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Paper Gold vs the Dollar? Interview with James Rickards
July 7, 2010
On June 25, 2010, Bob Sechler of Dow Jones News Wire came out with a story, "BANK BILL:GE Capital: Financial Bill 'Supports' Combo With GE," that basically said that the GE Capital unit of General Electric (GE) had no problems with the financial reform legislation, now styled as the "Dodd-Frank Wall Street Reform and Consumer Protection Act incidentally.
" We beg to differ. This week in the IRA Advisory Service, we look at the implications of the impending Dodd-Frank regulatory fiasco. This legislation represents a huge increase in regulation on GE as well as two dozen other grandfathered thrift holding companies. We provide our subscribers with a detailed analysis of the points of contention in the likely regulatory regime and a list of the companies that are affected. Contact us for more information.
This week in the Institutional Risk Analyst, we talk to James Rickards (twitter.com/JamesGRickards) about the dollar and the outlook for the U.S. currency in the global economy. Jim is Senior Managing Director for Market Intelligence at Omnis, Inc., a technical, professional and scientific consulting firm located in McLean, VA. Mr. Rickards' career spans the period since 1976 during which he was a first hand participant in the formation and growth of globalized capital markets and complex derivative trading strategies. He has held senior executive positions at sell side firms (Citibank and RBS Greenwich Capital Markets) and buy side firms (Long-Term Capital Management and Caxton Associates) as well as technology firms (OptiMark and Omnis). We met Jim at the hearing on financial models held before the House Subcommittee on Investigations and Oversight on September 10, 2009.
The IRA: Thank you for taking the time to talk with us. We previewed this interview yesterday on CNBC in a discussion with Ian Bremmer of Eurasia Group and Nouriel Roubini. We wanted to talk to you today about the global economy and the dollar. You may have seen our reference last week ("Country Risk: The World According to Robert Rubin (Updated)", June 29, 2010) to the new borrowing rights that the International Monetary Fund has created at the behest of the inflationist tendency in the White House.
Rickards: My day job is working with funds and banks, but by night I focus on the geopolitical implications of the global macroeconomic outlook. The intersection of finance and geopolitics is a place that far too few analysts feel comfortable. The people who can speak to a three-star general about asymmetrical warfare and then turn around and speak to a swap counterparty about collateral issues are few and far between. At Omnis we are finding more and more call for just this type of expertise. When credit default swaps are taking down Greece and you realize that Greece is a NATO ally, the reason for interest in financials by the security community is obvious.
The IRA: As we have said before, we note an increased interest in financial markets by members of the security community. If you go through the contract awards for SEC and the bank regulatory agencies you will see some names that are most often seen in the defense community.
Rickards: There are actually two flows at the moment. The capital markets have a voracious appetite for geopolitical insights involving, for example, Iran and Israel with obvious implications for oil prices. At the same time the national security community needs to understand capital markets because the security of nations is being undermined by fiscal policies and credit default swaps as we've seen in Greece. My firm is comfortable processing information in both directions; helping the national security community understand markets and helping capital markets participants understand geopolitics.
The IRA: Using techniques tuned to predict security events can also help with screening incoming tips for a regulatory hotline, for example. But many of the "issues" facing regulators in better attacking problems in the financial markets involve process issues, not decision about the desired result. When our political class becomes so dissolute that their behavior threatens national security, it raises some issues that Americans are not used to dealing with.
Rickards: Agreed. To give you a sense of how much interest there is in financial matters in the national security community, I recently headed a panel at a program sponsored by the Johns Hopkins Applied Physics Laboratory, one of the premier private research centers in the U.S. for developing everything from new weapons to nuclear strategy. The topic of my paper was a hypothetical press release issued by the Russian central bank announcing the creation of a new, gold-back currency. In the hypothetical, the Russians also announce that exports of energy and other natural resources will have to be made in this new "gold ruble." The Russians would become a market maker in gold and effectively control the marginal price of gold transactions. This is basically a plan for taking down the dollar.
