February 9th Gold Chronicles topics:
*Current Events Europe, US Leadership Vacuum
*Ramifications of Swiss Franc De-Peg
*Difference between ECB and Federal Reserve Quantitative Easing (money printing) programs
*How the ECB QE program will affect the economy
*Why Greece will not exit the Euro, they will reach an agreement
*Why the Ukraine crisis is a fait accompli for Putin
*Meeting with CIA operatives, US ambassadors, and US Intel community – they are making a classic mistake of mirror imaging
*The west assumes Putin thinks like the west, nothing is further from the truth
*There is more power concentrated in the Executive Branch than ever before
*When it comes to US leadership, there is no strategy for Ukraine
*Russia is not a peripheral player that you can just push around
*We are already in a war, it is not kinetic, its being fought in cyberspace and financial space
*Sanctions are not a form of diplomacy, it is a form of warfare
*Being kicked out of SWIFT is equivalent to using a nuclear bomb
*Russia has indicated that response to such actions has no limits
*Kinetic war still not likely, but one a scale of one to ten we have dialed it up past 5 and maybe as high as 8, and then back down to 5
*Current actions (as of Feb 9) are moving towards a kinetic proxy war between the US and Russia
*Huge volatility in markets and FX
*Gold is now trading like money
*World has woken up to threat of US confiscation of sovereign gold and are repatriating
*The scramble for gold by central banks proves gold is now moving back towards the core of the monetary system
*View of allocated gold funds versus paper gold
*Due-diligence on Physical Gold Fund
*View of silver versus gold in portfolio allocation
*What happens for the average person after the current monetary system trends unfold
Listen to the original audio of the podcast here
The Gold Chronicles: 2-9-2015
Jon Ward: Hello I’m Jon Ward on behalf of Physical Gold Fund. We’re delighted to welcome you to our latest webinar with Jim Rickards in this series we’re calling The Gold Chronicles. Jim, as you know, is an investment banker and investment adviser based in New York, and he also serves on the Investment Advisory Committee for the Physical Gold Fund. Jim Rickards is the author of the New York Times bestseller Currency Wars: The Making of the Next Global Crisis. And most recently, he’s the author of The Death of Money: The Coming Collapse of the International Monetary System, also a New York Times bestseller. Hello, Jim, and welcome.
Jim Rickards: Hi, Jon. Thank you. It’s great to be with you and on the call.
JW: We also have with us Alex Stanczyk of the Physical Gold Fund. Hello, Alex.
Alex Stanczyk: Hi, Jon. It’s good to be here, thank you.
JW: Alex will be looking out for questions that come from you, our listeners. As time allows, we’ll do our best to respond to you. I should emphasize ‘as times allows,’ because on this occasion there is an awful lot of ground to cover in one conversation.
Jim, we last spoke on January 12th. Let’s take a look at what’s happened in four short weeks since then. First, the Swiss Central Bank decoupled the Swiss franc from the euro; the Greek electorate drew up battle lines with the European powers that be; the European Central Bank announced a massive money printing bonanza; and sadly, Ukraine edged closer to a major conflagration. In a moment, let’s take these one by one, but first, at the macro level, what’s up with Europe?
JR: I’ve enjoyed all of these webinars in the series, but of all the ones we’ve done, I think this is the one with the biggest agenda or longest list. It’s not just headline-making events. I think a lot of the listeners are aware of those. But what is the meaning of them, and more importantly, to your question, how do they connect?
Looking at what’s going on in Europe whether it’s Switzerland, Greece, ECB, Ukraine, Russia, all the issues you mentioned and more, to me the common denominator is the lack of U.S. leadership. A quick glance at Europe’s history for the past 2,000 years shows that it’s divided, it’s warring, it has numerous ethnicities, numerous cultures. It’s even multiple civilizations if you want to look at the eastern orthodox and western Catholics. There are a lot of ways to divide Europe, but the history of Europe is warfare, bloodshed, and division up until the end of World War II.
Then the end of World War II coming so soon after World War I was such a disaster. Europe was so exhausted that it was really the U.S. creating a new world order using a combination of NATO, United Nations, the Bretton Woods Agreements, International Monetary Fund, the original gold standard coming out of Bretton Woods, and the Martial Plan. There were a whole host of things with one thing in common which was U.S. leadership, and U.S. has provided that leadership ever since.
Now, Europe has come a long way. Obviously, the European Union, there’s a very significant development going back to a series of treaties from the 1950s, and then the launch of the euro in 1999, and the actual use of euro currency in 2000. So Europe has done quite bit on its own, but the minute the U.S. is absent, the minute U.S. leadership is lacking, guess what? Europe goes back to its old mode of internal squabbling. We saw a little bit of this in the ’90s with the Bosnian genocide when the Clinton administration was very slow to get involved. It was only when the Clinton administration did get involved, led by Richard Holbrooke and others, that that crisis was resolved.
We’re going to take these one by one and talk about them in an economic context, but if you ask me to give a single, global, macro overview of what’s going on in Europe, I would say that U.S. leadership is missing. Whenever U.S. leadership is missing, Europe reverts to what Europe always does, which is a lot of squabbling and potential for war. That’s what we’re seeing now.
JW: That gives a very interesting and helpful context, thanks. Let’s focus on Switzerland first for a moment. On January 15, that country’s central bank ambushed us all with the decision to decouple the Swiss franc from the euro. There was brief chaos in the currency markets, but it seems now that everyone has returned to business as usual. Would you help us understand the decision, and are there any lasting implications we should watch out for?
JR: The timing of the decision was certainly a surprise and caught everybody off-guard including Christine Lagarde who is the head of the IMF. She gave a very interesting interview on CNBC around the time. I think she was in Davos, and normally she would have been someone they interviewed in Davos, but it happened to be the day the Swiss broke the peg to the euro. She was very visibly perturbed, visibly angry, upset, and clearly had not been consulted. So, yes, it’s a shock when you break the currency peg between two major reserve currencies and no one has the presence of mind to call the IMF and give a heads up.
