Jim Rickards, The Gold Chronicles January 11th 2016:
- Jim announces his new book, The New Case for Gold, now available for pre-order on Amazon: http://www.amazon.com/New-Case-Gold-James-Rickards/dp/1101980761
- Cyberwarfare didn’t exist 35 years ago. There are new reasons to buy gold today
- Explaining the “Impossible Trinity” of a pegged exchange rate, open capital account, and independent monetary policy 19:20 22
- Expect a global recession 2016
- Fed will reverse course and loosen monetary policy by end of 2016
- House of Saud going through major, generational changes which lays the groundwork for what could lead to World War III
- The world is facing a global dollar shortage. 20 Trillion in USD denominated debt has been created in recent years and not enough dollars to pay the debts
- Alex Stanczyk shares the story of how Physical Gold Fund began its relationship with Jim Rickards
- The USD has not yet topped. In the short term the USD will continue to strengthen. The Fed will ease perhaps beginning in November 2016.
- Oil / Gold Ratio – gold is now trading like money compared to other commodities
- The world is facing a global dollar shortage. 20 Trillion in USD denominated debt has been created in recent years and not enough dollars to pay the debts
Listen to the original audio of the podcast here
The Gold Chronicles: 1-11-2016:
Jon: Hello, I’m Jon Ward on behalf of Physical Gold Fund, and we’re delighted to welcome you to the first webinar of 2016 with Jim Rickards in the series we’re calling The Gold Chronicles. Jim Rickards is a New York Times bestselling author and the Chief Global Strategist for West Shore Funds. He’s the former General Counsel of Long-Term Capital Management and is a consultant to the US Intelligence Community and Department of Defense. He’s also an Advisory Board member of Physical Gold Fund.
Hello, Jim. Welcome and Happy New Year.
Jim: Happy New Year, Jon. Good afternoon. I’m glad to be with you.
Jon: We also have with us Alex Stanczyk, Managing Director of Physical Gold Fund. Hello, Alex.
Alex: Hi, Jon and Jim. It’s great to be here, as always.
Jon: Alex will be looking for questions that come from you, our listeners, so let me say that your questions for Jim Rickards today are more than welcome. You may post them at any point during the interview. You’ll see a box on your screen for typing in your question, and as time allows, we’ll do our best to respond to you.
Jim, there has been a lot happening since we last spoke. I’m sure our listeners will be keen to hear your take on the travails of the Chinese stock market, volatility in the US markets, the crisis around Saudi Arabia, and other hot topics. We’ll get to as much about that as we can today, but I’d like to start closer to home with some exciting news.
As I mentioned in my introduction, Jim is the author of two books, and both of them are hugely successful. Jim, in April of this year, you’ll be publishing your third book titled, The New Case for Gold. This book had a rather special inception I’d like you to share with our listeners and, perhaps more important, why you felt impelled to write about gold at this time.
Jim: Thank you, Jon. I am very, very excited about this new book. It has a publication date of April 5th and right now live on this call is the first time I’ve really spoken publicly about it. The book is available for preorder on Amazon, so it’s not like it’s some secret, but I haven’t done much in the way of publicity or interviews yet.
Of course, I’ll be doing all of that in the weeks and months ahead. People will probably be tired of hearing about it at some point! But this is quite literally the first time I’ve spoken about it, so I’m very happy to share with this audience.
The book, called The New Case for Gold, does have a distinctive origin. There will be some special editions I’d like to talk about, but first let me just say a word about the title. The title is a bit of a tribute to an earlier book of 35 years ago called The Case for Gold from Ron Paul and Lewis Lehrman.
It wasn’t long after President Nixon had gone off the gold standard when Ronald Reagan was elected president in 1980. President Nixon went off the gold standard in August of 1971, so in 1980, with Ronald Reagan as the first Republican President elected since then, there was a very strong movement at the time to go back to the gold standard. We look back now over 40 years since Nixon did what he did, but when Reagan came in, it had only been nine years, and so it was still fresh in people’s minds.
President Reagan didn’t want to endorse the gold standard in so many words, but he did agree to a commission to study it. That’s a typical Washington solution. When you want to kick the can down the road, so to speak, you have a commission. So a commission was appointed, the commission studied it, and they came back with a report. The conclusion of the commission as a whole was that the United States should not go back to the gold standard.
However, as is often the case, the commission was divided. There was a very strong vocal minority that thought we should go back to the gold standard, and they were allowed to write a minority report. The leader of that group was Congressman Ron Paul – Dr. Ron Paul at the time. He, along with Lewis Lehrman and some others, wrote this minority report arguing that we should go back to the gold standard.
This became a public record because it was a public commission. As with Shakespeare, anybody can print an edition of something in the public domain without having to pay royalties, so this minority report was turned into a book called The Case for Gold.
My book is called The New Case for Gold. It’s obviously a little tribute to the original minority report, but I put the emphasis on the word “new” because there are arguments in the book in favor of investing in gold that transcend or go beyond the same old arguments we’ve been hearing about for years.
I’m sure we have a lot of gold investors on the webinar today. People like gold or they don’t like it or they can see the logic for having some gold in their portfolio or perhaps they don’t. These debates have been going on and on and get a little tired. I do cover that in the book, but there are things in the book that are new and were not discussed 35 years ago because they didn’t exist.