The IRA: It is an entirely plausible scenario. The Russians could establish a "gold" price for oil and then the paper currencies would trade at a discount. Thanks to the lack of leadership in Washington by either party, the U.S. is quite vulnerable to the creation of a gold-backed or commodity-backed currency. This August is the 40th anniversary of the decision in 1971 by President Richard Nixon, aided and abetted by a Treasury official named Paul Volcker and Fed Chairman Arthur Burns, to break the link between the dollar and gold. The excuse then was justified based on the short-term need for growth and inflation. As a senior Fed official told us, look at the period since the 1990s. Count how many quarters we have not had either fiscal stimulus or accommodative interest rates by the Fed to maintain the illusion of growth.
Rickards: Precisely. But what is interesting is that a couple of days ago, we saw the arrest of this seemingly hapless Russian spy gang. These people were a relic of the Cold War, running around Montclair, New Jersey, and meeting in New York coffee shops. But the one little tidbit that came out of the complaint filed by prosecutors is that the one subject that got a lot of reaction from Moscow was gold. Whatever these people were collecting for the Russians, the information about gold was of great interest. Often times in intelligence you care less about what the field agents are collecting than who is asking and why they are asking. The paper I did is getting written up all over the web. But the fact that the information on gold touched a nerve in Moscow confirms my view about their intentions toward the dollar.
The IRA: Well it is so obvious. We interviewed David Kotok of Cumberland Advisers last month, some of which will appear in Chris Whalen's upcoming book. Kotok just published a bullish book on Europe, Invest in Europe Now, and Kotok is even more bullish today. As he puts it, the Greeks gave the Germans a 20% currency devaluation. Kotok thinks that the crisis in Europe will eventually force the EU to fully integrate. But we speak to insiders with precisely the opposite view, who say the Europeans do not have a grip on the financial problems. Does the EU emerge stronger from the crisis?
Rickards: I agree with the view that says the EU gets stronger. I keep reminding people that the European Central Bank and the 16 members of the monetary system have over 10,000 tons of gold. They have more gold that the U.S. Treasury. We have just over 8,100 tons ourselves. If the EU were to go to even a partial reserve coverage with gold, say 20% backing, it would put Europe at an enormous advantage. They have enough gold today to set a target and make a two-way market in gold. I think that the first major currency bloc that goes to gold will dominate the financial world because it will become the only currency anybody will want. The first mover will force the other nations to follow.
The IRA: This is the idiocy of the U.S. position. We have set ourselves up as an easy target for our enemies. It is astounding that the Chinese have not been more aggressive in selling dollars. Maybe they are going to manage our downfall gently.
Rickards: I think the Chinese probably are doing it gently. The Japanese and Chinese are both influenced by Zen which, in Western jargon, is really about optionality. The whole idea of Zen is to avoid black and white decisions and instead create a range of options and possible outcomes. Instead of committing yourself to a binary decision, you create a fan of probabilities and look for your openings. So in that sense, if you think of it in options space, the Chinese are probably content to play the American paper game with the dollar, but all the while preparing for the day when the dollar collapses completely.
The IRA: Americans are convinced that it cannot happen here, the greatest nation on earth. Reminds us of France after WWI. Same degree of self-delusion. And no reaction by U.S. officials to the Chinese and Russia gold purchases?
Rickards: The Russians do not hide their purchases of gold. The incremental growth of Russian gold reserves is visible in their monthly statistics. The Chinese have been more surreptitious in their purchases but even they have announced the reserves doubled in recent years. The way that both of these nations add to gold without impacting the global price is that they are buying from internal, captive producers. And they pay below market prices because even paying $800 per ounce still gives their miners a tremendous profit. Between 2004 and 2008, China almost doubled the gold stocks of Peoples Bank of China, but they bought it through other state agencies to keep it off their books.