The timing was a surprise, but the breaking of the peg was not a surprise. The reason I say that is whenever you have a non-sustainable policy, the one thing you can be certain of is that it won’t be sustained. In other words, you may not know when it breaks or the exact consequences of the break, but you can be sure of a break because if you have to have a peg, it means you’re fighting market forces to begin with. If the market was going the way you want it, why would you need a peg? You wouldn’t. If you have a peg, it means you’re fighting the market. Well, markets are always bigger than you are, even for a major central bank.
Remember how this worked mechanically — everybody wanted Swiss francs because it seemed like a good store of value. People were dumping euros because they were worried that the euro was going to fall apart, the European economy is collapsing. Some of those worries have only been exacerbated by what’s going on in Greece. At a very simple level, people wanted to dump euros and buy Swiss francs.
If you left market forces to work, the result would be that the Swiss franc would trade up and the euro would trade down. That’s pretty simple, but Switzerland didn’t want that because they have a highly export-dependent economy. We’re all familiar with chocolates, dairy goods, and cheeses, but they also make watches, precision machinery, and pharmaceuticals. They have a lot of hi-tech, high value-added exports. You can also think of tourism as a kind of export. They don’t ship the mountains to California, but Californians get on a plane and go there to ski, so that’s a kind of export, all very sensitive to exchange rates. For example, if the Swiss franc gets too strong and I want a European ski vacation, I can go to France or Austria instead of going to Switzerland. That’s why they wanted to keep the Swiss franc from appreciating or going up too much, but the market wanted it to go up because they wanted Swiss francs. In order to maintain the peg, they had to print Swiss francs, use them to buy euros at the pegged rate (that’s how they maintain the peg), then use the euros to buy euro securities, euro sovereign bonds and other euro anonymous securities.
Guess what was happening – they were inflating their balance sheet. They were piling up massive amounts of euro securities on the balance sheet of the Swiss National Bank and flooding the market with Swiss francs. If they didn’t break the peg, they were going to end up owning every euro in the world because the pressure never let up. No matter what they said or did, the market still wanted Swiss francs, so they were just going to blow up the balance sheet and own every euro in the world. This was clearly non-sustainable, so they picked a particular moment to break the peg. Maybe no one called Christine Lagarde at the IMF, but it sure sounds like Draghi and the head of the Swiss National Bank were talking, because this happened literally days before the ECB announced their quantitative easing. It was almost as if Switzerland were to say, “Okay, we’ve done our part to prop up the euro. Now over to you, European Central Bank, it’s your job.”
The reason they broke the peg was because they had to sooner or later since it was non-sustainable. The lesson for markets is to look around the world and find anything that looks like a peg. One that comes to mind is Hong Kong dollars to U.S. dollars. I’m not saying that Hong Kong is going to break the peg tomorrow, but whenever you have any currency that’s fighting the market, it’s probably just a matter of time before the market wins. Whenever you see any relationship like that or any effort to rig a market whether it’s the Fed and interest rates or any pair of exchange rates, it’s probably going to break down sooner or later. Usually when it does, there’s a shock factor because people aren’t ready for it.
That’s why they did it, and it was bound to happen. The timing was a surprise, but the event itself was not a surprise. There is another artificial peg in play which is Denmark. Denmark has cut interest rates four times in the past couple of weeks in order to try to cheapen their currency because people are flooding in to Danish capital markets right now trying to get the Danish krone. It’s very easy to predict that will break at some point. They’re going to let the krone go up, but for now they’re still fighting it, so that’s another one to watch.
JW: The excitement about the Swiss move was pushed aside by the next announcement you mentioned – the European Central Bank launching a huge asset-buying program. In the past you’ve emphasized in discussing this possibility the difference between the ECB and the Federal Reserve. I’m curious to know if you were surprised by this decision, and beyond that, will it work?
JR: Two different questions. This was about the most well-advertised easing program you can think of. Go all the way back to when Draghi said ‘whatever it takes.’ The euro was under attack and he needed to calm down markets so he said, “We will do whatever it takes to defend the euro, and believe me it will be enough.” Those were his exact words. He said that in the summer of 2012, so the fact that it took almost two and a half years to actually do something, like I say, it was pretty well advertised. At the end of the day, they probably did have to do something.
One of the important ways to understand this is that so many Western analysts – when I say Western, I really mean United States and U.K. – look at Europe and think this is a stimulus program similar to what the U.S. has done. I have news for them. Number one, quantitative easing doesn’t stimulate anything. It does have effects; it has channel effects in terms of creating asset bubbles and potential channel effects in terms of exchange rates, but it doesn’t create jobs or stimulate anything. That’s nonsense, and Draghi knows it’s nonsense, so they’re not doing this for the so-called stimulus reasons the U.S. supposedly did. They’re doing this to fight deflation. The European Central Bank does not have a mandate to create jobs and stimulate the economy the way the Fed does with the Fed’s dual mandate. They do have the mandate to maintain price stability, and the prompt for this was deflation. Neither inflation nor deflation is price stability. Whether the purchasing power of your currency is increasing or decreasing, by definition, you don’t have price stability.
That was really what prompted it, not any kind of stimulus program. That’s important, because it means they won’t go beyond doing what they need to maintain price stability. If you see the deflation start to level off in Europe — and I think we’re already seeing some signs of that — and you see them getting into a little bit of inflation rather than deflation, that signals that Draghi will not be doing much more. In the U.S. we think you should have QE1, QE2, QE3, multiple rounds, and keep doing it until you wipe out unemployment and create nominal growth. Draghi doesn’t believe in any of that, but he does believe in price stability, so they’ll do enough to avoid deflation but not more than that. Even though it’s now happened, in terms of the future, I wouldn’t expect a lot more. So that’s number one.
Number two, there’s less here than meets the eye. First of all, I love Draghi because he’s the master of saying little and doing less. They had this announcement in January and haven’t actually started the program yet. It’s supposed to start in March, so it’s still a few weeks away in terms of the launch. So this is still vaporware. But beyond that, a lot of these purchases are going to be from what they call the NCBs (national central banks) rather than the European Central Bank itself.
