Stig Brodersen  05:01

Wow. This was inspiring to hear, Jim. And for those of you that might not recognize this, Jim named Long Term Capital, just very briefly. And if you think that it sounds familiar, it’s something that we talked about several times during the podcast. And the funny thing is that we talked about how Warren Buffett experienced Long-Term Capital, and we talked about how Michael Lewis looked at Long Term Capital, but Jim was actually right there in the middle of a storm when it just came crashing down.

So, Jim, I’m just tempted to ask you this. Could you tell us an interesting story from that time, when the world was just looking at you and the company and when the financial world didn’t know what will happen tomorrow?

Jim Rickards  05:42

Sure. There are a lot of stories, of course. There was a great book on this by Roger Lowenstein and I spent quite a bit of time with Roger. It was funny, he said he had 120 interviews on the Wall Street side, talking to the banks, bankers love to blab. Well, nobody at Long Term Capital would talk to him. *Two guys win the Nobel Prize and then the firm loses $4 billion, it almost takes down the world. That’s a little embarrassing. There’s an embarrassment factor that was a shock factor of $2.6 billion, it was our money.

We were in the process of buying out our own investors. Eventually,  it would have been like a multi-family office. One billion dollars was from UBS. And that was the craziest deal I ever saw. As I said, we were buying out our investors. we had $2.6 billion, the fund was about $4 billion. we bought a seven-year at the money call option on our own performance. We said we’ll buy an option on us, expecting it to do very well. We paid real money for it. We paid $300 million for the seven-year at the money call option for a billion dollars of our own performance. And UBS wrote us the options. we now had 2.6 billion in cash, a one but billion call option, right?

So, UBS sits there, *this city in Switzerland, and they say, “Well, we just sold a call option for a billion dollars on the performance of Long-Term Capital. How are we going to hedge it?” So, they say, “Well, we better invest a billion dollars in the funds that when it goes up and up and up, and they call the option we’ll be able to deliver the option because we own the funds.” So, they put a billion dollars in.

07:04

It never occurred to anybody that we would lose money. I mean, the billion dollars went to almost a zero, but they lost a billion dollars. But it’s not funny. What it demonstrates is that nobody in the world, not the people there myself included, not UBS, not Wall Street, not the regulators. Nobody thought that we could lose money. We were just going to make money. The only question was how much.

So, $3.6 billion was either us or UBS. And then there was about $400 million from a couple of other firms. But one of the reasons we weren’t tarred and feathered is because most of the money we lost was our money or our friends at UBS. But on that on a serious note, what people don’t realize, what did not come out of the books, what did not come out of all the studies that were done on it was how close the entire world was to shut down those capital markets. We were hours away from every stock and bond market shutting down. And that’s not about us. That’s about the fragility of the system, the interconnectedness of the system, the opacity of derivatives, the leverage involved.

08:00

You know, people say Wall Street bailed out Long Term Capital. Not really. They bailed out themselves because we had $1.3 trillion of trades with Wall Street. And I like to say if we had gone to zero, we were on our way. We were days away. But if we had gone to zero, I would have just slept in the next day, you know, you start looking for another job. The 1.3 trillion would have flipped over to Wall Street. It’s like okay, now you guys own it. What are you going to do? And so, Wall Street thinks their hedge, right? They sold us 1.3 trillion of stuff. They buy it from the market. Now they have a hedge position, they’re making a little arbitrage profit, right? Well, take one side of the hedge away what happens? They’re just massively long. They got to go out and cover that long position, which would have meant massive selling, which would have taken down all the markets.

So, we got the 4 billion and we got the bailout down. We found the runways, had the fire engine standing by, came in for a soft landing the world did not end. But it was that close and that close. Just hours away.

08:52

What I learned from that and then what was intriguing in the next couple of years, I watched the policy response. Here’s what you should have done, based on that experience. You should have broken up big banks, bend most derivatives, not all, but most of them, increased transparency, increased margin requirements, etc. Instead, what did the Congress do? The next day, they repealed Glass Steagall, which let banks be hedge funds, but they repealed Swaps regulation, which let everybody bet on everything. They repeal the broker-dealer leverage ratio. If you go from 15 to one to 30, to one. They enacted Basel II, which allowed the banks to leverage up using this foot.

So, everything they did was the opposite of what you should have learned. I’m running around in 2004, 2005, and 2006, and look at the next crisis is coming. It’s going to be bigger than the last one. It’s inevitable. I can see it a mile away. And of course, it happens in 2007 and 2008. And it’s not like I said, “Okay, August 9, 2007, the mortgage will…” I wasn’t that specific, but within a range, I could absolutely see it coming because I had lived through it. I learned the lessons. I watch policy do the opposite. I said this is just going to happen again.

