September 15th, 2015 Gold Chronicles topics:
*Jim is correct again on no Fed rate increase
*No rate increase through end of 2015
*What the Fed needs to do is ease
*Fed’s easing options moving forward: QE4, Forward Guidance, Helicopter QE, Negative interest rates, Next salvo in currency wars
*The time to raise rates in 2010 and have missed and entire rate cycle
*The Fed does not lead the economy, it follows it. Raising rates will not make the economy stronger
*Nominal interest rate versus real interest rate
*Real interest rates is what effects gold price
*The dollar price of gold is just the reciprocal of the dollar fluctuating in value
*China’s sale of US Treasuries is being absorbed by the market. Bernanke: The financial system is a closed circuit
*Financial warfare and risks in digital assets from cyber threats
*Conversations with the only man who has ever been the head of both the CIA and the NSA
*Cyber financial warfare attacks are the Precision Guided Munitions of future warfare
*Physical gold cannot be hacked
*World monetary system is described by financial elites as”incoherent”
*Voices joining in cautioning catastrophic collapse of intl. monetary system include BIS, IMF, G20
*If the Fed cheapens the dollar, it will likely raise the price of gold
*The challenge with issuing helicopter money is that you need the cooperation of treasury, Congress, and the executive office working together in order to do it
Listen to the original audio of the podcast here
The Gold Chronicles: 9-15-2015
Jon: 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 U.S. Intelligence Community and the Department of Defense and is also an Advisory Board member of Physical Gold Fund.
Hello, Jim. Welcome.
Jim: Hi, Jon. How are you?
Jon: Excellent, thanks. And yourself?
Jim: I’m doing fine, thank you. It’s a beautiful day here.
Jon: Very good, and down here in Arizona, too. Jim, as we are recording this interview, it’s just before the start of the September Federal Open Market Committee meeting. You’ve consistently predicted no rise in interest rates, though I see that you remarked a few days ago that it’s a closer call now than at any time this year. I’m concerned with that ‘close call’ remark. Is this because U.S. and global economic fundamentals have actually improved?
Jim: It’s interesting, Jon. I said that in late 2014 and have continued to say that there will be no rate hike in all of 2015. Some of the listeners may follow me on Twitter, and the great thing about doing television interviews and this podcast is that we have all the video and audio links, so I can show clips from late last year where I said that.
Just to be clear, this is not guesswork or just staking out a position for the sake of attracting a little attention or being controversial. It’s all based on fundamental economic analysis. I don’t even try to be that heterodox or orthogonal to what the Fed is saying. I actually listen to the Fed, I read the speeches, and I read the minutes. I don’t listen so much to television commentators, but I listen to the Fed itself and what the Governors and Reserve Bank Presidents are saying. I then take those indicators, combine them with actual data, and draw my conclusions. I have been saying it all along.
I think I did say this one maybe is a little closer than usual, although I’ve actually backed away from that at this point. It’s unfortunate that it changes day to day. Again, I’ve consistently said that there will be no rate hike. What’s interesting about this time is when I said last year that the Fed would not hike rates in all of 2015, I wasn’t talking about a particular meeting. I said I didn’t see how it could change over the course of the year.
We all remember Wall Street saying they were going to raise rates in March. Instead, the Fed just took away forward guidance, removed the word “patient.” Then everybody said June – we were all spun up about June because there was a press conference – and that didn’t happen. Now everyone is saying September, and I still don’t see it happening. I expect that Thursday will come and go with no rate hike, and then we’ll all be talking about December, although if there is a surprise on Thursday, the Fed might drop a hint about October.
Just to digress on that, there are eight FOMC meetings per year. They don’t meet every month; they meet eight times a year, but only four of them have press conferences. They don’t always have a press conference, so the working assumption is they would only raise rates when there’s a press conference, because they’ll need that opportunity to explain their thinking to reporters.
But actually, that’s not true. Last spring, the Fed rehearsed an impromptu teleconference. They gave everyone one of those dial-in numbers similar to what we’re doing right here where our listeners can log in. They said, “Don’t assume it has to be at a press conference meeting. We might do it at one of the other meetings, and if so, we will do one of these webinars or teleconferences to explain ourselves, so don’t rule that out.”
Be that as it may, I am so used to being out of consensus that now it looks like the majority of the economists and even a large majority of the major Wall Street economists — at least those associated with primary dealers — and the Fed Funds Futures Market, and all the indicators we can find are saying there’s no rate hike this Thursday.
It always makes me a little uncomfortable when I’m in the consensus, because it makes me wonder what I’m doing wrong! In any case, it looks like Wall Street, the markets, and others have caught up to the view that I’ve been presenting all along, which is that the economy is just too weak to bear a rate increase. As I’ve said before, the time to raise rates was actually 2010/2011 when the economy was growing on a sustained basis.
It wasn’t growing strongly, nowhere near potential, for example unemployment was still high, but it was at the early stages of a recovery. That was the time to raise rates, but the Fed didn’t do it. They missed a whole rate cycle, and now it’s too late.
Right now we’re probably getting close to a recession. Undoubtedly the world is slowing down. You look around and see China not technically in a recession but slowing down dramatically, Brazil, Japan, and others in technical recessions, Russia and other major economies in recessions, and the U.S. slowing perceptibly.
