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Transcript: Jim Rickards on Currency Wars

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In this transcript, taken from September's Mises Weekends interview, Jim Rickards explores our current global currency wars, the rise of other global currencies, and the end games being explored by central banks today:

Jeff Deist: Jim, it appears that your long ago prediction that the Fed would continue suppressing rates this fall is correct and now we even have Christine Lagarde at the IMF, in effect, almost warning or lecturing Yellen that she should not raise rates in such a soft environment.

Jim Rickards: That’s exactly right, Jeff. You know, it’s obviously a delicate relationship when the Managing Director of the IMF is trying to communicate publicly with the Chairwoman of the Federal Reserve. They can’t exactly come out and call each other names, but there’s a new IMF report that just came out. This is in preparation for the meeting, the G20 Finance Ministers and heads of central banks, very high level meeting.

This is in preparation for the G20 Summit Meeting later this year in Turkey, where actually the heads of state, President Cheney and President Obama and others will be there. But the G20 is a powerful group, but they don’t have a fulltime bureaucracy or what’s called a secretariat, so they outsource that to the IMF. The IMF kind of does all the research and they just came out with a new report and they categorically said that monetary conditions need to remain accommodative, meaning don’t tighten.

This is not the first one; there have been whole series of warnings from the IMF to the Fed. Other prominent spokespeople have said this also, including Larry Summers. He’s a controversial figure, but I think everyone can see the fact that he’s got a big brain. And so these warnings are coming from all over the place and Yellen, she has to be aware of them. We’ll see what she does, but I said in late 2014 that the Fed would not raise rates in all of 2015 and of course, at the time while she was saying March, then they said June, then they said September. My expectation is that September will come and go and they’ll start talking about December.

They just seem to kind of keep moving the goalpost three months, but when I said that, it wasn’t a wild guess. I actually take the Fed at their word. The Fed says it was data dependent. The data’s weak, it’s getting weaker actually and so it’s a pretty easy call to say they can’t raise rates. The question is, how come I could figure that out and some others could figure that out, but the Fed couldn’t? How come they couldn’t figure out that their own rate path and the answer is that they base their expectations and all their tough talk about rates, was based on the forecast and the forecast, they have the worst forecasting record of any institution I can think of. They’ve been wrong by orders of magnitude six years in a row. So, when I see the Fed has a kind of rosy forecast, I immediately assume the opposite’s going to be true. But, if you’re basing it on hard data and good forecasting, it’s easy to see they can’t raise rates. If you’re basing it on the Fed’s forecast, you can see where the rate talk comes from, but they have a very flawed model.

JD: Do you ever get the sense that Janet Yellen is flailing? I mean, she’s talked about the limits to monetary policy, but as you pointed out, you could always do more QE, you could always venture into negative interest rates, right? I mean, what’s her next play?

JR: Well that’s a really good question, Jeff. The toolkit is not empty. Everyone says they’re at the zero bound they can’t cut, so there’s nothing more they can do. That’s not true.

For better or worse, I think a lot of these things don’t work, by the way, but who cares what I think? The Fed thinks they work and that’s the important thing, but they’ve got five tools in the toolkit. One is more quantitative easing.

Another one is negative interest rates, which has been used in Europe, but has not been used in the US, but that’s possible.

The third one is they can rejoin the currency wars, which means cheapen the dollar. The dollar is at not at an all-time high, but close to it and at sort of a ten year high, so they could cheapen the dollar again. Another thing they could do is helicopter money. That’s not well understood, but what helicopter money means, you actually have to work with the Congress and the Congress would create a larger deficit and then the Treasury would issue notes to cover the deficit and then with a wink and a nod, the Fed would say to the Treasure, well don’t worry, we’ll buy the notes. So it’s a form of quantitative easing in the sense that the Fed is going to print more money to buy the notes, but they do it in conjunction and coordination with a larger deficit.