The IRA: So there is the pretense of coordination among the G-20, but meanwhile China is preparing to operate in a hard currency world. Is this a good way to describe your view?
Rickards: We have been operating in a dollar world for decades. Notwithstanding the demise of Bretton Woods in 1971, it's still a dollar system. All of the world's expectations, all of its productive capacity, all of its allocations of capital are built around that system. When the caretakers of that system allow weeds in the garden and for the system to disintegrate and fall apart, which is what I see happening in the U.S., the immediate reaction is first confusion, then panic and then self help. This gets to the heart of the national security implications of the financial crisis. Initially other nations were content to wait for the U.S. response, but now I see nations like China, Russia and Germany increasingly willing to act on their own.
The IRA: The euro was up to 25% of global flows prior to the crisis. You could price oil in Euros. It's a big enough currency to be the unit of account and means of exchange for global energy.
Rickards: The trend in the amount of global trade priced in dollars has been going down for decades. This brings us today to the key question, which is what is the U.S. plan? Fed Chairman Bernanke wakes up every morning and tries to trash the dollar with quantitative easing, zero interest rates and swaps lines with the central banks. But it has not been working. The Fed has never taken it to the next step and asked what happens when quantitative easing does not work.
The IRA: The folks at the Fed have been talking about it. Read Vince Reinhart's FOMC briefing materials from October 2003. We also got some great stuff with Kotok on the 2001-2003 period that will appear in the book. But to your point, the problem since 2001 has been deflation. As we said above, since the 1990s the U.S. economy has been on one form of stimulus or another. The same political class who want to pretend that the economy is growing will never embrace gold because it implies a deceleration of the economy that could cut points off of GDP around the world. And as we have said before, the Fed's low rate policy is driving deflation, both by coloring perceptions and slowly destroying the income from fixed income assets.
Rickards: We are taught that Money Supply * Velocity = Real GDP * Inflation. The equation is what it is. But what the Fed always assumed was that velocity would remain constant and use the other variables for policy. Then the only question was what the inflation component would be. But velocity is not constant. And if velocity declines faster than the Fed can print money, then GDP will decline with it. Deflation is the dominant trend in my view but we could have a burst of hyperinflation on the path to deflation if the Fed is unwilling to accept the inevitable consequences of the easy money and asset price bubbles of 1998 to 2007.
The IRA: The issue of velocity makes you wonder what part of the Depression many economists studied. Everyone in Washington is so surprised to see the Europeans retrenching instead of spending more on stimulus. Being conservative in times of economic stress is the normal human reaction, a reaction that is not transcended by Keynesian economics, especially when the markets will not allow you to borrow. This is no longer about ideology but reflects the weight of accumulated debt and the public perception of future income vs. today's debt load.
Rickards: I very quickly reach the point where this is no longer about left or right, it's about the mathematics of compounding and the dynamics of complex systems. The Europeans get that point. We went from Dubai to Greece very quickly. The contagion effect was visible. You could not push Greece off the bus without unwinding the entire EU and the Europeans do not want to see that happen. You start with the Thirty Years War and work your way through Napolean, WWI and WWII. You have centuries of war and destruction in Europe. The Europeans arrived in the middle of the 20th Century and decided that they needed to come together to avoid another war. The monetary side has been a success, but political and diplomatic integration not so much to date. But the EU is the shinning success for Europe after centuries of war and holocaust and annihilation. They are not going to let it go.
The IRA: So here is the question: if the U.S. has its head buried in the sand, who is the leader of the global currency system going forward?
Rickards: Well, the leader of the process is not clear. This gets back to a whole series of very revealing interviews given by Treasury Secretary Timothy Geithner in the late 1990s that we have to dig out. He embraces something that he calls "convening power," I call it "a bunch of guys." Geithner's world view essentially consists of getting the finance ministers or heads of state in a room, developing an agenda, and then pursuing that process wherever it takes you. I think the US has embraced multilateralism within the G-20 as an alternative to U.S. leadership. I think we look at the G-20 differently than does China, Russia, Brazil and some others. The U.S. looks at the G-20 as a kind of benign, kumbaya, kind of global board of directors that working with the IMF can bring the world in for a soft landing. I don't think the Chinese or the Russians see it that way. They see the G-20 as an interesting tool but from a state-centric view.
