Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles March 2017

Jim Rickards and Alex Stanczyk, The Gold Chronicles March 2017

Topics Include:

*Commentary on FOMC and Rate Hike
*How VAT may enable a revenue neutral solution to allow Trumps fiscal and tax cuts plan
*One of the dangers to VAT is that it is prone to a creeping rise in the tax rate
*Scenarios for consumer reactions to VAT perceived as price inflation
*How increasingly fragile markets combined with highly leveraged financial services institutions are leading to amplified risk levels for the entire financial system
*Market fragility from Jim’s view is a function of system scale – if you double the size of the system the risk increases exponentially
*The system has not deleveraged since 2008, but has increased leverage and concentrated in an even fewer number of banks
*The derivatives market is approaching one quadrillion dollars in size, approximately ten times the size of global GDP
*Nation debt levels, debt ceiling, comments on the math of servicing the increasing debt burden in consideration of the debt to GDP ratio
*The first $20T of US Government debt is treasury debt, with a debt to GDP ratio of about 105%, and it does not include contingent liabilities such as social security and Medicare
*If counting contingent liabilities, it brings the US debt number to more than $100T, and the debt to GDP ratio closer to 1000%
*The most likely path out of the current debt for the US is inflation, which means inflation is ultimately required and likely

 

Listen to the original audio of the podcast here

The Gold Chronicles: March 2017 Interview with Jim Rickards and Alex Stanczyk

 

Jon:  Hello, I’m Jon Ward on behalf of Physical Gold Fund. We’re delighted to welcome you to the latest podcast with Jim Rickards and Alex Stanczyk in the series we’re calling The Gold Chronicles.

Jim Rickards is a New York Times bestselling author, Chief Global Strategist for West Shore Funds, and the former General Counsel of Long Term Capital Management. He is currently a consultant to the US Intelligence Community and to the Department of Defense. Jim is also an advisory board member of Physical Gold Fund.

Hello, Jim, and welcome.

Jim:  Hi, Jon. It’s great to be with you.

Jon:  We also have with us Alex Stanczyk, Managing Director of Physical Gold Fund. Alex is an expert in the physical gold industry dealing with the logistics chain from refinery to secure transport and vaulting. He has lectured globally to investor, institutional, and government audiences on the role of gold both in the international monetary system and in investment portfolios.

Hello, Alex, and over to you.

Alex:  Hi, Jon. I’m excited to be here and looking forward to today’s conversation.

Jim, you just recently got back from South by Southwest. Before we jump into this, do you have any interesting insights you’d like to share from this event?

Jim:  You’re right, I just flew in from Austin the other day. It was my first time at South by Southwest although it’s been going on for a long time and has a great following. It’s an interesting mixture. They have expanded the menu, so now they have a film festival for a few days, then they switch to tech and interactive for a few days, and then they finish up with music, which is the root of South by Southwest – that’s how it all began.

It’s a mixture of techno geeks, spring break partiers, music producers, and talent. They block off all the streets, so it’s a little like a street fair similar to New Orleans at Mardi Gras.

The highlight for me was being able to participate in the launch of a new media platform along with a number of other participants who were there. I actually got to play a few hands of Texas Hold’em with Phil Hellmuth. For listeners who may not know, Phil is the 14-time world champion of poker. It was like sparring in the ring with Muhammad Ali back in the day. People could not have been nicer, and we had a lot of fun, so I certainly enjoyed that and met a lot of other great folks.

Phil did have some interesting insights. As a world champion of poker, you’d obviously figure him to be a smart guy with great intuition and a very sharp, incisive mind. We talked a little bit at lunch before our poker game about efforts to create algorithms that could beat him or anybody at poker, basically poker-playing algorithms.

There’s a long history of that with IBM trying to beat Garry Kasparov, world champion at the time in chess. I had occasion to talk to Garry about it. He knew his days were numbered although he actually defeated a couple of IBM programs, and finally they came up with one called Blue Gene that was able to beat him.

I had lunch with him before that contest, and he said, “I’m going to beat them next time and they’re going to beat me the time after that, because I can sort of reverse engineer what their developers are doing.” Of course, there’s nothing random in chess. It’s a deep game, but it’s kind of a mechanical game in the sense that there is a “finite” number of moves and results, although I’d put that in quotation marks as it’s quite a large number.

Poker is different than chess because you have more of an element of luck. Phil said to me that he’s been playing some of these algorithms, and he beats them routinely. The reason is that nothing in artificial intelligence has been able to come close to a poker player’s intuition about fear, spotting a weak hand or understanding when the other guy is bluffing. These are things that no amount of automation is quite up to yet.

I found it an interesting insight, and you know me, I obviously carry that over to the gold and financial markets with all the high-frequency trading and automated trading. I think 90% or more of trading on the New York Stock Exchange these days is completely automated.

The ability to – as Phil put it – smell fear in markets and human nature’s herding instincts crowding in and then everyone trying to go for the exits at once, those are the things you can’t automate. Investors always need to bear that in mind. I think there are some lessons there for gold investors and investors in other assets as well.

Alex:  I have to agree with that entire element of being able to spot what’s going on with the crowd and just sense that. I’m not sure we’ll be able to teach machines how to do that, but it’s definitely an interesting topic.

Let’s turn our attention now to markets and the recent FOMC meeting. Your track record of predicting U.S. Fed moves is one of the best there is. As you are aware, the Fed just hiked interest rates. It seems the FOMC is divided in its views, though. Members of the Fed such as the Atlanta Fed don’t really see eye to eye with Yellen’s narrative.

We know that the Fed does not have the best record for forecasting the economy. Talk to me a little bit about why this matters and what you think the Fed is going to end up doing moving forward for the rest of the year.

Jim:  I have been able to call Fed moves with a lot of accuracy going all the way back to September 2013. That was not long after the famous taper talk by Ben Bernanke in May of 2013.

At the time, they were nowhere near raising interest rates, but he said, “We might begin to reduce our asset purchases.” In other words, reduce money printing. Although he didn’t do it in May, he just said, “We’re thinking about it.” Well, by September, the entire market was poised for that move, but I said it wouldn’t happen. It didn’t then and finally did a few months later.

The same thing happened in September 2015 with the market poised for what they called liftoff, which was the first interest rate hike. That was long after they had finished the taper, so there was no more money printing. They were still printing money to roll over maturing assets, but they weren’t expanding the balance sheet. That ended in late 2014 and took all the way until September 2015. There was a lot of expectation about liftoff; again, I said they’re not going to lift off. They didn’t, and that happened once more three months later. The first rate hike was in December 2015.

Then in late 2014, I was saying they would not be able to hike rates in all of 2015. Meanwhile, the markets were predicting March, June, September, and December for rate hikes. Through eight meetings, it was no, no, no, they didn’t hike rates. It was finally clear in December 2015 that they would.

About three months ago, in December 2016, I called for the most recent hike on March 15th and the market expectation in Fed funds futures contracts as implying a probability of a rate hike. That’s the wisdom of the crowds. The considered judgment of all market participants had it at 28% December and 30% through February. I was forecasting 75%, 80% and basically leaning clearly to a rate hike.

Suddenly, in the three trading days February 28th to March 2nd, the probability skyrocketed to 50%, then 80%, then 90%. By Fed day, March 15th, everybody was at 100%. That was easy, but there were two months there when the markets were 30% and I was 75% – 80% before we all converged at 100%.

Here’s what I would say about that:  I don’t have a crystal ball. It’s not like I’m doing some mumbo jumbo to figure this out, and I’m absolutely not smarter than my peers or the other people doing this. I know a lot of the quants and PhDs and friends on Wall Street who are all pretty smart.

All I have is a better model that is unbelievably simple. It’s not like you need IBM’s Watson to do your processing for you. As I’ve said all along – and we have discussed this many times – if you have the wrong model, you’re going to get the wrong forecast every time. If you have the right model, you have a much better chance of getting the forecast right.

So it’s really just about the model. I’m always happy to explain that to our listeners, because the thing is, the model works. It is your best guide to what’s going to happen with the Fed moving forward.

Of course, that has implications for the price of gold. There’s some extent – not perfect by any means, but some extent – to which the price of gold is correlated to the value of the dollar, and that in turn, ties to interest rates. So if you can get the Fed forecast right, you can at least have some insights into what’s going to happen with the price of gold.

Alex:  Let’s talk a little bit about Trump’s fiscal plan and how this is going to work in terms of tax cuts he wants to make, etc. We’ll keep in mind his fiscal plan as it’s already been outlined, as well as we’ve recently been reminded that the U.S. government is now dealing once again with the so-called debt ceiling. This is an issue that keeps coming up and doesn’t seem to be going away.

You’ve recently suggested that perhaps VAT may be a way for Trump to cut taxes and get the fiscal program he wants. VAT is an acronym for value-added tax and is pretty common in Europe.

Would you briefly explain what VAT is, and do you consider Trump’s plan doable if VAT is made into law?

Jim:  I’d be happy to do that and also talk about the impact of it, but to properly address that question, it has to be put in a broader context of the global economy – or if not the global economy, at least the U.S. economy which is a big part of the global economy.

VAT or value-added tax is very common around the world. The United States is the only major economy that does not have a value-added tax. The Treasury has wanted one forever going through Republican and Democratic administrations for decades.

Part of my background before I started doing more economic work and writing was spending the first ten years of my career as international tax counsel for Citi Bank, one of the world’s largest financial institutions. I had experience as a tax lawyer, so I’m pretty familiar with the ins and outs of this.

You can think of value-added tax as kind of a sales tax, but there’s a little more to it than that because there’s a value chain. They start with raw materials and inputs, then they sell to a manufacturer, then they sell to a distributor, then they sell to wholesale, then they sell to retail, and then retail sells to you and me. You actually apply the VAT at every step in this whole chain only on the portion of the value that you added. That’s why they call it a value-added tax.

There’s a wholesale element to it, but it’s basically a sales tax. Every time you sell your goods, whether you’re in the intermediate stage of the value chain or the end stage, you charge the value-added tax for the increase in the value relative to what you paid. It’s kind of like a super sales tax.

The reason the Treasury loves it is that it generates a ton of revenue and it’s also easy to sneak up on people. Maybe it would start at 3% or 4% (I’ll make up a number), and the next thing you know, it’s 5%, then it’s 7%, then it’s 8% like state sales taxes. I think our listeners have experience with state sales taxes that seem to only go one way, up and never down. Be that as it may, it’s a great revenue raiser and a way to pick people’s pockets.

The reason this is important is that it plugs into Trump’s bigger-picture fiscal plan. Getting back to the stock market and ultimately to the gold market, his fiscal plan is to cut taxes and add $1 trillion of infrastructure spending. The third leg of the stool is regulatory reform, but let’s leave that to one side for a moment although I think that’s positive for the economy.

Basically, he wants to cut taxes and spend more money, which implies bigger deficits. Congress is saying, “Hold on. We’ll consider the tax cuts,” but they have to be what they call revenue neutral, which just means that if you’re going to cut them in one place, you have to raise them someplace else.

What kind of tax cuts does Trump want? As Trump would say, they’re huge or amazing. He wants to cut the individual tax rate from roughly 39% to 33%, the corporate tax rate from 35% to maybe 25%, and he wants to bring back offshore earnings at maybe some favorable rate, 15% let’s say. All of this would cost the Treasury money relative to what they think they would get in a static projection.

The question Congress is asking is, “If you’re cutting those taxes, where are you going to raise taxes to make up the difference so that we don’t have larger deficits?” Think about that for a second. If it’s revenue-neutral and doesn’t increase the deficit, where is the stimulus?

Consider the whole idea of John Maynard Keynes as an economist. I’m not a Keynesian in terms of deficits as far as the eyes can see, but if you believe in Keynesian stimulus, you’ll say, “When the economy is as weak as it is now, deficit spending might be a good thing,” but if your tax cut is revenue-neutral, then there’s no additional deficit spending, so it’s hard to see where the boost is coming from.

It’s actually a little worse than that, because you have this concept of the marginal propensity to consume, which varies depending on total income and wealth. The issue is if you get an extra dollar in your pocket, what are you going to do with it? Are you going to spend the whole dollar, are you going to spend nothing and stick it in the bank, or are you going to spend 50 cents?

When you cut income taxes from 39% to 33%, that benefit mostly goes to people making $250,000 all the way up to $1 billion a year. They’re the ones in that tax bracket. Throw on a value-added tax or even something else called the Border Adjustment Tax, which is the other one that’s in the running that is highly regressive, meaning you’re taxing people who can barely get by.

If you have to go to the store and buy food for your family or you have to go buy clothing at Costco or you have to do any kind of shopping at all and you’re paying the value-added tax, then you’re paying that tax even though you might be poor or you’re just marginally getting by.

Whereas let’s think about those making $1 million a year, a pretty rare category. For people in that category, if they get a tax cut, are they really going to spend much more? Probably not. The people making that kind of money probably have three cars, five TV sets, two houses, and they take nice vacations already. Are they going to buy another house or take another vacation? Maybe, but probably not. They’re probably going to invest the money or save it.

The point is, if you cut taxes on people with a low marginal propensity to consume, they’re not going to spend a lot more, and if you raise taxes on people with a high marginal propensity to consume, meaning it really comes out of their pockets so maybe they spend less, that’s a headwind for the economy. That actually hurts what’s called aggregate demand; it hurts the economy.

So now you have two things going on. One is you’re revenue-neutral, so there’s no Keynesian multiplier or Keynesian stimulus. There probably wouldn’t be much of one anyway, but now you’re going to get none if you’re revenue-neutral. Plus, it’s not neutral in terms of consumption; you’re actually hurting consumption.

Now, there are advocates for them long term, but short term, this is going to basically cause the economy to slam on the brakes. I don’t understand why the stock market is so euphoric over Trump’s plans, because when you look at them, it’s hard to see where the stimulus is coming from.

The stock market does look like a bubble to me. That doesn’t mean it can’t go on. One of the lessons of bubbles is that they go on a lot longer than you think, so I’m not predicting that the bubble is going to burst tomorrow, and I’m not saying people should run out and short stocks. What I’m saying is we’re well into bubble territory.

As a very simple example, in early November right after the election, the stock market (I’ll use Dow Jones) went up a thousand points based on the Trump fiscal plan and tax cuts. Then in December, they came out with some more detail about the timing, and it went up another thousand points on the tax cuts. And then in February, around the time of the President’s address to Congress and they had more details along with Secretary Mnuchin adamant about getting it done by August, the stock market went up another thousand points.

