Preston Pysh  06:03

Now, I know you had a conversation with Bernacchi over in Japan. What did you guys talk about? Was it a long conversation or was it pretty quick?

Jim Rickards  06:09

It was about a half-hour. We had some private time. But it was interesting because when I wrote “The Death of Money,” my second book, I used Bernacchi’s research. He’s scholarly, but long before he was a central banker, he was a very noted scholar at Princeton University and he was the leading scholar of the Great Depression. Now, of course, you have Milton Friedman and Schwartz who paved the way with their monetary history of the United States. But Bernacchi is a younger generation, following their footsteps, and had written quite a bit on the Great Depression.

One of the things that struck me and this is Bernacchi’s own research because you often hear that gold caused the Great Depression. I just explained why that’s not true. It was a politically motivated price of gold, but also the gold constrained action in the Great Depression. Central banks could have been more aggressive, increasing the money supply if they hadn’t been on that, you know, dopey gold standard, so to speak. So this is part of the rap on gold.

07:02

Well, but what Bernacchi showed is that, by law at the time, the money supply in the United States was allowed to be 250% of the gold supplies, so take the gold market to market is $20 an ounce. And then two and a half times, that’s how big the money supply could be. The actual money supply was never more than 100%, which means that the Federal Reserve had the ability to more than double the money supply, while still on a gold standard without violating the law.

So the blunder was not gold, had nothing to do with gold. It was a failure of discretionary monetary policy. If you say to the Fed, “Hey, you could double the money supply with a gold standard.” And they don’t do it. Whose fault is that? Do you blame gold? Or do you blame the Fed? So that’s the way I read it. So when I had the opportunity to talk to Bernacchi, I teased him a little bit because I had been one of the people who helped to stand up the Center for Financial Economics at Johns Hopkins University, and we searched for Center Director as you always do and got a very senior, brilliant distinguished Ph.D. monetary economist from the Fed to come in as our director. And he was wasn’t even there two years and Bernacchi took him back to the Fed. Bernacchi picks us off.

So I teased him a little bit, “Mr. Chairman, you picked off my *inaudible. So well, we came back to you,” which is true because the scholar in question, he’s back at the center. So, but anyway, I had a copy of his book with me. And I know as an author myself, I know that you never turned down a request for an autograph. So when I asked him for his autograph, he very happily signed it. So I have an autographed copy of Bernacchi.

On a serious note, I said, “Mr. Chairman, I read your research to say that gold was not a constraint on money supply in the Great Depression. Do I have that right?” He looked at me and said, “Yes, you do.” So I have it straight from the horse’s mouth that doesn’t blame go for the Great Depression. But again, it’s another one of these myths that you hear over and over, “Oh, we can’t have a gold standard because it caused the Great Depression,” and that’s just simply not true.

Preston Pysh  08:52

Fantastic. I love your quantitative discussion when gold performs well, and when it doesn’t. As far as I’m concerned, you’re like one of the first people who has ever written a book that lays out some math and quantitative value for how to look at gold and when it performs well. Everything else just seems like it’s black magic, as far as I’m concerned.

I don’t like it when people say gold goes up when there’s fear in the markets. And the discussion that you have in your new book dispels that when you talk about areas where you do see it go up and go down.

For me, the dollar price of gold is a function of fiat credit expansion and contraction. And you described in an even better way and in detail that with nominal versus real interest rates. Can you talk to our audience a little bit about this idea and what environment gold prices do well when compared to domestic currencies, interest rates, and inflation?

Jim Rickards  09:41

Sure, I’d be glad to Preston. And you’re right, this is a tough one because it starts with a mathematical concept that the French called the *numéraire, and the numéraire is nothing more than how do you count things. So how do you measure things? So let’s say I have two individuals and there’s a football field and I get one of them a ruler, a one-foot ruler, and I give the other one a yardstick. I say, “Hey guys go out there and measure that football field.”

Well, the guy with the ruler comes back and says it’s 300 feet long, and the guy with the yardstick comes back and says it’s 100 yards long. Was it 300 or 100? Well, it depends what you’re using to count and the same thing applies when it comes to gold.

