Transcript of AFE’s interview with Jim Rickards on Sept. 20th, 2013.
Interview covers Jim’s view on the Fed non-tapering announcement, and how gold will perform under various conditions of inflation or deflation moving forward.
Jim Rickards Interview: 9-20-13
Jon Ward: Hello, I’m Jon Ward on behalf of Anglo Far-East and Physical Gold Fund. We are once again delighted to have with us here today Jim Rickards. Based in New York, Mr. Rickards is an investment banker and an investment adviser, and he is the author of the best-selling book Currency Wars: The Making of the Next Global Crisis. Welcome, Jim, and thank you for joining us.
Jim Rickards: Thank you, Jon.
JW: Well, Jim, it’s been quite a week. Most commentators predicted that the Federal Reserve would announce a tapering of their asset purchase program currently running at a modest $85 billion a month. That’s to say in layman’s terms, they would give up printing funny money — or at least so much of it. Now, “most commentators” did not include Jim Rickards. You predicted in your last interview with us that the Fed would keep shoveling new cash into the economy. So Jim, here’s my question: Apart from the natural satisfaction of being proved right, what do you draw from Mr. Bernanke’s decision this week?
JR: As you mentioned, Jon, I expected the Fed would not taper and said that in a number of interviews and venues including ours. It was a fairly straightforward call for me. Going back to last night when Chairman Bernanke first started talking about tapering, he said, “We expect to reduce asset purchases” – that’s so-called tapering – “before the end of the year….” But he went on to say, “….if the economy performs in accordance with our forecast.” The market focused on the first half of his statement, and just assumed they would taper, but ignored the second half stating it was conditional on economic performance.
Two things can be drawn from this week’s activities. Number one, the Fed had a very rosy forecast. Anyone who has looked at the Fed forecast over the years knows they have the worst forecasting record in economics, they truly do. They’ve been wrong four years in a row, and they’ve been wrong by a lot. So the fact that the Fed was putting out a positive forecast meant you should always assume the opposite based on their track record. That was the first indication that maybe they wouldn’t be tapering. Number two, when the data actually came in, there were statements all summer by the Fed that it was all dependent on data. Again, people glossed over that. The data was horrible. The August employment report was bad. Consumer confidence collapsed. Mortgage applications collapsed, and so forth.
The combination of the Fed’s poor forecasting record and hard data coming in well below expectations made it very easy to see that they were not going to taper, but the market just went on its own. This was a good example of what behavioral psychologists call ‘groupthink.’ Once enough people said they were going to taper, it was easier for everyone else to say ‘Yes, they’re going to taper.’ People were ignoring the evidence. They didn’t taper, so the question really is, where we go from here? It’s sort of silly to see people already talking about October and December. They’re saying, ‘Well, the Fed didn’t taper in September, so that means they’re going to taper in October.’ That’s nonsense, because the basic analytical framework has not changed. Whether they taper or not will be dependent on the data. So instead of guessing, why don’t we wait and see what the data is?
Before the next Open Market Committee meeting is the end of October. We’re going to have a September employment report and more reports on PPI, CPI, consumer confidence, etc., so let’s see what the data actually says. I don’t know what the September employment report will be. No one does, but my meta-view is that the economy is fundamentally weak. It may actually be heading in a recession. If I had to handicap it today, my expectation would be that the data will come in weak, and they’re not going to taper in October either, but let’s see when the data actually comes out. It could well be that we get all the way into next year and a new chairman—I think at this point it’s clear that it will be Janet Yellen—with still no tapering, because the economy is underperforming. I think that’s the lay of the land. Let’s just take one month at a time in terms of the data. It’s an easy analysis. Just take the Fed at their word; they say it’s data contingent, so let’s see what the data says.
JW: It is interesting you mentioned Janet Yellen. I believe she’s on record as saying that in a slack economy, money printing at any level does not produce inflation. Do you think she’s right or do you see the possibility of significant price inflation in the relatively near future?
JR: I think she’s wrong, but that’s kind of irrelevant. What matters is she thinks she’s right! To be more specific, she gave a speech in April 2012.(On a side note, Janet Yellen is a fine academic. Her personal forecasting record is pretty good. She’s been getting a lot of things right). In her speech she said there’s no example of an economy experiencing much higher than expected inflation with this much slack in labor markets and industrial output. So she’s looking at the dismal employment picture, declining labor force participation, massive excess capacity, industrial capacity and saying that there’s just no chance of inflation. That’s what makes her a super-dove: She’s fearless when it comes to money printing, and she doesn’t mind keeping asset purchases where they are, because she’s not worried about the Fed balance sheet and she’s not worried about inflation.
