August 2014 Interview with Jim Rickards topics:
*Russia is employing “hybrid warfare”
*Can the Ukraine conflict escalate into a larger scale shooting war involving NATO and Russia
*Sanctions vs. Russia are not working and are having a negative impact on the global economy
*Putin trying to re-assemble the Russian empire
*Unintended consequences can be a catalyst in a critical state system
*The FBI / NSA / Homeland Security found an attack virus in NASDAQ system software originating from Russia
*How Russia is circumventing the impact of sanctions
*Gold cannot be hacked because it is not an electronic asset
Jim Rickards Interview: 8-8-2014
JW: Hello, I’m Jon Ward on behalf of Physical Gold Fund and Anglo Far-East. We’re delighted as always to have with us here Jim Rickards. Mr. Rickards is an investment banker and investment adviser based in New York, and he also serves on the Investment Advisory Committee for Physical Gold Fund. He is the author of the New York Times bestseller Currency Wars: The Making of the Next Global Crisis and more recently he authored The Death of Money: The Coming Collapse of the International Monetary System, also a New York Times bestseller. Welcome, Jim.
JR: Thank you, Jon. It’s great to be with you.
JW: Jim, the world has been a bit short on peace since we last spoke. We’ve been witnessing major conflicts in Gaza, Iraq, and Ukraine. Setting aside, if we can, the horrors of war, all this conflict has, of course, enormous significance for the world economy. Today I’d like to focus with you on one area, the conflict in Ukraine. Using the categories you employ in your books, we can see the Ukrainian conflict in terms of both kinetic warfare (actual shooting) and financial warfare. Let’s begin with the kinetic side, the actual warfare. To briefly recap, as we’re conducting this interview today, Ukrainian forces seem to be gaining the upper hand and are closing in on the rebels’ major strongholds. Meanwhile, the Russians are building up significant forces on nearby borders. How likely, in your opinion, is a real shooting war here?
JR: I think this is highly likely. First of all, we have a real shooting war already. Ukrainian aircraft are being downed at a rate of several a week. The tragedy with Malaysian Airlines Flight 17, a civilian aircraft with almost 300 lives lost, was probably accidental — at least in the sense that someone launched a missile probably thinking they were shooting down a Ukrainian transport plane of some sort, and they hit a civilian aircraft. We don’t really know, but that aside, there are aircraft, helicopters, and military transport aircraft that are said being downed almost daily and there is actual fighting going on.
The question is, will it escalate? Will Russian troops be directly involved? What’s going on is a doctrine the Russians are very good at but the U.S. is not so good at. It’s called hybrid war. We’ll get to the financial side of it in a minute, but even in just the strictly kinetic sense, hybrid war means you’re using a combination of assets. You have some indigenous fighters, some sort of pro-Russian separatists or people of Russian ethnicity, who live in Eastern Ukraine. Remember that Ukraine was a republic of the Union of Soviet Socialist Republics for decades prior to the breakup of the Soviet Union. It’s an independent country today, but historically it’s really just part of a Russian Empire, so it’s not surprising that there would be a lot of Russians or people of Russian ethnicity in Ukraine, particularly Eastern Ukraine which borders Russia.
So you have these indigenous fighters, then you have probably Russian commandos. These are Russian insurgent leaders who are slipping over the border, such as the famous little green men who showed up in Crimea. They may have generic uniforms or purport to be Ukrainian separatists, but they’re actually Russian operatives. Some of them are from the intelligence services, not just the SVR which is the Russian foreign intelligence services equivalent to the CIA, but also the GRU, which is their military intelligence services. Some of these are operatives or paramilitaries. And then you have the potential for regular Russian troops, as we’ve heard reports of artillery fire and anti-aircraft fire coming from across the Russian border. All in all, you have a straight up Russian military, Russian operatives and paramilitary intelligence, and you have indigenous fighters all blended together in ways that are a little bit difficult to untangle. This is what we mean by hybrid war.
Throw in financial warfare on top of that,and these tit-for-tat sanctions that seem to be increasing. We talked about this in prior podcasts and warned months ago how that could escalate and spin out of control. This creates a very subtle, hard-to-untangle mix that is difficult to analyze, but this is how the Russians operate. They’ve operated in the past this way, and I think Putin is the master of this. He is an accomplished martial artist, has a very high IQ, is a multilingual intelligence officer, and is a very good chess player. He’s demonstrating his chess-playing skills on the global chessboard as we speak.
JW: What are the dangers of this conflict spreading into a Europe-wide conflagration that will drag in NATO and the United States on a military level?
JR: I think the odds that this drags in NATO and the United States on a military level are low. The president has proved very reluctant to use military force anywhere. Without debating whether that’s a good thing or bad thing, it’s just the case, so I think we can be sort of nonpartisan, non-hyperbolic about it and just treat it as a data point or as a fact in our analysis, without getting dragged into some of these contentious debates that go on. The President of the United States had said himself that he’s very reluctant to use American forces. Now we have these recent developments where some force is being applied in Iraq. It’s certainly the last thing the president wants to do. It’s very surgical, very limited, and has specific goals in mind, but even at that and announcing it, the president made it clear that this was something he hoped not to do.
