use patient? Did they use normalization? What words dropped out compared to the last time? A computer can do that in a nanosecond, and they’re preprogrammed to buy or sell based on that even if it doesn’t make sense. I guess if you wanted to mess around with it, you could use a keyword that would trigger selling that actually meant, “We would never do this,” but the word itself would trigger the selling. It’s probably not a good practice, but that’s how sensitive these computers are.
There’s no human decision-making behind the buy and sell order or in the middle of the buy and sell order. It’s fully automated and volume sourced. In that world, does anybody think that if everybody went to sell, anyone would stand up and buy? Or vice versa?
What you can do is what Warren Buffet has done. Berkshire Hathaway, led by Buffett, has $115 billion dollars in cash. It’s the most cash they’ve ever had. Now, Warren Buffet is not going to talk about markets crashing, because it’s not in his interest. Even if he felt inclined to talk about it privately, he doesn’t know when it would happen any more than anyone else does, but he does know that it happens from time to time. When it does, the guy with the cash can come along and scoop up some great bargains, but when the market is crashing around you, you don’t want to be too quick to do that. You want to wait until a couple of banks are calling up saying, “Hey, Warren, can you bail me out here?” Then you drive a hard bargain. That’s the world we live in.
There are many examples of this. October 15, 2014, we had the flash crash in yields in the U.S. Treasury market. This came out of nowhere. There’s an official Treasury joint working group report on this that I looked at that said there had only been four or five examples of such an extreme move in yields in such a short period of time. In every other case, there was a reason for it. Maybe the FED surprised the market or maybe there was a rumor that Alan Greenspan had a heart attack or a war broke out – something that might explain it. In the case of 2014, there was nothing. It just happened out of thin air.
I believe it was May 16, 2010, when we saw the Dow Jones drop a thousand points in two or three minutes. Back in the day when Jim Cramer and Erin Burnett were on CNBC, they were watching it and just couldn’t believe it. It bounced back, but that came out of nowhere. There was no major company that missed earnings expectations or anything that happened that day.
These things are happening repeatedly. We saw it in January 2015 when the Euro crashed 20% against the Swiss Franc in 30 minutes. That’s when the Swiss National Bank came out in December and said, “We are never going to break the peg to the Euro.” Then in January they said, “Whoops, we’re breaking the peg.” Boom – the Euro dropped 30%. Well, if you’re on the wrong side of that trade, you could be out of business.
There was a catalyst for the Euro example, but not for the other ones. But it doesn’t matter. What it shows you is that behind the day-to-day flow of buys and sells, there is no liquidity. What the IMF is referring to is, if that’s true – and it is true – what if it can’t be contained? What if it’s not a 30-minute headline-making crash that bounces back but just keeps going? That’s the danger, that it just keeps going. Then you say, “Who’s going to stand up to that and turn it around?” The answer today is nobody.
The central banks can, but does the FED want to be a market maker in foreign exchange? Does the FED want to be buying U.S. stocks? The answer is no. The Japanese and Swiss don’t mind it. There are central banks that trade in everything, basically, but the U.S. does not. In this situation, who comes in?
The central banks themselves are not in the kind of shape they were in 2008. In 2008, the Federal Reserve balance sheet was $800 billion dollars and had ample room to cut interest rates, so they did. They cut interest rates to zero, left them there for six years, and ballooned the balance sheet from $800 billion to $4.4 trillion dollars.
The problem is they haven’t normalized. Yes, they raised interest rates up to 2.25%, but if the U.S. economy goes into recession, they need rates at 4% or maybe 5% in order to have enough room to cut to get out of the recession. Well, they’re only halfway there. They’re still two years away from that level. The question I ask is, “Can you get to the level you want without causing the recession you’re preparing to cure?”