I’m looking at that and saying, “Hey, you just rallied three times on the same news.” There aren’t going to be three tax cuts; there’s only going to be one tax cut, but the market rallied three times on the same news. That’s bubbly behavior, and it looks like the market is way ahead of itself.

There’s a lot more to say, but I’ll wrap it up there. Some of this reality – meaning the stimulus is not going to be as great as expected, the impact of the tax cuts are not going to be as great as expected, and the whole thing is going to take longer than expected – is going to be a bit of a wakeup call for the stock market and could combine with other things to give us a serious correction, maybe down 10% or so by the summer.

Alex:  I have a follow-up question to the VAT topic. Instead of consumers looking at it and thinking it is additional tax, is there a scenario where VAT could be perceived by consumers as prices of things going up? Could this be some sort of psychological trigger that could accelerate the velocity of money or an inflationary-inducing kind of effect?

Jim:  It could be, and that’s a very good question. In fact, prices will go up. I’ll leave it to the people at the Commerce Department to sort out how they want to define inflation, but if you have something that’s $100 and you slap on 5% VAT, suddenly it’s $105.

The talking heads and people on financial television will tell you, “Oh, don’t worry about it. It’s not inflation; it’s only a tax,” but I’m not sure the average consumer would think of it that way. If they’re paying $105, that’s 5% inflation overnight.

There are other weird consequences such as we’ve seen in Japan, which is if they announce an effective date, you might actually get a short-term boost in consumption. That would be good short-term for the economy, because everyone will run out and buy stuff before the effective date. If they said “This is in the bill that’s going to pass Congress with an effective date of September 1st,” you might see everyone at the end of August shopping like crazy to beat the sales tax or value-added tax.

That did happen in Japan, but it’s only a Kool-Aid high. It’s a short-term boost, because the day the tax comes into effect, the economy falls off a cliff. All you did was bring the entire aggregate demand forward to get ahead of the deadline.

It’s still early days since this bill has to wind its way through Congress, but I know the value-added tax is getting a lot of consideration and always has.

I spoke to top people at the tax section of the American Bar Association. These people are career professionals, they’re lawyers who talk to the Treasury on a regular basis about policy. One of those top people said to me a couple of years ago during the Obama administration, “The Treasury has given up reforming the internal revenue code. It’s just too much of a mess. The only way they see that we can keep the U.S. from going broke and raise revenue is with a value-added tax, with a VAT.” That’s the default position.

With the Trump administration and Congress saying you have to be revenue neutral and Trump committed to income tax cuts, there’s no way to square that circle without a big revenue raiser, and VAT is the biggest thing out there. We have to keep an eye on it. It may be coming, but it can have these weird effects of bumping inflation.

There are offsetting forces, and that’s what makes it tricky. On the one hand, sticker shock at the counter might give you an inflationary mindset. On the other hand, if everyone is running around spending before the tax and then not spending after the tax, that can actually be deflationary if aggregate demand drops and the economy runs into a brick wall.

The problem with all this is it’s not difficult to define theoretical outcomes based on what we know, but because these things are behavioral and psychological – what I call emerging properties of complex dynamic systems – basically we’re manipulating behavior and shouldn’t be surprised if we get some very bad results.

Alex:  I had a really interesting conversation with a friend of mine whom you also know named Ronnie Stöferle. He manages a fund out of Lichtenstein called Incrementum. Our conversation was around this idea of fragility in markets. It seems clear to me, and to observers like Ronnie and other people I consider to be very smart, that the markets are becoming increasingly fragile.

If we can pick up on a comment you made in a recent interview, you said that companies most vulnerable to financial turmoil are those that rely heavily on high leverage and financial engineering to produce returns. You included banks in that category, and you forecast some potentially dire outcomes and consequences to this.

For those of our listeners who are new to these concepts, touch on why these are legitimate concerns and more likely to play out than not.

Jim:  You’re right; I do know Ronnie very well. He’s a great guy and very astute market analyst. I call him an Austrian for the 21st century, meaning he’s a follower of Austrian economics but he’s followed a lot of recent development in economics and theoretical approaches to it. He brings that Austrian mindset but with a lot of really good, up-to-date technology. I think he is one of the sharpest commentators and fund managers out there.

Let’s address the issue of fragility and the impact of leverage by starting with leverage. Leverage is a pretty simple thing to understand. It means borrowed money that could be derivatives, off-balance-sheet contracts, futures and options which have embedded leverage, or it could be outright borrowed money.

It means you get more of whatever you’re betting on. If I buy a stock for cash and it goes up 10%, I made 10% at least on a mark-to-market basis. But if I buy stock on margin, borrow half the money, and it goes up 10%, I don’t owe any more debt. I owe the original debt, so I actually made 20% because I only had 50% equity. My 10% return becomes a 20% return if I bought it with half borrowed money, because I’m making the same amount of profit on half the investment, so obviously that gets a higher return.

Naturally, it works in reverse. You can lose twice as much money. If you leverage ten to one, you can lose ten times as much money.

What leverage does in any form, whether it’s outright debt, a note, or a derivative contract of some kind, is just amplify your return. Depending on the amount of leverage, you’ll make twice as much or ten times as much or a hundred times as much, and you can also lose just as much.

If you’re on the losing side of a highly leveraged trade, a very bad thing happens, which is you go bankrupt. In other words, if I have $1 million and I leverage it ten to one so I have a $10 million bet with $1 million of equity and $9 million of borrowed money, if my $10 million bet goes down 10%, I’ve lost 100% of my equity because I’m leveraged ten to one in that example.

It only takes relatively small market moves to completely wipe out your equity and force a bankruptcy. This is what was happening in 1998 and 2008. It happens to individual firms along the way. You see people making these leveraged bets over and over. That’s the impact of leverage.

Now you get into something called contagion. The IMF likes to call it spillovers, but it’s the same thing. You make a big leveraged bet, and if you win, it’s nice because you make a lot more money – everyone likes that. But if you lose, you don’t just lose more money, you actually wipe out your equity and go bankrupt, so you walk away from the table.

Let’s presume you have trading partners. The thing about trading and capital markets (money markets, stocks, bonds, etc.) is that as Paul Simon once said in a song, one man’s ceiling is another man’s floor. One firm’s mark-to-market loss is somebody else’s mark-to-market gain.

If the loser goes bankrupt and the person on the other side of the trade who had the gain goes to collect his winnings and the guy is not there, it’s like he won at the casino, took his chips over, and somehow between the table and the cashier, the casino shut down and went bankrupt. He’s basically sitting there with a bunch of plastic or rubber chips and can’t get his money.

Now the guy on the right or winning side of the trade might find that he’s in financial distress, not because he made a bad trade, but because he had a bad credit by doing the trade with a person who’s no longer there.

This is exactly what happened with AIG in 2008. AIG had all the losing bets. Goldman and Citi Bank and many others had the winning bets, but when they turned to AIG to collect, AIG was practically bankrupt and couldn’t pay. The government had to bail out AIG, not because they loved AIG, but because they said, “If we don’t bail out AIG, all these other firms, starting with Goldman, are going to go bankrupt.”

That’s how the danger spills over or there’s contagion. Think of it as like a disease where one person infects another and it just gets worse. All of a sudden, we go from individual hedge funds, small institutions, and individuals to some dealers going bankrupt, then they have a clearing broker who goes bankrupt, and next thing you know, it’s threatening the solvency of the entire futures exchange or derivatives exchange or banking system as a whole. That’s how it spins out of control and fragility comes in.

That’s well understood, meaning people have observed that many times. Credit officers try to prevent it by not permitting that much leverage, but they never get it right. So much of it is hidden, so much of it is off balance sheet, so much of it migrates to new ways.

The regulators are always fighting the last fire. After 2008, they were very determined to make sure we didn’t have another housing credit crisis. I don’t think we’re going to have another housing credit crisis because it’s extremely difficult to get a housing loan right now. But how about dollar-denominated emerging markets debt? How about the high-yield market? How about various forms of derivatives? How about buyout loans that corporations take out to buy back their own stock or pay dividends?

There are a whole host of other areas where this problem could emerge. Just because regulators went around and cleaned up the mortgage market doesn’t mean they have a good handle on all those other things.

Let’s burrow down inside the off-balance-sheet commitments of a major bank where we get into things like asset swaps. An asset swap would be if I want to borrow money but the person I’m dealing with only takes high-quality collateral, let’s say treasury notes, and I have a bunch of garbage corporate bonds on my books. I go to a mutual fund or a pension fund and say, “I’ll swap you my corporate bonds for your treasury notes on agreement to swap back.” It could be one week, one month, an overnight trade or whatever, but I’d give a whole bunch of corporate stuff as collateral and they’d give me treasuries.

Then I turn around and pledge the treasuries to the first guy who didn’t want my corporate junk but he will take the treasuries. I’m swapping corporates for treasuries so I can do another deal where I post treasuries as collateral, get some other line of credit, and add some more leverage on top of that.

This asset swap is an off-balance-sheet transaction; it’s invisible unless you know where to look. What started out as a two-party trade between the bank and the counterparty turned into a three-party trade between the counterparty, the bank, and the pension fund in my example. Instead of two assets being swapped, you get three or four.

This goes on all the time. All these conversion futures, asset swap futures, and off balance sheets are expanding, and this is where we now segue into complexity theory and how I really think about markets.

To Ronnie’s point that markets are getting more fragile, I think that’s right, but I would say they’re always fragile to some extent. The question is, how do we think about the risk? How do we measure it?

The way I think about it is in terms of systemic scale. Scale is just a fancy, more technical word for the size of the system. The point is the risk of the system. I’ll define risk as the worst thing that can happen, so what’s the biggest meltdown, the biggest collapse, the most contagion, the 2008-type of event? What’s the biggest disaster that can happen in the system?

Intuition says if I double the size of the system, I probably double the risk. If I triple the size of the system, I probably triple the risk, although the value-at-risk jockeys, risk managers on Wall Street, wouldn’t even say that. They’d say no, you can double or triple the system and increase the risk not at all or very little, because it’s long-short, long-short, long-short. In other words, you’re pairing off all these trades that net out to a small number, and it’s only that small number that really reflects the risk.

This is complete nonsense for the reason I mentioned earlier. That way of thinking about risk is fine when nothing bad is happening, but the minute something bad happens, you don’t get to pair off, because there are two different counterparties, and now you’re worried about the counterparty of your winning trade.

You’re stuck with the losing trade. The winning trade that supposedly pairs off from a market risk perspective all of a sudden has the guy going bankrupt. The market risk converts into credit risk, so you still lose and go bankrupt yourself. That’s why value at risk has no capacity to deal with it at all.

Leaving that aside, the value-at-risk people would say risk is very little. The people using intuition would say you double the system and the risk. The fact is, if you double the system, you don’t double the risk; you increase it exponentially by perhaps a factor of ten or even more.

As we see these off-balance-sheet relationships, derivatives, outright leverage, and hidden asset swaps all grow, think to yourself, the system is not just getting riskier; it’s getting exponentially riskier.

We’re at a point now where the biggest banks are bigger than they were in 2008 with a higher percentage of total banking assets. The off-balance-sheet exposures are larger. The amount of debt in the world is significantly larger.

The notion that we deleveraged the system since 2008 is nonsense. We’ve not only increased the leverage – meaning the debt and the derivatives – but we’ve concentrated it in fewer and fewer hands. This makes it even more dangerous and more likely that one party in distress is going to take down the entire system.

What I expect based on very good science – not just my gut but you can actually see it unfortunately in front of your eyes – is a new collapse coming that is far worse than what happened in 2008. I think that’s Ronnie’s point, and I agree completely.

Alex:  This reminds me of a quote I heard that went along the lines of financial services today consisting of the dark art of shuffling and reshuffling the same paper assets over and over again in order to generate larger and larger returns.

On a scale perspective, give people an idea of how big this has gotten, the derivatives market. How big is this in dollar terms, and how big is it compared to everything else?

Jim:  It’s getting close to a funny number that is called $1 quadrillion at notional value. It’s a little bit lower than that, a little over $700 trillion, but is converging in on $1 quadrillion. $1 quadrillion is $1000 trillion, so take a second to get your mind around that.

That is approximately ten times larger than global GDP. Global GDP, the entire value of all the goods and services in the world, is approximately $70 trillion and the gross notional value of derivatives is approximately $700 trillion, so derivatives are ten times larger than global GDP.

Think of global GDP as the real economy, real stuff that we buy or make and sell, services we provide, etc. The derivatives are ten times that. Going back to what I said earlier, when you throw ten times leverage on something, it only takes a 10% drawdown to wipe you out.

A 10% drawdown on the gross notional value of derivatives would wipe out the entire global economy. Those losses would be larger than the total output of the world. That’s a pretty daunting thought.

Now take the second point I made, which is that it’s not linear, meaning when you scale up the system, the risk grows exponentially. This would be like an extinction-level event in archeology, geology, cosmology, and biology when all those sciences converge in different ways and have what is called an extinction-level event like when a comet or an asteroid hits the Earth and causes massive tsunamis, volcanic eruptions, black clouds, freezing temperatures or ice ages with a very high percentage of all life on Earth killed. There would be a few survivors, remnants, and then little by little, over millions of years, we would claw our way back to some kind of life. This is what happened to the dinosaurs and has happened more than once throughout history.

We could be looking at an extinction-level event in capital markets.

Alex:  The thing that is really concerning to me – and I’m sure others have thought of this, too – is the people who are driving these airplanes, so to speak. All of these derivative books are managed by human beings. What comes to my mind is that human beings are not infallible, as you well know. My question is, do these people actually know what they’re doing?

You had a front-row seat to a situation where the smartest guys in the room were running big money, and they could do no wrong. What is your view on that? Do they know what they’re doing? What is the chance that they don’t know what they’re doing, and that could really lead to some bad results?

Jim:  You’re right; I was Chief Counsel of Long-Term Capital Management. We had 16 PhDs in finance from Harvard, MIT, University of Chicago, Stanford, Yale, Colombia, and some others – what I call the usual suspects. Two of them won the Nobel prize. It’s an interesting mix. They were basically the biggest brains in finance.

We even had complaints from deans of some graduate schools of finance that we were depriving academia of the next generation of scholars because we were hiring so many top-flight PhDs to come work for us.

