Transcript of Jim Rickards Interview October 10th, 2014

Transcript of Jim Rickards Interview October 10th, 2014


October 10th Interview with Jim Rickards Topics:

*Decline in labor force participation has hit a 4 decade low
*Yellens primary indicator is real wage growth
*Why the overall economy is weak
*Accuracy of Government Statistics
*Update on China
*Hacking and Asymmetric Cyber-Warfare
*The new M.A.D. is mutually assured financial destruction
*Why it makes sense to allocate to hard assets
*Why the next financial collapse will be exponentially larger than the last one
*The End Game, Part II

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Jim Rickards Interview: 10-10-2014

Jon Ward: 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 the Physical Gold Fund. He is the author of the New York Times bestseller Currency Wars: The Making of the Next Global Crisis. More recently, Jim is the author of The Death of Money: The Coming Collapse of the International Monetary System, also a New York Times bestseller. Hello, Jim, and welcome.


Jim Rickards: Thank you, Jon. It’s great to be with you again.


JW: Jim, in our recent conversations, you’ve been consistently downbeat about the state of the U.S. economy. Right now, as I’m looking at my newsfeed, it seems like everyone is saying happy days are here again, particularly with regards to job growth. How should I understand the discrepancy between your outlook and the media consensus?


JR: First of all, Jon, you’re exactly right in how you frame the question. My analysis along with some others is much more negative or at least reserved on growth in the U.S. economy versus what you read in the mainstream press and certainly on much of financial television. There are a couple of reasons for that. First, a lot of what you see on financial TV is populated by sell-side analysts. They’re good people, but they’re working for Goldman Sachs, Morgan Stanley, JPMorgan or one of the wire houses or they’re working for issuers of securities. They’re sort of corporate spokespeople and, of course, have a large vested interest in selling you stuff and making you think it’s all going to go up. So there’s a little bit of a cheerleading effect that goes on. Most investors and listeners are alert to that, but I wouldn’t underestimate the power of it. So there are a lot of people with a vested interest in the happy talk.


Beyond that, there are serious economists and mainstream analysts who are very buoyant, if you will, about the last employment report. A fair number of jobs were created in September, and some of the prior months were revised upwards, but you have to peel behind the numbers a little bit. You can’t stick with the headlines. The thing that struck me was the decline in labor force participation. Keep in mind that labor force participation is not the same as the unemployment rate. It’s basically a very simple fraction – how many people are able to work versus how many of them are actually working. Just when you think it can’t get any worse, that number has been going down and down and down is now at an all-time low. They haven’t kept these records forever. The records go back to the ’70s, but you have to go back to 1978 at this point to find lower labor force participation. That’s around the time when women started entering the work force in much larger numbers, so the labor force participation went up. Now it’s all the way back to where we were in the 1970s.


What is an economy? The economy is really just how many people are working — that’s the labor input — and how productive are they — that’s the capital or technology input. That’s it: who’s working and how productive are they. If fewer people are working, then obviously output is going to be lower unless productivity is going up; however, recent productivity figures show it’s going down, so we’re going down on both vectors. The number of people working and the productivity of those who are working are both going down. That’s a major drag on the economy in addition to a lot of other structural impediments standing in the way of the U.S. achieving its potential growth.


The best advice I can give anyone trying to understand the economy and know what Janet Yellen is looking at, is to look at real wages. Real wages are where labor force and inflation or price stability come together. Now, let’s go back to the Feds’ statutory dual mandate. You can argue about whether it’s sensible or even achievable. In my view it is not, but that is what the law says and that’s what guides the Fed and Janet Yellen, in particular. Their dual mandate is price stability—in theory that means no inflation, no deflation, just stable prices—and also reducing unemployment or maximizing employment in the economy.


Sometimes these mandates are at odds, so the things they need to do to get inflation under control might actually cause unemployment to go up. Today we’re in the opposite situation, which is to say Yellen is concerned primarily with getting more people back to work, increasing that labor force participation we just talked about, so she’s not worried about inflation for the time being because none of the inflation signals are blinking red. How do you reconcile these two things? How and where do price stability and maximum employment come together? The answer is real wages or inflation-adjusted wages. Basically take how much wages are going up, subtract the inflation component, and that’s the real wage. Real wages are flat to down and have actually been negative in some recent readings. In Yellen’s mind, when she sees real wages going up, that will be her inflation signal telling her that people can get a raise.