The idea that anything larger would come out of Ukraine is remote. Russia would have to actually invade a NATO ally, and of course, Ukraine is not part of NATO. Certainly, if Poland were involved or the Baltic republics or any member of NATO, then, yes, you’d have possibly the beginnings of something that looks more like World War III. I think Putin is smart enough not to do that, and I think NATO will be restrained in the absence of that, so Ukraine itself will not be cause for a wider shooting war with NATO. It does bear some analogies, however. We’re here remembering or recalling the 100th anniversary of World War I. World War I started through a series of action-response functions, blunders, and miscalculations. Historians look at it and shake their heads, because it didn’t have to happen. It was one of the bloodiest and most destructive wars in history and yet probably fought for no good reason. And analogies bear watching.
I feel this as perhaps more similar to World War II, where Poland was the tripwire, but Adolf Hitler and the Third Reich were able to successfully peel off half of Czechoslovakia and all of Austria without a shot being fired. I see Putin more like Hitler trying to take what he can without launching a war. Ultimately Hitler did launch a war by invading Poland, and that triggered a declaration of war by the U.K. and France and others who were duty-bound by treaty to come to the aid of Poland. If Russia crossed into a NATO ally, I do think you’d see something that resembles Hitler’s going into Poland where it would be a shooting war among major powers, but I think Putin is smart enough to stop short of that. He can do a lot — including invading Ukraine — without triggering that function, so I think we’ll see more turmoil, more violence, more outright warfare, and probably a Russian invasion of Eastern Ukraine. That will have ramifications worldwide, particularly financial, and it will certainly affect relations between the NATO powers and Russia, but I don’t think that by itself will lead to a wider war that would include NATO forces.
JW: Before we turn to the financial warfare side, the U.S. has recently accused Russia of violating a major nuclear arms treaty, the 1987 treaty, which the Russians in turn are threatening to abandon. Given what you’ve just said, perhaps this is not such a serious development. Do you have any comment on that aspect of the story?
JR: In terms of treaty, international legal norms, and strategic thinking, it’s a very big deal, but as a practical issue, it doesn’t matter, because Putin doesn’t care. To me, that is the biggest miscalculation the West has made. We just talked about how there won’t be a wider shooting war if this is confined to Ukraine, which I expect it will be, but we are in a financial war and sanctions are being applied. Sanctions have a nice rather clinical antiseptic ring to it — it’s one of those neutral words — but the listener should understand that this is a financial war. We’re fighting a war with Russia right now. It’s just that we’re fighting it in capital markets and commodity space rather than kinetic space.
The miscalculation the West has made applies to this treaty and also to the financial war. This might be a good segue into the fact that Putin doesn’t care. We put on sanctions, he doesn’t care. He escalates the violence, we put on more sanctions, and he doesn’t care. He escalates again, we put on more sanctions, he puts on counter sanctions, and he still doesn’t care. What the West has to understand is that this is not working. Now, President Obama made a very revealing comment the other day, and a lot of people criticized him for sounding confused, but he was actually making a point. When asked at a press conference if sanctions are working, he said, “We don’t know if they’re working, but they are working as intended.” That’s almost a verbatim quote listeners can look up. Again, he said, “We don’t know if they’re working yet, but they’re working as intended.”
A lot of critics came out and said, “What are you talking about? You’re trying to have it both ways.” What he meant when he said “working as intended” was that if we ban a certain bank from raising funds or we ban certain financial transactions or we freeze certain assets, then yes, those assets are frozen and those banks are not able to raise money. When he said “it’s not clear if they’re working,” he meant it’s not clear if it is changing Putin’s behavior. The key point is that we put the sanctions on: we actually mechanically watched these banks and Wall Street. We make sure that nobody is lending money to anyone they’re not supposed to lend to, etc., so at an implementation level, they’re working, but they’re not working in the sense of Putin’s behavior changing.
What’s the source of this blunder? Are people dumb? Do they just not get it? I think the source is that a lot of our strategic thinkers have gone so long—really decades—since having to think strategically in military and kinetic space. We’ve had brush fire wars such as in Iraq. That was a big deal, but Iraq wasn’t a great power. It was a big war and a lot of lives were lost, but nobody thinks of Iraq as a great power. When you go up against Russia or China and potentially Iran, you are looking at something more like a great power confrontation where the world has been at peace for a long time.
We’ve had decades of very strong economic growth, although very weak in recent years. Going all the way back to the 1980s and the end of the Cold War in 1991 and growth in the 1990s, those were two decades under Republicans and Democrats (the Reagan administration, George H. Bush, and also Bill Clinton) when we had very strong economic growth. Walls came down, markets were globalized, finance was globalized, capital controls were taken down, free-trade treaties were signed, trade expanded, growth expanded, and people got richer including the middle class. Folks simply became very accustomed to thinking about everything as an economic problem and forgot about thinking of things as strategic and military problems.
Along comes Putin. He’s like something out of the 19th century with 21st century technology. When Obama criticized Putin as a little bit of a throwback, he was right, and I think Putin’s proud of it. Putin is trying to reassemble the Russian Empire. The Soviet Empire was really a Russian Empire in communist drag. Go back to the 18th and 19th century when there was a very ambitious effort to create a real Russian Empire, and I think Putin is looking more at people like Peter the Great than he is at Khrushchev or Stalin for his models.