What I call the happy-talk crowd likes to look at 2015 second-quarter GDP at 3.7%. That was pretty strong although a lot of it was inventory accumulation. There is a tool put out by the Federal Reserve Bank of Atlanta that’s not perfect, but it’s the best information we have. It’s a real-time GDP tracker, and it’s showing third quarter GDP. Of course, we’re almost at the end of the third quarter coming on September 30, but we won’t have the official number for the third quarter until the end of October. Here we are almost five-sixths of the way through the third quarter, and that’s indicating 1.5%. Combine 0.6% in the first quarter with 3.7% in the second quarter and 1.5% estimated in the third quarter, and it looks like 1.9% growth from January to September, most of the year. In other words, it’s the same kind of crummy 2% or less growth we’ve had all along since 2009. This is certainly not a compelling case for raising rates.
There’s my expectation, but we’ll all find out on Thursday. One of the things I do in my analysis is when I have a view, I’m not necessarily shy about expressing it, but I do ask myself, “What if I’m wrong? What if they do raise rates?”— notwithstanding my expectation that they won’t. That could actually be catastrophic.
It’s a good reason for investors to think now (actually, you should have been thinking all along) about probably increasing your cash position, and if you don’t already have let’s say 10% gold, adding to your gold position. Get into some of those safe-harbor assets, because if the Fed raises rates — again, I don’t expect it, but if they do — this is going to exacerbate what’s already an emerging markets meltdown with massive capital outflows coming out of emerging markets, coming into the U.S., making the dollar stronger, and it could be very, very nasty sailing.
Even if they don’t raise rates, I do expect more of the same. When I say, “More of the same,” the Fed will continue to talk tough. In other words, they’ll talk about raising rates even though they don’t raise them. If they don’t raise rates but continue to talk tough and even hint at October, which again would not surprise me, that’s going to keep the dollar strong and keep the pressure on emerging markets.
We’ll have more of what we’ve been seeing since August, which is pressure on emerging markets’ currencies, capital outflows, volatility in U.S. markets, concern about a global slowdown, and possibly the beginning of a bear market in equity. I think all of these things will continue. If they do raise rates, I would expect all that on steroids. Basically, they would accelerate what could be a market panic comparable to 1997.
The thing I least expect is the Fed to do what they actually need to do which is ease a little bit, because, as I say, we are in danger of tipping into recession. People say, “How can the Fed ease rates? We’re at zero.” They actually do have five tools in their toolkit. I’ll leave aside for a separate discussion whether any of these things work, but at least in the Fed’s mind, they all work.
1) They could look at QE4. 2) They could look at negative interest rates. Although that would be a bit of a shock in the US, they could do that. 3) They could resume the currency wars and try to cheapen the U.S. dollar particularly against Europe and Japan. 4) They could go back to forward guidance — that’s just jawboning — re-introduce the word “patient” (“We’re going to be very patient at this time”), which they took away in March. 5) They could use what’s called ‘helicopter money.’ Helicopter money is when they work with Congress to run larger deficits, the Treasury papers over the deficits with borrowing by issuing bonds, and the Fed buys the bonds. It’s simply another form of money printing. The difference between QE and helicopter money is that when you do QE, you give the money to the banks; when you do helicopter money, you give the money directly to the people in the form of whatever programs Congress decides to support.
Again, I’m not here to debate whether those are good or bad ideas, but there are five ways for the Fed to ease or purport to ease. I don’t expect any of them, but if things get worse, which they may, we could see those things early in 2016.
For now I’ll stand by my forecast of no rate increase on Thursday, maybe a hint of an October surprise, and more volatility. To your point, Jon, whatever closeness in the call I might have seen a couple of weeks ago has disappeared, and the economic data since then has confirmed my long-held view that they will not raise rates.
Jon: Let me ask you one twist on this question, Jim. You’re right that many more commentators seem to be lining up with your long-held forecast that they won’t raise rates, but I’m hearing some voices say, “The fundamentals don’t justify them raising rates, but it’s very dangerous if they don’t, because then they’ll be leaving it too late, and when they do eventually raise rates, it’ll go too fast.” Is there any validity in that anxiety? What’s your view on that?
Jim: That doesn’t fit the facts or the data. Here’s what I mean by that. When commentators say, “If they don’t raise them now, they’ll leave it too late,” I would say it’s already too late. The time to raise them, as I said, was 2010.
We’ve had 38 business cycles since the end of World War II that all follow a classic pattern. The economy gets stronger and stronger, things get a little hot, labor markets get tight, capacity utilization gets tight, inflation picks up, the Fed says, “Okay, time to raise rates” and they do, but they’re usually behind the curve so they raise them again and again, and then finally the economy cools off, things slow down, unemployment goes up, inflation goes down, capacity utilization drops, then things look kind of bad, we’re in a recession, the Fed says, “Okay, time to cut rates,” they cut them, and you go up again. It’s like a sine wave up and down, up and down. That’s a normal business and credit cycle.
What’s different this time is that we’re not in a normal cyclical recovery; we’re in a growth depression. When you get 2% growth for seven years, that’s a growth depression. That’s not a normal recovery, but it’s still a recovery. It may be weak, it may be well below potential, it may be depressionary in that sense, but it’s still a recovery and you’re supposed to normalize rates in a recovery. As I say, the time to do that was 2010/2011.
