3 Minute Gold News
A Quick Read for Busy People
3 minute synopsis of a recent speech given by Jim Rickards, author of Currency Wars, senior managing director at Omnis.
This is a brief synopsis. The speech goes in depth into specific theories and models.
Topics:
Financial Warfare
Currency War I
Currency War II
Currency War III
Inflation vs. Deflation
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Jim Rickards
Bratislava
September 26, 2013
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FINANCIAL WARFARE
Jim was at the Pentagon recently and he put forward that the time will come when a US destroyer will pull up at the refueling depot in Singapore and be asked for the fuel to be paid in SDRs (the IMF’s Special Drawing Rights).
He told them that for the first time the US will have a very expensive forward deployed military that they will have to pay for in a currency that they don’t print.
There is more to the dollar now than just economics.
It has a national strategic aspect. As China and Russia, and other countries, Iran and perhaps others try to compete with the United States, and perhaps have an adversarial relationship with the United States. They will not seek power through the traditional military.
The US is very dominant in the traditional military.
They will seek it in Asymmetric Warfare. That can involve various means: weapons of mass destruction, saga warfare, and Jim believes in the future, financial warfare.
So it is a very important subject.
WHAT IS A CURRENCY WAR?
Currencies do fluctuate in their exchange rates. There are good economic reasons for the currencies to fluctuate. These have to do with changes in comparitive advantage, trade advantage including demographic, technological, other structural policy changes or natural resource discoveries. So there are good reasons for currencies to change in value as compartive advange shifts.
That is not a currency war.
A currency war is when a country intentionally and purposefully, as a matter of policy, seeks to cheapen its currency for the sole purpose of stealing trading advantage from its neighbours.
In other words, it’s not the result of fundamental changes in economic factors, it’s a result of manipulation and policy, for the purpose to getting a trading advantage from your partners.
We don’t have currency wars all the time.
They tend to arise in periods when there is insufficient economic growth in the world.
Debt diminishes growth, and then countries are tempted to, in effect, steal growth from their trading partners through currency wars.
Currency wars can last five, ten or even fifteen years.
HISTORY
Currency War 1
This lasted from 1921 – 1936, about the time of the Great Depression. Hyperinflation was happening in Germany. Their money became completely worthless and people became so bitter it was swept down the sewers.
What happened then is Germany launched a gold backed currency. First they had a new currency backed by mortgages. They got a loan from the United States and were able to import some equipment, then to begin to export and have some export earnings. They used the money to acquire gold and created a gold backed currency.
From 1924 – 1929 Germany was the fastest growing major investor economy in the world.
Germany had an educated workforce, a transportation network, energy, factories, technology. They had everything they needed.
What they did not have was a strong currency.
Once they got the strong currency in 1924, the economy grew very strongly for the next five years.
This shows the importance of a strong currency. If the people lack confidence in the currency then there is dysfunction. If they have confidence then the economy can be very productive.
From 1925
Prior to World War I , from 1870 – 1914 approximately, the world had been on a very pure “Classical Gold Standard”, where the currency was fixed to an amount of gold.
This meant that the cross rates of major currencies were fixed. Two currencies backed by the gold had a fixed relationship to each other.
It was a world of fixed exchange rates and a gold standard. It worked very well. It was a period of prosperity, low inflation, deflation for part of it, with great technological advances like steamships, radios, and airplanes, and international finance.
That was the first stage of globalization.
1989 to today is the second stage of globalization.
The first stage ended abruptly in 1914 with World War I. Countries quickly abandoned the gold standard because they needed to print money to fight the war.
By the 1920s countries wanted to go back to the gold standard. But at what exchange rate?
The problem was that they knew the price before World War I but they had doubled the money supply. They had printed money in order to fight the war.
So, they had a parity with gold at one level, then doubled the money supply, and then wanted to go back to parity.
You really only had two choices:
1. you double the price of gold (cutting the currency value in half)
2. you cut the money supply in half
France cut the value of their currency in half, meaning they doubled the price of gold. This meant a 50% devaluation of the French franc.
This was highly inflationary in France. The Woody Allen movie Midnight in Paris showed American singers, artists and writers in Paris in 1925, living an extravagant lifestyle. That’s because of the French devaluation, so their American dollars were worth more, and they could live like a king.
England made a different choice. Winston Churchill felt duty bound to go back to gold at the pre-World War I level. So they cut the money supply in half and it was extremely deflationary. England was in a depression four years before the rest of the world.
England had the most overvalued currency in the world. It meant that France, Italy and others had a trading advantage in terms of a cheaper currency. They got more tourists, more exports while England’s economy was suffering.