President Obama has pointed to the U.S. Treasury as our strategists. There’s a financial war room in the U.S. Treasury where they sit around a table and come up with these sanctions. Obama says, “He’s my favorite combat commander.” Well, that’s a pretty big statement. Think about the major combat commands such as USCENTCOM, PACOM out in Hawaii, AFRICOM, and our major combat commands around the world. Think about famous generals like General Petraeus, General McRaven, and other special operations commanders who directed these forces. Now here is Obama pointing to a bureaucrat — pretty smart guy, but basically a bureaucrat — the Treasury, saying he’s my favorite combat commander.
What’s the source of this confusion? The source is that everyone thinks in terms of wealth maximization and efficient markets. We say if we start to push Russian banks out of the financial system, start to limit their capital-raising capabilities, and start to impact their trade deficit and economic growth, it’s going to be so painful on Putin that he’s going to back off, because why wouldn’t you want to maximize your wealth? The answer is there’s more to geopolitics than wealth maximization. Putin is not a wealth maximizer; he’s a power maximizer.
Wealth and power can sometimes run together, but they don’t have to. You can spend wealth to gain power with the view that maybe you get more wealth in the long run. I pointed out in chapter two of my book The Death of Money that aircraft carriers are not free. The United States is in the process of upgrading our strategic aircraft carrier fleet and going to something called the Ford class after the previous Nimitz class and Enterprise class. This is a trillion-dollar exercise to build a fleet of these carriers — the support vessels, the land support that goes with it, the communications channels, and all that. You’re spending a trillion dollars or more to put all this together and operate it, so that’s not free.
When the president says we’re going to impose costs on Putin if he takes Ukraine, of course he’s imposing costs, and there are costs that the Russian economy is suffering, but Putin says that’s a price worth paying. We in Russia are not building a fleet of Ford-class aircraft carriers and spending a trillion dollars. We’ll spend our money in other ways. In effect, we’ll incur those costs in other ways by seeing our economy slow down, but it’s a cost worth paying, because we’re getting Ukraine or securing natural-gas routes or securing energy customers or we’re putting Europe under our thumb or we’re achieving other geostrategic, geopolitical goals.
Too many of our strategists in Washington are wearing these efficient market hats. They need to take those hats off, put on their geopolitical hats, and understand that nothing is free and that imposing costs is just a result of doing business from Putin’s perspective. That’s why the sanctions are not working.
JW: Is there another aspect of this in a sense that both sides of the financial war are pussyfooting around a little bit, because if they really took the gloves off, they’d hurt themselves as much as they hurt each other. In other words, there are significant constraints on the kind of sanctions America can impose on Russia without damaging its own economy. Conversely, Russia has just banned food imports which seems a little trivial. Are they also being a bit cautious in their tit-for-tat on the sanctions aspect because they don’t want to hurt themselves?
JR: There’s no question about that, Jon, you’re exactly right. If you separate what the U.S. is capable of doing from what we’re actually doing, those things are night and day. Let’s just talk about the capabilities. Of all the things the U.S. has talked about and threatened, of course we haven’t done them all. We’ve actually done very little. It’s interesting to observe Putin’s behavior. Of the things we’ve talked about, the one that hit Putin where it hurts that he reacted to in an immediate and very tangible way, believe it or not, was cutting off MasterCard and Visa. You would think that the banking sanctions or trade sanctions or freezing of the assets or going after the oligarchs would be more meaningful. No, it’s MasterCard and Visa.
Let’s discuss the reason for that. Prior to the end of the Cold War, consumer credit in Russia and things that we take for granted like online banking, direct deposit, paychecks, debit cards, and credit cards simply didn’t exist. The ‘90s were a period of turmoil when Russia tried to modernize, but corruption, the gangsterism — and Yeltsin drinking three quarts of vodka a day probably didn’t help — so Russia was really in chaos. It wasn’t until the early 2000s that Putin was able to establish some order and allow these large payment processors. MasterCard and Visa are among the largest payments processors in the world. They’re certainly the largest in consumer credit, and they dominate the Russian bankcard market. Interestingly, China has their own bankcard. I think it’s called Unicard if I’m not mistaken. You can use MasterCard and Visa in China, but China has set up their own system. Russia hasn’t, at least not to any great extent. By the way, Japan has the JCB card which is very popular in addition to MasterCard and Visa.