One example is cyberwarfare. Today people say, “I’m wealthy, I have a certain net worth, here are my assets.” You say, “Well that’s interesting. Your house is real; I can go up and knock on the door. If you have some physical gold, that’s real. You can touch it and keep it in a secure place. But stocks, bonds, other money market accounts, bank deposits, those things aren’t real. Those are digital. They are electrons in some system that can be erased by Vladimir Putin’s cyber brigades.”
Digital wealth is extremely vulnerable. I’m not saying sell all your stocks and buy gold, but what I’m saying is just be aware of the risks. When you talk about having those assets, bear in mind that they are electrons, they are digital, and they can be erased.
That’s something people weren’t talking about 35 years ago, because cyberwarfare and the Internet didn’t exist. Yes, there was electronic recordkeeping, but you got paper statements, paper confirmations, and a lot of things to back it up. Today, many people are 100% digital.
There are threats out there that didn’t exist 35 years ago that add to the argument in favor of gold. I discuss some oldies but goodies, several things that some of us may be familiar with, others less so, and some new 21st-century arguments in favor of gold. That’s why I call it The New Case for Gold.
The origins of this project are right here on this call. I’ve been on the Advisory Board of the Physical Gold Fund, now into our third year. It’s been a great relationship. Along the way, we’ve always thought about new and better ways to reach out to interested parties, whether it’s through education or communications. How can we at Physical Gold Fund do a better job of getting the story out, reaching out to interested parties and helping people either learn more or actually invest in gold if they would like?
That was also the origin of this podcast series. We decided to do a monthly call, invite people to join in, post it as a podcast, and make the transcripts available. We’ve been doing this for a couple of years now, and we realized in looking at the transcripts that we had a lot of material, well over 100,000 words. Well, a good, long book is about 80,000 or 90,000 words, so we said, “Why don’t we turn this into a book?”
Believe me; it’s not as simple as taking a bunch of transcripts, sending them to the printers, putting a nice cover on it, and calling it a book. We had to do a lot of rewriting. One of the things I discovered in the process is that the way we speak is not the way we write, or at least not the way I write, so things that sound like perfectly normal, conversational English on a call like this can look a little clunky when the words are in a row on the printed page.
We smoothed out the rough edges, removed the redundancies, and added some completely new material. There’s material in the book that none of our listeners or colleagues have seen because it’s completely new. We’re happy about that, because this is not just a retrospective; we want to stay on the cutting edge.
Candidly, it’s got information in it that when it comes out will make a few headlines, some things I’ve never heard before. I’ve been very involved with gold, but in the course of doing research and thinking about this, we developed some new things that I think will shake the gold world up quite a bit.
On top of that, Physical Gold Fund has arranged with my publisher, Penguin, for a special edition. I’ll leave it to them to describe the marketing channels for that, but I’ve contributed some material that will only appear in the Physical Gold Fund edition. Whether you want to preorder from Amazon right now or wait until it’s in your bookstore or wait to hear more from Physical Gold Fund about how they intend to distribute their special edition, I leave all that to the listeners. But I’m very, very excited about the book.
Although the publication date is April 5, not that far away, some channels may receive a couple of copies early, depending on how they work. I’ll leave that to my publisher, but it’s coming, it’s new, and it’s a very exciting project. I’m very happy with the way it came out. I thought my publisher did a great job with the cover. It looks like a nice bar of gold, so hopefully it will catch readers’ attention.
Jon: Thanks, Jim. I’d like to say thanks to our listeners as well, because your participation in these podcasts, your great questions, your involvement and presence keep us going and has actually made the whole thing possible. You should see yourselves as participants in this new book project.
Now turning to China, the last time we talked about a sudden crash in the Chinese stock markets, you warned us on this podcast to not expect it to end here. Those were prescient words. Chinese markets continue to be in turmoil, and now the US markets seem to be losing their nerve. My question is: Are we simply seeing more of the trends you’ve outlined for us before, or is something new emerging here?
Jim: It’s truly both. Just to talk about the trends a little bit, we see the Chinese stock market and the US stock market both going down. There are things that international economists call spillovers or complexity theorists call contagion, so there are certainly linkages between these markets, but I don’t want to suggest that’s just a reflex reaction as if they go down and we go down. It’s not as simple as that. Let’s look at the fundamentals first and then come back to some of the more technical factors.
The fundamentals are that world growth is slowing down rapidly. I would not rule out a global recession in 2016, but even if it’s not technically a recession, this slowdown feels like a recession. What’s the difference? If you go from 4% to 2%, or go from 2% to 0%, maybe one of them is technically a recession and the other one isn’t, but both of them represent a very sudden slamming on of the brakes and a very significant diminution of global growth. Even if you’re in positive territory in terms of growth, when you slow down that much, it feels like a recession around the world.
The US may actually be in recession. If not, we’re uncomfortably close to one and maybe heading for one. We have something called the National Bureau of Economic Research in Cambridge, Massachusetts, and they’re the referees. Much like the umpire in a baseball game who calls balls and strikes, this bureau decides officially when we’re in a recession or not.
The problem is they’re eggheads – PhD economists by and large – who don’t usually tell you you’re in a recession until you’re almost out of it. In other words, a year from now, the National Bureau of Economic Research may say, “You know, we studied things closely and decided that the US economy went into a recession in January 2016.” Well thank you very much, but you’re a year late. As analysts and as investors, we need to operate a little closer to real time.
