Our exclusive interview on Multi Lateral Default with JIM RICKARDS, Editor of Strategic Intelligence and New York Times best selling author, investigates the future of the global monetary system, as Executive Global explore the potential impact of a sovereign debt and global monetary crisis that may emerge as a result of a U.S. dollar default, the future of the Chinese yuan, as well as the new case for gold. We gain a fundamental insight into one of the most brilliant minds to emerge from Wall Street, exploring the preparatory measures that should be considered by high net worth individuals and institutional investors to hedge against risk.
Multi Lateral Default
Executive Global: The Chinese yuan has recently been added to the International Monetary Fund's Special Drawing Rights and the Chinese are known to favour gold. While the value of gold seems to be on a downward slope, there is a thought that it still may supplement the influence of the petrodollar in the coming years. If that were to become reality, how would that affect the American economy?
James Rickards: The inclusion of the Chinese yuan in the SDR calculation base, and Chinese acquisition of gold are closely related developments. Both involve efforts by China, and other countries to move away from the U.S. dollar as the benchmark global reserve currency.
Today the dollar comprises about 60% of global reserves and 80% of global payments. This gives the U.S hegemonic power in terms of imposing economic sanctions, freezing assets, cutting off access to dollar payments systems, and using other means of weaponising the dollar to dictate foreign policy outcomes. The only potential rivals to the dollar are special drawing rights, and gold. China is expanding in both markets.
China has more than tripled its gold reserves in the past ten years and likely has far more gold than its official figures indicate. This creates a natural hedge for its Treasury holdings. If the U.S. inflates the dollar, the Treasuries will lose value but gold will gain value. China has created a hedge against U.S. inflation by buying gold. The next financial crisis will be larger than the ability of central banks to reliquify the system. The only source of liquidity will be the issuance of SDRs by the IMF. This will cause global inflation. Lost confidence in dollars will mean the end of the petrodollar also. The new global benchmark currency will be the SDR.
Effects on the U.S. economy will be devastating. Lost growth, and lost wealth will lead to money riots and a neofascist response resulting in martial law. Events in recent years in Cyprus, Greece, India and Venezuela are all previews of what is coming to the U.S.
EG: While the milieu of debt-based currency constantly fluctuates under the influence of international events, does that make gold - the ultimate anchor of (relative) global stability?
JR: The core problem with the international monetary system today is there is no anchor at all. In my two recent private discussions with Ben Bernanke, former Fed chairman, and John Lipsky, former IMF head, each used the same word to describe the monetary system today, “Incoherent.” They’re right. This incoherence is due to the lack of an anchor. On January 15, 2015, the euro dropped 20 percent against the Swiss franc in 30 minutes.
The Renminbi, U.S. Dollar, and Gold
JR: On August 10, 2015, the Chinese yuan dropped 3 percent against the U.S. dollar instantaneously. On June 23, 2016, pounds sterling dropped 14 percent against dollars in two hours. Typically foreign exchange markets trade in increments measured to five decimal places. Moves of the type described in the past two years are shocking and show just how unanchored the system is. Gold is not a perfect anchor, but history has proven it to be better than any other. Unless the system finds a new anchor, preferably gold, these shock devaluations will continue to occur to the point of collapse.
EG: In the case that gold reclaims its place at the core of the global economy, when do you think will be the most optimal occasion to purchase gold in order to reap the most of its profitability in the years to come?
JR: The best time to buy gold is now. The price is volatile when measured in dollars, but that’s a reflection of dollar instability, not gold instability. When the systemic collapse comes, which is just a matter of time, gold will soar in stages to $10,000 per ounce or higher. That price target is the implied non-deflationary price of gold based on global money supply and official gold supplies if gold is used as a benchmark in a new monetary system. The problem is that the availability of physical gold is starting to dry up. I’ve spent time with Swiss gold refiners and private secure logistics firms and have made inquiries on the availability of physical gold from Shanghai to New York. The story is the same everywhere. There’s nowhere near enough physical gold to satisfy demand from paper gold contract holders in the event of a gold buying panic. This means that even if you want to buy gold when the price starts to move, you may not be able to find any. The time to acquire physical gold is now, before the panic, while you still can.
EG: Once we secure our assets by turning them into gold, what is the next move? Shall we just let it marinade for a while, or are there upcoming opportunities that we should be on the lookout for?
JR: I recommend that investors allocate 10 percent of their investible assets to physical gold. That leaves 90 percent for other asset classes including cash, fine art, private equity, stocks and bonds. You don’t have to go to the sidelines or live in a cave; a 10 percent allocation to gold will serve you well. Don’t obsess over day-to-day fluctuations in the dollar price. Those fluctuations say more about instability in the dollar than they do about gold. Once you have your gold allocation, just sit tight. There’s nothing else to do until the collapse comes!