If you privilege the dollar, if you say the dollar, the US dollar is the measure of all things, that’s how we’re going to measure the football field. Then people look at gold and say, “Well, it’s up or it’s down you know, it’s 1215 ounces down to 1200. Now, it’s 1900 or it’s whatever.” That’s how they tell you the price of gold.

But what if you’re using a different measuring stick or what I do is I use gold as the measuring stick, I use the weight of gold. Then when I look at the price of gold, I say well, when people say gold is $1,050 an ounce, I say no. A dollar buys you one 1050th of an ounce of physical metal. And when gold is 1300 dollars an ounce, I say no. A dollar buys you 113th of an ounce of physical metal. And in that scenario, I wouldn’t say the price of gold went up, I would say the dollar went down, the value of the dollar went down, the purchasing power of the dollar went down, measured in gold.

So right away, you have to go through the looking glass and think about how you’re going to measure things. So that’s the starting place. But specifically, to your question, Preston, people are very confused about interest rates, because they’ll say, “You know, interest rates are at an all-time low or interest rates are near an all-time low.”

11:23

Well, nominal interest rates are close to an all-time low, but real interest rates are not and what’s the difference? The real interest rate is just the nominal interest rate minus inflation. So let’s say you have a 5% interest rate, and you have 3% inflation. Well, the real interest rate is 2%, because if you borrow money at 5%, but there’s 3% inflation, you get to pay the money back in cheaper dollars. What you’re paying back doesn’t have as much real value.

So the real cost of the 5% loan, in a world of 3% inflation, is 2%. That’s the real cost. I remember when I got my first mortgage in 1980, it was 13%. My mother cried and because of her first mortgage, it was like 2%. I said, “But Mom, I’ve got a 13% mortgage but inflation is 15% so my real cost is negative two and my taxes were 50%, it was tax-deductible. So on an after-tax basis, I was making 4% or 5%.” So the bank was paying me to be a borrower. But that’s the thing. In other words, when interest rates were 13%, the real interest rate was lower than it is today because of the impact of inflation. So right away you gotta put that inflation factor in there if you want to see what’s going on.

And interest rates today, actually, are pretty high because inflation is so low. This is why Europe is chasing…So Europe has negative interest rates because they’re trying… Europe is trying to get to a negative real rate. A negative real rate is one where the bank pays you to be a borrower. You get to pay them back and cheaper dollar. There’s no project that doesn’t make sense in a world of negative real rates because like you’re paying me to borrow money, what’s the big deal? If I lose money, I still make money.

So but as Inflation gets lower and lower, you have to take the nominal rate lower and lower to get to a negative real rate. So as you’re chasing your tail, it’s like nominal rates are chasing inflation down, trying to pass them, and get to a lower level so you can have negative real rates. And it’s not working, because inflation continues to…

13:19

By the way, we spend an hour on why this is all true, but just to make the point, if the interest rate is negative 1%. Sounds low, right? But let’s say inflation is deflation, negative two. What’s the real rate? Well, it’s negative one minus negative two, when you subtract a negative, you add the absolute value, the real rate is plus one. It’s still a very high real rate. It’s expensive money.

Negative 1% is expensive money if inflation is negative two because the real rate is plus one. Now we’re through the looking glass or subtracting negatives. The math is hard, but it’s a little bit counterintuitive. So that’s the world we’re living in, but just to cut to the chase, Preston, gold loves a negative real rate because the world of negative real rates is the world of higher dollar prices for gold, because what’s the rap on gold? It has no yield, okay? But if real rates are negative, then gold with no yield is a high yield asset. Zero is greater than any negative number. So if interest rates are negative and gold has zero yields, you have a positive yield on gold. Gold is a high yield asset.

Stig Brodersen  14:27

Perfect. In your book, Jim, you clearly distinguish ed between paper gold and physical gold. And you highlighted the risk of the former market easily being 100 times bigger. Could you please explain why investors might think that they are vested in physical gold, might only be exposed to the price of gold, and which other risks it entails?