Preston Pysh  09:56

Well, so now here we are, 2016, and banks are now bigger than they were before. Now in the US, they have different requirements as far as their cash reserves and stuff, but where they don’t is over in Europe. I look at Deutsche Bank. For me, that’s scary. Talk to us about the present times. you saw that in 2008. Now, where are we at right now? And I know you’ve got your new book, “The New Case for Gold,” where you’re talking about is just lay it on people from 2008 to now, what are the differences that you see?

Jim Rickards  10:27

Actually, it keeps getting worse. I mean, if there are differences, they’re pointing in the wrong direction. Right now, and this is the reason I wrote my book, “The New Case for Gold,” I’ve done all I can. I’ve knocked on every door in Washington. And the thing about Washington, I get to meetings and I’ve been in the Treasury and in the Fed. I’ve been in the Pentagon, the National Intelligence Community, Homeland Security, the Congress, Senate House. I get all the meetings. People are very kind. They listen to you, they hear you out, but then no one does anything. At some point, you throw up your hands.

So, the reason I wrote “The New Case for Gold,” and I’ll come back to your point about the differences today, is that having done all I can… I continue to and I continue to talk to policymakers and presidential candidates, but I don’t see anything changing for the better. Look, I’m going to write a warning to individuals, okay? I’ll still try to influence policy, but it may be too late for that but at least we can help individuals get some of their assets, not all by any means, get some of their assets in physical gold. That’s your fire insurance when the house burns down. You’ll be protected, you’ll be well served. That was part of the motivation for the book.

11:27

We’re going back to your question, candidly, Preston. I feel right now in 2016, exactly the way I felt in 2006, which is I look back at the last crisis. I see the mistakes. I see that none of them are being fixed. None of them have been addressed in the right way. The system is getting more unstable. We’re heading for another crash. Look at this time post, 1990 is Long Term Capital. Wall Street bails out the hedge fund. 2008, the financial crisis AIG Lehman, the central banks bail out Wall Street. Come forward to 2018, keep up that 10-year tempo, who’s going to bail out the central banks?

In other words, each bailout is bigger than the one before. And each time you need a bigger, you know, Sugar Daddy, if you will bail out whoever got in trouble. Wall Street bailed out a hedge fund. The central banks bailed out Wall Street. All that happened in 2008, you cured a private debt crisis with public debt. Now you’ve created a public debt crisis of even greater magnitude. Who’s going to bail out the central banks when the system crashes, which you can see in my way?

12:25

The answer is there’s only one clean balance sheet left in the world, there’s only one place without that much liquidity can come from, which is the IMF or the International Monetary Fund. What that means is… How does the IMF print money? The SDR, the special drawing rights, so and that’s the end of the dollar. By the way, there’s a meeting in Paris just a couple days ago where they put this on the table, you know, Christine Lagarde, the head of the People’s Bank of China, a few other central bankers and finance ministers. And this SDR train is leaving the station if people think you make this stuff up. I mean, no, it’s all there. Some websites, some papers, there’s a lot you can learn about it.

Yeah, the IMF is a strange institution but extremely powerful. Lots of us influence behind the scenes that China’s becoming more influential. But they wanted to get out of Greece, they have a history of not taking losses. They only land. They want to be the senior preferred lender, they want to be the first one paid, the first one to get out. There’s supposed to be a bridge lender or swing lender, not the permanent capital if you will if you think of it in that corporate finance space. Of course, a lot of that is just for show. I mean, they are the most politicized financial institution in the world, which is looking at Ukraine.

Ukraine’s got billions of dollars of IMF loans, no hope of repayment. Completely uncreditworthy, no sustainable program, but they got the money because of the new Cold War, if you will, between the United States and Russia. We’re propping up our side of that, you know, we’re propping up Western Ukraine in Kyiv, just as the Russians are intervening and propping up Donetsk in eastern Ukraine. This is a good example of how finance is used in the battlespace. people are shooting at each other and they’re financing each other and one is side by side with the other.

Stig Brodersen  13:58

Perfect, Jim. Again, interesting. And we actually have to talk about the book now. And that was actually the whole point of the interview. And then we just, you know, went all over it. But one of the things that I want to talk to you about today is that on the podcast, we have frequently talked about a shift in the balance of power between the US and China.