There was no shortage of brainpower, but they absolutely did not understand risk or any of the things we’ve been discussing on this call. I wasn’t particularly focused on it at the time I was there as a lawyer making sure the contracts got done, making sure compliance was good, and negotiating deals. I knew what was going on and saw all of the contract flow, but I was seeing it from a lawyer’s perspective instead of the financial risk management perspective.

It all blew up, and we brought the thing in for a soft landing in the sense that we got the Wall Street rescue money. Wall Street didn’t rescue us; they rescued themselves.

Going back to what I said earlier, we had $1.3 trillion of swaps on the books. This was one hedge fund in Greenwich, Connecticut. It wasn’t like JPMorgan Chase, but even our hedge fund had $1.3 trillion of swaps. If we had failed, if we had filed for bankruptcy, I would have just slept in the next day and caught up on my sleep after the whole bailout drama, but Wall Street would have been left with all the losses. They put in capital to keep us going so they could collect on their bets, so they bailed themselves out.

That group absolutely did not know what they were doing. Unfortunately, things aren’t much better. I look around at the central banks, the FOMC, monetary research staff at the Board of Governors in Washington or the Federal Reserve Bank in New York, and other central bankers around the world. What I discover is that these people got the same PhDs from the same schools as my former colleagues. In fact, they were associates.

I believe the PhD advisor on at least a couple of the partners at Long Term Capital was Stanley Fischer who today is the Vice Chairman of the Federal Reserve Board. It’s a club, they all know each other, they taught each other, they all believe the same thing. It seems impervious to new learning. They know what they know.

The short answer to the question is, no, these people do not know what they’re doing.

There’s no better example than around this time last year when Jamie Dimon had an annual letter to the shareholders of JPMorgan Chase. Around April or so, they come out with their annual report that always includes a letter from the CEO.

He was discussing events from the year before, from 2015. We were in the aftermath of the London Whale fiasco when they lost billions of dollars because of that derivatives trader. Based on what had happened, Dimon was saying this is like a 15-standard-deviation event (I forget the exact number), this is something that should only happen once every three billion years, it was so rare, etc. I read that and didn’t know whether to laugh or cry. It was certainly an embarrassment to Jamie Dimon.

All that jargon about three billion years comes from an understanding of risk management based on what’s called a normal distribution of risk. Sorry, but risk is not normally distributed. If you look at the time series of movements in any capital market be it stocks, bonds, commodities, and certainly gold, the degree of distribution is not normally distributed. It’s distributed in accordance with what’s called a power law or a power curve.

It’s not a dry academic argument about the shapes of two different curves. Those curves are just graphical representations of two completely different systems that function in totally different ways with different shocks and different outcomes to be expected.

That’s a scary example from the head of practically the biggest, most powerful bank in the world that shows they really don’t understand risk.

However, there are some people who do and are going along with this because they personally enrich themselves. In other words, if your understanding of a system is that you can pull the wool over someone’s eyes, this is anywhere from highly immoral and unethical at best to just outright illegal depending on who’s doing it and how.

I do believe there are people in capital markets who, even if they don’t comprehend exactly how risk works, recognize that the standard models understate the risk, which means they can go around selling garbage to their customers who won’t understand it.

It’s like signing up for fire insurance, they’re pouring gasoline in the basement getting ready to light a match, and then the insurance is no good when the fire burns the house down. That’s kind of how they operate.

There are also some people who do get it but they’re like me; they’re writing books, they’re doing commentary, they’re practically yelling that the system is ready to implode. If you’re not actually running the Federal Reserve, then you try to have impact, but it’s a challenge.

I think most of the policymakers have no idea what they’re doing, some do but they’re kind of in it for the money because they can enrich themselves, and others do but they’re not in a position to change policy except through influence such as writing and speaking.

Eventually things will get straight. The question is, how much more damage will we have in the meantime?

Alex:  I can tell you from personal experience that I concur. I’ve seen a large number of former and current Wall Street traders and people who have run large companies in financial services go to gold and buy gold for the very reasons you’re talking about.

The financial media and a lot of people in positions of credibility in financial services may not talk a good game about gold – probably because they don’t make any money selling it – but at the same time, I have seen them go to it for the very things we’re discussing.

Let’s shift our attention now to the national debt and where that’s at, how it gets serviced, what are the outcomes, and what are the solutions. National debt is sitting right around $20 trillion, and the debt ceiling has been a big deliberation lately.

Depending on how you work the numbers, I’ve read that there’s as much as maybe $10 trillion of additional deficit that’s probably going to end up happening because of spending that’s basically already been approved and is on the books.

You recently said that real economic growth is simply a matter of how many people are working and the productivity of those workers. What is the productivity of those workers? Demographic trends are what they are; there’s not much we can do to change those forces.

In much of the developing world, we have an aging workforce that is not being replaced with the same number of younger workers. Combined with the fact that productivity has been stagnant and not really growing sufficiently to service the increasing debt burden, we have a math problem here that does not seem to have a plausible solution.

We’ve discussed over time that certain structural reforms could help with this, but there’s no political will to do so, and therefore one more reason for people to get their financial house in order.

The way I look at it is time is growing short, maybe too short for systemic changes to be made, so why do people need to be paying attention to this, and what should people be studying to better prepare?

Jim:  One of the points you raised, Alex, is that this is a math problem. We are so spun up today in ideology, left versus right, elites versus everyday people, Republicans versus Democrats, progressives versus nationalists, take your pick. Everybody is yelling and screaming at each other, everybody is upset, and nobody is getting along, but the thing about math is that it has no ideology; it’s just numbers. You can look at this deficit problem very clinically. It doesn’t matter if you’re a Republican or a Democrat; these numbers are going to eat you alive if you don’t do something about it.

Let’s just look at a couple of relationships. Throwing out a number of $20 trillion in national debt is important, but a debt in isolation doesn’t tell you very much. You have to compare it to your ability to pay, meaning that I look at the debt-to-GDP ratio.

Here’s a very simple example:  Let’s say you make $30,000 a year and have $100,000 on your credit card. You’re probably going to go bankrupt, because you can’t service $100,000 of debt at the exorbitant credit card interest rates with a $30,000 income. Now let’s say you make $5 million a year and have $100,000 on your credit card. No problem; you can probably just write a check and pay the whole thing off. The point is, you cannot look at the $100,000 of credit card debt and answer the question of whether that’s a bad thing or an okay thing without understanding how much income the person has to service it. The $30,000-a-year person is probably going broke while the $5-million-a-year person is probably just fine.

When you say $20 trillion of debt, I immediately look at it in terms of the GDP. Now that ends up being a scary number. I’ll go all the way back to when Ronald Reagan was sworn in as president in 1981 and our debt-to-GDP ratio was 35%. I can’t recite the numbers off the top of my head, but it doesn’t matter. The numbers are a lot smaller, and what matters is the ratio of 35% I just mentioned.

Reagan was actually a big spender contrary to his conservative credentials. He took the debt-to-GDP ratio up to 55%, which is a 60% increase. If you throw 20 percentage points on top of 35% to start and get up to 55%, that’s a 60% increase in the debt-to-GDP ratio in the eight years of Reagan.

Having said that, we got something for the money, which is we won the Cold War. Reagan spent it on a 600-ship navy and Strategic Defense Initiative – the so-called Star Wars. He at least spent the money on a lot of good things, and the Soviet Union collapsed, so we won the Cold War. I would say yes, he spent a lot of money, but we fought a war, won it, and got something for the money.

In the years of George H. W. Bush and Bill Clinton, the debt-to-GDP ratio did not go up a lot. It went up a little bit, 60%, 61%, and came back down again. Believe it or not, Clinton actually banged out a couple of surpluses at the end of his administration, but it remained pretty constant in that 60% level.

Now, 60% is a big deal, because that’s considered the outer limit of the danger zone. If you look at Europe and the Maastricht Treaty and what the members of the European Monetary Union (the so-called Eurozone) commit to, they say they’re going to keep the debt-to-GDP ratios below 60%. They haven’t all done it; Greece is off the charts at about 120%, but nevertheless, they’re held to that 60% standard, and that’s how Angela Merkel measures it.

Kenneth Rogoff of Harvard and Carmen Reinhart who was at University of Maryland and might be at Colombia now are two of the leading monetary scholars and economic historians. They have looked at this closely, done a ton of research, and they think the danger zone is 90%.

This would mean that 90% debt-to-GDP is the place where more debt doesn’t help you. More debt doesn’t give you any bang for the buck but actually retards growth, and it makes it more difficult to pay off the debt. You start to look more like the person with $100,000 credit card debt making $30,000 a year.

Guess where we are today? We’re at 105%. By any definition whether Angela Merkel’s definition or the Rogoff and Reinhart definition, we are way in the danger zone. This simply means that Trump does not have the degree of freedom Ronald Reagan had.

Trump wants to be a big spender. He wants to rebuild the military and do infrastructure – bridges, tunnels, airports and new roads. We all love all that stuff, don’t we, but he doesn’t have the fiscal space – the running room – that Ronald Reagan had. Not even close.

In fact, he’s highly constrained, and Congress is going to insist that tax cuts be revenue-neutral. Where are you going to get the stimulus for all this spending that everyone keeps talking about?

The $20 trillion is just the tip of the iceberg. That’s treasury debt. Those are bills, notes, and bonds where we owe you the money and you get some contractual right. That doesn’t count contingent liabilities or include Medicare, Medicaid, social security, veterans’ loans, federal home, farm loans, student loans, food stamps. These are all conditional and contingent liabilities the U.S. government has piled on.

If you do that, multiply it by ten, and we don’t have a 105% debt-to-GDP ratio; we have a 1000% debt-to-GDP ratio. There’s $103 trillion of these contingent liabilities.

I’ve heard mainstream economists say, “You don’t have to count that, because we could always change the law.” Really? You think you’re going to get rid of social security? Technically you can change the law, but that’s just wishful thinking and is absolutely not happening in the short run, because Trump says he’s not touching entitlements.

How do we get out of this? Notionally, there are four ways out. One is growth. You could grow your way out of it if you held the debt constant or it didn’t go up very much and you grew the economy faster than the debt was growing. That would lower the debt-to-GDP ratio and is exactly what the United States did from the end of World War II until around the time of Ronald Reagan as I just described.

But that gets back to what is the source of growth? It is simply expansion of the labor force times productivity. How many people are working? How productive are they? Like the old song by Peggy Lee, Is That All There Is? That’s all there is – working force times productivity.

The problem is, if your working force is growing about 1.5% a year and your productivity is about 1% a year or a little bit more, you multiply one by the other and get a number that’s less than 2%. But how much is the deficit going up?

Today we’re in a sweet spot where the deficit is going up around 3% to 3.5% of GDP, but projections that just came out of the CBOE show that we’re past the sweet spot. That number is going to start to go up to 4% and ultimately 5% and 6%.

Let’s be generous and say your economy is growing 2% and your debt is growing 3% or 4%. Your debt-to-GDP ratio isn’t going down; it’s going up. It’ll go up from 105 to 106 to 110. You’re on the path to bankruptcy just like Greece.

What can you do to increase the labor force? One of the big ways to do it is immigration. By the way, people are not having enough kids. I’m going to leave that debate to others, but the fact is demographically, indigenous population is not growing. We’ve been relying on immigration.

What’s Trump doing about immigration? He’s building a wall through Mexico. Again, I don’t want to jump into these policy debates. You could be pro-wall or anti-wall, knock yourself out. I’m just saying that this approach to immigration is not going to help the U.S. expand the workforce.

Then beyond that, you can say, “Let’s get people off the couch. Let them stop eating Doritos and watching Final Four basketball and get back in the workforce.” Really? Check out the opioid epidemic. There’s more to it than that, but this is devastating. There are a lot of reasons to think that we’re not going to be able to grow the workforce more than about 1% if we’re lucky.

Productivity is declining, and economists are not sure why. That’s an interesting debate for another day, but those are just the facts. So, it doesn’t look like we’re going to grow our way out of this. Growth is a good way out, but it’s not happening.

The other thing we can do is simply default on the debt and say, “Hey, we’re not paying you.” That’s not going to happen. Why should it? We can print the money, so why on earth would we default on debt denominated in a currency that we can print? You wouldn’t do it, so that’s not going to happen.

The only thing that’s left is inflation, and that’s what they’re trying to get. The irony is that we have a central bank that’s been trying for eight years to get inflation, and they can’t do it. It’s a pretty sad thing when the central bank wants inflation and can’t get it.

Inflation is the traditional way out, but we’re not getting the inflation. We look like Japan; we are Japan. I said that in my first book, Currency Wars, and even before that. In 2009/2010, I said we are Japan.

Ben Bernanke scurried around in the 1990s and early 2000s as a private economist and as a member of the Federal Reserve Board and later Chairman yelling at Japan, “You’re messing this up, you don’t understand how to use monetary policy,” really bashing the Japanese. Yet he went out and made every single mistake the Japanese made. We are Japan and will stay that way as far as the eye can see. It’s a slow-motion train wreck that sneaks up on people.

One of the reasons I own gold is because it’s kind of immune. If we have inflation, gold will do just fine. If we have a catastrophic collapse, again, gold will do just fine.

Maybe that’s a good place to wrap up. We’ll drill down on gold the next time, but gold is your insurance.

It’s been a pretty gloomy call, but it’s always a pleasure to talk with you, Alex and Jon, and our listeners. We’ve covered a lot of systemic risk and market risk, we’ve talked about leverage, derivatives, complexity theory, and the debt-to-GDP ratio. All of these things seem to be pointing in very bad directions, and they are. That’s not being a pessimist; that’s just being realistic and trying to do some good analysis.

The solution to all of them, at last for the individual, is to get some insurance through gold. I recommend a 10% allocation of physical gold. If you don’t have that much, start your allocation today and try to get there. Don’t use paper gold. Get either gold in storage – which is, of course, what Physical Gold Fund offers – or for smaller accounts, go get some coins and bars and put them in a safe place.

Alex:  Very good. I want to thank you, Jim. It’s been a great discussion today, and I really appreciate it. As always, it’s very insightful, and I look forward to doing it again next time.

Jon:  Indeed. Thank you, Jim Rickards, and thank you, Alex. It’s always a pleasure and an education sharing this time with both of you.

Most of all, thank you to our listeners for spending time with us today. Let me encourage you to follow Jim and Alex on Twitter. Jim’s handle is @JamesGRickards, and Alex’s handle is @AlexStanczyk.

If you’ve enjoyed this podcast, please recommend it to your friends. If you’re watching on YouTube, please click “like” and “subscribe.” If you’re listening on iTunes, please give us a rating and a review.