Jim Rickards  14:47

You know, when you hear the phrase paper gold, just take an eraser and erase the gold part. It’s one of the great oxymorons of all time because it’s just paper. But I’ll make the distinction.

So physical gold, its bullion. It’s you know American gold eagles. It’s a one-kilo bar. That’s physical gold in safe non-bank possession. I don’t recommend putting it in banks because that’ll be the first place it gets locked down to the next financial crisis. You won’t be able to get your gold. That’s no fun. So but there are reputable non-bank vaults readily available. I’m not in the business of recommending vaults, but there are names like Brinks Dunbar, Loomis, others. Brinks has been around for over 100 years. They’re bonded and insured.  They’re reputable. But there are other less well-known vault operators just make sure they have insurance. Make sure they have a better business bureau rating and get some references and you know, do your homework and that thing.

15:37

But to save time, that’s physical gold. That’s easy. So let’s talk about paper gold. It comes in three flavors, there’s the COMEX futures contracts. There are the ETFs, exchange-traded funds, and then there’s what’s called unallocated gold from the London Bullion Market Association, LBMA. These are the big gold dealers.  We know Citibank, JP Morgan, Goldman Sachs, and HSBC. So it’s a half dozen or so, maybe 10 or so big banks. So let’s take them one at a time.

Let’s take the COMEX Gold Futures. Well, I can call my broker and buy a futures contract on gold. And if gold goes up, I win, I make money on that futures contract, and I don’t have to get my hands dirty with physical gold, no storage costs, etc, just a commission. But what’s wrong with that? Well, what’s wrong with that is that futures contracts allow for physical delivery. So as the holder of a futures contract, I can sell my contract back to the market and just take my profits. I can roll it over into another *inaudible to keep my position open, or I can give delivery notice. I can tell the exchange, “Hey, I own this futures contract please give me the gold.” And they will allow you to do that. They’ll ship the gold to a designated place.

16:46

The problem is the amount of gold in the warehouse is about 1% of all the futures contracts outstanding. What do you think would happen if all the long holders of gold futures contracts all call up and say give me the gold?” Well, clearly, they wouldn’t do it. They couldn’t do it. And guess what? They don’t have to.

I’m enough of a geek that I read the rule books of all these exchanges. They say in the rulebook, we are not a source of supply. In other words, they allow for physical delivery just to keep the trading honest, just to keep the physical paper arbitrage in line, but they don’t consider themselves gold dealers. They say we’re not a source of supply. And they also have a rule in the rulebook that says they can change the rules. You know, you go back to the Hunt Brothers, when they cornered the silver market in 1980 and the exchange changed the rules and everybody went, “Oh, you know, you changed the exchanges. It’s all rigged. You know, you changed the rules.” No. They have a rule that says they can change the rules.

17:35

So they also have another rule that says in the event of disorderly markets that the Board of Governors can issue emergency orders. So they have all the tools they need to say sorry, you know, you 100 people lined up for one bar of gold, you’ve got 100 bars of gold long futures. We got one bar gold in the vault, you all want it, sorry, you can’t do it. You can trade for liquidation only, which means you can rollover your contracts or they could terminate the contracts at the close of business yesterday and send you a check. They won’t steal your money, they’ll send you a check for yesterday’s close. But what you want is today’s price because when is this going to happen?

This is not going to happen in calm times. There’s a conditional correlation. This is going to happen when the full-scale buying panic going on. So you’re gonna be sitting there, price of gold goes up to $100 an ounce up to hundred dollars an ounce the next day, up to $300 an ounce the day after that. You’re going to be watching the price to go up on television, but you’re not going to be able to get your gold. You’re going to get a letter from the COMEX saying, “Here’s your check for you know, yesterday’s price or two days.”

So you’re not gonna you’re not going to get the protection exactly when you most need it. So that’s the other thing people don’t get. The time when these contract clauses and exchange rules are invoked to deny you your profits will be exactly the same time when your profits are the greatest because there’s a correlation between panic and emergency action. Same thing with ETFs. People say “Why on GLD that’s… I don’t want to pick on GLD. But that’s the ticker symbol. That’s the biggest ETF. So I own gold.”