Finally by 1931 England had had enough. Banks in England collapsed. The England banking crisis has been closely studied, but Jim’s book is the first one that compared them, and the similarities are striking. All the major English banks would have failed but for the fact that the Bank of England abandoned the gold standard and devalued sterling against gold. Something that they should have done in 1925.
So:
Germany devalues their currency in 1921.
France devalues in 1925.
England devalues in 1931.
So who’s left? The United States.
At that point the US had the most overvalued currency in the world, and by 1933 had suffered through depression. So finally the US joined the club and devalued their dollar against gold.
Gold was about $20 an ounce at the beginning of 1933 and at the beginning of 1934 it was $35 an ounce. So about 40% devaluation of the dollar as compared to gold.
President Franklin Roosevelt did a very clever thing. He knew he wanted to devalue against gold so he issued an order, and confiscated all of the gold in the United States. It became illegal for US citizens to own gold. You could be arrested and put in jail for five years.
He bought up all the gold at $20 an ounce and then revalued it at $35 an ounce. So the government captured the profit.
The purpose for devaluing the gold was to cause inflation.
Nothing happens in isolation. If gold goes from $20 – $35 an ounce then the price of everything else will go up too. Oil, cotton, wheat, steel etc. That’s why President Roosevelt did it. He wanted to cause a generalized inflation and it worked.
The US grew from 1933 – 1935 and got out of deflation. The trick worked although at the expense of private gold investors.
In 1936 England and France devalued again.
It was a period of “Beggar Thy Neighbour” currency devaluation.
That period was the Great Depression, where unemployment skyrocketed and the stock market crashed. That’s what you got for your currency war.
CURRENCY WAR II
1967 – 1987 was the period of Bretton-Woods.
We were back on a gold standard starting in 1944. Gold was $35 an ounce and the United States citizens still couldn’t own gold. The US gave gold to its trading partners. If the trading partner earned a surplus in trade they could take the surplus dollars and change them for gold.
In 1950 the US had 20,000 tonnes of gold. By 1970 the US had only 9,000 tonnes of gold.
Where did the 11,000 tonnes of gold go? It went to the trading partners who traded their surplus for gold. By 1969 it was clear that this system was unstable. People were losing confidence in the dollar. People believed that the United States would not be able to maintain the dollar at $35 per ounce.
There was a private market where gold was selling for $42 per ounce. So some of the US trading partners were cashing in their dollars for gold at $35 per ounce, then turning around to the private markets and selling it for $42 per ounce.
In August 1971 Nixon shut this “gold window” and said that from now on you can take our US dollars and buy stocks, bonds, anything else, but not gold.
Now the US presently has about 8,000 tonnes of gold.
Again, a period of disastrous economic reforms.
The US expected that by devaluing the dollar they would increase exports and increase US jobs. But the opposite happened. We had three recessions back-to-back-to-back.
The dollar came close to collapse in 1979.
WHY DIDN’T THE DOLLAR COLLAPSE?
The dollar did not collapse because of Paul Volker and Ronald Reagan.
Volker made the dollar valuable again when he raised interest rates, giving dollar holders a return higher than inflation. President Reagan cut taxes and regulation.
This made a period known as “King Dollar”.
KING DOLLAR
This was a sound dollar. Beginning in 1980 and up to 2010 the world was not on a gold standard. We were on a dollar standard, and the US said they would maintain a strong dollar so that countries could trade in dollars and fix their currencies to the dollar.
King Dollar was maintained through Republican and Democratic administrations.
It was successful until 2010.
CURRENCY WAR III
We are in Currency War III now.
In January 2010 President Obama, Ben Bernanke, president of the Federal Reserve, and Timothy Geithner, secretary of the Treasury, together abandoned the sound dollar.
They said that it was now the policy of the United States to cheapen the dollar.
Some people think that cheapening the dollar has to do with export but that is not the real reason why the United States is cheapening the dollar.
The reason the US is cheapening the dollar is to import inflation.
The US is a net importer. If you cheapen the dollar then you have to pay more for your foreign goods – energy, Chinese manufactured goods, India textiles, what ever you import.
That is the reason why they are cheapening the dollar – to import inflation.
The same is true in Japan.
Central banks are desperate to import inflation right now because they worry about deflation.
BEN BERNANKE’S VIEW OF THE CURRENCY WARS
He gave a speech not too long ago, where he urged a policy in which the US, the UK, Japan and Europe would all engage in monetary ease at the same time.
It’s like four countries holding hands and jumping out of a plane together.
Bernanke’s view was that the problem with the 1930s was sequential devaluations, which he believed resulted in no one being able to rely on anything.