If I go to my boss today and ask for a raise, I’ll probably get thrown out of his office if not fired. By and large across the board, people aren’t getting raises although some people are in some sectors. When I can go to my boss and get a raise, that’s a sign that I’ve got some bargaining power. If I don’t get the raise, I might quit my job and go work somewhere else or there’s a new company opening up across the street, and they’ve got a for-hire sign out, and so forth. Real wages are a sign that labor has bargaining power. Once they get the wages, they’ll start to spend the money. That’s a signal that velocity will increase and inflation will take off. Those are signs that tell Yellen she might need to raise rates. Right now those signs are not flashing red, so it looks like there’s no inflation in the system at all.


Yellen is trying to create jobs by printing money. She’s not worried about inflation and not seeing real wages go up on her dashboard. That means her inclination or default position is to print more money. I understand that right now we’re in tapering mode, but as I’ve said before in prior interviews, tapering was a blunder. The Fed tapered into weakness which is starting to show up in stock market action, in corporate earnings, and in a variety of indices. They will finish the taper, because they’re locked in to that with only one month to go. My expectation is that there will be no rate increases in 2015 because the economy is doing very poorly. It would not surprise me at all to see them go to QE4 and actually increase asset purchases by, say, March or June of next year.


Unfortunately, happy days are not here again. Labor force participation is declining. Many of the jobs being created are part-time jobs, and not the kind of jobs that are going to provide incomes necessary to stimulate consumption. Inflation looks more like deflation at the moment, so the economy looks very, very weak.


JW: Let me ask you about economic information sources. There are those who argue that government statistics are themselves manipulated, for example, the CPI (Consumer Price Index). I’m thinking of websites like ShadowStats contending that inflation is far higher than official reports. What’s your take on this?


JR: I’m familiar with ShadowStats. I do look at it and think that’s extremely valuable information, but I actually don’t need ShadowStats. I just talk to my 83-year-old mother who tells me about the price of milk at the counter or price of gasoline or heating oil or some of the things she pays for, so I’ve got my own built-in inflation gauge. I think it is true that for things Americans buy over the counter day-to-day, actual inflation is significantly higher than what the U.S. government puts out in the Consumer Price Index series. I’m willing to take it as a given, but let’s step back from that a little bit and talk about what we mean by manipulation. If by manipulation we mean there’s actual fraud, that people sitting inside government offices are getting data and then manipulating the data or lying about it or printing out numbers that are just not true, I don’t believe that’s happening. I would be shocked to discover that is true.


However, having said that, there’s a lot of gray in these government statistics. You have to work in these agencies or be a trained economist to understand what goes on behind the curtains. There’s a lot of room for maneuver that’s not outright fraud or outright lying, but it does involve subjectivity in judgments, seasonal adjustments, and estimates. These numbers that come out are aggregated from reports coming in from all over the country. Some of these are samples, meaning they don’t get the data from everyone possibly affected but rather from a subset or a sample that they take. Some of them are estimates, so they’ve got some of the data, but not all of it, and they use that part to estimate what’s missing. Some of them are seasonal adjustments but because of a variety of factors such as demographics, climate, weather, etc., the seasonal adjustments may be out of date.