No, you don’t. GLD is a share of stock trader on the New York Stock Exchange, in a trust that has administrators and trustees and authorization. So yes, there is a vault in London that does have gold and I’m not saying there’s no gold anywhere but you can’t get it. All you can do is sell your stock, right? What if the stock exchange is closed? People say, “That would never happen.” Guess what? The New York Stock Exchange was closed for five months, from July to December 1914.

The New York Stock Exchange was closed for five months. It was closed in Hurricane Sandy. It was closed after 9/11. It is closed every weekend. It’s closed on holidays. The New York Stock Exchange closes all the time. So exchanges close, you can’t trade your shares. And by the way, they can also suspend trading and send you a check for yesterday’s price.

19:40

The last one is that to be the most insidious of all it’s called the LBMA, unallocated gold contracts. So I called JP Morgan and say, “Hey, guys, I want to buy a million dollars worth of gold.” And they say, “kay, send us your million dollars. Here’s a contract. Sign here. You own the gold.” That contract calls for something called unallocated gold, and this goes back to our billionaire friend, Kyle Bass when he went to Hong Kong and said, “Where’s my gold?” Well, it’s all over the place. In other words, you don’t own any physical gold, you have a claim on gold, but they could have one tonne of gold and sell one-time niche to 100 investors. They could sell 100 tons of paper gold for one tonne of physical gold.

Preston Pysh  20:18

It almost sounds like these multiples of 100 sound… I just don’t know how that could be legal. And I know you’re a lawyer, as well, Jim. So I guess you could talk to the specifics of that. But instead of that, let’s go on to the next question.

One of the billionaires that Stig and I study a lot is Ray Dalio and Dalio has this saying that financial markets find themselves in a risky situation when nominal growth does not exceed nominal interest rates. This is also something that you mentioned in your book. And when I read it in your book and your new book, “The New Case for Gold,” it just immediately, like a light bulb went off. I was like, “Oh my god. Jim is saying the exact same thing that Ray Dalio is always preaching as well.” So could you talk this idea a little bit more with our audience and share where you see where we’re at in the market in April 2016?

Jim Rickards  21:03

Ray is exactly right. And there’s no better illustration of this than the United States of America. So what’s happened with the budget deficit that why did we not hear about the budget deficit? Remember, you know, the fiscal cliff and shutting down the government and all this battling between Republicans and Democrats in the White House in 2010-2011, about showing that. Why do we not hear about that anymore?

Well, the reason is that the budget deficit dropped from about $1.4 trillion in 2011, down to about $400 billion today. That’s a dramatic drop. And they did, the Congress and the White House, did bring the budget deficit down by over a trillion dollars in the last four years. Okay, the deficit is down to $400 billion. That’s correct. But it’s still 3% of GDP. And GDP is only growing at 2%. So even with the progress, the deficit is still going up faster than the economy is growing, and that’s Dalio’s point. You’re still going broke. Now you’re going broke a little more slowly than you were. But you’re still on the path to Greece.

22:05

So just think of it this way. Let’s say you have a job and have a credit card and your boss is giving you a 2% raise every year, but your debt is going up 3%. You’re going to go bankrupt, it may take a little while. Now you can pay the minimum or whatever, you know, song and dance with the credit card, but you’re going to go broke. So that’s the basic math. If your debts are going up faster than your growth, you’re going broke. And that’s true in the United States, even with the progress now.

22:30

But there’s another even deeper point that Dalio is making, which is when he uses the word nominal because go back to our discussion on real interest rates, nominal interest rates. Nominal growth is real growth plus inflation. So what Dalio is saying is, well, there’s another way out of this debt trap, which is we don’t have to have real growth. But we do have to have nominal growth so we can layer a little inflation on top of that.

So let’s say that the debt is going up, the nominal debt is going up 3% a year. Well if real growth is 2%, which is a problem, but you can have 2% inflation so that nominal growth is 4%. Now, what’s happening? Now your nominal growth is greater than your debt, and you’re coming out ahead.