So, what that does, it creates money, but instead of giving it to the banks, which is normal QE, they give it right to the people and put it in people’s pockets, in the form of tax cuts, so that’s the difference between helicopter money and QE.

And the fifth thing they could do is go back to “forward guidance.” You know, they ended forward guidance last winter when the removed the word patient from the statement, that we will be “patient about raising rates.” I think that was the phrase, but patient was the latest in a long line of words and phrases.

I think they’ve probably worn out their thesaurus at the Fed coming up with these, but they say, “we’re not going to raise rates for an extended period” and then they say “we’re not going to raise rates for a considerable period.” Even earlier, back in 2010, they stuck in some dates. They said “2010,” they said, “we’re not going to raise rates until 2013.” Well you know, 2013 came and went and then they started talking about 2014, then they gave that up. So, they ended forward guidance.

They could go back to that. They could say, “you know, we’re going to be very patient this time about raising rates.” But here’s the thing. If they did any of those things, that would be a form of ease relative to expectations because the market is expecting tightening, that timing is up in the air, but the market still expects tightening, but I don’t think that’s what’s going to happen. I don’t think they’ll raise rates.

We talked about that, but I don’t think that they’ll go to any of these easing techniques either. I think what they’ll do is not raise rates, but continue to talk, continue to give markets reason to expect that they will raise rates perhaps at the next meeting, December or early in 2016 at this point. The question is and this is kind of what you’re getting at is, what about your credibility? This is like the boy who cried wolf. How many times can you say, “rate hike, rate hike” before you lose credibility?

But the Fed’s problem is, they’re going to have to choose between credibility and catastrophe. If they don’t raise rates, they’re going to slowly lose credibility, but if they do raise rates in a weak environment, they’ll cause emerging markets meltdowns. So, this is what happens when you manipulate every market in the world for seven years, you paint yourself into a corner and you can’t escape the room.

JD: But that’s just it, right? The rest of the world is very much affected by this. I mean when you talk and write about currency wars, do you think people really understand that it is a form of political war? Do investors sort of think it’s actually some kind of benevolent form of economic competition?

JR: Well, it’s definitely a form of economic competition, but it’s not benevolent and of course, I’ve said that all along. Part of what we’re discussing comes out of my second book, The Death of Money, that came out in 2014, but going all the way back to my first book, Currency Wars, which came out in 2011, I made the point that the conventional wisdom is that you cut your currency and this will cheapen your currency. This will make your exports more attractive, you’ll get more export orders that will create more jobs, give your economy stimulus, and so on.

And I made the point then that that’s not what happens, that you can cheapen your currency, there are ways of doing that, but you don’t get more exports, all you get is inflation. And I’ve made the point all along and I think this is consistent with Austrian economics is that the way you generate exports is to value-add technology, education, innovation.

I buy German cars, I don’t buy German cars because they’re a little bit cheaper this week; I buy them because they’re great cars. We buy French wine and we take an Italian vacation, whatever it may be, but we do that because of the perceived value in whatever it is that’s being offered, rather than the fact that it’s 10% cheaper this week.

But what does happen is you import inflation. Remember, in your two way training system, you’re not just an exporter, you’re also an importer, so if you cheapen your currency, the price of your imports goes up and that inflation tends to feed into the supply chain and make prices in general go up and that’s actually why they do it.

Governments always say, we’re cheapening the currency to encourage the exports, but they actually know better. What they’re doing is trying to get inflation because the world is facing a deflationary meltdown, a deflationary liquidity trap and everyone’s trying to get out of it. The problem with all this, Jeff, is that one country can benefit in the short run and I emphasize short run. It’s not a long run solution at all. It can give you a little boost in the short run, but it comes at the expense of your trading partners. So, one country might be a little better off for a short period of time, but the world is worse off and that’s what we’re seeing and this is very much a replay of the 1930s. A little bit of a slow motion replay, not quite as severe, but could be more prolonged.