Remember to look at the popularity ratings. Obama’s popularity ratings are sinking to an all-time low. He’s down to about 40% which is the lowest since he was sworn in as president. Once a president gets the 3 handle, when you’re 39% or lower, you’re in serious trouble, and that’s where Obama is. Putin’s approval ratings are in the high 80s and rising now. Make some allowance for the fact that some of that data may be hyped a little bit, but he is extremely popular in Russia. There is nothing that would make Putin unpopular faster than telling Russians their credit cards or debit cards don’t work, so that’s why Putin reacted. He did two things: He basically told MasterCard and Visa that they had to post a multibillion-dollar cash bond, and if there was any discontinuity in the processing of credit card transactions, they would forfeit the bond. Right away that put MasterCard and Visa between a rock and a hard place, because they are subject to U.S. sanctions. We haven’t imposed them or triggered that, but if we did, they would have to go along. On the other hand, Putin is saying if they do, they’re going to have to forfeit billions. Of course, Putin could then use the billions to build his own system. In fact, they’re now working on their own system. Russia could also turn very quickly to China and say, hey, why don’t you guys come in? Your Unicard system works so let’s just plug that into our systems. Who knows, maybe they’d hire Oracle, IBM or SAP or somebody to build a system very quickly.
That’s really hitting Putin where it hurts. We could do other things like the kinds of things we did to Iran. Telling a U.K. subsidiary that they can’t raise capital more than one year forward hurts a little bit, but telling the Russian banks, VTB Vneshtorgbank and Sberbank, their two biggest banks, that they cannot process dollars anywhere in the world, or worse yet going to SWIFT and saying you can’t even process other currencies like euros, Swiss francs and so forth, would paralyze them. We haven’t done any of those things. Why not? Obama said we don’t really seem to be affecting behavior very much. Well, I can guarantee you that cutting VTB out of the global dollar payment system or turning off MasterCard and Visa in Russia would cause a change of behavior immediately. So why don’t we do that?
The answer is that Putin can push back, maybe not in credit card space, but he can do a number of things — freeze U.S. assets in Russia, or dump his U.S. Treasury securities. There’s a cost associated with that, but everything has costs. This idea of pointing to a particular action and saying they would never do that because it would cost them money is nonsense. Of course, it costs them money, but it’s a price they’re willing to pay. That would basically cause a spiking in U.S. interest rates, sink our housing market, sink our stock market, etc. But Putin has an even more powerful secret weapon, which is his ability to close U.S. stock exchanges. Imagine if you woke up one day and learned that the New York Stock Exchange was closed and no orders were being processed. They were trying to get it to reopen… almost like the power going out in a storm or hurricane or something for a few days, and they eventually restore it.
Imagine being told that the New York Stock Exchange was closed, and all of your so-called liquid stocks or 401(k)s were suddenly in effect private equity. You had no idea what the price was. There’d be good reason to believe that the price was plunging at that point, because there would be panic selling and no idea when the exchange would reopen. That’s what Putin can do. So you’re right, we are tiptoeing around these sanctions. They have the appearance of doing something, and it’s probably better than doing nothing, but neither side really wants to escalate. The real impact is to world growth. Even the sanctions we have now, which are very tame, are hurting growth in Russia and hurting world trade.
If you look at what the IMF and the BIS (the International Monetary Fund and the Bank for International Settlements) have been saying in their public statements over the past two weeks, Christine Lagarde and Jaime Caruana at the BIS are saying that world growth is hanging by a thread. They’re acting like cheerleaders in terms of what appears to be a good U.S. growth although that’s very superficial and not as strong as second quarter GDP made it appear. World growth in China is slowing down, Japan seems to be back in a funk, parts of Europe are in recession, the U.S. is not as strong as it looks, and emerging markets are suffering. World growth is slowing down. This whole bubble that’s been created the last few years is just starting to collapse… the air is being let out, so to speak. And along comes a financial war with Russia, so that’s not helping.
The third thing: Firstly, they don’t want to escalate, because escalation could lead to the financial equivalent of a nuclear war with the New York Stock Exchange actually being closed. Secondly, even at best, it’s slowing down world growth at a time when world growth is tenuous. The third factor, I think, restraining behavior is the prospect of an accident. When you get into these complex systems and game theoretic war fighting scenarios, even in financial warfare, there’s the risk that somebody pushes the wrong button or they press the right button but there’s an unintended consequence and things spin out of control in completely unexpected ways.
Now you’re back to the World War I analogy. Imagine going to the Kaiser, Emperor Franz Joseph, Czar Nicholas, Lloyd George, leaders of the major European powers and so forth in June of 1914, getting them all in a room and saying, “Gentlemen, the course you’re on will have the following results: Twenty million people will be killed, world trade will come to a halt, your countries will be devastated, you’ll set the stage for even worse things to come including Nazism, the Austro-Hungarian Empire will fall, the Ottoman Empire will fall, the Russian Empire will fall, and we’ll have the beginning of the bankruptcy of the British Empire and the ultimate demise of the British Empire. Now, do you want to go ahead?” In other words, if you had painted that future picture to the leaders, they would say, “What are you talking about? We’re going to stop this right now.” They didn’t. They didn’t think ahead and understand the consequences. They blundered, and all those things came to pass. So if you start playing footsie in the financial space, actually start a financial war, could it lead to a global catastrophic financial collapse that would be the financial equivalent of World War I and World War II combined? The answer is yes and all the more reason to pull back.
JW: Let me just clarify one small point, if I may, in that very large answer. When you say that Putin could, if he chose, close the New York Stock Exchange, are you referring to the notorious Russian hackers?