Where she’s wrong is that inflation is not primarily a monetary phenomenon, as Milton Friedman said, and it’s not primarily a function of excess capacity or slacking capacity. It’s really psychological and behavioral. It depends on the velocity of money, the turnover, and how eagerly people want to borrow, lend, and spend. That’s a psychological phenomenon, and only a partial function of money supply. I would point to Weimar, Germany, in 1921. There you had the famous Weimar hyperinflation which basically took the Reich’s mark to the point where it wasn’t even money anymore; it became litter. Well, there was a lot of excess capacity, extra labor, and extra industrial capacity in Germany at the time, but they had hyperinflation anyway because of the behavior — because people simply lost confidence in the money, dumped it, and turned it over and spent as fast as they could lay hands on it. We could have that happen again.
I think the combination of Janet Yellen being the new chairman, her not fearing inflation and not worried about the Fed balance sheet, combined with the psychological behavioral dimension I just mentioned, means that they could actually win this battle with deflation and cause some inflation. If that happens, if you change the psychology and bend the velocity curve, it could really take off way beyond their expectations. There’s no doubt the Fed wants to see inflation get up to about three percent. But if it actually moves from one and a half to three, it could go right to seven or eight, because at that point, the genie is out of the bottle. If you change the psychology, it’s not so easy to change back, and it could overshoot. That would more closely resemble what happened in the 1970s.
JW: You mentioned deflation in that answer, and you’ve pointed out that this is a graver anxiety to the Fed than inflation. How serious is the threat of deflation, and what would that look like? I would say for myself, and I think for some people, the picture of inflation is easier to see than the picture of deflation. Could you describe that and how likely it is?
JR: Yes, I think that’s exactly right, Jon, that there’s something intuitive about inflation. When price levels take off, everyone says, well, housing is going up, gold’s going up; people kind of understand why asset prices (hard assets) increase in an inflationary environment. Deflation is much less intuitive. First of all, I do think deflation is a serious threat. I think the government, the Treasury, will do everything possible to avoid it, and that’s why I expect inflation. What’s going on in the economy right now is a tug of war between deflation and inflation, with both going on at the same time. The price indices we see are really the net of two very powerful forces that are, to some extent, cancelling each other out. The deflation is natural: It’s what you would expect in a depression, which we’re in. It comes from deleveraging asset sales, reducing balance sheets, etc. The inflation is induced by policy that comes from money printing. If you had one without the other, if you just had a depression with no money printing, we’d have very serious deflation today. If you had money printing without a depression, we’d have very serious inflation today. In fact, what we’ve got is something closer to zero, about one percent, because the forces are pushing against each other.
I believe inflation’s going to win the tug of war, because deflation is the Fed’s worst nightmare, due to the debt-to-GDP ratio. In other words, when you have deflation, you can have a world where nominal GDP is actually going down but real GDP is going up. That’s because, real GDP is nominal GDP minus inflation. If inflation is a negative, in other words if it’s deflation, you have to subtract the negative, which means you add the absolute value. So you can have a world of nominal GDP going down one percent, and three percent deflation. One minus negative three equals positive two, so you could actually have real growth in a world with declining nominal GDP. Now, the real growth is good, but the decline in nominal GDP is, as I said, the Fed’s worst nightmare, because of what that does to the debt-to-GDP ratio. We know the debt’s going up, because we continue to have budget deficits, but if nominal GDP is going down, that means your ratio (of debt to GDP) is going up. That means we start to look more like Greece or Japan and risk a complete collapse of confidence in U.S. government securities and the dollar as a whole.
That is a nightmare scenario. It’s very non-intuitive, so I call it ‘through the looking glass.’ It’s kind of seventh-grade math, but it’s just tricky enough. When you subtract the negative, you add the absolute value. How does that work? It’s not intuitive for people, but with deflation you can have real growth in a deflationary environment with declining nominal GDP. It’s a very strange world. Japan has had this from time to time over the last 20 years, yet the U.S. hasn’t seen anything like it, actually ever. The last time we had deflation, it was so severe that nominal GDP was collapsing even faster and we didn’t have real growth. That was in the period 1927 to 1933. So it’s just never happened in U.S. history, but it’s a danger we’re facing now. Precisely because it’s so dangerous, that’s what leads me to conclude that the Fed will move heaven and earth to avoid it, which means more money printing. They may actually have to increase asset purchasing. Far from tapering, they may do the ‘anti-taper’: They may increase asset purchases to a hundred billion a month if that’s what it takes to get the inflation, so I wouldn’t rule that out either.
