TIP138: JIM RICKARDS
CURRENCIES, THE EURO, & CENTRAL BANKING (PART II)
14 May 2017
In this second part episode, Preston and Stig continue their conversation with world renown economist and central banking expert, James Rickards. Jim is the New York Times Best Selling Author of books like Currency Wars, The Death of Money, and A New Case for Gold. During this episode, Jim provides important insights into the way currencies work. Additionally, he provides his contrarian point of view on the power of the Euro as a currency.
TRANSCRIPT
Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.
Preston Pysh 0:02
Hey, how’s everybody doing out there? So this is our second part interview with Jim Rickards. If you missed the first episode, I highly recommend that you go back to the previous episode and listen to it. Quick background on Jim, if you haven’t listened to our first episode, Jim is a graduate of Johns Hopkins University. He has a doctorate from Penn.
He also went to New York University School of Law. He’s written multiple New York Times bestselling books, and he’s one of our most popular guests on the show because of his comments about the Federal Reserve, different ideas about macro, and where he sees the general economy is going.
Stig Brodersen 0:37
In this episode, we will have a very detailed discussion about currencies in a world where everyone seems to be bearish on the euro. We’ll talk about why Jim is bull and whether or not the euro might end up replacing the dollar.
We will also investigate if the world will be better off with a fixed exchange rate system the way it used to be. Finally, we will revisit the idea of replacing the current monetary system as we know it with gold and SDR, and why it seems to be a more and more popular solution.
Preston Pysh 1:11
So without further delay, we’re going to jump right into this episode. So if you guys are ready to do this, let’s go ahead and hop to it.
Intro 1:21
You are listening to The Investor’s Podcast, where we study the financial markets and read the books that influenced self-made billionaires the most. We keep you informed and prepared for the unexpected.
Stig Brodersen 1:41
So Jim, I would like to kick off the second part of our conversation with a discussion about currencies, specifically about the Chinese yuan, In international comparison, it’s actually a very small currency.
That being said, China has gradually asked their trading partners to sell the transactions in yuan, as opposed to USD. Do you see this as a long term strategic move to support a yuan-based bond market? And if you do, is it really just the first step in the markets’ bigger global plan for the currency?
Jim Rickards 2:13
I think the answer is yes. I mean, we all know we’re students of Chinese history and Chinese culture. We know that they are the ultimate long-term thinkers. You know, one of my favorite quotes is a conversation between John Lyon and Henry Kissinger in the 1970s, when Kissinger was over there secretly preparing the way for Nixon to go to China.
As the two pretty big brains, the intellectuals and Henry Kissinger asked John Lyon what he thought about the French Revolution. And Joe turned and said, “Too soon to tell.” In other words, 200 years was not long enough to see how things really play out since the Chinese mentality.
So yeah, there’s no doubt that China is the second largest economy in the world. It’s the fastest growing major economy in the world. They do have hegemonic ambitions in Western Pacific, East Asia. We all know what’s going on in the South China Sea. They’re expanding the periphery. They’re making some very audacious plays.
One thing, I think is not that well appreciated, think of the major rivers in Southeast Asia: the Mekong River, the Irrawaddy River, there are a number of them throughout Myanmar, Thailand, Malaysia. All those major rivers, they have their headquarters in Tibet, which is controlled by China.
China is building a series of major dams at the headwaters of those rivers, which means that when the not too distant future when China can look to South Asia and say, “You guys want water? Toe the line.”
In other words, they can literally cut off the water supply to all Southeast Asia by just stopping up these dams and building reservoirs. So, that’s the kind of long term thinking and really hegemonic type of plays that the Chinese are making.
So with that said, there’s no doubt that they’re applying that to the currency. Now, they’re not even close to having the yuan as a reserve currency. And here’s why, here’s what maybe their biggest impediment is [and] why they may never get there.
What makes a reserve currency mean? It’s sort of, yeah, the dollar is 80% of global payments. It is 60% of global reserves. It’s like why do the letters on the keyboard say what they say? Well, the answer is once upon a time, somebody laid them out that way, and everyone learned and they never want to change it, because we all learned a certain kind of keyboard. Nobody wants to relearn it.
So there is this first mover advantage there is this, you know, this kind of inertia that once you get this critical mass, you tend to keep it and that certainly applies to the US dollar. But the key is the bond market. In other words, what are the country’s reserves? Well, it just means they had trading partners and they ran a surplus.
And so, if you make $50,000 a year, and you spend $40,000, then taxes and rent and car payments and shopping, and you have $10,000 leftover when you put it in the bank, those are your savings. Well, it’s no different for a country.
If you sell goods to the rest of the world, you buy them and you sell more than you buy, you’re gonna have a surplus and you build up the surplus. So the question is what do you do with the surplus? If your country can’t stick it under your mattress, you have to invest it somewhere.
There aren’t too many markets in the world capable [of[ absorbing those kinds of inflows. But the one that is is the US Treasury Market. And so, people invest in US dollars, not because they love dollars, not because they think the US government’s doing everything right, simply because there’s nowhere else to put the money. And we do have a lot of things going for us.
