Strengthen the Dollar or Face the IMF as 'Central Banker to the World'
Q and A with James Rickards
By Robert Stowe England
James G. Rickards is a lawyer, economist and investment banker with 35 years of experience in capital markets on Wall Street. His new book The Death of Money, published by the Penguin Group, is a New York Times bestseller. His first book, Currency Wars, published in 2011, and was also a Times bestseller. In his new book, he explores further the consequences of the weak dollar policy pursued by the Federal Reserve Bank, coupled with the huge run up in deficits and debt by the United States, and the failure of Congress and the Obama Administration to devise policies that would spur faster economic growth. Rickards is a portfolio manager at West Shore Group, LLC, Haddonfield, N.J., an investment fund set up in 2013, and an adviser on international economics and financial threats to the Department of Defense and the U.S. intelligence community. He gained first-hand experience on the front lines of a financial crisis as counsel for the hedge fund Long-Term Capital Management, when he was principal negotiator in the 1998 bailout of the fund by the Federal Reserve Bank of New York.
Q: Now, looking at the scenarios you point out in Chapter 11 [“Maelstrom”], it appears that most likely candidate to become the centerpiece and central reserve for a new international monetary system if the dollar collapses is something called Special Drawing Rights or SDRs issued by the International Monetary Fund is the. Would the SDR be backed by gold?
Rickards: I don’t think they want it to be backed by gold. I don’t think there’s a central banker in the world who wants gold-backed money. But, the point I make is that they may have to. They may have no choice. If people have lost confidence in paper money, such as the dollar, why should they have any more confidence in the paper SDRs?
[On the other hand,] they might [have confidence in SDR as a paper currency] for two reasons. Number one. No one understands it. I’ve spoken to international economists who don’t understand SDR. Certainly mainstream economists and market analysts certainly don’t understand it. Everyday Americans or citizens around the world don’t understand it. Why should they? It’s a very technical subject. I’ve met experts who don’t understand it. So you might be able to get away with it because nobody knows what it is. The inflation [in local currencies tied to the SDR] would show up the grocery store, at the gas pump, but nobody would know where it’s coming from. They would say oh, those guys at the IMF they’re crazy, you know. Good luck figuring out who they are – a bunch of Communists and dictators and kings. Its unaccountable, unelected super-elite who meet behind closed doors. No one knows what SDRs are. This is the stuff that infuriates me. This is world money but they don’t want to call it that. So they call it special drawing rights. Is there anything more anodyne and bureaucratic [a name for money] that you can think of? I can’t. They do this stuff on purpose for exactly the reason they don’t want people to understand it. So it might work in the short run on that basis. And, it might not.
Gold is sort of what I call Plan B. If you go to Plan B, the United States has enough gold. Europe has enough gold. China doesn’t. And so China has to get their gold in case we go to Plan B. And even if we don’t go to Plan B, just when you sit down at the table to come up with a new system, even if you don’t use the gold standard, your gold is going to be your chips [as you bargain and negotiate the design of a new system]. Think of it as a poker game, you want a big pile of chips. And the guys with a little chips -- they’re going to go to the little table. And the guys with a lot of chips are going to sit at the big table. And China of course, needs a seat at the big table because they’re the second largest economy in the world.
Q: One of the scenarios you lay out after the crash of the dollar and the international monetary system is that the dollar would survive the crash and again by the lead reserve currency because officials decided to back it with gold. If that happened, you estimate the dollar price of gold would be set at $9,000 an ounce.
Rickards: I quote the value of the dollar in a future international monetary system and by the way $9,000 is the right price. That has all kinds of consequences. How likely is that scenario? People say now wait a second, Jim. You said $7,000 in your first book Currency Wars. Now you’re saying $9,000. What happened? So, the answer is they printed another trillion dollars [since the first book.] I don’t make these numbers up. I use actual data. And it’s a very simple ratio of physical gold at market prices to paper money. It’s eighth grade math. It’s not difficult. So, if you change the inputs, you change the outputs. If you print more money you get a higher price.
