May 18th, 2015 Gold Chronicles topics:
*War on Cash
*Cashless society sets world up for negative interest rates
*Herding people into banks and digital wealth
*Daily limits on cash withdrawals
*Impose negative interest rates on deposits
*Potential freeze on bank accounts in the event of emergency
*Trans-pacific Partnership (TPP) and currency manipulation
*Currency Wars – not all currencies can be weak at the same time, they take turns
*If you are at a poker table with four or five people and you don’t know who the sucker is, you are the sucker, this applies to currency devaluation as well
*Spike in German gold purchasing
*Gold in Euro has skyrocketed, it is perfectly sensible
*Europe already has negative interest rates
*Add in geo-political risk, gold makes a lot of sense
*It is almost impossible for the Fed to raise rates without a bloodbath in markets
*As people discover the Fed can’t raise rates, it should be good for gold
*Jim’s view on best economics schools to attend
*Proper gold allocation in a portfolio
*Can Central Banks perpetually hold up stock markets by continual money printing
*ZIRP is taking money out of the pocket of savers and giving it to big banks
*The Fed is in effect forcing people into the stock market if you want returns
*There will come a time when the magnitude of the crisis will be bigger than Central Banks can create liquidity for
Listen to the original audio of the podcast here
The Gold Chronicles: 5-18-2015
JW: 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 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. He’s a consultant to the US Intelligence Community and to the Department of Defense. He’s also an Advisory Board member of Physical Gold Fund.
Hello, Jim, and welcome.
We also have with us Alex Stanczyk of Physical Gold Fund.
JW: I’d like to begin with a very interesting question that Alex himself raised in a recent conversation. He was commenting on what has been called the “war on cash.” What he means by that is there’s been an increasing chatter about the coming disappearance of old-fashioned cash — bills and coins that you carry in your wallet or purse.
One implication of this, of course, is a major expansion of financial surveillance, and as Alex pointed out, a greater ease for governments to seize assets. My question to you, Jim, is: Do you see the cashless society as something happening in the foreseeable future? And if so, what are the implications for gold, which you’ve always insisted is itself a form of money?
JR: Jon, that’s a great question. It’s got a lot of parts. Let me go through those one at a time. First of all, what’s sometimes called the “war on cash” or the drive to a cashless society, not only do I see it coming, it’s sort of here. Like many things that involve a loss of liberty, I think it’s snuck up on people. It’s already here, and people don’t quite realize it because they have a few bucks in their wallet. You pull out your wallet or your purse, and you look in and you might have $50, $100, or a couple hundred bucks. In Philadelphia, we used to call it “walking around money”, and that’s fine. Maybe you put $100 in a birthday card every now and then. Cash is still out there.
But if you think about it, what you do day in and day out, if you have a paycheck, it’s probably direct deposit from your employer. Most of the money you spend is probably either a credit card or a debit card. Maybe you do some wire transfers, moving money back and forth between money market accounts and brokerage accounts and your bank accounts. That’s all digital.
Probably, 99% of what you do is already digital, and you think that cash is available, but it really isn’t. We’re even at the point where maybe with four bucks at the Starbucks counter, you’re buying a latte or something, you probably just swipe your debit card. You don’t even reach in your pocket and pull out a $5 bill.
The cashless society, the digital society, is already here. People say, “So what? It just seems really convenient.” And I do all these things myself. I have debit cards and I’m no different from anyone else when it comes to that. But it does have some implications.
First of all, it sets up the world for negative interest rates. People ask, “What are those?”
Basically, you put $100,000 in the bank, and at a 1% negative interest rate, you come back a year later and you’ve got $99,000. Instead of giving you $1,000 or $2,000 or $5,000 of interest, which is what used to work, they’ll actually take away part of your money as a negative interest rate. This is designed to get people to spend it, because if you spend it, they’re not going to take it away, but if you leave it in the bank, they will, so it’s a way to force people into spending money to get the economy moving. It’s not really working: the economy has more serious structural defects, but that’s the idea behind it.
The other idea behind it is to get to negative real interest rates. That’s a little more complicated, but a real rate is basically the rate that you get minus inflation. A typical way of thinking about it is let’s say you get a 5% interest rate and inflation is 3%. You do 5 minus 3, and your real gain is 2%, because you have to adjust for inflation.
What do you do when inflation is deflation? In other words, you’re subtracting a negative. This goes back to a sixth or seventh grade math where, when you subtract a negative, you add the absolute value. Now, if you have a 1% interest rate (positive 1%), but inflation is actually deflation, let’s say negative 2, so now what’s the real interest rate? It’s 1 minus negative 2, which is plus 2, which is 3. A 3% real interest rate is very high if you’re trying to get people to borrow money and invest.
If you want to get the economy going, you have to have negative real rates, but how do you get to a negative real rate in a world of deflation? You have to have negative interest rates. A simple example would be if deflation is minus 1, but the interest rate on your bank account is minus 3. Well, minus 3 minus negative one is minus 2, so that’s the negative real rate, and that’s designed to get people to spend money.
It’s a little bit of a through-the-looking-glass world, but that’s the world we’re living in. They’re setting people up for negative interest rates, either to take your money or to induce you to spend it. But to do that, they have to get rid of cash.
Going back to my $100,000 example. The person with the $100,000 in the bank leaves it there and comes back a year later and has $99,000 because of the negative 1% interest rate. But suppose you took the money out and had the $100,000 in cash. You’ve got a stack of one thousand $100 bills, you put them in a safe place. Yyou come back a year later – you still have $100,000, your neighbor has $99,000, but you have $100,000 because you didn’t leave it in the bank. Cash is a very easy way to defeat negative interest rates. To force people into negative interest rates, you have to get rid of cash.