So, before the yuan is ever a reserve currency, they’re gonna have to build up a bond market because if you trade with China and you get yuan, you don’t want the yuan, unless you have something to invest it right. Now, there is no Chinese sovereign bond market to speak of man. It’s a small market, but it’s not just a question of issuing bonds. You have to issue bonds in all maturities, so you have a yield curve.
We have a 30-day bill, and we have 30-year bonds and everything in between. You buy a two year note, a five year note, a 10 year note, etc. So, you need all those maturities. You need dealers.
We have a system of primary dealers who make two way markets and if you don’t make a two way market, the Fed kicks you out of the club. And they’re very credit worthy dealers. They’re all the biggest banks. You need settlement clearance. You need clearance. You need a wire transfer system. And you need a repo market so I can finance my positions. You need futures and options, so I can hedge my position. So, you need all this stuff.
So where are the futures, the options, the derivatives, the repo, the settlement, the clearance, you know, all the things you need to have a bond market? Well, none of them exist. None of them exist.
They’re all there in primitive form, but this will take at least 10 years, perhaps 20 years to build. And the one thing, above all, I just gave you a long list of things, you need to have a big enough bond market to be a reserve currency.
One thing above all, is the rule of law. China is a communist, I mean, it’s a communist society. They may pretend to have a rule of law, but if the leader wakes up one day and wants to change it, then it gets changed as the *inaudible about the rule of law.
I mean, we have disappeared. It’s like a Paulie in The Godfather. You won’t see him no more. So, these firing squads in China, they confiscate property left and right. It’s an utterly corrupt society. There’s no recourse. There’s no court system.
Again, not the way we would recognize this. So the only countries in the world that have really good rule of law, and certainly the UK, the US. However, there are two other alternatives to the US dollar in play. And we’ve talked about them on this show before, which are gold and SDRs. SDR being a special drawing right. That’s the IMF world money.
Now, El-Erian, he’s about as elite as you can get in terms of the global monetary leads. He worked at the IMF and he’s I think, Chief Strategist for Allianz, one of the biggest insurance companies in the world and was the number two guy [of] PIMCO for all those years.
He’s on various committees. He’s a Davos man. He’s about as plugged in as you can get. And it’s about the SDR is kind of like, “Hey, is the time right for the SDRs? That’s interesting. The IMF spring meetings just concluded on Sunday.”
When I look at things like that, I say, “Oh, so the IMF just had their semi annual meeting and the next day, El-Erian comes out with a pro-SDR op-ed, I don’t think that’s a coincidence. I think there’s something in the air. I’ll leave it at that.”
And there are other things going on behind the scenes with the BRICS, getting veto power at the IMF. That’s going to take a year to play out. But that’s already been agreed in principle and it’s in the process of playing out.
So, and the whole thing they did in the summer of 2016, they came up with two kinds of SDRs. There’s the SDR-O, and the SDR-M. The SDR-O is the official SDR. That’s the one that the IMF issues. But the SDR-M, it stands for market SDR. So, they’re encouraging private organizations to issue SDR bonds, create SDR liquidity and SDR yield curve, and this is what El-Erian was talking about in the op-ed.
But right on cue, the World Bank issued, I believe, a $2 billion SDR denominated bond issue. It’s not denominated in dollars. You buy one. You pay in SDRs, and it gets paid off, and you can convert them to dollars. Obviously, it’s just a simple math problem.
So, this is coming. Gold thing again, we’ve talked about that at length. So my favorite central banker, there aren’t too many central bankers, who understand central banking. But one of them is Elvira Nabiullina, who is the head of the Central Bank of Russia. She totally gets it.
And it’s kind of interesting, when the oil price collapsed in June 2014. That was pretty tough on Russia and their reserves. But they had all this dollar denominated debt, or Gazprom and Rosneft and all these guys, but they weren’t getting the dollars in the door, because of the oil price collapse.
And then, Obama posed the sanctions on because of Crimea and Eastern Ukraine, and that made it worse. So their reserve position drew down from the *rallies round numbers from about $500 billion to $300 billion, and it was dropping precipitously.
And you can almost say, here comes Russia again with another foreign exchange reserve crisis. But the point being throughout that foreign exchange crisis, they never stopped buying gold. They bought 25 tons in March.
Whereas, [the] China we know is buying gold, hand over fist and largest mining output in the world. So my question is simple. Are China and Russia stupid? Or do they see something coming that most people don’t?
Well, they’re not stupid. I’ve been to Moscow. I’ve been to Beijing, Shanghai, Nanjing. I’ve studied these people. I’ve friends in Russia and China. They’re not stupid. They know exactly what they’re doing. Americans don’t get gold, but everyone else does. So that’s the real [deal]… in a crisis, we’re either going to go to SDRs or gold. Those are the real alternatives.
Stig Brodersen 10:21
Speaking of the next currency system, we talked about SDRs, we talked about gold. As you just said, if we’re looking at the current monetary system, we have where the dollar right now is the most important reserve currency. It might seem, for a lot of people like it’s really gonna be hard to change because that is what most people remember.
And like today, I read this very interesting book not too long ago. It was written by you, Jim, “The Death of Money.” And one of the very interesting thing I found from that, it really surprised me was that you were talking about the possibility of having Germany or the euro, *inaudible by Germany, to be the most important reserve currency by 2025, because of a number of factors.
