November 14th Interview with Jim Rickards Topics:
*Comments on the gold price
*The time horizon for the next international monetary crisis
*Fundamentals and math for the gold market has not changed
*Depressions are structural, not cyclical
*Jim comments on his article “In the year 2024”
*Bail-Ins to be announced post G20 Australia
*The world is on a shadow gold standard and moving towards a more formal one
*Jim’s views on gold mining company stocks
*2% Inflation cuts the value of the dollar in half every 35 yrs
*Will quantitative easing lift the US out of depression when it didn’t work in Japan
*The Fed must change the psychology in order to get velocity of money
*No interest rate increases in 2015
*QE4 by end of 2015 possibly 2016
*Bank of Japan printing effect on US stock market
*Zero Interest rates has created an environment of regime uncertainty
*How Jim evaluates gold storage companies and jurisdictions
*Switzerland is the top gold storage jurisdiction in every dimension
*November 30th Swiss Gold Initiative Referendum
*Swiss / Euro Peg
*The Fed is leveraged 80 to 1, IMF leveraged 3 to 1
*Can the Fed collapse, and will the IMF bail out the Fed
*Lagarde: US has until Dec 31st to meet its obligations
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Jim Rickards Interview: 11-14-2014
Jon Ward: Hello, I’m Jon Ward on behalf of Physical Gold Fund. We’re delighted to welcome you to our first webinar with Jim Rickards, in the series we’re calling The Gold Chronicles.
Jim is an investment banker, an investment advisor based in New York, and he also serves on the Investment Advisory Committee for Physical Gold Fund. Jim is the author of two New York Times bestsellers, Currency Wars: The Making of the Next Global Crisis, and most recently, The Death of Money: The Coming Collapse of the International Monetary System.
Hello, Jim, and welcome.
Jim Rickards: Hi, Jon. It’s great to be with you and our webcast listeners.
JW: We also have with us Alex Stanczyk of Physical Gold Fund. Hello, Alex.
Alex Stancyzk: Hi, Jon.
JW: Alex will be looking out for questions that come from you, our listeners, so let me just say that your questions for Jim Rickards today are more than welcome.
In these webinars, we’re going to address some pressing current questions that impact the gold market and also take a step back and look at some of the fundamental issues.
Let me begin with a hot topic, the price of gold. Jim, for quite a while, you’ve been calling for a dramatic rise in the valuation of gold sometime in the relatively near future. Meanwhile, the yellow metal has taken quite a hammering, especially in recent weeks. Now we have commentators calling for gold at $900 and even $800 an ounce. I’m aware this is a topic we’ve addressed in our recorded podcasts, but could we touch on it again here today?
JR: I’d be glad to. Yes, we can all read the tape and know the price action, but I will say there’s nothing that has fundamentally altered my view. Whatever has been expressed before, we are getting closer by the day to some kind of collapse of the international monetary system. That doesn’t mean tomorrow morning, but sooner rather than later. It’s not a 10-year forecast. Could it be five years? Maybe. Could it be one year? Yes. We can never know the exact time, but somewhere in that time frame and certainly soon enough to begin taking action today. That kind of coming international monetary crisis doesn’t mean you automatically go to a gold standard, but going to a gold standard is one of the possible outcomes that may be necessary to restore confidence. If you do that, you have to determine what the dollar price of gold is. If you’re going to have a gold standard, you have to set a dollar price. One of the great economic blunders of the 20th century — and maybe of all time — was when countries went back to a gold standard in the 1920s at the wrong price. They had printed so much money in World War I that to go back to the gold standard at the ‘old price’ (the pre-World War I price) was disastrously deflationary. They had to recognize the fact that they had printed the money, and the gold should have come with a much higher price, but they didn’t do that.
The math is not that difficult. To have a gold standard today that was non-deflationary, you’d have to have a price at the low end probably around $10,000 an ounce and at the high end perhaps $45,000 an ounce. I’m not predicting or expecting $45,000 gold, but I am expecting $10,000 gold based on a return to some kind of gold standard to restore confidence. Again, nothing has changed in that forecast.
In other words, if you say governments around the world are taking steps to avoid the monetary collapse, then I might change my forecast and say we’re going to steer away from the disaster because we’re enacting smart policy. But in fact, I see the opposite. I don’t see the smart policies. Therefore, I see the collapse coming and leading to a much higher dollar price for gold in order to restore confidence. It’s a very basic exercise. These are not numbers I pull out of the hat or make up to get provocative headlines. To me, it’s just a straightforward analysis.
Having said that, gold has indeed been volatile. It’s not a lot of fun if you’re a gold investor and are watching the dollar price go down; no one enjoys that. Personally, I don’t get too euphoric when the dollar price goes up, and I don’t get too depressed when the dollar price goes down. To me, it’s just market information that tells me something. When I see the dollar price going down, I certainly don’t sell gold. Occasionally, I buy more because I like the price and think it’s probably a good entry point.
I just spent a couple days in the Dominican Republic with Jim Rogers. I’m sure a lot of our listeners know Jim Rogers, a very celebrated investor, commodities trader, and one of the cofounders of the Quantum Fund along with his then partner George Soros. Jim Rogers and George Soros have since gone their separate ways, but Jim has had a very successful career as an investor. He’s been around all markets, and like me, he owns gold and is sitting on his gold. Jim is not selling any of his gold, and he said he’ll buy more. In conversation, he made a very interesting point. He said that no commodity has ever rallied to its ultimate potential or its end level without a 50% retracement. That’s not just gold — it’s also copper, wheat, corn, oil, stocks, you name it.
If you had an all-time peak of about $1,900 an ounce for gold, a 50% retracement would be $950. So $1,900 minus $950 gets you down to $950; let’s call it $1,000 for a round number. Jim Rogers says it wouldn’t shock him to see gold go to $1,000, and at that point you do have a 50% retracement, so he would back up his truck and load up! He said he’s a buyer at $1,000. I’m not Jim Rogers nor the commodity trader he is. I like the entry point right here where gold is about $1,200, give or take.