JR: Yes, but it’s not speculation, Jon. I have been speaking about this for years, and I mentioned it specifically in my first book, also in chapter two of The Death of Money. But let’s put some concrete facts on the ground so the listeners can realize we’re not just speculating. On August 22, 2013, the NASDAQ was closed for half a day, just shut down. They have never given us a credible explanation as to what happened. Now, they certainly looked into it, and if they had discovered the problem, they could have and should have told us about it by now. They should have said there was a bad piece of code or an engineer blundered or we were updating some software and the update didn’t go well and that’s why we shut it down. They’ve never told us.
Why not? Surely they know by now, so why haven’t they told us? The answer is it’s probably something nefarious, it probably was hackers. Now, they could be Russian or Syrian or Iranian or come from a number of sources. Imagine a press release from NASDAQ saying, dear investors, the reason we shut down the exchange in August 2013 — only a year ago, by the way; this wasn’t 15 years ago, it was not even a full year ago from the date of this podcast — but the reason we’re not telling you is because actually it had to do with a Russian virus or attack. Investors would sell everything and move to gold which they should do to some extent anyway. You should have some physical gold, because one of the things I like about physical gold is that it’s not digital. You can’t hack my gold, you can’t delete and erase my gold, and you can’t hijack it or infect it with a computer virus, because it’s physical bullion. That’s one of the great things about having physical gold in your portfolio — not 100% by any means, but at least 10% just to give you that insurance and have something that can’t be hacked. So it’s highly likely in my view that this was an attack virus, and the reason they’re not telling us is because they’re worried it would cause panic, and there are national security implications to that. That’s one fact.
Let’s go now to a recent article, and I give Bloomberg Business Week credit for breaking this story. The story itself is old, going back to 2010, but it was only in late July 2014 when their cover story was called “The NASDAQ Hack.” You can easily find it online. I’ve written about it and others have as well, when the NASDAQ, with help from the FBI, NSA, and Department of Homeland Security, actually found a Russian attack virus in the NASDAQ operating systems. This is not speculation or the range of probabilities. They actually found the bug, traced it back to its source, and determined that it was an attack virus. It wasn’t a criminal gang, it was the Russian state.
Credit to the Business Week reporters for getting the scoop, but often that stuff is spoon-fed to reporters from official sources and you have to wonder why that story came out now. (There’s nothing wrong with that, by the way.) So why now? I don’t know for sure, but my suspicion was that somebody in the administration wanted to reveal the extent of Russian invasion of U.S. financial exchanges as a way of perhaps showing the Russians that we knew what they were up to as part of this financial war we’re talking about. Read the article. It has quotes from NSA officials saying that this had the potential to close the exchange.
By the way, this is something I know about more than just as a bystander. My former company was OptiMark Technologies. I used to run this company as the second ranking officer along with the CEO, one of the co-operating officers of this company at the senior level, which actually built the NASDAQ order entry system called Super Montage. We were building our own stock exchange within NASDAQ in sort of a joint venture to build a special facility within the NASDAQ. It was a little bit like some of these electronic exchanges and blind pools we have today, except this was much earlier in the timeline and we were one of the first. In time, because we were so well acquainted with NASDAQ, we were actually hired as a development company to build their order entry system, and we did. In building that software, we worked very closely with their teams in Connecticut and elsewhere, so I have good inside working knowledge of NASDAQ operating systems, if you will.
I read about this particular virus although I had, again, spoken and written about it much earlier in other respects, so we’re not speculating here, Jon. This stuff is real and it’s happening. No one’s pushed the button or launched that nuclear weapon, but they can whenever they want. How many bugs have we not discovered? What’s going on in the New York Stock Exchange? That’s what’s waiting for us down this road of financial warfare, so I do think that’s a reason why people are not in a hurry to escalate. A lot of what’s going on is kind of for show and certainly not changing Putin’s behavior in Ukraine as we discussed. More to the point, leaving aside the politicians and geostrategists, if I’m an investor, I don’t want all my wealth in digital form. I want some of my wealth in tangible form, whether it be land, fine art, silver or physical gold, because those are the things that cannot be wiped out in a computer.
JW: The financial war we’re discussing, this conflict at whatever stage it’s at, is not simply between, say, Russia and the United States. There’s at least one other major player in the story, and that’s Europe. As I understand, Europe has a huge dependence on Russia for its primary energy supply. How does that play into the story? One thing the Russians could do is presumably turn off the tap, close the faucet, and not supply Europe with much needed energy. Do you think that’s a possible scenario? Is it likely, and what would the implications be?
JR: Good question, Jon. It’s not only possible and likely, it’s actually happened several times. I talk about this in my first book, Currency Wars, that came out in 2011. I’m happy to say that it’s still selling very well, by the way, and I encourage listeners even if they’ve read The Death of Money to pick up Currency Wars because it’s still fresh. The book is almost three years old, but open at chapter eight and there’s a long discussion about Russia, Ukraine, and natural gas as a weapon, the same serious concerns we’re talking about today. This is old news to anyone who read Currency Wars three years ago when it first came out, but I encourage people to pick it up today because it’s still very timely. In fact, Russia has turned off the natural gas several times, and parts of Europe froze in the dark in the early 2000s as a result of this weapon.