Could you please elaborate on that, especially in times where it seems like the entire world is bear on the euro?
Jim Rickards 11:12
Well, you’re right that the entire world is bearish on the euro, except me and a couple of other people. One of the reasons I said why the Euro, the yuan is not ready to be a reserve currency. The Russian ruble is not ready to be a reserve currency.
SDRs and gold, those are more extreme solutions waiting in the wings in a panic, but let’s just take the steady state and roll it out.
So, what’s the real competitor to the dollar if there is one? And the answer is the euro because the euro actually has the conditions I described. Now, it has a rule of law. It has banks. It has dealers. It has clearance and settlement. It has futures and options. It has all those things I mentioned.
One thing it doesn’t have is a bond market, because the euro is a single currency with I believe 19 members in the Eurozone. And of course I think the listeners know that the Eurozone is not quite the same as the EU.
There are countries in the EU that are not in the Eurozone. So right now we’re talking about just the countries in the Euro, the Eurozone, whose currency is printed by the European Central Bank.
There is a German bond, there’s an Italian bond market, there’s a Spanish bond market, there’s a Netherlands bond market, but there is no euro bond market. And when I say euro bonds, I’m talking about a euro denominated bond guaranteed by the full faith and credit of the Eurozone.
All those members and the ECB get together, and they back this bond. That bond does not exist. And until it does, it will be difficult for the euro to even give the dollar a good run for its money as a global reserve currency, because the reason we mentioned is you don’t have the liquidity in the bond market. Yeah, you can buy bonds and you can buy Italian government debt.
But of course, that’s been extremely volatile because they don’t have a common fiscal policy. They’re just tiptoeing into common bank regulation, but you go back to, let’s say, 2012 even earlier, when you know, Joseph Stiglitz, Paul Krugman, and Nouriel Roubini were running around the hair on fire saying, “You know the euro is coming to an end, and Greece is going to be kicked out, and Spain has to quit and go back to the peseta and devalue the currency and lower the unit labor costs. There’s going to be a northern tier and a Southern Tier. Remember all that?”
And I said, “No, none of that’s true. None of that is happening. The euro is sticking together. It’s Hotel California, nobody can check out. They will add members, which they have when I started saying this, it’s 16 members today, they have 19 members. We’ll see if Scotland becomes the 20th.”
So, they really got the strength to strength, and I’ve been very bullish on the euro. Now, I have a theory on why Americans don’t understand the euro because you can’t… The opinion, I just express you can’t hear it anywhere because all you’ll hear is the euro is a mess, right? It’s because Americans get their information from the economist in the FT, but they know nothing about the euro.
Those are London publications, they hate the euro. Everybody in England hates the Euro, right? So, if you’re getting your information from the FT and The Economist, it’s like reading a Hilary campaign brochure trying to figure out if Trump’s going to win.
So, you have to go to Germany, you have to go to Italy, you have to go to Spain. But one of the reasons I was bullish on the euro, I did an interview last Friday, so just go buy the euro right now, versus going from the $1, 6-2, almost a dollar-nine in one trading day.
But I said even if Le Pen wins or does better than expected, I didn’t think that. But if she does, she can’t make the euro go away with a wave of her hand. All she said was “I’m going to have a referendum.” So if she became the president of France, she can have a referendum, but she’s going to lose the referendum because the poll shows 60% of the French people support the euro.
And you go back to spring of 2015, which was just about the height of the Greek debt crisis. I mean, it really looked like they were that’s as close as Europe came to kicking somebody out. And the people in Athens, they were ready to march on Berlin and burn the place down.
I mean, they hated austerity. They hated Merkel. They hated Schauble and the whole German financial establishment. But the polls show that 60% of them favor the euro. So they kind of went both ways: they want the Euro, but they don’t want the austerity.
But the reason is, they remember the drachma. The Italians remember the lira. The Spanish remember the peseta. Those were highly inflationary currencies. The government’s use those currencies for decades to steal everyday people from savers by inflation.
And when they got the euro, they got price stability, so they love the euro. They may not like Merkel. They may not like Berlin and Brussels. They may not like austerity, but they love the euro and it’s here to stay. But the big thing is coming.
To get back to your question, Stig, about the reserve currency status. What they need is a common fiscal policy. Now, the rap on the euro has been, “Hey! You guys have a unified monetary policy, but you don’t have a unified fiscal policy.”
You got these Greeks running crazy deficits and you know, etc. They’re all borrowing in euros or prewriting on the European Central Bank discipline, but not showing any fiscal discipline. So Merkel is running the show. Merkel will support a euro bond provided that the members of the US Eurozone get their fiscal house in order, and they establish a common fiscal authority.
When you see that, when all of a sudden Greece can’t just run any deficit they want, but they’ve got to run it by a unified [system]…basically think of it as a euro finance minister. That job does not exist today.
However, imagine a day [when] there’s your finance minister, who can tell the Greek, “Sorry, you got to cut your spending. That doesn’t work for us.” Then, Merkel will buy into the Euro bond issue.