I’m not waiting for them to call strike three here. It looks like a recession to me. Certainly, there’s a lot of data indicating that, so it should come as no surprise that the stock markets are going down. That’s what stock markets do. Stock markets discount the future. They go down in advance of a recession, generally speaking, so if we’re heading for a recession, which I believe we are, the fact that stock markets are going down now makes perfect sense. It’s not the end of the world or some awful unprecedented thing.
Because it’s been eight years since the last recession and since the stock markets went down in any kind of sustained way, people forget. Memories are short, there’s a lot of wishful thinking, a lot of denial, and people forget that these things happen.
Let’s talk about expansion for a minute. This expansion that began in the summer of 2009 has been going on for six and a half years. The point is this is one of the longest expansions ever. Granted, it hasn’t been a great expansion. We’ve had sort of 2% growth, which is a far cry from the 3% or 3.5% growth or even sometimes 4% or 5% growth that we’re used to in expansions, so it’s been a very weak, anemic expansion, but an expansion nonetheless. And it’s 79 months old. The average expansion since 1980 is only 76 months. The average expansion since the end of World War II (a longer timeframe) is about 38 months. This is a grandfather-type expansion in terms of its longevity. That by itself doesn’t say you’re in a recession – expansions don’t die of old age – but it should come as no surprise if it does die because it’s been around so long.
Combine that with all of the other factors we’re seeing such as world trade contracting, manufacturing contracting, commodity prices collapsing, China slowing down, Russia in a recession, Japan in a recession, Brazil in a recession, and Canada looking close to one. This is a global story, and it does look like the US is heading into a recession. Therefore, I look at the stock market and say it’s doing what it’s supposed to do. I’m not a stock picker, I’m more of a global macro analyst, but this should really come as no surprise. That’s the first thing I would say.
Now as far as the technical linkages are concerned, the Chinese have their own problems. I gave a couple of interviews last week and said that people forget they’re communists. I don’t say that as a name-calling or finger-pointing exercise. They are communists – the Communist Party of China runs the country.
Everyone says, “They’re really capitalists.” Well no, they’re really communists who have a quasi-modified capitalist system. They’ve got some markets, but at the end of the day, those markets exist under an umbrella of communist top-down central planning and control.
I like to say when you put communists in charge of a market economy, it’s like handing a loaded gun to a three-year-old; somebody is going to get hurt. In other words, they don’t actually know what they’re doing. They think they do and they’re kind of stumbling and bumbling their way through this. For a concrete example of that, look no further than the Chinese devaluation of last August, which was a complete shock.
Anyone who knows anything about international economics or the international monetary system knows that when you’re going to do something like devaluation, you don’t shock people, you don’t spook people. You indicate it, you leak it, you do it in baby steps, and you do it in such a way that it doesn’t shock or disrupt the markets. But that lesson seems not to have sunk in with the Chinese.
And look at the circuit breakers they had until last week. They were binary circuit breakers, so if the Shanghai Exchange Index went down a certain amount, they closed the market. Boom, just like that, for the whole day.
That’s not what circuit breakers are designed to do or how they work in the United States. In the New York Stock Exchange, if it goes down a certain amount, they will close for a short period of time. Then they reopen it and see what happens. If it bounces back, great; if it goes down again by another amount, they will close it again for a certain period of time and so on. If after a certain number of times and it’s sufficiently late in the day, they will close it for the rest of the day, but that doesn’t happen until it’s already shut several times and you’re much closer to the end of the day.
The point is the circuit breakers are not designed to keep the market from going down, because if it was going to go down, it’s going to go down. Circuit breakers are a timeout so that people have time to think, to break that cascade or panic reaction of everyone selling and it drives it down, they sell more and it drives it down, – it just cascades out of control. By calling a timeout, it allows people to think, “You know, maybe I like it here. Maybe this is a good level. Maybe it’s not going to go down more. Maybe somebody can say something reassuring or Fed Governor can give a speech, whatever it might be.” That’s why you have circuit breakers. It’s a timeout.
The Chinese weren’t really using it as a timeout. They closed the market for the day and that caused more panic and, of course, the same thing would happen the following day. They got rid of their circuit breakers, but they’ll probably come back with new and improved ones.
Looking at how they bungled the currency devaluation in August and bungled the circuit breakers in January shows you that they don’t really understand how markets work. They’re amateurs at this, and, as I say, it’s like a child playing with a loaded gun. There’s going to be some damage and, indeed, we are seeing damage.
Jon, you started the question with a comment about trends. As far as where these trends are going, China is facing something that international monetary economists call the Impossible Trinity. I don’t want to spend a whole lot of time on it but will explain it briefly.
The Impossible Trinity says there are three things you cannot have at the same time. You can have one or two, but you can’t have all three. The three things are 1) an open capital account meaning people can get money in and out, 2) a pegged exchange rate, so you’re targeting trying to preserve some value for your currency relative to something else, and 3) independent monetary policy, which means you’re preserving the right to raise or lower your interest rates as you see fit.