And what Preston I have done on the podcast is to look at the macroeconomic factors, we’ll be looking at GDP and the potential for the Renminbi as a reserve currency. But one thing that we haven’t paid attention to is the role of gold. And in your new book, “The New Case for Gold,” as you say, that in the past seven years, you estimate China has bought as much as 3000 tonnes of gold, perhaps even more. And that is in addition to what they already have.

So, you’re estimating that it might be at least 4000 tonnes, and that would make China the second biggest holder of gold in the world outside of the US. And just to give people some numbers to refer to, the US has an estimate that is around 8000. And the official goal in the world is around 35,000 times. And you also say that contrary to popular belief, you argue that it’s not to launch a currency backed by gold but among seven reasons, its tool of hedging its investments in US Treasuries. I’m curious to hear if you can explain why you hold this opinion.

Jim Rickards  15:11

Sure, Stig. I would be glad to. A lot of my book, “The New Case for Gold,” a lot of what I do and writing and interviews and so forth is explaining to people how gold is money, how gold should be in your portfolio, how it will preserve wealth, etc. That debate has been going on for a long time. There are kinds of arguments pro and con. I talked about them in my book. I take the arguments against gold, and I shoot them down one by one and we can talk a little bit more about that because to me, that’s a good starting place because if you raise your hand and say something positive about gold or gold to be in a portfolio, people are just ready to shoot you down. They’re like you’re a wing nut you’re a golf nut, you’re a Neanderthal, you don’t understand money. And here’s why. And they give you all these reasons.

None of the reasons hold water. I heard an interview last night with Skidelsky who was the very distinguished economist, author, researcher, who wrote the definitive biography of John Maynard Keynes. And he said, “Well, you know, you can’t have a gold standard because there’s not enough gold.” And I almost fell off my chair. It’s completely untrue. There’s always enough gold. It’s just a question of price. I explained that in my book but to see brilliant, distinguished individuals repeating the same flawed arguments just shows how embedded they are.

16:15

So, with that, as a prelude, it’s hard enough to get people to think about gold as money. Try getting people to think about gold as a weapon, as a financial warfare weapon, as a threat to national security because that’s what your question goes to, Stig.

So, what is up with the Chinese? First of all, where do I get my estimates? The Chinese officially say that they have about 1700 tons of gold. My estimate is they have at least 3000 times perhaps 4000, perhaps even more. What do we base that on? Well, we do have some reliable data. The Chinese may lie about their figures, but Hong Kong doesn’t.

So, Hong Kong exports to China of gold, those are reliably reported. They’re about 1100 tons a year give or take. And that’s been going on for six years. marked down 7000 tonnes from Hong Kong. Geological Survey shows that China is the largest gold producer from its own mines, in the world about 450 times. Again, take that six years, there’s another 2500. You put all that together, you’ve got 10,000 tons of gold, either being imported into China or produced in China. Chinese gold exports are zero. There are 10,000 tons there.

And what we’re not as clear on is how much of that went to private consumption individuals because of the Chinese love gold. I’ve been there and seen these gold boutiques, they’re open all hours at night. They’re lit up like Times Square. We’ve got gold hostesses and long soap dresses walking around with trays of bars, coins, jewelry. The Chinese love gold. How much is private? How much is the government? It’s hard to know. But I would estimate the government’s at about 30%. And I had that from a Swiss source, head the world’s largest gold refinery and he talks to the Chinese every day. If you take 30% of 10,000 tonnes, there are 3000 tonnes. That’s my estimate. But if I’m wrong, I’m probably wrong on the low side. The actual number is a lot higher.

17:56

So, here’s the point. Why is China acquiring 4000 tons of gold in a world where you know everyone from Ben Bernanke, Janet Yellen, Christine Lagarde, Jack Lu, every senior elite policymaker you talk to will tell you that gold is worthless. It has no role in the monetary system. We’re not on the gold standard. We never will be, etc.

But the Chinese just acquired say three or 4000 tonnes. Are the Chinese stupid? Or do they see something most of us don’t? Well, guess what? They’re not stupid. I’ve been to Beijing, Xi’an, Shanghai, Wuhan. I’ve been all over China. I have a lot of friends there. I go there frequently. I’ve met with the Sovereign Wealth Fund Communist Party officials, government officials, they’re not dumb. They see something coming that most people don’t.

18:36

By the way, just to drop a footnote. Same thing with the Russians. The Russians have acquired 1000 tons of gold in the last six years. And to put that in perspective, and you’re exactly right to say they’re about 35,000 tons of official gold. That’s the gold owned by central banks and governments. If China bought, let’s say, 3000, Russia bought 1400, that’s more than 10% of all the official gold in the world. And again, if I’m wrong, the actual numbers are going to be higher. That’s a lot of gold.