Goodbye for now to everyone, and we look forward to joining you again soon.

 

Listen to the original audio of the podcast here

The Gold Chronicles: March 2017 Interview with Jim Rickards and Alex Stanczyk

 

Learn more about Jim Rickards new book, The New Case for Gold at http://thenewcaseforgold.com/

You can follow Alex Stanczyk on Twitter @alexstanczyk

You can follow Jim Rickards on Twitter @JamesGRickards

You can listen to the Gold Chronicles on iTunes at:
https://itunes.apple.com/us/podcast/the-gold-chronicles/id980027782?mt=2

You can Listen to the Global Perspectives on iTunes at:
https://itunes.apple.com/ca/podcast/physical-gold-fund-podcasts/id1056831476?mt=2

You can access transcripts of our interviews at:
http://physicalgoldfund.com/category/transcripts/

You can subscribe to our Youtube channel to access these interviews and more at:
https://www.youtube.com/channel/UCXRWzw0vaNgCwo7nTMEAwkA

By listening to this podcast or reading its associated transcript (collectively, this “Podcast”), you agree with the following.

This Podcast is not an offer to sell, nor a solicitation of an offer to purchase, any security. This Podcast is intended for general education and information purposes only, and may include broad discussions of markets, geopolitics, monetary policy, and geoeconomics. Nothing in this Podcast constitutes investment, legal or tax advice, nor an evaluation of or prospectus for any particular investment or market, including gold. This Podcast should not be relied upon to make any investment decision. You are encouraged to seek the advice of qualified financial, legal and tax advisors before making any investment decisions.

This material is provided on an “as is” and “as available” basis, without any representations, warranties or conditions of any kind. In particular, information provided by third parties in this Podcast has not independently evaluated or confirmed. Furthermore, we take no responsibility to update this Podcast to reflect any changes in any of the information presented. Physical Hard Assets Fund SPC and Physical Gold Fund, its officers, directors, employees or associated persons will not under any circumstances be liable to you or any other person for any loss or damage (whether direct, indirect, special, incidental, economic, or consequential, exemplary or punitive) arising from, connected with, or relating to the use of, or inability to use, this Podcast or the information herein, or any action or decision made by you or any other person in reliance on this information, or any unauthorized use or reproduction of this Podcast or the information herein.

The Gold Chronicles: March 2017 Interview with Jim Rickards and Alex Stanczyk

Jim Rickards and Alex Stanczyk, The Gold Chronicles March, 2017

Topics Include:

*Commentary on FOMC and Rate Hike
*How VAT may enable a revenue neutral solution to allow Trumps fiscal and tax cuts plan
*One of the dangers to VAT is that it is prone to a creeping rise in the tax rate
*Scenarios for consumer reactions to VAT perceived as price inflation
*How increasingly fragile markets combined with highly leveraged financial services institutions are leading to amplified risk levels for the entire financial system
*Market fragility from Jim’s view is a function of system scale – if you double the size of the system the risk increases exponentially
*The system has not deleveraged since 2008, but has increased leverage and concentrated in an even fewer number of banks
*The derivatives market is approaching one quadrillion dollars in size, approximately ten times the size of global GDP
*Nation debt levels, debt ceiling, comments on the math of servicing the increasing debt burden in consideration of the debt to GDP ratio
*The first $20T of US Government debt is treasury debt, with a debt to GDP ratio of about 105%, and it does not include contingent liabilities such as social security and Medicare
*If counting contingent liabilities, it brings the US debt number to more than $100T, and the debt to GDP ratio closer to 1000%
*The most likely path out of the current debt for the US is inflation, which means inflation is ultimately required and likely

 

 

Learn more about Jim Rickards new book, The New Case for Gold at http://thenewcaseforgold.com/

You can follow Alex Stanczyk on Twitter @alexstanczyk

You can follow Jim Rickards on Twitter @JamesGRickards

You can listen to the Gold Chronicles on iTunes at:
https://itunes.apple.com/us/podcast/the-gold-chronicles/id980027782?mt=2

You can Listen to the Global Perspectives on iTunes at:
https://itunes.apple.com/ca/podcast/physical-gold-fund-podcasts/id1056831476?mt=2

You can access transcripts of our interviews at:
http://physicalgoldfund.com/category/transcripts/

You can subscribe to our Youtube channel to access these interviews and more at:
https://www.youtube.com/channel/UCXRWzw0vaNgCwo7nTMEAwkA

By listening to this podcast or reading its associated transcript (collectively, this “Podcast”), you agree with the following.

This Podcast is not an offer to sell, nor a solicitation of an offer to purchase, any security. This Podcast is intended for general education and information purposes only, and may include broad discussions of markets, geopolitics, monetary policy, and geoeconomics. Nothing in this Podcast constitutes investment, legal or tax advice, nor an evaluation of or prospectus for any particular investment or market, including gold. This Podcast should not be relied upon to make any investment decision. You are encouraged to seek the advice of qualified financial, legal and tax advisors before making any investment decisions.

This material is provided on an “as is” and “as available” basis, without any representations, warranties or conditions of any kind. In particular, information provided by third parties in this Podcast has not independently evaluated or confirmed. Furthermore, we take no responsibility to update this Podcast to reflect any changes in any of the information presented. Physical Hard Assets Fund SPC and Physical Gold Fund, its officers, directors, employees or associated persons will not under any circumstances be liable to you or any other person for any loss or damage (whether direct, indirect, special, incidental, economic, or consequential, exemplary or punitive) arising from, connected with, or relating to the use of, or inability to use, this Podcast or the information herein, or any action or decision made by you or any other person in reliance on this information, or any unauthorized use or reproduction of this Podcast or the information herein.

Global Perspectives: February, 2017 Interview with Alex Stanczyk and special guest Ronald Stoeferle

Physical Gold Fund Hosts Global Perspectives with Alex Stanczyk and special guest Ronald Stoeferle February, 2017

gp-Ronald

Welcome to Global Perspectives, a new podcast featuring some of the sharpest minds in the world. We delve into the key concerns, opportunities, mindset, and practices of some of the most successful professional money managers, entrepreneurs, and world class personalities today.

This episodes special guest is Ronald Stoeferle.

Topics Include:

*Quantitative Easing (money printing) does not seem to be working. The market knows that the Central Banks at some point will lose control of the situation.
*Recent as well as historic evidence shows that command economies do not work
*The most important price in the market, the interest rate is being manipulated by Central Banks and is the root cause of market volatility
*Low interest rate policy, to zero interest rate policy, to negative interest rate policy and its impact on gold
*The zero-interest rate trap is adding fragility to the global system
*Fatal long term consequences of zero interest rate policy for institutional investors and society itself
*Monetary inflation is working as a tax where some are benefitting to the detriment of others
*Central banks are still a long way from normalization. This has a strong effect on the fragility of the market.
*Natural systems mimic financial systems in many ways, and shows us that trying to control it is a fool’s errand
*What the Austrian School of economics is, and why it matters
*Inflation happens in three stages. Monetary inflation, then asset price inflation, then finally comes velocity of money and price inflation in the regular economy
*Three types of people observing the economy and where this is going to lead
*Bond market yields in the US relative to Eurozone
*Anti-fragility and which assets may thrive in an increasingly fragile market
*Why gold is one of the most liquid assets / currencies on earth
*The global debt situation will resolve in time. Which pathways can this take.
*Focusing on the big picture, and ignoring the daily noise

You can follow Ronald Stoeferle on Twitter @RonStoeferle

You can learn more about Ronald Stoeferle at: http://www.incrementum.li/en/


You can follow Alex Stanczyk on Twitter @alexstanczyk

You can listen to the Gold Chronicles on iTunes at:
https://itunes.apple.com/us/podcast/the-gold-chronicles/id980027782?mt=2

You can Listen to the Global Perspectives on iTunes at:
https://itunes.apple.com/ca/podcast/physical-gold-fund-podcasts/id1056831476?mt=2

You can access transcripts of our interviews at:
http://physicalgoldfund.com/category/transcripts/

You can subscribe to our Youtube channel to access these interviews and more at:
https://www.youtube.com/channel/UCXRWzw0vaNgCwo7nTMEAwkA


By listening to this podcast or reading its associated transcript (collectively, this “Podcast”), you agree with the following.

This Podcast is not an offer to sell, nor a solicitation of an offer to purchase, any security. This Podcast is intended for general education and information purposes only, and may include broad discussions of markets, geopolitics, monetary policy, and geoeconomics. Nothing in this Podcast constitutes investment, legal or tax advice, nor an evaluation of or prospectus for any particular investment or market, including gold. This Podcast should not be relied upon to make any investment decision. You are encouraged to seek the advice of qualified financial, legal and tax advisors before making any investment decisions.

This material is provided on an “as is” and “as available” basis, without any representations, warranties or conditions of any kind. In particular, information provided by third parties in this Podcast has not independently evaluated or confirmed. Furthermore, we take no responsibility to update this Podcast to reflect any changes in any of the information presented. Physical Hard Assets Fund SPC and Physical Gold Fund, its officers, directors, employees or associated persons will not under any circumstances be liable to you or any other person for any loss or damage (whether direct, indirect, special, incidental, economic, or consequential, exemplary or punitive) arising from, connected with, or relating to the use of, or inability to use, this Podcast or the information herein, or any action or decision made by you or any other person in reliance on this information, or any unauthorized use or reproduction of this Podcast or the information herein.

Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles February 9th, 2017

Jim Rickards and Alex Stanczyk, The Gold Chronicles February 9th, 2017

Topics Include:

*Golds role as an international alternative to the United States Dollar
*How financial warfare between sovereigns works
*Strategic view on changes to sovereign gold reserves
*China is slowly shortening the maturity structure of its US Treasuries and letting them run off the books versus selling
*Analysis of projected Trump policies; deep dive into some of the inconsistencies and potential scenarios
*Trump may be able influence the appointment of as many as 4 or 5 members of the FOMC
*Currency Wars are alive and well, new rounds of devaluation are starting
*Helicopter money and price inflation
*Are capital markets complex systems, and why it matters
*Why traditional models such are VaR are old science that may no longer apply to markets
*Specific criteria used in physics to identify a complex system
*Triffin’s Dilemma and gold

 

Listen to the original audio of the podcast here

The Gold Chronicles: February 9th, 2017 Interview with Jim Rickards and Alex Stanczyk

 

The Gold Chronicles: 2-9-2017:

Jon:  Hello, I’m Jon Ward on behalf of Physical Gold Fund. We’re delighted to welcome you to the latest podcast with Jim Rickards and Alex Stanczyk in the series we’re calling The Gold Chronicles.

Jim Rickards is a New York Times bestselling author, Chief Global Strategist for West Shore Funds, and the former General Counsel of Long Term Capital Management. He is currently a consultant to the US Intelligence Community and to the Department of Defense. Jim is also an advisory board member of Physical Gold Fund.

Hello, Jim, and welcome.

Jim:  Hi, Jon. It’s good to be with you.

Jon:  We also have with us Alex Stanczyk, Managing Director of Physical Gold Fund. Alex is an expert in the physical gold industry dealing with the logistics chain from refinery to secure transport and vaulting. He has lectured globally to investor, institutional, and government audiences on the role of gold both in the international monetary system and in investment portfolios.

Hello, Alex.

Alex:  Hello, Jon. It’s great to be here. I’m very excited about today’s podcast. This is a new format where we’re recording directly, so we’re going to dive right in.

Jim, you recently collaborated with some of the nation’s leading experts on economic security and contributed to a report published by the Center on Sanctions and Illicit Finance. Would you talk about gold’s role as an international money alternative to the United States dollar?

Jim:  I’m happy to, Alex. The report you’re referring to was just released, and you’re right, it’s the Center on Sanctions and Illicit Finance – CSIF, we call it. It’s part of a larger Washington think tank called the Foundation for Defense of Democracies. It has quite a distinguished setup of scholars, advisors, boards of directors, and so forth.

They have a website, so everything we’ll be talking about here is publicly available. I encourage listeners who are interested to go to the Center on Sanctions and Illicit Finance at the Foundation for Defense of Democracies, FDD. You’ll find it easily.

Our release was a new report geared to the transition. I was one of the contributors out of a number of other contributors and editors involved. We started working on this last summer not knowing whether Hillary Clinton or Donald Trump would win the election. My own view was that Trump would win. It was proposed as a transition document to help whichever administration came in to understand these linkages.

To help our listeners understand it, just picture a simple Venn diagram – two big circles. Think of one circle as defense, intelligence, national security, diplomacy – all those aspects of national security broadly defined. The other circle is global capital markets that include stocks, bonds, commodities, derivatives, obviously gold, foreign exchange, etc.

Imagine these two circles intersecting so they converge and there’s some overlap. That overlap where national security issues and global economic issues come together I’ll call “geo-economics” for a word. That’s really my specialty and the area this group and I work in.

That area is getting larger and larger. It’s difficult to think of a national security issue today that is not also an economic issue. Going back to the Obama administration, there were a lot of confrontations with Russia, North Korea, and others. Going back even further through the Bush and Clinton administrations where for whatever reasons the United States did not want to use military force but did not want to be uninvolved or let countries do whatever they wanted, we used economic sanctions.

Nobody wanted to start a war in North Korea, but we wanted to put economic pressure on them to stop their nuclear program. Nobody wanted to start a war in Iran, but we wanted to put economic pressure on Iran, again with regard to their uranium enrichment program. Then there were kind of rogue states like Syria where we would use economic sanctions to try to make it more difficult for the regime in power.

This whole area of economic warfare, financial warfare, includes an even more specialized part called cyber financial warfare using cyber techniques, which can affect any part of critical infrastructures. It could affect dams, hydroelectric plants or the power grid, etc., but we would aim it specifically at banks, stock exchanges, financial message traffic systems like SWIFT, etc., in an effort to disrupt the economy.

Kinetic warfare involves bombs, tanks, and things that shoot or explode – physical force. The purpose of kinetic warfare is usually to degrade the economic power of your opponent. In World War II and wars, we bombed railroad depots, pipelines, and factories not only to attack military forces but also to degrade the economy.

If you can do that with sanctions and cyber financial warfare, you can skip the bombs and get the same effect using other 21st-century cyber financial techniques. That’s what our center does. We just released this report that will go to senior officials in the Trump administration, but it was really a bi-partisan approach calling attention to this.