To reiterate, this kind of price action or volatility is not unusual, but the long-term forecast has not changed simply because the fundamentals and the math haven’t changed. I’m sticking to the much higher forecast. I recognize the recent price action, but we’re certainly a lot closer to the bottom than the top, and we can expect the turnaround sooner than later.
JW: I have another topical question. We just had midterm elections here in the United States that resulted in the Republican Party strengthening its grip on the House of Representatives and taking control of the Senate. Does this have any bearing on the dollar’s present rise in the currency markets and therefore, if the dollar is rising, perhaps on the lower price of gold?
JR: I don’t think it does. You’re right about the price action. We do see the dollar going up and the dollar price of gold going down, because those two things are linked, albeit just inverse to each other. To me, a lower gold price just means a strong dollar. Likewise, the thing that will cause the dollar price of gold to go much higher is a weak dollar. The dollar/gold relationship is exactly what you described, but I don’t think the elections had very much to do with it, and here’s why. It’s obviously a big deal politically. If you’re Harry Reid and now not the Majority Leader, that’s not a lot of fun, while I’m sure Mitch McConnell is happy to be the new Majority Leader. The question is, will this lead to cooperation between the White House and the Congress on important structural issues?
As you know, in some of our past podcasts and some of my writings, I’ve made the point that we’re in a global depression; we’re not in a cyclical recovery. The economy has been in a technical recovery since the end of 2009, but I don’t view this as the normal post-World War II cyclical recovery. What we are in is a sustained period of below-trend growth. If your trend or your potential is, say, 3.5 %, and your short-run potential is 5% or 6% but you’re actually growing at about 1% or 2%, which we are, that fits John Maynard Keynes’ definition of a depression. The definition is not a collapsing or continuously declining GDP. You can have rising GDP in a depression, but it’s rising well below your potential growth. If you could grow at 3.5% and you are actually growing at 2% for a long period of time, that’s a depression and what we’re in today. Depressions are structural; they’re not cyclical. In other words, there’s nothing monetary policy can do about a depression. In a normal business cycle or credit cycle, monetary policy — easing and tightening — can have a role and can help the economy or cool it down as the case may be, but not when you’re in a depression.
Depressions are structural, ergo you need structural solutions. Structural solutions are things that come from the Congress and the White House, such as fiscal policy, tax rates, capital gains taxation, global taxation, the fair labor standards act, minimum wage, the Keystone pipeline, Obamacare, and environmental regulation. Those are the structural handicaps the economy is suffering under, and the economy is not going to get better until we do some smart structural changes. With a Republican Congress that wants to lean in that direction and a White House that can read the tea leaves, you might say, well, gee isn’t there the potential for some cooperation and some smart policy that might get real growth moving that could impact the dollar price of gold? My response is, well, the potential’s there, but will it be realized?
The President has a choice. He can look at a Republican electoral victory in the 2014 midterm election and say, “Okay, I get the message. Voters are unhappy with the course we’re on and want a change. They put Republicans in charge of the Congress to cause that change, so I’m going to get the message, heed the wakeup call, and start to work with them.”
By the way, this is exactly what Bill Clinton did in 1994. In the first two years of the Clinton administration from ’92 to ’94, he was pursuing a very progressive agenda. He had what we called Hillarycare at the time, which was Hillary Clinton’s version of Obamacare. That was his big initiative, and he did a few other things by executive order where he looked a little bit like a progressive Obama. And then he lost the midterms. Well, Clinton got the message; he read the memo. He sat down with Newt Gingrich, and they did some good stuff over the next six years. The U.S. had a very strong economy throughout the 1990s. If you look at what Clinton actually did, I always called him one of our great Republican presidents. Clinton’s three big accomplishments were a balanced budget, free trade, and the end of welfare. If that’s not a Republican platform, I don’t know what is. So Clinton’s a guy who started out on a progressive path, had a wakeup call in the midterm election, did a pivot, and worked with Republicans to get some good things done.
Now, Obama is no Clinton. Obama is on a progressive path and has been for six years. He also took a setback in the midterm election, but he’s not getting the message. For example, he seems to be doubling down on the confrontation over immigration, with his threat to issue amnesty, which the Republican Congress does not want. Now it looks like the approval of the Keystone pipeline could go through in a matter of days and would be one of the structural changes I’m talking about. It was passed by the House today, it is probably teed up for Senate passage, and the indication is the President will veto it.
I’m not here to debate the pros and cons of all those things. I know you can get bogged down in the immigration and Keystone pipeline debate, but I’m not here to debate them. I’m just here to say that those are some structural changes I’m talking about. What we’re seeing is not cooperation but confrontation; therefore, I expect just more dysfunction and more fighting between the White House and the Congress and the President really defying the Republican Congress by poking a stick in their eye. Again, you can debate the politics all day long, but as an economic analyst, to me, that’s just more dysfunction. No structural changes, therefore no changes in the depression we’re in, and we’ll continue to have this tug of war between inflation and deflation.
By the way, going back to your first question, Jon, what the price action of gold tells me among other things is that deflation is winning. Since my first book Currency Wars, I’ve described this inflation-deflation dynamic as a tug of war between two very powerful forces. No team has conquered the other team yet. We haven’t gone into severe 1930s-style deflation nor have we gone into severe late 1970s-style borderline hyperinflation. We don’t have either one, but the tug of war continues. Deflation seems to be winning right now, but what that tells me is that the Fed is nowhere close to raising interest rates. They may even come back late next year or early 2016 with QE4. The stars are still aligned, if you will, for inflation, which at the end of the day, if the Fed wants it, they’ll get it even if it takes years, and we all know what that will do to the price of gold.
Yes, elections are interesting, but I don’t see cooperation; I see confrontation. That tells me more of the same from a policy perspective and more money printing at the end of the day by the Federal Reserve.