If you said we’re at the margin, would a highly politicized administration try to fade the numbers a little bit? That could be. It’s different from outright lying, but it’s a kind of political manipulation, if you will. There’s probably a little bit of that going on, but I think less than some of the critics might imagine. Beyond that, over the decades, there have been changes in the methodology. These changes are announced, they’re debated beforehand, and some people still debate them. One of these methodology changes is called hedonic adjustments, which refers to the quality of goods. You can’t take an automobile from 1979, line it up next to an automobile from 2009, and simply say they both have engines, four doors, four tires, glass windshields, so let’s just compare the price. The hedonic adjustment would say you’re getting more for your money with the 2009 car because it is safer, it has anti-lock brakes, airbags, SiriusXM radio, and a lot of other features. It’s not enough to just say two cars have four wheels and let’s look at the price. You’re getting more for your money. Well, that tends to be deflationary. Obviously, I just described how it’s done in theory, so there’s a lot of subjectivity there. Between the seasonal adjustments, hedonic adjustments, estimates, and let’s call it the gray, there’s plenty of room to fade these numbers somewhat. It’s not deep, dark, black helicopter conspiracy stuff but just people doing the best they can and maybe using flawed methodologies.


Here’s where I come out on this, Jon. It doesn’t matter what I think. What matters is what Janet Yellen thinks. I have opinions on all this, people who do ShadowStats have opinions, and any listener can follow whatever series they want to draw their own conclusions about what’s really going on. That’s one of the great things about the Internet age — allowing ample sources of information and competing views. But if you’re trying to understand policy, if you’re trying to figure out how to invest, if you’re trying to figure out how to allocate you’re portfolio, for better or worse you have to understand what Janet Yellen is thinking. She may be right, she may be wrong, she may be using flawed models. I think, in fact, she is using flawed models and gets some bad data, but it is what it is.


I attempt to put aside my own views and biases and way of understanding how the economy works, at least for the purpose of trying to figure out policy. To do that, I have to put myself in Janet Yellen’s shoes. She believes the government statistics. They may be flawed, gray or at odds with what people encounter when they go to the grocery store, but if that’s what Janet Yellen is using as a guide, then I need to look at that number if I want to understand what she’s going to do next. Those official numbers not only show no inflation, but lately they’re showing deflation. Deflation is a central bank’s worst nightmare, so that tells me she’s going to print more money. This is why I said I wouldn’t be surprised to see QE4 next year. Kudos to the people at ShadowStats. I think it is important stuff, but I don’t put too much weight on it only because I’m trying to figure out what Janet Yellen is thinking. To do that, you have to look at the official statistics.


JW: Let me now turn to the world situation, Jim. This morning as we’re recording, it seems that political unrest in Hong Kong may not be over. Given the status of Hong Kong as a financial center, how significant is this story looking forward?


JR: I think it’s very significant. You’ve actually touched on one of my pet peeves lately which I’ve referred to in other interviews as the curse of a two-second attention span. We do live in a digital world with digital media and the Internet, and I think it’s fantastic that people have so many sources of information, but part of what comes out of this is that every story just kind of comes and goes. We wake up and want our digital fix, if you will. We want our new story so we forget about the old stories and the fact that these things have not gone away. There are many examples, but just go back to earlier this year in February and March when we had the so-called Maidan Square riots in Kiev, Ukraine, which were a protest against the government. Markets got a little jittery, the government was overthrown, and Putin reacted by invading Crimea. Markets went down on that news, but then a couple of days later we were like, okay, Putin got Crimea, we’re not going to do anything about it, at least not militarily. People started rationalizing it, and everything went back to normal as if it’s too bad for the Crimeans, but that story is over.


Well, it wasn’t over and it was never going to be over. Then they got into Ukraine, then there was the shooting down of the Malaysian Airliner, then the Kiev forces advanced, then Putin moved in and supplied the Ukrainian rebels, then there was more fighting, now it looks like fait accompli that Putin has, in effect, peeled off two eastern Ukrainian republics, and it’s still not over. I’m always surprised at how people think these stories last for one or two days as if it were a car crash or something when in fact they don’t go away. It’s the same thing with the Islamic State, with the Iranian nuclear program, and I think with Hong Kong. These stories may seem to come out of nowhere to people who are not experts in those particular areas. We tend to dismiss them after a day or two, but I just keep piling them up and saying none of them are going away; all of them are coming back. Any investor who is surprised when these things reemerge or is surprised that they’d get worse shouldn’t be, because they’re not really paying attention to the dynamics behind them.