Stig Brodersen  19:01

Because one of the things you also talked about is Bretton Woods, our new Bretton Woods if something should go terribly wrong. And the monetary system as we know, today simply needs to be looked at again, from all the major powers. You’re saying that gold, if the new currency will be backed by gold, China will also have an equal say, because right now, the way it works, for instance, with IMF that what you point out is also created when the tens of *inaudible, the gold standard system, the US has a veto. you are also saying that if something should go wrong, China would perhaps have an equal say to the US in the new world with a new currency system.

Jim Rickards  19:35

That’s part of the dynamic and you’re exactly right to say. The way I think about it, imagine a horse race. You have the Kentucky Derby and all the horses are in the paddock and they chop up close, the paddock opens, and here come the horses running around the track. And think of them as currencies. There’s the dollar, there’s the Euro, there’s the yen, there’s yuan. But there are two other horses in the race: gold and special drawing rights. The SDR. Just to clarify the special drawing right, the SDR, that’s world money. The Fed can print dollars, the European Central Bank can print euros, the International Monetary Fund, the IMF can print SDRs. Just like that. I mean, they need votes in this governance process and all that, but they can print us SDRs and hand them out to the member nations. That’s the currency.

So, coming around the track, my view is one by one, those horses are going to stumble and fall and be out of the race. In the end, when we get to the finish line, they’re only going to be two horses: gold and SDRs.

20:26

Now, just to be clear, there’s no one central bank in the world that wants a gold standard. If you were a central banker, would you want a gold standard? If you had control of the money supply if you had your hand on the printing press, why would you want gold? You’d want all that power, you’d want all the influence that comes to controlling the money. But people have a voice in it because money is nothing more than the subjective preference of consumers for different types of money.

So, we’re all in the grandstands betting on the horses, right? And some people want to bet on the dollar. That’s fine. Bet on the Euro. Increasingly, people will look at gold and SDR. If confidence in all the other kinds of money fails, why would you have any more confidence in the SDR? If it works, it’s only because no one understands it. I know a Ph.D. Level international monetary economist who cannot give you a straight answer on what’s an SDR. Can one can hardly expect everyday citizens around the world to understand it. If they at least pull it off, it’s because nobody gets it.

21:20

But my guess is in an age of social media and podcasts like this, and you know, Twitter and Facebook and other media channels, YouTube and podcasts and so forth, that people will catch on pretty fast and it will actually fail. Then you’ll have to go back to a gold standard.

So, think of the reset of the International Monetary System, like a poker game. We’re all going to sit around the table. When you’re at a poker game you sit down, what do you want? You want a big pile of chips, right? Gold is your chips. The US has a big pile. We have 1000 tonnes. Europe combined, the members of the European Monetary System, the eurozone have a big pile, they have 10,000 tonnes actually, more than the United States. China’s got maybe 4000 tonnes, but they still need to buy three or four thousand more tonnes secretly, by the way, they use military and intelligence assets to do this. That when they sit down, they’ve got, let’s say, 8000-9000 tonnes. That’ll be an interesting poker game.

Stig Brodersen  22:10

I’m happy that we actually discuss this because, on the podcast, we have discussed gold as an investment several times. And when reading your book, it’s quite evident that that’s not what this episode is about because you are actually saying that gold is money. we have to think of gold as money. And when you think of that, in terms of your portfolio, you’re not saying go hundred percent in gold, because it will increase tomorrow. You’re saying 10% because it helps you to diversify. And for listeners of our podcast, think back to our discussion of the Black Swan, Nassim Taleb’s book, if something should go terribly wrong, and which is also the same thing that Jim is talking about, gold might be a way to be diversified.

Jim Rickards  22:53

Well, first of all, that’s exactly why I don’t recommend doing going 100% in anything, I learned that the hard way in Long Term Capital management. I lost some money in that I tell people, it was my tuition. And my financial education is a very costly education. First of all, don’t go a hundred percent in anything. And you definitely want to be diversified. But the problem is there are real diversification and foe diversification. I run into people and they say, “You know, I’m very diversified. I own 100 different stocks in 10 different sectors, very diversified.”

I say, “No, you’re not. You have one asset class, you have one asset class called stocks. I don’t care if you got 100 stocks. And I don’t care if Wall Street tells you there are 10 different sectors, etc. You’re in one asset class. That’s not diversification.”