Putin’s excuse was always about unpaid bills. He said, you Ukrainians are not paying your bills. Very interesting how it worked in practice, because the natural gas pipelines, not all of them but many of them, run from Russia through Ukraine to all of Europe. They connect to the European pipeline network. The percentage of Russian gas that people get varies from country to country. For some of the Eastern European countries — Romania, Hungary, Bulgaria, and others — it’s a very high percentage. When you get over to Germany and France, it’s a significant percentage that’s not quite as high as some of those Eastern European countries, but they’re all dependent to some extent.
There’s a certain quantity of flow with gauges and ways of measuring that. Russia would say to Ukraine, everyone else paid their bills, but you Ukrainians have not paid your bills, so we’re going to reduce the flow by the amount of gas you haven’t paid us for. Of course, gas is gas. It’s a molecule that’s fungible. So when the Russians pumped gas for everybody else and reduced the flow by the amount that the Ukrainians hadn’t paid for, all the Ukrainians did was take their gas anyway. They reduced the flow further down the pipeline, so the guy at the end of the pipeline was the one losing gas and Ukrainians kept taking what they wanted off the top even though they hadn’t paid their bills. Putin knew this would happen, because he’s not a fool, but the point being you always have a very convenient excuse for turning off the gas because Ukrainians don’t pay their bills. The impact is felt further down the food chain, if you will, down the pipeline by the end user who’s getting less flow because Ukrainians skimmed off the top.
Now they’re building new pipelines. There’s North Stream that comes in across the Baltic directly into Germany bypassing Ukraine. It’s one of the reasons for a very tight alliance, by the way, between Russia and Germany. Angela Merkel has to do what she has to do in terms of standing up publicly and chastising Putin over his actions in Ukraine, and the Germans have joined some sanctions but not very many, not even as many as the United States. The short answer to the question is, yes: parts of Europe may be freezing in the dark this winter and this is not speculation because Putin has, in fact, done it before and he’ll do it again.
JW: There are a few commentators who see not only Putin having an agenda of expansionism as you’ve described in terms of restoring the Russian Empire. There are some people who still see an expansionist agenda in the United States. Do you buy into that or do you see the U.S. as primarily in a defensive posture in this current conflict?
JR: I don’t even see the U.S. in a defensive posture. I see the U.S. in retreat, and that’s Obama’s policy. He’s the commander-in-chief. Again this is clearly not my speculation. Just look at the president’s own speeches and his famous West Point speech a few months ago in May or early June where he laid out what might be called the Obama doctrine of very, very limited engagement. Actually, I would say no engagement except in very limited circumstances, let’s put it that way. We’re seeing this play out in Iraq, Syria, Libya, Ukraine, and in the South China Sea. We’re seeing it around the world.
I want to be clear that I’m not here to debate policy. I may have a policy view and the listeners will have their views, but I’m not here to say whether this is right or wrong. I’m here to say it’s a fact. As investors and analysts, we have to deal with the facts, not the ones we wish were true but the ones that are actually true. One of the most famous dictums of geopolitics or science for that matter is that nature abhors a vacuum. When you create a vacuum, it doesn’t remain. Someone or something rushes in to fill it. When the U.S. withdraws power, you create a power vacuum, and it’s not long before others rush in to fill it. That’s exactly the kind of behavior we’re seeing from the Russians. There are no U.S. boots on the ground in Ukraine. That’s almost inconceivable but I think it’s very highly likely that there are Russian boots.
By the way, just one addition to my comments and the answer to your prior question about natural gas getting cut off to Europe. I described it as Europeans freezing in the dark, meaning your home, heat, and the electric plants run on natural gas so you have no heat or light. That’s a serious issue, but the bigger issue is industry. A lot of manufacturing capability in Europe is natural gas-powered, so you’re not just causing inconvenience at the home. You’re shutting down industry, manufacturing, and jobs. The economic ripple effects of this are enormous and come on top of the already weak global economy which we spoke about.
There’s just no way out of this. Putin is not deterred. He’s not afraid. He’s gone this far so why would he stop now? He’s going to get what he wants. There’s not much the U.S. can do about it. If we try, we’re going to have one or more of these unintended consequences which are either financial catastrophe or just economic catastrophe in terms of reduced global growth.
JW: I’m glad you turned to that last point, because this is where I want to round this out and talk about the economic impact of the scenarios we’ve been discussing. Also, the potential impact on the monetary system has been a continuous theme of our conversations. How do you see this conflict playing out in terms of its impact on the fate of the dollar, on the currency wars, and on the role of gold in the near future?
JR: We spoke about the potential economic sanctions. I don’t think it would go that far, but there is a lot the U.S. can do. Everything the U.S. can do — every financial weapon the United States can throw at Russia such as dollar payments, dollar clearings, dollar settlement, dollars for export, dollars for energy -— involves the dollar. These all revolve around the role of the dollar as the dominant number-one reserve currency and for that matter the number-one trade currency. We’ve spoken before about the difference between a reserve currency and a trade currency. A lot of people confuse the two. They look at these Chinese bilateral currency swap deals and think that it’s the launch of the yuan as a global reserve currency. It’s not; it’s significant but really has to do with the yuan’s status as a trade currency. Getting back to the dollar, the dollar dominates both (reserve currency and trade currency).