So there are two ways to solve the debt problem. One is real growth, which is good, everyone likes that. But if you can’t get real growth, get some of the phony-baloney nominal growth, which is real growth plus inflation. So what Dalio is saying is that we’re not even doing that, like not only just real growth stink. Nominal growth stinks because we don’t have any inflation to speak of. So you can win the deck game if nominal growth goes up faster than nominal debt. But hidden behind that is the idea that you don’t need real growth, but you do need inflation. And this is what Janet Yellen is trying to get. Ang she said, it goes back to Mick Jagger, you can’t always get what you want. The math is simple. Everyone understands the math and Janet Yellen understands the math. The point is she can’t get there.

Preston Pysh  23:58

So I guess my point to Dalio and whoever else is trying to get there. Let’s look at Japan. They can’t get there. They’ve been spending too… I mean, they’re buying equities through ETFs at this point. They’re trying to get there so bad and they can’t. So I guess from when I’m looking at it, can we get there without a 1922 Germany situation?

Jim Rickards  24:19

Well, there are two ways to get there. One is the one you mentioned, Preston, which is 1922 Germany, which is you know what? If you print enough money, you just have to put the pedal to the metal. This is what Paul Krugman is talking about. Paul Krugman, he’s notionally right. I don’t think he’s right in terms of what’s best for America. But his math is correct, which is that Krugman looked at the $900 billion stimulus bill in 2009. That was Larry Summers, Christina Romer, who were the economists and they were in the White House at the time and President Obama signed on. Congress passed it. $900 billion stimulus spending bill. Krugman said that should have been 2 trillion. You know you want some stimulus, do it right.

But the problem, this goes back to something you said earlier, Preston, when you were talking about velocity. or the turnover of money, right? So let’s say it’s evening, I’ve got two choices in my life” I can go out to dinner. And you know, tip the waitress, and the waitress can take a taxi cab home and tip the taxi driver and the taxi driver can take some tips, take the tip and put some gas in this car, right? In that example, my money has a velocity of three: you got the waitress tip, the taxi tip, and the gasoline purchase. So $1 turns over three times, so it produces $3 of GDP. That’s the velocity of three.

25:33

But what if I stay home and watch the Final Four and do nothing? My money has a velocity of zero, right? Because I didn’t spend it. So velocity is just the turnover of money.

Nominal GDP and that’s what Dalio was talking about. Nominal GDP is just the money supply. But trying to get nominal GDP up, trying to get inflation up, is like trying to make a ham and cheese sandwich with ham. You need the cheese, right? So the money supply is the ham and velocity is the cheese. Tou wants to have a cheese sandwich, which is nominal GDP, you need ham and cheese.

The Fed can control the money supply to like a decimal place. They can stick the landing. They can make the money supply whatever they want. But velocity is psychological. It’s a psychological concept. The Fed can’t make you spend money. They can’t make me spend money. They have to lie to us. They have to this is… Now we’re into behavioral economics, psychology.

The velocity problem, which is psychological that yeah, if you don’t have money, you’re not spending money. You’re absolutely right about that. But you could be pretty wealthy, you could be well established in the middle class, you could have a rising income and yet you don’t feel like spending money because you’re concerned, you’re troubled, you know, “I want to save more. I want to pay off my debt. I want to deleverage my personal balance sheet.” And that is a psychological problem that may be with us for generations.

26:48

I think what happened in 2008, you know, going back to the sequence we described in 1998, the Asian financial crisis, 2000, dot-com bubble, 2007, the mortgage crisis. So it’s just taking this sequence we talked about earlier: 1998 with the long term capital crisis, 2000 with the dot-com, 2007 with the mortgage crisis, 2008 with AIG Lehman. At some point people… they want to get off the roller coaster. They’ve seen these crashes and off, they just want to get out. And this is why negative interest rates are not working, you know?