But this is on Macron’s platform. He said, “I think we should have a European finance minister.” So, it’s coming in. I’m not saying next year, but it may be sooner than we think. When you get that and you get the Euro bond, and there are more people in the euro zone than the EU, rather than the United States.
I think 430 million people and a very large economy, obviously. And they’re very well positioned vis-a-vis the Middle East and Russia is a natural trading partner. They’ve got so much going for them.
And the big variable will be China’s capital flows, the Chinese capital will start to flow into Europe. The Chinese are very conservative, they’re very risk averse. And they see too much kind of funkiness around Europe. But as Europe gets his act together, which they are doing, the Chinese capital will flow in there. And there’s a currency that could displace the dollar
Stig Brodersen 17:14
In continuation of perhaps having a euro to replace the dollar and get into fiscal policy in order and clearly, also the monetary policy, which is somewhat united as is right now, there’s this great quote by Mario Draghi, the President of the European Central Bank, where he’s saying that the ECB is ready to do whatever it takes to pursue the euro. Now, you are also saying that the euro will persist? What do you think he means by that?
Jim Rickards 17:43
Well, I said earlier that most central bankers don’t understand central banking. I gave Elvira Nabiullina as an example of someone who does. My other favorite central banker is Mario Draghi, and the reason is he also understands central banking. What Draghi understands is that central banks are actually completely impotent. They can’t do anything.
This idea that I mean [is] they go through the motions, but just like the Wizard of Oz, it’s just a pretense. Don’t dare pull the curtain back, because you’ll see what a sham it all is. Draghi gets that. And so, when you’re in the position of perceived power when you don’t have much actual power, the best policy is to say little and do less. And that’s Draghi.
So you go into the United States. You got these Regional Reserve Bank presidents and Members of [the] Board of Governors yakking away. I think two weeks ago, there were 14 speeches in one week.
I mean, it’s like every single Regional Reserve Bank President: Loretta Mester, Esther George, Eric Rosengren, Jim Bullard, they were all giving speeches, and Draghi just keeps his mouth shut, which is really smart.
But the one time he came out [and] said something, he said, “Whatever it takes.” What did he mean by that? Probably doesn’t even know but it was just sort of a threat. It was like, I don’t want to mess with this guy. So, that’s what I made about. He just kind of played close to the vest. I thought it was very, very clever. It was psychological.
The interesting thing about that [is] he didn’t actually do anything. He said it. I believe it was June 2012. We can look it up. June 2012. At the height of the close to the height of the European sovereign debt crisis, he said, the full quote was, “I will do whatever it takes, and I assure you, it will be enough.” That was the rest of the sentence. The markets were like, “Whoa, don’t mess with this guy.”
But because his words were so effective, he didn’t actually do anything. He didn’t cut rates. Actually, he did raise rates at the time. It was months later, it was really into 2013. And later that he started the Euro QE and some of the other programs that they have today, which they’re now trying to get out of. It didn’t really work very well there either. But he bought a lot of time. That’s my second favorite Draghi quote.
My favorite Draghi quote was [when] he was giving a symposium at the Kennedy School up at Harvard. This was about three and a half years ago. And *inaudible* Silver who’s a journalist specialist. And gold somehow got a ticket, and he lined up with the kids to ask a question because Draghi is there like, yeah, takes questions from the students, and there were no false pretenses.
But I’m sure Draghi thought he was talking to a Harvard student and probably didn’t realize he was talking to a gold journalist. And so, Silver asked him about gold and he said, a very interesting thing. This was a video that you can find on YouTube.
He said, “Well, before I was head of the ECB, I was head of the Bank of Italy.” And Italy is one of the largest holders of gold in the world. They have over 2000 tonnes, which is a lot for the size of Italy. And he says, “When I was governor of the Bank of Italy, I never sold a single ounce of gold, because I thought it was a good hedge against the dollar.”
I almost fell off my chair, when I heard that like, “Oh, you’re a central banker. You’re the guys who want us to believe that gold is not a monetary asset, that [it] has no role in the monetary system, and it’s a barbarous relic or whatever. And yet as the Head of the Central Bank of Italy, you said you never sold your [gold] because you wanted to hedge the dollar.” By the way, which is smart, I would do the same thing. But I was very surprised to hear him say that.
Preston Pysh 21:07
So Jim, I want to change gears just a bit. And I want to open up a real broad question for you. If we look at the narratives, everyone’s got a narrative in the market. What is the narrative that you’re hearing today in the second quarter of 2017 that you think is just dead wrong?
Jim Rickards 21:25
Growth. I just think it’s the opposite. Let me be more. Let me be specific about that. So Trump wins and in the wee hours of November 9, literally two or three o’clock in the morning, it was becoming clear that Trump is going to be the next president.
The stock market sold off, it was in dow points. It was down 800 points. Gold was soaring. I thought that would happen, but I thought it would reverse. I didn’t know it would reverse in two hours. I thought it might reverse in the course of two days, but it did reverse in a matter of hours and by the morning of November night.
The stock market was back to even and by the close of the first day was up, and then it never looked back. It went up, [the] dow was up 3000 points from the round numbers from 18,000 to 21,000 since then.
The reason I thought it would go up after an initial dip was that during the campaign, Trump’s behavior was so vulgar, and so off putting to so many, and nobody thought he would win. I think you guys know, I was running around the week before saying he would win.