I think the answer is no. Long before they get to the 4% level, they will have stalled out the economy. And they’re making even less progress on the balance sheet; it’s still about $4 trillion dollars. It’s come down a little bit, but one of the reasons it hasn’t come down faster is because people are not refinancing mortgages. A mortgage-backed security doesn’t have the maturity the way a Treasury bond does. It pays off when it pays off. People refinance their homes long before their 30-year mortgage is paid off dollar for dollar, so the weighted average maturity in a lot of these things is seven years, give or take.
When interest rates go up, there’s no longer any advantage in refinancing. They’ll keep their 2% mortgage, thank you very much, because they don’t feel like paying 5%. They don’t move, because the new mortgage is going to be more expensive, and they can’t afford it. The prepayment rate for mortgages slows down, so the maturity of those securities is extended, and they don’t pay off as fast as the FED thought they would.
The reason they’re not is because the FED raised rates. Duh. “Oh, you raised rates on the one hand, but you’re surprised that your mortgage payments dried up and you’re stuck with the mortgages?” The FED has painted themselves into a room, and they can’t escape. They’re trying, but it’s not clear that they will be able to.
Here is what the IMF is warning about:
- There is no liquidity.
- If you need liquidity and turn to the central banks, they don’t have the degrees of freedom they had in 2008.
Was the FED supposed to take the balance sheet from $4 trillion to $8 trillion? Legally they could, but can they do that without destroying confidence in the dollar? And where is the boundary? Maybe they could take it to $5, $6, $7 or $8 trillion? I don’t know where the boundary is, but I do know it’s there somewhere. Part of the reason the FED is trying to reduce the balance sheet is because they also know it’s there. They’ve never said it publicly, but that’s one of the drivers behind this.
It really is kind of a double tightening, so fair warning to investors. If you think you can just go along, la-di-da, buy your stocks and bonds, and watch your account go up and look forward to a happy retirement – and hopefully you do have a nice happy retirement, no one’s against that – I would warn investors. First, the kind of drops we saw in the flash crashes I mentioned could spin out of control, keep going, and not bounce back. Second, the ones that did not bounce back until there was government intervention were seen in the 2008 financial panic and 2007 mortgage panic.
Going back before that, 2000 was different. The dot-com crash was as severe – NASDAQ dropped 80% – but what was different about 2000 was there wasn’t that much leverage. That’s what causes a financial crash to spin out of control. It’s not that a particular market went down (it’s just tough nuggies for the holder; your stocks and bonds went down), but when there’s a lot of leverage behind it, you’ve got to sell. You can’t sit there. You’ve got to sell, because brokers are breaking down your door for margin calls. You more or less have to sell.
We saw that in 1998 with long-term capital management Russia, 1994 with Mexico, and on October 19, 1987, when the Dow dropped 20% in one day. That would be the equivalent of 5,000 Dow points today – not 500, but 5,000.
I think five crises in the last 30 years is not that infrequent. They happen every six, seven, eight years. It’s been nine years since the last one. I’m not predicting one tomorrow, although it’s possible, but I am saying that the next one will come along sooner than later. The liquidity won’t be there. The central banks’ hands are tied.
Coming back to my earlier point, an investor needs true diversification. When I say true diversification, a lot of investors say, “I’ve got 50 different stocks in my portfolio. I’ve got semiconductors, consumer non-durables, technology, etc., and I’m fully diversified.”
I say, “No. You may think you’re diversified with your 50 stocks, but you have one asset class: stocks. Today stocks have become commoditized. They tend to go up and down together with their high correlation. It’s risk on/risk off. We’ve seen this over and over. Your diversification in the stock market doesn’t help you.”
For true diversification, you’d have some stocks, cash, bonds, land, and gold as part of your portfolio. That’s a much more robust form of diversification.
Alex: I agree. The single point of failure if you’re all in stocks, obviously, is the stock market. If the stock market is not working, you’re in deep kimchi.
As part of this discussion from the IMF about markets selling off, gold has been characterized as a flight to safety asset in terms of that most recent activity. Do you have any thoughts on that?
