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Though much
has happened in the gold market this month - notably, a Fed pledge that has
awakened the sleeping bull - we wanted to take a step back and shed
some light on what is fundamentally driving the precious metals market today.
A
Wall Street pro named James Rickards recently
released his first book, Currency
Wars: The Making of the Next Global Crisis, and it's creating a buzz. Euro
Pacific Precious Metals' CEO Peter Schiff often talks about competitive
devaluation of currencies as the main driver behind our gold and silver
investments. Recently, Peter sat down with James to get his perspective on
what's behind these currency wars, and find out what he recommends investors
do to preserve their wealth through this tumultuous time.
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Peter
Schiff: You
portray recent monetary history as a series of currency wars - the first
being 1921-1936, the second being 1967-1987, and the third going on right
now. This seems accurate to me. In fact, my father got involved in economics
because he saw the fallout of what you would call Currency War II, back in
the '60s. What differentiates each of these wars, and what is most
significant about the current one?
James
Rickards: Currency
wars are characterized by successive competitive devaluations by major
economies of their currencies against the currencies of their trading
partners in an effort to steal growth from those trading partners.
While
all currency wars have this much in common, they can occur in dissimilar
economic climates and can take different paths. Currency War I (1921-1936)
was dominated by a deflationary dynamic, while Currency War II (1967-1987)
was dominated by inflation. Also, CWI ended in the disaster of World War II,
while CWII was brought in for a soft landing, after a very bumpy ride, with the
Plaza Accords of 1985 and the Louvre Accords of 1987.
What
the first two currency wars had in common, apart from the devaluations, was
the destruction of wealth resulting from an absence of price stability or an
economic anchor.
Interestingly,
Currency War III, which began in 2010, is really a tug-of-war between the
natural deflation coming from the depression that began in 2007 and
policy-induced inflation coming from Fed easing. The deflationary and
inflationary vectors are fighting each other to a standstill for the time
being, but the situation is highly unstable and will "tip" into one
or the other sooner rather than later. Inflation bordering on hyperinflation
seems like the more likely outcome at the moment because of the Fed's
attitude of "whatever it takes" in terms of money-printing;
however, deflation cannot be ruled out if the Fed throws in the towel in the
face of political opposition.
Peter: You and I agree that the dollar is on
the road to ruin, and we both have made some drastic forecasts about what the
government might do in the face of the dollar collapse. How might this
scenario play out in your view?
James: The dollar is not necessarily on the
road to ruin, but that outcome does seem highly likely at the moment. There
is still time to pull back from the brink, but it requires a specific set of
policies: breaking up big banks, banning derivatives, raising interest rates
to make the US a magnet for capital, cutting government spending, eliminating
capital gains and corporate income taxes, going to a personal flat tax, and
reducing regulation on job-creating businesses. However, the likelihood of
these policies being put in place seems remote - so the dollar collapse
scenario must be considered.
Few
Americans are aware of the International Economic Emergency Powers Act
(IEEPA)... it gives any US president dictatorial powers to freeze accounts,
seize assets, nationalize banks, and take other radical steps to fight
economic collapse in the name of national security. Given these powers, one
could see a set of actions including seizure of the 6,000 tons of foreign
gold stored at the Federal Reserve Bank of New York which, when combined with
Washington's existing hoard of 8,000 tons, would leave the US as a gold
superpower in a position to dictate the shape of the international monetary
system going forward, as it did at Bretton Woods in 1944.
Peter: You write in your book that it's
possible that President Obama may call for a return to a pseudo-gold
standard. That seems far-fetched to me. Why would a bunch of pro-inflation
Keynesians in Washington voluntarily restrict their ability to print new
money? Wouldn't such a program require the government to default on its bonds?
James: My forecast does not pertain
specifically to President Obama, but to any president faced with economic
catastrophe. I agree that a typically Keynesian administration will not go to
the gold standard easily or willingly. I only suggest that they may have no
choice but to go to a gold standard in the face of a complete collapse of
confidence in the dollar. It would be a gold standard of last resort, at a
much higher price - perhaps $7,000 per ounce or higher.
This
is similar to what President Roosevelt did in 1933 when he outlawed private
gold ownership but then proceeded to increase the
price 75% in the middle of the worst sustained period of deflation in U.S.
history.
Peter: You also write that you were asked by
the Department of Defense to teach them to attack other countries using
monetary policy. Do you believe there has a been an
deliberate attempt to rack up as much public debt as possible - from the
Chinese, in particular - and then strategically default through inflation?
James: I do not believe there has been a
deliberate plot to rack up debt for the strategic purpose of default;
however, something like that has resulted anyway.
Conventional
wisdom is that China has the US over a barrel because it holds more than $2
trillion of US dollar-denominated debt, which it could dump at any time. In
fact, the US has China over a barrel because it can freeze Chinese accounts
in the face of any attempted dumping and substantially devalue the worth of
the money we owe the Chinese. The Chinese themselves have been slow to
realize this. In hindsight, their greatest blunder will turn out to be trusting the US to maintain the value of its currency.
Peter: In your book, you lay out four
possible results from the present currency war. Please briefly describe these
and which one do you feel is most likely and why.
James: Yes, I lay out four scenarios, which
I call "The Four Horsemen of the Dollar Apocalypse."
The
first case is a world of multiple reserve currencies with the dollar being
just one among several. This is the preferred solution of academics. I call
it the "Kumbaya Solution" because it assumes all of the currencies
will get along fine with each other. In fact, however, instead of one central
bank behaving badly, we will have many.