The great thing about doing interviews like this is you get to save the audio clips. And so, if you make a good or bad [decision], but if you make a forecast, and you’re right, you can always come back and say, “Yeah, there it is.”
I was doing TV interviews saying Trump would win, but that was certainly unexpected. So the point is market participants. Because they couldn’t get past Trump’s demeanor and his behavior, they never looked at his policies. And then, suddenly, when he wins, it is like, “Oh, well, what are his policies?”
Oh, he wants to cut taxes, reduce regulation, $1 trillion to infrastructure spending, what’s not to like? So all of a sudden people like well, you know, if you’re going to cut taxes and companies, domestic earnings are going to have higher earnings per share. So, I got a bit of those stocks and infrastructure. I’ll buy Caterpillar and John Deere. If you’re going to repeal Obamacare, I’ll buy pharmaceuticals.
And if you’re going to repeal Dodd Frank, I’ll buy banks and there was nothing not to like. Every sector went up. Initially gold in the bond market went down, because the Trump reflation trade and expectation of higher interest rates and all that.
I watched it, and so, the Dow Jones goes up 1000 points in November based on the Trump tax policy. Then, it goes up 1000 points in December based on the Trump tax policy. And then, it goes up 1000 points in January based on the Trump tax policy. And I thought to myself, “You guys just went up three times on the same policy mean. He’s not going to cut taxes three times.”
Why does it come back to your question about the narrative? The narrative in November was Trump’s going to cut taxes. Okay, I got it, December. Well, they leaked out a few details and look at this, okay another thousand points. January, it’s going to be in this State of the Union Address. Boom, another thousand points.
And we’ll probably go up, as we speak, because they’re going to announce some more details again. They still don’t have a bill. I spent the first 10 years of my career as international tax counsel at Citibank, I got a graduate law degree in taxation. I know a little bit about the subject.
The last time they did a big overhaul, the Internal Revenue Code was 1986. The time before that was 1954. And the time before that was 1939. In other words, these things happen every 30 or 40 years, they’re really hard to do.
The idea that they’re just going to like, bang through something, it’s nonsense, but then, when the stock market went up based on that, and a few other things, but let’s look at the reality. So first of all, the infrastructure bill is nowhere to be seen. Most recent has gone from a trillion dollars to $400 billion. Most of that is not deficit spending.
It’s going to be public private partnerships. And if you’re going to use public bonds to finance it, you’re going to have to pay the bonds which means tolls. So bridge tolls, tunnel tolls, airport user fees, etc. I’m not saying we don’t need the infrastructure. I’m all for the infrastructure, but you’re not getting it for free. And you got to put all those tolls on everybody that’s the kind of tax as a tax increase.
The Congress has made it very clear that in a tax cuts have to be revenue neutral so if Trump wants to take *inaudible today, they *leaked that they’re going to cut corporate tax from 35% of 15%. They want to cut the individual tax from 39% to 33% roughly. That sounds good, but where are you going to get the money?
I mean, what you’re gonna have to raise somewhere else and whether it’s the VAT which I doubt whether it’s the VATm the value added tax, which I do believe is coming or getting rid of the deduction on home mortgage interest, getting rid of the deduction for corporate interest expense. There are a lot of ways to do it, but they all represent tax increases to somebody.
So all you’re really doing, you’re cutting taxes on one group and you’re raising taxes on another group and you’re keeping it revenue neutral. Hard to see where the stimulus comes. ‘m not saying it’s a bad idea. I mean, just to take that a step further, who benefits from a personal tax cut from 39% to 33%?
Well, rich people. You got to be making $300,000 to $400,000 a year or more to get that tax benefit. If they slap on a value added tax who pays? The little guy, it’s a sales tax, value added tax is just a fancy name for sales tax, right?
The income tax cut benefits the people with the lowest marginal propensity to consume. If you’re that rich, and well, you already got everything you want. The point being, you’re not going to spend more, but the guy with the value added tax, that’s coming out of his pocket, he’s got to spend a little less at you know, Wendy’s or a little less at the gas station because he’s paying more for whatever when he shops at Walmart.
Your tax plan is A) revenue neutral, which means no stimulus and B) regressive in the sense that you’re rewarding the people, who don’t spend and you’re hurting people who do. So, I don’t see [if] the stimulus comes from that.
The infrastructure thing looks like a chimera or unicorn. That’s not happening. The tax bill might have… Oh, by the way, two other effects. One is, remember I said the stock market went up in November and December was because they thought we’d get a tax bill in 2017.
Well, now the earliest they can pass this thing is November, November, December, which means the earliest effective date is going to be January 1 2018. So, you have a whole year of earnings, increases at the stock market price, then that just disappeared. Well, is the stock market corrected for that? No, because to me, it looks a little bit like a bubble. It goes up, stays up, because it’s a bubble.
My point being [is] they price stimulus they’re not going to get. They priced the timing they’re not going to get. They priced infrastructure they’re not going to get. They haven’t repriced, that is to say the market hasn’t come down.