The IRA: Geithner's strategy, if you can call it that, reminds us of the shallow management pretense visible in many Wall Street firms. The Chinese and Russians see themselves in the ascendancy and, unlike the U.S., these nations have a vision of where they want to be a century from now. Americans just want to borrow more money.
Rickards: Correct. The U.S. exit strategy, as seen from Washington, involves special drawing rights (SDRs) issued by the IMF. This brings up Triffin's Dilemma, which says that the world needs a global liquidity pump. If there is not one leading country willing to run deficits, then global trade grinds to a halt. The only problem, thus the dilemma, is that the deficit nation goes broke.
The IRA: That would be us. The conventional view has always been that the other nations of the world, seeing their currencies rise in value as the U.S. defaults on its debt via inflation, would eventually inflate their own money to maintain some type of parity for trade purposes. What happens when the U.S. embraces quantitative easing as part of normal policy and begins to explicitly monetize the federal deficit?
Rickards: Well we are not there yet. Where the Treasury would like to lead us to is the SDR. Two important things happened in 2009. For the first time in history, the IMF leveraged its balance sheet. In the past, the IMF quota system was essentially equity. The IMF has issued over $500 billion worth of debt denominated in SDRs. The greater use of and acceptance of the SDR is step one and solves Triffin's dilemma. Then step two, as China rises, we can dial up the value of the SDR by including the yuan. Remember that the SDR is rebalanced every five years and the yuan is not currently reflected.
The IRA: So if you add the Chinese yuan to the SDR, you devalue the dollar?
Rickards: Yes. The dollar buys fewer SDRs. This not only solves Triffin's dilemma but also addresses beggar thy neighbor. We are not going to walk around with SDRs in our pockets, but this is how we balance global capital accounts and rebalance deficit and surplus countries in the trading system. You create a new asset against which you can devalue. But you also create a new asset which you can print without accountability to any democratic process. Nobody elects the G20 or the IMF.
The IRA: It turns the IMF into a global clearing house and central bank. In the post WWII period, the global ledger was dollars and gold on one side as reserve assets and the other currencies on the other. Now we are putting the dollar with everyone else. Does this arrangement result in fiscal discipline in Washington?
Rickards: No, I think it just kicks the game upstairs and down the road. China was a big buyer of these SDR bonds. They diversified with minimal market impact. The IMF took in dollars for their SDR notes and lent the dollars to Hungary, Iceland, etc. Thus the IMF not only levered their balance sheet, but they also created over a hundred billion in new SDRs. The IMF essentially printed money and they spread them all over the world to all of the member nations. I see this as testing the plumbing. Now the IMF is on standby. The next time we are in the situation that existed in 2008, you won't see another $1 trillion stimulus package because we cannot afford it. Instead you'll see a trillion SDRs going out the door suddenly. Remember, when they were first created in the 1970s SDRs were called "paper gold."
The IRA: Global quantitative easing? So the old problem remains, namely supporting global growth. So here is the question going back to the EU: If you are Poland or the Czech Republic, do you align with NATO and the Europeans or cut a deal with Moscow? Does this SDR-based exit fantasy of Robert Rubin and Tim Geithner exist alongside the resurgent Euro?
Rickards: I think you already see in formation a German-Russian axis. Merkel and Medvedev have been very active in their discussion. I can't think of two economies in the world that are better matched than Germany and Russia. The former is an export technological powerhouse, Russia is a commodity producer and importer of technology. Russia has a credibility problem, but combined with the EU they would become the new alternative to the dollar.