Now, there are other aspects to it. Obviously, there’s a war on drugs. Drug dealers like to use cash. There’s a war on terror. Terrorists have to use cash. The government authorities are always going to say, “We’re not really against everyday citizens. We’re just trying to get these bad drug dealers and these bad terrorists, tax evaders, and others. That’s why we don’t allow people to have cash.”
But there are tons of good, legitimate reasons to hold cash. You might have a cash business. You might want to, as I say, have some cash for emergencies. If you live where I do, we’re very vulnerable to hurricanes here in the East Coast, or just bad storms, and the power goes out. When the power goes out, the ATMs don’t work. It’s good to have a little bit of cash around for occasions like that.
Basically, the war on cash is designed to set us up for negative interest rates, set us up for confiscation, and encourage people to spend their money. But to do that, you need to herd everybody into one of these big banks and some form of digital wealth, and get rid of physical cash.
By the way, this is very reminiscent of what happened to gold in the early part of the 20th Century, from around 1910 to 1914. If you were in anywhere in the United States in, say, the 1890s, and you had to pay for something, you might very well reach in your pocket and pull out a gold dollar or silver dollar. Maybe it was a gold $5 coin or whatever, but people carried around solid silver and solid gold coins. I remember when I was a kid, a quarter or dime was still solid silver. It was only in the 1960s that they debased it by adding copper, zinc, and a couple of other alloys.
How did they get people to give up their gold coins? This was the origin of the 400-ounce bar. People who follow Physical Gold Fund have probably seen a picture of me from a trip to Switzerland where I’m holding a 400-ounce bar. And they’re not light, by the way! They weigh a good 30 pounds. It’s like lifting a heavy free weight.
What they did is they said, “Okay, you can have gold.” This was not 1933, after Franklin D. Roosevelt made gold illegal. This was in 1914-1920, when gold was still legal. But what they did is melted down all the coins, took the coins out of circulation, and put it into 400-ounce bars. Nobody is going to walk around with a 400-ounce bar in their pocket. They said to people, “Okay. You can own gold, but it’s not going to be in the form of coins anymore. It’s going to be in the form of these bars. By the way, these bars are very expensive.” That means you need a whole lot of money to have one and you weren’t going to take it anywhere. You were going to leave it in a bank vault.
It was a process gradually, and people didn’t seem to notice the substituting of paper money for gold coins without making gold illegal all at once. They created these 400-ounce gold bars in very large quantities and got rid of gold coins. Later, they made gold completely legal, but by the time they did that, in 1933, not very many people were using gold coins. They had paper money. They just thought they could go get gold and found out they couldn’t.
So this whole war on cash reminds me of the war on gold coins from earlier in the 20th Century, but it’s the same process. It’s forcing people into the banks, herding people into a small number of institutions, making it less and less convenient to have the old form of money, and more convenient to have the new form of money. But the new form of money implies tighter forms of government control. People don’t really notice until it’s too late.
We’ve kind of come full circle, because I talked about the war on gold in the first half of the 20th Century. Now in the 21st Century, we’re seeing a war on cash, but part of the solution is to go back to gold. Because, of course, gold is now legal. Earlier in the 20th Century, it was illegal and inconvenient but now it is a legal form of ownership. You can buy large bars if you want. And you can buy 1-kilo bars, which are a lot more convenient than 400-ounce bars, but you can also buy gold coins.
The US Mint will sell an American Gold Eagle or American Buffalo. It’s a 1-ounce solid gold coin. Physical Gold Fund, of course, has larger quantities in their structure, but the point now is that gold is legal and convenient, and it actually becomes a way to get out of the way of this digitation of money and the war on cash.
So I do think this trend is significant. I think it’s being done for a purpose. The purpose is to impose negative interest rates and to leave people nowhere to go. With all-digital money, they can also lock down the system, not only impose negative interest rates, but actually do a Cyprus-type situation, where they reprogram the ATMs and say you can only have, perhaps, $300 today for gas and groceries. And the authorities will say, “Why do you need more than $300 a day for gas and groceries? We have a temporary emergency, so we need to lock down the bank accounts and only let you get that much walking around money. You don’t really need more than that.”
The war on cash, all this digitization, is basically setting people up for two things: first, negative interest rates; and eventually, a freeze on bank accounts in the event of some kind of emergency.
It probably is prudent to get cash, but I think that it has become very, very difficult. Go down to the bank and ask them for $5,000. There’s nothing illegal about it, but you might be required to show some ID, sign a bunch of things, have reports filed with the government — a Form SAR, Suspicious Activity Report, or a Currency Transaction Report, CTR. There’s a whole reporting network around this. I think it’s almost too late to get your hands on cash, but it’s not too late to get some gold.
JW: Thanks, Jim. I’d like to turn to a different topic: the subject of your first book, Currency Wars. It’s a topic that’s surfaced recently in a political dogfight here in the United States. The Obama Administration has been trying to push through the Trans-Pacific Partnership, which is a wide-ranging free trade agreement. A major stumbling block for Congress, or some parts of Congress, is the failure of the Trans-Pacific Partnership to address currency manipulation, specifically by China.
It’s not often that we see currency wars at the center of focus in public debate. I’m curious to hear your view on this.
JR: As you know, Jon, the currency wars, at least the one we’re in now, started in 2010. Here we are in 2015; it’s still going strong. I’ve said many times that the world is not always in a currency war, but when we are in a currency war they can go on for 5 or 10 or 15 years, sometimes longer. I’m not the least bit surprised that here we are five years into this currency war, and it’s still going on, it’s still a topic for conversation, and I think that will continue. I believe we can come back a year from now, maybe two years from now on one of these Physical Gold Fund podcasts and we’d still be talking about the currency wars.