The Fed could have raised rates in baby steps with big gaps in between. Over the course of two years and 16 FOMC meetings, they could have gotten them up to 1.5% – 1.75%, something like that. If they had done that — and they should have done that — they would be in a position to cut rates today just doing 25-basis-point cuts to keep the economy going. That’s a normal cyclical process.
The Fed missed an entire cycle. They just skipped it because of Bernanke’s experimentation. I spoke to Ben Bernanke in Korea recently and we talked about this. He used the word “experiment.” It wasn’t me; that was his word for what he was doing. This looks like a failed experiment.
Analysts have this exactly backwards. There’s a sense out there that I see everywhere and I’m incredulous. It says, “Oh, gee. If you raise rates, that means the economy is strong, and you better raise them fast before the economy gets too strong.” As if somehow raising rates made the economy strong. That’s the exact opposite. What’s supposed to happen and what normally happens is that the economy gets strong and then the Fed raises rates.
The Fed doesn’t lead the economy up and down; the Fed follows the economy up and down. As the economy actually gets stronger, then yes, at some point the Fed does have to raise rates. But there’s this idea out there of, “You’d better raise rates to make the economy strong.” It doesn’t make the economy strong; it actually slows the economy down. That’s the whole idea.
With this notion that “You’d better raise rates before it’s too late,” show me the evidence of inflation. Where is it? Show me the evidence that labor markets are tight. I understand the employment rate is 5.1%, but so what? Labor force participation is at an all-time low, job creation peaked last November and has been going down fairly precipitously ever since, labor force declined last month, and real wages are going nowhere.
When you look behind the headline happy-talk data, the labor market is showing no sign of tightness, no sign of real wage increases, and no signs of inflation. In fact, inflation numbers are coming down, economic growth is coming down — we already talked about that. In looking at every indicator, this is not an economy that’s getting stronger.
In fact, we are 77 months into this recovery. By the way, that’s a very selective period, because we’ve had two of the longest recoveries in history — in the 1980s during the Reagan years and the 1990s during the Clinton years. The average recovery since 1980 is 78 months. We are now at 77 months. In other words, we’re one month away from having an exceptionally long recovery. If you figure the average since World War II, it’s much shorter, down in the low 40s. So this is a very long recovery.
If you knew nothing else — if you didn’t have any data about employment, inflation, growth, past utilization, or anything — and you were just looking at the longevity of it (and I agree that that’s not dispositive), you would say, “We’re pretty close to a recession.”
This notion that somehow raising rates means you have a strong economy is nonsense and completely backwards. It puts the cart before the horse. When you have clear signs of a strong economy, which we don’t, that’s when you raise rates.
There was one honest analysis where an analyst was very candid and said, “I get the weak data part, but you want to raise rates anyway. It’ll take the stock market down 25% and cause a recession, but you ought to do it anyway, because the danger on the other side is you’re creating bubbles and it’s going to end badly.”
I agree with that completely. I think if they do raise rates, it will take the stock market down 25% in a hurry — that’s one reason to have some gold and cash — and it will cause a recession if we’re not in one already. This is an outside analyst saying this, and I think the analyst did a very good job of thinking about it that way. Instead of the happy talk saying raising rates makes the economy strong, it’s saying raising rates is going to put us in a recession, but we ought to do it anyway. It’s like, “Take your medicine, kid.”
Show me a Fed Chairman or Fed Board of Governors who has ever tried to pop a bubble, who has ever tried to get out in front of an economic cycle or even knew a bubble when they saw it. While I agree with that analysis, I don’t think that’s how Fed Governors and Fed Chairs think about the problem. They’re looking much more in real time and therefore don’t see bubbles. They didn’t see the bubble in 2007, they didn’t see the dotcom bubble, they didn’t see the emerging markets bubble in 1997, and they didn’t see the Mexican bubble in 1994. The Fed has demonstrated that they can’t see bubbles when a bubble is ready to come up and bite them in the ankle. Why would this time be any different?
The case for raising rates is either delusional in the sense that people think it’s magically going to make the economy stronger, which it won’t, or it’s candid, which is it would cause a recession. But that’s actually a reason not to raise rates.
Look, anything can happen and I understand that, but we do the best we can as analysts, and that’s how I see it.
Jon: Let’s step back for a moment from this immediately topical question of tomorrow’s FOMC meeting. I’d welcome a little refresher and guidance from you on the underlying structures we’re consistently talking about. What I’m thinking about is the relationship of interest rates to the strength of the dollar, and then the relationship of both of those to the inflation and deflation. Would you give us a little two-minute seminar on how these three forces — interest rates, the dollar, and inflation/deflation — impact each other?
Jim: Jon, as you and I have spoken before, you know that when anyone brings up the subject of interest rates and how they interact with prices, inflation, deflation, and policy, etc., I’m always very quick to make the distinction between nominal interest rates and real interest rates. That’s a very important distinction that I think is too often overlooked in the discussion.
As a quick primer, nominal interest rates are the rates you see. Whatever the coupon or yield to maturity on a bond is, whatever the bank is paying you on your deposit, whatever you’re actually getting whether it’s 0.25% or 2% on a 10-year note, that’s the nominal interest rate. To get to the real rate, take the nominal interest rate and subtract inflation. As a simple example, if the nominal interest rate is 3% and inflation is 1%, it’s 3 minus 1, so the real rate is 2% or positive 2. That’s how you think about real rates. Real rates have much more of an impact on the real economy and commodity prices, including gold, than nominal rates do.