JW: Jim, I’d like to shift here and ask you about a bit of a stir you caused with a recent article you wrote. The title, as I recall, is “In the Year 2024.” Some people have read you as predicting worldwide gold confiscation. Can you tell us what you actually wrote and elaborate on this article?
JR: I did write an article called “In the Year 2024.” I’m enjoying writing a monthly newsletter called Rickard’s Strategic Intelligence published by Agora Financial down in Baltimore, and this was one of the articles I wrote. The newsletter is by subscription, so it’s behind a paywall — pretty reasonably priced, by the way, but you have to sign up for that. Some of the articles are occasionally taken out and put on the Web so that everyone can see them, and this was one such article. It was serious article, but I was trying to have a little fun with it. Yes, I’m a serious financial analyst and these are serious matters when we talk about money and gold and people’s net worth, but a little humor goes a long way.
I was not writing a prediction saying, here’s what’s going to happen and all the gold’s going to be confiscated. I did talk about things like that, but it was meant to be in the same vein as Franz Kafka, George Orwell or Aldous Huxley where you’re writing about the future, but what you’re really doing is writing about the present, i.e., using the future as a literary device to warn people about things that are going on today that they need to pay attention to. It was a very dystopian article that talked about everyone having biometric implants in their arms in order to qualify for government healthcare. If you didn’t have the implant, you couldn’t get healthcare, and the implant would monitor your activity and control your thoughts, and people had to wear goggles. It was almost like a Philip K. Dick science-fiction piece.
To my dismay, I think a lot of the humor was missed by some of the readers. In the first sentence, I referred to the bug that’s implanted as insect-size: that was obviously a reference to the first line of Franz Kafka’s Metamorphosis where the protagonist wakes up as an insect. I don’t know, maybe we were playing over some people’s heads a little bit… The point is if you take George Orwell’s 1984 as an example, not everything George Orwell wrote about happened in the year 1984. We lived through 1984. (There may be some 19-year-olds listening, but I think most of the listeners did). The reason George Orwell called it 1984 was because he wrote it in 1948. He just took the 4 and the 8 and flipped them around to get 84. In 1984 he was really writing about 1948 to warn people that some of the unpleasant dystopian neofascist things in his future novel were actually happening then and there in 1948. Obviously, he was thinking about Stalin and the Soviet Union.
I was doing something very similar. I called it In the Year 2024, but I was really writing about things that are happening today that investors should be concerned about. It was a serious article in which I tried to use some literary references and a little humor but with a serious purpose, which is to warn investors about trends.
There’s something I think a lot of listeners have heard of called a self-fulfilling prophecy where you predict something and it comes true because people believe it’s going to come true, they act accordingly, and they make it come true. It’s a prophecy that causes itself to happen because of adaptive behavior. There’s also something called a self-negating prophecy. It’s when you make a prediction about the future, and by providing a warning, people act in helpful ways to make the bad thing not come true. That’s what I was trying to do by warning about potential bad things and perhaps getting some positive behavior or positive policy outcomes today that would actually prevent the bad things from happening.
I think gold confiscation is extremely unlikely for two reasons: (A) It’s difficult to do and (B) We live in a global world much more so than in the past. What one jurisdiction does, another jurisdiction can undo. By the way, this is a reason to possibly have gold in multiple jurisdictions. Also, to be candid, there might be a little pushback. In 1933 when FDR confiscated the gold of the American people, there was enormous trust in government, fear about the economy, and a belief that the President must know best. If the President tells us to hand over our gold, we’ll hand it over. I believe all those conditions have changed. I feel there’s a lack of trust in government, that politicians do not know best, and therefore, I think there’d be perhaps a lot of civil disobedience when it came to that, which might be a reason why people wouldn’t try it in the first place.
The other thing that was missed in the article is before I got to this end game, I did say that gold had gone up to $15,000 an ounce or higher and people who were smart enough to buy it when it was $1,000 or $1,200 did quite well. Maybe they bought at $1,200 and it went to $15,000, they sold at $15,000, bought a farm, and lived happily ever after. We’re a long way from that, but there was a lot in the article to suggest that having some portion of your investable assets in gold is a smart strategy. I know I do, and I recommend it to investors. I hope people do find the article and enjoy it, but it was taken literally and without a sense of irony or humor, and I think some of the critics missed the point.
JW: I’d like to step back for a minute and ask you somewhat of a big-picture or elementary question about gold. Why is it that when we discuss gold, we seem to always find ourselves talking about so many other things that might seem unrelated? We talk about the composition of the Federal Reserve or the role of the IMF or the crisis in Ukraine or the true meaning of unemployment figures… What I’m thinking is this: If I invest in land or fine art, I probably want to be aware of a general context, but I surely won’t be peering into the mind of Vladimir Putin or worrying about what happens on the streets of Hong Kong. What is it about gold that demands attention to such a big canvas?
JR: Jon, that was your longest question, and I think I can give it the shortest answer. The reason people are fascinated by gold is because gold is money. I don’t necessarily think I have to go on at length about the fact that money is a fascinating subject, but it makes a serious point. I talk about this in chapter nine of my book, The Death of Money. It’s why gold just confuses the heck out of people. I’ve always been able to look at it in fairly straightforward terms, but it sure is difficult in a lot of conversations. Gold is a form of money. Now, the dollar bill is money, Bitcoin can be money, and the euro is money. There’s more than one kind of money in the world, and there have been times when different kinds of money have competed for a role as the global reserve currency. In the 1920s you had three global reserve currencies: the pound sterling, the U.S. dollar, and gold. Indeed, under the gold exchange standard up into the 1920s, if you looked at the balance sheet of a country, its reserve position or its central bank balance sheet, that’s exactly what they had. They had the reserves in a couple different currencies and gold.