Now, wars have battles, and the tide of war shifts back and forth, so there’s always something new to say about currency wars. In 2011, it was the weak dollar. In 2012, with Abenomics, it was the weak yen. Beginning in 2014, coming into 2015, with negative interest rates in Europe and quantitative easing by Mario Draghi, and now the weak euro — although I think the euro is bouncing back.
This is just the world taking turns because, of course, not every currency can devalue against every other currency all at the same time. If some currency is going to be weak, some other currency has to be strong. It cannot be any other way. It’s like two kids on a seesaw on a playground. I don’t even know if they still have seesaws — they are considered dangerous — but when I was a kid, you had a seesaw. If somebody is down, the other person is up and vice versa.
If the dollar is down, the euro can be up. If the dollar is going to get stronger, then the euro has to get weaker, and vice versa. These things go back and forth. It’s like a real war. If you go back to World War II, the US was pretty badly beaten up at Pearl Harbor and the French surrendered to Germany in the early stages of World War II. In 1942, it looked like Germany and Japan were going to sweep the board. It looked like Germany was going to take over Europe and Japan was going to take over Asia. But the tide of battle turned and those had very different outcomes. It’s the same thing in the currency wars. One currency looks like the strong one for a while, but that can quickly turn around.
Let’s take that background on currency wars and put it into these trade negotiations, and you’re exactly right. It’s not only the Trans-Pacific partnership – that’s a big deal – but there’s another one being negotiated at the same time called the Trans-Atlantic Trade and Investment Partnership.
The Obama Administration is working on major multilateral free trading NAFTA-type deals with our Pacific Rim trading partners and our European trading partners all at the same time. The currency manipulation has been thrust into the middle of this.
Now, the conventional wisdom that I think the White House operates by is this whole theory of free trade comes from the economist, David Ricardo, and his theory of comparative advantage. What he said was this: Let’s say there are two trading partners, and one’s really good at making wine and the other one is really good at making textiles. They ought to trade wine for textiles. It doesn’t necessarily make sense for the wine-producing country to go out and create a textile industry, and it doesn’t make sense for the textile-producing country to plant grapes. Let them trade with each other and they’re both better off.
There is something to that. I’m not saying that’s a nonsensical theory. As a pure theory, it makes some sense, but there are all kinds of qualifications to that. One of the big qualifications is we’re going to have comparative advantage. Here’s how it works. We’re going to say that certain countries are better at certain things than others, and they ought to focus on those, and then trade with their trading partners to get the things that their trading partners are good at, and everybody’s better off. That’s the theory.
So do you measure comparative advantage? You have to measure it in the price of inputs. What’s the cost of labor? What’s the cost of capital? What are your natural resource endowments? What’s your technology? You have to look at all those things that are your inputs, your factors of production, and weigh them up to find out where you have your comparative advantage.
But how do you figure out prices? You use currencies. You use dollars and yen or yuan, etc. Now here’s the question: What if I’m manipulating my currency? All of a sudden, the whole theory of comparative advantage goes out the window. Because if I’m using prices to determine my comparative advantage and if comparative advantage is supposed to dictate the terms of trade and that’s the basis for coming up with a free trade area, but someone is manipulating the currency and distorting the price mechanism, then you could be kind of a sucker.
If you’re allowing free trade with a trading partner who is manufacturing its comparative advantage out of thin air by manipulating the currency, then you’re just a sucker in that poker game. There’s an old saying, Jon, if you’re at a poker table with four or five people, and you don’t know who the sucker is, you are the sucker. In other words, everyone else has ganged up on you. The US looks more and more like the sucker in free trade because we don’t really suspect or understand what trading partners are doing to kind of rig the game.
The other problem with Ricardo’s theory of comparative advantage is it assumes that the factors of production are immobile. In other words, they stay in one place. If you’re comparing US and China, you would say, “Okay, maybe China has a comparative advantage in labor, but maybe the United States has a comparative advantage in capital, because we have more developed capital markets, better rule of law, etc. And since labor and capital are both factors of production, let them compete in a level playing field and may the best country win.” That’s kind of a fair trade or free trade type of argument.
But what if the capital picks up and moves to China? In other words, what if the factors of production are not immobile, what if they’re highly mobile in a globalized society? All of a sudden, China has the cheap labor and the cheap capital, and that’s encouraged by currency manipulation. That’s really the point of the President’s opponents. I don’t think the President is a good listener. In fact, I know he’s not. He tends to get an idea in his head and assume he’s right and not be a very good listener and not willing to understand what the other side is saying. He just tends to polarize and demonize the issue a little bit.
But I do think that some of the opponents of these trade agreements in the Congress do have a point. They’re not all protectionists. They’re not all tub thumping, high-tariff trade bashers. They’re actually, I think, fairly thoughtful in a lot of cases, and they’re saying, “Hey, United States, you need to wake up and realize that you’re the sucker at the poker game. You need to do something about it.”
It’s interesting to see. And you’re right, having written a book four years ago on the currency wars, the one thing I said at the time is they’re not going away quickly, and that has turned out to be the case.
JW: Let’s head over to Europe for a moment, Jim. I’m curious to read that German investors are “piling into gold.” Allowing for media hyperbole, our European friends do seem to have discovered a new enthusiasm for the yellow metal, with reported purchases up 20% in the last quarter. What do you make of this?
