Peter Schiff recently had an interesting interview with author James Rickards author of the sensational Currency Wars: The Making of the Next Global Crisis.
Find below the interview along with my comments [bold italics]
Peter Schiff: You portray recent monetary history as a series of currency wars - the first being 1921-1936, the second being 1967-1987, and the third going on right now. This seems accurate to me. In fact, my father got involved in economics because he saw the fallout of what you would call Currency War II, back in the '60s. What differentiates each of these wars, and what is most significant about the current one?
James Rickards: Currency wars are characterized by successive competitive devaluations by major economies of their currencies against the currencies of their trading partners in an effort to steal growth from those trading partners.
While all currency wars have this much in common, they can occur in dissimilar economic climates and can take different paths. Currency War I (1921-1936) was dominated by a deflationary dynamic, while Currency War II (1967-1987) was dominated by inflation. Also, CWI ended in the disaster of World War II, while CWII was brought in for a soft landing, after a very bumpy ride, with the Plaza Accords of 1985 and the Louvre Accords of 1987.
What the first two currency wars had in common, apart from the devaluations, was the destruction of wealth resulting from an absence of price stability or an economic anchor.
Interestingly, Currency War III, which began in 2010, is really a tug-of-war between the natural deflation coming from the depression that began in 2007 and policy-induced inflation coming from Fed easing. The deflationary and inflationary vectors are fighting each other to a standstill for the time being, but the situation is highly unstable and will "tip" into one or the other sooner rather than later. Inflation bordering on hyperinflation seems like the more likely outcome at the moment because of the Fed's attitude of "whatever it takes" in terms of money-printing; however, deflation cannot be ruled out if the Fed throws in the towel in the face of political opposition.
[My comment:
At this point policy actions by global authorities do not seem to indicate of a currency war or competitive devaluation as the olden days (as per Mr. Rickards scenarios].
While major central banks have indeed been inflating massively, they seem to be coordinating their actions to devalue. For instance, the US Federal Reserve has opened swap lines to major central banks and to emerging market central banks as well. Japan’s triple calamity a year ago prompted a joint intervention in the currency markets, which included the US Federal Reserve.
Current actions partly resembles a modern day concoction of Plaza Accord and Louvre Accord]
Peter: You and I agree that the dollar is on the road to ruin, and we both have made some drastic forecasts about what the government might do in the face of the dollar collapse. How might this scenario play out in your view?
James: The dollar is not necessarily on the road to ruin, but that outcome does seem highly likely at the moment. There is still time to pull back from the brink, but it requires a specific set of policies: breaking up big banks, banning derivatives, raising interest rates to make the US a magnet for capital, cutting government spending, eliminating capital gains and corporate income taxes, going to a personal flat tax, and reducing regulation on job-creating businesses. However, the likelihood of these policies being put in place seems remote - so the dollar collapse scenario must be considered.
Few Americans are aware of the International Economic Emergency Powers Act (IEEPA)... it gives any US president dictatorial powers to freeze accounts, seize assets, nationalize banks, and take other radical steps to fight economic collapse in the name of national security. Given these powers, one could see a set of actions including seizure of the 6,000 tons of foreign gold stored at the Federal Reserve Bank of New York which, when combined with Washington's existing hoard of 8,000 tons, would leave the US as a gold superpower in a position to dictate the shape of the international monetary system going forward, as it did at Bretton Woods in 1944.
[my comment: the direction of current trends in policymaking is the destruction of the US dollar standard. The alternative would be the collapse of the banking system along with the welfare-warfare state. Policymakers are caught between the proverbial devil and the deep blue sea.]
Peter: You write in your book that it's possible that President Obama may call for a return to a pseudo-gold standard. That seems far-fetched to me. Why would a bunch of pro-inflation Keynesians in Washington voluntarily restrict their ability to print new money? Wouldn't such a program require the government to default on its bonds?
James: My forecast does not pertain specifically to President Obama, but to any president faced with economic catastrophe. I agree that a typically Keynesian administration will not go to the gold standard easily or willingly. I only suggest that they may have no choice but to go to a gold standard in the face of a complete collapse of confidence in the dollar. It would be a gold standard of last resort, at a much higher price - perhaps $7,000 per ounce or higher.