I think the Hong Kong story is a very big story that’s not going away, and we’re going to be hearing more about it. Let’s look at it from Beijing’s perspective. The reporting, although not inaccurate, is stating that this is a pro-democracy demonstration and Beijing is getting very heavy-handed with the voting or electoral situation in Hong Kong by saying you guys can have an election but you can only vote for people we approve of. Guess what, all three candidates are henchmen or minions, and so it’s really not much of a choice. It’s sort of a sham democracy, and people realize that, so they’re protesting against it.


From Beijing’s point of view, they have no tolerance for any protest. It doesn’t matter if it’s a democracy movement in Hong Kong, if it’s the Falun Gong movement in China, if it’s the Catholic bishops (at least the ones the Vatican approves, not the Communist-approved Catholic Church), if it’s the Uyghur separatists in western China or if it’s people protesting about being pushed off their land. I expect we’ll see money riots in the near future when people realize that the Ponzi scheme of wealth management products has collapsed and their statements have been wiped out.


Any kind of protest or instability is taken with great concern by Beijing. This is because China has a history of collapse which I call the accordion theory. State power is concentrated and concentrated, then it collapses, then it falls apart, and then it expands into all the regions and districts. Over a long period of time, it’s concentrated again, and then it falls apart again. This is the history of Chinese governance, government, empire, and dynasty for the past 4,000 years. History has said it can fall apart very quickly and very unexpectedly.


The paradigmatic case is the Taiping Rebellion which lasted over 10 years from 1850 to the 1860s. It involved a man who failed an entrance exam a couple of times to the civil service, the Mandarin, so to speak, and realized he wasn’t going to get the job he aspired to. He went to bed, had a dream that he was the brother of Jesus Christ, woke up, told a friend, and the two of them started the Heavenly Kingdom movement. “Taiping” in Chinese means Heavenly Kingdom. Within a year they had 100 million followers, they had taken over half the Qing Dynasty, they set up a capital on Nanjing, and they were attacking Shanghai. The whole empire had fallen apart within a year based on two guys one of whom had a dream, right? So the Qing Dynasty forces combined with foreign forces. Imperialist troops, put down the rebellion with approximately 20 million casualties. 1850 sounds like a long time ago, but not to the leadership in Beijing. They are a centralized communist dynasty following on the Qing, the Ming, the Sung, the Tung, and other famous Chinese dynasties. It’s a communist dynasty highly concentrated, highly vulnerable, and they have zero tolerance for any kind of shock like this, because they know how quickly things can fall apart.


That’s how they look at the current protest. That’s how they looked at Tiananmen Square which was just in 1989. No one knows the exact number, but some historians estimate that thousands were killed by People’s Liberation Army troops. They came in, shut it down, and killed people in the square trying to escape. Of course, that has been covered up ever since. We casually look at the Hong Kong demonstrations as yeah, they have some students and some younger people and some others who are a little upset about how the elections are going to go, but Beijing looks at them as a potential Taiping rebellion that could spread to the mainland.


I talked to one of the top Chinese princelings. “Princelings” is shorthand for the elites and oligarchs who are second- or third-generation descendants of people who were on the Long March with Mao Tse-tung. One of them told me that the greatest fear of the leadership in Beijing is not the U.S. Navy: it’s Twitter mobile apps. Mobile apps are harder to interdict than the Internet, because they operate through cell systems rather than hard lines and Internet backbone. People can communicate readily and spread information, so they’re very fearful of this.


JW: Talking of stories that won’t go away, you’ve repeatedly warned us of the real threat from hackers especially, but not exclusively, emanating from Russia. Since we last spoke, there have been reports of massive hacking intrusions affecting about 12 major U.S. financial institutions. I wonder if you have any comment on that?


JR: When we saw events in Crimea and later Ukraine starting last winter, I wrote an op-ed on the topic of financial warfare in which I said, clearly the U.S. was not going to intervene militarily, at least not in a kinetic way, but our response would be economic sanctions. I was warning the White House that if they pushed those too far, Russia would push back asymmetrically, meaning they would do things that were not strictly military but could be damaging to the U.S. In effect, we were back to the Cold War of escalation and mutually assured destruction. I actually called it “mutually assured financial destruction.” Since then, I think Russia has behaved in exactly the way I expected. We put economic sanctions on their oligarchs, we prevented some of their major corporations from raising debt in European markets, and in the U.S. we closed off the capital markets a little bit. There’s a lot Russia can do. They could sell U.S. assets and thereby raise U.S. interest rates, etc., but it seems they are operating in the cyber warfare space.