JR: It’s not completely surprisingly, Jon. I’ll tell you why. Whenever I’m asked about exchange rates or the price of gold or the value of the dollar – is the dollar going up or down, gold going up or down, or whatever – I always respond with a question. My question is, “Compared to what?” In other words, if you want to know the price of something, you have to say, “What’s your numeraire?”
A numeraire is a fancy French term for your counting system or your numbering system. How do you measure things? Let’s say US-based investors are looking at gold. Today, it’s around $1,220 an ounce, give or take. It’s shown a little bit of strength lately just in dollar terms. I’ll come back to Germany in a second.
We’ve seen a bottom here five or six or seven times. Gold has gone down to the $1,130 to $1,180 range I think six or seven times in the last three or four years. Every time, it’s bounced back. In other words, it’s shown enormous resilience. I think a lot of people are frustrated that gold hasn’t gone higher, but I’m extremely encouraged by the fact that it hasn’t gone lower, considering what’s happened to oil prices, iron ore prices, commodity prices, the price of a lot of other things, and negative interest rates.
If you look around, you see a massively deflationary world. Gold has bounced off the bottom, and it’s actually shown a lot of strength. I think that’s a good sign going forward. Right now, gold is a little bit stronger in dollars, and that’s good for dollar investors. But you have to remember that the euro in the past year has dropped from, around $1.30 to a $1.05 (in round numbers), and then it’s bounced back. The euro right now today is a little closer to $1.13. As recently as about two months ago, it was down at about $1.05.
If you’re looking at gold not in terms of dollars, but in terms of euros, gold has skyrocketed. In other words, Americans are looking at gold saying it hasn’t done much, but for the European investor, the German, the Italian, the Spanish, the French investor, they are looking at gold, saying, “Man, it’s up 20% or 30%.” Because, well, the euro is down. In other words, the euros that you need to buy an ounce of gold are up 30% or so because the euro has come down so much.
Counting in dollars, gold hasn’t done a lot, although it is up a little bit lately, but counting in euros, gold has skyrocketed. For the European investor, they’re looking around saying, “Greece is a basket case, as usual (no news there), but that could be enormously disruptive to the euro. There could be a financial panic in Europe. If I’m counting in euros, gold is up 25% or so, so I want to get some gold.” It’s perfectly sensible.
Remember, Europe does have negative interest rates. We talked earlier in the call about the possibility of negative interest rates coming to the US, and that’s part of the reason for the war on cash. Europe is already there. They have negative interest rates in Europe. Between no interest on your savings, gold going up a lot in euro terms, which it is, and all the geopolitical risks from Greece and Ukraine and Russian and Putin and elsewhere, gold makes a lot of sense.
I believe it makes sense, anyway. I don’t wait for difficult times to buy gold. I like to buy gold on a consistent basis, get up to the right allocation and stay there, but right now I do think it makes a lot of sense for the Germans. I’m not really surprised to see it.
Now, what’s going on, though, is that the euro is starting to bounce back, and the dollar is getting a little bit weaker. That’s because it’s becoming very apparent that the US economy is falling off a cliff.
Look at the the first half, January 1 to June 30, 2015 — of course, we’re still a month away, five weeks away, we haven’t completed that period. But based on all the best available data, it looks like the US economy is going to finish the first half of 2015 with zero growth. Very, very close to recession. We may even be in a recession now and not know it.
The official National Bureau of Economic Research up in Cambridge, Massachusetts is the official arbiter of when we’re in a recession and when we’re not. They don’t make those decisions until months, sometimes a year or more, after the fact. They’re being cautious and they really care more about the history books and the record books, and that’s fine for a bunch of academics, but we all have to deal in real time with the real world.
We could be in a recession right now. If we’re not, we’re close enough, as the expression goes: we’re pretty close to zero growth for the first half. This means it’s going to be impossible for the Fed to raise rates. I’ve said that all along. I said in 2014 that they would not be able to raise rates in 2015. All that’s happening is the perception of the rest of the world, including the Federal Reserve, is starting to catch up with that forecast.
The Fed can’t raise interest rates, but we’ve had a strong dollar for the past couple of years based on the expectation that the US would raise interest rates, going all the way back to May 2013. That’s when Bernanke, remember, started hinting about taper. They didn’t actually start the taper until December 2013. They didn’t finish the taper until November 2014, and then they’re still talking about raising rates in the minutes of the FOMC meeting. But now, from March, we’re hearing the word “patience”.
Actually, right now, May 2015, is the second anniversary of the beginning of the taper tantrum when Bernanke first started talking about taper. They’ve been setting us up for two years to let us know that they’re going to raise rates. Guess what? They can’t raise rates. They can’t. They’re stuck because the economy is in awful shape. It’s actually in worse shape now. If they were going to raise rates, they should have done it in 2013 when the economy still had legs, but it doesn’t now.
It’s almost impossible for them to raise rates. If they do, you’re going to see a bloodbath in the markets. But because the markets thought they were going to raise rates, and that made the dollar stronger. Now everyone is discussing that the Fed cannot raise rates, and that’s going to make the dollar weaker, which should be very good for the price of gold.
When was the all-time high for gold? In August 2011, gold came in around $1,900 an ounce. Where was the dollar in August 2011? It was at an all-time low. Notice that the all-time low for the dollar corresponded almost exactly with the all-time high for gold. That’s not surprising because they’re just two forms of money, and as I said earlier, it’s like the seesaw. If one’s down, the other one’s up. With a weaker dollar, I would expect to see a stronger price of gold for that reason alone.
