James Rickards: ‘When the international monetary system collapses—it’s going to be about how much gold you have’

James regularly consults with institutional fund managers, governments, and banking leaders worldwide, and participated in the Pentagon’s first ever, financial war games. As described in Currency Wars, James’ indicates that when the financial wars intensify, “Russia and China [may] acquire massive amounts of gold and then ultimately announce a new gold backed currency,” requiring their trade to be conducted in the new currency as a way to marginalize the dollar.

Speaking to this concept and much more, here are his interview comments with Bull Market Thinking’s Tekoa Da Silva:

Tekoa Da Silva: James, starting out on the Fed–what were your thoughts when you saw the unchanged policy and corresponding short-term jump in all asset prices, especially the jump we saw in gold?

James G. Rickards: Well, it wasn’t really surprising. I’ve been saying since the summer that they wouldn’t taper – in speeches, in interviews, on Twitter, and of course, there was the overwhelming view that the Fed would taper. So when they didn’t taper, it really didn’t come as any surprise, as that was my expectation.

So my expectation of that was based on the Fed’s own words. The Fed said – going back to when Bernanke first raised this issue, he said, “We are going to reduce asset purchases before the end of the year”, in other words taper, “If the economy performs in accordance with our forecast”. What happened was the markets focused on the tapering part, but they ignored the condition which was that the economy would be doing better which is what the Fed was expecting.

Well, anyone who has followed Fed forecasts knows they have the worst forecasting record in economics. Every year the Fed produces a one-year full length forecast. So in 2009, they predict 2010. In 2011, they predict 2012 and so forth. If you go back and look at the last four years, they’ve been wrong every time. They’ve been wrong four years in a row and wrong by a lot, by orders of magnitude. They were predicting 3% growth and it would come in at around 1.5% and they would predict 3.5% growth and it would come in at 2%, etc. They just weren’t even close.

So the first thing was that if the Fed was basing policy on their forecast, you have to go off the fact that their forecasting record is terrible and they’re probably going to be wrong again and the economy is probably going to underperform. So that was the starting place.

But beyond that, when the data actually came in, it was awful. It was disappointing. Consumer confidence collapsed. Mortgage applications collapsed. The important data just kept coming in, showing the economy was fundamentally weak. And of course we’re all familiar with things like over 50 million Americans on food stamps. Over 26 million Americans either unemployed or underemployed, over 11 million Americans on disability, and all those numbers are going up. Those are all at all-time highs and are going up, which means that people are really suffering in this economy.

So what I did was I put all that together and I took the Fed at their word. I said “Well, the data says that they won’t taper,” so it was very easy to say that they were not going to taper.

Unfortunately most market participants got that wrong because they engaged in a lot of wishful thinking. They sort of saw the green shoots or thought they did and read the data differently or rationalized things – people were so convinced. It was actually an interesting case study and what psychologists, behavioral psychologists call “group think”, which is once enough people said they were going to taper, it’s easier for the next guy to join in the chorus rather than try to separate himself from the pack and so you just have this overwhelming balance of opinion that they were going to taper.

Of course when the shock came and the markets reversed, stock market went up, gold went up, all that was to be expected because the markets have so heavily discounted the prospect of tapering that when there was no tapering, they had to kind of re-price themselves upwards.

So as I said – none of it was really surprising but it was interesting to watch everybody get it wrong by just not listening to what the Fed was saying.

TD: James, you noted that there are people hurting in the economy yet over the past number of months, I’ve heard a number of money managers speak about a recovery underway and that the recovery is real. So is it just a recovery in equities, a recovery in asset prices with the real economy continuing to decline?

JR: Well, in part, yes. What’s going on in the stock market is a bubble. The Feds are inflating the bubble as they did in the late 90s, and as they did in the mid-2000s with money printing and monetary ease.

So I expect stocks will go up by the way between now and the end of the year, so you don’t want to fight the Fed or fight the tape but that’s not really fundamental. That’s just money printing. It’s just another bubble that will end badly, but the thing with bubbles is they can go on a lot longer than you expect. I mean it could go on well into next year before correcting.