Gold is just a different kind of money. Our friend Warren Buffet always criticizes gold and says gold has no yield. Well, it’s not supposed to. Money is not supposed to have a yield because it’s the safest kind of asset. As an example, take a dollar bill out of your wallet, put it on the table or desk in front of you, and look at it. Does it have a yield? No, it doesn’t have a yield because it’s money. Money doesn’t have a yield. People say, oh, I can put my money in the bank and get half or 1% interest. Of course you can, but when you put your money in the bank, it’s not money anymore. Now it says certificate of deposit at a bank.
Everyone says that’s the same thing as money. Well, I have news for you. The President of the United States and world leaders are in Australia right now as we speak at the G20 summit. If you look at the final communicaé, which is coming out tomorrow, they are going to warn the world that if you have money in the bank, you are a general unsecured creditor of the bank, subordinate to bond holders and other secure creditors of the bank. So what people think of as money, specifically bank deposits, is no better off than Cyprus. What if the government shuts down the ATM machines or reprograms the ATM machines to say, oh, you’ve got $20,000 in the bank, well, that’s fine. We’re going to limit you to $300 a day for gas and groceries. That’s plenty for gas and groceries, but no more or we’re going to freeze your money until further notice.
That’s what the major governments of the world are telling people today and tomorrow. That’s one of the things to come out of this meeting in Brisbane, Australia, at this G20 summit. It’s a wakeup call. Last summer the SEC enacted rules saying that they can freeze money market funds. Most people who have money market funds think that’s money. They say, if I need money, I can call my broker, redeem some money market fund shares, and that money will be in my bank account tomorrow for a big-ticket purchase or to pay some bills or buy a car or house, etc. They think it’s money. The SEC just passed a rule saying they can freeze the money market accounts, so it’s not money.
There’s a lot of confusion on the subject, so the things that people think are money, such as money market funds and bank deposits, turn out to be subject to government freezes and lock-ins, therefore they’re not really money. I would call a stack of $100 bills money or some Bitcoins a form of money or if you had some gold bullion, that’s a form of money, but none of them have any yield. Money doesn’t have yield because it’s a counting device to store wealth; and gold is the purest form of monetary assets.
I know gold trades on commodity markets and I know it’s marketed as an investment, but to me, when you have gold, what you really have is money. I explain to investors if you like stocks and bonds and land and fine art, all that stuff is fine and might have a place in the portfolio, but if you want money, get some gold. I think people understand it, but it’s not intuitive because they have been told for 40 years that gold is not money. My question to the United States is this: If gold is so worthless, why are you hanging on to 8,000 tons? Why have you not sold practically an ounce since 1980? If gold is not money, why are the Chinese buying thousands of tons? If gold is not money, why did the Russians double their gold reserves in the last five years?
When you look at what’s actually going on in the world as opposed to the happy talk you get on television, it is very apparent that the world is on a shadow gold standard already, is moving back to a more formal gold standard — treating gold as money — and banks are acquiring it hand over fist. It’s not just a commodity like wheat or corn or oil that’s trading on commodity markets, and it’s hard to even call it an investment because it doesn’t have a yield. Warren Buffet is right about that, but my view is that’s okay. It is money and money is not supposed to have a yield, but it’s the one form of wealth that isn’t digital, can’t be hacked, and can’t be frozen. If you have physical gold, you’re good to go. I think when you strip away all the mystique and some of the propaganda and happy talk, what you realize is that the reason gold is so fascinating is because it is the purest kind of money, and needless to say, money is fascinating.
JW: Thank you, Jim. Now we have some questions from our listeners, so here’s Alex Stanczyk with those questions. Over to you, Alex.
AS: Thanks a lot, Jon. We have quite a few questions here. By the way, I’m just going to use first names. We’ll dive into the first question coming from Christopher G. His question is, “Jim said he’s not a fan of gold mining stocks. Why not?”
JR: It’s not that they don’t have a place so you shouldn’t buy them. It’s just that it’s hard for me to recommend them, and here’s why. Gold is totally uniform. Its atomic number is 79. It’s an element. It doesn’t get much purer in terms of the uniformity and grade and so forth. Gold is even superior to oil and other commodities. There are 49 different kinds of oil around the world when you get to grade, sulfur content, viscosity, and all that, but there’s one and only one kind of pure gold. Now when we get to gold miners, they’re not generic. There are excellent gold mining companies out there with good management, good prospects, good feasibility studies, and solid capital structures. And there are horrible gold miners out there that are penny stocks, borderline fraudulent, incompetent, and don’t know what they’re doing.
The difference is mainly management. That is to say gold is gold, geology is geology, feasibility studies are what they are. Those things don’t really differentiate gold miners. What does differentiate them is what differentiates any company: management, balance sheet, and capital structure. I can speak generically about gold, but I cannot speak generically about gold miners, because I think there are good ones and there are frauds. How do you know which is which unless you’re a really good stock analyst?
I look at people like John Hathaway who runs the Tocqueville Gold Fund and others such as Doug Casey of Casey Research. There are people out there who spend their time thinking about the issues I just raised regarding gold miners. That’s not what I do, because I’m a global macro-analyst, an economist. I think about gold a lot and its monetary role, I can read a balance sheet, but I don’t hold myself out as a stock picker, so I don’t really like to talk about gold miners because I haven’t done my homework on them. I would say that gold miners have been beaten down badly again. Gold mining stocks are a leveraged bet on gold itself. Gold is volatile and gold miners are more volatile because of the economics of mining and fixed cost versus variable costs and some other constructs inside the balance sheet. If you think gold’s a roller coaster, try the gold miners.
I would say that when something is down 90% or 95%, there are only two ways for it to go. It’s either going to go to zero or bankruptcy or they’ve gone as low as they can go. In other words, the company’s going to file for bankruptcy or it should bounce back. If you can be alert to the ones that are maybe heading for bankruptcy and think about the ones that maybe have gone as low as they can go, there might be some opportunities there. Again, I’m not going to name names or pick stocks. I’ll leave that to the listeners and those who are smarter than I am when it comes to that kind of analysis. The short answer is miners are a leveraged bet on gold but they’re not homogenous. They’re highly differentiated and you really have to do your homework to know who’s who.