Now, there are other reasons to own gold. There are other reasons as to why gold could be going up from here. One of them is this weaker dollar coming from a weak economy, based on the fact that the Fed can’t raise rates. It’s a good example, Jon, of how everything is connected. I realize in the course of answering this question, I’ve digressed from the euro, to Germans buying gold, to the dollar, to currency wars, to gold possibly going higher in the United States, to Fed interest rate policy… But these aren’t really digressions. The fact is they’re all connected, and I think it’s now that you have to see how one thread runs through them all.
JW: Let me follow the thread one step further before I turn this over to Alex for questions from our listeners. Here’s another possible reason for owning gold. Goldman Sachs just released a report suggesting that 2015 could be the year of so-called peak gold. We’re familiar with the phrase peak oil, and now we’re hearing about peak gold. That’s the point where new discoveries of underground gold begin a permanent decline. Do you take this report seriously? And if so, what are the implications?
JR: I’m not an expert on mining output or geology, and I don’t want to pretend otherwise. I think about gold as money. I do have decades of experience in bond markets, derivative markets, government finance, the international monetary system — both academically and in my career. I’ve done an enormous amount of research.
When I think about gold, I think of it as money, and that’s how I discuss it. I’m not a geologist and I’m not a miner, so I don’t want to pretend to know more than I do about that subject. But just because I follow it in terms of supply and demand, I do know that gold output has leveled off around 2000 tons around, give or take. It could be a little higher or a little bit lower in some years. With all the new technology and with the higher price of gold a few years ago, we’re not seeing a lot more gold produced.
That’s kind of leveled on the demand side, of course. Russia and China and now India and others are buying all the gold they can lay hands out. Not just mining output, but also gold coming out from other sources. The supply/demand balance or imbalance, as the case may be, does seem to favor stronger prices, but output is not going up.
Whether there is less gold in the ground, I leave that to Goldman Sachs. I’m not a big fan of their monetary research, but I’d say the same of all of Wall Street — no need to pick on Goldman Sachs, this would be true at Morgan Stanley and Merrill Lynch, and the other big banks on Wall Street. Most of the Wall Street economists worked at the Fed, worked at some central bank somewhere, and they come out of the same academic programs at MIT and Harvard and Chicago and Stanford and Wharton and Yale and a few other schools. They follow the same career path. They go to the IMF, they go to the Fed, they work for a number of years in those positions, and then they get hired away by Wall Street. They all drink the same Kool-Aid and think the same way, so I’m not a big fan of their market or monetary research because I think they’re missing a lot.
But if one of their analysts did a deep dive on gold output, geology, and knows something better, I would tend to give that some credit. Without being an expert myself, I guess I would say that this is probably a credible report and probably a bullish for gold.
JW: Thank you, Jim. Now, we do have questions from our listeners. Here’s Alex Stanczyk with those questions.
Alex: Very good. The first question that I want to cover here is actually coming in from Twitter. For those of you who want to ask questions on Twitter, use the hashtag #AskJimRickards. Anytime you do that, we have people who are watching that, and we pick up on those questions, and we can either use them for the current webinar or perhaps a future webinar.
The first question from Twitter is coming in from @swapnesh09, and his question is: “Is there a sane-headed business school in the US to learn economics, especially macroeconomics, that does not have Keynesians.”
JR: That’s a great question. What I advise people when it comes to academic programs is don’t focus so much on the school. Of course, you want to pick a high-quality school and a good program. But focus primarily on the faculty. Even in a very strong Keynesian school, you can find individual faculty members who are a little more market-oriented, are using what are called heterodox or other, maybe even Austrian, economics and so forth.
I would take an a la carte approach and be looking for good professors. And then when you show up at that school, you’ll take your micro and macro courses. They’re all going to be the same. But then get acquainted with that individual professor and try to take advantage of the opportunity to learn.
Now, in terms of a school, I would look at George Mason University in Virginia. It’s a fine school. And George Mason is well-known as having an economics department that is more Austrian-oriented, more free-market oriented. That’s one where I think you can get a breath of fresh air.
I got a graduate degree in international economics. That was a specialty, but as an undergraduate, I studied economics. I had a hard time. My grades were okay, but I really, really struggled with it. I just thought that I wasn’t very good at it. It was only decades later that I discovered that the reason that it made no sense was because it made no sense! I was trying to struggle with something that really didn’t make sense. I can see that now, so I feel a little bit better about my academic performance, but at the time, I was taking it seriously and I didn’t understand the whole neo-Keynesian way that economics was taught.
By the way, Keynesianism does not have a lot to do with Jon Maynard Keynes. I’m kind of a fan of Maynard Keynes; I’m just not a fan of Keynesianism. Keynesianism was hijacked by Paul Samuelson and the faculty at MIT in 1947, and that was taught in the ‘50s, ‘60s, and ‘70s, and even today as Keynesianism. I don’t think Maynard Keynes, if he were alive, would even recognize it. I can say a kind word for Keynes without being much of a fan of neo-Keynesian economics.
The only two things that I would say are, look for faculty rather than schools. And I do think that George Mason University is a fine school that I happen to be acquainted with a good economics department. I wouldn’t rule out Harvard. I would just go through the academic brochures and try to find a good professor.
Interestingly, Joseph Schumpeter taught at Harvard throughout the 1930s. He’s one of the most famous economists of the 20th century, trained in the Austrian School at the University of Vienna, was classmates with Ludwig von Mises and others, a dyed-in-the-wool Austrian economist, but he was on the faculty at Harvard. I don’t think we can ding Harvard. Like I said, look for your individual faculty members.
We should widen the aperture a little bit. The London School of Economics, they’ve got their share of Keynesians, but I think you’ll find some good heterodox economists there, as well.
Alex: I’m really glad you pointed out the difference there as far as the difference between what Keynes taught and how it’s kind of been hijacked today. I know Keynesians get picked on quite a bit in certain circles, and I think that that’s really important to point out those differences there.