According to the Impossible Trinity, if you try to have all three, you will fail. Whenever you see a country trying to do this, you can be sure they’re going to fail, and then the only question is how will they fail and when. Up until last summer, China was trying to do the Impossible Trinity. By the way, there’s nothing new about this theory. It was articulated by Robert Mundell, a Nobel-Prize-winning economist, in the early 1960s, so this theory has been around for 55 years.
I don’t know what the Chinese have been reading, but they tried to peg to the dollar at 6.2 to 1, they tried to have an open capital account so they could get in the SDR basket for the IMF because that was one of the conditions, and they wanted an independent monetary policy so they could cut interest rates if they needed to stimulate their economy. The theory says it can’t be done, and sure enough, it wasn’t. They broke the peg in August, they slapped on makeshift capital controls, and the one thing they have hung on to is independent monetary policy. They are reserving the right to cut interest rates and will probably do that.
As I said, you can have one or two of these, but you just can’t have all three. As a result, I would expect the Chinese devaluation to continue because they have no other choice. Their reserves are running out the door at the rate of $1 trillion a year. When you start with $4 trillion and are losing $1 trillion a year, guess what? In four years you’re broke. I think that if they don’t do anything, the tempo will accelerate, so I estimate they’ll be broke by the end of 2017 if not sooner.
They’re not going to sit there and let that happen. They’re not going to let all that money run out the door, so they’re devaluing the currency, and then they may put on some capital controls, they may cut interest rates, or they may deal with all three legs of the Impossible Trinity.
What does it mean for us if they continue to devalue? It exports deflation to the United States. What does that do? It makes it harder for the Fed to reach its inflation goals. What does that mean? The Fed is going to raise rates? The Fed wants inflation, but raising rates makes the dollar stronger and imports deflation. China is cutting the exchange rate, which imports more deflation, so all the trends are deflationary, but the Fed says they want inflation, so how does that play out?
My estimate is that the Fed is not going to be able to stay on track in terms of raising interest rates. I think they will raise in March or possibly June. I’m fairly confident they will raise in March because they’re not listening to this call. I don’t think Janet Yellen is on the call. My point being the Fed doesn’t look at the real world; they look at models that tell them inflation is right around the corner and growth is robust. Meanwhile, back in the real world, all we see are signs of deflation and probable recession. The Fed will be the last to know, but they’ll probably wake up by the summer.
Let’s say they raise in March and in June. I definitely expect March and I think June is likely. At that point, the target Fed Funds Rate will be 75 basis points putting them in a position to cut by September. By then, even the Fed should understand how weak things are, but there’s another problem, which is that it is 45 days ahead of the election when the September FOMC meeting comes around. So what are they going to do? If they cut interest rates 45 days before the election, Ted Cruz will go burn down the Fed! That would be such a blatantly political move favoring the Democratic nominee that I don’t think the Republicans will let them get away with it, and the last thing the Fed wants is political crossfire because they’re already under a criminal investigation for insider trading.
I think that if we get to September, the economy is as weak as I expect, the Fed has raised interest rates in the face of weakness (which is a blunder), and they then decide to reverse course, they actually won’t be able to for political reasons. They may go to some kind of forward guidance.
These things are all connected. China has its problems with their capital account being depleted, the Impossible Trinity, and the need to devalue. The US has its problems with a central bank that doesn’t live in the real world and is raising rates into weakness. The US and China together are a little over one-third of the global economy. If they’re both slowing down, what does that mean for the global economy? Look for a global recession in 2016.
Jon: Turning to one corner of the globe familiar to these conversations and the news cycles – the Middle East. The execution by Saudi Arabia of a leading Shia cleric has further raised tensions in the Middle East, in particular between Saudi Arabia and Iran, and the uproar has focused the world’s attention on what looks like an increasingly fragile Saudi regime.
From an economic and monetary point of view, what are the implications of this crisis?
Jim: A very important question, and you’re right about the increasing tensions. There are a couple of things going on. One, we have a fairly new king, King Salman, of Saudi Arabia. He’s doing something that is really shaking up the House of Saud.
For this you have to go all the way back to the 1930s and the first king of Saudi Arabia, Al Saud. That’s where the name Saudi Arabia comes from. I’m estimating a little bit but will try to get the numbers right. I think he had about 40 wives and 75 children, something like that. These children are, for the most part, half-brothers because the women don’t count. They count in my world but not in Saudi Arabia, so we’re really only talking about the men in terms of the line of succession.
There is this huge ‘herd’ of 35 or 40 half-brothers. Some of them are full brothers because they came from the same mother, but a lot of them are half-brothers, so there are these little mini clans of maybe four or five or seven full brothers from a single mother and then their half-brothers are the other 35 or 40.
A lot of them are dead now having been born in the 1930s, some of them a little more recently. I think the youngest one is in his 70s and a lot of the older ones are already deceased. In Saudi Arabia, the kingship is passed from brother to brother, not from father to son. We’re familiar with England where it will go from Queen Elizabeth to Prince Charles to Prince William as the third in line, but in Saudi Arabia, they go from brother to brother.
That’s been going on for a long time except now that these brothers are dying or getting old and senile, they’re starting to run out of suitable heirs. King Salman named his son Deputy Crown Prince next in line. After decades, he is finally setting it up to transfer to the next generation. This has caused a lot of resentment among some of these other brothers and half-brothers who are still around and their children who are all part of let’s call it the third generation who look like they’re being cut out of the line of succession completely. That’s caused a lot of internal intrigue.