The theory of negative interest rates, which today we have in Europe, Switzerland, Sweden, Japan is spreading around the world. The theory is pretty simple. It’s like, “Hey, you got $100,000 in the bank,” go back to our velocity example, right? I want to make you spend it. I’m saying to you, “You know, Preston and Stig, if you leave your money in the bank, I’m going to take it away.” That’s what a negative interest rate is. You put 100,000 in the bank, a 1% negative, you come back a year later, you got 99. They took it away. So if you want to sit on your money at zero velocity, we’re going to take your money away. So you guys, you better get out there and spend it right. So that’s the gun to the head about going out and spending money.

27:54

But it seems to be having the opposite effect. People are saying well, “Wait a second, if I’m not getting any return on my money, I better save more to make up the difference, okay, I better put some more money in the account because you’re taking it away.” So the savings rate goes up. And then as far as spending is concerned, people say, “Well, what message is the central bank sending with negative interest rates?” They’re sending a message of deflation. Deflation means lower prices. So I’m going to defer my spending decisions because the prices are going to get lower. I’m going to go out and get a bargain for six months. Why should I buy today?

So negative interest rates, which are intended to encourage spending and increase velocity are increasing savings and deferring purchases and diminishing aggregate demand is a typical Ph.D. play. Like they come up with a theory, the theory is completely wrong, the model is wrong, and the behavior is the opposite of what the banks want. So you’ve got all these unintended consequences floating around. You’re not getting the velocity you want. Income inequality is certainly not helping. And that’s a serious social problem in and of itself.

28:50

So, getting back to, you know, the whole theory of nominal growth being lower than nominal rates. We’re not getting the nominal growth, we’re not getting the velocity. We’re not getting into a turnover. It’s a psychological problem. I think you have savers and investors who have been scarred for generation, it’s not going to be easy to do. So the question is, how do you get to Weimar? Well, there are two ways there. One is if you print enough money to print, forget 4 trillion, take your balance sheet to 8 trillion. I’m talking about the Federal Reserve 12 trillion. At some point, people just say, “I’m out of here. I’m dumping these dollars because you guys are not going to start… “

By the way, do you know in Weimer, Germany, the constraint on the money supply was paper and ink? I have a specimen. At one point they started printing the money on one side to save ink. So I have like a trillion Reich mark note and the other side is blank because they were trying to save ink and the government was like commandeering printing presses. There were physical constraints om producing money. So we don’t have that today. We have electrons that are free, and they can print all they want. So I suppose you could do it that way.

29:55

But the other thing you have to do, the other thing you can do. I’ll see this… I’m sure. I bet it’s very possible in the long run, is just to fix the price of gold. I can get inflation in 15 minutes. Here’s what you do. You call a board of governors meeting, you go in the room, you lock the door, you take a vote, you come out 15 minutes later, you stand in front of a microphone, you say, “Ladies and gentlemen the price of gold, as of now, is $5,000 an ounce. And we’re going to use the gold in Fort Knox and West Point to back up that price. If you think that price is too low, come and get it. If you think the price is too high, sell us your gold, whereas we’re a buyer at 4995 we’re sellers 5050. We’re going to make a market. We’re going to peg the price of $5,000 gold.”

If you do that, you’ve got inflation because nothing happens in isolation. If you have $5,000 gold, oil is going to 400, silver’s going to 100, gas at the pump is going to be $10 a gallon. It’s not that gold goes up, everything goes up because that’s the de facto devaluation of the dollar. And if you use the gold in Fort Knox, by the way, quick aside, people ask me all the time, who controls the gold? Is it the Fed or the Treasury? And I say it’s the US Army. The goal is in two army bases, Fort Knox and West Point army bases. So the Army’s got the gold under lock and key, but assume they play ball with the Treasury.

But the point is, you could declare, you could buy fiat, you could declare that gold is $5,000 an ounce. You could make it stick by open market operations: buy when it is low, sell when it’s high, give the people the freedom to buy and sell the gold in the government and then gold would be $5,000 an ounce, and then you would have 80% inflation overnight. So you can either just do the Weimar thing, just print till you run out of ink or electrons, or peg the price to go to $5,000. So those are the only two things that work. Because how do you change the psychology? Everything they’re doing is failing, is having the opposite effect. This is a very tough problem.