In late July there was a cover story in Bloomberg BusinessWeek I remember recommending to our listeners, and it’s easy to find online. It was about the NASDAQ hack, where the FBI and Department of Homeland Security found a Russian attack virus inside the operating system of the NASDAQ stock exchange, one that was “capable of completely shutting down the exchange.” That’s not inference: that was an exact quote from a U.S. government official. This virus came not from some criminal gang but from the Russian government. They’re entirely capable of this, and I said so at the time. We are seeing more and more evidence of it now. The most recent story indicates a massive intrusion into JPMorgan’s systems and other large banks and financial institutions, apparently coming from Russia.


The usual intrusion is trying to steal a credit card number or a Social Security number to do identity theft and online fraud, but this doesn’t seem to have been that type of attack. It’s much more planting viruses and getting ready to disrupt or take down the financial system or perhaps it’s a warning shot. In the old days when two naval vessels confronted each other, if they didn’t want to sink the other guy right away, they fired a shot across the bow. That was the expression to show they were capable of sinking him and to try to get him to be on his best behavior. This looks to me like a shot across the bow: Putin letting the attack be discovered as a way of saying “Look what I can do, don’t mess with me.”  Very much Putin style.


Interestingly, the New York Times reported that this was taking place and being monitored by the intelligence community and White House over the summer, but it was just revealed really in the past few days. The question the President kept asking was, is this Putin’s revenge? He wasn’t thinking of it in a financial space; he was thinking of it in military and geopolitical space as a form of cyber financial warfare. I think it’s a good question and the right way to think about it. It’s pretty clear that this is Putin sending a message to the U.S. – look, if you want to keep putting sanctions on our energy companies and banks, be my guest, but don’t be surprised if you wake up one day and your stock exchanges are closed. There are real examples of this. I just gave one as reported by Bloomberg about this attack virus, but remember that on August 22, 2013, the NASDAQ exchange was closed for half a day. It shut down around noon and didn’t reopen for hours. Everyone kept saying, “Why won’t they tell us what’s wrong?” If what was wrong was some kind of computer glitch, they would have told us it’s a computer problem. Some engineer was loading some software and did it the wrong way and we’re really sorry, it won’t happen again.


The fact that they haven’t told us and never offered a public explanation suggests to me that the real explanation is one they don’t want people to know about, which is that is was some kind of cyber attack. If people realized that, they’d start pulling some of their money out of the stock exchange and getting it into hard assets such as gold, land, fine art, and things that are not digital that can be erased by Putin’s hackers. I think this is a very serious threat and we’re seeing Putin fire shots across the bow demonstrating what he’s capable of. The U.S. is getting the message which is one reason why the sanctions won’t go much further — because of the threat of retaliation, which means that Putin keeps Eastern Ukraine and Crimea.


This is something that starts out in traditional geopolitical space but today plays out asymmetrically in cyber financial warfare. It’s the new world we live in which, again, I call mutually assured financial destruction. As if investors didn’t have enough to worry about, here’s one more thing, but to me it’s an argument for not keeping all of your wealth in digital form but keeping some of it in physical form including gold, precious metals, land, fine art, and other tangibles.


JW: Let me turn to a gold question here, and it’s on a global level to begin with. You’ve talked to us before about what you called the rebalancing of sovereign gold stocks with a concerted shift of gold from West to East, specifically to China. As I understand it, this shift is implicitly endorsed by the United States. We received a question by e-mail from Lawrence Rodriguez that reads as follows: “What is the actual end game? Jim gets us to the point where China and the U.S. have equal amounts of gold, but what happens then? Is that when the U.S., China, IMF countries, and the other G20 agree on a gold batch trade settlement standard or what? What is the final state of currencies?”