Let me go back to the Cold War. If the US is building up its nuclear arsenal, then Russia wants to build up its nuclear arsenal as well. Russia was very good at stealing U.S. nuclear secrets toward the end of World War II and throughout the Cold War because they wanted to meet that threat head on. Now we’re in a financial war and Putin’s looking at the dollar as the equivalent of an ICBM, intercontinental ballistic missile. He’s not going to stand still for that, so he wants to get out from under the dollar system. Now, wanting to get out and being able to get out are two different things. We’ve already talked about how Russians are great chess players and how Putin is a strategic thinker and a good chess player, so you can be certain that Russia is moving behind the scenes to get out from under the dollar payment system. How are they doing this?
One way they’re doing it is by acquiring gold. Of course, China’s doing the same thing as we’ve spoken a lot about in the past on prior podcasts our listeners can go back to. The Central Bank of Russia has been a major acquirer of gold also, and they’ve recently picked up the tempo. For years, about five years in 2009 through 2013, they had been acquiring approximately 100 tons a year and were actually fairly transparent about it. China is very non-transparent; they lie about their gold holdings. Every month, you could actually go to the Central Bank of Russia website where they would update their reserve positions. They include gold in their reserves so you could see that they added 8 or 7 or 5 tons adding up to about 100 tons a year. They gradually got their gold reserves up from about 600 tons in 2009 to over 1,000 tons recently, but they’re still going and have increased those purchases. They’re now acquiring at a rate higher than 100 tons a year a lot of which comes from their own mining output. They don’t have to go to the London bullion market, because they are one of the largest gold producers in the world. All they have to do is capture their own production, send it to refineries, turn it into good delivery bars, and stick it in a vault. I guarantee that vault’s in Russia. It’s not at the Federal Reserve Bank of New York. The Russians aren’t foolish enough to leave their gold with the Federal Reserve.
This does not mean that tomorrow morning we wake up and the ruble is a gold-backed global reserve currency. I don’t expect that at all. There are so many problems with Russian corruption, Russian rule of law, and the absence of a significant Russian bond market. We’re not going to see the ruble be a global reserve currency anytime soon, but what it does let you do is start to do gold transactions, gold swaps. We’ve seen this recently with a lot of publicity in July around the massive China-Russia multi-year multi-ten-billion-dollar natural gas and oil trade and development deal. That was a very big deal, but Russia recently announced a similar, admittedly somewhat smaller but still quite large deal, with Iran. Iran is another country that’s undergoing economic sanctions, so here you have two big countries, Russia and Iran, as the target of U.S. economic sanctions. Iran was actually kicked out of the dollar payment system. That hasn’t happened yet with Russia, but it’s a threat, so they’re finding each other and saying we can trade oil for gold and oil for other currencies.
What’s interesting is that Russia agreed to buy Iranian oil. Now, that’s odd, because Russia is one of the largest oil exporters in the world. If they’re not first, they might be second, but they’re one of the top one or two. So if Russia is a major oil exporter, why would they want to import oil from Iran? The reason is that the Iranians cannot very easily sell their oil in the open market because of U.S. sanctions, so suddenly Iran sells the oil to Russia. Well, oil is generic. It’s another fungible; oil is oil. There’s no little stick on the molecule that says this came from Iran or this came from Russia. Once Russia gets their hands on Iranian oil, they can re-export it to the Chinese and in effect act as middlemen in the sale of Iranian oil to China to keep Chinese hands clean. China just did a currency swap with Switzerland so they can get their hands on Swiss francs, and Russia and China are members of these BRICS banks.
Start to connect the dots. China’s got easy access to Swiss francs. The Swiss franc is a highly desirable hard currency. Iran’s selling oil to Russia. Russia can resell it to China. China can pay Russia in Swiss francs and they can intermediate all this through the BRICS bank. All of a sudden, where’s the dollar? The dollar’s not there. You have to look at all the pieces — the BRICS developments, the Iranian developments, the currency swaps. All of these countries are working behind the scenes to end the dollar hegemony while the U.S. seems to be asleep at the switch. This doesn’t happen overnight, but it is happening in ways that are accelerating. I think investors will wake up one day and find that the dollar’s in free fall and they won’t know why, but you can really see this coming.
JW: Jim, thanks for this very revealing discussion of the global situation, and the extraordinarily complex interplay around reducing the status of the dollar over time. Now, what are the implications for investors? Let’s give some focus here to the individual — and not only the individual. We have listeners who are responsible for other people’s wealth as well as their own. What is the guardianship, what is the stewardship that is most appropriate in the environment you’re describing here?
JR: There’s a short answer and a long answer. The short answer is one word, which is gold, but let me expand on that a little bit, because there are a lot of people out there who bang the table and say you need to get some gold. They have this Chicken Little sky-is-falling routine but they don’t offer much in the way of analysis. If I were an investor who was not familiar with gold and did not have gold in my portfolio, some of the gold advocates would not be particularly persuasive to me, because they rely on fear and hysteria rather than analysis. Let’s try to give investors some analysis so they can judge for themselves as to why physical gold should be in their portfolio. We’ll take the two things we just talked about. One way to illustrate this is to think about bitcoin. I don’t recommend bitcoin in portfolios, but there are a lot of bitcoin fans out there so we don’t have to really spend a lot of time on it, but people refer to bitcoin as a digital currency.