This is similar to what President Roosevelt did in 1933 when he outlawed private gold ownership but then proceeded to increase the price 75% in the middle of the worst sustained period of deflation in U.S. history.
[my comment: I don’t think current policymaking trends has entirely been about ideology, a substantial influence has been the preservation of the incumbent political institutions comprising of the welfare-warfare state, the politically privileged banking and the central banking system. True, the markets will eventually prevail over unsustainable systems]
Peter: You also write that you were asked by the Department of Defense to teach them to attack other countries using monetary policy. Do you believe there has a been an deliberate attempt to rack up as much public debt as possible - from the Chinese, in particular - and then strategically default through inflation?
James: I do not believe there has been a deliberate plot to rack up debt for the strategic purpose of default; however, something like that has resulted anyway.
Conventional wisdom is that China has the US over a barrel because it holds more than $2 trillion of US dollar-denominated debt, which it could dump at any time. In fact, the US has China over a barrel because it can freeze Chinese accounts in the face of any attempted dumping and substantially devalue the worth of the money we owe the Chinese. The Chinese themselves have been slow to realize this. In hindsight, their greatest blunder will turn out to be trusting the US to maintain the value of its currency.
[my comment: There are always two parties to a trade, if China would be “dumping” then there has to be a buyer. Question is who would be the buyer? If the world will join China in the US treasury dumping binge, then obviously the buyer of last resort would be the US Federal Reserve. If the US Federal Reserve does not assume such role, then there would be a freeze in the global banking system similar to 2008 or worst.
As to freezing of China’s account; that may happen after the US Federal Reserve consummates the transaction. This stage may not even be reached, unless the US will declare economic sanctions against China which would signify an indirect declaration of war.]
Peter: In your book, you lay out four possible results from the present currency war. Please briefly describe these and which one do you feel is most likely and why.
James: Yes, I lay out four scenarios, which I call "The Four Horsemen of the Dollar Apocalypse."
The first case is a world of multiple reserve currencies with the dollar being just one among several. This is the preferred solution of academics. I call it the "Kumbaya Solution" because it assumes all of the currencies will get along fine with each other. In fact, however, instead of one central bank behaving badly, we will have many.
The second case is world money in the form of Special Drawing Rights (SDRs). This is the preferred solution of global elites. The foundation for this has already been laid and the plumbing is already in place. The International Monetary Fund (IMF) would have its own printing press under the unaccountable control of the G20. This would reduce the dollar to the role of a local currency, as all important international transfers would be denominated in SDRs.
The third case is a return to the gold standard. This would have to be done at a much higher price to avoid the deflationary blunder of the 1920s, when nations returned to gold at an old parity that could not be sustained without massive deflation due to all of the money-printing in the meantime. I suggest a price of $7,000 per ounce for the new parity.
My final case is chaos and a resort to emergency economic powers. I consider this the most likely because of a combination of denial, delay, and wishful thinking on the part of the monetary elites.
[my comment:
I am less inclined to think of a global money (or second) scenario.
I think that the incumbent currency system may transform or morph into a regime of multipolar currencies and or with possible gold/silver participation.
Since I don’t believe that the world operates in a vacuum, even if a global hyperinflation does become a reality, people, communities, states or even governments will act to substitute a collapsing currency incredibly fast.
The currency crisis hasn’t happened, yet we seem to see signs of nations already taking steps towards self-insurance, partly by engaging in bilateral trade financed by the use of local currencies (Brazil-Argentina, China-Japan), and partly by increasing gold’s role in trade: Some US states have begun to promote the use of gold and silver coins also as insurance.
So the seeds to a transition of monetary standards are being sown]
Peter: What do you see as Washington's end-game for the present currency war? What is their best-case scenario?
James: Washington's best-case scenario is that banks gradually heal by making leveraged profits on the spreads between low-cost deposits and safe government bonds. These profits are then a cushion to absorb losses on bad assets and, eventually, the system becomes healthy again and can start the lending-and-spending game over again.