Jim: We see these terms all the time. There is flight to safety, a haven, a safe haven, it’s a dead asset, blah-blah-blah. The same words and phrases are used over and over by the pundits.
As you and a lot of our viewers know, we’ve been continually talking about Russia and China in terms of buying gold. Russia and China have tripled their gold reserves in the last ten years. We’re talking hundreds of tons. In the case of Russia, 1400 tons, and in the case of China, maybe 2000 tons. That’s a lot of gold.
As we’ve mentioned before, the total official gold in the world is about 33,000 tons. When I say official gold, I mean gold owned by central banks, finance ministries, sovereign wealth funds, basically owned by countries. That doesn’t count personal gold, private investments, somebody’s wedding ring, etc. That’s separate. There are about 33,000 tons of official gold.
I think it’s a reasonable estimate that China and Russia, just the two of them, have acquired over 4,000 tons in the last ten years. Think about it. That’s more than 10% of all the official gold in the world, which is huge. The entire mining output of the world by all the miners in all the continents is a little over 2,000 tons per year. That’s flatlining, by the way. There’s no California gold rush going on. The producers continue to produce and some new mines get started, but old mines get shut down. There has not been any trend or tendency to big gold discoveries, even at these higher prices, that would make that number go up.
We have flat supply and increasing demand, so where’s the gold coming from? The answer is, it’s coming from existing holders who, for whatever reason, want to sell, and Russia and China are sitting there with their checkbooks open ready to buy. That’s the tailwind for gold. That’s what’s helping to keep the gold price where it is. The headwinds are the FED raising interest rates, European Central Bank thinking about raising interest rates, and a few other concerns.
People keep saying, “Why isn’t the price of gold going up?” I keep saying, “You should be surprised it’s not going down.” Real interest rates are soaring. As the FED raises nominal rates, there’s no inflation. There’s a little bit, but the most recent inflation data indicates it went down. We’re getting back to a mild form of disinflation.
If you raise nominal rates and there’s no inflation, then real rates have gone up. Real rates are the biggest single headwind, and the strong dollar. A strong dollar means a lower dollar price for gold. Higher real rates is usually a lower dollar price for gold, because the real rates compete with gold which doesn’t ever yield, so gold has to be going up to make money. That’s what’s keeping gold from going up. What’s keeping gold from going down is the constant demand I mentioned in a world where supply is not increasing. That’s the balance.
What’s changed very recently is that Poland announced they were acquiring gold for the reserve. Wait a second – Poland is in the EU. They’re supposed to be one of these countries that goes along with this system of paper money and no gold, etc., and yet they’re buying gold for the reserves.
There was an even bigger announcement the other day. Hungary, which is not in Europe, has the Hungarian Forint currency. They announced that their reserves increased by 1,000%. I don’t want to get this wrong, but I believe they increased their reserves by a factor of ten, which is also huge. And it’s hard to buy that much gold without market impact.
All of a sudden, the markets are going to say, “Hey, wait a second. It’s not just Russia and China. It’s our friends in our backyard, our friends in Europe.” I think this was a catalyst for people saying, “Maybe I ought to get a little gold.”
What occurred to me the other day is perhaps it’s not a safe haven. Maybe it’s not a flight to quality. Maybe it’s just money. Why do we have to rationalize it? Why do we have to justify it? If it’s money, you want some. What’s happening is that central banks, observers, and analysts are starting to say that gold is money. As JP Morgan said in 1910, “Money is gold and nothing else.”
If you’re a central bank reserve manager, you look at your books and say, “I’ve got some treasuries and bonds, I’ve got some Japanese government bonds. Maybe I ought to have some gold.” And they’re starting to buy. Put that demand on top of existing demand in a world of flat supply, increasing nervousness, and the kind of thing we just talked about in the IMF, and you’re going to see a higher dollar price for gold.
In our last call, I talked about how gold has been trading in a very narrow range for months. The range was $1185 to $1215; that’s a $30 range centered around $1,200 ounce. That was a 2.5% trading range, and it was stuck there for three months.