In the U.S. we have one Federal Reserve System. There are 12 regional Federal Reserve banks, but they’re all under the thumb of the Board of Governors and the FOMC in Washington and don’t really act very independently, at least not in terms of monetary policy. In Europe, they do have the European Central Bank, but none of the national central banks went away. There’s still a Central Bank of Greece, a Bank of Italy, the Deutsch Bundesbank, which is the central bank of Germany, and Banque de France, the central bank of France. All these central banks still exist. Draghi said the central banks have to go buy these bonds, so you’re going to see the Deutsch Bundesbank buying German bonds, and the Greek central bank buying Greek bonds. A lot of this has been pushed down to the national central banks, and that’s important for credit risk reasons, meaning that if those bonds go bad or are devalued or restructured, those losses are going to fall not on the ECB but on the balance sheets of the national central banks. So again, even in terms of the ECB, there’s less here than meets the eye.
And finally, one of the big trends of the past two years was that the European Central Bank was reducing its balance sheet. Some of the ease they put into the marketplace in 2012 and 2013, some of those asset purchases, were actually being unwound during the course of 2014. This is unlike the Fed, which blew up its balance sheet and never looked back; the Fed has tapered additional long-term asset purchases, but they haven’t done much, actually very little in terms of reducing their balance sheet. Their balance sheet is still at a very high level or a very inflated level. The ECB actually did, so to some extent this quantitative easing is just putting back some of the easing they took away in 2014. On net, the balance sheet isn’t any bigger than it was in 2013.
Putting all this together, the fact that they’re only doing enough to avoid deflation, it’s not really a stimulus program, the heavy lifting has been pushed down to the national central banks, and all they’re doing is putting back some of the money they took away last year. To me, this is a big nothing burger and I wouldn’t get too excited about it. It does have one very important effect, however, in that it has helped to keep the euro low. The euro traded down from about a high of 160. In recent years it’s been around 140 traded down through 120 where it was in the crisis all the way down to about 113. I think it is close to a bottom at that level. I’m not saying it couldn’t go down a little more as it probably would tick down a little bit as we see some bad days and bad headlines coming out of the Greece crisis, but we’ll talk about Greece in a minute. So I’m not saying it can’t go lower, but it does feel like it’s near the bottom. I think the ECB program was putting the icing on the cake.
One other thing, by the way, is that a lot of the easing already took place courtesy of our friends, the Swiss. Go back to what I said earlier. They broke the peg in January, but before that, they were printing francs to buy euros, and then taking the euros and buying euro securities. That was a form of easing — it’s just a different central bank. It wasn’t coming from the ECB; it was coming from the Swiss National Bank, so a lot of the easing was already in the marketplace. The ECB is just sort of not really doing a lot more than keeping a lid on it and keeping the euro where it is, so we’ll see the euro at these levels at least until later this year. If there’s a reversal, it won’t be because wonderful things are happening in Europe but because the Fed wakes up and realizes they’re not going to be able to raise rates, although that’s a separate discussion. The big takeaway is that this is keeping the euro at a weak level. I don’t expect a lot of stimulus, but it is another example of the currency wars.
JW: You mentioned the next shock to the European system, which arrived on January 25th. With the election in Greece of the left-wing Syriza Party, this put Greece on a collision course with the so-called Troika — the European Commission, the European Central Bank and the IMF — on the issue of sovereign debt. How will this one play out?
JR: I think it’s going to play out the way it has played out before. I have a long history with this subject going back to my first book Currency Wars in 2011 and a series of interviews I’ve done since. We’re really talking about three and half years at this point, even a little bit longer, going back to 2010. At the time I was the only voice and even now one of the few voices who have been of the view that Greece is not leaving the euro or being kicked out of the euro. The euro, as a system, will add members as it has in recent years and isn’t going anywhere. I call it the “Hotel California,” i.e., you can check in but you can’t check out. I continue to be of that view, and I’ve been pouring cold water on the “grexit.”
In 2012 we heard the grexit voices including Roubini, Krugman, Stiglitz, Zero Hedge, and all these guys saying Greece was going to get kicked out, Spain was going to quit, and Italy was going to quit. They were all going to go back to their local currencies, devalue and lower their unit of labor cost, and that was going to be the antidote to austerity and all that. At the time I said that was nonsense, and I said it again in my second book, The Death of Money. I’ve been consistently of that view, and I remain of that view. In other words, there’s not going to be a grexit.
Now having said that, let’s not underestimate the seriousness of the situation. We do have a political party that has staked out some very tough ground, which is new. The political parties that were in charge up until now favored working with the Troika. Now there is a political party leading a government that wants to confront the Troika. This is new, riskier, and a more dangerous situation that’s going to grab some headlines and make a lot of people nervous. I recognize that we have a new political reality on the ground, but I still hold the view that Greece is not leaving the euro, and here’s the basis for that. This is not different than any other negotiation I’ve ever been in. I’ve done a lot of negotiations over 40 years having served the capital markets and banking markets all this time and also having been a lawyer. I’ve done quite a few deals. Prior to going into a room, closing the doors, sitting down, and banging through the negotiation itself, there’s a lot of posturing and positioning. Even when the doors are closed, you start out that way and then begin to reach for common grounds.
Right now these negotiations have not begun in earnest. They will shortly, but in the meantime, the two sides have been huddling on their own. We have speeches from the Prime Minister of Greece and interviews from the Finance Minister. The European major countries, major participants, European Central Bank, have been meeting on their own in Brussels working out their position. Everyone has their press releases out and everyone is posturing. Now we know what the two sides are. The lines are more starkly drawn and they are confrontational, but here’s how to understand the negotiation dynamic. You have to say to yourself, what do I have to gain or lose by reaching some kind of agreement or some kind of compromise? And what do I have to gain or lose by walking away from the table?