Well, the dollar is a digital currency. Yes, we may have a few dollars in our pockets. If I go to the grocery store, I may pull out a 20-dollar bill but probably not. I’ll probably pull out my debit card. If you think of how the dollar payment system works, it’s completely digital. When you get your paycheck, it’s probably a direct deposit to your account. When you pay your bills, you probably use online banking. When you go shopping, you probably use a credit card. The amount of cash you’re using is tiny relative to the economic transactions, and certainly at the portfolio level it’s all digital. In fact, the largest securities market in the world, the United States Treasury market, hasn’t had a physical paper certificate since the early 1980s. There might be a few old ones floating around in someone’s attic, but the physical paper Treasury bond market went away in the early ‘80s. It’s completely digital and the payment system is digital.
That’s what we use as a weapon but what does it say when your wealth is digital? Digital wealth is subject to power outages, infrastructure collapses, hackers, online theft, and other forms of exchange collapses, etc. Everyone says, oh, I’ve got a big-dollar portfolio, I’ve got a billion-dollar dollar portfolio. Well, what good is that if it can be, in effect, wiped out overnight? So that’s one problem right there. The second problem we talked about is the dollar itself. We don’t even have to hypothesize a digital wipeout. We could have a dollar wipeout through a collapse of confidence because the Fed does not understand the statistical properties of risk. The Fed thinks they can print money in unlimited quantities to deal with macroeconomic problems that they can’t really deal with because those problems are structural and not monetary. They’re trying to use a monetary solution to a structural problem. That won’t work, but they think it’ll work, so they keep trying and doubling down. You can collapse confidence very easily there. Plus, we know that Russia, China, Iran, the BRICS, and others are actively working night and day behind the scenes to get away from the dollar independent of whether the Fed crashes it first.
You have all these vectors threatening the dollar. If you have digital-dollar denominated wealth, digital assets are under attack, ergo, the dollar is under attack. When you have digital dollars in your portfolio, you have exponentially greater risk because you’ve got the two things combined. How can you mitigate that? I don’t expect that someone with a 10-billion-dollar portfolio is going to require $10 billion of gold. Good luck with that. But you should have some gold as your insurance, and it should be physical gold because an ETF and a COMEX future are just digital gold. Even a contract with JPMorgan might be on paper somewhere, but it’s still a contract, and contracts can be terminated under various termination clauses or force majeure clauses. They’ll send you a check for yesterday’s price and you’ll miss out on tomorrow’s spike. You won’t get your gold when you want it, etc.
If you don’t have some physical gold in your portfolio, you are vulnerable to all these other things. Investors are rightly worried about normal market risk. We’ve seen the stock market draw down lately. Will that get worse? Will it bounce back? It’s hard to say, but there’s certainly cause for concern. Is growth as strong as people think it is? Are earnings as strong? These are the things investors normally worry about – growth, earnings per share, and the macroeconomic environment. What I’m suggesting is that there are even more serious concerns on top of that – geopolitical concerns, digital concerns, confidence concerns, and things that could collapse the value of a portfolio. The way to insure against all of that is with some physical gold, because you can’t hack it, you can’t wipe it out, and it’s not dollar-based.
That’s another point of confusion, Jon. People say they’ve got gold and today’s price is around $1,300 an ounce or a little bit more. They will say my gold’s going to go down to $1,250 or someone else will say it’ll go up to $1,375. It’s bouncing around. People get very hung up on the dollar price of gold. What I try to explain to investors is that gold is money. When you have gold, you should think about the quantity of gold and what that represents in terms of your portfolio. Don’t get too hung up on the dollar price, because the dollar could collapse very quickly and then the dollar price won’t matter. What will matter is how much gold you have.
In that scenario, you may not be able to get gold, so the time to get it is now. Instead of thinking about gold in terms of dollars, start thinking about dollars in terms of gold. Let’s make gold your benchmark, make gold your numeraire, and ask yourself one question. In the years ahead, given all the risks and the dangers we’ve described, is the dollar going to get stronger or weaker? If you think the dollar is going to get stronger, you might not want so much gold. If you think it’s going to get weaker, which I do, then you certainly want some gold. You don’t have to correlate gold to anything. Just think of gold as money. Think of it as the inverse of the dollar or the anti-dollar, if you will. If you’re concerned about the dollar – and I think there’s good reason to be concerned about the dollar – then you certainly want some gold.
JW: Thank you, Jim Rickards. It’s been great having you with us today. You can follow Jim Rickards on Twitter. His handle is @jamesgrickards. Speaking of Twitter, we’d love to hear from you, so please share your questions with us for our next podcast. The hash tag is #askjimrickards followed by your question. Wherever you post that on Twitter, we’ll find your question. Once again, thank you, Jim, and thank you to our listeners. We’ll see you next time. Goodbye.
If you would like to ask Jim Rickards a question on Twitter which may be used in a future interview, please use hashtag #AskJimRickards