On top of that, put in the rivalry with Iran, which is bitter and existential, and they have multiple layers of rivalry. There are two powerful countries on opposite sides of what I’ll call the Persian Gulf. I think that’s what geographers and cartographers agree on, although I’m always very careful when I’m in the Middle East addressing an audience in Kuwait or Dubai or somewhere like that. I always try to be as polite as I can and refer to it as the Gulf of Arabia not to insult my host. It really is the Persian Gulf, but if you say the Persian Gulf on the Arab side, you’ll get some dirty looks. They can’t even agree on the name of the water. One side calls it the Arabian Gulf; the other side calls it the Persian Gulf.
The Iranians are not Arabs. The Arabs are Arabs and the Iranians are Persians, so there are different ethnicities and two different religions. It’s all Islam but the Sunni Muslims are on the Arab side and the Shiite Muslims are on the Iranian side, although you’ve got a lot of Shiites in Saudi Arabia, particularly the Eastern Provinces, who are a little bit of a fifth column in the sense that some of them are under Iranian influence.
We see the normal geopolitical struggles, competition in oil output for a limited amount of dollars, religious divides, historical divides, and cultural divides. And now Iran is trying to create and is pretty far along in terms of a nuclear weapons program. This is the entire recipe for basically World War III.
In the past, the United States has tried to intermediate and exert its own presence and military to try to keep the lid on, but President Obama has decided to withdraw from the Middle East to reduce the US footprint and leave local hegemonic powers to deal with their neighborhoods as sort of a cop on the beat. The US is clearly tilted in favor of Iran, and this does not sit well with Saudi Arabia. They consider it a stab in the back.
We might look for Saudi Arabia to push back a little bit. If it’s looking for a new ally, it probably would look to China since China is the largest purchaser of Saudi oil. The US doesn’t buy much oil from Saudi Arabia. Most of that oil goes to China. China, of course, is doing what? Backing away from the dollar.
With Saudi Arabia backing away from the dollar, that’s another exchange rate reserve position worth watching. If China’s dumping treasuries in Saudi Arabia, Saudi Arabia’s reserves are draining out, because they’re running a fiscal deficit.
We’ve bounced around a little bit from Iran to Saudi Arabia and China back to the US, but if you want me to try to capture all of these global capital flows in one phrase or sentence, I would say that there’s a global dollar shortage – the greatest since the 1950s.
People say, “The Fed printed almost $4 trillion. How could there be a dollar shortage?” The answer is the Fed may have printed $4 trillion, but the world has created about $20 trillion of new dollar-denominated credit. Yes, the Fed printed money, but people were printing IOUs faster than the Fed was printing money, and all those IOUs have to be paid back. With growth slowing, trade contracting, the Fed raising rates, and money coming to the United States, there aren’t enough dollars to go around to pay off that debt. We’re looking at massive, massive defaults, outflows from China, Saudi Arabia, and from around the world. Debt defaults are looming.
This is a potential global catastrophe. No one roots for a catastrophe, but I would have to say as this plays out, you would certainly want to have some allocation to gold.
There are fundamental drivers of the price of gold starting with negative real rates and inflation, so those are obvious ones.
An inflationary world where inflation starts to outstrip the rate of interest is called financial repression. There’s no doubt that central bankers favor that, and it’s a very bullish fundamental case for gold, but that’s probably a 2017-2018 story.
In the shorter run, meaning 2016, we could see gold go up significantly on this fear trade, geopolitical risk, and basically global financial crisis. If not a complete meltdown, then certainly there will be a lot of distress having to do with what I’ve described as the dollar shortage.
Unfortunately, the dollar shortage is not going to get better, because the Fed is on this kamikaze mission to raise rates and make US monetary policy even tighter. As I said, they’ll wake up but will be the last to know.
I would look for more stress and more drains from reserve positions in some of our major trading partners and more geopolitical risk. All of this will give a lift or, at a minimum, put a floor under the price of gold.
Jon: Before we turn to Alex, I’d like to ask you a rather broad question I’ve wanted to ask in some form for most of last year. In the course of our interviews, I’ve often heard you comment as you just did on the dire state of the international monetary system. You’ll often say something to the effect of, “The trouble is they (meaning the world’s financial authorities) refuse to make the necessary structural changes.”
My question is what structural changes? To put it another way, if you had the levers of monetary power in your hands for a day or a year or however long it would take, what would you do differently?
Jim: The problem is that having my hands on the monetary levers is a monetary solution, not a structural solution. As a monetary solution, can you create easier monetary conditions or print money? Yes, you can, but that’s not going to solve the problem. Indeed, it has not solved the problem for the last eight years.
What do I mean by structural solutions? How do you implement those? What are they specifically? Those are all very good questions. The point I make is that weak growth, the looming recession, global slowdown, all the stresses we’re seeing around the world, and all the things we’ve talked about so far on this call are not amenable to monetary solutions. They require structural solutions.
We are in a structural growth depression with emphasis on the word “depression,” and printing money won’t fix it. What are structural solutions? These are things that are more specifically in the hands of the fiscal authority rather than the monetary authority. The fiscal authority is the Congress or the legislature. It could be the Congress in the US, it could be a parliament in the case of the UK or Canada or any other parliamentary democracy, or it could be a Council in the case of the Kingdom of Saudi Arabia. Whoever calls the shots, whoever makes the laws, they’re the ones who are in a position to deal with structural problems and create structural solutions.