This is a classic negative-sum game. These are not crazy people. I recognize that they may be political and adversarial, but they are rational, so you put it in the game-theoretic context. This is a classic negative-sum game, which means that if they don’t reach an agreement, both sides are worse off. Clearly, the European Union and the euro zone will be worse off if Greece does leave the euro. I don’t expect that, just to be clear but if they did, that would be catastrophic. It’s hard to know what the ripple effects would be, but certainly you would see Podemos sweep to power in Spain. You might see the National Front, Le Pen, gain significantly and maybe even become President of France if you can imagine that. Similar parties would arise in Italy. They’re already there, but they would gain power. There will be a domino effect. People would expect Portugal, then Spain, then Italy, and possibly Ireland to quit the euro. The euro would literally fall apart very quickly with unforeseeable consequences in terms of the target two balances, declining asset values, and global financial catastrophe. So there’s your downside, pretty bad. This isn’t just a shoving match between Germany and Greece.
On the one hand this is catastrophic, but on the other hand, let’s imagine you’re Greece. It’s not a lot of fun. You actually want to quit the euro? Okay, that’s fine, but now you’re back to the drachma, which is barely worth the paper it’s printed on. You’ve already admitted your government is bankrupt as a negotiating posture, so now you’re going to come out with your own currency not backed by anything? By the way, there are a hundred tons of gold pledged to the ECB to secure the prior bailout they got. So now, they have no gold, a bankrupt country, a paper currency nobody wants, and everyone is running for the exits. Good luck with that. My point being if they fail to reach a settlement, there are disastrous consequences for Greece and disastrous consequences for Europe. That’s the ultimate negative-sum game, which means that in behavioral game-theoretic space, they’re going to reach an agreement.
One of the questions I get asked most frequently is who’s going to blink first? The answer is they’re both going to blink. Both sides will give more than they want and both sides will not be totally happy with the outcome, but an outcome is an outcome. If there’s some agreement, both sides will walk away saying they got part of what they want. You can count on the Germans to emphasize what little sliver they managed to get. You can count on the Greeks to emphasize whatever sliver they got. Maybe Greece will get a little more than Germany this time around, but they will find a way. The short-term deadline is the end of this month, and there’s significance to the end of February. That’s when the existing bailout has its next tranche. The way they have been doing this is that the Troika have been dispensing money to Greece in exchange for which Greece agrees to adhere to an austerity program, which so far they have in terms of raising taxes, cutting expenses, reducing public payroll, cutting deficits, privatization, etc. It’s a whole long list of things they’ve agreed to do. They have been living up to their end, not very happily, and that’s why the Syriza was able to sweep to power.
Now Syriza says they are not going to adhere to the program any longer. The Troika says, if you don’t, we’re not going to dispense any more aid. This train wreck is set up for the end of the month, but there is a way out, which is this idea of a bridge loan. The bridge loan would be new money with no strings or very few strings attached for 30 days or maybe 60 days. The idea would be to buy time to rework the fundamental agreement. It would not be a continuation of the existing bailout; that would very possibly be over at the end of February. The two sides would then get to work on negotiating a new long-term solution with some concessions in favor of Greece. To get 30 or 60 days to do that, they need some kind of bridge loan. Who would the lender be? It remains to be seen. It’s very unlikely to be the ECB and could actually be the IMF or Brussels. The EU has been very creative in coming up with emergency facility.
I look for a game of chicken between now and the end of the month. There will be increasing tensions, increasing volatility, lots of bad headlines, lots for the grexit groupies to cheer about, some kind of last-minute bridge loan probably coming from Brussels, 60 days of hardball negotiations, finally a new settlement, and Greece remains in the euro. That’s my expectation and what I would advise investors. Expect volatility, bad headlines, and bad days in the meantime. I think I’m right for the reasons I mentioned, but if I’m wrong, I’ll go way, way the other way and say that the catastrophic consequences to that are actually worse than the worst skeptics have imagined. That’s why I think they’ll find a way. It’s precisely because I can envision a worse catastrophe than the critics, my expectation is we won’t go there because both sides understand how bad it can be.
JW: Finally, the Ukraine crisis. What’s striking here is that there may be a growing rift between Europe and the United States. We see Angela Merkel and her European colleagues apparently negotiating an effective surrender of the Eastern Ukraine provinces to Russia. Meanwhile the U.S. is talking up lethal aid to Kiev. Where will this one end?
JR: Surrender is an interesting word. You’re kind of right in pointing in that direction. The technical term for it is ‘fait accompli’ which is a phrase meaning something that has already been done. In other words, Putin just took what he wanted, and no one’s going to do anything about it. It’s a fait accompli and he wins. The question is how do you accommodate that? How do you fit that within your own understanding of the world order? How do you learn to live with it, like it or not? I think your first point is a very powerful one, which is there is a wedge driven between Europe and the United States. That goes back to my first point about the lack of U.S. leadership.
I was in Washington last Wednesday morning meeting behind closed doors with a group of national security professionals. There were about 15 of us. We have what we call “Chatham House rules” which means you’re not allowed to mention names of individuals or give quotes attributed to individuals. You’re allowed to talk about it on general terms; you just can’t say, Mr. Jones said this or Mr. Smith said that. I’ll honor and respect those rules, but just to give the listeners a flavor, we had U.S. ambassadors, CIA covert operatives, people from Treasury, from the National Security Council, and from think tanks. It was a pretty high-level group. The tenor of the conversation was sort of: “What does Putin want? We need to figure out what Putin wants. Does Putin want this or Putin want that? We need to know what Putin wants so we can figure out how to affect his behavior,” etc.
I was listening and trying to be polite, but sometimes I can’t help myself. At some point I just interjected and said this is ridiculous. This is a prime example of what an intelligence analysis would call mirror imaging. Mirror imaging is a flaw in intelligence analysis that arises when the analyst assumes the other guy thinks the way you do. In other words, the West looks at Putin, assumes Putin thinks the way we do and says, what does the guy want? Once we figure that out, we’ll know how to change his behavior in certain ways, etc. First of all, I said, Putin doesn’t think the way we do so get that out of your heads. That’s where mirror imaging comes in. Get away from mirror imaging and understand he’s a different breed of cat. He thinks about things very differently.