EG: Considering the fact that not everyone is involved in trading stocks and ever fewer will invest into gold, how will the fluctuations of the USD and the rise of gold affect the life of the average American?
JR: The end result of instability in the international monetary system will be very high rates of inflation, perhaps hyperinflation. This is the only way to alleviate the high debt burden of sovereign states and corporations around the world in an age of insufficient growth. This will affect everyday citizens in the U.S. even if they have no assets at all. However, the inflation will not come in a straight line. It may even be preceded by deflation due to demographics, technology and deleveraging. Yet, in the end, inflation must prevail because it’s the only way out of the debt trap that governments have led us into.
EG: Is there a way for businesses to navigate the upcoming turmoil of the economy to result in their favour, while most of the world is headed for the bottom?
JR: Business can navigate monetary turmoil by creating real value and dealing in real assets. These approaches include creation of intellectual property, possession of natural resources, and investment in human capital. Such assets will retain value even through episodes of extreme inflation or deflation. Companies that are the most vulnerable to financial turmoil are those that rely on high leverage and financial engineering to produce returns. Companies in this latter category including banks may be heading for insolvency in the next financial crisis.
U.S. Sovereign Debt Default
EG: We will likely witness a loss of confidence in the US dollar (if we haven't already) with the decline of the petrodollar system. Will it be sound to retain assets in USD at this time, or is there a more appealing alternative as far as currency goes?
JR: A loss of confidence in the U.S. dollar is already underway as demonstrated by Russian and Chinese efforts to acquire thousands of tons of gold, and the fact that foreign investors have become net sellers of U.S. Treasury securities. This migration away from the dollar is proceeding in an orderly way for the time being, but the momentum is irreversible and will accelerate suddenly and unexpectedly into a full-scale dollar collapse. In the short-run the euro is an attractive alternative to U.S. dollars. The only long-run alternatives to the dollar are gold, silver and the IMF’s special drawing rights, or SDRs.
EG: The US doesn't manufacture like it used to and we witness a consumer society with too many consumers for the amount of producers, trading in debt rather than goods. How does productivity relate to the current issues at hand?
JR: Productivity is arguably the most important economic policy challenge in the world today. Real economic growth is simply a matter of how many people are working and the productivity of those workers. The total number of workers in large economies is not growing due to declining birth rates and disasters such as China’s one-child policy and sex-selective abortions in India and China. Unfortunately productivity is also declining although economists do not agree why. Debt burdens are sustainable if economic growth exceeds the growth of debt. Unfortunately the opposite is happening. Debt burdens continue to grow while economic growth, both real and nominal, has stalled out. Demographics take decades to turn around. Productivity increases are the only way to avoid a global debt crisis. But there are no signs that productivity will increase fast enough to save the day.
EG: Is there a way that the government could intervene to help the economy reset in an orderly fashion rather than culminate in an epic collapse?
JR: The government could do a lot to make the financial system safer including breaking up big banks, separating commercial and investment banking, and banning most derivatives. Unfortunately all of these policy changes are unlikely due to the power of bank lobbyists. The government could also move to improve productivity by reducing tax and regulatory burdens. But, regulatory changes take time to affect investment decisions, and tax cuts will make deficits worse at a time when the U.S. debt-to-GDP burden is already 104 percent, well into the “danger zone” of 90 percent identified by Kenneth Rogoff and Carmen Reinhart. Avoiding catastrophe is not impossible, yet time is short and the chances of avoiding collapse are small.
EG: How could we prevent this scenario from happening again and how do we re-route the economic system towards a path of sustainability?
JR: We should not be optimistic about the capacity of policymakers to learn lessons from the crisis. There are three reasons for this. The first is that we had an equally grave systemic crisis in September 1998 and no lessons were learned from that, in fact, policymakers did the opposite of what was needed. The second is that policymakers use obsolete equilibrium models that produce flawed forecasts and misapprehend the statistical properties of risk. The third reason is the ability of bankers and their lobbyists to defeat change even if reforms were put forward.
EG: With the emerging trend for online transactions and digital currency – what role does gold play in that equation?
JR: Gold is the perfect asset for the digital age. The reason is that along with digital wealth and digital payments come cyber-financial warfare and cyber-threats. Wealth in digital form (all bank deposits, stocks, bonds, money market funds etc.) can we wiped out by Russian or Chinese cyber brigades. Gold is physical and cannot be hacked, frozen or erased. Gold is the best way to preserve wealth in a world of digital attacks. This is one reason China and Russia have been acquiring gold because they see this cyber-financial warfare on the horizon.