AS: Very good. The next question is from a gentleman named Jeremy A. who asks, “Despite a printing press, the Bank of Japan couldn’t stop deflation post ’89 in Japan. Why will it be different in the United States with the Fed and the IMF?”
JR: The short answer is it may not be different, and that’s a very good point. I like to say it’s a sad day when central banks want inflation and can’t get it. There’s no question that every major central bank in the world right now wants inflation. That’s not reading tealeaves: they say it. It’s not as if you haven’t heard the Fed say their inflation target is 2%. The European Central Bank and Japan have all said they have an inflation target of 2%. By the way, you shouldn’t be all warm and fuzzy about 2% inflation. Two percent inflation cuts the value of the dollar in half in 35 years, and cuts it in half again in another 35 years. If you take a 70-year normal lifetime from birth to age 70, even with 2% inflation, the dollar will lose 75% of its purchasing power.
So two percent isn’t benign. I analogize 2% inflation to an 8-year-old kid who looks in his mom’s wallet and sees $50 in singles and says, I know if I steal the whole $50, I’ll get caught and I’ll be in trouble with mom, but if I steal $1 or $2, she won’t notice. That’s how the Fed steals your money — a little bit at a time. That’s what 2% inflation does, but they can’t even get 2%. The reason for that goes back to what I call this tug-of-war (between inflation and deflation), and it also explains why we have not had an inflationary breakout with all the money printing.
Money printing is the other side of the coin. It’s a fact that the Fed has actually printed over $3 trillion in the last five years. At the beginning of that process, there were a lot of people sounding alarms, saying, oh, my goodness, if you print that much money, we’re going to have inflation, etc. The inflation has not shown up, but there’s a reason for that, which is money printing alone does not give you inflation. You need two things. You do need the money printing but you also need velocity with the turnover of money. You need people to actually go out and borrow it, spend it, invest it, and use it. If you don’t have that, you’re not going to get inflation. The money supply via printing has been enormous but velocity has been collapsing. The simple quantity theory of money is pretty straightforward: Money supplied times velocity equals nominal GDP. I like to remind people that four trillion times zero is still zero. In other words, if you have $4 trillion of money but zero velocity, you have no economy, so therefore, the money printing has not caused inflation because it’s been offset by the decline in velocity which has barely kept nominal GDP constant. That’s how you can understand the tug-of-war in formal mathematical, analytical space.
How do you change velocity? They can make money supply whatever they want, they really can, but velocity is psychological, it’s behavioral. You have to change people’s behavior. Let’s say it’s a Friday. If I’m feeling good and I want to go out tonight and take some friends to dinner and buy drinks for everyone at the bar, that’s one state of the world. I’m spending a lot of money. But if I decide to stay home, watch some college football, and not go out, the velocity of my money is zero because I’m not spending anything. What the Fed has to do is lie to us and manipulate us to try to get us out and lend and spend and get the old velocity-nominal-GDP machine cranked up again.
Getting back to Jeremy’s question, think about what the Fed and the Bank of Japan have tried to do in different ways to get velocity moving, to change the psychology. First is cutting rates. They can do that so far but will get to zero. Then there’s quantitative easing, which is money printing, and currency wars, which is cheapening your currency. Even when you’re at zero interest rates, you can create monetary ease by cheapening your currency, which a lot of people think is to promote exports but that’s not really the reason countries do it. They do it to import inflation in the form of higher import prices. In Japan, a cheaper yen would mean they’d have to pay more for imported oil, and that inflation would feed through the Japanese supply chain, so that’s how they’re hoping to get inflation.
In the case of the United States, remember we have a trade deficit. We import more than we export, so a cheap dollar would lead to higher import prices. The problem with currency wars is that not everybody can cheapen at the same time against everybody else. That’s a mathematical impossibility, so right now we’re seeing a cheaper yen and a cheaper euro versus a stronger dollar. The U.S. is saying, in effect, we think we’re strong enough to import some deflation from around the world, and let Japan and Europe try to get a little inflation going because they need help more than we do. That won’t last because the U.S. economy is a lot weaker than most people expect. I think by late next year we’re going to have to go back to the cheap dollar policy which means that at least Europe’s going to have to suck it up and deal with a stronger euro. This just goes back and forth and back and forth and shows the power of deflation. It shows the fact that the bag of tricks — QE1, QE2, QE3, currency wars, forward guidance, zero interest rates, Operation Twist — all these things have failed to get inflation going, which shows you the power of deflation.
I guess what I would say is there are reasons why central banks cannot tolerate deflation, but nevertheless, deflation is very strong, as Jeremy points out. This makes policy easy to predict, because if deflation is powerful and central banks have to have inflation and they’re not getting it, guess what? They’re going to try harder. That’s why I see no interest rate increases in 2015, and possibly QE4 by the end of 2015 or early 2016, which is why I still have a much higher gold price in the forecast.
AS: Next we hear from Daniel H. His question is, “In terms of liquidity for the U.S. stock market, which seems unstoppable” — and I happen to agree, Daniel — “at what point does yen and euro weakness negate the liquidity that the Bank of Japan and the ECB are providing?”
JR: There are two different things going on. One is liquidity in the U.S. stock market. A lot of that is driven by leverage. Remember we have zero interest rates. New York stock Exchange margins loan are at an all-time high, so the stock market is reaching new highs, but it’s doing that on narrow breadth and ultra leverage. That’s almost the definition of a bubble. It doesn’t mean that it can’t go on or won’t get higher or lead to higher prices, but it does mean it has a bubble dynamic which is very unstable. Now when you get over to Japan and Europe, as I just explained in the last answer, they are cheapening their currencies to import inflation in the form of higher import prices (and promote exports as a by-product) to try to get a little bit of inflation into their economies. What that has resulted in because of the end of QE3 and because of Wall Street research (which I don’t agree with by the way but most people follow), they expect interest rate increases in 2015.