Number two, asking what Putin wants is the easiest question in the world. I know what Putin wants. He wants Georgia, he wants Ukraine, and then when he gets those two things, he’ll figure out what’s next, probably Moldova and a few other places. He’s on a tear in terms of territorial expansion. It’s easy to figure out what Putin wants. The hard question is, what does the United States want? This is where our leadership and our foreign policy have fallen down. We have no strategy. We have no well-articulated set of goals. As Henry Kissinger says, it’s important to know what you want and it’s also important to know what you don’t want. In other words, you should have a list of things you will not allow. Is Russian occupation of Eastern Ukraine and Crimea something we will not allow? Yes or no?
If the answer is yes, then you have a war on your hands, and you have to go for the throat. If the answer is no, then live with it. The point is we’re not asking those kinds of thoughtful questions, the kind that Kissinger is very good at framing. Forget the State Department and to some extent forget the Defense Department. I’ve never seen an administration where more policy is concentrated in the White House than we have today. Very powerful departments like Defense and State and for that matter the intelligence community end up being peripheral players because there’s so much power concentrated in the White House in the West Wing.
These people are amateurs. I don’t know what to say. There’s nothing wrong with being younger. I’m all for getting younger people around, but the problem of being younger is you’re young. You don’t have the seasoning that you get from a George Shultz or a Henry Kissinger or a Madeleine Albright. Too bad Richard Holbrooke died at a young age. He would have been one of the people you could turn to in a situation like this on the Democratic side, and there are certainly a few people on the Republican side. It’s not a partisan comment; it’s just that it’s amateur hour at the White House. They centralize power, they micromanage, and they don’t know what they’re doing. They just go from day to day, headline to headline, spin to spin, and say what feels good today, what looks good today, but none of it thought through. No one’s asking questions about what U.S. interests really are, what we will permit, what we will not permit, how we will align our goals with our resources and capabilities.
This is a massive, massive problem with the result that Putin is getting what he wants and the Western response is a muddle. Just to bring the conversation back to economic space, Europe does not want these sanctions on Russia. They are the eighth largest economy in the world and a major trading partner to Europe. Depending on the country, they provide anywhere from 90 to 30 percent of energy imports of all the major countries in Europe. This is not a peripheral player you can push around. It’s not even like Iran. Iran’s a pretty big country but it’s not that heavily integrated into the global economy in ways that you have to worry about. Russia is.
Europe doesn’t want sanctions; Obama does. You have a lot of hawks. By the way, it’s not just the Democrats. You have Republican hawks McCain, Lindsey Graham, and others who are banging the drum over this. None of them, as far as I can tell, have really thought it through. What I see is a lack of U.S. leadership, a lack of U.S. strategy. Putin is focused like a laser beam. He knows what he wants. People ask is there a potential for war here? My answer is we’re in a war. Unfortunately, it’s just that a lot of our leadership don’t realize it.
This is what I said to the group of experts on Wednesday, because they were talking about economic sanctions as a form of diplomacy and an alternative to warfare. I said no, economic sanctions are warfare. You’re not shooting and dropping bombs necessarily. It’s non-kinetic, but it’s not diplomacy; it’s warfare. The alternative to economic sanctions is diplomacy. This is what Merkel is saying, and I think that message got through to Obama based on what I’ve seen about their meeting today. Merkel has said clearly there is no military solution in Ukraine, and she’s right. That means you have to have a diplomatic solution. The White House still thinks that sanctions are a form of diplomacy, but what I’m saying and the way Putin looks at it, sanctions are a form of warfare. And it’s a warfare that risks escalation.
What’s the equivalent of a thermonuclear bomb in economic sanctions? The answer is kicking you out of the SWIFT system. SWIFT is the Society for Worldwide Funds Transfers based in Brussels. That’s the messaging system or central nervous system for the entire global financial system. They process $6 trillion a day of bank transfers, message traffic between the banks. Kicking Russia out of SWIFT would paralyze their economy. That’s the equivalent of dropping the H-bomb on Moscow. Dmitry Medvedev, the president of Russia, said the other day, “If that happens, the Russian response will know no limits.” Those are his exact words, “no limits.” No limits means the Russians can escalate up to and including a nuclear response. That’s how we’re kind of playing with fire here.
As far as I can tell, Merkel did a pretty good job of getting through to Obama that economic sanctions were counterproductive. We’re either in a war or close to a war. We need diplomacy. Diplomacy at this point means Putin gets a lot of what he wants. Maybe we’ll circle back and punch him in the nose somewhere else in the world. Again, I can’t attribute specific quotes to specific people, but I’ll just say the view is expressed that Putin is wondering why we’re not doing sabotage somewhere. He’s used to that, but he’s not used to these sanctions. People in the White House think it’s a good way to put pressure, but it doesn’t put pressure.
Again, the mirror imaging comes in in the following way: These people in the White House who are pretty naive say let’s put pressure on the oligarchs, and the oligarchs will put pressure on Putin and will change his behavior. That’s the analysis. Well, it works in reverse. If you had a way to put the screws to Bill Gates, Warren Buffett, and a couple of hedge fund kings, I dare say they would find a way to get through to the White House and get the White House to change their behavior. That’s the way it works in our system, but it’s not the way it works in Russia. It’s easy to put pressure on the oligarchs, but if the oligarchs put pressure on Putin, he’ll put a bullet in their heads. Obama’s not going to assassinate Warren Buffett. He’d probably do what Warren Buffett wants. But Putin will see to it that an oligarch gets assassinated. There’s an asymmetry where the mirror imaging falls down. This whole naive idea that you can put pressure on Putin via the oligarchs is nonsense. It seems we’re waking up to that. It does look like Putin’s getting most of what he wants, but hopefully that war will die down. I think it’s going to take a while. Let’s just say we’ll have more bad days in Greece and more bad days in Ukraine before this is all over.
JW: Let me follow this with a question that came up between colleagues. In everything you’ve described, do you feel that the hazard of a kinetic war between NATO and Russia is any more likely or less likely? Is that possibility a concern for you?