JW: Jim, you mentioned the dollar. Let me ask you something about the dollar. In a recent interview, you made a striking comment about the monetary system. If I can try to capture this correctly, you said that until 1971, the world was effectively on the gold standard, then there was a short period of limbo, and then the world was effectively on what you call the dollar standard. But you observed that since 2010the U.S. government, if I understood you correctly, has effectively abandoned the dollar. That seems an extraordinary policy for the U.S. government to adopt. Please explain a bit what you meant by that comment.
JR: Sure. First of all, your summary is exactly right, Jon, and that is how I looked at it. The gold standard ended in 1971. The period from 1971 to 1980 was really one of chaos, muddling through, and moving the floating exchange rates. Of course, it was a horrible period of economic performance. The U.S. had three recessions between 1973 and 1981. The price of gold went from $35 an ounce to $800 an ounce. Inflation took off. The value of the dollar was cut in half. So it was a horrendous period.
The dollar was rescued by Paul Volker and Ronald Reagan beginning in 1980 and 1981. This is when we got on what’s called the ‘king dollar standard’ or the ‘sound dollar standard’. Basically the U.S. told the world there’s no more gold standard, but we’re going to have a dollar standard and we’re going to maintain the purchasing power of the dollar in all the other countries in the world. All their trading partners were essentially told they could anchor to the dollar. That actually was very successful from 1981 to 2010, a period until the very end characterized by solid growth with long expansions in the 1980s and 1990s. This policy was continued through Republican and Democratic administrations. James Baker under President Bush and Bob Rubin under President Clinton both continued the sound dollar policy.
Flash forward to 2010. The U.S. tore up the deal and said to the world, ‘We’re going to cheapen the dollar and you’re on your own’. In effect, they said to their trading partners and emerging markets: ‘You have your own central banks, so you figure it out.’ Why did the United States do that? And let’s note here that Japan’s doing the same thing. This goes back to the earlier point of our conversation, Jon. The purpose of cheapening the dollar was to import inflation in the form of higher import prices. Everyone assumes that cheapening the dollar is all about promoting exports. It can have a little positive effect on exports, but that’s not why the United States and Japan are doing it. They’re not cheapening the currency to promote exports; they’re cheapening the currency to import inflation in the form of higher import prices.
Remember, the United States is a net importer. Whatever benefit we might get on exports – and I think it’s small – we import more than we export. By cheapening the dollar, that means we pay more for clothing, energy, electronics, and manufactured goods, all the things the United States imports. Those price increases feed through the supply chain and cause more generalized inflation. At least that’s what the Fed hopes for, so that was the reason for the policy to cheapen the dollar. And that was the beginning of the currency war that has been playing out ever since. The currency war has no logical conclusion: I now equate it to a tennis match between two very evenly matched strong opponents. The ball can just go back and forth and back and forth for a long period of time before anything is resolved, and that’s the way currency wars are. It’s a very scary period, and it explains a lot of the volatility we’re seeing in markets, including gold, because there is no anchor.
On and off for a hundred years, from 1870 to 1971, we had predominately a gold standard. For 30 years, from 1980 to 2010, we did not have a gold standard, but we had a dollar standard. Now we have no standard — no gold standard, no dollar standard, no Taylor rule. There are no rules whatsoever in the international monetary system, so it should not come as a surprise that we’re seeing the kind of confusion, volatility, and sub-optimal performance we’re getting. That’s what happens when you make it up as you go along, which is what the Fed is doing.
JW: You’ve just returned from a trip to South Africa where you’ve been focusing on emerging markets and the so-called BRICS —Brazil, Russia, India, China, and South Africa. I’m curious, how is this monetary policy impacting them? And also, how might their response impact us in return?