The only debate is will it be March or will it be June. My answer is it will be never, at least as far as the eye can see, but that’s not the consensus. The consensus is that it will be sometime in the spring or summer of next year. If you’re an investor, you’re looking at Japan saying, you guys are at zero rates and maybe going negative, Europe, you guys are already negative, and U.S. looks like a rate increase, so I’ll sell my yen and euros, buy dollars, and then flood into the dollar system. Then that money has to find a home, so there’s a bid for treasuries, which is one of the reasons the treasury market has rallied, and there’s a bid for stocks and a strong dollar.
I’ve never seen so much money around, by the way. Money is not the problem. The problem is — as I explained earlier — psychology and philosophy and what economists call regime uncertainty: the unwillingness of businesses to invest because they don’t know what the rules are. What’s going to happen to taxes? What’s going to happen to health care? What’s going to happen to the environment or the Keystone pipeline? Going down the list, making five-year infrastructure investments is hard enough just trying to account for normal business risks, but when you have to layer that much policy and political risk on top of it, people say they’d rather just sit on their cash and wait. That’s one of the drags on the economy right now.
The short answer is there’s a flood of dollar liquidity, a strong dollar, but it’s based on expectations of higher U.S. interest rates. My expectation is the data in the months ahead will show the U.S. economy to be a lot weaker than most people expect. That will make it clear that there’s not going to be rate increase next year, that we may even see QE4. At that point, the whole seesaw will flip and then the money will flood out of the United States back into Europe and Japan. It’ll be carry trade back on, stronger yen, stronger euro, weaker dollar, but not right away. I really don’t expect to see that until maybe this time next year.
AS: This next question is coming from Chinyani M.: “Jim, how do you evaluate gold storage companies, and which countries are the best to store gold in?”
JR: My advice would be first of all to go with private gold storage companies, not bank storage. The reason is that, of course, banks are heavily regulated. I’m looking at the potential for asset freezes. I talked to you earlier about freezing bank accounts and money market accounts. They might try to freeze gold that is in banks, so if you’re in non-bank storage, you have a better chance of surviving that sort of thing. There are some very reputable firms out there. The advice we give is the same advice we give on almost any type of business decision, which is to look for reputation, look for people with long track records, look for people with references, with insurance and bonding. Don’t go with the fly-by-night guy who just set up shop. He might be okay, but how do you really know? Go with established custodians.
And one of the things I like about the Physical Gold Fund is how they store their gold. They offer storage facility to the customer, and they’ll handle all the details, so that’s great. When you ask where the gold is, it’s actually in Via Mat, which is one of the high reputation firms. There are Via Mat, G4S, Brinks, Dunbar, a few of them. Physical Gold Fund is with one of those non-bank but high-quality, well-established vaulting companies. So that’s what I would recommend.
As far as jurisdictions are concerned, you have some tradeoffs. My favorite jurisdiction in the world is Switzerland when it comes to gold. Now, we all know what’s happened with U.S. citizens opening bank accounts in Switzerland. There’s enormous amount of tax fraud there. I’m not on the side of tax fraudsters, but what has happened as a result is that the famous Swiss bank secrecy is pretty much a thing of the past at least for U.S. customers. If you’re a Russian or South American or Chinese and you have a Swiss bank account, you can probably still count on Swiss bank secrecy, but if you’re a U.S. citizen, no. They’re just going to hand over your information.
But we’re not talking about Swiss bank accounts. We’re talking about gold storage. And there, when you look at the rule of law, constitutional protections… even military protections — Switzerland has a history of never being successfully invaded by anybody as long as anyone can remember. We all know it’s a highly mountainous terrain. One of my favorite expressions someone said, “Switzerland doesn’t have an army; Switzerland is an army.” In other words, practically every able-bodied man and woman in the country is ready to be a frontline soldier in very, very difficult and in some ways nuclear-bombproof terrain. So it’s a nice country physically, but that’s not enough. There are physically daunting places in the world that don’t have good rule of law. But in every dimension, Switzerland checks all the boxes.
U.S. citizens might want something closer to home. I think it all depends how much gold you have. If you have twenty 1-ounce silver coins—that’s about $25,000 worth of gold, give or take—you don’t necessarily need to be in a Swiss vault. If you’re looking at larger quantities such as 400-ounce bars or kilo-bars, I would certainly have a look at Switzerland. Singapore has a lot to offer as does Australia, but Australia is pretty close to the U.S. Singapore has a lot of the attractions of Switzerland in the sense of being good rule of law jurisdiction and safe in various ways, but it’s in a worse neighborhood. It’s pretty close to a lot of political instability in Thailand and Malaysia and elsewhere and not too far from communist China. Until recently I would have said Hong Kong was okay, but, of course, Hong Kong is obviously coming under the thumb of the communists. I think my first two choices would be Singapore and Switzerland, and of the two, I prefer Switzerland.
AS: Now Jim M. is asking us, “Can we please ask Jim to comment on the upcoming Swiss referendum, its likelihood of passage, and the effect on the price of gold?”
JR: Most of us know that on November 30th, there is a referendum in Switzerland. They have a few interesting features in their democratic republican form of government. One is that citizens are allowed to petition to get a referendum on the balance. It’s very similar to California. We’ve all heard about everything from Proposition 13 to Proposition 42. It’s the same thing in Switzerland — if you get 100,000 signatures, you can get on the ballot, so a group did that. The Swiss Gold Initiative has a couple of provisions. One is that it will require Switzerland to repatriate their gold, in other words, bring their gold back to Switzerland. Right now most of it is stored abroad. People say they’re going to have to ship from the Federal Reserve Bank of New York. Well, no, Switzerland actually does not have any gold in New York. Swiss gold is in Canada and London. Be that as it may, the Swiss National Bank would have to call up Canada, Toronto, and London to get their gold back. So that’s the first thing.