Just to illustrate that, gold went from $35 an ounce in 1971 to $800 an ounce in 1980. That’s a 2000% increase in about nine years. What was happening to interest rates at the time? Interest rates we’re going to the moon. They went to 6%, 7%, 10%, 13%, 15%, and ultimately short-term rates got to 20% and 30-year bond rates got up to 15%. Interest rates were sky high and the price of gold was sky high, but what that leaves out is the fact that while the nominal interest rate was going up, the real interest was going down because inflation was going up even faster than the nominal interest rate.
For example, there was a time in 1980 when the nominal interest rate was 13% for 30-year-bonds but inflation was 15%. What’s 13 minus 15? At least where I went to school, that’s negative 2. In other words, the real rate isn’t even positive anymore; it’s negative.
It sounds crazy, but to me 13% interest rates were lower than 3% interest rates. “Wait a second, Jim. How can 13% interest rates be lower than 3% interest rates?” The answer is that nominally the 3% rate is lower, but when you do it in real space, 13 minus 15 is negative 2, and 3 minus 1 is positive 2. In the first case, real rates are minus 2, and in the second case, real rates are positive 2.
It’s the real rate that kills you. It makes gold go down and investment difficult. When real rates are low or even negative, that tends to be associated with high inflation. It’s bullish for gold, at least in nominal terms, and encourages spending and investment. You have to always make those distinctions.
People like to say interest rates are at an all-time low right now, but actually nominal rates are close to all-time lows and real rates are nowhere near all-time lows. A 10-year note, which I think is a good proxy, is about 2% right now and inflation is running around 1%, give or take, so the real rate is positive 1. That is a fairly high real rate and one of the reasons deflation has the upper hand and gold prices have kind of gone sideways. That’s an important way to think about interest rates when you’re trying to sort it all out.
Having said that, what’s the impact on the dollar? Again, high real rates make for a strong dollar. Look around and you’ll see that interest rates are being cut. Go around the world — Canada, Australia, New Zealand, China — they’re all cutting interest rates. The Bank of England is, Bank of Japan is at zero, and yet if you look at the US, I can go out and buy a 10-year note and get a positive return. Even though nominal rate is 2, with inflation at 1, I get a positive return of positive 1. For capital allocators looking around the world, all of a sudden the U.S. looks like a very attractive destination for capital because the real rates are high. That brings capital into the U.S., which means you have to buy dollars, which makes the dollar stronger.
In some ways, the dollar price of gold is just the reciprocal of the dollar. A strong dollar can mean a lower dollar price for gold, and a weaker dollar can mean a higher dollar price for gold. Of course, you know I like to say that gold doesn’t change – an ounce of gold is just an ounce of gold. That’s my constant. When someone says the dollar price of gold is going up or down, I just say, “Fine, that’s a dollar problem; it’s not a gold problem.” A lower dollar price of gold just means a strong dollar. That is what we’re seeing because of the real interest rates.
The point being, these things are all connected. The nominal rate is not dispositive. You have to look at the real rate, you have to think about things in real space, you have to adjust for inflation, and you have to think about the impact.
Jon: Let’s stay with the dollar part of this story for a moment and look at how China plays into this. I’ve read that China has been selling off a record volume of U.S. Treasuries recently. This plays into a rather popular narrative that China is almost waiting to pounce and at some moment offload huge volumes of its U.S. debt basically in a ploy to wreck the dollar and the U.S. economy. Give us your view of this theory.
Jim: Some of it is theory and some of it is fact, so let’s start with the facts. That’s always a good place to start! China is, in fact, selling Treasuries and reducing several holdings of Treasuries.
There’s been an enormous drain of reserves from China. They’ve lost over $400 billion of reserves in the past three months. Part of it was used to prop up their stock market, part of it was used to defend their currency at least until they broke the peg in early August, part of it is still being used to defend their currency now because they have a new peg at a lower level, and some of it is going because there’s capital flight coming out of China. Chinese oligarchs, Princelings, and the politically connected people are saying, “I want some dollars. I want to get out of here and buy a nice condo in Vancouver, Melbourne, Sydney, Istanbul, London or all these places around the world.”
What’s interesting is that when you have $4 trillion in reserves, which is where China started this process, it looks like an impregnable castle. It’s like, “Wow, $4 trillion, that’s a lot of money.” That’s fine if the dynamic is going your way, but when the dynamic reverses and you start to lose reserves and you begin to drain your reserves because you’re pursuing some policy, it’s amazing how quickly they can disappear. Of course, the emerging markets found this out the hard way in 1997, Mexico found it out in 1994, and places even today such as Malaysia are draining away their reserves.
It’s a scary thing to watch. Think of watching the gas in your gas tank go down. You may still have three-quarters of a tank, but if you keep going and can’t find a gas station, you’re going to hit empty.
China is quickly losing reserves and is selling Treasuries to basically pay for that outflow of dollars. So why aren’t U.S. interest rates skyrocketing? Why hasn’t the U.S. Treasury market collapsed? Why aren’t all these horrendous things happening that so many people predicted when China started selling Treasuries? The answer is that there are plenty of buyers. In other words, if somebody is selling, somebody is buying.
By the way, this is not some kind of coordinated assault on the U.S. dollar. It’s not some nefarious plot by the Chinese to dump Treasuries and sink our markets. Far from it. China is playing defense. They’re not on offense; they’re playing defense by trying to either manipulate their currency or deal with the demands for capital flight or prop up their stock market, as the case may be.