JR: I did just go back to South Africa for two weeks, and I’m actually leaving Monday for a visit to Warsaw, Vienna and Bratislava in Eastern Europe where I am spending time focused on emerging markets. This current monetary policy is having very deleterious effects, because they don’t know what to do. Remember what I said about ‘the world without an anchor.’ The Fed has tried to wash their hands of the emerging markets. The Fed, including Chairman Bernanke and others, have said in a number of speeches, ‘Hey, we’re the Fed. We worry about U.S. economic performance. It’s not our job to worry about emerging markets. You guys have your own central banks, so you figure it out.’ It’s like a drunk driver who runs over pedestrians and then blames the pedestrians for being in the way. That’s the Fed’s attitude. They’re the drunk driver and the emerging markets are the innocent victims.
To put it another way, the Fed says to South Africa, ‘You have a central bank. If you think your currency is too weak, then raise interest rates.’ Well, how are they going to raise interest rates when they’ve got serious unemployment problems? And that’s true around the world. The Fed is being a little insincere, a little glib. The dollar is still the world’s reserve currency, at least for the time being. I think that’s in jeopardy, going forward, but it is the leading reserve currency. These emerging markets, the BRICS and others, have for the most part all of their reserves in dollars. The dollar capital markets are huge relative to the emerging markets. When you look at these markets and actually study them, their capital markets are not that big. You throw a trillion dollars in somebody’s capital market, and that’s a hundred percent of the capital market in a place like South Africa.
Our dollar capital flows in and out— based on hot money, based on Fed market manipulation —just overwhelms these emerging markets. It’s almost an invitation to put on capital controls. If the money flows in and then it looks like the Fed’s going to taper, they’re going to raise interest rates. The carry traders borrow dollars, convert them into South African rand or Thai baht, buy the local markets, make a spread, and make a lot of money. Well, the first whiff of an increase of interest rates in U.S. dollars, which is what the tapering talk was about, they would want to get out of that trade. So they dump the emerging market stocks and currency, pay off their dollar loans, and get out of the trade. Well, that’s just money piling in and money piling out, and these markets can’t absorb these kind of inflows. One of the dangers the Fed is facing is that they may trigger an emerging market crisis not unlike what happened in 1997 starting in Thailand that got out of control and spread around the world. There was blood in the streets of Jakarta and Seoul, it ended up affecting Russia and Brazil, and of course the famous collapse of the Long-Term Capital Management hedge fund, something I’m very familiar with. I was very involved in that fund, and that bail out at the time.
The Fed is really playing with fire. I think it’s disingenuous of them to ignore the impact of having an emerging market. Emerging markets don’t know which way to turn, because they’re dependent on the dollar, and you know the Fed is manipulating the dollar, which means manipulating every market in the world. I have a lot of sympathy for their position. We’ll see how it plays out. If somebody is still vulnerable, it wouldn’t surprise me to see some of these countries putting on capital controls. But that’s politically hard. It’s like drugs—the money feels good when it’s coming in, and when the money goes out, that’s like withdrawal. But it’s all a symptom of Fed manipulation, and I’m certain it will end badly, sooner than later.
JW: Let’s spend a few minutes in conclusion looking at this from an investor perspective. Jim, you’ve predicted another liquidity crisis similar to 2008, but larger. To this I have a particular question. What impact do you feel this next liquidity crisis could have on investment portfolios, particularly portfolios that are entirely based on paper assets, portfolios that have no precious metals? What’s the outlook in the next crisis for those types of portfolios?
JR: They’re extremely vulnerable, and here’s why. First of all, I do expect this crisis, because all the conditions that existed in 2008 exist today except they’re bigger, worse, and more dangerous. The same too-big-to-fail banks of 2008 are bigger today with a larger percentage of the banking assets and larger derivatives books. Nothing in Dodd-Frank or in the regulation sense has made any of that any safer. The regulators and bankers themselves are still using the wrong models. They’re using these value-at-risk models, which are completely illusory, so you’ve got a worse situation, a more dangerous situation, greater embedded risk, and continued failure or misapprehension of the statistical properties and risk. By putting all these things together, you can see the next crisis coming.
Now, here’s the thing. The last time there was a crisis, the Fed dealt with it with massive money printing, trillions of dollars of printed money and swap lines and guarantees and all kinds of other things. The Fed has now created several trillion dollars in the last few years without a liquidity crisis. We had a liquidity crisis in 2008, but QE2 and QE3 were not in response to liquidity crises. That was an attempt to stimulate the economy. Of course, we will look back on that and see it as one of the greatest failures in economic history. But the Fed has destroyed its balance sheet. They look like a really bad hedge fund right now.