I view this as unlikely because the debts are so great, the time needed so long, and the deflationary forces so strong that the banks will not recover before the needed money-printing drives the system over a cliff - through a loss of confidence in the dollar and other paper currencies.
[my comment: debts are symptoms of prior government spending both from welfare-warfare state and rescues/bailouts of crisis affected institutions including governments]
Peter: I don't think this scenario is likely either, but say it were... would it be healthy for the American economy to have to carry all these zombie banks that depend on subsidies for survival? Wouldn't it be better to just let the toxic assets and toxic banks flush out of the system?
James: I agree completely. There's a model for this in the 1919-1920 depression, when the US government actually ran a balanced budget and the private sector was left to clean up the mess. The depression was over in 18 months and the US then set out on one of its strongest decades of growth ever. Today, in contrast, we have the government intervening everywhere, with the result that we should expect the current depression to last for years - possibly a decade.
[my comment: indeed]
Peter: How long do you think Currency War III will last?
James: History shows that Currency War I lasted 15 years and Currency War II lasted 20 years. There is no reason to believe that Currency War III will be brief. It's difficult to say, but it should last 5 years at least, possibly much longer.
[my comment: past performance may not guarantee future outcomes]
Peter: From my perspective, what is unique about a currency war is that the object is to inflict damage on yourself, and the country often described as the winner is actually the biggest loser, because they've devalued their currency the most. Which currency do you think will come out of this war the strongest?
James: I expect Europe and the euro will emerge the strongest after this currency war by doing the most to maintain the value of its currency while focusing on economic fundamentals, rather than quick fixes through devaluation. This is because the US and China are both currency manipulators out to reduce the value of their currencies. In the zero-sum world of currency wars, if the dollar and yuan are both down or flat, the euro must be going up. This is why the euro has not acted in accord with market expectations of its collapse.
The other reason the euro is strong and getting stronger is because it is backed by 10,000 tons of gold - even more than the US This is a source of strength for the euro.
[my comment:
I don’t think the ex post gold holding under current monetary system will significantly matter.
Some countries (like crisis affected Europe) may sell gold while others (such as emerging markets) may buy gold. So gold ownership will be in a state of continued flux.
The crux would revolve around the following issues
-control of debt build up from government spending
-allowing markets to clear
-what governments does with their gold holdings or will governments reform their currency system by eliminating policy induced bubble cycles? How?]
Peter: You and I both connect the Fed's dollar-printing with the recent revolutions in the Middle East. This is because our inflation is being exported overseas and driving up prices for food and fuel in third-world countries. What do you think will happen domestically when all this inflation comes home to roost?
James: The Fed will allow the inflation to grow in the US because it is the only way out of the non-payable debt.
Initially, American investors will be happy because the inflation will be accompanied by rising stock prices. However, over time, the capital-destroying nature of inflation will become apparent - and markets will collapse. This will look like a replay of the 1970s.
[my comment: the $64 trillion question is inflate against who? Every major central banks seem to be engaged in synchronous-coordinated inflation.]
Peter: How long do you think China's elites will put up with the Fed's inflationary agenda before they start dumping their US dollar assets?
James: The Chinese will never "dump" assets because this could cause the US to freeze their accounts. However, the Chinese will shorten the maturity structure of those assets to reduce volatility, diversify assets by reallocating new reserves towards euro and yen, increase their gold holdings, and engage in direct investment in hard assets such as mines, farmland, railroads, etc. All of these developments are happening now and the tempo will increase in future.
[my comment: Dumping isn’t going to happen unless there would be a buyer. See my earlier comment above]
Peter: In your view, what is the best way for investors to protect themselves from this crisis?
James: My recommended portfolio is 20% gold, 5% silver, 20% undeveloped land in prime locations with development potential, 15% fine art, and 40% cash. The cash is not a long-term position but does give an investor short-term wealth preservation and optionality to pivot into other asset classes when there is greater visibility.
[my comment:
I would adjust portfolio according to the evolving circumstances.
Taking a rigid stance under current heavily politicized conditions could bring about huge market risks. For example, if hyperinflation occurs which Mr. Rickards sees as a “more likely outcome at the moment”, then cash and bond holdings will evaporate]
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