My particular contribution was a section I wrote involving gold. I thought that’s where I could make the biggest contribution, because even though there were a lot of scholars, as you and our listeners know, I still regard gold as money. I regard gold as the foundation of the international monetary system, but that’s a bit of a minority view.

Most people – certainly mainstream economists, central bankers, and others you talk to in the economics profession and policymakers – think gold is kind of a joke. They’re like, “Yes, we have some, but as Ben Bernanke said, it’s a tradition,” or “We don’t think it plays any role,” or they’ll quote John Maynard Keynes saying it’s a “barbarous relic.”

We all know the rap on gold. I went through this in my book The New Case for Gold, where I took these objections one by one, deconstructed them, refuted them, and showed that they don’t hold up. We’ve talked about that on prior podcasts, so I don’t need to repeat that whole analysis. But it’s fair to say that most economists and analysts don’t like gold very much, and yet I think about it quite a bit not only in monetary terms but also in strategic terms.

Since this was for the new president, it will go to Trump’s cabinet members and others, so I thought it was a good opportunity to inject gold into the discussion.

Here’s the point I made, and this is all obviously factually based. There’s something I call the axis of gold. I presently include four countries, although I could include others perhaps over time. They are Russia, China, Iran, and Turkey. We probably need to include North Korea in some ways, but let’s just start with those four.

What do I mean by the axis of gold? Number one, they are all acquiring massive amounts of gold. We spent a lot of time in the past talking about the Russia/China story. Russia has tripled their gold reserves in the last ten years from around 600 tons to 1800 tons in round numbers. China has done likewise officially, but unofficially we estimate that they have even more gold than they admit. China has gone from about 600 tons to 800 tons that they acknowledge, but my estimate is they probably have 3000 or 4000 tons, perhaps more off the books in the State Administration of Foreign Exchange. So, the Russia/China story is pretty well known.

Less well known is the Iranian story. We have even less information on Iran than we do on China, because Iran is an outlier and a bit of a pariah in the international financial system. There’s not a lot of gold mining output in Iran. There is in China, by the way. China is the largest gold producer in the world from a mining perspective, producing – at least for the time being – about 450 tons a year. That’s more than twice as much as the next closest country.

Iran is not. Iran gets their gold from abroad. Where? A lot of it comes in from Turkey, trans-shipped through Turkey. Some of it is smuggled in from Dubai right across the Strait of Hormuz.

I’ve been to Dubai a number of times. The smuggling boats, called dhows, are down in the waterfront called the Baniyas Road, and they’re all lined up. You see boxes full of HP printers, Sony TVs, Apple iPhones, and all that, but who knows what’s inside the boxes? There is probably a fair amount of gold in there.

They fly it in from Turkey, they smuggle it by boat from Dubai, and they recently got billions of dollars of gold courtesy of the United States of America. Our listeners are familiar with President Obama’s efforts to induce Iran to sign a deal that would in theory defer their uranium enrichment program for ten years and slow down their effort to become a nuclear power. I don’t want to spend a lot of time on the deal itself, because there are enough critics out there, and our listeners can find out all they need to know about that.

Part of the deal is that the U.S. would release some funds we froze years ago that were owned by Iran and also provide other money that could look a little bit like a ransom for some hostages. Leaving that aside, the amount was well over $10 billion.

Over $1 billion was in the form of cash. When I say cash, I don’t mean a wire transfer; I mean physical bank notes. We couldn’t give them U.S. dollars, because Iran doesn’t want dollars. They’re pretty much out of the dollar system. We actually had to call the central bank of the Netherlands and do a swap with them. They sent large-denomination euro notes to Iran, because they’ll take euros and other forms of money, including gold.

Included with these ransom payments was billions of dollars of gold. We don’t know the exact amount as that’s never been disclosed, but you can think of it as several hundred tons, perhaps more. So, they’re all accumulating gold.

Why are they doing this? They’re doing it for a couple of reasons. One is to insulate or protect themselves from U.S. dollar inflation. The U.S. has an unmanageable, non-sustainable debt problem approaching $20 trillion of debt.

That wouldn’t be so bad if the economy was growing fast enough to pay it, but it’s not. Our annual deficits are over 3% of GDP and our growth is around 2%. If you grow your deficit faster than your economy is growing, you’re going broke. You may be going broke slowly, but you’re heading down the same path as Greece.

Also, the Trump administration is talking about $1 trillion of critical infrastructure spending over and above the existing deficit. All of this looks completely unsustainable, but there is one way to deal with it, which is inflation. If you can generate enough inflation, the real value of the debt goes down and you end up paying it with cheaper dollars. You just print the money and pay it off.

What single entity has the most dollars in the world? The answer is China. They have well over $1 trillion of U.S. treasury notes that are vulnerable to devaluation through inflation. China can’t dump those. The treasury market is big but it’s not that big, and China knows it. If they tried to do it in a malicious way, the president could stop them with one phone call.

What they’re doing is letting it run off little by little. They shorten the maturity structure. Every month that goes by, a certain number of these treasuries mature. China just gets the money, but they don’t have to sell anything. They don’t have to dump them; they just kind of run off. It begs the question, what do you do with the money? One of the things they’re doing is buying gold.

Some people have speculated that they’re trying to come up with a gold-backed yuan. I find that highly improbable. There are many reasons why the yuan is not ready for prime time or it’s not in a good position to be a global reserve currency even though the IMF says it is. I think the IMF bent the rules to do that for political reasons.

The yuan is not ready. They don’t have a bond market, they don’t have rule of law, they don’t have repos, futures, options, dealers, auctions – all that plumbing and infrastructure needed to run a bond market so that people who have your currency have something to invest in. It just doesn’t exist and won’t for at least ten years, perhaps longer.

They don’t have enough gold to back their currency. The People’s Bank of China has printed more money than the Fed. People like to beat up the Fed about printing money – and they should. They printed close to $4 trillion since 2008, but the People’s Bank of China has printed even more with less gold than the United States. So, they’re not ready for that.

What they are doing is creating a hedge. Let’s say that there is no inflation and the dollar is stable. I don’t expect that, but let’s just assume it’s true. The dollar price of that gold might not do very much, but China will be happy because they’ll get their treasury securities paid off in real dollars.

On the other hand – and I think this is far more likely – we inflate the currency. We say to China, “Hey, China, here’s your $1 trillion. Good luck buying a loaf of bread, because we printed all the money.” China could shrug and say, “Yes, maybe our treasuries are worth less because of inflation, but our gold is worth more.”

Without dumping a single treasury and while continuing to have a substantial investment in U.S. dollars, the physical gold acts as a hedge so that if we resort to inflation (which in my view, we will), the gold will be worth more and their wealth will be preserved.

By the way, that’s a reason for every investor to have an allocation of gold. I recommend 10%, but people can do more or less according to their personal preferences. If nothing else, gold is good if the monetary system collapses, it’s good in a panic, and it always preserves wealth in the long run.

There are many, many reasons to have gold in your portfolio, but one of the most obvious that people get is inflation insurance. I like to say if it’s good enough for China, it’s good enough for me. I do recommend savers and investors allocate some of their portfolio to physical gold for that reason. That’s exactly what China is doing.

Russia is doing something similar, but I think Russia is more aggressive. They’re actually looking for ways out of the dollar payment system, maybe create a ruble zone. The ruble is also not ready to be a global reserve currency, but it could be an effective regional reserve currency meaning something that trading partners would accept.

Those trading partners would include places like Kazakhstan, Belarus, Crimea is part of the Russian Federation now, and Turkey, which is a major trading partner of Russia. That could be an effective inflation hedge as I described in the Chinese situation, but it’s also a form of wealth.

Iran is not very plugged into the global payment system. They’ve been in and out of SWIFT, and some of the sanctions are starting to ease up, but now the Trump administration is slapping them back on again.

Obama put them on through the end of 2013 to get Iran to the bargaining table. Once Iran came to the bargaining table to talk about the uranium enrichment program, Obama started to alleviate the sanctions, which he did to a great extent although not completely. Now that Trump is in, he is slapping sanctions back on again, because Iran is violating the agreement with missile testing.

This switching back and forth between sanctions and gold and dollars and missiles I hope makes my point that the geopolitical and the economic are converging and are very closely related.

For Iran, it’s an alternate form of wealth. Gold is fungible, it’s non-digital, you can’t hack it, you can’t erase it. If you take it to a refinery, even if you receive bars with serial numbers on them and assay stamps on them, big deal. Melt them down and make your own bars with your own new serial numbers. It’s an element; it’s atomic number 79. It’s completely untraceable. You can turn gold in one form into gold in another form. It’s still gold, but in such a way that it can’t be traced.

Iran’s motives are a lot more nefarious, and I talked about Turkey also. Turkey has confronted NATO and the United States. They’re somewhere between Iran and Russia in terms of looking for alternate stores of wealth on the one hand, but also thinking about what happens if they get kicked out of the financial system. How can they conduct trade and suddenly bounce payments?

Now let’s introduce North Korea. North Korea might be the most dangerous spot in the world. We certainly hear about confrontations in eastern Ukraine, the South China Sea, and the Senkaku Islands off of Japan. There are enough hot spots to go around, but North Korea may be the most volatile, the most dangerous.

North Korea is obviously testing intercontinental ballistic missiles. They don’t have one that works consistently yet, but they’re getting better at it and are moving in that direction. When they fire a missile and it fails or blows up or falls into the sea, everyone says they failed, but in their minds, they didn’t fail; they learned something. They are a learning organization, so failures are not really failures; they point to something that can be improved, and then you do better the next time.

They’re weaponizing their uranium and plutonium, making it smaller. They’re increasing the distance of their missiles. They’re not there yet, but they’re getting closer to being able to fire a nuclear missile at Seattle and kill millions of Americans.

We’re not going to let that happen, which means that the U.S. is set up to attack North Korea with air power, bunker buster bombs, and maybe something even more powerful than that to degrade and destroy their weapon systems, their enrichment programs, and their missile testing systems.

In the meantime, North Korea is going down this path. Why are they doing that? Well, 98% of their people are practically eating bark off of trees. They’re starving and suppressed, but a very small elite live fairly well with a lot of luxury goods. That’s how Kim Jong-Un bribes his own military commanders, spy chiefs, elites, and others – with Western goods and money.

How do they get money? They’re not integrated with the international monetary system, so one of the ways is gold. Why are they developing these programs? Do they really want to attack Seattle? You can’t rule it out, but what they really want to do is sell it to Iran to use against Israel, and Iran pays for it with gold.

If you were to do a dollar-denominated wire transfer payment from Iran to North Korea, it would be frozen by the United States. It wouldn’t go through. All dollar payments have to go through a U.S. bank or a member of what’s called Fedwire, a wire transfer payment system the United States controls. We would see that payment, stop it, and freeze it.

But if I put gold on a plane and fly it from Tehran to Pyongyang and unload it to pay for my missiles, that’s completely untraceable. It’s non-digital, there’s no message traffic, there’s nothing. You don’t even know what’s in the plane. It could be tourists or it could be gold, or both. It probably is both, because you don’t want to shoot it down and kill the tourists.

These countries are now using gold to settle payments between themselves for weapon systems and other illicit transactions in ways that are non-traceable, cannot be interdicted, cannot be hacked, cannot be frozen, etc.

That was the point I was making in the CSIF report. If you are the incoming Secretary of State or Secretary of the Treasury – you’re Rex Tillerson or Steve Mnuchin – and you have to deal with this in addition to all of the normal sanctions relief you may or may not be familiar with, you certainly have to come up that learning curve pretty quickly. There’s a new kid in town which is gold, and this axis of gold as I describe it is using gold to preserve wealth, get out of the payment system, and actually settle transactions including illicit arms transactions between and among themselves.

That’s in the report. I hope the listeners will go find it online at Center on Sanctions and Illicit Finance, CSIF, Foundation for the Defense of Democracies.

Jon:  Thanks, Jim. That’s a fascinating outline.

I’m wondering, Alex, if you have any thoughts about Jim’s insights here.

Alex:  Jim, it’s interesting that you mention that gold is being used in these ways and that it’s a relatively new method of doing it. You’re a student of history just like I am, so you know that this is a repeat of what has happened in the past. Gold has been used for thousands of years as international money, and I think that’s what you’re getting at.

If you look at central bank managers or governors of central banks or former chairs of central banks among the elite financial crowd, many of them don’t look at it as money, or at least they don’t say that when they’re in office. I found it interesting that recently the former Governor of the Reserve Bank of India, after getting out of office, did say that gold was in fact the best international money, and former Federal Reserve Chairman Alan Greenspan said the same thing.

Jim:  Yes, we’re seeing more and more comments like that. I’m always fascinated by central bankers, and Alan Greenspan is a classic case. Before Alan Greenspan became Chairman of the Federal Reserve, he had a lot of positive things to say about gold going all the way back to the 1960s including through the 1970s and early 1980s before he was appointed Fed Chairman.

After leaving the Fed, he has given a series of public speeches where he had positive things to say about gold. The only time he didn’t have anything nice to say about gold was when he was Chairman of the Federal Reserve.

It’s almost as if you take that job and automatically shut up about gold, which tells you something right there, that it probably is important but they just can’t talk about it. Greenspan is an interesting case of a guy who has spoken candidly and favorably about gold before and after he was Fed Chairman but not during.

Jon:  Speaking of Greenspan, let’s turn our attention to the U.S. for a moment. The opening weeks of this new administration have hardly been uneventful, and I welcome your thoughts on the likely impact on the markets of the Trump White House.

We’re spoiled for choice. There are so many factors here – Trump against Janet Yellen, trade wars, banking deregulation. Perhaps you could pick the factor with the most immediate significance and take it from there.

Jim:  That’s actually a very tough question. First of all, you’re right; there’s no shortage of information or proclamations that are coming out of the White House about economic policies, whether it’s an actual executive order, pending legislation, a speech, or a tweet. We all wake up and read the President’s tweets to find out what’s going on. There’s a lot of stuff out there, and a lot of it is very significant.

Donald Trump has given some interviews. He said, “I go to bed around midnight or 1:00 and I get up at 5:00.” It’s like, “Okay, that’s four hours of sleep,” and he’s full of energy. He’s working 20-hour days. You hear stories about him calling generals at 3:00 am.