To me, the interesting question is not that China is selling, which they are, but who are the buyers? There are plenty of them. First of all, people are getting out of other markets. It’s almost like the Malaysian company forces the Malaysian Central Bank to sell Treasuries to give them dollars, and then that individual company takes the dollars and buys the Treasuries.
This is something that was explained to me 35 years ago. I was a young senior officer at Citibank, 27 or 28 years old, sitting at lunch across from our Chairman and CEO, Walter Wriston, one of the most famous bankers of the 20th century. I said, “I’ve just seen this movie Rollover,” an oldie but goodie movie from the 1980s with Jane Fonda and Kris Kristofferson. The plot of the movie was that the Arabs were secretly pulling all their money out of U.S. banks and buying gold, and that was going to lead to the collapse of the banking system and the dollar.
Then I said, “Mr. Chairman, what do you think about the possibility of the Arabs pulling all their money out and buying gold? Wouldn’t that be the end of our banking system?” He looked at me benignly and said, “What you have to understand is that the global financial system is a closed circuit. The Arabs certainly could pull their money out and buy gold, but the guy who sold them the gold is going to get the money, and that guy is going to put it back in the bank, and that bank is going to lend it to us.” In other words, as long as the interbank lending system functions, the money doesn’t go anywhere; it’s a closed circuit.
We’re seeing something similar in Treasuries. It is true that the Chinese are selling, but there are plenty of buyers, and some of the buyers may be wealthy Chinese who are getting their money out in the first place. They just take the dollars from the Central Bank, come to Vancouver, buy some Treasury bills, and you’re back where you started.
At the end of the day, there is one buyer of last resort, and that is the big U.S. banks. They will be forced to buy the Treasuries. This goes under the heading of financial repression. I think a lot of people have heard that term, but this is financial repression in real life. It’s an economic analysis that’s been articulated by Carmen Reinhart. Reinhart’s seminal paper credits Alberto Giovannini, a former partner of mine at Long-Term Capital and a very well-known Italian economist who wrote about this in the 1990s.
The idea is that, at the end of the day, governments can make banks do whatever they want. In 2008, all the banks got bailed out. In early 2009, these bankers took their head out of the foxhole. The shooting had stopped, there was smoke, damage, and carnage everywhere, and they’re like, “Hey, I survived. My bank is still here. I got bailed out by the government. I still have my phony-baloney job. I still have my $1 million plus bonuses. This is great. I can get back to business and pay myself lots of money.”
They missed one thing. They were bailed out, they did keep their jobs, they did keep their bonuses, but what they missed is that they’re now wards of the U.S. Government. They’re working for the U.S. Government, and if the Fed makes them buy bonds, they will buy bonds. In effect, the Fed can just say, “If you don’t, we’ll shut you down.”
I’m not too worried about Chinese selling, because there are plenty of buyers out there, and if all else fails, the banks will be forced into becoming buyers. This will equilibrate the market, so I don’t think it’s that cataclysmic.
Jon: Thank you. Now shifting the focus for a moment, you recently had an extensive conversation with a very interesting individual. I’m referring to General Michael Hayden. You dubbed him as America’s top spy, and with good reason. He is the only person to have headed up both the Central Intelligence Agency and the National Security Agency.
The focus of your conversation, as I understand it, was financial warfare, a recurring theme in our conversations. I’m curious to know what you gleaned from this exchange with the General.
Jim: It was a very interesting conversation. Mike Hayden is my favorite spy. He’s a really, really nice guy, brilliant, a four-star Air Force General. He has led multiple intelligence agencies including Air Force Intelligence before he became head of the NSA, the National Security Agency, and finally, Director of the CIA.
He’s kind of bald, wears glasses, and is a little shlumpy. He looks about as much like James Bond as Elmer Fudd, but that’s the real world. Not all spies are running around in tuxedos playing at Casino Royale. Some of the best spies are actually people you wouldn’t even notice in a crowd, and that can be very effective.
General Hayden told me stories about how, when he was in Bulgaria, he used to buy a ticket on a train to the end of the line. He’d ride the train all day, get to the end of the line, buy a ticket, and ride the train back. In places like Bulgaria where the road system is not that well developed, a lot of stuff moves by rail including tanks, military hardware, and troop trains, etc. Just by being a passenger on a train and going from one end of the country to the other in the course of the day, he picked up enormous intelligence that he could then debrief to his associates. That’s old-school spying and very effective.
We talked about was cyber financial threats to national security, i.e., cyber financial warfare. That’s a bit of a specialty of mine, and he was fully conversant with that. The NSA is actually in charge of what we call SIGINT. Any ‘INT’ is just short for ‘intelligence’. SIGINT is short for signals intelligence, which is basically intercepting radio transmissions, telephonic transmissions, Internet, and any kind of telecommunications. Then there’s HUMINT or human intelligence. That’s the old cloak-and-dagger type of spy stuff.
He was very conversant with this concept of cyber financial threats. Categorically, he called cyberwarfare or cyber financial attacks the PGMs of the 21st century. For those who don’t know, ‘PGM’ is ‘precision-guided munitions’ such as a cruise missile, Tomahawk cruise missile, or something from a Predator drone. He didn’t suggest that that would be the main battlespace today, but over the next ridgeline or maybe the one after that, it’s how wars would be fought. I disagreed a little bit and said, “General, I think it’s here now.” Of course, he would know as well as I, but it’s a pretty active field right now.