Going back to a little bit earlier about something that you had mentioned as far as gold doing really well in the euro and not necessarily measuring it in the US dollar. I just pulled up a chart, and looking across the board, that’s absolutely correct. Looking at prices in 2015, gold was up 9.4% in the euro and up, over 3% in most other currencies. Across the board, 2013, there was a pretty big pullback. The average for the last 15 years in virtually every major currency is higher than 7%. I agree with you there. It just depends upon how you’re measuring it.
The next question here is coming from Sean F: “With bail-ins a certainty and a stock market meltdown a significant possibility, where should you put your cash? Physical gold?”
JR: I will answer that question, but before I do, I just want to put in a footnote. I obviously say a lot of favorable things about gold. I invest in gold myself. I manage a fund that has gold, I’m on the Board of Advisors to the Physical Gold Fund, which offers a solid gold fund. It is a fund that you can invest in where it’s completely backed by physical gold. You can leave it in the vault or you can have it delivered. You can have it converted to cash. It’s a very well thought-out plan.
So I’m an advocate for gold as an analyst, as an investment manager, and as an advisor. But I’ve never said, and I’m not going to say now, sell everything and buy gold. I don’t believe in going 100% into anything. I think the right allocation for most investors is about 10%. If you want to be aggressive and lean in a little bit, go to 15%-20%, if you like. I don’t recommend 50%. I don’t recommend 100%. I think it’s foolish no matter how much I like an asset category — and I do like gold — to go all in.
Here’s where I get beaten up all the time. I will say something good about gold and then somebody will say, “Gold went down. You’re an idiot.” I say, “No — if you have a 10% allocation and it goes down 10%, you’ve only lost 1% on your portfolio. No one likes to lose money, that’s no fun, but 10% of 10% is only 1%. That’s part of the reason for diversifying.”
So yes, I do think gold is a good place to put liquid assets. Gold is also funny in the sense that it’s liquid and thinly traded. That’s a very unusual combination. Usually things that are thinly traded are illiquid. Let me describe the difference. Thinly traded means that the volume of trading relative to the volume of the stock (or whatever asset it is) is fairly small. Maybe the number of dealers is fairly small, etc.
And saying something is liquid means that you can get it in and out of the market with relative ease and minimal market impact. You’re not going to upset the market or have a hard time. If you try selling a private equity fund or shares in a venture capital company or some other assets, you’re going to have a very difficult time. It’s not that it can’t be done, but that’s illiquid.
You’ll never have problems buying or selling gold, and yet it is thinly traded. Gold is a market where you can get in and out with relative ease. I’ve never seen a situation where there wasn’t a bid for gold or where you couldn’t buy the gold if you wanted. But there’s not that much gold that’s actually traded.
So I do recommend for investors 10%. I think it’s the right amount. If you’ve got 2% or 3%, you might think of increasing your allocation. If you got 50%, it’s a little too much for my taste, but to each his own.
There’s a place for cash. There’s a place for gold. I even own some stocks in private companies. I don’t think they’re liquid. If I have to pay the electric bill tomorrow, I’m not counting on my venture capital investments to be able to pay the bills. I’ve got to have cash for that. But it has a place in my portfolio. So I think diversification is key, and bear in mind the possibility of a stock market meltdown — which I think is a real one, by the way. I can see stocks falling a lot, meaning at least 20%, but maybe 30% or 40% in a short period of time. It doesn’t mean one day, although it could happen that way, but even over a couple of weeks.
Here’s the funny thing about stocks falling — let’s say they fall 30% in three weeks, just to pick an example. The market goes down 3% or 4% in one day, that’s a big drop, and people say, “Oh, okay. I’ll buy the dips,” and then they buy more and it goes down 5% the next day. They’re like, “Huh. Maybe I’ll buy more. I’ll sit tight because I know it will bounce back.” And it goes down 4% the next day, and it’s like, “Wow, this is really getting ugly. We’re getting into a bear market.”
The point is you say to yourself, “I never would have sat there and watched it go down 30%.” But that is actually what people do. They do sit there and watch it go down 30%, because they’re in denial about what’s happening. They’re watching these 3%, 4%, 5% drops day after day, and the whole time they’re telling themselves, “Buy the dips. It’ll come back. I just need to sit tight, don’t panic. Everyone on television is saying don’t panic….”
Next thing you know, it is down 30%. They’re like, “Wow, what happened? I just got wiped out.” That’s human nature. It’s very hard to fight human nature. The best traders I ever met worked with people like Bruce Kovner and others. They have ice water in their veins. They are very unemotional. Something goes down — and boom! they get out and get a good night’s sleep. Maybe they come back in the next day, but at least you cut your losses there.
Yes, I do think stocks are very vulnerable. By the way, when I say stocks are vulnerable, they are. They’re very dangerous. Stocks could actually be higher at the end of the year based on the fact that the Fed is going to blink. The Fed is not going to cut interest rates, and the market kind of expects a rate increase, and when they find out they’re not going to get it, that’s the psychological equivalent of a cut, and stocks are very vulnerable in that.
I’m not saying stocks are going to go down 30% tomorrow. I’m just saying they might. I actually think stocks may be higher at the end of the year, but I still don’t like them because I think it is a bubble and I think it’s too dangerous.
Banks, likewise, I think that in a financial panic, you’re very vulnerable to getting locked down, à la Cyprus, à la what will probably happen in Greece, so you don’t want all your money in the banks, either.