Now, here’s what the number means. Again I’ll emphasize that there are analytics behind this. These are not just provocative numbers designed to get a headline. It actually comes from some place. Here’s what the number means. That’s the implied non-deflationary price. And what that means is that we don’t have to have a gold standard but if we do, you have to pick a price and you better get it right because if you get it wrong you can actually make things worse and create a super depression. This is what happened in the 1920s. From 1870 until 1914 the world had a very successful gold standard, the classic gold standard. In 1914 they abandoned that because they knew they had to print money and borrow money to fight World War I.
So when World War I was over there was actually a period of turmoil. In 1919 and 1920 you had deflation and hyperinflation going on side by side. There was extreme inflation in the United States in 1919 and then we had the depression in 1920. And then you had hyperinflation in Weimar Germany in 1922. This is a period of enormous turmoil in the international monetary system and of course there wasn’t a gold standard. So in 1922 there was an international monetary conference in Genoa, Italy, and the major powers agreed to go back to a gold standard. But, it was a very bastardized form of gold standard called the gold exchange standard.
Q: So, what was the problem with a gold exchange standard?
Rickards: Here’s the problem. Having abandoned [the gold standard] in 1914 at a certain parity and having printed enormous amounts of money to fight World War I, and now deciding in 1922 to go back to the gold standard, what would the new price of gold be measured in your currency? Well, you sort of had two choices. You could be candid about the fact you had printed all the money and go back to a new parity where your currency is divided by half. That is one choice. And that is what France and Belgium and some others did.
Or, you could back to the old parity. Because it’s always a ratio of paper money to gold. So the amount of gold is pretty much fixed, so if you doubled the amount of paper money and you want to go back to the old parity, you have to cut the money supply in half. And that’s what England did in 1925 when Winston Churchill was Chancellor of the Exchequer. Well, that meant cutting the money supply in half, which they did and which threw England into a depression three years ahead of the rest of the world. You know people kind of date the depression from 1929, but England was severely depressed in 1927 and 1928. Churchill later said that was the greatest blunder of his life because he was a good general and good statesman but not a very good economist and he understood the implications.
And now come all the way forward to 2016 and 2017 and we’re at the international monetary conference and we’re basically trying to do same thing, rewrite the rules of the game. I make the point that you don’t have to have a gold standard but if you do, you better not repeat Churchill’s blunder. You better not pick a price that is so low that the implied money supply cannot finance gold trade and world commerce without causing a depression. So, the question is what is the right price? And the answer is $9,000 an ounce.
Q: Now, if the United States wants to avoid losing its leading role in the world monetary system, you indicate it could do so by returning to a set of strict monetary policy rules like those put into place in the 1980s, when Paul Volcker was chairman of the Fed and the Reagan Administration pursued a King Dollar strategy. If such policies were put in place, you say that could preserve the role of the dollar.
Rickards: Correct. Those rules had to do with what is a sustainable budget deficit and what is a sustainable debt load. And when I say sustainable I mean based on your debt and deficits, your total debt-to-GDP ratio and your ongoing deficits, what set of conditions is the market will to go along with you? OK, you’ve got a lot of debt and you’re running deficits, but your economy is such that we believe you are now on a sustainable path and we will continue to buy your bonds. And what I talk about in Chapter 7 [“Debts, Deficits and the Dollars”] are the formulas for that. And the theory if you stay within those boundaries, you don’t need a gold standard and you’re not facing a sovereign debt crisis and you might not be facing a currency collapse. You can kind of keep going. So that’s what I really talked about and I outlined those metrics.
The problem for the United States is that despite all the happy talk from Washington, we are continuing to go down the path to Greece. Now in the last year, year and a half there’s a lot of self-congratulations in Washington because we’ve cut the budget deficit in half, which is true. The budget deficit in round numbers has gone from about $1.4 trillion to about $700 billion in two years. That is true. But the debt to GDP ratio is still going up. It is still going up because even if you bring the deficit down from 8 percent to 4 percent of GDP, if your GDP is only growing at 2 percent, you’re still making the debt-to-GDP ratio worse even though you cut the budget deficit.