JR: It’s a good question and something I cover in chapters 9 and 11 of my new book, The Death of Money. The process is the one you described, Jon, and we’ve talked about it before. It’s very widely recognized that gold is moving from West to East. Gold is moving from central bank warehouses in the West, in Europe, and in the GLD warehouse in London to Chinese warehouses in Shanghai. That movement and acquisition of gold by China is very well documented. What’s interesting is I’ve seen some figures recently that the cost of gold mining (Chinese production inside China) is now approaching $2,000 an ounce, which is way above the current market price of about $1,200 an ounce. What that tells me is that the Chinese are running out of gold. In other words, the quality of the ore is deteriorating and the degree of difficulty in finding it and mining it is getting harder and harder. The fact that they’re still doing it tells you that they’re price insensitive. In other words, they want the gold and actually don’t care about the price.


By the way, the Chinese use horrendous mining techniques. They use cyanide to get the ore. They mill it, grind it, and then leech out the gold using cyanide. Now if you’re a Canadian or U.S. company, you have to account for every drop of cyanide. You have to cache it, store it, measure it before, and measure it after to prove that you did not let any cyanide go into the environment even though you’re using it. That’s not true in China. They just dump it in the rivers and poison their own people. They don’t care. The fact that their costs are so high tells me they’re running out of gold. I said that some years ago when China was sort of at the back of the pack producing 90 tons a year. The Big Five produces about 200 tons a year. China came from the back of the pack to 450 tons a year, way out in front, twice as large as the next largest producer, in a couple of years. It was almost seemingly overnight, but people were extrapolating that far into the future.  I said, well, I know what’s going to happen; they’re going to have a couple of good years in terms of acquisition of gold, but then those mines are going to be depleted and they’re not going to find any more. This appears to be what’s happening. They’ve stripped the mines bare so that the 450 tons a year they’ve been banging out for the past 4 or 5 years looks like it’s coming to an end. That just makes the supply side even tighter.


Now, what’s the end game? What happens when China reevaluates or re-announces its gold? We all know they have thousands of tons more than they’ve announced publicly, and one of the questions is when will they update their figures and admit to the fact that they actually have 3,000 or 4,000 tons as opposed to the official 1,000 tons they say they have. It’s hard to know, but I’ve estimated it sometime maybe in the middle of 2015. That’s an estimate, so it could be sooner or later, but I have revised my target upwards. I had China trying to acquire perhaps 4,000 or 5,000 tons so that their gold-to-GDP ratio would equal the United States, but the problem with that is their GDP is rising faster than the U.S., so it’s a moving target. Even when they hit the target, they’ve got to buy more gold because they’re growing faster than the other guy. If they want to maintain that gold-to-GDP ratio, they have to keep piling on the gold. This may be the case, so my latest thinking based on reports coming out of China and some research is that they may just be going for 8,000 tons. They may be thinking, Just forget about the gold-to-GDP ratio; let’s just have more than the United States as a way of declaring that we’re a larger economy and a larger financial power, etc.


Whether they’re targeting 4,000 tons, 5,000 tons or 8,000 tons, it’s still the case that they’ve got to acquire all the gold they can. So the question is what happens when they get there? What happens when they announce it? What happens when we live in a world where Chinese gold and U.S. gold are equilibrated by whatever measure you want to use? The answer is inflation. To understand why that’s what this is leading up to, you have to go back to the beginnings of Bretton Woods in the 1950s when the United States had 20,000 tons of gold. By 1970 the United States was down to 9,000 tons. Where did the 11,000 tons go? It went to the U.S. trading partners of the time including Germany, France, and Italy who all got 2,000 or 3,000 tons each. Netherlands, Japan, and others got something in the hundreds of tons, but if you added it all up, that was there the 11,000 tons went. In those days up until 1971, if you traded with the United States and ran a surplus – you had dollars in your reserves – you could cash the dollars in and get gold. They did to a very great extent and acquired all that gold.