And then, combine that with what we talked about [at] the beginning of the podcast with the Fed tightening into weakness, and the natural deflationary factors demographic debt deleveraging and technology. You have a recipe for a recession. So, the big miss I would say is that there’s this growth *inaudible* narrative out there that I’m kind of taking the other side of that.
Preston Pysh 28:04
Very, very thoughtful.
Stig Brodersen 28:06
Jim, in your book “The Death of Money,” you discussed fixed exchange rates. And if you read a typical textbook about fixed exchange rates, it would typically highlight the advantage of limiting speculation and providing a stable trading system.
While I will also say that you need to be cautious about the inflexibility, your central bank would have, since you can no longer incentivize growth, which we talked about before, for instance, by lowering the interest rate.
So, could you please provide us with two cases on an economy which will benefit and not benefit respectively from such an exchange rate regime?
Jim Rickards 28:41
Well, it’s a great question, Stig. The world needs to go back to fixed exchange rates of some kind. I mean, there are a lot of ways you can structure it. Why do we have floating exchange rates because we didn’t know, from 1870s and 1914, the world was on what’s called the classical gold standard.
By the way, at that time, the US had no central bank. People are surprised that was the time we didn’t have a central bank. Well, from 1835 to 1913, no, we did not have a central bank. And there was no IMF, believe it or not. The world got along fine without the IMF. So, that was the classical gold standard.
Now, there was no supervising authority. It was a voluntary system, a country will say, “Hey, I’m going to peg my currency to gold at this rate. And I’m going to defend it at that rate. Also, if I want to deficit with you, and you want to show up with my currency and get the gold, I have to give you the gold. And conversely, if I run a surplus with you, and I take your money, and I show up with your banks, you got to give me the gold.”
In addition, gold moved back and forth as an equilibrating mechanism, when you started to run out of gold, you said, “Hey, I better tighten my belt here a little bit and make my industry more efficient and lower by unit labor costs and get back to surplus.”
And if you were running big surpluses, you were supposed to expand the money supply and that would be inflationary, and that would, you know, so it was sort of self equilibrating wasn’t perfect by any means, but it’s [a] pretty darn good system with nobody in charge.
But they were fixed exchange rates because everyone pegs to gold, then by extension, just transit *inaudible your peg to each other. In the Bretton Woods in 1944, they took that system and they formalized it with a couple exceptions. One is that the only currency pegged to gold was the dollar. And everyone else was pegged to the dollar. No surprise, we designed the system, so we put ourselves in the middle.
Now, by extension, it’s a fixed exchange rate system. But there was a little wiggle room, you could devalue against the dollar if you got IMF approval, and blah, blah, blah. There was a whole process and it happened every now and then. But the one thing that couldn’t happen was the US dollar could not devalue against gold.
And of course, that’s exactly what happened in 1971. But what was the intellectual genesis of that and who was kind of whispering and Richard Nixon’s ear in 1971, telling him that floating exchange rates were a good idea and fixed exchange rates were a bad idea?
The answer is our friend Milton Friedman. And that opens the door to a very interesting backstory because Friedman was the author, not the author, but the leading exponent of what’s called the Quantity Theory of Money, which is a very simple identity. So basically, how much money is there? How fast is a turnover, and that equals nominal GDP, which has two parts, the price index and real output.
And Friedman said, “Well, in a mature economy, real output, central tendency was about three and a half percent a year.” And Friedman used to joke that we don’t even need central banks, because we can just take a computer and tell them to do what I just described. Now there’s more to it than that. I’m being a little glib, but that was the basic idea.
However, this ran into something else, and this is really the backbone of international economics from the great Robert Mundell, and he and his co-authors articulated this [I] believe in 1961, which is called the Impossible Trinity, or sometimes called the Trilemma.
What this says is the following in international capital flows and international trade, there are three things you cannot have at the same time. You can have two out of three, or one out of three. But you cannot have all three.
The three things you cannot have: an open capital account, a fixed exchange rate, and an independent monetary policy, because if you have an open capital account, that means money can go in and out, all right? And if you have a fixed exchange rate, that means you stand ready to exchange your money for other people’s money at a set rate.
But if you have a monetary policy that’s independent of other central banks, then there’s always going to be an arbitrage because your rates [are] going to be too high or too low compared to somebody else. So, people are just going to suck your reserves dry, where you’re going to get massive inflows. There’s going to be some imbalance.
What Mundell said is that you can have two out of three but you cannot have all three. So you can have an independent monetary policy and it makes your trade if you close the capital account. Or you can have an open capital account and independent model policy, if you have a floating exchange rate.
Or you can have no open capital account and a fixed exchange rate, but you’ve got to tie your monetary policy to somebody else, kind of what China is doing right now raising rates as the Fed raises rates. Okay, so there’s the setup. There’s Mundell’s Impossible Trinity or trilemma.
And here’s Friedman’s Quantity Theory of Money. Now, what Friedman is saying to Nixon in 1971 was this is Friedman thinking behind the curtain… So Friedman is thinking, well, we need an independent monetary policy, we need to be able to dial money supply up or down to grow the economy, we need what’s called elastic money. That was the key word elastic money. If we don’t have that, then we don’t have the ability to get out of recessions or pull down expansions, etc, etc.