Stig Brodersen  31:37

Fantastic. Jim, thank you so much for helping us with these two episodes. The last question I’m gonna ask you, aside from your own books, what are the best resources you have ever come across through the years that have drastically increased your understanding of the market?

Jim Rickards  31:51

Well, after my experience at Long Term capital, I set out on a 10 years personal Odyssey because I was the lawyer there just. Not to wash my hands because I was involved in writing all those contracts, but I was a lawyer, I was not the head of risk management but… And I lost a lot of money personally in that and I don’t fault anyone but myself for that because I made those decisions.

But I was sitting there and said, “Wait for a second, and they’re all good guys. They’re friends of mine. It’s we had 16 PhDs. You folks went to MIT, Harvard, Yale, Chicago, Stanford. You’re the fathers of modern financial theory, two Nobel Prize winners, seasoned traders, and obviously, we got this disastrously wrong. Everything you thought you knew, must be wrong because otherwise, this wouldn’t have happened.”

32:32

So I set out on a personal Odyssey to figure out two things. Number one, what went wrong? It took me about five years, and I did figure that out. But then I kept going. I said, “Well, if those models, the models that we’re using, don’t work. Are there models that do work? Are there better ways of thinking about this?” And this is what set me apart from… Nassim Taleb, author of “The Black Swan,” great book. Taleb took a baseball bat and demolished the bell curve. He pounded into it. “Bell curve doesn’t work. Risk is not normally distributed, your value risk models don’t work. It’s all junk science.” And he was exactly right. But then he stopped there and threw up his hands and said, “You can’t model this. See you later, I’m going to be a philosopher.”

I wasn’t satisfied with that answer. I agree completely with Taleb about demolishing normally distributed risk in the bell curve, but I wanted to build new models that would work. One is complexity theory. One is behavioral economics or behavioral psychology. And the third one is something called inverse probability or Bayes theorem. And interestingly, I found kindred spirits in the national security and the physics community. And it teaches you about risk and complex systems, how systems break down, how risk is an exponential function of scale. And that’s a big deal because when you triple system.

33:49

So let’s say I triple the size of JP Morgan’s balance sheet and I went to Jamie Diamond and say, “Mr. Diamond, you tripled your balance sheet. How much did the risk go up?” He would say, “Well, almost zero because we tripled up. It’s long, short, long, short, long, short, everything pairs off, everything hedges everything oil go down to zero. And it’s a very small thing.”

If you ask my mother who’s, she’s a brilliant woman, but non-economist, 85 years old, I said, “Mom, I tripled the balance sheet, JP Morgan, how much did the risk go up?” She would probably use intuition and say went up three times. Well, Jamie Diamond is wrong and my mother’s wrong. When you triple the scale of a system, the risk goes up exponentially. It goes up maybe 10 times or 100 times depending on all the factors and that’s what’s happening in the banking system. And that’s why the next crisis will be much worse than in 2008. But that’s good science. That’s physics. And that’s what it brought from physics.

Behavioral psychology, I think that ground is pretty well known. Even some Ph.D. economists are starting to use it: Tversky and Airlie and others. And lots of experiments to show that we are not rational as economists define it. We have all kinds of risk aversion and other behavioral things that you have to take into account.

34:54

The third thing I learned in working with the United States intelligence community because you see at CIA and elsewhere all the time is Bayes theorem. Bayes theorem is a tool that lets you solve problems when you don’t have enough information. A statistician like Janet Yellen would say, “Give me lots and lots and lots and lots of data. And I’ll do the regressions, correlations and that’ll guide policy and all that.” Well, that’s fine, if you have the data. What if you don’t have the data?

9/11 was one data point. What if your job is to look out for the next spectacular terrorist attack? Which is the job of the intelligence community? That’s your job. What do you do wait for 1000 text, you know, 3 million dead, and then say, “Well, I have enough data and I think I can solve the problem.” You don’t have enough data. How do you solve problems when you don’t have enough data? The disappeared Malaysian airliner had one of those, you know, how do you add yourself? That’s where Bayes theorem comes in. And I use that quite a bit.