Now flash forward 30 or 40 years. China’s the big trading power, the big country running the surpluses, but they never got the gold. Nixon ended that in 1971, so all the Chinese could do is get dollars. They could buy treasuries, stocks, land in the U.S., and a lot of things with those dollars, but what they couldn’t get is gold from the U.S. at a fixed price like our trading partners in the ’60s were able to do. So China was thinking wait a second, this system is rigged against us. Back in the day, trading partners of the U.S. could get gold, and now we can’t get the gold, but we’re going to get it anyway. We’re just going to buy it on the market. The reason is that they’re extremely vulnerable to inflation. If you have $4 trillion of reserves, which the Chinese do, and say $3 trillion of that is denominated in U.S. dollars, which it is, then all the U.S. has to do to get out from under that debt is to have inflation and in fact devalue the dollar.


Every time there is 10% inflation, it’s like a $300 billion wealth transfer from China to the United States. In other words, people say China has us over a barrel because we owe them $3 trillion, but no, they don’t. We have them over a barrel because we can just print the money, hand it to them, and say, hey, China, here’s your $3 trillion back. Good luck buying a loaf of bread, because it’s not worth anything. The oldest joke in banking is if I owe you a million dollars, I have a problem, but if I owe you a billion dollars, you have a problem, because you have to collect the money from me and I might not pay you. When we owe China $3 trillion, they have a problem, because we’ll give them the money, but like I say, it might not be worth very much. So they’re extremely vulnerable to inflation.


What they’re doing is piling up gold as a hedge. They can’t dump the treasuries and get out from under the paper side of the equation, because the market is big, but it’s not that big, and the U.S. could stop them in various ways. So they can’t dump the treasuries, but what they can do is pile up enormous amounts of gold. Then they’re insulated; they’re hedged. If the dollar is stable, maybe the gold won’t do very much but they’ll collect the real value of the dollars. If we inflate the dollars, which is much more likely, they will lose on the paper side but they’ll make it up on the physical gold side.


The U.S. is okay with this, because the U.S. is counting on China for a lot of things. We need help in the confrontations with Japan and confrontations in the South China Sea. We need them to hang on to their dollars, not dump the dollars. We need them to buy more treasuries. Given all that background, all the things we need China for, we’re always badgering them about currency wars and currency manipulation. Our quid pro quo is to say to China we understand that you’re worried about the dollar, you’re vulnerable to the dollar, and all the other trading partners have big piles of gold and you don’t, so we’re going to acquiesce or cooperate even in allowing you to get the gold. This is the gold rebalancing, but what it means is that if inflation took off before China had the gold, China would lose because they would lose more in the paper than they would be making on the gold. If they get enough gold, they’re hedged because then if inflation takes off, they’ll lose on the paper side but they’ll make it up on the gold side as would the United States and Europe for that matter. Europe has more gold than the United States. They have 10,000 tons combined compared to the U.S., 8,000 tons. Rebalancing is the green light for inflation, so inflation probably won’t take off until the rebalancing is done.


Once the rebalancing is done, you can just say to inflation, let ‘er rip! — because now the Chinese are on the bus. The Chinese are concerned that the Europeans and the U.S. are on the bus, but when China gets enough gold, suddenly they’ll be on the bus. Then all the major powers can let inflation rip and basically steal from their own citizens who are holding paper assets. They’re the ones sitting on all the gold — 10,000 tons in Europe, 8,000 tons in the U.S., and let’s say 8,000 tons in China — so they’re protected. That’s what’s going on, so the end game is once China gets enough gold, that’s the green light for inflation. That’s how this will end up.


JW: Jim, may I finish with a somewhat philosophical question? In your two books and your many interviews, you’ve been describing a global monetary system that is heading for a collapse. Stepping back, what is the underlying cause? Was it really avoidable? Banks will be banks! Or, if I can take a leaf from Thomas Piketty’s book, are we simply seeing what happens when market forces are let loose on the world?