I think he’s driving his staff crazy, but he seems to have more energy than any of the people around him, and they’re all struggling to keep up. This is one of the most hyperactive administrations ever. You probably have to go back to Franklin Delano Roosevelt in 1933, but even then, I’m not sure they got as much done in 20 days. You always hear about the first 100 days of FDR, but this has only been 20 or 21 days of Trump and they’ve already turned the world upside-down, so there’s plenty to say.

I’d like to step back from that for a second and make a higher-level observation. Look at Trump’s individual statements; not just the President, but some of his cabinet appointees, members of Congress, people he’s working with, people on his staff, etc. Taken individually, there’s a lot of merit in many of them. I don’t agree with all of them, but who cares, that’s just my opinion. But a lot of them have merit.

Most of us think that cutting taxes is good because it’ll free up money for consumption and private spending or building infrastructure. It’s a good idea because our bridges, tunnels, and airports are falling apart, reducing regulation is a good idea, and so forth.

Individually, they sound like good ideas, but when you look at all of them, they don’t add up. There are some big contradictions and inconsistencies, and that’s what I’m focused on. It’s not so much a matter of being right or wrong; it’s just that if two things contradict each other, then there’s going to be a train wreck somewhere along the way.

Let me be very specific about what I mean by that. During the campaign, Trump complained that Janet Yellen was holding interest rates too low for too long. That’s probably true. I said they should have raised interest rates in 2009. I didn’t get much agreement at the time, but with hindsight, they skipped an entire cycle.

They wouldn’t be so desperate to raise them now during a period of weak economic growth and the late stage of a business cycle (which is not when you’re supposed to raise interest rates) if they had done their jobs and raised them in 2009 or 2010. But they didn’t. They missed a whole cycle and now they’re playing catchup, probably at the worst possible time.

They think two wrongs make a right, but they don’t. It’s just two wrongs. They should have raised them and then didn’t. They should not raise them now and they will, so they’ll probably mess up both times. They’re desperate to do that, but they did hold them too low for too long.

They probably had a good opportunity to raise rates last September 2016, but they did not do so because they were trying to help Hillary’s chances in the election. Trump has been critical of that. At face value, Trump wants higher interest rates.

There are two vacancies on the Board of Governors right now. These seats were left unfilled by Obama to help Yellen because he thought Hillary would win and she could fill the seats.

Oops, they’ve made a mistake there, because they didn’t foresee that Trump would win, and now Trump gets to fill those two vacancies. He’s going to have two Fed governors right off the bat. I would expect those announcements. There are some behind-the-scenes discussions with a couple of names being floated that I’ve heard about. We’ll see what happens, but I would expect those sooner rather than later.

Beyond that, Yellen’s term as Chairman expires next January. He’s clearly not going to reappoint her, so he’s probably going to pick somebody by December. They have to be confirmed by the Senate and ready to go by the time Yellen actually leaves in January.

There’s another governor, Dan Tarullo, whose role is regulatory matters. He’s not a monetary thought-leader in the way some of the others are, but he’s pretty strong on regulation. Trump will clearly appoint someone else to do the regulatory role, so I would expect Tarullo would leave because why would he stay if someone else just took his job?

So, Trump may get four appointments: the two vacancies – Tarullo and Yellen – and there are others coming out. Trump may get four or five out of seven seats to fill by the end of this year. That’s extraordinary and means that Trump can remake the whole Board of Governors.

He complained that interest rates are too low. Is he going to fill those seats with hawks so they’re going to raise interest rates? Well, hold on a second. Trump has also complained that the dollar is too strong; he wants a weaker dollar.

He accuses China and Mexico of currency manipulation. He also accused Germany and Japan of currency manipulation. Germany doesn’t have its own currency, they use the euro, so you have to point the finger at the ECB. Be that as it may, Trump has painted with a very broad brush and said that Mexico, Germany, Japan, China, and others have cheap currencies and that’s how they promote exports and cost Americans jobs.

This is currency wars 101. It’s what I wrote about in my first book, Currency Wars, a few years ago. I said at the time that they would continue for a long period of time, meaning 15 or 20 years. That book came out in 2011, so I’m not the least bit surprised that here we are in 2017 and not only are we still talking about currency wars, but they’re actually more urgent than ever because Trump is the President and he’s making a point of it.

Take everything I said in the last five minutes. Trump complains that interest rates are too low and he might appoint hawks, but he thinks that the dollar is too strong and he wants a weaker dollar. What happens when you raise interest rates? It makes the dollar stronger. It pushes in the opposite direction from a weaker dollar, which is what Trump says he wants.

There’s a basic contradiction there. You can’t have it both ways. You can’t have hawks raising interest rates and a cheap dollar at the same time, because higher rates make the dollar more attractive, money comes in, and the dollar gets stronger. That’s one problem.

Let’s take another issue called the border transaction adjustment or border transaction tax. This is something designed to promote exports and reduce imports, which would in theory reduce the U.S. trade deficit, help growth, create U.S. jobs in our export industries, and perhaps make it more attractive to manufacture in the United States instead of Mexico and China. This has been pushed by Peter Navarro, Dan DiMicco, Robert Lighthizer who is the designated U.S. trade representative, and some of the other inner circle members of Trump’s team.

What does it mean when you put tariffs on? You would tax imports with something like a tariff, and the cost of imports would not be tax deductible. If you’re a U.S. manufacturer and import components, you can’t deduct whatever you spend on those imported components from your taxes. In effect, it increases the cost of imports to a U.S. taxpayer.

Likewise, if you export items, the revenue from the exports is not taxable income. You don’t have to pay any tax on that. So, you lose your tax deduction on the cost of imports, you get a tax exemption on the proceeds from exports, and the combination of the two promotes exports and hurts imports. It acts like a tariff on imports. In effect, that’s what it is.

There’s another identity in economics, which is that savings equals investment in the aggregate. What happens when U.S. domestic savings are less than our investment which they are right now?

The United States spends more on investment, whether it’s housing or capital goods or other forms of infrastructure or long-term goods, than we save. The U.S. doesn’t save enough. Where does the difference come from? It comes from abroad, from overseas.

Foreigners invest dollars in our economy, and that’s how we make up the shortfall between domestic savings and investment. Where do foreigners get the dollars? They get it from running a trade surplus with the United States. They sell us stuff, we give them dollars, they take the dollars, and invest it back here.

There’s an identity there which is the shortfall between domestic savings and investment, which is exactly equal to the trade surplus of foreigners with the United States. It just has to be, because that’s where the dollars come from. They don’t come from Mars.

When you increase the cost of imports – in other words, when you put a tariff on or you do something like this border tax adjustment we talked about – and you increase the cost of exports, if that were the only thing happening, it would reduce our trade deficit. But then where would the foreigners get the money to make up the investment gap in the United States? And they have to.

The way that works out is that is that the dollar gets stronger. The stronger dollar offsets the impact of the tariffs. My imported goods could be French wine, a nice German pair of skis, a Japanese car, Chinese textiles, clothes you buy at Costco from Thailand, whatever it is. If the price of that goes up because of tariffs, the dollar has to get stronger so that the real price doesn’t change at all. In other words, the stronger dollar offsets the impact of the tariff. That’s how you adjust this global savings versus trade surplus identity that I described.

I’ll skip the economics lecture, but the bottom line is that all things being equal, tariffs make the dollar stronger because that’s how you offset the impact of the tariffs and maintain the foreign trade surplus that gets invested in the United States.

Once again, there’s a contradiction. Trump says he wants a weaker dollar, but tariffs would actually make the dollar stronger. There are other solutions including a collapse of investment so that you close the savings/investment gap by shrinking investment, but that would just throw the U.S. economy into a recession and nobody wants that.

Once again, we have Trump calling for a policy of tariffs or border tax adjustments on imports that would make the dollar stronger, yet at the same time, he wants the dollar to be weaker.

The reason I’m going through this in a lot of detail is to make the point that taken individually, these policies may have something to offer or they may not if you disagree with them, but collectively they don’t add up. Something is going to break.

What I expect is that the solution to this tariff savings shortfall issue I just described is inflation. If the dollar just gets stronger, that is by itself deflationary, but what if you generate inflation through easier monetary policy, i.e., we run larger deficits? The Fed accommodates the deficits. Well, that is what helicopter money is.

We get inflation. Now you may find that the nominal value of imports is going up, but the real value isn’t, because a lot of it is just inflation. You’d have a stronger dollar from imports, but you’d have a weaker dollar from monetary policy, and on net, you’d probably get inflation through higher input prices that would feed through the supply chain, etc.

Once again, I come back to gold. I can describe all this and give an economics lecture on it, but I can’t predict exactly how it’s going to turn out. I can tell you that not all these things will happen, because they contradict each other. The tariff thing flies in the face of a weak dollar. The Fed hawks fly in the face of a weak dollar, so you’ll probably get Fed doves, weaker dollar. You’ll probably get tariffs too, but they’ll solve that with inflation, and all roads lead to gold.

This is why gold is going up. Gold has gone up 10% in the past seven weeks from the middle of December until now. This is because expert traders look at the issues I’m describing and say, “There’s only one way out of this. There’s only one way to get to debt sustainability. There’s only one way to have larger deficits if that’s what Trump wants, which is inflation.”

People are getting ahead of that. Smaller investors should understand that this move in gold is not a normal blip or volatility; it’s actually being driven by a very fundamental understanding of the contradictions in Trump’s economic policies.

A lot of people remember election night when the returns were coming in and it became more and more apparent that Trump was going to win. Initially, the price of gold was soaring up to about $1330 to $1340 an ounce. It was a huge surge, and then it just hit an air pocket and went all the way down to I think a low of $1150 in mid-December.

Why was that? One reason was because in a very public way, Stan Druckenmiller sold all of his gold. Prior to the election, Stan Druckenmiller was one of the biggest bulls on gold. He acquired a very large gold position, some paper and some physical. Duquesne Capital is his family office/hedge fund. It’s not an open hedge fund; it’s a family office at this point.

When Druckenmiller saw that Trump was going to win, he said, “I was buying gold because I was worried about Hillary. Now that Trump won, I dumped all my gold.” People found out about that and said, “If Stan’s out of gold, I’m getting out of gold.” People sold their ETFs, this whole thing got a momentum, and gold went all the way down to the $1150 range, as I said.

Well, guess who’s back? Stan Druckenmiller is now buying gold. Now that the Trump train and the Trump euphoria are over, he’s looking at these contradictions and saying, “Trump really does want a weak dollar, and he’s in a position to get it because of his Fed appointments. A weak dollar means a higher dollar price for gold, so it’s a great price to buy gold.” He’s back in the market. Other people are getting tuned into this, and that is why gold is rallying. I would expect the rally to continue.

Alex:  One of the things I’m hearing you say, Jim, is that basically all roads right now are leading to inflation, which also means that all roads are leading to gold as well.

I’d like to turn for a moment and talk about some core concepts. When I say core concepts, I mean the type of thing that you and I have discussed for years now and many of the regular listeners of our podcast are aware of. For people who are new to this podcast and the things we talk about, I recommend you go back and take a look at Jim’s first book, Currency Wars, and bring yourself current.

One of the most interesting things we’ve discussed since I’ve known you, Jim, is your description of capital markets as complex systems, and this is a view I’ve come to agree with. Why are capital markets complex systems? Would you talk a little bit about why that is? And for analysts using measurements such as VAR and other traditional tools, why does this matter?

Jim:  Let me give you a fairly succinct version of that, Alex. As a lot of topics, I could deliver a two- or three-hour lecture on that, and I have, but let me give you the short version.

The question is, are capital markets complex systems? I think that is the most important question in economics today, and here’s why: There’s a difference between complexity and complicated. People use those two words interchangeably, and that’s fine in terms of everyday conversation, but in scientific terms they mean very different things, and I’ll explain why.

The models in use today by central banks, Wall Street, risk managers, etc. fall into one of two categories. One is equilibrium models. These assume that you have efficient markets, good pricing information, people are rational, they’re wealth maximizers, they act rationally, so the economy really works like a well-tuned Swiss watch.

Just in case it gets out of tune, every now and then there’s something economists call hysteresis, but basically something comes along and disturbs the equilibrium. It’s like your watch needs to be wound up because it’s running slow or whatever.

All the central banks have to do is come along, put a little pressure in the opposite direction, tip it back into balance, and then it’s like winding a watch. All of a sudden, it’s running like a Swiss watch again and it’s keeping very good time. An equilibrium model more or less takes care of itself, everything balances out, but just in case it gets out of balance for whatever reason, you can tip it back into balance.

The other model of risk management concerns events in capital markets. When I say events, I mean price goes up, price goes down, normal fluctuation or extreme fluctuation, panics, etc.  That what’s called the degree distribution, which is how you compare the frequency and severity. How often do really severe things happen? How often do really small, little things happen? What’s the extent of both of those things?

Just imagine an X- and a Y-axis, a normal grid, where the vertical Y-axis is the frequency of the event and the horizontal X-axis is the severity of the event. The assumption is that it looks like a bell curve. A bell curve kind of smoothly slopes downward from upper left to lower right where the small events happen all the time, so you have high frequency and low impact. Extreme events happen almost never or at all, so by the time you get way out to the right on the X-axis (the really extreme events), the curve has come down and made a nice soft landing on the axis itself. In other words, the frequency is close to zero.

Extreme events never happen or happen very, very rarely, and common events happen all the time. That’s what’s called a normal distribution also known as the bell curve, and that’s the assumption behind a lot of risk management modeling including value at risk, which is the major model.

You have these two assumptions: 1) equilibrium models, and 2) normally distributed risk. Both of those things are empirically wrong, meaning it’s not just my opinion. You can look at data and the degree distribution of shocks and events in capital markets. You can actually look behind the operation, the system dynamics (capital markets), and see that empirically and analytically, those two models the central banks and Wall Street use do not correspond to reality.

If you have the wrong model, that’s pretty bad. It’s like thinking the sun revolves around the Earth. We all know that the Earth revolves around the sun, but for a thousand years or longer, people thought the sun revolved around the Earth. Try flying to the moon if you think the sun revolves around the Earth; you’re going to fail.

If you have the wrong model, you’ll get bad results every time. This is why central banks, the IMF, BIS, and others never see recessions coming, they never see panics coming, they never see anything like 2008 coming. They never see it coming, because they have the wrong models.

What’s the correct model? This gets back to your question on complexity theory. Imagine we were enrolling in the physics department at the University of Michigan or MIT, some fine school with a professor who knew nothing about economics. We wanted to go into the physics department and study complexity theory, and we were being taught by someone who didn’t know anything about capital markets. What would they teach us? What would they say a complex system is?