35:42

So Neil Johnson wrote a book called “Simply Complexity,” great title, but again, good but rigorous but accessible, layman’s introduction to complexity theory. “Thinking, Fast and Slow” by Daniel Kahneman. Not an easy read, a best seller. I’m not sure how many people read it, but it’s a summary of all that he’s done in 30 years of research, so you can go dig out all those papers if you want. But the most important ones are printed as an appendix to the book. And then he goes through all the literature. So if you want one book that will take you through all behavioral economics in about 500 pages, that’s the one.

36:15

And for Bayes theorem, there’s a book called “The Theory that Wouldn’t Die.” These are books that I recommend. I get a lot from history a lot from Schumpeter, as I mentioned. So these are the sources that have influenced me. And I think that 30 years from now, talking about complexity theory and Bayes theorem, and behavioral economics and behavioral psychology and economics will be the conventional wisdom. But right now, it’s not the conventional wisdom. The Fed and other central banks are still using Value at Risk and the cost of general equilibrium models and things that are just simply obsolete.

Preston Pysh  36:47

So Jim, I know I’m talking for our audience when I say wow, this interview is just phenomenal. We are just so thrilled to be able to just have this discussion, in front of our audience for them to listen to this and just have access to your just brilliant mind and all the research and hard work that you’ve done through all the years. For anybody else out there that’s listening to the show and you want to know more about Jim Rickards, first of all, he has a book called “Currency Wars.” He has another book called “The Death of Money.” And now he has a new book, and it’s called “The New Case for Gold.”

Jim, if people want to learn more about you or want to go to your website, could you give them a handoff and tell them where they could learn more about you? And I also follow your Twitter, which is fantastic. You have a lot of great posts on Twitter for people that are looking for more current events, but where else could they find you, Jim?

Jim Rickards  37:37

My Twitter feed is @jamesgrickards. I use my middle initial G for George. So @jamesgrickards, it’s about 90% international monetary economics, and 10% Phillies baseball, so you gotta take the good with the bad. My website is www.JamesRickardsProject.com.  So www.James RickardsProject.com. A lot of resources there, the Twitter feed we mentioned. And then, of course, my new book, “The New Case for Gold.” covers a lot of what we talked about in this interview and the first two books, “Currency Wars” and “The Death of Money.” We’re macro top-down, critiquing the system, making recommendations for the system.

“The New Case for Gold” is a little bit more of a manifesto, a little bit shorter than the other book saying, “Look, I’m still trying to fix the system and still trying to help policymakers but just in case, they’re not listening, here’s what’s gonna happen, get yourself some gold.” But I want to give people reasons why I never make a claim or never make a recommendation without giving the backup, the research, the history, the analysis, it’s all there. But I had written about gold in my other books, one chapter here, a couple of chapters there, and I said, “You know what, I need to sit down, put it all in one place, everything I’ve learned everything I know, everything I’ve experienced, put it all in one place, make it easy for the reader.” So that’s “The New Case for Gold.”

So, Preston Stig thank you for the opportunity. Thank you for inviting me on the show. It’s been a great conversation. enjoyed it and hope the listeners enjoyed it as well, I’m sure they will.

Stig Brodersen  39:02

As Jim is dropping off this call, I just want to thank everyone for listening. Before we let you go, I just want to give you a quick shout out for the free executive summaries that Preston and I typed up and send to you twice a month. You can sign up on our website where you can find the 35 summaries that we already did. Also on the site, you can find the link to a free Audible book, which is a free book from Preston and me to you. You can also claim your free book on audible.com/TheInvestorsPodcast. That was what we had for this week and see you guys next week.

Outro  39:35

Thanks for listening to The Investor’s Podcast. To listen to more shows or access to the tools discussed on the show, be sure to visit www.theinvestorspodcast.com. Submit your questions or request a guest’s appearance to The Investor’s Podcast by going to www.asktheinvestors.com. If your question is answered during the show, you will receive a free autographed copy of The Warren Buffett Accounting Book. This podcast is for entertainment purposes only. This material is copyrighted by the TIP Network and must have written approval before commercial application.