There is this recognition in the intelligence community and the national security community that cyber financial warfare is as much a threat as chemical, biological, and radiological weapons or certainly conventional kinetic weapons of a kind we’re all familiar with.
That has interesting implications for investors. We all know the traditional arguments in favor of gold, but there’s now a new 21st century argument in favor of gold, which is that it’s not digital. You can’t wipe it out, you can’t hack it. I’m talking about physical gold. If you have paper gold on COMEX or something, or ETFs, then that’s a digital asset that can be hacked or erased.
I know people who have a lot of their wealth in a brokerage account like Charles Schwab or Merrill Lynch or Goldman Sachs. They say, “I’m really wealthy, because I’ve got all these stocks and bonds.” I say, “Really, where are they?” They’ll show you an account statement. Maybe they get the account statement in the mail, but that’s probably online, too. I then say, “Well, that’s interesting. Look at all those nice assets here on the account statement. You realize it can all be wiped out and erased in a heartbeat. What do you really have?”
What they have is a bunch of digital representations of potential wealth in a rule-of-law society, but what if that’s erased? What if it’s hacked? What if the rule of law breaks down? What if governments freeze assets, etc.? Physical gold is the one thing that’s immune from all that. It’s not a reason to have 100% gold, but in my view it is a reason to have 10% gold, because it gives you some protection against that in addition to all the traditional reasons for gold.
It is interesting to meet with and talk to someone as experienced, plugged-in, and prominent as General Hayden who is in complete accord with me and others that financial warfare is the battlespace of the 21st century.
Jon: Before we turn to Alex here, there’s been a consistent vocal minority, of which you’re a part, predicting an imminent financial crisis. You’re not saying when it will happen, but you’ve said again and again that we’re in for a financial crisis even beyond the scale of 2008. I often hear people speaking rather dismissively of “the doomsday crowd.” You pointed out recently that some of the voices in this so-called doomsday crowd include the Bank for International Settlements, the IMF, and the G20. I wonder if you could elaborate on that a little bit?
Jim: Sure. You’re right, Jon. I do see a catastrophic collapse of the international monetary system. I don’t think it’s inevitable; I don’t think it has to happen. I just think it’s very likely that it will happen, because I don’t see any signs that the remedial or preventive steps are being taken.
I can give you four or five things that could be done tomorrow that would prevent it from happening including breaking up the banks, banning derivatives, or banning high-frequency trading. None of these things really serve any particular purpose other than to enrich the individuals who are behind them. They don’t do society any good, so getting rid of them would lead to a more stable system that would still serve everyday investors in terms of market liquidity and being able to trade stocks in secondary markets, etc., which was the original purpose of a stock market.
I think there are things that could be done to prevent it, but then as an analyst, you have to say, “Okay, is anyone doing those things? Is anyone taking those steps?” The answer is no. Therefore, I’m back to the other branch of the tree, and that is if we don’t have systemic reform, we will have systemic collapse. That’s very easy to see. When I say easy, I mean there are recursive functions, analysis, science, and other equations behind it, but it’s a pretty straightforward analysis.
As far as timing, you cannot call it to the day, the month, or the year. I think over a five-year horizon, it’s more likely than not; over a three-year horizon, still more likely than not. But it’s not the same as saying it would be next month or next week, although it could be. That’s the interesting thing about it. When I say it’s more likely than not in three years, I don’t rule out the fact that it could happen tomorrow. I’m not predicting tomorrow; I’m just saying that that’s part of the analysis.
Having said that, I do not consider myself a doom-and-gloomer; I do not consider myself part of the doomsday crowd. When this catastrophic collapse that I’m describing happens, it will not be the end of the world. We will not all be living in caves eating canned goods with our trigger fingers on machine guns. I don’t think that’s true at all. I think we’ll still be in our houses, we’ll still wake up, and life will go on, but it will be a different world financially.
We’ll see extreme responses. We’ll see an emergency summit conference of leaders not unlike the November 2008 G20 conference in Washington that George Bush and Nicolas Sarkozy put together on fairly short notice. We’ll see a reformation of the international monetary system, maybe in a venue something like Bretton Woods. I would like to see that happen today in a rational forward-leaning way before the collapse happens.
As mentioned earlier, I recently spoke to Ben Bernanke, former Chairman of the Federal Reserve. I also had a conversation with John Lipsky. John is a very fascinating individual and a great guy. He is the only American ever to head the IMF.
People who are familiar with the IMF say, “Wait a second, the IMF job is reserved for non-Americans by tradition.” It’s not a law as such, but when Bretton Woods was set up, there was a sort of handshake deal that the head of the World Bank would always be an American and the head of the IMF would always be non-American. That’s been true for all these years, and yet John Lipsky, an American, was briefly head of the IMF for only a few months.
It was after Dominique Strauss-Kahn was arrested on an airplane in JFK and faced some fairly scandalous charges. Normally, the IMF succession is very orderly, but that was a little disorderly. Dominique had to resign. John was the number two guy, Deputy Managing Director, so he became Acting Head for a short period of time until they could decide on Christine Lagard, who came in a few months later.
Having spoken to the former Chairman of the Fed and the former head of the IMF just a few weeks apart – one conversation in Korea, one in Washington – they both used the same word to describe the international monetary system. That word was “incoherent.” I don’t think they rehearsed that for my benefit; I think it’s just the word that comes to mind among the power elite as to what’s going on.