I said that when you see that pattern, a couple of things will occur. Number one, it’s going to break out either down or up. My analysis was that it was going to break out to the upside for the reasons we just discussed which are fundamental supply and demand and the view that if the FED goes much further when they say are, they’re going to slow the U.S. economy and then have to pause. When that happens, watch out, because that’s like a boxer in the corner throwing in the towel. That says you can’t tighten any more without sinking the economy. That’s that, which means that gold will definitely have its day, because it won’t be competing with rising interest rates any longer.
That’s exactly what happened over the past week. Gold did break out to the upside as I expected and told our viewers. It’s at a new level between $1,225 and $1,230. We’ll see what happens next. I would expect that as the market has these bad days, as the Saudi story continues to unfold, as intellectual property theft becomes more front and center and the U.S. clamps down on China, we’re still throwing sanctions on Russia, plus the actions of central banks…. This is not just analysts or people like me anymore. Central banks are saying, “Get me some gold.” Everything I’ve just described is going to push people to wake up and do that themselves.
It looks like a very bullish picture, and gold will have a good run between now and the end of the year, and maybe even more next year.
Alex: I had a thought while you were talking about gold being money, i.e., why don’t we just look at it as money. I’d like to point something out for our listeners that many of them probably already know. One thing about gold as money is that it’s different from every other form of money on the planet. Gold is money regardless of the counterparty issuing the money. United States dollars are issued by the United States government, yuan is issued by the Chinese government, and so on. Even Bitcoin and cryptocurrency rely on a counterparty of source. It relies on a functioning Internet, so if the Internet is gone, the Bitcoin is useless and valueless. What if a country is gone? I’m not saying China is going to disappear tomorrow, but historically empires have risen and fallen. If the empire falls, guess what? That money is worth nothing, whereas gold will at all times retain its value.
On another topic, Jim, you recently did a lecture on the future of the International Monetary System. That’s no surprise, because you’re in high demand. You’re probably one of the top experts in the world on this right now. Would you name a few key takeaways from that lecture that you thought were important?
Jim: I’ve recently done a lot of lectures probably because of my books. People read my books, and I get invited to an event. Sometimes they’re huge events like a national resource conference, and sometimes they’re quite small. The one I’m doing Friday is invitation only, closed door. We’ll have a small group of maybe 15 or 20 government officials and subject matter experts. It’s not the kind of place to do a slideshow, but we’ll be talking about what you and I are talking about now.
I have a standard presentation I just update. When I’m getting ready to give a presentation, I pull out the last one and say, “What happened since then? What have we learned about the FED? Any personal changes? Any announcements?” It’s always fresh, but I kind of work off the foundation and freshen it up.
I had two basic presentations. One was about the International Monetary System, currency wars morphing into trade wars, the role of gold and the future the International Monetary System, etc. We’d go through that story.
I got invited to a lecture with the military and intelligence community for a group of mid-career officers who are on track to be the big brains, the strategic thinkers of the future at the U.S. Army War College. Then, just a few weeks ago, I went down to the Naval base in Norfolk, Virginia, and gave a presentation to one of the Joint Commands. We had Army, Navy, Air Force, Marines, the Coast Guard, and the CIA all in the room. It was confusing me, because they all showed up in camouflage and I couldn’t read their ranks. I know what the ranks are, but I was squinting at their uniforms. What are you? A Colonel, a Major, a General? How deferential should I be here? Again, it was a very top-tier group.
That presentation was on financial warfare and some of the things we’re talking about in this conversation. What I realized is that they’re not two separate subjects anymore. They’re really the same, just different facets of the same subject. This goes to your point that there’s never been a strong empire or country with a weak currency. They don’t go together.
When the British empire was at its height, the pound sterling was at its height. When the U.S. was at the height of its power at the end of World War II and the decades that followed, the U.S. dollar was at the height of its power. You can track the rise and fall of great powers side by side with the rise and fall of their currencies. It’s a high correlation.