23:35

After my second book, “The Death of Money” came out, I gave a free lecture at the New York Public Library. I do a lot of paid speaking around the world, but libraries and universities, I often try to do pro bono. But when I finished my remarks, we do Q&A and one guy raised his hand he said, “You know, I listened to everything you said and I am inclined to agree, but I work for a corporation and I have a 401k and my options with a 401k are all stock funds. And a couple of money market funds What should I do?”

And I said well, “You should quit your job and get a rollover IRA and then you can buy some gold>” I was being a little bit glib, but the point was you are right, Stig. A lot of people are locked into the system created by Wall Street, propagated by Wall Street, which is about them selling you stocks. It’s not about your financial well-being and that’s also part of the reason I wrote my book, “The New Case for Gold” because it’s education.

I’m not a gold salesman, you can’t buy gold from me. I don’t get a commission but I’m trying to provide some education so people can look out for themselves. 10% gold to me is the right amount. If I am completely wrong, and happy days are here again, the stock market goes up and there’s no inflation, you’ve got 10% gold. You’re not going to be hurt badly by that. It will preserve wealth, but if I’m right and everything else melts down, and a lot of your assets dropped 30-50% which they have time and time again, just look at 2008, 2000 dot-com meltdown, what almost happened in 1998. In October 1987, the stock market fell 22% in one day, not a week or month. One day. In today’s Dow Jones index, that would be the equivalent of 4000 dow point. Now, if the Dow fell 400 points, it’s all you’d read about in every website, newspaper. Anybody would be talking about was a 400 point drop in the Dow.

Imagine 4000 points. That happened in 1987. It wasn’t that long ago. These things do happen. And in that world, you definitely want the gold. I recommend physical gold, we can get into the whole distinction between paper gold contracts and physical gold, you definitely want physical gold. And again, it’s an analogy, but it’s like fire insurance in your house. Nobody wants this house to burn down, heaven forbid. But if it does, you’re sure glad you have the insurance. And when you write the check to the insurance company, you don’t think you’re throwing your money away, you think you’re doing something prudent. That’s how I think about buying gold.

Preston Pysh  25:45

So, it’s funny, Jim, back in December of 2015, just a few months ago, I had watched a video with Stanley Druckenmiller and he was talking about his expectation moving forward. And this video was from December of 2015 as well. And Stanley had made the comment that he thought that if you’re going to do well in the markets moving forward, you’re going to have to do it in commodities or currencies over the next year to three years, whatever it might be.

And it plays right to the point that you’re saying, and I love this comment where you said, “I’m diversified into 100 stocks.” And you’re talking about one asset class. It’s just… In my opinion, that’s priced for just total disaster at this point. You know, it could run another year for all I know, but I know one thing, it’s not going to go much higher in a year. If it would go up, it might go up a couple of percents.

So, then you got to talk about my asymmetrical risk-reward portion of that by being completely in stocks. I just loved the fact that you brought that up. I think it’s something that people need to think about. They need to think about their asset class and how they’re diversified in a currency versus equity or fixed income versus a currency. You know, it’s, oh, man, that’s such an important thing for people to get as investors.

Jim Rickards  26:56

Well, you’re exactly right, Preston. And by the way, you know, when you talk to billionaires, it’s interesting because a lot of the names that get thrown around. These are billionaire hedge fund managers, billionaire portfolio managers and they’re in the stock market and their bond market. Go on TV like anyone else and talk about you know, whatever Tesla or some pharmaceutical company, but when you talk to them privately and I do, they have a lot of gold. A lot of them are building gold vaults in their homes.

I happen to live in Darien, Connecticut, it’s a wealthy town but we’re one to exit on the highway away from Greenwich, Connecticut, which is an even wealthier town, lots of billionaires there. You’d be amazed how many of them have you know, not to say, friends, that you hear about but also private vaults in their home. Now, a guy who’s a little more public, and of course, you know, Stanley Druckenmiller, you mentioned is a multi-billionaire hedge fund manager. He’s putting his portfolio into gold, that’s very well known.

27:46

But one of my favorite stories is Kyle Bass. Kyle lives down in Texas just outside of Dallas. He was one of the participants in The Big Short, he wasn’t in the movie, but he was one of the guys who made billions you know, shorting the mortgage market in just before the crash in 2007. But he’s a trustee of UTIMCo, University of Texas Investment Management Company. That’s the endowment for the University of Texas, which is a very large endowment. And he persuaded his fellow trustees to allocate some of the portfolios to gold, not a lot as a percentage, but I think he bought $500 million worth of gold, which is a lot of gold. They bought it from Hong Kong Shanghai Bank, which is a major dealer, and their vault is at 39th and Fifth Avenue. Yes, right there. It’s actually right next to the New York Public Library, I mentioned earlier.