This is indicative of the state of affairs and points to what you were saying, Jon. If you were to ask me who really runs the world of finance or what are the most powerful establishment institutions in the world, you could have the Fed on that list in terms of the elites and look at the Bilderberg Conference (I’ve spoken to Bilderbergers about this), but the three most powerful multilateral institutions would be the Bank for International Settlements (BIS) in Basel, Switzerland, the International Monetary Fund (IMF) based in Washington, and the Group of 20 (G20), which is a floating crap game of developed economies and BRICs and some emerging markets that meet all over the world on a rotating basis.
All three of them have issued very dire warnings. It’s not just, “Oh, gee. We better slow down. We better do this or that.” It’s “No, we are looking at a highly unstable financial situation.” They practically threatened Janet Yellen. Christine Lagard gave her multiple warnings. The G20 finance ministers just met in Turkey and issued a warning. These are very blunt warnings.
When I see the power elite warning about global financial instability and the potential for collapse, not only does it confirm my own analysis, but it says to me that they’re trying to wash their hands of this. They’re saying, “We told you.” When it happens, they’ll be able to say, “Hey, don’t blame us. We told you this was coming.”
I hate to blame the victim, and I do sympathize with people who lose a large percentage of their net worth because they were all in the stock market and didn’t have some gold. However, when it happens, as much as one might sympathize with any investor who’s not prepared, there’s really no one to blame, because you have been warned.
Jon: Thanks, Jim. Here’s Alex Stanczyk with questions from our listeners.
Alex: Thanks, Jon. We have about five minutes left of our traditional time slot, but Jim has graciously agreed to give us a little bit longer. I want to thank all of our listeners and the people who sent in questions.
When we schedule these webinars, we receive questions over Twitter, some by e-mail, and we also get some coming in live while we’re doing the webinar. Let me give some quick guidance about submitting questions. Please refrain from asking questions having to do with legal advice, tax advice, and possibly some trading advice. Also, we’ve already answered a lot of questions that tend to come up over and over again. After doing this with Jim for almost two years now, we have a large archive of webinars available, so may I direct you to the Physical Gold Fund website where you can access a huge archive of various different webinars that answer a lot of the most frequently asked questions.
That said, we’re going to move on and go to the first question. This is a Twitter-based question coming from @awyee707 who asks, “How can the Fed cheapen the dollar without raising the price of gold?”
Jim: They probably can’t. I think if they cheapen the dollar, it will raise the price of gold. As I mentioned earlier, the dollar price of gold is just the reciprocal of the dollar. Strong dollar is lower price of gold; cheap dollar is higher price of gold. Now it’s not as simple as that or a perfect correlation, but it’s a strong correlation. The other driver, which we also talked about earlier, is real interest rates.
If you somehow had a cheap dollar in a world of high real interest rates, that’s a mixed bag. You’d have one force pulling gold down, which would be high real interest rates, and another force pushing gold up, which would be a cheaper dollar. That’s just back to this inflation/deflation tug of war I started talking about in 2011 in my first book, Currency Wars, and hasn’t gone away. That dynamic is still in place.
The bottom line is, “How do you get to a cheap dollar?” You can’t just wave a wand and say ‘cheap dollar.’ You actually have to do something. That would probably mean a stronger euro, a stronger yen, a cheaper dollar. We’d start to import inflation into the United States in the form of higher import prices. That, in theory, would feed through the supply chain and get a little bit of inflation going. Remember the equation of nominal rates minus inflation equal real rates. With higher inflation, real rates are going to come down, and that’s good for gold. If the Fed does try to engineer that, that’s very bullish for gold.
Alex: The next question is coming from [@juhaem]: “Is there some kind of big problem with helicopter money? Why haven’t the Central Banks used it if they really want inflation?” I think what our questioner is referring to is money that’s given directly to people.
Jim: They haven’t, but they may yet. A couple of days ago, the President of the Federal Reserve Bank of Minneapolis, Narayana Kocherlakota, gave an interesting speech where he talked about this. But here’s the problem. To do helicopter money, you need cooperation between the Congress, the White House, the Treasury, and the Federal Reserve. They all have to be involved.
The notion is you print up a bunch of dollar bills, rent some helicopters, fly around, push the bills out of the helicopters, and everyone scoops them up. It’s an interesting metaphor, but that’s not actually how it works. The way it’s done is by Congress voting larger deficits to spend money. Where would that money come from? The Treasury would borrow it. How would the Treasury finance the borrowing? The Fed would print money and buy the bonds.
The handoff goes from the Congress in terms of voting on spending, then the President has to sign the bill, then the Treasury has to finance the deficit, and then the Fed has to print the money and buy the bonds. They all have to work together.
At the end of the day, the Fed is still printing money. When they print money in QE, they buy existing secondary market bonds from the banks and credit the banks’ accounts with dollars that come out of thin air. But where does the money go? It goes to the banks.
The problem is it’s just been sitting there. Banks take the money and redeposit it with the Fed in the form of excess reserves, and then the money just sits there. Banks don’t lend it, people don’t want to borrow it, nobody is spending it, velocity is down. You can print all the money you want, but if it’s not getting lent and spent and there’s no velocity, that doesn’t do anything for inflation or nominal GDP.