We really cannot talk about the future of the dollar and the International Monetary System without discussing U.S. National Security and the future of the U.S. as a great power. In my more recent presentations, I’ve merged those two. I talk about both, and I’m breaking down that distinction.
The presentation I gave the other day down in North Carolina was for a great group, fairly small, a smaller conference than I often do. It was a local organization that invited speakers in. I don’t want to overstate this, but they were sort of conservative in nature and were in the middle of the research triangle. You got the UNC on one side, Duke on the other side, and all these major universities and research labs. It’s kind of a liberal part of North Carolina. Even though it’s a conservative state, it was the most liberal part, and there was this little cadre of conservatives saying they were going to keep the torch burning, so I was very happy to be talking to them.
I went through much of what we’ve talked about in this conversation and explained that a lot of the future of the International Monetary System is well under way. This is not guesswork and certainly not science fiction. These are not things that are going to happen in ten years. They’re happening now, and more to the point, they’ve already happened. We’re down the path.
That’s interesting to me, because I think that’s why this meeting I’m going to be attending tomorrow morning was convened. People in Washington are starting to wake up to this even though I’ve been talking about it for ten years and other people have been talking about it even longer.
It used to be that the conventional wisdom on the future of the dollar went something like two schools of thought. One was, what are you talking about? The dollar is the global reserve currency and has been for a long time. It is today, and it always will be. They bang the table and say, “Just stop talking about it. It’s not a threat.” You can’t really argue with those people, because they have a very ossified point of view.
If you know more about it and know more history, you know that any currency is vulnerable. Any currency can be deposed as the global reserve currency. You must look out for that and take steps if you want the strong dollar. When I say strong, I don’t mean any particular exchange rate. What I really mean is the stable dollar; the dollar continuing to have its role as part of global reserves.
If you want that, you have to work at it. You can’t take it for granted. You need to have an attractive investment environment, a strong military, a stable fiscal policy, and you can’t be going broke which, unfortunately, the U.S. is.
By the way, it wouldn’t hurt to buy a little gold. I always tell the Treasury while I’m here: why don’t you guys go buy some gold? That would shock the world, but it would be a pretty smart move on the part of the United States. We have the most gold, so why not make it go up?
That’s the debate. The rebuttal of even the more sophisticated counterparts used to be, “Okay, Jim, I hear you. There are some vulnerabilities here, but where are you going to go?” Is anyone going to use the ruble or the yuan? No. Argentinian pesos, anybody? How about the Euro? Well, the Euro is always falling apart according to Paul Krugman and Joe Stiglitz, so maybe that’s not the way to go.
Look around the world, and there really aren’t any good alternatives based on one of several factors: liquidity, rule of law, financial infrastructure or how big a bond market is. Everyone says the Chinese are starting to shoot bonds. Well, maybe, but there’s no rule of law stopping them from reneging on all those bonds. The market is not that big and not that liquid. It’s a long list.
Then, I say, “Where are the dealers, the repos, the futures, the options, the critical infrastructure, what’s your settlement?” You need all those things people take for granted to run a bond market, and you need to have a bond market to have original currency, because otherwise there’s nothing to invest in. So, that’s a valid criticism.
What has changed is, I can get up from this table, walk out of the room, come back in 15 minutes, and start a currency. I can buy software to start cryptocurrency in about 10 or 15 minutes or less. It could be a GMICO, but more likely it’s going to be the Bitcoin. The point is, it could be the PutinCoin or the XICoin. In other words, if you’re starting with a blank sheet of paper, then all the deficiencies in the ruble and yuan don’t count. What counts is how good is the new thing you just created?
Imagine the following. When I say imagine, I’m just trying to get people to think about it. It already exists in part, and they’re working on the finishing touches right now. So, imagine a highly secure, highly encrypted distributed ledger maintained by Russia and China with others allowed to join in. That would include Turkey, Iran, North Korea, Syria, Venezuela, Brazil would probably sign up, etc.