As far as the money managers are concerned, most of them don’t understand what’s going on in the economy. They’re using the wrong models. Everyone is using cyclical models, using business cycle analysis going back to the end of World War II where the economy gets overheated and the Fed tightens and then unemployment goes up and inflation drops and industrial production slows down and then we get into recession and the Fed eases, then there’s more money around and then it picks up again, etc.

That’s the model everyone is using, and they’ve been using it since 2008 expecting some kind of robust recovery. If you go back and look at the last four years, in 2009, all you’ve heard about was green shoots. In 2010 Secretary Geithner was talking about the “recovery summer”. In 2011, economists were expecting higher growth in the second half. Same thing in 2012, same thing this year, and they’ve been wrong every single time. But the reason is that we’re not in a cyclical recovery. None of these models apply. We’re in a depression. We are in a depression for the first time since the 1930s.

You have to be 90 years old to have a firsthand living memory of what a depression is like but if you’re curious and you want to know what a depression feels like, it feels like this because we’re in one.

The problem with a depression is that it’s not a business cycle. It’s a different condition and so cyclical remedies such as monetary easing don’t work. Those are liquidity remedies but we have structural problems. You can’t solve a structural problem with a liquidity remedy. You need a structural remedy and that means changes in tax laws, labor mobility, regulatory policy, fiscal policy etc., all the things that the republicans and democrats are fighting over.

I don’t see any resolution of the structural issues on the table and therefore I would expect that this depression will continue indefinitely.  A lot of people don’t understand what a depression is. They think it’s a continuous decline in GDP and that’s not the definition of a depression.

You can have growth in a depression. It just means you have below trend growth. You never get back to trend and a gap between trend growth and actual growth keeps getting wider, which represents lost wealth.

Remember The Great Depression from 1929 to 1940. We had growth in 1933 and 1937. In 1933 and 1934, those were great years for the stock market. Unemployment came down, but it came down from a very high level. It came down from over 20% to 14%. The point is that it was still very high even after the improvement.

Then we went back into a second recession within the depression in 1937 and we may be repeating that. By the way, it wouldn’t surprise me if we had a recession in 2014. All these economists and money managers you mentioned are all sitting around predicting higher growth. They say, “Well, it’s just a matter of time, this recovery, it’s going to take off.” Again, this recovery is four years old. The average economic expansion lasts somewhere around 58 months. So we may be closer to a recession than a continued expansion and it wouldn’t surprise me.

People say forecasting is hard. I like to say forecasting is easy. What’s hard is getting the model right. The reason most of the consensus’ forecasts have been wrong on everything from economic recovery to expansion to tapering, is because everyone is using the wrong models.

But using the correct model which would be based on the complexity theory and understanding that we’re in a depression, I would expect low growth to continue indefinitely at best and we might have a recession as early as next spring.

TD: James, on an anecdotal basis, what kind of things are you seeing and hearing from the emerging commodity countries that have seen their currencies fall apart this year?

JR: Well, I just got back from South Africa. I spent a couple of weeks down there, so I had the opportunity to talk to all the largest institutional investors as well as some government officials. I’m heading to Eastern Europe next week. I’ll be in Warsaw, Vienna, and Bratislava.

So I’m actually spending quite a bit of time lately focused on emerging markets and they’re just baffled. They are really the victims of Fed policy. Now the Fed would like to wash their hands clean of emerging markets and Bernanke, other central bank presidents, and members of the Federal Reserve Board of Governors have said to emerging markets, “We have to take care of U.S. economic policy…you’re really on your own. You’ve got your own central banks, so you guys figure it out.”

Well, it’s not so easy. The dollar is the global reserve currency. These emerging markets had most of their reserves denominated in dollars and capital inflows come from dollar-based investors. So they’re completely dependent on the dollar in terms of how the economies expand or contract or how their monetary policy plays out, and the Fed is manipulating the dollar, manipulating interest rates, manipulating exchange rates.