Well, that means you need an independent monetary policy. Now, obviously, everybody wanted an open capital account, the United States could not close the capital account. We weren’t Russia.
Friedman as an advocate for elastic money, under the Quantity Theory Money, said, “Well, if I want an open capital account, and I want an independent monetary policy, I have to have all the exchange rates. I can’t have fixed exchange rates because Mundell says I can’t and he was right.”
So, Friedman had a bias to blow up the fixed exchange rate system, to blow up Bretton Woods basically, and go to floating exchange rates, so he could solve the Trilemma and have the independent monetary policy. he wanted to pursue his theories under the Quantity Theory of Money.
What’s wrong with that? Well, everything Friedman thought was wrong. The whole, everything I just described, I spent 10 minutes describing an intellectual theoretical edifice. The whole thing comes tumbling down around one point. Velocity is not constant. Velocity is not constant and it is not constant because it’s behavioral is because it depends on you and I feel, like if you and I want to, we feel great.
We want to go out Friday night and go to a restaurant and see our friends at the bar and drinks on us. Spend money. That’s one state of the world. But if we feel depressed or frugal or squeezed, and we stay home and watch TV, and we don’t spend money, that’s a different state of the world. Well, those are different kinds of losses: me going out spending a lot of money and me staying home watching TV. I stay home and watch TV, my money has [a] velocity of zero.
Where trillion dollars times zero is zero. In other words, you can have all the money in the world. But if you have no velocity, you have no economy. And so, Friedman didn’t get the fact he thought people were kind of robots under like variations, efficient market theory and rational expectations.
Friedman didn’t quite get the fact that velocity was highly volatile based on psychological conditions, because in fairness to Friedman, velocity empirically was constant from 1950 to 1980, which is a long time and that was the main part of his working career.
But if you looked at data from the 1930s, we’re actually looking at data in the last 20 years, velocity fell off a cliff in 1998. And it’s been falling ever since. So the point being, once you say velocity is not constant and the whole Quantity Theory of Money, it goes out the window as a policy tool.
Now, it’s still interesting, as a thought experiment. I use it to help solve problems, but it’s not going to guide you to policy. And therefore, if you don’t need flexible money, then you can revisit the subject of fixed exchange rates.
So to answer your question, Stig, you asked for examples, I’d say there’s no country that’s better off with a floating exchange rate. The whole world would be better off with fixed exchange rates. We just have to bear the burdens and meet the responsibilities that come along with that. There’s one thing Friedman did get right. He said there’s no free lunch.
Preston Pysh 36:37
In a way Jim, isn’t this with the whole cryptocurrency movement as trying to establish as far as fixing the monetary baseline so that it can’t be manipulated in order to create this fixed medium of exchange? Is that what they’re really trying to do with the movement? That’s my opinion.
Jim Rickards 36:53
It’s part of I have a lot of reservations about Bitcoin and look, I’ve read all the original papers and I’ve started closely and I understand blockchain. I’ve been down in Tampa with US Special Operations Command working on methods for interdicting Bitcoin flows used by the Islamic State.
So, I’m not a technophobe. I’m not a Neanderthal, when it comes to this, but I have some serious reservations about Bitcoin. One of which is that it’s never been to a business cycle. Bitcoin was invented in 2009. We have not had a recession or a panic since then. So how would it behave and panic conditions may be just fine, but maybe not. So that’s one, one thing.
The other point I would make is the idea that there’s a maximum number of Bitcoins that can ever be produced, and they get progressively harder and more expensive. So that momentum slows down and you need more processing power and all that. Says who?
I mean, that’s the protocol, but the Bitcoin community of developers and miners can get together and change those rules. The same way Richard Nixon changed the rules on August 15, 1971. So, I’m not saying they will. I’m saying they could. So is it really any different than any other medium where you’re relying on a fixed rule, when it turns out your reliance is misplaced? That’s the second reservation I have.
Then I have others. But the thing is, Bitcoin floats. I mean, the dollar Bitcoin. If you think of Bitcoin as a currency it is a $1 Bitcoin cross, right? The same way there is with $1 euro request rate or a US dollar-Canadian dollar request rate, so it has no more of an anchor.
If somebody took Bitcoin and said, “We’re going to fix it in terms of units of gold, you know that to one bitcoin equals half ounce of gold, or whatever it is.” That would be interesting. How you enforce that, by the way, is a matter of law, separate question, but my view is the first currency goes to gold. It will be the only currency in the world that anyone wants.
Preston Pysh 38:46
So, Jim, when you say that, and we think through the dynamics of that isn’t a country that would adopt gold and make that they’re pegged currency to gold, isn’t that breeding a deflationary environment for them, so they’re disincentivized in order to do that?
Jim Rickards 39:03
Not necessarily, that could be the result. But it’s a question of getting the price right. You know, the old expression, you hear it all the time, you can’t have a gold standard because there’s not enough gold in the world to support the money supply. Well, that’s nonsense. I mean, there’s always enough gold. It’s just a question of price.
So if you pick a deflationary price, yes, it can be extremely damaging. It could put your country or by extension the world into a depression. That’s absolutely right. So just pick a non-deflationary price.