Then you say, “Well, okay, if the stock market is too risky and the banks are going to get locked down, other than a little bit for walking around money, what should I do with my portfolio?” It’s a hard question. I understand that, but I do think a 10% allocation in gold is a very good place to put some of your wealth where the wealth will be preserved, it won’t be locked down, it will maintain its value; and if you need to sell it, you can.
Alex: A quick point of clarification. This is coming from Leo H. He’s asking, “Jim, when you say 10% allocation to gold, is that 10% of your liquid portfolio, meaning stocks, bonds and cash, or 10% of net worth, including, for example, home equity?”
JR: It’s a really good question, and I’m glad that was asked. That’s 10% of your investable assets, what’s called your liquid portfolio. I always say take your home equity and take your business, if you’re a small businessperson, and set it aside. Maybe you have a restaurant or a dry cleaner or a pizza parlor, or you’re a car dealer, or you’re a doctor or dentist. Whatever that is, however you make your living, if you have some business capital, put that to one side. Put your home equity to one side.
Whatever is left, those are your investable assets. I recommend 10% of that, 10% of your investable assets.
I don’t recommend going out and taking a home equity loan and taking 100% of your home equity and pouring it into gold. I like gold for all the reasons we’ve talked about and some more that we haven’t had time to get to on this call, but gold is volatile. That’s just a fact. To be precise: It’s volatile in dollars. I actually think of gold is constant, I don’t think of gold as moving around. I think, when people say “gold is up” or “gold is down”, what they mean is that the dollar price of gold is up or the dollar price of gold is down. When I see that happening, I say, “Gold is constant and the dollar is bouncing around.” If the dollar gets strong, the dollar price of gold goes down. If the dollar gets weak, the dollar price of gold goes up.
But to me, it’s not gold is moving around. It’s the dollar that’s moving around. That’s how I understand currencies and the currency wars. I think of gold as a constant store of value and constant store of wealth — but that’s me.
Having said that, if you’re measuring in dollars, if dollars are your numeraire, then gold is volatile, and leverage is volatile. You don’t really want to put volatility on top of volatility. In other words, you don’t want to be a leveraged investor into gold. You want to put money into gold that is your money, your wealth, as an allocation.
Put your home equity and your business equity to one side. Whatever is left, those are your investable assets or your liquid portfolio, and I recommend 10% of that for physical gold.
Alex: We get a wide range of people who come to these webinars, everything from students to business owners to managers of substantial funds in the institutional money managers. This next question is coming from a business owner. His name is Brad C., and his question is: “As a business owner, I often wonder if I should continue reinvesting in my business versus increasing my hedges against certain financial disaster in the future. My business depends on customers’ ability to spend, and given that the future isn’t looking so good, would Jim recommend that I keep reinvesting free cash flow back into the business or use those funds to build a financial moat, so to speak? Thank you, Brad C. from Washington, D.C.”
JR: Brad, thanks for the question. I appreciate it. To be completely candid, I’m just not in a position to answer that. I get all kinds of questions all the time, whether it’s a webinar like this, which I thoroughly enjoy doing, or I’m on live TV or live radio or print media or whatever. I’m not shy about answering questions, but I’m also careful to stick to what I know and not try to be the show answer man for every question that comes up. Honestly, on a call like this, it’s impossible to know enough about your business to give advice like that, so I’ll refrain from doing that.
The only thing I would add is I don’t know what business you’re in. Some businesses do well in tough times, but I do see the US economy, as I said earlier in the call, is flat right now. The prognosticators say, “Well, the Fed says we have to have 3.5% growth, so I guess they mean if it’s going to be zero in the first half, somehow it’s going to be 6% in the second half, and that will average out to 3%.” I don’t see that.
Something like that did happen last year. Go back to 2014, first quarter GDP was negative in 2014. Then it found a pulse in the second quarter. The first quarter was negative, the second quarter was positive, the first half was flat. But the second quarter was positive. The third quarter was gangbusters. The economy grew 5% in the third quarter of 2014, and that’s when the Fed got the crazy idea they could somehow afford a strong dollar and let the euro crash, which it did.
I said at the time, that was a bogus number. In that 5% for the third quarter, the Commerce Department failed to make the seasonal adjustment for defense spending. That’s a really big deal because if you know anything about defense spending, and I actually do because I do some consulting for the government in the defense intelligence sector, the government is on a September 30 fiscal year. The government doesn’t use the calendar year. The government is on September 30 fiscal year, which means the year is over September 30.
If you’re a contracting officer in the Department of Defense or some other agency, you don’t get even get your Congressional approval, your authorization to spend money, probably until February, so the whole period from October 1st to the following February is frozen because they haven’t approved the budget.
Then, around February, they get around to approving the budget, so now you’ve only got seven months left in the year. But even then, the contracting officers don’t do anything because they like to keep their options open. If they sign a big $1 billion contract for something, that means if a better idea comes along, then too bad; you already spent the money. They wait until June and July, but then you can’t wait too long because it takes 30 days to sign a contract, so you’ve got to get them all done by August if you’re going to lock it in for the fiscal year.
Believe me, they spend the money. It’s a principle of use it or lose it. Nobody ever gives money back to the Treasury. What that means, as a practical matter, is that the lion’s share of defense contracting gets done in July and August versus the rest of the year, and that’s why the Commerce Department makes the seasonal adjustment to smooth that out. They didn’t do it this year, and that was, I think, to pump the number, because that third quarter GDP number came out right at the end of October, just a couple of days before the election. It has the look of the White House wanting to kind of goose the election in their favor by coming out with a blockbuster GDP.
They did that, but when I saw it at the time, I said, “Well, okay. You can play the game but you’re going to pay for it. If you put too much spending in the third quarter, it’s going to come out of some other quarter, and sure enough, it did. Fourth quarter was dropped significantly.