Look at Japan, they’ve been in a depression for 25 years. I talk about a 25 year US depression and people kind of laugh out loud, but I said look, it started in 2007. We’re already eight years into it, we only have 17 to go, but I don’t see any way out absent structural reforms.

JD: Well, you talk about structural reforms. The world is awash in debt. We’re not just talking about the sovereign debt of individual governments, but all the bad debt owned by commercial banks, for instance, all the household debt that may well never be repaid, do you almost feel like we’re ripe for some sort of global reset or monetary realignment?

JR: Well, that’s going to be a necessity and the short answer is yes. I do see that and by the way, that is the condition in which currency wars arise and again, I said that in my first book. The world is not always in a currency war, but when we are, they can last for a long time; they can go on for 10, 15, 20 years.

The currency war we are in now started in 2010. I’m not the least bit surprised that here we are in 2015 and it’s still going on and people say, oh gee, how did you know five years ago that we’d still be in a currency war? And the answer is, is that’s the way they roll; they do less for a very long period of time. And the reason for that, is they don’t have a logical conclusion. You know, I cheapen my currency to get the edge on you and then you cheapen your currency. Well, just multiply that by 168 members of the IMF and you can see that that really has no end.

There are two ways currency wars end. One is systemic reform, which I think is maybe what you mean by global reset, where you have a Bretton Woods style conference, or at least something like the Plaza Agreement in 1985, where the leaders of the major trading financial powers get together and they just say look, this is ridiculous, we need to reshuffle the deck and come up with a new deal, so that’s one way out.

The other way out is systemic collapse, where the system just falls apart as it did on the verge of World War I and World War II and again, in 1971 when Nixon suspended the convertibility of the dollar into gold. So, I think it’s systemic reform or systemic collapse and actually if you have systemic collapse, that would force systemic reform. So, one way or the other, you get to a global reset.

And interestingly, I’ve had private discussions in the last couple of months with Ben Bernanke and John Lipsky, John was the former head of the IMF. So, you’ve got two individuals, both PhD economists who headed the two most powerful financial institutions in the world 10,000 miles apart. I spoke to Bernanke in Korea and I spoke to John in Washington and they both used the same word to describe the international monetary system. They both said this is incoherent.

I thought it was really interesting that they chose the same word. I’m not suggesting that they cooked it up for my benefit. It just shows that the people who are most knowledgeable about the system are looking at it and know that it doesn’t work. So, we’re heading for one of these two outcomes. My concern is that because of denial, delay and sort of pulling rabbits out of a hat, such as quantitative easing, they’re going to delay the reform to the point where we actually have the collapse and then again, we’ll see that and that’s really what I’m trying to do for readers and subscribers to my newsletter and people on interviews like this is just say, let’s put ourselves into that scenario and see how it plays out and then come backwards and say, what would you be doing today with your portfolio to prepare for that kind of monetary reset?

JD: That reset might come on the heels of a euro or a dollar end game, right? And you’ve talked quite a bit about the role that IMF special drawing rates might play in a new global system. And years ago, Pat Buchanan talked about how he saw the future of currency as being one of two things, either some sort of collapse, whereby nations retreated to their own nationalist impulses and interests with their own currency is like a resurrection of European currencies, for instance, or that there would be some sort of monster global currency and I’d be interested in your thoughts on whether the IMF special drawing rates are going to be that monster global currency in that scenario.

JR: Well, first of all, I agree with Buchanan. I would add one element. Buchanan said, either the world would retreat and go talk and come up with local currency as said, or go to a monster global currency.

There’s a third path I would put in the mix, which would be a gold standard of some kind. You know, when I say gold standard, I know Austrian economists have a very definitive view of what that means, no fractional reserve and one-to-one ratio and gold to back dollars, etc. and that’s one way to do it. It’s not the only way to do it. There are other ways to structure the gold standard, some more rigorous than others, some not much more than using gold as a reference point.