So, Kyle called them up and said, I had dinner with him in the endowment. He told me the story. He said he called him up and he said, “Well, I want to come and see my gold, the gold of Texas, in other words.” And they were, “Well, you’re being a pain in the neck.” He said, “No, I want to see and pay for it. I want to see that gold. This is all right.”

So, after some delay, he got into the vault, and he said, “Where’s my gold?” “Well, some of it’s over here, and some of it’s over there.” He said, “No, I’m coming back. I want my gold in one place. I want serial numbers on the bars. I want the manifest. I want to be able to go bar by bar, make sure it’s all here. I’ll be back. You do it.”

So, they agree but again, they were like you’re obviously a pain in the neck customer. He went back the second time and yeah, the gold was all there. There was no wrongdoing. But it just goes to show you how cavalier the banks are about gold and how adamant Kyle was about actually getting his gold.

Preston Pysh  29:15

I love that story. That’s awesome that you had that personal experience with him. That’s pretty cool. Hey, so I’m curious now that we’re talking about Kyle Bass and we will get to some of these questions we had typed up, but Kyle’s play on shorting the yuan, I’m curious what your opinion is on that because he’s been getting beaten up, I think since he put that on.

Jim Rickards  29:33

Oh, yeah. The People’s Bank of China woke up a couple of weeks ago and punched him in the nose just to see. Here’s the thing, Kyle has got the analysis exactly right. And I can explain why and he’s going to make a ton of money on that trade. But if you, and he is a good guy, if you ask me what mistake did Kyle make? Kyle was way too public. He was on CNBC and Bloomberg, every show you can think of and got the new Big Short, of course, the reference to the Big Short The movie on the Michael Lewis book about guys getting out ahead of the mortgage crisis.

Fundamentally, he’s right. He will make a ton of money, but by being so public, and this is an important show, Preston, everything in China is an about-face. It’s all about face, you can win or lose in the markets but don’t make people lose face. And what he was doing by being so public, he was causing the People’s Bank of China and the Central Committee of the Communist Party of the Politburo to lose face. They just went out one day and just arbitrarily increased the value of the yuan. They bid up the yuan, by dumping dollars, buying yuan, bid up the price on a mark to the market basis that caused large losses for Kyle in the short run. They were very public about that. That was a way of them regaining face.

So, we think we’re talking about fundamental analysis and markets and profit loss. But what we’re talking about is Texas culture versus you know… Texas culture is in your face, and China’s all about not losing face. you got a Texan and a Chinese. I mean, that’s crazy. I mean, that’s what’s going on. I would have… Kyle does not need any advice for me but my advice would have been “Great trade, Kyle, just keep it to yourself.”

31:06

So, but just to spend a minute on why Kyle was right because yes, it’s a funny story, but he is fundamentally right. There’s something in economics called the Impossible Trinity. And this was a theory developed by Mundell–Fleming in the early 1960s. And Robert Mundell later won the Nobel Prize for his work in international economics. And he said that a country there are three goals you can have in terms of the central bank and foreign exchange policy, but you can’t have all three.

And the three are an open capital account, a fixed exchange rate, and an independent monetary policy. Everybody wants to open the capital account because it shows you money can come in and out. You’re an attractive destination. The fixed exchange rate is in theory stable and independent monetary policy, dial it up and dial it down. Everybody wants all three, but you cannot have all three. You can have two out of three.

And the reason has to do with the fact that if you’re pegging your currency to somebody else. But you move your monetary policy in a different direction like you ease when they’re tightening. The money is going to come out of your economy because you have an open capital account. That’s exactly what’s happened in China. China is trying to have the Impossible Trinity. They’re trying to have an open capital account because they want to play nice with the IMF because the IMF just included them in the SDR, okay? They want an independent monetary policy because of their economy’s weakening. If the Fed tightens, they don’t want to tighten. They want to be able to ease but they want a pegged exchange rate at about, it’s floating around right now, but about 6.5 to one because China and the US are the two largest economies and the world largest trading partners, massive capital flows, and the Chinese like stability. But you can’t have all three, that’s what Mundell said 50 years ago.

And so, what’s happening is that the capital is flowing out of China and I mean a lot. 15 months ago, their reserve position was $4 trillion, sorry a little over $4 trillion. Today, it’s down to 3.2 trillion. They’ve lost $800 billion or 20% of their reserves in 15 months.

33:02

Now the thing about reserve outflows. And we’ve seen this in Brazil and Argentina, and we’ve seen it all around the world, they accelerate. In other words, this is like people running for the exits, right? The theaters on fire, we’re all running for the exits, trying to get out. Well, maybe the first guy gets out, maybe five people behind him get out. But at some point, the crowd is just surging for the door. That’s what’s happening now. It accelerates.