Now what are those solutions? Let’s begin with taxes. Tax policy is number one. Cut tax rates. You don’t need a PhD to figure that one out. Taxes in the US are way too high and that impedes growth. At this point, upwards of $10 trillion in corporate cash is sitting offshore that won’t come back to the United States because our corporate taxes are too high. That’s just one of many examples.
Another is the regulatory structure. You can pick any regulation you want and get into a policy debate, but I don’t want to debate all these individual policies. The problem is that they just keep piling up regardless of the intrinsic merits. I don’t care whether it’s transportation regulation, climate regulation, environmental regulation, Fair Labor Standards Act, and on and on. We simply keep piling up regulations that make it harder and harder to do business, harder to start a business, harder to create jobs. It should come as no surprise that the economy is slowing down.
Better outcomes for women would be another very important point. The US is pretty good on that score although we could do more to improve, but there are countries like Japan and certainly the Middle East where outcomes for women are not good at all. If women were more empowered, obviously they can be very productive and creative contributors to economic growth in their own countries. That would be the first one on my list for Japan, but Japan’s got its own cultural impediments, and we know what’s going on in the Arab countries.
Immigration is another one. I don’t like clichés, but people keep using the expression that the US is the least dirty shirt in the laundry, meaning we’re not great, but we’re not as bad as everyone else. Why are we not as bad as everyone else? Growth is weak, it could be better, but why are we doing better than other people?
Part of the reason is immigration, and that’s part of the reason Germany let in as many refugees as they did. That’s turning out to have a lot of serious problems associated with it that Germany has to address, but they are smart enough to know that if people aren’t having babies and you want to grow your labor force, you’d better get some immigration. I’d be very bullish on the Japanese economy if they let in a million Filipino immigrants every year.
As I travel around the world and go to a Catholic church in the Middle East, it feels like you’re in an underground society. They’re usually behind high walls and barbed wires. Some of the countries are actually pretty tolerant such as Bahrain. I go to a Catholic church there, and it’s me and 5000 Filipinos, because they’re all there as guest workers and immigrants and people who are invited in to provide labor and services.
Japan could do something similar, but they won’t. Labor migration; why can’t we get excess labor from Greece and Spain into the Netherlands and Germany? Forget about refugees from Syria. How about just people from inside the European Union?
I could go on and on, but taxation, regulation, outcomes for women, immigration, labor laws, and labor mobility. This is what I mean by structural changes we have to do to get growth going. Printing money won’t do it.
Jon: I don’t think there’s going to be any big surprises in your answer to this question, but the question wants to be asked: When you look around the world, what are the chances of those changes being made? And if they aren’t made, how should wise investors protect themselves?
Jim: Unfortunately, the chances are very low. I just spent some time explaining the structural changes the world needs to make to encourage growth, and I could spend an hour explaining why none of these things are happening. Printing money won’t do it; structural changes will do it.
Too many vested interests, too much political posturing, too much partisanship, too many people looking out for themselves instead of for the country, and too much ideological opposition. The thing about ideology is it’s the opposite of reality. Reality means you take the facts as they are and try to make things better. Ideology is: “I’ve got an idea in my head and I’m going to try to implement my idea regardless of the cost.” That’s a good way to ruin an economy or ruin a country.
We know what the solutions are, and I wouldn’t rule them out – I certainly look for them – but ask me what I think the odds are of these things happening. What are the odds of Japan letting in a million Filipino immigrants? Zero. What are the odds of Arabia overnight improving outcomes for women? Close to zero. What are the odds of the US cutting corporate taxes? Close to zero, and so forth.
In other words, none of these things are happening, so my best case forecast would be more weak growth of the kind we’ve had. Worst case, maybe even likely at this point, would be a recession. What will come from that is the Fed will, at some point later this year, get off their kamikaze mission of tightening rates, maybe actually turn around, and provide some easing first in the form of forward guidance and possibly by December or early 2017 cut some rates. That could give markets a lift, but it hasn’t worked that well for the last seven years, so we don’t know why that by itself would solve the problem.
The thing that will turn things around is helicopter money. Helicopter money is basically running bigger deficits, borrowing the money to cover the difference, and then monetizing the debt. It’s a form of money printing but instead of just printing money, handing it to banks, and having the banks hand it back to the Fed – that’s QE – here they print the money and buy debt that was used to run bigger deficits because the government is spending more money.
That is something I think is coming perhaps closer to being a 2017 story, and that’s the one that will get gold skyrocketing again. People will look at that and say, “Aha! Nothing else worked, but you’re determined to get inflation. If you can’t do it with monetary policy, you’re going to do it with deficits, and so now it’s back to the ’70s.” I think that’s when gold will really get a huge lift.
It will get a good lift in the short run based on geopolitical vectors, but in the longer run, meaning 2017-2018, the big boost to gold is going to come from helicopter money.
Jon: Thanks, Jim. Now Alex Stanczyk is here with questions from our listeners. Before you go there, Alex, I have a question for you. It’s the start of the New Year, and with Jim’s book, The New Case for Gold, coming out in April. Would you tell us a little bit about how you and Physical Gold Fund got to know Jim in the first place? I think it’s a story our listeners would enjoy hearing.