Take the whole spectrum from “fully backed by gold — no fractional reserve” on the one hand to “just using it as a frame of reference” on the other, but that’s a spectrum of various types of gold standard and I would put that in the mix as well.

There’s no doubt that global monetary elites want is the special-drawing-rights currency (SDR). They want a global currency. The great Robert Mundell, the Nobel Prize winner said, oh, I think 50 years ago, the optimal currency zone is the world. He said as long as you have more than one currency in play, there’s going to be some transaction cost or some inefficiency or some arbitrage that you’re going to have to deal with.

(By the way, when I use the phrase elites, I’m not talking about some black helicopter conspiracy. We know who these people are. It’s Christine Lagarde and Janet Yellen and Marty Feldstein and Kuroda at the Bank of Japan and the heads of central banks and finance ministries and leading academics and powerful financiers, people like Jamie Dimon and the people who shop at Davos, in other words. We know who they are, it’s not a mystery.)

So, the world’s moving slowly in that direction and that would be the SDR, the world money issued by the IMF, acting in its capacity and in fact, it’s the de facto central bank of the world.

Gold is out there, you know, maybe a gold-backed SDR is not such a bad idea.

Now, I was taking Mundell’s idea of an optimal currency zone with the whole world using SDRs, but combined with an old Austrian idea of a gold standard. That could work theoretically. The problem with that is the accountability of the IMF. The IMF doesn’t answer to anybody. They’re self-appointed, self-perpetuating. I mean, they have articles of agreement and I know it came out of the Bretton Woods agreements, etc., so there is some governance there, but they’re unelected, nondemocratic, and you’ve got everything from kings and dictators and communists side by side with functioning democracies. So, I’m a little troubled by the lack of accountability.

But what about the idea that that the system would actually break up into little blocks? We’re seeing that also, Prime Minister of Russia, Vladimir Putin, announced the other day that he’s advancing the ruble as a regional reserve currency. Now the ruble is not ready to perform well as a global reserve currency, that’s not even close. But in their periphery — basically the former Soviet Union and the former Commonwealth of Independent States — you have countries where their trade and interactions would be denominated rubles. That’s basically is a way of getting rid of the dollar.

And of course, we see the Chinese Yuan expanding as well. So, I think all three horses are in the race and I don’t want to predict a winner. What I’m trying to do is keep an eye on the horses, see who’s ahead and hopefully help investors structure their portfolios in such a way that, no matter what happens, that they come out with their wealth preserved.

JD: It seems to me that in any sort of reset scenario, there are winners and losers, right? The US has been thought of as a winner for out of the Bretton Woods agreement and certainly the petrodollar arrangement has benefitted the US tremendously. Are winners and losers going to be identifiable if this IMF led process begins and doesn’t that raise the specter of war or tension?

JR: Well, I think winners and losers are identifiable and again, that’s what I spend kind of most of my time doing. It goes back to your earlier question, Jeff, about the debt.

Depression and currency wars, what are the preconditions for that? Well, the preconditions are, too much debt and not enough growth. It’s as simple as that: too much debt and not enough growth. When was the last time the world saw this? Well, after World War I in 1919, 1920, Germany owed onerous reparations to England and France. England and France owed enormous war debts to the United States. Nobody was forgiving any of the debt, everyone was insisting on payment in full, there wasn’t enough to go around and that lead to an outbreak of currency wars and that led to a Great Depression and that, in turn, led to World War II.

And then trade wars were thrown on top of that. So there was a very deleterious and destructive path that came out of that. We saw the same thing in the late 1960s and early 1970s. England still had too much debt, had not paid off its World War II debt and the US was going into debt to finance the combination of the Great Society and the Vietnam War, the so-called guns and butter policy of President Johnson. So there, the reset wasn’t World War III, it wasn’t deflation and depression there, the reset was inflation, enormous inflation. From 1977 to 1981, the United States had 50% inflation in a five year period.