So when you do that in the dollar, you’re manipulating every market in the world. So I think it’s a little – at best, kind of naïve and at worst really disingenuous for the Fed to say, “Oh, you emerging markets. You guys figure it out. That’s not our job.”

Well, they’re manipulating every market in the world. So what’s happening in emerging markets, is that prior to the 1970s we had a gold standard. From 1980 to 2010, we at least had a dollar standard. It wasn’t a gold standard but the US pledged to maintain the stability of the dollar and that was a fairly stable period, but since 2010 when the U.S. unilaterally declared the currency wars to try and cheapen the dollar, we’ve had no anchor at all.

There’s no gold standard. There’s no dollar standard. There’s no Taylor rule. There are no rules whatsoever in the international monetary system, so these emerging markets are just hoping for some stability but they’re not getting it. I mean they’re kind of like road-kill.

The Fed is like a drunk driver running over pedestrians and then blaming the pedestrians for being in the way. So I think this will continue because the Fed’s intervention and manipulation is going to continue. We don’t really see any end to it and one of the possible bad outcomes is you could have an emerging market crisis of the kind that happened in 1997 which spread around the world throughout ’98 and eventually affected everything from Russia to Brazil to Long Term Capital Management. Things could easily spin out of control because of the Fed’s lack of understanding of how the emerging markets are really reacting to and dependent upon the Fed manipulation.

TD: James, to ask you about gold–you’ve commented in the past that the US is in possession of about 8000 tons held at military installations at Fort Knox, the other being West Point as well as the Federal Reserve Bank of New York holding about 6000 tons belonging to a number of different countries. If a financial war were to break out, you’ve indicated that it would be easy for the US to simply seize all the world’s gold held in custody without any recourse.

So earlier this year we saw Germany ask for their gold back, and we’ve seen warehouse supplies sort of empty-out all year long. Do you think there’s a ‘grab for gold’ going on right now that maybe people are thinking let’s get it while we still have the chance?

JR: Sure, this is a worldwide phenomenon. You’re seeing it with massive acquisitions of gold in Russia and China. Now the Russian and Chinese gold was never held by the Federal Reserve back in New York in the first place, so that’s a little bit of a different issue, but they’re acquiring it from their own mines. In the case of China, they’re importing it.

I described this in my book Currency Wars. In 2009, the Pentagon conducted a financial war game, the first ever financial war game. I was involved in the game design, working with the Pentagon, and I also participated in the game. We did it at a top secret weapons laboratory right outside of Washington D.C., and one of the scenarios that we put on the table and played out was that Russia and China would acquire massive amounts of gold and then ultimately announce a new gold backed currency and it’s such that Russian natural resource exports, and Chinese manufactured goods could only be paid for in this new currency as a way of marginalizing the dollar.

Now, just to be clear, there’s no way that the Chinese yuan or the Russian ruble are going to become reserve currencies anytime soon, maybe ever. So I’m not talking about the Chinese yuan replacing the dollar. That’s not going to happen.

But what we were positing was a completely new currency backed by gold to marginalize the dollar. Now it was fair to say we were laughed at by a lot of people and ridiculed for even putting that on the table. But since 2009, things have played out exactly the way we projected, meaning Russia has increased its gold reserves by 65%. They’ve gone from about 600 tons to over 1000 tons. China has increased its reserves by a multiple, they’ve gone from 1000 tons to some number and they don’t disclose it, so you have to use various sources, but somewhere between 3000 and 4000 tons seems to be a reasonable estimate.

So Russia and China have proceeded down exactly the path that we projected in 2009 even though people thought that was kind of a joke at the time.

Others are acquiring gold as well and you mentioned the German repatriation. This is also a political issue in Switzerland. It’s a political issue in the Netherlands. Venezuela of course got their gold back from the Bank of England a couple of years ago under Hugo Chavez. So yes, people want physical custody of the gold. They’re worried that the United States will expropriate it in an emergency. Same thing with the Bank of England. They’re acquiring gold by other means, either through mining or buying mines or buying in the open market, et cetera.