The IRA: We'll be watching. Thanks Jim.
http://us1.institutionalriskanalytic...ub/IRAMain.asp
July 7, 2010
On June 25, 2010, Bob Sechler of Dow Jones News Wire came out with a story, "BANK BILL:GE Capital: Financial Bill 'Supports' Combo With GE," that basically said that the GE Capital unit of General Electric (GE) had no problems with the financial reform legislation, now styled as the "Dodd-Frank Wall Street Reform and Consumer Protection Act incidentally.
" We beg to differ. This week in the IRA Advisory Service, we look at the implications of the impending Dodd-Frank regulatory fiasco. This legislation represents a huge increase in regulation on GE as well as two dozen other grandfathered thrift holding companies. We provide our subscribers with a detailed analysis of the points of contention in the likely regulatory regime and a list of the companies that are affected. Contact us for more information.
This week in the Institutional Risk Analyst, we talk to James Rickards (twitter.com/JamesGRickards) about the dollar and the outlook for the U.S. currency in the global economy. Jim is Senior Managing Director for Market Intelligence at Omnis, Inc., a technical, professional and scientific consulting firm located in McLean, VA. Mr. Rickards' career spans the period since 1976 during which he was a first hand participant in the formation and growth of globalized capital markets and complex derivative trading strategies. He has held senior executive positions at sell side firms (Citibank and RBS Greenwich Capital Markets) and buy side firms (Long-Term Capital Management and Caxton Associates) as well as technology firms (OptiMark and Omnis). We met Jim at the hearing on financial models held before the House Subcommittee on Investigations and Oversight on September 10, 2009.
The IRA: Thank you for taking the time to talk with us. We previewed this interview yesterday on CNBC in a discussion with Ian Bremmer of Eurasia Group and Nouriel Roubini. We wanted to talk to you today about the global economy and the dollar. You may have seen our reference last week ("Country Risk: The World According to Robert Rubin (Updated)", June 29, 2010) to the new borrowing rights that the International Monetary Fund has created at the behest of the inflationist tendency in the White House.
Rickards: My day job is working with funds and banks, but by night I focus on the geopolitical implications of the global macroeconomic outlook. The intersection of finance and geopolitics is a place that far too few analysts feel comfortable. The people who can speak to a three-star general about asymmetrical warfare and then turn around and speak to a swap counterparty about collateral issues are few and far between. At Omnis we are finding more and more call for just this type of expertise. When credit default swaps are taking down Greece and you realize that Greece is a NATO ally, the reason for interest in financials by the security community is obvious.
The IRA: As we have said before, we note an increased interest in financial markets by members of the security community. If you go through the contract awards for SEC and the bank regulatory agencies you will see some names that are most often seen in the defense community.
Rickards: There are actually two flows at the moment. The capital markets have a voracious appetite for geopolitical insights involving, for example, Iran and Israel with obvious implications for oil prices. At the same time the national security community needs to understand capital markets because the security of nations is being undermined by fiscal policies and credit default swaps as we've seen in Greece. My firm is comfortable processing information in both directions; helping the national security community understand markets and helping capital markets participants understand geopolitics.
The IRA: Using techniques tuned to predict security events can also help with screening incoming tips for a regulatory hotline, for example. But many of the "issues" facing regulators in better attacking problems in the financial markets involve process issues, not decision about the desired result. When our political class becomes so dissolute that their behavior threatens national security, it raises some issues that Americans are not used to dealing with.
Rickards: Agreed. To give you a sense of how much interest there is in financial matters in the national security community, I recently headed a panel at a program sponsored by the Johns Hopkins Applied Physics Laboratory, one of the premier private research centers in the U.S. for developing everything from new weapons to nuclear strategy. The topic of my paper was a hypothetical press release issued by the Russian central bank announcing the creation of a new, gold-back currency. In the hypothetical, the Russians also announce that exports of energy and other natural resources will have to be made in this new "gold ruble." The Russians would become a market maker in gold and effectively control the marginal price of gold transactions. This is basically a plan for taking down the dollar.