I know Ron Paul and Austrians like to point to the tenure of the Federal Reserve and they’ll say, since the creation of the Federal Reserve in 1913, the dollar lost 95% of its purchasing power, which is true, but no matter what you have left, you can always lose 95% of what you have left and that’s what happened, except from ’77 to ’81, there was a 50% devaluation in a very short period of time and that solved the problem, but it caused enormous destruction and enormous losers.

So, who were the winners and losers in these various scenarios? Well, in inflation and there’s no question that central banks, the IMF, the global elites, the use of SDRs, all of that is designed to cause inflation. By the way, it’s all failing so far. They haven’t really played the SDR card very aggressively, but they could and I do expect that in the future.

I call this Mick Jagger economics. The Rolling Stones had a song, “You Can’t Always Get What You Want.” The Fed wants inflation, but they can’t get it. They’ve been failing to get it for eight years in a row, but if the inflation comes, the losers are savers, anyone with a fixed income, if you have an insurance policy and annuity, a retirement, a savings account, anything where you depend on the amount of dollars, nominal dollars, you’ll be one of the losers in that.

With deflation, up to a point, the debtors lose because the real value of debt goes up, but you have to play that through, so you say okay, we have deflation, the value of debt goes up, my debt becomes more and more onerous and that gets back to a point about dollar denominated debt issues by companies in emerging markets and the BIS estimates there’s nine trillion dollars of dollar denominated debt issued by private sector emerging markets.  The debtors aren’t sovereigns who can go to the IMF and get a loan.

These are corporations — state owned enterprises. They’re from Brazil, Turkey, Indonesia and Malaysia, Russia, and China.

China’s a big player in this, but the problem is with more and more deflation, the debt gets more and more onerous. So what do they do? They default. So, it kind of comes back to the creditors. The creditors are feeling like the debts are going up in value for a while, which feels good, until the guy actually doesn’t pay you.

Then you destroy the banking system and then you get to hyper deflation, but since central banks can’t tolerate that, you come back to inflation. So, I think all roads lead to inflation, but what’s not clear is, are we going to go straight to inflation or are we going to have a more severe deflation, the opposite, which will then be resolved by going to inflation, by increasing the price of gold, which of course is exactly what happened in 1933. So, my advice to investors is be prepared for both and use what I call the barbell strategy.

So have your inflation hedges, which would include gold, land, perhaps some fine art and have your deflation hedges, which would include, say ten year treasury notes, cash and other very liquid assets and then have a big slug of cash in the middle.

People are sometimes surprised to hear me say that. They say, hey Jim, you’re the guy talking about the death of money, why would you have cash? Well the answer is that you might not have it forever, but you might have it in the short run for three reasons. One, it’s a good deflation hedge, the value of cash goes up in deflation and two, it reduces the volatility of the rest of your portfolio, which can help you sleep better at night and number three, it has huge embedded optionality. If the world’s falling apart in unexpected ways, the person with cash is the person that can pivot and take advantage of that. So, some inflation hedges, some deflation hedges, cash to give you optionality and just watch what’s going on and again, this is what I try to do in my newsletter because you know, I get comments from people. They say well, you told me to do this and this isn’t working out and I said well yeah, I said that two years ago. You have to keep listening, you have to stay tuned. You can’t just, as the expression goes, set it and forget it. In an environment like this, which is dynamically unstable, you have to be very nimble and you have to be kind of paying attention all the time and that’s exactly the service we try to provide in my newsletter.

 

James Rickards is chief global strategist at the West Shore Funds, editor of Strategic Intelligence, a monthly newsletter, and director of The James Rickards Project, an inquiry into the complex dynamics of geopolitics + global capital. He is the author of New York Times best seller The Death of Money (Penguin, 2014), national best seller Currency Wars (Penguin, 2011), and The New Case for Gold (Penguin, 2015). He has held senior positions at Citibank, Long-Term Capital Management, and Caxton Associates. In 1998, he was the principal negotiator of the rescue of LTCM sponsored by the Federal Reserve.

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