So, the budget deficit cannot be thought of in isolation as an absolute number. You have to think of it relative to the economy. And since economic growth is weak, cutting the deficit isn’t enough. And I’m asked if that means you have to cut the deficit further and I say you have to either cut the deficit further or you have to figure out a way to grow your economy. That’s where the austerity structural change that Europe is going through comes in. Europe is doing everything right. It’s been painful but they’re restructuring things in ways that will be sustainable, all under the direction of Angela Merkel and that’s what I talked about in Chapter 5 (“The New German Reich”). But the U.S. is not doing that. So, we’re still driving the bus off the cliff. We’re just going a little bit slower.
Q: Seeing how well Europe has handled its crisis and the sustainable path they have chosen and the amount of gold they have – which is the highest gold to GDP ratio among regions of the world – why would Europe and the euro not become the leading reserve currency in a new monetary system?
Rickards: Well, it might and I can’t rule it out. And to put a finer point on that, there’s one big thing standing in the way right now and it may go away in a few years and then the euro might play that role. But here’s the impediment. This has to do with the difference between a reserve currency and a trade reserve currency. You hear a lot of talk about the Chinese yuan. They are doing bilateral deals with Brazil and they’re opening up a yuan bond market, doing all these things deals around the world, doing deals with us, opening the capital account in small stages, widening the trade deficit. All that has to do with making the yuan a trade currency. But being a reserve currency is different.
To be a reserve currency you have to have a very wide pool of investable assets. Because what are reserves? Reserves are just a savings account for countries. So, we make a certain amount of money and we spend some of it and we have some left over. Those are our savings. And we put them in the bank and maybe buy some stocks or whatever. It’s no different for a country. If you export and import and you export more than you import, and you have capital inflows, you end up with savings and that’s what your reserves are. You have to invest them in something. When they’re $4 trillion, as in the case of China, or a $1 trillion plus for a country like Taiwan, Korea and others, you need a really big pool of assets [in which to invest]. You can’t buy $4 trillion of Australian bonds. I don’t think all capital markets in Australia are close to that.
So you can’t buy stuff like that beyond a certain amount. So, what’s standing in the way of Europe? Well, the Eurozone as a whole is bigger than the United States in terms of population and I think the economy is slightly smaller but it’s on a par. But the sovereign bond market is chopped up. You’ve got Italian bonds, French bonds, German bonds, etc. Now, imagine all those countries had a bond market where every bond was backed by the full faith and credit of the entire Eurozone. That would be comparable to the U.S. Treasury market and that’s what they mean to do. And then at the point you’d want euros because then at the point the bond market would be big enough. Right now it’s not. I mean, the Italian bond market is the biggest of the bunch but even it is not big enough for the kind of capital flows we’re talking about. And, you’re concentrating risk. You’re taking concentrated Italian sovereign risk. Or Spanish sovereign risk – exactly what the whole European sovereign debt crisis was about from 2010 to 2012.
But if you unify and back it by the full faith and credit of the entire Eurozone, now you’re talking. Now they’re trying to do that. But Merkel won’t let that happen until all the fiscal costs have gone through. She doesn’t want to write a blank check. So she’s holding that as a carrot to the stick. The unified credit backed by the full faith and credit of the Eurozone, which is basically Germany, is the carrot. But the stick is get your fiscal house in order. But they’re doing that. They’ve signed a fiscal treaty. They’re monitoring it coming out of Brussels and the IMF. They now have unified banking regulation. They’re going to have unified deposit insurance. They’re doing a lot of things in steps. But they’re still a few years away. No one knows exactly. But my estimate is that they are at least three years away. They may be a little longer before they can have a unified European sovereign debt market. So that’s what’s standing in the way [of being able to have the euro as take a greater role as a reserve currency]. But if they got there, and the system doesn’t collapse in the next five years, and Europe goes to a unified sovereign bond market backed by the full faith and credit of the entire Eurozone, at the point you do have a viable alternative to the Treasury market. And I would expect the European component of the reserves to go up significantly and the dollar would go down.