JR: That’s a very good question, Jon. I like to put it in analytical and scientific space. What I mean by that is I have come out in my books and in public speaking and interviews with some fairly dire forecasts. People tend to think I must live in a cave surrounded by machine guns and canned goods, which is not true. I live in a very nice house with a very attractive view of Long Island Sound. I wake up every day, manage a portfolio, and I get out and about, so I have a fairly normal life in that respect. My personality is actually rather optimistic about things, so I might not be the doom and gloom people are imagining me to be, but I am an analyst. I do have models and they do predict some fairly dire things including the collapse of the international monetary system, but I don’t think people are helpless. We don’t have to be victims. We can see it coming and do things. There are always things for investors to do such as strategies and asset classes to, first of all, survive it, preserve wealth, and then even prosper and gain wealth through the chaos. People like Warren Buffett and others have done this for decades, and the Chinese are doing it now with their gold acquisitions.


My best advice to investors is to just get some gold, not too much, around 10% of your portfolio. I’m constantly badgered by people because we know that gold’s been going down. It hit an all-time high in August 2011 and it’s down from there. People say Jim, you recommend gold, and you’re an idiot because can’t you see it’s coming down and all that. Again, that gets back to the two-second attention span I talked about earlier, but that’s why I recommend 10%. You don’t put 100% of your assets in gold; you have a diversified portfolio. I’ve made very good money in fine art, in alternatives, and in other things, and I also have a large component of cash. A fund I manage has 40% cash, and on days when the stock market is down 2% or 3% in a day as we’ve seen, cash looks like a warm, comfortable blanket because cash didn’t go down on the day the stock market did. The key is diversification, but gold is an important part of that.


What I like to do is not just say the sky is falling, because there are a lot of people saying that. I think if that’s all you’re saying, it’s content-free. Maybe you’re a bit of a scaremonger, and I don’t think you have much to add to the debate. I look at it through the lens of complexity theory that involves inputs and outputs. The most important metric is scale. What’s the scale of the system? That’s just a technical word for the size of the system, because the worst thing that can happen in a complex system is an exponential function of scale meaning that if you double the system, you more than double the risk. If you triple the system, you more than triple the risk because the function is, as I say, a nonlinear exponential function.


What we’ve been doing is doubling and tripling the system. All the banks are too big to fail, and all the derivatives books today are bigger than they were in 2008 when we had the last financial panic. This is the equivalent of sending the Army Corps of Engineers out to make the San Andreas Fault bigger. We all know that the San Andreas Fault is an earthquake risk and some pretty bad earthquakes can happen, but nobody thinks it’s a good idea to make the fault line bigger. That is what we’re doing in the financial space — making the fault line bigger by allowing the banks to get bigger, allowing derivatives to get bigger, and so on.


It therefore doesn’t take a lot of analysis to see that the next financial collapse will also be exponentially bigger than what has come before, because the system within which it takes place has grown enormously. It would be fine if regulators, bankers, and policymakers understood this the way I just described it to the listeners, Jon, but they don’t. They’re using outdated, flawed equilibrium models that involve normally distributed risk. Their whole mental and mathematical tool kit for understanding risk and banking is worse than obsolete. It is obsolete, but it’s dangerously obsolete because it points them in the wrong direction, which is worse than just being blindfolded.


Given the fact that the system has scaled up, it’s a complex system in which catastrophe or avalanches gets exponentially bigger. Also, we’ve had five years of very low volatility without a panic, and that’s a long stretch as these things go. Panics happen every 5, 7 or sometimes 10 years, but they’re not 20 years apart. Sometimes they’re only 4 years apart, so we’re overdue in that sense. That doesn’t mean it happens like clockwork tomorrow, but it does mean no one should be surprised if it does.


JW: Thank you, Jim Rickards. It’s been great having you with us today, and thank you to our listeners. You can follow Jim on Twitter. His handle is @jamesgrickards. Speaking of Twitter, please share your questions there for our next podcast. Use the hash tag #askjimrickards followed by your question. Wherever you post that on Twitter, we’ll find your question. We’d love to hear from you. Just as a reminder, you can find Jim’s new book The Death of Money at Amazon or at any good bookstore. Get yourself a copy; it’s a great read. Goodbye for now, and we look forward to joining you again soon.


If you would like to ask Jim Rickards a question on Twitter which may be used in a future interview, please use hashtag #AskJimRickards


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