They would say it has four main parts or characteristics in determining whether a system is complex or not. The four things are diversity, connectedness, interaction, and adaptive behavior, so DCIA.

Let’s take them one at a time. In any system, you have what are called agents. Agents are the individual actors. An agent could be, in effect, a molecule or an atom if you’re talking about a radioactive element. It could be a person if you’re talking about getting stuck in traffic or trading, buying, and selling stocks. Whether it’s subatomic or at the human level, individual actors in the system are the agents.

The first thing you need is diversity of agents. If everybody acts the same, thinks the same, and responds the same, it’s not a complex system because there’s no clashing, there’s no divergence of opinion. There’s nothing to create unexpected outcomes.

Imagine it’s just a bunch of cave people in a primitive society all living in caves. If every one of those cave people thought exactly the same thing about everything, that’s a really boring system. That’s not a complex system. But if you have different points of view, now you have the beginnings of a complex system.

The second thing is connectedness. We have agents, actors in the system, with different points of view, but are they connected somehow? Can they find each other? If not, then again, that’s really boring. Everyone just sits in their cave and thinks what they think, but there’s no action. But in fact, if you all come out of your cave, sit around a campfire, and get into a discussion at night, now you have connectedness.

The third thing is interaction. We’re diverse, we think differently, we’re connected. Are we doing anything? Are we transacting in any way?

The fourth thing is adaptive behavior, i.e., my behavior affects your behavior, your behavior affects my behavior. We change what we do based on what we observe other people doing.

Again, to go back to the caveman analogy, the diverse cavemen come sit around the fire, they’re communicating, they interact, they all decide to go out and hunt for mastodon the next day. But one caveman goes in a different direction. Everyone else gets food but he doesn’t, so he thinks, “You know what? I better adapt my behavior. I better go with these other guys tomorrow, because that way I’ll get some food for my family.” There’s my caveman example illustrating these four things.

We can take these four things and apply them to physical elements, earthquakes, sunspots, or forest fires. There are many, many examples of complex systems, but let’s take what I just described and apply it to capital markets.

Do we have diverse actors? Of course we do. We have bulls and bears, fear and greed, long and short, leveraged and non-leveraged. We can get ten opinions on every stock or bond or commodity you want to mention, so yes, we have very diverse actors.

Are they connected? Absolutely. We have Thomson Reuters, Dow Jones, Bloomberg, chat rooms, telephones, e-mail, CNBC, podcasts. We are probably overly connected, but we’re certainly connected.

Are we interacting? Big time. Trillions of dollars of stocks, bonds, currency, commodity, transactions taking place every single day, every single minute. We’re transacting and interacting at a massive scale.

Finally, the last question is, do we have adaptive behavior? Well, of course we do. I just gave an example of Stan Druckenmiller selling his gold on election night. As soon as people found out, they went and sold their gold. We have adaptive behavior.

We’re four for four. The four key pillars of complexity theory taught by someone who knew nothing about capital markets, when applied to capital markets, reveal that capital markets are complex systems. They’re not only complex systems, they’re one of the best examples of a complex system you can think of.

It’s an interesting lecture, but what is the significance; what does it mean? The significance is that risk or events in complex systems are not normally distributed. They’re distributed according to a different curve called a power curve, not a bell curve.

It’s not just an argument about the shape of two different curves; those two curves are simply manifestations of events in the real world that have a completely different characteristic, different reaction functions, different frequencies, different severities; everything about it is different.

The minute you go through the looking glass and say, “Capital markets are not complicated systems with normally distributed events; they’re actually complex systems with events distributed along a power curve,” you have entered a completely different risk profile, a completely different way of understanding the world.

That’s what I do in my own analysis. Those are the models I use. The point being that if you’re stuck in the failed, incorrect, obsolete view that risk is normally distributed and systems operate in a kind of complicated equilibrium, you are going to miss everything. You’re going to miss every turning point, every crisis. You’re going to lose money and get wiped out every seven or eight years.

On the other hand, if you can embrace complexity theory, understand it, apply it, and see that the risks are far greater than what Wall Street tells us and that the worst thing that can happen is exponentially greater than what Wall Street believes and that the frequency is a function of scale and the scale keeps getting bigger, which means the frequency of the severe events gets exponentially bigger, you’ll be scared to death. You’ll look at the system we have and say, “It may not break down tomorrow, but actually, it could, and we could get completely wiped out.”

This is another reason to have gold in your portfolio, because gold will withstand these extreme events much better than other kinds of financial assets.

Alex:  Outstanding. I love the caveman analogy. That’s really great. As far as all these indicators most financial professionals are basing what they’re doing on but is really based upon false assumptions, to me it’s like being on an airplane. You have all these indicators, but they’re feeding you information off false data. As you mentioned, that is a pretty scary situation.

We have a little bit of time left and want to go to a question from one of our listeners. We like to do as much listener interaction as possible, so for those of you who want to ask questions for the podcast, you can always submit them by e-mail to us at our website or ask directly on Twitter. We get those, and when we can, we include them.

This is a Twitter question coming from a user by the name of Absolute Hokies. That’s an interesting handle there! In reference to Triffin’s dilemma as it relates to the border adjustment tax, repatriation of funds, and Fed hikes, his question is, “Doesn’t BAT repatriation counter Triffin’s dilemma forces regarding dollar movement? And if so, does a stronger dollar worsen the debt crisis?”

Jim:  That’s a compound question. I spent a little bit of time talking about the impact of border adjustment tax, and what I said was that if you impose it, it’s a kind of tariff. The reaction function would either be a collapse of investment because there wouldn’t be enough of a foreign surplus to fund the investment deficit so investment would collapse which would put the U.S. economy into a recession and be deflationary, or the dollar would get stronger to offset the higher input prices so that the foreign surplus can be just as big and they could fund the investment shortfall.

Either way, you end up with deflation or a stronger dollar. The deflationary impact of a stronger dollar offsets the inflationary impact of the tariff, and so the combination of the two is net neutral. It doesn’t really go to Triffin’s dilemma.

For the benefit of our listeners, Triffin’s dilemma goes back to the 1960s. It was named after a Belgian economist named Robert Triffin who spoke about when a country issues the global reserve currency. That is the situation with the United States, it was then and it is today. Today, U.S. dollars are 80% of global payments and 60% of global reserves, so it’s the dominant global reserve currency.

The world needs dollars to conduct transactions, it needs dollars to pay each other, it needs dollars to hold its savings, etc. Where do they get them? They get them from the U.S. trade deficit. If the U.S. ran a trade surplus, we’d be sucking up all the dollars in the world.

It’s only by running a deficit that we spread dollars around the world. Other countries earn the dollars from us, and then they have dollars to buy oil or things in the United States or invest or whatever they need.

Triffin’s dilemma said if you run the global reserve currency, you also have to run persistent deficits. If you don’t, the world won’t have enough of your currency for commerce to grow. But if you run persistent deficits, eventually you’ll go broke. In other words, the dilemma was that the thing you need to do to supply the world with dollars will eventually cause you to go bankrupt because your deficits will catch up to you.

He said this in 1960, and it’s turning out to be true. It took 55 years to play out and there were a lot of strong dollar/weak dollar episodes along the way, but the bottom line is that what Triffin predicted 55 years ago is playing out today, which is that the U.S. is going broke. Our debt is not sustainable, and we’re getting closer and closer to a dollar crisis every day. That’s Triffin’s dilemma.

Now, the border adjustment tax doesn’t really affect that one way or the other. I don’t want to put words in anyone’s mouth, but I think what the listener was getting at is, if you have a border tax adjustment, doesn’t that reduce the trade deficit and solve Triffin’s dilemma?

The answer is, no. If you get a stronger dollar as a result, the higher price of imports is offset by the stronger dollar, meaning you get more for your buck, so the trade deficit for the U.S. and the external trade surplus in dollars is the same. The exchange rate adjusts to offset the impact of the tariff, so the net effect on the deficit or surplus is the same, and therefore there’s no impact on Triffin’s dilemma.

Having said that, the whole issue with Triffin’s dilemma is coming to a head. The solution to Triffin’s dilemma is not the U.S. trade deficit or surplus; it’s the SDR or special drawing rights. The SDR is a form of world money issued by the IMF, and the IMF is not a country. The IMF doesn’t have a trade deficit or a trade surplus because it’s not a country. It just pulls the money out of thin air.

For foreigners to get dollars from the U.S., they have to earn them by running a trade surplus with the United States. That means we have a deficit; that’s Triffin’s dilemma. But for foreigners to get SDRs, they don’t have to do anything. They just have to wait for a phone call from Christine Lagarde, and she says, “Here are your SDRs.”

The real solution to Triffin’s dilemma is the SDR, but the impact of that is certainly inflationary, which, in my view, is one more reason to own gold.

Alex:  Very good. Jim, I want to thank you for your time. It’s been an excellent discussion. And thank you to all of our loyal listeners.

Jon:  Yes, thank you, Jim Rickards. This is fascinating new material. And thank you, Alex. It’s always a pleasure and an education sharing this time with both of you. Most of all, thank you to our listeners for spending time with us today. Let me encourage you to follow Jim and Alex on Twitter. Jim’s handle is @JamesGRickards, and Alex’s handle is @AlexStanczyk.

If you’ve enjoyed this podcast, please recommend it to your friends. If you’re watching on YouTube, please click “Like” and “Subscribe.” If you’re listening on iTunes, please give us a rating and a review.

Goodbye for now to everyone, and we look forward to joining you again soon.

 

Listen to the original audio of the podcast here

The Gold Chronicles: February 9th, 2017 Interview with Jim Rickards and Alex Stanczyk

 

Learn more about Jim Rickards new book, The New Case for Gold at http://thenewcaseforgold.com/

You can follow Alex Stanczyk on Twitter @alexstanczyk

You can follow Jim Rickards on Twitter @JamesGRickards

You can listen to the Gold Chronicles on iTunes at:
https://itunes.apple.com/us/podcast/the-gold-chronicles/id980027782?mt=2

You can Listen to the Global Perspectives on iTunes at:
https://itunes.apple.com/ca/podcast/physical-gold-fund-podcasts/id1056831476?mt=2

You can access transcripts of our interviews at:
http://physicalgoldfund.com/category/transcripts/

You can subscribe to our Youtube channel to access these interviews and more at:
https://www.youtube.com/channel/UCXRWzw0vaNgCwo7nTMEAwkA

By listening to this podcast or reading its associated transcript (collectively, this “Podcast”), you agree with the following.

This Podcast is not an offer to sell, nor a solicitation of an offer to purchase, any security. This Podcast is intended for general education and information purposes only, and may include broad discussions of markets, geopolitics, monetary policy, and geoeconomics. Nothing in this Podcast constitutes investment, legal or tax advice, nor an evaluation of or prospectus for any particular investment or market, including gold. This Podcast should not be relied upon to make any investment decision. You are encouraged to seek the advice of qualified financial, legal and tax advisors before making any investment decisions.

This material is provided on an “as is” and “as available” basis, without any representations, warranties or conditions of any kind. In particular, information provided by third parties in this Podcast has not independently evaluated or confirmed. Furthermore, we take no responsibility to update this Podcast to reflect any changes in any of the information presented. Physical Hard Assets Fund SPC and Physical Gold Fund, its officers, directors, employees or associated persons will not under any circumstances be liable to you or any other person for any loss or damage (whether direct, indirect, special, incidental, economic, or consequential, exemplary or punitive) arising from, connected with, or relating to the use of, or inability to use, this Podcast or the information herein, or any action or decision made by you or any other person in reliance on this information, or any unauthorized use or reproduction of this Podcast or the information herein.

The Gold Chronicles: February 9th, 2017 Interview with Jim Rickards and Alex Stanczyk

Jim Rickards and Alex Stanczyk, The Gold Chronicles February 9th, 2017

Topics Include:

*Golds role as an international alternative to the United States Dollar
*How financial warfare between sovereigns works
*Strategic view on changes to sovereign gold reserves
*China is slowly shortening the maturity structure of its US Treasuries and letting them run off the books versus selling
*Analysis of projected Trump policies; deep dive into some of the inconsistencies and potential scenarios
*Trump may be able influence the appointment of as many as 4 or 5 members of the FOMC
*Currency Wars are alive and well, new rounds of devaluation are starting
*Helicopter money and price inflation
*Are capital markets complex systems, and why it matters
*Why traditional models such are VaR are old science that may no longer apply to markets
*Specific criteria used in physics to identify a complex system
*Triffin’s Dilemma and gold

 

 

Learn more about Jim Rickards new book, The New Case for Gold at http://thenewcaseforgold.com/

You can follow Alex Stanczyk on Twitter @alexstanczyk

You can follow Jim Rickards on Twitter @JamesGRickards

You can listen to the Gold Chronicles on iTunes at:
https://itunes.apple.com/us/podcast/the-gold-chronicles/id980027782?mt=2

You can Listen to the Global Perspectives on iTunes at:
https://itunes.apple.com/ca/podcast/physical-gold-fund-podcasts/id1056831476?mt=2

You can access transcripts of our interviews at:
http://physicalgoldfund.com/category/transcripts/

You can subscribe to our Youtube channel to access these interviews and more at:
https://www.youtube.com/channel/UCXRWzw0vaNgCwo7nTMEAwkA

 

By listening to this podcast or reading its associated transcript (collectively, this “Podcast”), you agree with the following.

This Podcast is not an offer to sell, nor a solicitation of an offer to purchase, any security. This Podcast is intended for general education and information purposes only, and may include broad discussions of markets, geopolitics, monetary policy, and geoeconomics. Nothing in this Podcast constitutes investment, legal or tax advice, nor an evaluation of or prospectus for any particular investment or market, including gold. This Podcast should not be relied upon to make any investment decision. You are encouraged to seek the advice of qualified financial, legal and tax advisors before making any investment decisions.

This material is provided on an “as is” and “as available” basis, without any representations, warranties or conditions of any kind. In particular, information provided by third parties in this Podcast has not independently evaluated or confirmed. Furthermore, we take no responsibility to update this Podcast to reflect any changes in any of the information presented. Physical Hard Assets Fund SPC and Physical Gold Fund, its officers, directors, employees or associated persons will not under any circumstances be liable to you or any other person for any loss or damage (whether direct, indirect, special, incidental, economic, or consequential, exemplary or punitive) arising from, connected with, or relating to the use of, or inability to use, this Podcast or the information herein, or any action or decision made by you or any other person in reliance on this information, or any unauthorized use or reproduction of this Podcast or the information herein.