The IRA: It is an entirely plausible scenario. The Russians could establish a "gold" price for oil and then the paper currencies would trade at a discount. Thanks to the lack of leadership in Washington by either party, the U.S. is quite vulnerable to the creation of a gold-backed or commodity-backed currency. This August is the 40th anniversary of the decision in 1971 by President Richard Nixon, aided and abetted by a Treasury official named Paul Volcker and Fed Chairman Arthur Burns, to break the link between the dollar and gold. The excuse then was justified based on the short-term need for growth and inflation. As a senior Fed official told us, look at the period since the 1990s. Count how many quarters we have not had either fiscal stimulus or accommodative interest rates by the Fed to maintain the illusion of growth.
Rickards: Precisely. But what is interesting is that a couple of days ago, we saw the arrest of this seemingly hapless Russian spy gang. These people were a relic of the Cold War, running around Montclair, New Jersey, and meeting in New York coffee shops. But the one little tidbit that came out of the complaint filed by prosecutors is that the one subject that got a lot of reaction from Moscow was gold. Whatever these people were collecting for the Russians, the information about gold was of great interest. Often times in intelligence you care less about what the field agents are collecting than who is asking and why they are asking. The paper I did is getting written up all over the web. But the fact that the information on gold touched a nerve in Moscow confirms my view about their intentions toward the dollar.
The IRA: Well it is so obvious. We interviewed David Kotok of Cumberland Advisers last month, some of which will appear in Chris Whalen's upcoming book. Kotok just published a bullish book on Europe, Invest in Europe Now, and Kotok is even more bullish today. As he puts it, the Greeks gave the Germans a 20% currency devaluation. Kotok thinks that the crisis in Europe will eventually force the EU to fully integrate. But we speak to insiders with precisely the opposite view, who say the Europeans do not have a grip on the financial problems. Does the EU emerge stronger from the crisis?
Rickards: I agree with the view that says the EU gets stronger. I keep reminding people that the European Central Bank and the 16 members of the monetary system have over 10,000 tons of gold. They have more gold that the U.S. Treasury. We have just over 8,100 tons ourselves. If the EU were to go to even a partial reserve coverage with gold, say 20% backing, it would put Europe at an enormous advantage. They have enough gold today to set a target and make a two-way market in gold. I think that the first major currency bloc that goes to gold will dominate the financial world because it will become the only currency anybody will want. The first mover will force the other nations to follow.
The IRA: This is the idiocy of the U.S. position. We have set ourselves up as an easy target for our enemies. It is astounding that the Chinese have not been more aggressive in selling dollars. Maybe they are going to manage our downfall gently.
Rickards: I think the Chinese probably are doing it gently. The Japanese and Chinese are both influenced by Zen which, in Western jargon, is really about optionality. The whole idea of Zen is to avoid black and white decisions and instead create a range of options and possible outcomes. Instead of committing yourself to a binary decision, you create a fan of probabilities and look for your openings. So in that sense, if you think of it in options space, the Chinese are probably content to play the American paper game with the dollar, but all the while preparing for the day when the dollar collapses completely.
The IRA: Americans are convinced that it cannot happen here, the greatest nation on earth. Reminds us of France after WWI. Same degree of self-delusion. And no reaction by U.S. officials to the Chinese and Russia gold purchases?
Rickards: The Russians do not hide their purchases of gold. The incremental growth of Russian gold reserves is visible in their monthly statistics. The Chinese have been more surreptitious in their purchases but even they have announced the reserves doubled in recent years. The way that both of these nations add to gold without impacting the global price is that they are buying from internal, captive producers. And they pay below market prices because even paying $800 per ounce still gives their miners a tremendous profit. Between 2004 and 2008, China almost doubled the gold stocks of Peoples Bank of China, but they bought it through other state agencies to keep it off their books.