They would have a new coin called the PutinCoin or the XICoin. Call it whatever you want – it could be baseball cards – it doesn’t matter. All you’re doing is keeping score. Denominate it in SDRs, Special Drawing Rights. Say one XICoin is worth one SDR, and there’s your anchor. You don’t have to talk about the dollar or the euro anymore. One of these new coins is worth one SDR. The same thing with Russia. If they all agree that one coin is worth one SDR, you suddenly now have a relatively stable global store value maintained by the IMF.
Now you start trading. Iran ships oil to China, North Korea sends weapons to Iran, China sells critical infrastructure to Russia, and Russia sells weapons back to China. Wealthy Russians go on vacation in Turkey, and Turkey buys whatever from Iran, and so forth. You now have a trading network. Throw in Brazil, India, and some other countries, and it could be a very significant trading network.
Denominate everything in these new coins in SDRs, maintain a highly encrypted, private intranet with a distributed ledger to keep score, then periodically – monthly, quarterly, once a year – look at the scorecard. If somebody owes a balance to somebody because of running up a trade deficit or surplus, then settle up in gold.
What’s interesting about the settle up part is that this is on a net basis. A net settlement is always much smaller than a gross settlement. If I had to send you a gross amount of gold for the weapons I just bought, and you had to send back to me a gross amount of gold for the oil you just bought, that’s a lot of gold flying around and it’s a bit clunky. But if we keep score in SDRs, tally up quarterly, and only pay the net, the net should be much smaller. There’s a little bit of gold to put on a plane. If U.S. intelligence is good enough, it’s still an act of war to shoot down the plane, so I don’t know how you’d actually interdict that.
That system works fine, but to do it, you need a lot of gold to start, because your first couple of balance payments could be negative. Guess what? That’s what they’ve done. Russia, China, Iran, Turkey, and all the countries I mentioned have been stockpiling gold. We know they have the technology. We know Putin’s meeting with SKYcoin, Vitalik Buterin, (the guy who co-founded Ethereum), and that whole smart contract network. When you mention this, all the crypto groupies run out and go, “Oh, buy Bitcoin.” No, don’t buy Bitcoin or Ethereum or Ripple or any of the known coins.
Imagine a coin that doesn’t exist, that is created out of thin air, sponsored by Russia and China, anchored to the SDR, and net settled in gold. What’s missing from what I just said? The dollar. That is a much more clear and present danger than the world going to something like the ruble. The world is not going to go to rubles, because the Russians always steal your money and China is not much better.
That’s the kind of threat we must be alerted to and the kind of model we must carry around in our head to see this coming. When it is unveiled, which it will be eventually, the dollar could collapse immediately. I’m not saying it’s the end of the dollar – we’ll still have dollars when you want to buy a pack of gum or pay your electric bill – but what would the dollar be worth relative to the SDR or these other currencies I mentioned? That’s the threat
Let’s say you forward deploy a U.S. Navy aircraft carrier task force. A destroyer pulls up to a fuel depot in Singapore and says, “Fill ‘er up.” The guy says, “Fine. Pay me in SDRs.” Suddenly, you have to pay for a forward deployed military in a currency you don’t print.
That’s the threat I will talk about more tomorrow morning. I’ll have to check the ground rules to see what I can say or not, but maybe in our next call we’ll have more information to share with our viewers.
Alex: I was just thinking about the dynamic with retail investors in the cryptocurrency markets. The cryptocurrency market’s heyday that got a lot of stir and buzz back in the very beginning of this year and even the entire year of 2017 saw a large influx of capital. If there was something like what you’re describing where large transactions were being settled in XICoin or whatever it turns out to be, and that continues to grow, I think there’s going to be a lot of runway where people will start to see it coming. With the cryptocurrency buzz, it got so much attention, but it was still just a very tiny drop in the ocean of actual liquidity in U.S. dollar terms that’s out there.