JR: It’s a concern. I don’t think it’s going to happen, but if you said we’re kind of dialing it up from 0 to 10, we got way past 5 last week, maybe even up to 7 or 8. This all happened while I was in Washington for this meeting, and over the course of Monday and Tuesday, the White House leaked to the New York Times that they were considering arming Kiev, Kiev being the Western Ukrainian forces. They were considering providing lethal aid. Right now they’re giving them body armor and defensive stuff, but they would actually give them some more heavy weapons.
Then Wednesday morning, it was reported that Poland had agreed to sell weapons to Ukraine. Interestingly, ‘sell them’ not ‘give them,’ but I guess the Pols need the money, so that’s understandable! All of a sudden, you’ve got Russia arming rebels in the east and the U.S. arming Kiev forces in the west. Now you have a proxy war between U.S. and Russia. That would be a proxy kinetic war. As I said, the financial war and the cyber war are already here. This would be kinetic. Everything short of U.S. troops or NATO troops confronting Russian troops. You would come very close to that with, in effect, NATO arms confronting Russian arms and I dare say Russian troops. I think there are Russian troops in Eastern Ukraine.
You could have the specter of Russian Spetsnaz (their Special Forces) being killed with NATO weapons. How does that feel? Not so good. We were really barreling in that direction as of last Wednesday. Now here it is Monday. There were talks over the weekend, and the U.S. seems to have backed off on that a little bit. Merkel is the only adult supervision in the story. This is like a playground. Putin’s out there, difficult for some people to understand, but it’s easy for me to understand. He’s kind of a thug and a killer and he feels that he’s been dissed. Just to put it in the language of the basketball court, we dissed Putin.
Think about what Obama has said about Putin publicly. He said Putin is like the kid who sits in the back of the class and wiggles and doesn’t pay attention. He’s like the dumb kid or the kid with ADD in class. Here’s the president of the United States calling the prime minister of Russia a kid in the back of the class who’s not too bright, and on and on. How is that a way to run a bilateral relationship? How is that a way to create dialogue? How is that a way to engage in diplomacy when you’re publicly insulting the head of state of the eighth largest economy, one of the major thermonuclear powers in the world? Again, this shows you the amateurish nature of Obama’s foreign policy. To answer your question, Jon, probably as late as Wednesday or Thursday we dialed it up to maybe 8 on a scale of 10. As of today it’s dialed back down to maybe a 5 or a 6. That’s good news, but this was a game of chicken played by people who didn’t really understand how chicken ends.
JW: I’m very mindful of people with us wanting to ask you questions, but we call this series The Gold Chronicles, and I really have to ask you briefly about gold. In a way, through all this drama, it has behaved quite un-dramatically. It’s bounced up and down a little bit in the dollar price, but there have been no spectacular swings. It’s as if gold is, as a sort of market intelligence, not reacting very intensely to all these huge upheavals we’ve been discussing. What’s your take on that?
JR: You’re absolutely right in terms of the price action. It took a beating last fall and then picked itself up, got off the bottom, and traded up around the $1300 range. It’s backed off from that, but it does seem to be holding most of those gains, most of that retracement from the lows. That’s a very positive sign given what’s going on around the world, particularly given the strong dollar.
Now for a couple of comments on gold. I talk about this in chapter nine of my book, The Death of Money, and I also talk about this a lot in my monthly newsletter Strategic Intelligence. I say gold is money, but I recognize the fact that it trades like a commodity on commodity exchanges and people treat it like a commodity. It has some inflation-insurance aspects to it. I get that, but I try hard to think about gold as money. It helps me understand what’s going on. If you look at a chart of gold and a chart of commodity indices that include gold, along with a lot of other things such as iron ore, copper, aluminum, other agricultural commodities, what you see is a very high degree of correlation with a downward trend through most of 2014.
Right around the end of 2014 in the November/December timeframe, they completely diverge. The commodity index plunges mainly because the oil price collapsed, which we all know about. Gold starts to go up from trading off those $1,100 lows closer to $1,300. When I see very sharp diversions like that — the high correlation between gold and broader commodity indices suddenly breaking down, the commodity indices continuing to collapse but gold goes up, which it did — that tells me that gold is now trading like money. In other words, it stopped trading like a commodity and started trading like money. People just wanted it independent of what was happening to deflation and commodity prices and other things.
That happened, by the way, right around the same time there were large outflows from the Federal Reserve Bank in New York. Again, this is a very sophisticated audience we have on this call. I think listeners are aware of the repatriation movement, that movement to get your gold back. It’s also something I talk about in my newsletter Strategic Intelligence and in the opening pages Currency Wars, my first book in 2011. I was the first one to say, hey, Europeans, Japanese, all you people, you have your gold in the Federal Reserve Bank in New York. Don’t be surprised if the U.S. seizes your gold in some kind of future financial crisis. We have a good track record of seizing assets when we feel like it.
I remember sending that book to a good friend of mine who is a PhD economist. In the foreword or introduction I said it was a possibility that we could seize all the European gold. My friend said to me, “Jim, I read that. If I didn’t know the book was written by you, I would have thrown it in the trash right there. That was such a ridiculous comment. I almost stopped in my tracks, but I knew it was by you and I kept going and read the whole book.” So we had a laugh about that. Well, guess what, since then the world has woken up to the threat. The Germans are getting their gold back, the Dutch are getting their gold back, and there was a referendum in Switzerland, which, unfortunately, failed because the Swiss National Bank lied to people about the peg. If they lie to you once, shame on them; if they lie to you twice, shame on you. So maybe people will wake up the next time. There’s also talk about it in France and Belgium and elsewhere.
This movement is alive and well. Those shipments out of the Federal Reserve reached a peak for the year right around November and December 2014, and they’re continuing. We have these two data points – major shipments of physical gold coming out of the Federal Reserve in November/December 2014, and a sharp divergence between the dollar price of gold and the gold index right around the same time. I look at those two things and it tells me that the scramble for gold is now thinking of gold not as a commodity, not as an investment, but as money, which I think is the right way to think about it.