And of course, this is the blunder that Churchill made in 1925. He took the UK back to the gold standard at the wrong price. He went to the pre-World War One parody, after the Bank of England had doubled the money supply to fight the war. So that wasn’t going to work.
You either had to double the price of gold or cut the money supply in half to reestablish equilibrium, all by choosing the old price. They cut the money supply in half, and threw England into a depression three years before the rest of the world. Churchill later admitted that was the greatest blunder of his life.
And so, you can get it wrong. But the good news is that you don’t need calculus. It’s eighth grade math. You sit there, how much gold do I have? What’s my money supply? What percentage backing do I think I need to send up to the world? You know, 20%, 40%, 100%? And then do that math. That will give you an applied no- deflationary price. And bingo, there you go.
Preston Pysh 40:19
So you provide an example where it was priced wrong. And then would you say in 1933, they priced it correctly, in order to reflate the US economy. Would that be correct?
Jim Rickards 40:28
Yeah, the US did that in 1933. The UK did it in 1931. In 1931, the UK reversed the blunder of 1925. And the US in 1933 took the price of gold in $20 an ounce to $35 an ounce and that worked. That broke the back of deflation and simulated inflation and Roosevelt did not do it to reward gold holders. In fact, he was pretty clever. He confiscated all the gold before he did it. So the profits went to the Treasury, not to the American people.
But be that as it may, he wasn’t trying to make gold more valuable. He was trying to create inflation. He wanted inflation in oil, cotton, wool, and all the other commodities, and corn. It worked. [It] got the US economy out of a deflationary spiral. The US economy grew fairly well.
In 1933 to 1934, [the] stock market went up, so it can work. And in today’s world, you might take a one time hyperinflationary hit. Meaning that, when you do this math I described, you might discover that your currency is worth 5% of what you think it is when you express it in terms of gold at face price.
But once you do it, you know and make some adjustments for retirees or people who are savers, or people who might suffer the most. Bondholders might lose too bad, but what you would be doing is putting your enemy on a sound footing going forward.
Preston Pysh 41:44
All right, Jim. So this is the last question, and we want to give you an opportunity to talk about the relaunch of “The Death of Money.” So [tell] our audience what’s going on. Why are you relaunching the book?
Jim Rickards 41:54
Sure, “The Death of Money” came out in 2014. The New York Times bestseller and typically a publisher will bring the paperback maybe a year after the hardcover. Maybe not at all, depending on how they sell. But “The Death of Money” stayed in hardcover for three years because I’m happy to say it sold very well and found a very good audience.
Now, we’ve come out with the paperback edition, but we have a new preface that I wrote. So there’s some new material. And so, if you don’t have the book at all, get the paperback. Even if you do have the hardcover, you might want to pick up the paperback for the new material.
The new material specifically related to insider trading, in advance of 9-11, a subject I covered in chapter one. I talked about Project Prophecy at the CIA, where I was a co-project manager and we worked on market price signals to detect terrorist attacks with a lot of success. This is all post-9-11 when we were kind of you know, you pick up the pieces of that failure and then say, “Well, what can we learn?”
Also, one of the things we learned was that we could use market price signals to detect terrorist attacks, but after that came out, I put you know, whatever I could say that wasn’t classified. We put it in the book. But people read it.
And then, people started calling me, they came forward, they had their own stories, top Wall Street traders, people or primary dealers, people who saw things that they knew were insider trading, they weren’t terrorists. They weren’t folks. They didn’t do anything wrong.
They didn’t realize until after the attack, looking back on trades the day before the attack. There was no other explanation than the fact that somebody knew. And candidly, people want to unburden themselves.
One guy, just one of the top guys on Wall Street just told me his story in tears. I mean, he really just wanted to get it off his chest. So I put those stories in the book, not ones that I knew about at the time, but as a people came forward afterwards. I’ve been able to include some of those stories in the new paperback edition.
Preston Pysh 43:47
That sounds fascinating. So Stig and I have both read the original print that came out and just love this book. Every book that you’ve come out with Jim has just been phenomenal, and Stig and I have read all of them.
We can’t encourage our audience enough. Get out there, read Jim’s material. If you haven’t noticed yet, Jim’s brilliant. If you haven’t noticed that by now after two episodes, and his writing is equally brilliant, and I guarantee you, you will really learn a lot going through his material.
Jim, thank you for your time. Always a pleasure. We really hope to have you on the show again in the future. So, thanks for taking time out of your busy night here.
Jim Rickards 44:24
Thank you.
Stig Brodersen 44:25
All right, guys. That was all that Preston and I had for this week’s episode of The Investor’s Podcast. We will see each other again next week.
Outro 44:31
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IN THIS EPISODE, YOU’LL LEARN:
- Why Jim is a bull on the Euro and whether or not it can replace the Dollar.
- Why the world would be better off with a fixed exchange rate system.
- If a new currency that few have heard about will replace the monetary system as we know it.
- Why high economic growth won’t be happening in the US anytime soon.
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BOOKS AND RESOURCES
- James Rickards’ book, Currency Wars – Read reviews of this book.
- James Rickards’ book, The Death of Money – Read reviews of this book.
- Preston and Stig’s discussion with Jim about gold.
- Preston and Stig’s discussion with Jim about his book, “The Road to Ruin”.
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