The
second case is world money in the form of Special Drawing Rights (SDRs). This
is the preferred solution of global elites. The foundation for this has
already been laid and the plumbing is already in place. The International
Monetary Fund (IMF) would have its own printing press under the unaccountable
control of the G20. This would reduce the dollar to the role of a local
currency, as all important international transfers would be denominated in
SDRs.
The
third case is a return to the gold standard. This would have to be done at a
much higher price to avoid the deflationary blunder of the 1920s, when
nations returned to gold at an old parity that could not be sustained without
massive deflation due to all of the money-printing in the meantime. I suggest
a price of $7,000 per ounce for the new parity.
My
final case is chaos and a resort to emergency economic powers. I consider
this the most likely because of a combination of denial, delay, and wishful
thinking on the part of the monetary elites.
Peter: What do you see as Washington's
end-game for the present currency war? What is their best-case scenario?
James: Washington's best-case scenario is
that banks gradually heal by making leveraged profits on the spreads between
low-cost deposits and safe government bonds. These profits are then a cushion
to absorb losses on bad assets and, eventually, the system becomes healthy
again and can start the lending-and-spending game over again.
I
view this as unlikely because the debts are so great, the time needed so
long, and the deflationary forces so strong that the banks will not recover
before the needed money-printing drives the system over a cliff - through a
loss of confidence in the dollar and other paper currencies.
Peter: I don't think this scenario is likely
either, but say it were... would it be healthy for the American economy to
have to carry all these zombie banks that depend on subsidies for survival?
Wouldn't it be better to just let the toxic assets and toxic banks flush out
of the system?
James: I agree completely. There's a model
for this in the 1919-1920 depression, when the US government actually ran a
balanced budget and the private sector was left to clean up the mess. The
depression was over in 18 months and the US then set out on one of its
strongest decades of growth ever. Today, in contrast, we have the government
intervening everywhere, with the result that we should expect the current
depression to last for years - possibly a decade.
Peter: How long do you think Currency War
III will last?
James: History shows that Currency War I
lasted 15 years and Currency War II lasted 20 years. There is no reason to
believe that Currency War III will be brief. It's difficult to say, but it
should last 5 years at least, possibly much longer.
Peter: From my perspective, what is unique
about a currency war is that the object is to inflict damage on yourself, and the country often described as the winner is
actually the biggest loser, because they've devalued their currency the most.
Which currency do you think will come out of this war the strongest?
James: I expect Europe and the euro will
emerge the strongest after this currency war by doing the most to maintain
the value of its currency while focusing on economic fundamentals, rather
than quick fixes through devaluation. This is because the US and China are
both currency manipulators out to reduce the value of their currencies. In
the zero-sum world of currency wars, if the dollar and yuan are both down or
flat, the euro must be going up. This is why the euro has not acted in accord
with market expectations of its collapse.
The
other reason the euro is strong and getting stronger is because it is backed
by 10,000 tons of gold - even more than the US This is a source of strength
for the euro.
Peter: You and I both connect the Fed's
dollar-printing with the recent revolutions in the Middle East. This is
because our inflation is being exported overseas and driving up prices for
food and fuel in third-world countries. What do you think will happen
domestically when all this inflation comes home to roost?
James: The Fed will allow the inflation to
grow in the US because it is the only way out of the non-payable debt.
Initially,
American investors will be happy because the inflation will be accompanied by
rising stock prices. However, over time, the capital-destroying nature of
inflation will become apparent - and markets will collapse. This
will look like a replay of the 1970s.
Peter: How long do you think China's elites
will put up with the Fed's inflationary agenda before they start dumping
their US dollar assets?
James: The Chinese will never
"dump" assets because this could cause the US to freeze their
accounts. However, the Chinese will shorten the maturity structure of those
assets to reduce volatility, diversify assets by reallocating new reserves
towards euro and yen, increase their gold holdings, and engage in direct
investment in hard assets such as mines, farmland, railroads, etc. All of
these developments are happening now and the tempo will increase in future.
Peter: In your view, what is the best way
for investors to protect themselves from this crisis?
James: My recommended portfolio is 20% gold,
5% silver, 20% undeveloped land in prime locations with development
potential, 15% fine art, and 40% cash. The cash is not a long-term position
but does give an investor short-term wealth preservation and optionality to
pivot into other asset classes when there is greater visibility.
[Editor's
note: Opinions expressed are the interviewee's own and do not represent investment
advice from Peter Schiff or Euro Pacific Precious Metals.]
Peter: What, if any, silver lining do you
see for us in the future?
James: I continue to have faith in the
democratic process and the wisdom of the American people. Through elections,
we might be able to change leadership and implement new policies before it's
too late.
Failing
that, the worst outcomes are all but unavoidable.
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We
would like to thank James for speaking to us about this topic and educating
the public about the dangers of currency wars. We at Euro Pacific Precious
Metals believe they represent the greatest threat to investors' financial
wellbeing today.
While
James and Peter may disagree on some key points, we think he has accurately
diagnosed the mentality that may drive the US to a dollar collapse. Unless
the US decides to quit the currency wars, investors will continue to be
pushed into precious metals and other hard assets. And, as James illustrates,
declaring a truce is easier said than done.
James G. Rickards is Senior Managing Director at
Tangent Capital Partners LLC, a merchant bank based in New York City, and is
Senior Managing Director for Market Intelligence at Omnis, Inc., a technical,
professional and scientific consulting firm located in McLean, VA.
Peter Schiff is CEO of Euro Pacific Precious Metals, a gold and
silver dealer selling reputable, well-known bullion coins and bars at
competitive prices. To learn more, please visit www.europacmetals.com or call (888) GOLD-160.
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