Now in 2015, first quarter is zero. It looks like it’s going to be revised negative in two weeks, and then second quarter indication is close to zero.
We’ve had to pay the price. I see the US economy is very weak. Again, I don’t want to give individual business advice because I just don’t know enough about it, but if the broader question is, “How is the US economy doing?” the answer is not too well.
Alex: Here is a really interesting question. It’s kind of appalling to me that we even have to talk about this, because I think everybody already knows the answer, but we do still need to talk about it. This question is coming from Juha M.: “Is it possible that central banks can prevent stock market crashes infinitely by buying up stocks every time there’s a severe correction to the downside?
JR: The answer is no. They can do it for a while. First of all, the Federal Reserve so far has not bought stocks, at least not publicly traded stocks. They bought some hodgepodge of crummy assets from Bear Stearns when they bailed out Bear Stearns in March of 2008. But other central banks can buy stocks and some of them do. They can buy derivatives, they can buy stock futures. There is some capacity to prop up markets. The Fed has other ways of propping up the stock market without buying stocks. One of them is zero interest rate policy.
I once got a phone call from a retired lady in her early 80s in Florida, and she said, “I have $100,000 in the bank,” that was kind of her life savings, and she had some Social Security and retirement benefits and health care. She wasn’t impoverished, but that money was all she had in the world. She said, “I used to get $2,000 or $3,000 a year interest, even at 2% or 3% on 100 grand, and that paid for my meds. And now I get zero and I’m having to do without my meds. What can I do?” That was her question and it’s a sad state of affairs.
This is what Janet Yellen’s zero interest rate policy gives you. It steals money from savers and hands it to the big banks, hands it to Jamie Dimon and people like that, because if the bank isn’t paying you anything, and you’re not getting any interest in your savings account, who wins? The bank wins because they get to use your money for free, and they get to lend it out to somebody else and make it spread.
The whole zero interest rate policy is taking money out of the pockets of savers and handing it over to the big banks. That’s what has been going on. Now, you say, “Wait a second. That’s really unfair. I got to get some return, what can I do?” Janet Yellen is saying, “Buy stocks.” They actually have a technical name for this. It’s called the channel effect. The channel effect is we, the Fed, want you to channel your money into stocks. Over here, oh, you want to put money in the bank? We’ll pay you zero, and the portfolio channel effect idea is that if you want a return, you’ll go buy stocks.
By having zero interest rate policy and paying savers nothing, the Fed is, in effect, forcing you to go into the stock market to buy stocks if you want a return. Janet Yellen’s answer to this 82-year-old lady in Florida would be, “Buy stocks.” Of course, my answer is, “Don’t even think about it. You’re 82 years old. That money is all you have. If the stock market goes down 30% in a short period of time, you’re going to be wiped out, so you have no business being in the stock market.” Maybe if you’re younger and a portion of your portfolio, you have a long-term view, that’s different if you want to take that risk, but not for someone in that position.
That’s how the Fed props up stocks, basically through this portfolio channel effect and the zero interest rate. But the question was, “Can they do it indefinitely?” The answer is absolutely not. Something will break. I don’t know exactly when, I don’t know exactly where. I could identify a range of possible dates and a range of possible triggering events or catalysts. I’m not saying we have no idea. I’m saying we actually have probably quite a few ideas, but it’s hard to know which one.
My estimate is sooner than later, meaning could it be 2017-2018? Yes. Could it be tomorrow? Yes. Is it something that will erupt in emerging markets or China or the oil patch, fracking junk bonds, geopolitical risk? Yes. It could be all of the above, but it doesn’t matter. What matters is you can see it coming and you can do prudent things in advance to preserve your wealth.
There will come a time when the magnitude of the catastrophe will be greater than the capacity of central banks to bail it out. That will be an interesting time. Just go back over recent times. In 1998, Wall Street got together and bailed out a hedge fund called Long-Term Capital Management. I happen to know a lot about that because I was at Long-Term Capital Management and I actually negotiated that bailout. Global markets were hours away from shutting down. That’s not an exaggeration. That’s actually something that Alan Greenspan and Bob Ruben testified to, and I was there and I can verify that it’s a true statement.
Global markets were hours away from shutting down, and Wall Street bailed out a hedge fund. In 2008, ten years later, central banks bailed out Wall Street, and again, markets were, if not hours, then just days away from shutting down.
In 1998, Wall Street bailed out a hedge fund. In 2008, the central banks bailed out Wall Street. Go ahead ten years to 2018, who’s going to bail out the central banks? What’s bigger than the central banks? There’s only one thing in the world bigger than the central banks. That’s the IMF. That’s where world money and the special drawing rights come in.
There comes a time when it’s not kicking the can down the road: It’s kicking the can upstairs to a higher authority, but there is no higher monetary authority than the IMF. When that bail out comes with SDRs, that will be highly inflationary. But at that point, people might lose confidence in all forms of paper currency, and then that’s when gold will be the only safe haven.
Alex: That pretty much does it for our time available today. Jim, thank you very much. As always, thank you for your insights. With that, I will be handing it back over to Jon.
JW: Thank you, Alex. And let me remind our listeners. You can follow Alex Stanczyk on Twitter. Just go to Twitter, type in Alex Stanczyk. Great insights and valuable links to follow there from Alex. And thank you, Jim Rickards. It’s always a pleasure and an education having you with us. Most of all, thank you to our listeners to spending time with us today. Of course, you can also follow Jim on Twitter. His handle is @jamesgrickards. Goodbye for now, and we look forward to joining you again soon.
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