More importantly for gold investors and people holding gold, it would require the Swiss National Bank to back the currency with gold to a certain extent. I believe that’s 30% but whether it’s 20% or 30%, the number is higher than the amount of gold they have today, so that would require Switzerland to go out and buy gold. In addition to repatriating the gold they have, they’d have to go out and buy more gold to meet this requirement. That would put a major bid in the market. We know China’s buying gold left and right and Russia’s buying all the gold they can. If you put Switzerland in the mix, Switzerland would be more transparent about it. China is doing everything by stealth and covert operations, using military and intelligence channels, and lying about it. I think we could rely upon Switzerland to be very transparent, and we’d know exactly what they’re doing.
It has to be bullish for gold in two ways. One, we just put a bid on the market. They’d have to go out and buy this gold. Bear in mind, Switzerland is printing Swiss francs to buy euros. Switzerland was worried about a strong franc, and so they were basically trying to fight the currency wars by attempting to trash their own currency via pegging to the euro. That meant that as the Swiss franc got stronger, they had to try to weaken it by selling francs and buying euros to maintain the peg. Well, that meant that they had to keep printing francs. The more money you print, the more gold you have to buy to maintain the ratio. That’s where the referendum and the currency peg would interact.
Not only would the Swiss National Bank have to buy more gold to meet the ratio, but if they were trying to maintain the peg at the same time in printing more money, they’d have to keep buying more and more gold because they would be printing more money, creating more assets, and therefore need more gold to meet the ratio all at the same time. It’s a very interesting dynamic. They’d be chasing their own tail, because the gold referendum would strengthen the Swiss franc, but the Swiss National Bank would want to weaken the Swiss franc, so they’d start out with a stronger franc, they’d print more money to trash it, but that would mean they’d have to buy more gold, which would strengthen it. You really are a dog chasing your tail at that point, but it’s very good for gold investors.
In terms of what’s going on in Switzerland, it’s a very interesting dynamic there as I’ve learned by speaking to some of these sponsors, some of the people involved. You’re not allowed to advertise on TV, so the campaigning has been by word of mouth, leaflet, putting up posters in train stations, and interestingly on social media — Twitter and Facebook and things like that. Number one, it’s a little bit of a 21st-century campaign but not a lot of television. Number two, there’s no real ‘No’ campaign. In Scotland, we saw the referendum on Scottish independence, where there was a big ‘Yes’ campaign and a big ‘No’ campaign. They to pull in the poor Queen. She’s 80-something and they had to get her involved, and they had David Cameron and Gordon Brown and all these people running around Scotland saying vote No. They put a lot into it, the ‘Noes’ prevailed, and that referendum did not pass.
Now in Switzerland, there’s a ‘Yes’ campaign but not a big ‘No’ campaign although there is a little bit of scare tactics and some information. They’re telling people if we have a stronger franc, it’s going to kill our chocolate bar exports and ski holidays and all that. There’s something to that, but there’s a benefit in having stronger currencies well, which is you make yourself a destination for investments, so I see more upside than downside. Interestingly, we’re seeing one scare tactic that I haven’t seen since the 1960s which is, if you vote Yes and Switzerland has to buy gold, the big beneficiary is going to be the Russians. They’re one of the largest gold producers and they have a lot of gold, so vote No because we want to hurt the Russians.
That’s what they said in the 1968 – ’69 when gold was $35 an ounce under the old Bretton Woods standard, the private market for gold was $40 – $41, and the London Gold Pool was suppressing the price of gold. Some economists said, who are we kidding here? We have to revalue the gold. A lot of people said, no, you can’t do that because it’ll help the Russians. Of course, they were the communist Soviet Union at the time. It’s interesting to see this old 1960s argument about helping the Russians being dusted off and recycled in the middle of the Swiss referendum.
In these interesting times, I don’t know how it’s going to turn out. There’s not a lot of polling, because, as I know from my own political activities, the problem with polling is that it’s really expensive and can run $100,000 to do it right. The Swiss “Yes” forces are a bit of a rag-tag army although they have received some contributions, and there are ways to contribute to them legally. Without a lot of TV advertising or polling, it’s very hard to know what’s going on. I have seen some reports that say that, yes, maybe winning, but I don’t know how reliable they are. It looks like it’s going to be close, so watch the space.
This is all the more reason maybe to position a little gold right now, particularly after Scotland. Keep in mind that Scotland has nothing to do with Switzerland. There was a lot of buzz about Scotland. When it turned out to be a No, I think a lot of people now consider it a non-event and assume Switzerland will turn out to be a No. With people just counting on a No, if it turns out to be Yes, that could be a shock and might be a little surprising for world markets at the end of the month.
AS: Next is an interesting question I’m going to paraphrase so maybe it’s a little easier to understand. This is coming from Steph T. who asks, “Can the Fed collapse? If so, would the IMF bail out the Fed?” There’s another part to this. So the first question is, can the Fed collapse? If it does, would the IMF bail it out? The second part being, is there any chance the IMF would need money from China and Russia? And if it did, would Russia even allow that kind of thing, and what kind of risk would that create?
JR: Great question and a pretty sophisticated one, so let me just take those in order. In talking about the Fed collapsing, the Fed has already collapsed. Let me explain what I mean by that. I come out of a hedge fund background among other things, and I think of the Fed as a really bad hedge fund. Number one, the Fed is leveraged at approximately 80 to 1. When you have about 50 billion of capital and over 4 trillion of assets, that’s 80 to 1 leverage. That’s kind of high leverage. Consider that Wall Street collapsed in 2008 with 30 to 1 leverage, and here’s our central bank with 80 to 1 leverage. Number 2, the Fed is insolvent on a mark-to-market basis. That is to say, if you took the assets and priced them not at historic purchase price but at what they’re worth today, it would wipe out the Fed’s capital.