So what’s going to happen when the next liquidity crisis comes? The Fed has used up its dry powder, they’ve taken a balance sheet, they’re approaching$4 trillion. What are they going to do —go to 8 trillion, 12 trillion? They can’t, because they’ll be at the limit. The next time we have a crisis, it’ll be worse, and it’ll be bigger than the Fed. They will not be able to respond to it, because they’ve already printed so much money in a non-crisis environment. They’re not going to have any dry powder for the crisis. What does that mean?
By the way, other central banks are in the same situation—the Bank of England, the Bank of Japan —they all have trashed their balance sheets, so the only clean balance sheet left in the world is the IMF. When the next crisis comes, the world will be re-liquefied by printing SDRs, these special drawing rights, which is the IMF world money. That could work, but no one understands it. That will be highly inflationary in dollar terms, so that’s just going to destroy capital formation by destroying the real value of dollar-denominated assets. The only shelter in the storm is going to be hard assets, which will be gold, silver, fine art, land, and things of that kind. Smart investors are positioning that way, and so are the big guys — Russia and China.
JW: As we wrap this up, may I ask you to clarify the role of gold in the two scenarios we’ve talked about, inflation and deflation? With inflation, the picture’s rather clear. Prices go up, currencies weaken, and gold strengthens. What happens in deflation? If prices drop, gold presumably drops, too. Are gold investors in trouble then?
JR: If deflation gets out of control, which it might —it’s not my central case, but I absolutely can’t rule it out – it is a danger. In that situation, you’ll see gold come down in nominal terms. Let’s say it’s $1,350 or$1,400 now. That could come down to $1,000 or even lower in nominal terms. But everything else will come down, too. I think it’s important for investors to understand that nothing happens in a vacuum. The world of $900 gold is also the world of maybe $6,000 on the Dow or $500 on the S&P. Everything else is going to be coming down even more in that extremely deflationary world. So gold could go down in nominal terms, but I still like it as an investment, because everything else will be going down more, and gold will still preserve your wealth.
If it gets worse, if deflation really takes off as in 1933 for example, what did the government do when we were in the grip of extreme deflation? The government revalued the price of gold higher. The government took the price of gold from $20 an ounce to $35 an ounce. It wasn’t the market taking gold higher; the market went into deflation. It was the government taking gold higher in order to cause inflation. The reason the government did that in 1933 was not because they wanted gold to go up, but because they wanted everything else to go up. They wanted to increase the price of cotton, oil, steel, wheat, and all these other things. By cheapening the dollar against gold, they caused the inflation to get out of the deflation. That could happen again.
In a period of extreme deflation, the government could unilaterally take the price of gold to $3,000 or $4,000 an ounce, not to reward gold investors(although it would), but really to cause generalized one-time hyperinflation. In a world of $4,000 gold, all of a sudden oil is $400 a barrel, silver is $100 an ounce, gas is $7 a gallon at the pump, etc. It would break the back of deflation. Even in extreme deflation, gold will end up going much higher, because the government will force it in order to cause inflation since they cannot have deflation for the reasons we discussed. This is gold is funny. It does well in inflation and deflation, but it’s volatile. It is a tough path and a very difficult thing for investors to understand, but at the end of the day, gold is money. If you want money, you should have some gold.
JW: Let me ask you one last practical question. When gold does go up in either scenario, will there actually be the gold available for people to buy?
JR: That’s a good question, because there will be physical shortages. Bullion banks and very large investors and others should be able to get gold directly from the refineries in large quantities, but the small investor will not be able to get physical gold. It won’t be a question of price. You see the price go up to $4,000 an ounce and you say, oh, gee, inflation’s out of control, and run down to your gold dealer to buy some American Gold Eagles, or ten-ounce bars or something. You’re not going to be able to find it. There’ll be physical shortages at that point, because all the big guys will have locked up all the gold. The proven thing is to buy the dips, buy gold now, have it in a safe place, and when the day comes, you’ll be fine.
JW: Thank you, Jim Rickards. We greatly appreciate having you with us today. And thank you to our listeners. Let me once again encourage you to get hold of Jim’s book, Currency Wars. It’s an illuminating and very readable road map to the current global crisis. I also want you to know that Jim has a new book coming out in April 2014 called The Death of Money: The Coming Collapse of the International Monetary System. So we look forward to that. Meanwhile, on behalf of Anglo Far-East and Physical Gold Fund, goodbye for now, and I do look forward to joining you again soon. Bye-bye.
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