Peter Schiff, Eurocapital, has just published his February 2012 "Gold Newsletters" where he interviews James Rickards, economist, investment banker and author of the book Currency Wars: The Making of the Next Global Crisis
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Here's the transcription of the interview:
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.
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.