The IRA: So there is the pretense of coordination among the G-20, but meanwhile China is preparing to operate in a hard currency world. Is this a good way to describe your view?
Rickards: We have been operating in a dollar world for decades. Notwithstanding the demise of Bretton Woods in 1971, it's still a dollar system. All of the world's expectations, all of its productive capacity, all of its allocations of capital are built around that system. When the caretakers of that system allow weeds in the garden and for the system to disintegrate and fall apart, which is what I see happening in the U.S., the immediate reaction is first confusion, then panic and then self help. This gets to the heart of the national security implications of the financial crisis. Initially other nations were content to wait for the U.S. response, but now I see nations like China, Russia and Germany increasingly willing to act on their own.
The IRA: The euro was up to 25% of global flows prior to the crisis. You could price oil in Euros. It's a big enough currency to be the unit of account and means of exchange for global energy.
Rickards: The trend in the amount of global trade priced in dollars has been going down for decades. This brings us today to the key question, which is what is the U.S. plan? Fed Chairman Bernanke wakes up every morning and tries to trash the dollar with quantitative easing, zero interest rates and swaps lines with the central banks. But it has not been working. The Fed has never taken it to the next step and asked what happens when quantitative easing does not work.
The IRA: The folks at the Fed have been talking about it. Read Vince Reinhart's FOMC briefing materials from October 2003. We also got some great stuff with Kotok on the 2001-2003 period that will appear in the book. But to your point, the problem since 2001 has been deflation. As we said above, since the 1990s the U.S. economy has been on one form of stimulus or another. The same political class who want to pretend that the economy is growing will never embrace gold because it implies a deceleration of the economy that could cut points off of GDP around the world. And as we have said before, the Fed's low rate policy is driving deflation, both by coloring perceptions and slowly destroying the income from fixed income assets.
Rickards: We are taught that Money Supply * Velocity = Real GDP * Inflation. The equation is what it is. But what the Fed always assumed was that velocity would remain constant and use the other variables for policy. Then the only question was what the inflation component would be. But velocity is not constant. And if velocity declines faster than the Fed can print money, then GDP will decline with it. Deflation is the dominant trend in my view but we could have a burst of hyperinflation on the path to deflation if the Fed is unwilling to accept the inevitable consequences of the easy money and asset price bubbles of 1998 to 2007.
The IRA: The issue of velocity makes you wonder what part of the Depression many economists studied. Everyone in Washington is so surprised to see the Europeans retrenching instead of spending more on stimulus. Being conservative in times of economic stress is the normal human reaction, a reaction that is not transcended by Keynesian economics, especially when the markets will not allow you to borrow. This is no longer about ideology but reflects the weight of accumulated debt and the public perception of future income vs. today's debt load.
Rickards: I very quickly reach the point where this is no longer about left or right, it's about the mathematics of compounding and the dynamics of complex systems. The Europeans get that point. We went from Dubai to Greece very quickly. The contagion effect was visible. You could not push Greece off the bus without unwinding the entire EU and the Europeans do not want to see that happen. You start with the Thirty Years War and work your way through Napolean, WWI and WWII. You have centuries of war and destruction in Europe. The Europeans arrived in the middle of the 20th Century and decided that they needed to come together to avoid another war. The monetary side has been a success, but political and diplomatic integration not so much to date. But the EU is the shinning success for Europe after centuries of war and holocaust and annihilation. They are not going to let it go.
The IRA: So here is the question: if the U.S. has its head buried in the sand, who is the leader of the global currency system going forward?
Rickards: Well, the leader of the process is not clear. This gets back to a whole series of very revealing interviews given by Treasury Secretary Timothy Geithner in the late 1990s that we have to dig out. He embraces something that he calls "convening power," I call it "a bunch of guys." Geithner's world view essentially consists of getting the finance ministers or heads of state in a room, developing an agenda, and then pursuing that process wherever it takes you. I think the US has embraced multilateralism within the G-20 as an alternative to U.S. leadership. I think we look at the G-20 differently than does China, Russia, Brazil and some others. The U.S. looks at the G-20 as a kind of benign, kumbaya, kind of global board of directors that working with the IMF can bring the world in for a soft landing. I don't think the Chinese or the Russians see it that way. They see the G-20 as an interesting tool but from a state-centric view.