The difference with helicopter money is you bypass the banks, disintermediate the banking system, and give the money directly to people. When I say people, if the Congress votes an infrastructure project, that money is going to go to construction workers and owners of construction companies. If the Congress votes some new benefit, that money is going to go right to the people who participate in that particular welfare or benefit program. Those are the people who get the money. The point is, you’re not relying on the banking system.
It’s theoretically possible, and if they get desperate enough, they’ll try to make it happen. You might not see that until 2017 because you’re probably going to have to have the same party – Democrat or Republican – running the White House and the Congress to make it happen. Republicans and Democrats are barely talking to each other, so it’s hard to see how they could actually pull this off, but 2016 is an election year. There’s nothing Congress doesn’t like about more spending in an election year, so maybe it will happen after all. That’s how it works and that’s what you have to watch for.
Alex: This topic comes back around to the whole idea of the Fed being able to push the economy in the first place. As you said a little while ago, the Fed follows the economy; it doesn’t lead the economy. Looking at what the Fed’s tried to do ever since 2008 and even before, it doesn’t seem like anything they’ve done really has any kind of effect.
What we’re probably looking at here, if I remember correctly from things you’ve said before, is that in order to get real inflation, we’re going to have to have some kind of sentiment or shift in the psychology before something like that happens.
Jim: That’s right, and it’s not easy to do. It took the worst recession and the worst financial panic since the Great Depression to shift people from spending to not spending. What’s it going to take to get them to shift back again into spending? I don’t see that happening anytime soon.
Alex: We have time for one other question coming from Steve M. who asks, “With Europe continuing to slow, do you see Draghi increasing euro QE into the end of the year?
Jim: Draghi is my favorite Central Banker, because he’s the only one who really understands central banking as far as I can tell. He understands that Central Bankers actually have very little power, so you have to talk a good game. If you talk a good game and put on a brave face, people actually believe you.
Go back to June of 2012 during one of the periodic sovereign debt crises. Greece has been in continual crisis from 2010 into 2015, but some periods are worse than others. The summer of 2012 was one of those acute periods, and Draghi said, “I will do whatever it takes to defend the euro, and believe me, it will be enough.” That phrase, “Whatever it takes,” I thought was a little bit of bravado, but he meant it. I think Draghi will do whatever it takes.
The euro seems to have stabilized. As I’ve said, I don’t see any real chance that the euro is going to fall apart. I have been pretty much laughed at for years about that, but it’s working out that way. If you go to Athens tomorrow, you’re going to spend euros. They’re not out of the euro, nor will they be.
Europe is doing okay for the time being, but remember the reason they’re doing okay is because of the currency wars. The euro got cheap. It went from $1.60 to $1.40 to $1.20, and in February of 2015, it was $1.05. At that time, everyone said it’s going to par but I said, “No, this is the bottom.” It’s come back up a little bit. I see it getting stronger next year, but the euro has held together, and that’s what has given Europe a lift.
The Irish economy is doing very well, and the Spanish economy is doing very well. Sure, there are pockets like Greece and Eastern Europe – and even France, for that matter – that are not doing that well. Germany is probably going to decelerate a little bit because of the slowdown in China and the fact that they have such a large trading relationship with China. It’s a mixed bag, but on the whole, Europe is a little bit of a bright spot because the euro got cheap.
The interesting part is that the U.S. engineered a weaker euro and stronger dollar to help Europe in the belief that the U.S. economy was strong enough to bear a strong currency. That was a blunder. It turns out that the U.S. economy was not strong enough to bear a strong currency. We got the strong currency but we’re flirting with a recession.
At what point does the U.S. wake up and say, “You know what, the strong dollar thing is not working for us. We need a weaker dollar like we had in 2011 to keep the game going. Hey Europe, you know what that means: we get a weaker dollar, you get a stronger euro.” If that happens, Draghi may actually do more QE or maybe even deeper negative interest rates just to give Europe a little bit of a lifeline.
The problem with currency wars is not only are they not a positive sum game, they’re not even a zero sum game. Cross rates are a zero sum game, but currency wars are probably a negative sum game because of the uncertainty that gets introduced into the global capital flows and the global trading system.
Again, I think Europe is a bright spot for now. I doubt that’s going to change in the near term. I suspect the Fed will continue to blunder in their forecasting ability by thinking that the U.S. economy is stronger than it actually is, by continuing to talk tough, by talking about the October surprise to keep a strong dollar, and believe somehow that’s all going to work.
By late this year or early next year, I believe even the Fed will see reality. At that point, you may see the beginning of a weak dollar policy and a stronger euro. Draghi is just going to have to go along with that. At the end of the day, the Fed has Europe under its sway because of the importance of the dollar/euro swap alliance between the central banks to prop up the European banking system. It’s all connected in interesting ways that will play out.
Alex: That sounds like possibly the beginning of the next round of salvo in the currency wars, which may continue until we see that psychology shift. Thanks, Jim.
Jim: Thank you, Alex.
Alex: With that, we’re going to hand it back to Jon.
Jon: Thank you, Alex. Let me just briefly remind our listeners that you can follow Alex Stanczyk on Twitter. Go to Twitter and type in @alexstanczyk for great insights and very valuable links to follow there.
Thank you, Jim Rickards. It’s always a pleasure and an education having you with us.
Jim: Thanks Jon.
Jon: Most of all, thank you to our listeners for spending time with us today. You may 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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