Jim: The difference is that what I’m describing is backed by countries. I would imagine if you’re in Moscow and you want to buy a beer or a pack of gum, you’re still going to use ruble as a street level consumer in Russia. What I described is for the big boys. This is for countries. This is a mercantilist system. It’s a way to settle balance of payments transactions among participating countries. How long before the U.S. has to get onboard?
My advice to the Treasury would be:
- Look out for this, because it’s coming.
- It might be a good time to buy some gold.
Alex: That’s the other thing I wanted to comment on before we wrap this up. You said every time you’re there, you tell the Treasury, “Hey, maybe you guys should buy some gold.” I don’t disagree with that – I think that’s a great idea – but what it makes me think of is the entire plan. If you go back and read papers that have been declassified such as private conversations at Camp David, etc., between the President and his top financial advisors going back to the ‘70s, all this information has been revealed about an intentional delinking of gold as money from the U.S. dollar. This is not a conspiracy theory; there’s plenty of documented evidence of this. Can they go back, and can they do that? Will they do that?
Jim: August 15, 1971, is the infamous day when Nixon ended the conversion of U.S. dollars into gold by our foreign trading partners. For U.S. citizens, that had been ended in 1933 by Franklin Delano Roosevelt. Gold was contraband. Having gold in the ‘60s for a U.S. citizen was like having drugs. You could get arrested for it, technically. But if you were a foreign trading partner (France or Italy, or whatever), you could still cash in your dollars for gold. There was a run on the bank, a run on Fort Knox, and Richard Nixon ended that.
There were five decision makers and close advisors at Camp David that weekend. It was President Nixon, John Connolly, who was Secretary of the Treasury, Arthur Burns, who was the Chairman of the Federal Reserve, and Paul Volker, who at the time was Deputy Secretary of the Treasury. He was not yet Chairman of the Federal Reserve. This sounds like a John le Carré novel, but there was a fifth man there, and I never knew who he was. I couldn’t find any record of it.
I spoke to Paul Volker about it personally, and then I had a good friend who was Dean of the University of the Chicago Law School who used to be with me on some of these intelligence efforts I described. I was talking to him once and said, “You know, I’ve never been able to figure out the fifth man.” And he looked at me and he said, “It was me.”
At the time, he was a young attorney in the White House. It was literally the case that they were all leaving the Treasury, and as they were getting in the helicopter to fly to Camp David, Connelly thought, “Maybe we need a lawyer here, because we’re going to make a pretty big decision. Can he come with us?” He said, “You come with us. You’re the lawyer.” So, off they went.
I’ve spoken to two of the five leading participants who were at Camp David, and they both told me the same thing: Nixon thought it was temporary. He did not think he was permanently going off the gold standard. They just wanted a time out. They knew they were going to have to divide the dollar and reset Brenton Woods. That’s why they had the so-called Smithsonian conference in Washington the following December. They thought they were going to go back to Brenton Woods with a devalued dollar, but they never did.
What happened was, Japan, Germany, and some others said, “The heck with it. We’re going to foreign exchange rates. We’re just going to do our own thing.” In other words, you Americans figure it out.
There was some compromise, some give and take. Gold got devalued, revalued to $42 an ounce instead of $35 an ounce, a 20% devaluation of the dollar, but that was it. We never went back to the gold standard, of course, and we’ve been living in the nightmarish world of foreign exchange rates ever since. Again, they didn’t think they were doing that. They thought it was just a reset.
We now may be back at a point where we need to do another reset, except it’s the other way which is to strengthen the dollar and buy some gold. As individual investors, I would love to be ahead of that curve.
Alex: Yes, so would I, and I think a lot of our listeners feel the exact same way.
Jim, thank you very much for being with me again today. It was a great discussion our listeners are really going to appreciate. As always, I look forward to doing it again next time.
Jim: Thank you, Alex. See you soon.
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