Alex: Jim first came on my radar around middle to early 2012. One of my research team came to me and said, “Alex, you need to come see this. There’s this guy on Bloomberg who is talking about gold, and he actually makes sense.”
I watched the interview and thought to myself, “Okay, this guy gets it.” The thing that impressed me about Jim is he spoke the language of institutional investors. Typically, we get people talking about gold usually framed in more of the gold bug category or a market analyst specialist, like a bank analyst who specializes in the metals market, for example. But Jim was the first person I had ever seen who spoke this institutional language.
I read his first book, Currency Wars, towards the end of 2012 and decided it would be really great if we could have Jim advising our board, so we reached out to him. At first, he was pretty understandably standoffish. I can only imagine how many gold-related businesses talk to him or try to contact him about gold. But he agreed to meet with me, and so I and another one of our directors, Nestor Castillero, flew to New York, met with him, and I showed him what we were doing.
Jim is one of the smartest people I know. Once I had shown him how we had Physical Gold Fund structured, he immediately got it. He recognized right away that we weren’t the typical fund in this space because of the way we do our vaulting and handle clearing risk and we have an insistence on making sure everything is non-correlated to risk on a systemic level.
Because of these things, he agreed to come on board with us. He may talk more about that in his book, but that’s basically how we met and how we agreed to start working together.
Jon: Thanks, Alex. And now what questions do you have today from our listeners?
Alex: This question is coming in from what I think is an anonymous source because his name is “John Gold III.” Some of you may recognize that name. He says this: Jeff Gundlach announced recently that he’s buying bonds denominated in currencies other than dollars for the first time in five years, and that the dollar has topped. Has the dollar topped?
Jim: Not yet, but it’s getting close to a top. The dollar, although not quite at an all-time high, is at a ten-year-high. I don’t necessarily think it will get to an all-time high, but it does have a little more headroom. The reason why is that the Fed is going to continue to raise rates. If you go back to the December FOMC statement, a press conference and the famous dots in the forecast of the Fed FOMC members and so forth, it put the Fed on track for four interest rate hikes per year. Basically, one per quarter or every other meeting. They do eight meetings per year, so that would be 25 basis points every other meeting. It was not automatic; they put in all the usual qualifiers, but that was the track they were on.
The market doesn’t believe it. If you look at the Fed Fund Futures Markets and say, “What are actual people betting real money on in the markets? What are they discounting? What are they anticipating?” They think maybe two. There’s a couple of people think three, and the view that there’s going to be four is extremely low, but not zero.
In my view, the Fed is not looking at the market; they’re looking at other things such as their models, which are based on things like NAIRU and Phillips curve. I don’t need to digress into what those things are, but let’s just say they’re obsolete.
The Fed’s actually going to keep raising rates, and as long as they do, they’re going to rebut or refute these market expectations. So if the market’s pricing at a low probability of four and the Fed actually goes ahead with two, you have to price in some probability of number three and number four, and that’s going to make the dollar a little bit stronger.
At some point, this will reverse. I gave some interviews right around New Year’s Eve that I called “The Year of the Boomerang,” meaning Janet Yellen threw her rate hike boomerang out there. It’s going to go out for a while then turn around and come back and maybe hit her in the head. Hopefully, she’ll duck.
The Fed’s going to have to reverse course. They’re going to have to turn on a dime and start cutting rates, but for the reason I mentioned, I don’t think they’ll really see that until the summer. Then I think it will be impossible to cut because of politics. The earliest I see the Fed cutting is December, which is about a year too late. They should have eased some more in December, maybe with negative rates or something else.
Does it make sense? No. Is the Fed going down a blind alley on a kamikaze mission? Yes. Be that as it may, it’s going to tend to make the dollar stronger, particularly with China, Saudi Arabia, and other people trying to get their money out.
I don’t think it will be a lot stronger, because there is a limit here, but in the short run I would expect the dollar to get stronger. Now you’ve got to pick your cross-rate, because stronger against the euro or the yen or the yuan – or gold for that matter. I think of gold as a form of money. The problem with cross-rates is you have to say, “Compared to what?”
The euro might not go down. I don’t see the euro getting a lot lower, but certainly against the yuan and Asian currencies. There are some currencies spiraling out of control like the South African rand, Brazil, and the Canadian dollar.
So yes, I do think the dollar will get a little bit stronger at least for a while.
Alex: That’s something on the mind of quite a few investors who are watching global macro and how that’s going to impact everything from commodities to everything else they’re doing.
The next question is coming from “Joshua B.” This goes back to our earlier conversation on the Middle East, but it’s referencing your first book. His question is: Is the Gulf Cooperation Council still a feasible currency block with the price of oil as a currency peg as you mentioned in Death of Money?
Jim: It is feasible, and I think it’s a good idea for them. I have been in the Persian Gulf and recommended this to policymakers there. I don’t think it’s happening, at least not in the short run, so it’s one of these things that just because it makes sense doesn’t mean it’s going to happen.
We talked about divisions inside the Kingdom of Saudi Arabia. There are lots of rivalries and jealousies among these Arab kingdoms. The UAE, Bahrain, Kuwait, Qatar, and Saudi Arabia can’t even agree on where to put the central bank.