Now a lot of this is taking place through channels that bypass the London Bullion Market Association, the so-called bullion banks in China. They’re buying mines in Western Australia. They’re having the ore refined right there in Australia and at the Perth Mint, and then shipping the gold straight to Shanghai. They’re completely bypassing the London market where they minimize their market impact, which is a smart move. That’s what you would do if you were trying to buy gold and not run up the price. You would do everything in secret and that’s what’s going on.

So sure, people are sort of positioning for the day when there’s a massive loss of confidence in paper money and the world economic powers have to restore confidence and there are really only two ways to do that.

One is the IMF issues ‘world money’, these SDR so-called special drawing rights inflate the world with liquidity, which would be highly inflationary. People won’t really understand it but that’s one solution.

The other one of course is some kind of gold standard and if you want a seat at the table there, think of it as a poker game like Texas hold ‘em and you want a big pile of chips. Well, when the international monetary system collapses and it comes time to rewrite the rules of the game and create a new system, you know your chips at the poker game are going to be how much gold you have. So it’s not surprising that everyone is trying to get their hands on as much gold as possible.

TD: James, being that you mentioned the financial war simulation games, I remember you mentioning at the time that you felt that the inclusion of media personnel would add value to the game.

So to ask here about Germany, when a news story like that hits the wires, is that a separate strategic technique to say, “OK, now let’s let all the world news sources know about what we’re doing here as a part of the strategy in the game”?

JR: Well, the Deutsche Bundesbank had to be somewhat transparent about what they were doing with the Fed, although that story is not very well understood because the spin that you’re hearing from a lot of blogs and websites and all that is that, “Gee, maybe the gold is not there because they can’t ship it right away and they’re going to take eight years to send the gold back to Germany and that’s proof that the Federal Reserve doesn’t have the gold.”

That’s all nonsense; the Fed does have the gold. What people don’t understand is Germany actually doesn’t want the gold back. Germany wants the gold in New York so they can use it to manipulate the market because New York has all the leasing–you know this is all contractual. When you lease gold, you don’t just like throw it in the truck and drive away. You’ve got contracts, you’ve got lease agreements, you’ve got settlement and clearance channels—those have all been established for decades and they’re all based in New York and London.

So if you move the gold to Frankfurt, it makes it more difficult to kind of recreate that system and use the gold market manipulation that the central banks are involved in.

So the Deutsche Bundesbank actually likes having the gold in New York. It was the German Bundestag, their parliament, this is a political decision because of course Angela Merkel is facing election and it became a political issue in Germany. Her party said, “Why don’t we ask for some of the gold back to show the German people that we’re standing up to the United States?” So the Deutsche Bundesbank went along with it but it’s a political decision with political implications. But the actual central bank to central bank relationship, they’re not unhappy about the fact that it’s taking so long. They actually want the gold in New York for the reason I mentioned. So it’s a very deep game. It’s not very well understood. You have to look behind the curtain so to speak, motivations, and how things actually work.

A lot of people, even people who talk about gold manipulation, don’t really understand how gold leasing works and what’s involved.

So it’s a very deep game but you can see it playing out and it will come to an end in the next couple years.

TD: James, I believe you have an upcoming new book release. For people reading–what can they look forward to there?

JR: Thank you Tekoa. Currency Wars is still available on Amazon, so if folks haven’t read it, I would certainly encourage them to have a look. It has got a lot more details on the things we just talked about including the financial war simulation game.

My new book is called The Death of Money: The Coming Collapse of the International Monetary System from Penguin Random House. That will be in the bookstores on April 8th, 2014. We’re working on the editing and updating right now but that will be out in April and in the meantime, for those who are interested, they can follow me on Twitter. My Twitter account is @JamesGRickards.

TD: James G. Rickards, Senior Managing Director of Tangent Capital, author of the New York Times best seller Currency Wars and now the upcoming The Death of Money: The Coming Collapse of the International Monetary System, thank you so much for sharing your comments.

JR: My pleasure Tekoa, thank you.

By Tekoa Da Silva