He said that if we all print money at once then it’s not a currency war, because the cross rates and comparative advantage would be unchanged. Bernanke said, “This is not “Beggar Thy Neighbour”, this is “Enrich Thy Neighbour”.”.
Jim believes there are a few things wrong with this:
1. Europe doesn’t want to go along with this plan.
The US, the UK and Japan are doing this and printing as fast as they can. Europe only wants to print if they have to in order to save the Euro. They don’t want to print to create inflation.
2. The rest of the world, the BRICs and emerging markets, are disadvantaged and distressed by it. Their currencies all rise and it hurts their exports.
Emerging markets only have two choices:
a.) If you’re China, for example, and you want to peg your yuan to the dollar, then you have to print in order to maintain it to the dollar. That means the inflation they wanted in the US comes out in China.
b.) If China doesn’t want inflation they have to let their currency rise, but this would hurt their exports, which hurts jobs.
Bernanke’s response to China is that if they don’t pick a. or b. then they get c., which is that the US economy collapses and it takes China with it.
Right now there is no standard and nothing to rely on, and the US Central Bank is just making it up as they go along.
INFLATION VS DEFLATION
In 1936, F. Scott Fitzgerald said, “The test of a first rate intelligence is the ability to hold two opposed ideas in mind at the same time and still maintain the ability to function.”
Here are the two opposed ideas: we are experiencing inflation and deflation at the same time which is undermining the economy.
Deflation is the natural consequence of a depression.
We’re not in a normal business cycle where we go down and they ease lending and we go up and they tighten lending. Today the world is going through a depression.
Depression does not mean that growth declines all the time. You can have some growth, but it does not get back to trend. The growth you have is not your potential growth, it’s significantly lower. And over time if you draw a line of potential growth and a line of actual growth that gap between them gets larger and it cannot be recovered.
That’s a depression: a long period of below trend growth. That’s what we’re in.
The problems are structural and not just a business cycle. So you need structural solutions.
The Central Banks are all responding with cyclical solutions. That’s why it won’t be fixed. That’s why this depression will continue.
What we need is a structural solution.
DEFLATION
In a depression people deleverage, sell assets, pay down debt and reduce their balance sheet. Selling assets pushes prices down more and more people get in distress. Then they sell assets and the cycle feeds on itself.
This is what central banks fear.
INFLATION
Inflation is caused by money printing.
So you have the two forces offsetting each other. It’s like tectonic plates.
You can stand on a fault line and it’s not moving but you know it’s unstable. Underneath there are extremely powerful forces pushing against each other.
We have a very powerful inflationary vector and a very powerful deflationary vector. The net can be zero so it looks like things aren’t moving, but it’s highly unstable and there’s a danger that it can tip very quickly.
Investors need to be prepared for either outcome because either is possible.
The Rise and Fall of Empires (We Know How it Goes)
words and music Elaine Diane Taylor
© 2009 Intelligentsia Media Inc. All rights reserved.
SOCAN/ASCAP
available on iTunes
……………………………………
Another Week on Wall Street
words and music Elaine Diane Taylor
© 2012 Intelligentsia Media Inc. All rights reserved.
SOCAN/ASCAP
from the album Coins and Crowns
See the bankers wave the Wall Street wands
See the conjured piles of paper green
Now they’re betting all their tricks go wrong
They’re betting the world as you know it
If they win
You lose the whole world as you know it
Ever seen a long con?
Ever seen a tampered wand?
Ever seen the betters sipping tea?
Making bets just sipping tea
Well don’t talk back
Your betters
Your bankers are having a tee, hee, hee
Heyo heyo, just another week on Wall Street
Heyo heyo just another week on Wall Street
A little grease (Greece) is floating out to sea
Little PIGS (Portugal, Italy, Greece, Spain) are bobbing up and down
So send a storm and we’ll see
when the tide goes out who’s naked on the beach
Ever seen a long con?
Ever seen a tampered wand?
Ever seen the betters sipping tea?
Making bets just sipping tea
Well don’t talk back
Your betters
Your bankers are having a tea, hee, hee
Heyo heyo, just another week on Wall Street
Heyo heyo just another week on Wall Street
Who’s that wizard hiding behind that hedge?
Who’s that wizard hiding behind that hedge (fund)?
See the bankers wave the Wall Street wands
See the conjured piles of paper green
Now they’re betting all their tricks go wrong
They’re betting the world as you know it
If they win
You lose the whole damn world as you know it
Ever seen a long con?
Ever seen a tampered wand?
Ever seen the betters sipping tea?
Making bets just sipping tea
Well don’t talk back
Your betters
Your bankers are having a tea, hee, hee
Heyo heyo, just another week on Wall Street
Heyo heyo just another week on Wall Street
Elaine Diane Taylor 