The IRA: Geithner's strategy, if you can call it that, reminds us of the shallow management pretense visible in many Wall Street firms. The Chinese and Russians see themselves in the ascendancy and, unlike the U.S., these nations have a vision of where they want to be a century from now. Americans just want to borrow more money.
Rickards: Correct. The U.S. exit strategy, as seen from Washington, involves special drawing rights (SDRs) issued by the IMF. This brings up Triffin's Dilemma, which says that the world needs a global liquidity pump. If there is not one leading country willing to run deficits, then global trade grinds to a halt. The only problem, thus the dilemma, is that the deficit nation goes broke.
The IRA: That would be us. The conventional view has always been that the other nations of the world, seeing their currencies rise in value as the U.S. defaults on its debt via inflation, would eventually inflate their own money to maintain some type of parity for trade purposes. What happens when the U.S. embraces quantitative easing as part of normal policy and begins to explicitly monetize the federal deficit?
Rickards: Well we are not there yet. Where the Treasury would like to lead us to is the SDR. Two important things happened in 2009. For the first time in history, the IMF leveraged its balance sheet. In the past, the IMF quota system was essentially equity. The IMF has issued over $500 billion worth of debt denominated in SDRs. The greater use of and acceptance of the SDR is step one and solves Triffin's dilemma. Then step two, as China rises, we can dial up the value of the SDR by including the yuan. Remember that the SDR is rebalanced every five years and the yuan is not currently reflected.
The IRA: So if you add the Chinese yuan to the SDR, you devalue the dollar?
Rickards: Yes. The dollar buys fewer SDRs. This not only solves Triffin's dilemma but also addresses beggar thy neighbor. We are not going to walk around with SDRs in our pockets, but this is how we balance global capital accounts and rebalance deficit and surplus countries in the trading system. You create a new asset against which you can devalue. But you also create a new asset which you can print without accountability to any democratic process. Nobody elects the G20 or the IMF.
The IRA: It turns the IMF into a global clearing house and central bank. In the post WWII period, the global ledger was dollars and gold on one side as reserve assets and the other currencies on the other. Now we are putting the dollar with everyone else. Does this arrangement result in fiscal discipline in Washington?
Rickards: No, I think it just kicks the game upstairs and down the road. China was a big buyer of these SDR bonds. They diversified with minimal market impact. The IMF took in dollars for their SDR notes and lent the dollars to Hungary, Iceland, etc. Thus the IMF not only levered their balance sheet, but they also created over a hundred billion in new SDRs. The IMF essentially printed money and they spread them all over the world to all of the member nations. I see this as testing the plumbing. Now the IMF is on standby. The next time we are in the situation that existed in 2008, you won't see another $1 trillion stimulus package because we cannot afford it. Instead you'll see a trillion SDRs going out the door suddenly. Remember, when they were first created in the 1970s SDRs were called "paper gold."
The IRA: Global quantitative easing? So the old problem remains, namely supporting global growth. So here is the question going back to the EU: If you are Poland or the Czech Republic, do you align with NATO and the Europeans or cut a deal with Moscow? Does this SDR-based exit fantasy of Robert Rubin and Tim Geithner exist alongside the resurgent Euro?
Rickards: I think you already see in formation a German-Russian axis. Merkel and Medvedev have been very active in their discussion. I can't think of two economies in the world that are better matched than Germany and Russia. The former is an export technological powerhouse, Russia is a commodity producer and importer of technology. Russia has a credibility problem, but combined with the EU they would become the new alternative to the dollar.
The IRA: We'll be watching. Thanks Jim.
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