They had some conversations about where to put the central bank and what the central bank should look like, but they couldn’t even agree on that. Abu Dhabi wanted it in Abu Dhabi and Saudi Arabia was insisting it be in Riyadh. They didn’t really get off the dime.
Is it feasible, is it a good idea? Yes. Could it ultimately peg to the price of oil or commodity basket or some other index? By the way, the Chinese have just done that. The way the Chinese wiggled out from under their dollar peg is to say, “We’re still pegging, but we’re just pegging to something else.” It turns out that something else is a wholly invented trade-weighted basket of currencies based on their trading partners, so it’s got the Russian ruble, the Malaysian ringgit, and all these other sort of off-the-rung currencies in there.
Could Saudi Arabia and the GCC do something similar? Yes, but I don’t see that right away.
Alex: The next question comes from our research team. There’s a gentleman on our team I’ve known for almost a decade now who follows different ratios and different indices. One of the ratios he’s followed for a number of years very closely tracks the oil/gold ratio. Historically speaking, there’s an average, and it typically comes back to a mean every now and then. When it’s really out of whack like it is right now, it is often coinciding with some kind of major geopolitical event.
What are your thoughts on that? Do you think gold is too high or oil is too low? Do you think that it’s possibly signaling some kind of impending crisis?
Jim: First of all, I think it’s a very interesting question and setup. I look at the gold/oil ratio myself. Around 16 to 1 is normal. Right now it’s a little bit closer to approximately 24 to 1. I’m just doing this off the top of my head, but it is way out of whack. What it implies is that either gold has to come way down or oil has to go way up or they have to meet in the middle.
When we’re talking about barrels of oil and ounces of gold, we have to convert them both to dollars to just do the math, and so the thing that’s really out of whack is the dollar. The dollar is way too strong.
The ratio is based on inflation. Inflation, deflation, the economy slows down, we get more deflation, the price of oil goes down, demand for oil goes down, but deflationary means high real interest rates. It’s usually pretty bad for the price of gold, so the price of gold would go down.
Within a range, that ratio would be maintained. The opposite is true when you get inflation all of a sudden. The price of oil goes up and the price of gold goes up, and again, we’re talking about the dollar price, the ratio is maintained.
That’s why that ratio exists and why it’s constant, because they’re really just two alternatives, two stewards of wealth that are both alternative to the dollar. If they’re constant in real terms, which they are over a long period of time, then the ratio should exist.
What’s going on now is something else, which is gold is not trading just like a commodity. Gold is trading like money and perhaps a new form of money pegged to the Chinese currency or the Russian currency. In other words, the way to think of the question is to consider the alternatives. Why isn’t gold lower? Oil, iron ore, copper, bauxite; all of these commodities have come way down. Gold’s off the top, obviously, but relative to 2011, in percentage terms, it has not come down as much as all these other commodities.
Why is gold doing relatively well compared to everything else? The answer is that there’s a kind of floor under it. I don’t want to suggest it’s a hard floor, but the Chinese are in the process of reallocating their reserve position out of dollars into gold. I’m not saying they’re dumping all of their dollars although $1 trillion have practically walked out the door, but they are in a rebalancing.
This rebalancing won’t last forever but may last for two or three more years, and that is why the ratio is out of whack. Ultimately, that ratio will be restored probably in the form of much higher oil prices once inflation kicks in, but the inflation is not here.
The way I would expect it to be restored is that we’ll have one more lousy year, then we’ll get to helicopter money, then inflation will take off, then oil will start to go up and gold will start to go up. Oil will go up a little faster, and then the ratio will be restored.
There is a geopolitical shock behind it, but it’s a hidden shock. It’s not a war; it’s a behind-the-scenes effort by the Chinese to acquire massive amounts of gold through stealth and deception. That’s the shock, that’s what’s getting it out of line. It will be restored when two things happen: 1) The Chinese get a lot more gold so they feel they can match the US in terms of a gold-to-GDP ratio, and 2) When the helicopter money kicks in and both oil and gold go up, oil will go up a little faster and the ratio will be restored.
Alex: What I’m hearing you say is that in 2016 we’ll be looking at much of the same with some slight fluctuations, but in 2017 we’ll possibly be looking at inflation starting to kick in and then it’s off to the races from there.
Jim: The world has to get inflation. It’s not pleasant; it’s a form of theft. I’m not advocating for inflation, but as an analyst, it’s not my job to be an advocate; it’s my job to get the analysis right. The global monetary elites have to cause inflation, because there’s no other way to pay the debt. They failed to do so for the last seven years, but they’re going to keep trying.
Alex: Thank you very much, Jim. As always, this has been a very illuminating conversation. I also want to thank our listeners for the questions they’ve submitted. We have far too many questions than we have available time to ask, but I want to encourage you to continue to submit questions, because this dialogue we developed with you has really shaped the conversations we’ve had with Jim over the last couple of years. With that said, I’m going to turn it back over to Jon.
Jon: Thanks, Alex. You couldn’t have said it better, and let me add my thanks to you, Jim. What a fantastic start to the year’s programs. It’s always a pleasure and an education having you with us. Let me also add my thanks to our listeners for spending time with us today and encourage you to follow Jim on Twitter. His handle is @jamesgrickards.
Goodbye for now, and we look forward to joining you again soon.
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