So, at this rate and at this tempo, China will be breaking by the end of 2017. It will not be two more years before the last, you know, $3 trillion runs out the door. Now, obviously, that’s not going to happen, right? China’s not going to let that happen. But it is happening. what are they going to do to stop it? They have to bust one of those three legs of the stool. You got three legs of the stool, you got to break one of those legs. Well, are they going to close the capital account? No, because they just joined the SDR, the IMF would kick them out of the club, if you will. They have to maintain up *inaudible. Are they going to give up independent monetary policy? No, the Fed is on the path to tightening. It’s an irregular path, but they’re not going to raise interest rates at a time when their economy is sinking.

33:59

So, there’s only one thing left: devalue the currency. It’s as close as you get to a sure thing in international economics. That’s what Kyle has figured out. That’s the bet he has placed. He’ll be right in the long run. It doesn’t mean he’s right in the short run. China is putting on a brave face, you know.

Back to the concept of face, they actually strengthened their currency just to send him a message, saying, “Hey, this is not a one-sided bet.” But at the end of the day, they’re going to have to devalue because they cannot do anything else.

Preston Pysh  34:26

I’m sorry, I have to ask one more question that is not on the list here. And it’s about Japan. Jim, I see Japan in this situation where this is looking like this is getting grim fast. And I mean, like in the next quarter or two, that they might have something devastating happen over there. Do you see it in the same light as far as their equity market and just, I mean, it’s getting worse?

Jim Rickards  34:49

Well, I do, Preston. And with a footnote and let me explain. The basic story on Japan is awful, you know, major developed economy, high tech, etc. They have the highest debt to GDP ratio in any developed economy, well over 200%. Now the US looks like a train wreck to me, we’re about 100%. They’re more than 200%.  They’re worse than Greece. Greece’s debt to GDP ratio is in the high or mid-100.

Preston Pysh  35:15

I’m sorry to interrupt you, but Japan, they control their currency where Greece wasn’t in that situation. That’s the thing that led to their… Is that correct?

Jim Rickards  35:23

That’s one difference. They print their own. They print the money that people want, whereas Greece can’t print it. People do want euros but Greece doesn’t print euros, the European Central Bank prints it. They don’t have control of their own currency. That’s correct. That gives them more degrees of freedom. And also, their bond market, by and large, is owned by domestic institutions.

So, this is a problem for the United States. A lot of US bonds are owned by foreigners. They’re owned by the Chinese and the Russians have some and institutions around the world. The US is a little bit vulnerable to a loss of confidence by foreign investors. In Japan much less so. The bad news is a very high debt to GDP ratio, awful, demographics they have not only an aging population, which is not great for productivity but a declining population. It’s not the birth rate slowing down, they are actually losing people. Declining population, aging population, high debt to GDP ratio, and a stagnant economy. They’ve been in a depression for almost 30 years with occasional technical recessions in the middle of that. That story is a mess.

On the other hand, people have been reciting that story for 25 years and they’ve been wrong. That is to say, Japan has not collapsed and this trade you’re talking about Preston, short Japan, you know, short Japan equity, short Japan debt, it has a nickname is called the Widowmaker. Because so many people have lost so much money shorting Japan and being wrong, that people get carried off in the trade now.

So, your question is, okay, but what about right now? Is this thing about to turn? I think it might. I think it might for a couple of reasons. Number one, there is a limit. It hasn’t been a *raise in the last 25-30 years, but we may be getting close to it. We’re starting to see signs the other day, a couple of days ago, the volume in 30-year bond trading. And Japanese government bonds was zero. The wheels are starting to lock, this thing is starting to freeze up. But the other big deal is the Shanghai Accord, which was just reached on February 26, secretly by the G20, central bankers and finance ministers. And this gets back to the currency wars. That was the title of my first book. just to explain it very briefly, which is in a world.

Preston Pysh  37:25

Stig just held up a copy.

Jim Rickards  37:27

I recognize that cover. Thank you. In a world of too much debt and not enough growth, that’s the world we live in today. And by the way, that’s also the world of 1919, after the Versailles conference, after world war one: the world of too much debt, not enough growth. That’s the world we’re in. How do you as a country, get a little pickup? How do you get your economy moving? It’s a zero-sum game, but you can do it through the currency wars by cheapening your currency. You import some inflation in the form of higher import prices. You improve your export competitiveness that creates some jobs. you get a little bit of a lift, but it comes at the expense of your trading partners. You may be temporarily better off but the world is not better off. And that’s what’s been going on for the last eight years.