You don’t have to take it from me; it’s the case. I’ve had private conversations with two members of the Federal Open Market Committee — one from the board of governors and another is one of the regional reserve bank presidents. These are not things you’ll see on Charlie Rose, so to speak, but privately, we’re friends so I kind of badger them a little bit and they admit it. I got one of the FOMC members to admit on the third try, and then the person went on to say that central banks don’t need capital. Then the other FOMC member also said something along those lines. To recap, the Fed is highly leveraged, it looks like a bad hedge fund, and it’s insolvent, so if you said, are they broke today? I would say, yes, they’re already broke.
What does that mean? What does the collapse of the Fed mean? What it really means is that it’s the collapse of confidence in the dollar, because the Fed prints dollars, right? If you make McDonald’s hamburgers and nobody wants McDonald’s hamburger, then you might have a corporate collapse. If you make dollars and nobody wants a dollar, then that’s probably my definition of collapse. The other thing people say is, the Fed can never go bankrupt because they can just print dollars, but what people don’t understand is that a dollar is not an asset to the Fed; it’s a liability. The Federal Reserve knows this and knows it is a form of debt, so when the Fed prints money, they’re just digging themselves a deeper hole, because those are the notes. Those are the things that people have to believe in in order for the Fed to still be standing.
To me, a collapse would mean a loss of confidence in the dollar because that’s the Fed’s main product. Could it collapse? The answer is yes, it could, but what that means is the collapse of confidence in the dollar which would pretty quickly lead to hyperinflation. Could the IMF bail them out? The answer is yes. In fact, I expect that. Let’s remember back in 1998 when Long-Term Capital Management was collapsing. I was very involved in that and had a front-row seat, so I know that case inside out. Roger Lowenstein also talks about it in his book, When Genius Failed. When Long-Term Capital Management was collapsing, the fund was bailed out by Wall Street. There was no federal money, so it was not a Fed bailout. The Fed did orchestrate it, but the money came from Wall Street, so in ’98 you had a hedge fund bailout by Wall Street.
In 2008, Wall Street was collapsing. It wasn’t a hedge fund anymore, Wall Street itself was collapsing and the Fed bailed them out. The dynamics of 1998 and 2008 are identical except that in one case it was Wall Street bailing out a hedge fund, and in the second case, it was the central banks bailing out Wall Street. Notice that each bailout gets bigger than the one before. If we have a 10-year tempo, the next crisis may be 2018, so we’ll go 1998, 2008, 2018. I’m not predicting that, but that’ll give you a timeframe. It’ll be the central banks themselves that need to be bailed out, not the hedge funds and not Wall Street. The only clean balance sheet left in the world, the only thing bigger than a central bank, is the IMF.
The IMF is leveraged about 3 to 1, not 80 to 1, so they’ve got a lot of headroom and can print a lot of money. Their money has a funny name called the Special Drawing Right or SDR. It’s really world money. They don’t call it world money because that’s too spooky, but that’s what it is. So it’s possible the IMF will print SDRs to bail out the central bank. Now, the third part of the question was where does the IMF get their money? They get it in two places. One, they can print SDRs, as I just described. They don’t need anything on the other side of the balance sheet to print SDRs; they can just print them and hand them out. So that’s one place. But to the extent they don’t do that, to the extent that they want to make loans or extend bailouts without printing SDRs, they do have to get money from the members. Would China and Russia give the money? China and Russia have already given the money since 2009. This was something that was announced at the G20 summit in Pittsburgh in September 2009.
I mentioned earlier that there’s a G20 Leaders’ Summit going on right now as we speak in Australia. This is one of a series. If you go back to the September 2009 G20 summit in Pittsburgh, Mike Froman and President Obama cut a deal where we basically agreed to refinance the IMF by coming up with a trillion dollars for the IMF so they could go bail out everybody else. Everyone signed on for a certain amount, and guess what? Japan, Netherlands, China, Europe, Spain, and everybody kicked in their share except for the United States. The United States signed up for a hundred billion, and so far we have not funded our share. This is why Madame Christine Lagarde, the head of the IMF, is so enraged. She threatened the United States last spring and said that we’ve got until December 31st to pay up or the IMF will start to go its own way, perhaps without the United States, cozying up to the BRICS and other members.
That’s a big threat, but I think Congress may call her bluff. This is one of these real inside Washington stories I don’t expect average everyday investors to follow. You have to be kind of a geek like me to be immersed in it, but this will be one of the stories in the lame-duck Congress that play out between now and the end of the year. Will John Boehner and the Senate find a way to slip in the IMF money, the hundred billion, before the end of the year? I think they might. They may do it on this war appropriation, because the President wants, I think, several billion, maybe 6 billion. He’s got two things going on. He wants some billions to fight the Islamic State and he wants a few billion to fight Ebola. Those are bills nobody wants to vote against, so assuming they both pass, what you would try to do is slide this amendment into one of those bills and the IMF would get their hundred billion. I can’t imagine the taxpayers being happy about it.
The short answer is the IMF does need money. They do get it from the members including Russia and China and those who haven’t contributed. The deadbeats right now are the U.S., but they’re going to try to slide that by the taxpayers between now and the end of the year.
AS: We still have another 11 or 12 questions in the queue but are unfortunately out of time. I do want to take a moment and thank all of our attendees for the questions that were asked. Many of these questions were very smart and sophisticated, so thank you for that. I will now turn it over to Jon.
JW: Thank you, Alex, and indeed, thank you Christopher, Jeremy, Daniel, Chinyani, Jim, and all the people who asked questions. We apologize to those of you who we didn’t get to today, but we’ll be mindful of your questions as we plan the next webinar in this series.
Thank you, Jim Rickards. It’s been great having you with us here today and sharing all your insights.
And thank you most of all, of course, to our listeners. Without you, these webinars would not be happening.
Just so you know, you can follow Jim Rickards on Twitter. His handle is @jamesgrickards. Let me remind you that you can find Jim’s latest book, The Death of Money, at Amazon or any good bookstore. Get yourself a copy, because it’s a fascinating read. Watch your e-mail for details, and we look forward to joining you for our next webinar in this series.
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