I’ve gone a step further in my thinking, which is the whole thesis that China and Russia are acquiring gold. At a minimum, this will be your pile of poker chips in the game of Texas Hold’em the next time they reset the international monetary system. Could you possibly have a gold-backed currency? I don’t necessarily predict that, but it gives you an option. There’s price suppression going on to keep the price low while these two countries back up the truck and get all they can. There’s a diminution in the floating supply, which is different than the total supply.
We’ve talked about all those things before and will again, but I’ve gone a step further. This is starting to look like a corner. I don’t want to put a stake in the ground on that; I need to do more work and think about it a little more, but it’s starting to look like a corner to me. There’s never been a successful corner in the gold market. There was the famous one attempted September 26, 1869, by Big Jim Fisk on the old New York Gold Exchange. There was certainly an attempt to corner and a panic, but then the corner was broken by President Grant and the Treasury agreeing to release some gold.
A lot of listeners are familiar with the Hunt brothers’ effort to corner the silver market in 1980. That was busted by two things. They got pretty far long, and the price of silver spiked up, but there were two phenomena. One, you had every grandmother in America climbing up to her attic, getting out the family silver, and selling it to salesmen who were going around door to door. In the precious metal industry that’s called “scrap” although it may be a nice silver set, flatware, bracelets, necklaces or whatever. That kind of scrap silver literally came out of the woodwork and flooded the market, so there was suddenly a lot more floating supply. Secondly, of course the government changed the rules, although a lot of people whined about that. My view is to get over it. There’s a rule that says they can change the rules, so you should see that coming in. They changed the margin requirements and busted the corner.
The Hunt brothers got caught between granny and the government and that failed. These corners usually fail, but Russia and China are different. Recognize that the scrap has been coming out of the woodwork already, independently, without a price spike. In our conversations with refiners in Switzerland, they’ve said they’ve had trouble sourcing scrap. There’s a little “We Buy Gold” sign on every corner of America. People like at CNBC enjoy making fun of that as if it somehow diminishes the role of gold, but I remind them that those signs don’t say, “We Sell Gold;” they say “We Buy Gold.” So a lot of the scrap has been hoovered up and refiners are having trouble sourcing it.
I think the grannies have already done their thing and the government can’t do their thing, because Russia and China are sovereign governments who don’t care what the CFTC [Commodity Futures Trading Commission] thinks. They’re kind of immune to what happened to the Hunt brothers, and they probably have a little more in resources than Big Jim Fisk from the 1860s, so it could be a corner. Again, I don’t want to predict that, but it is something I’m watching very closely and another reason to own gold.
JW: That’s interesting. Thanks, Jim. I’m going to turn quickly to Alex, hoping we have time for at least one or two questions from our listeners. My apologies to everyone. We really needed, as I think you are hearing, to cover a lot of ground in this conversation. Alex, over to you.
AS: Thanks, Jon and Jim. We have about eight minutes left and are going to do our best to answer a couple of questions here. As per usual on these webinars, we have way more questions than we have time available to answer. They’re very good, smart questions from a wide range of people. I have one here from a 25-year-old university-educated geologist who is underemployed all the way up to managers of substantial funds that we have on the call as well. The first one comes from a gentleman by the name of Arthur. His question is, “How do you view holdings in a fully allocated physical gold trust like Sprott?”
JR: Obviously, I advocate and recommend to investors that they have something in gold, and I’ve been pretty consistent that 10 percent is the right amount. Some individuals have more — that’s a choice for the portfolio manager or the individual — but if you look at institutional allocations on the whole, they’re actually closer to 1 percent. So there’s a lot of headroom between where people or institutions are and where they need to get to. If you don’t like 10 percent, then do 5 percent, but have some significant allocation to gold.
That said, I do recommend physical bullion, not paper gold. Paper gold would be COMEX futures, ETFs, unallocated forward contracts, etc. I think all of those are very flawed ways to hold gold. What you really want at the end of the day is wealth preservation and price exposure. The paper instruments are going to give it to you up until the day gold spikes out of control, then they’re going to terminate your contracts as of the close of business on the prior day, and after that they’re going to send you a check. They’re not going to steal your money, but you’re going to get a check for yesterday’s close. You’re not going to get today’s price action, because that’s the thing that will break the banks. So you need physical gold.
Now, the question is, how do you hold it? It all depends on if you’re talking about five coins or $100 million allocation out of a billion-dollar portfolio. When you get into those large amounts, you do need structures. I’ve seen a lot of these. Believe me, I often am shown documents or charts and things like that on many of them. One of the things I’ve always liked about Physical Gold Fund is that it’s very well thought out from the Swiss vaults to really technical things like keeping the gold inside the LBMA network. By this, I mean there’s a whole approved list of refineries and secure logistics providers right down to who’s driving the armored car and where the vault is. I don’t want to get too in the weeds on that, but there’s a lot to know there. Physical Gold Fund has thought through all that, so I like it.
There are others out there. Sprott is a good name. I can’t say I’ve done the diligence on Sprott the way I’ve done on Physical Gold Fund, but as far as I’m concerned, any reputable firm that’s offering physical gold fully allocated with the ability to get the gold if you want it, meaning you call them up and say, I’d like to redeem my units and I’d like the gold to ship to the following destination. It could be a private vault or any designated custodian, then that’s a good structure. So again, I caution investors to do your own due diligence. Talk to your lawyers and accountants, read the documents carefully, and understand what it is you’re getting. All gold investments are not created equal. Again, I’m comfortable with Physical Gold Fund because I’ve done the diligence there and spent time with that, but there could be other good ones out there as well.
AS: Very good. This next question comes from a gentleman by the name of Joseph. He is a managing partner in what looks like a fund management company. He says, “I hear you loud and clear about the reasons to hold gold in a portfolio. I own some in physical form, but I own far more physical silver than I do gold. Given the historical role that silver as money has played, why do you emphasize the role of gold so resoundingly and rarely mention the investment merits of silver? Are there attributes to silver that make it less valuable money?”