So, 2009, the era of the cheap Chinese yuan, 2011 the cheap US dollar, 2012 beginning of Abenomics in 2013, that’s the cheap yen. Mid-June 2014, Draghi announces negative interest rates, January 2015 Draghi announces euro QE, that’s the cheap euro. The yuan, the dollar, the yen, and the Euro have taken turns being the cheap currency. Meanwhile, the world is still sick. The world is not getting stronger.

38:37

So, my analogy here is a good way to understand it. Imagine five soldiers during combat they’re fighting hand to hand. It’s a very hot day and they’re thirsty and they catch a break, and they got one canteen. What do you do, right? Everybody wants to drink the whole canteen, but you don’t. You take a sip and hands it to your buddy. He takes a sip pass it to his buddy, you pass the canteen. That’s the currency wars. They’re passing the canteen of cheaper currencies knowing that everybody can’t get a drink at once, but you can take turns.

Right now, it’s time for a cheap dollar again and a cheap yuan. It’s China and the US has turned that means Europe and Japan, those currencies have to strengthen, the euro and the yen are getting stronger. Strong yen combined with the illiquidity in the bond market, combined with everything else we’re talking about. This could be the killer for Japan.

Preston Pysh  39:22

Yeah, because they can’t handle it.

Stig Brodersen  39:24

That’s right. I love that you said that. Because you also wrote about that in your book. And let’s just briefly reset to your book, which was again the whole purpose. Sorry, if we’re not speaking so much about your book, but a lot of interesting topics to cover, because one of the things you will relate is currencies and gold and specifically, you’re talking about… I think you have an example with US devaluing and how that will influence Europe and the other way around, and then you’re saying gold can fight back, which is like your thesis for the gold standard. what do you mean when you say that gold can fight back and why might that be a better system than the one we have?

Jim Rickards  39:58

So, the currency wars go back and forth the way I described it. When you coordinate it as they do sometimes, that’s passing the canteen. But there’s another metaphor, which is, you know two kids on the seesaw, I’m up and you’re down. Well, if I go down, you’re going to go up and there can’t be any other way. I remember in 2012 when you know Paul Krugman and Joe Stiglitz and Nouriel Roubini everyone was turning out the *inaudible fires and the Euro is going to collapse. Greece is going to get kicked out, Spain should quit the Euro, go back to the peseta, devalue lower the unit labor costs. Northern tier, Southern tier…

I said nonsense. I said none of that is going to happen. Nobody’s getting kicked out of the euro. Nobody’s leaving the euro. The Euro will add members, which they have. There were 16 members of the time today, there are 19 members, several applications pending. Euro is strong and getting stronger. And I base that on the fact that on two things.

40:46

Number one, the eurozone has never been an economic project. It has always been a political project. In 1992, Margaret Thatcher was bitterly opposed to German reunification. As she says because every time the Germans get together, they take over Europe, why would we want that? And she was exactly right. They got together, they’re taking over Europe, not with a blitzkrieg, but with financial warfare. This is, I call it the Fourth Reich, Germany peacefully using economic means is establishing hegemony over Europe. That zone is not breaking up.

What it means as a practical matter, is that the Euro is going to get stronger, which means the dollar has to get weaker. That’s the seesaw effect where not everybody can weaken at once. But there’s one exception to that if you think of gold is money. You see, how do I fight back? If I want to cheapen the dollar, how do I do it? I defer interest rate hikes, I print more money, I do QE, I use forward guidance. These are all the tools. Same thing in Europe. If I want to cheapen the Euro, how do I do it? Print more money, it goes negative interest rates, you know, etc. There are tools.

So, it goes back and forth and back and forth. Gold can fight back. You can’t print gold, you can’t change the… gold has no yield. you can’t make it negative. You can’t talk about the foreign value of gold because you don’t control it. All the tools in the central bank toolkit don’t apply to gold.

42:00

So, there is one way and only one way for every currency in the world to cheapen at the same time. And that is if they cheapen against gold, which means a higher dollar price for gold, a higher euro price for gold, significantly higher in the long run. gold wins the currency wars because it won’t fight back. And it’s the only way that the whole world can devalue at once, which is against gold.

Stig Brodersen  42:25

As you can probably hear, we could discuss forever with Jim. Next week, you will hear the second part of the interview. Here we actually talking a lot more about gold than we did in this episode. That was what we had for this weekend. And Preston and I can’t wait to share the second part of the interview with Jim next week.

Outro  42:42

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