JR: I’m not a silver basher or a silver hater. I think silver has a role to play, and I have some silver in my portfolio. Here’s what I would say. Silver is always going to tag along with gold. There’s no way gold is going to $5,000, $6,000 $7,000 an ounce (which I do expect) and silver doesn’t go to $100, $150 or some rough equivalent. If gold takes off, silver’s going to take off with it. It’s not going to be left in the dust, and therefore it’s a good holding. The only reason I don’t talk about silver a lot is because gold actually isn’t good for anything except money.
Money is a pretty good thing to have when the world’s falling apart, so I like gold for that reason. Gold has very limited industrial uses. Yes, it’s used for jewelry, but I consider jewelry wearable wealth. People talk about getting a new watch from Apple, and they call it wearable technology. Well, to me, gold is wearable wealth. You can put on a nice necklace or bracelet or pair of earrings or whatever. That is what they do in India. You see these women adorned in gold. That’s their bank account. I don’t really separate jewelry from wealth. Gold jewelry is stored wealth, even though I think the world gold council probably does treat it separately. If you treat jewelry as just a form of wealth, really no different than bullion bars and coins, then gold has no industrial use.
Silver does. Silver is good for a lot of things, a lot of industrial inputs, which means it’s always going to move on two vectors. One is the monetary vector, but the other one is the industrial vector. They can be pointing in different directions. The monetary vector could be pointing up if there’s a flight to quality or outbreak of inflation or just on a fear trade, but the industrial vector could be pointing down because of a slowing global economy and less demand for silver and some industrial inputs. To me, it’s a mixed bag, and I don’t hold myself out as an expert on all the industrial applications of silver. I know they’re there, and to me it just muddles the picture a little bit. I’m not anti-silver; it does have a place in the portfolio. I just don’t spend as much time on it, because I’m a global macro analyst, not an industrial engineer. I’ll leave it at that.
AS: Perfect. Normally we’d be turning this back over to Jon so that we could wrap this up, but there is one last question I want to try and squeeze in here. We may run just a couple of minutes overtime, but it’s a really good question. This question is coming from Sasha, and I’m going to read what she wrote in an e-mail. She says, “I’m a 25-year-old university-educated geologist and underemployed. I have no mass wealth to protect by the purchase of gold, although I do own a few bars. However, I have not seen any benefit from this supposed growth.” I think what she’s talking about when she mentions “growth” is what’s parroted in the mainstream media and by the current administration. “For my family and friends, it’s just a creep up in asset prices and the cost of living. Will there come a time in the near future when the honest work of individuals will be enough to purchase a home, raise a family, and enjoy the quality of life where one needs not worry about how to merely survive from day to day?” I guess the summary of it is will a real and equitable economic expansion take place after the fall of the dollar and the restructuring that you’ve written and talked about, Jim?
JR: Here’s hoping we can get to the kind of growth Sasha is asking about without a collapse in the international monetary system. My views on that are based on the trends I see, the instability I see, a lot of dysfunctional public policy, and a lot of misapprehension of the statistical properties of risk by the Fed and other policymakers. That’s why I warn about that. I hope I’m wrong and it doesn’t happen, but right now we are on track for that to happen. Unfortunately, if it does happen, there are two possible outcomes. One is a massive wakeup call maybe like Noah after the flood. The waters go down, we land the ark, we get out, and we start over again. Maybe that restart is a much healthier kind of economic dynamic, the kind of opportunity Sasha is talking about. That’s one possibility but not the only one.
The other one is a much darker vision of a neo-fascist response as financial institutions collapse, as money riots break out, as things go from bad to worse. Governments as they always do don’t go down without a fight, and they respond by using militarized police and surveillance. People like the convenience of E-ZPass, but you have to remind people that every E-ZPass tollbooth in America is a surveillance interdiction point where they’re using facial recognition software and license plate scanning. Operating on government orders, you can be seized and detained. If you think the government isn’t politicized, just look at what the IRS did to the Tea Party. That’s the dark side of what’s going on. I hope we don’t get there. What I hope is that myself and others, acting as a wakeup call working through the electoral process and educational process, over time can lead us to some better policies.
By the way, for Sasha and actually all the listeners, and at the risk of throwing in another promotional link here, I’m going to do a debate. It’s actually live on Broadway, Wednesday night at 6:30. The sponsor is a group called Intelligence Squared. That’s really all you need to know. Just Google ‘Intelligence Squared’ and you’ll find the link quickly or I’ll put it out on my Twitter feed. The event’s sold out but they’re going to live stream it. This is an Oxford Union-style debate, so nobody’s going to interrupt anybody and no one’s going to scream at each other. Hopefully, we’ll have four thoughtful people who stand up and make their points.
The proposition is “Declinists Be Damned, Bet on America”, so it’s a pro-American proposition. The people who are going to be ‘For’ are Josef Joffe, a very prominent intellectual, and Peter Zeihan who had a long career at Stratford. Arguing ‘Against’ are myself and Chrystia Freeland who’s a rising star in the Liberal Party in Canada, a member of the Parliament, a very prominent journalist, and a public intellectual. We have some good firepower on the stage if you want to find that link and live stream it [or see the recording]. We’re going to be talking about exactly the kind of thing that Sasha and maybe some of the other listeners are interested in, which is what it is the future of America.
AS: Thank you very much, Jim. With that, I’m going to turn it back over to Jon to wrap it up.
JW: Thank you, Alex, and thank you, Jim Rickards, for a really illuminating conversation. It’s been great being with you today. Thank you most of all to our listeners and for some really phenomenal questions. As Alex said, I know there are a whole lot of other great questions in the pipeline. I think we need to find a way to really address those, so we’ll discuss that and figure something out.
You can follow Jim Rickards as you know on Twitter. His handle is @jamesgrickards. Look out for that debate; it sounds extraordinary. “Intelligence Squared” was the phrase to Google.
Jim mentioned his newsletter Strategic Intelligence. It’s very affordable and a great way to follow Jim’s in-depth thinking month by month. One final note, you can find recordings of all The Gold Chronicles webinars with Jim Rickards online. The way to do that is to visit the website Physical Gold Fund Podcasts and register for updates. Thank you for staying with us overtime today. I hope you found it fruitful. Goodbye for now, and we look forward to joining you again soon.
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