Transcript of Global Perspectives EP1: February, 2017 Interview with Alex Stanczyk and special guest Brent Johnson

gp-youtube-splashpage-4

Welcome to Global Perspectives, a new podcast featuring some of the sharpest minds in the world. We delve into the key concerns, opportunities, mindset, and practices of some of the most successful professional money managers, entrepreneurs, and world class personalities today.

This episodes special guest is Brent Johnson of Santiago Capital.

Topics Include:

*Two of the most powerful forces at play in markets today
*Stock and flow of the money supply; Why the flow is so essential
*The key design flaw of the current debt based monetary system
*How continued decrease in the velocity of money can create a compounding deflationary effect
*Velocity of money has been on a downward slope for 16 years which has forced the Fed continue to add to the money supply
*How the Basel III regulatory framework is compounding parking of capital and adding to deflationary forces
*How growth of regulation has created burden on small business reducing competition and raising the cost of entry into markets
*What is “velocity of money” and why it matters to inflation
*Why quantitative easing has led to a situation where inflationary forces could accelerate faster than central banks expect
*How inflation is closely tied to psychology and not just creation of new money
*The case for why zero to negative interest rates are having the opposite effect to what central banks expect
*Trump is a wild card for market psychology
*Why Trump could be highly inflationary
*Global demand for US dollars could push the USD continually higher over the next few years
*Why and how a strengthening dollar could cause its own demise

 

Listen to the original audio of the podcast here

Global Perspectives: February, 2017 Interview with Alex Stanczyk and special guest Brent Johnson

 

Global Perspectives Episode 1
Alex Stanczyk and Brent Johnson

Jon:  Hello, I’m Jon Ward, on behalf of Physical Gold Fund. We’re delighted to welcome you to the first podcast with Alex Stanczyk in the series we’re calling “Global Perspectives.”

Alex Stanczyk is the Managing Director of Physical Gold Fund. Alex is an expert in the physical gold industry, dealing with the logistics chain, from refinery to secure transport and vaulting. He has lectured globally to investor, institutional, and government audiences on the role of gold, both in the international monetary system and investment portfolios.

Hello, Alex.

Alex:  Hello, Jon. It’s great to be here. This is going to be a wonderful conversation today with someone whom I’m a big fan of, personally.

Jon:  I’m sure it is. Our guest today is Brent Johnson. He’s the CEO and portfolio manager at Santiago Capital, a hedge fund that focuses primarily on bullion and other metals-related investments.

Brent has been creating and managing wealth-management strategies for high net-worth clients since the 1990s. Early in his career, he was a financial auditor for Philip Morris Management Company, and he went on to serve private clients for Credit Suisse.

Brent recognized early on the need for a robust precious metals solution for his clients, and that’s what prompted him to launch Santiago Capital. Since then, he has attracted a growing following as an expert on gold.

Now, in his spare time, Brent devotes himself to educating the public on financial and monetary issues. His work is often featured throughout the blogosphere, including Zero Hedge.

Welcome, Brent.

Brent:  Hi, guys. Thanks for having me. It’s great to be with you today.

Jon:  Now, Alex, over to you.

Alex:  Okay, thanks a lot. Let me start out by saying, Brent, it’s great to have you on. One of the things that I find interesting about you is that you don’t follow the crowd. There are a lot of different analysts in the space. Interestingly enough (and you’re probably already familiar with this), the common theme that you see amongst analysts in the sector is that they all often parrot each other. I find it curious how that happens. It isn’t so often that you run across someone who has got some original thinking and original content.

You definitely fit that mold. I shouldn’t even call it a mold. You’ve broken the mold. You’re the person who looks at the whole situation in your own sort of way. I’m looking forward to what you have to say on a lot of these different levels.

If you don’t mid, Brent, let’s talk a little bit about your latest presentation. It’s called “Don Yuan.” Can you give us a quick summary of “Don Yuan” and what it means to you?

Brent:  Sure, yeah. Thanks for the nice words you said, by the way. I’m excited to be able to come in and talk with you. I’ve been a fan of you and your work, as well. This is a great opportunity.

As it relates to “Don Yuan,” it’s a play on two of the biggest forces that I see in the world today. It’s not just market forces. It’s political forces. It’s social forces. It’s Donald Trump, “The Don,” and then China and the yuan.

Rather than “Don Juan,” I titled my latest presentation “Don Yuan,” because I really do see those as being the two primary forces right now. It’s kind of a funny play on words, but it’s actually a pretty serious topic when you really get down to it. It’s a very divisive topic, but it’s an important one. That’s a long way of explaining the “Don Yuan” title.

Alex:  I understand. Let’s dig a little deeper into some technical areas that you had mentioned in your other series, “Step into Liquid.” One of the things that you talked a great deal about was stock and flow of the money supply.

A lot of people are familiar with this concept of stock and flow, but they may not understand why the “flow” part of the stock and flow is so essential and why it plays such a big role in your framework of looking at the world.

Can you talk to us about that and about why flow is so essential?

Brent:  Yeah, absolutely we’ll do that, because it’s the key to everything. It’s funny, because I learned of this stuff in college, but I probably just learned it long enough to memorize it to pass whatever test I was taking, and never thought of the real-world implications of it. Then 10 to 15 years ago, I started looking at it closer. Ten years ago, when we started getting into 2007/2008 timeframe, I took a hard look at it. That’s when it hit me.

The stock and the flow goes back to a debt-based monetary system, where money, for lack of a better word, is loaned into existence. The way that our monetary system is designed has a severe design flaw in it. You can argue whether it was done on purpose or whether it was done by accident. We could probably do a whole hour just on that.

Regardless, the flaw is there. The flaw is that in a debt-based monetary system, where money gets loaned into existence, all loans have interest attached to them. If you loan money into existence, then at the end of the year, you need more money to pay the interest than actually exists.

Either the existing money in the system has to be circulating – or the flow, for the lack of a better word, has to be flowing – at a fast enough rate where that money can change hands and satisfy everybody’s interest payment.

If that flow is not flowing at a high enough rate to where the interest gets paid, then loans go into default. It’s like a daisy chain. It starts cascading all the way back to the base money from which that money was loaned into existence to begin with.

You look back, and all the central banks are like this. They’re all based on the same design. For this argument, let’s just look at the United States. The monetary base is around $4 trillion. About $2-2.5 trillion is reserves at the Fed, which isn’t flowing. That money just sits there as the banks’ reserves.

Then there’s about $1.5 trillion of physical currency. That’s money that actually exists. That’s the base money. All the other money is basically digital money, ones and zeroes, that’s loaned into existence and it shows up on a ledger somewhere that says, “You have this money,” etc.

If you look at the total banking system, the banking system has – depending on how you measure it — say $15 to 16 trillion of banking assets. If $4 trillion is base money, then that means there’s $12 trillion of money loaned into existence, and some other assets, etc.

Anywhere from $10 to 12 trillion is loaned into existence. There’s interest attached with that $10 to 12 trillion.

Alex: A lot of interest!

Brent:  Right. If that money isn’t circulating, those loans go into default. You can think of it similar to a collateral account on a brokerage account. If you buy on margin and whatever you buy doesn’t go up, then the equity gets eroded and you have to resupply the collateral, or else the whole account fails.

It’s very similar. If GDP and money velocity are not high enough, there are not enough transactions going on to satisfy all those interest payments. Well, then the Fed has to come in and plug the hole and add money back to the collateral, which is the base money.

That’s the stock and the flow. If you look at the velocity of money, it really started in the late ‘90s, probably around – this would be a great question for Jim Rickards, who I know you’re very close with. It all started around the ’98 crisis, with Long-Term Capital Management, the Russian debt crisis, and the Asian currency crisis.

You can look at the velocity of money. Going back there, it’s been on a downward slope ever since then. Now, there have been a couple times where it’s turned back up for a year or so, but then it’s turned right back down. We’ve been in this downward motion for 16 years now, almost 20 years now.

You can go back, and you can look at the reserves, at the Fed, and the base money, and it’s ramped up since then. There’s a direct correlation. Money is not moving, and they have to continually fill up the collateral. That’s the essence of the stock and flow. That’s the essence of the flow in our monetary system.

The other part of it is if the money is circulating and there are no problems, the interest attached to it, even if it’s just 1% a year, it becomes an exponential system. It doesn’t matter. You can start with the number 1.

Alex:  I agree.

Brent:  If you take 1 x 1.01, year after year after year, it will eventually grow exponentially. It’ll turn straight up. Then you get the inevitable blow-up process that ends with a magnificent crash.

Alex:  That’s the hockey stick on the chart.

Brent:  Exactly. It doesn’t really matter whether or not the money is flowing or not flowing. That design flaw of the money loaned into existence is a catastrophic flaw, and it’s bound to fail.

Alex:  Yes, I agree. We’re not talking about philosophy here. This isn’t about whether this monetary system or that monetary system is a good thing, or a gold standard is a good thing or a bad thing, or whether Keynes is a good thing or a bad thing. We’re talking about math right now.

Brent:  If you believe in math, buy gold. Our monetary system, mathematically, certainly will fail. That shouldn’t really be a provocative statement. It’s just math. You can argue with math if you want to, but you’re going to lose.

Alex:  You’re going to lose, absolutely. I totally agree. That’s something that I think a lot of people don’t realize about our monetary system. I think there are a lot of people caught up in this argument about whether Keynesian is a good thing, whether the gold standard is the way to go, or whatever, all those kinds of things.

I’m not going to argue that one way or another right now. If you just think about the math, that’s really critical. People need to understand that it’s going to change. It’s only a matter of time.

Brent:  Exactly.

Alex:  Let’s move on and talk about regulation. That’s been a big topic for the current incoming Trump administration, and I’m sure for business owners for years now, at least going on a decade, and probably longer.

The amount of regulatory creep that’s been occurring has been getting more and more intrusive, and not just in the United States, but globally. Our fund operates internationally. We’ve done business globally for a long time. We’ve seen the regulatory creep effect there and how that’s affecting things.

What do you think is going to happen as this creep continues to impact the banking system? How does this present a problem?

Brent:  That’s a big topic. There are a lot of different ways it can be a big problem. There’s probably one area that I can focus on that will help explain it in a somewhat simple manner.

If you think back, after all the problems that happened, let’s call it, between 2006 and 2010: the run-up and the real-estate bubble, the explosion of the real-estate bubble, and then all the ancillary negative effects that happened for the couple years after the bubble popped.

The banks did a number of things wrong. We can just leave it at that. We don’t have to get into all that detail right now. They did a number of things wrong.

Alex:  I think everybody agrees, yes.

Brent:  The public bailed them out. Perhaps rightly so, the government said, “Well, we’ve got to go in and do something to make sure this doesn’t happen again.” Like all good government programs, they might even start off with good intentions, but they end up with a really bad result.

One example is the Basel 3 and Dodd-Frank requirements that are now imposed on the banks. It makes sense. The Basel 3 comes from Basel, Switzerland, where the Bank for International Settlements sits, as potentially the central banks’ central bank.

They are trying, on a globally coordinated basis, to establish a framework through which all these other central banks, governments, and monetary authorities can craft a global solution to keep this from ever happening again. Again, it starts off with good intentions.

The way that we can use it as an example is they thought, “Well, we need to make sure that the banks are adequately capitalized so that if we ever have another downturn, they don’t go through this big liquidity event where their capital evaporates and the public has to bail them out.”

In theory, that sounds pretty good. The problem is getting all these different countries to agree on the same thing. Then, of course, politics comes into it. They say things like, “You can hold these different securities on your balance sheet, but they’re all going to have different ratings. Of course, they give their own debt (the country’s debt) a zero-risk rating. You can buy a Greek bond, a Portuguese bond, a US bond, or a Chinese bond, and they’re essentially all given a zero-risk rating, which on the face of it is ridiculous, right? But that’s the rule.

The intention is good. That’s just one example of where banks can now hold risky assets on their balance sheet and say they don’t have any risk at all when, in fact, they’re carrying a lot of risk, especially when you look back.

I don’t know if there’s ever been a country in history that ever paid off its debt without inflating it away. The fact that you take the one entity, which is the government, which has never made good on a debt, and you give it a zero-risk rating, in my opinion, it’s a bit ridiculous. That’s just one example.

Let’s take it a little bit further. The framework for the US is Dodd-Frank. One area in particular that they took a look at was money market funds.

For several years, they have said that by October of 2016, money market funds will have to mark their book to market. Basically, what that means is for a long time, these money market funds were created as a way to provide short-term financing for banks and other big corporations. It’s almost like cash.

People that are invested in it, they kind of assume that it’s cash, so it always just keeps a par value. If you put a dollar in, it shows a dollar on your statement. But in actuality, these are bonds underlying these money market funds. Now, they’re very short-term bonds, but they’re bonds, and there is risk.

Occasionally – especially like in 2008 – there were some failures, and some of these money market funds broke the buck so to speak. They actually printed 99 or 98, rather than 100 cents on the dollar.

Well, in their infinite wisdom, the government said, “We can’t have that anymore. We’ll give you a few years to get on board, but by October 2016, you’re going to have to get these funds to market.”

That was the case for prime funds, which are corporate-backed funds, but not government funds. The government doesn’t have to mark their books to market, because, “We’re the government. We’re never going to default. We don’t have any risk.”

What you saw, the natural progression, is people who didn’t want to take that risk left prime funds, and they moved all their money into government funds. There’s been a big sea change from prime funds to government funds.

Perhaps on one level that’s good, but the problem is that now you’ve got even more people huddled and concentrated in one area – again, government funds – which, in my opinion, have in many ways more risk than a AAA-rated corporate bond does. That’s one example.

Not only that, but a lot of the banks that they’re trying to protect against, they used to get their short-term funding from these money market prime funds. Now that those money market prime funds are gone, they don’t have that competition. There’s no competition between prime funds and prime funds anymore. They’ve lost one area of financing, so the cost of financing has gone up.

You can look at things like LIBOR. If you look at LIBOR between July of last year and October of last year, it almost doubled. A big part of it was because of this movement in the money market funds. Now you’ve got a higher concentration of funds, a higher cost of funds, and a lot of people concentrated in an area that perhaps has more risk than they otherwise think it has.

That’s just one example of how regulatory good intentions end up being long-term bad solutions. That’s probably the easiest way I can explain it.

Jon:  Thanks, Brent. Just talking of concentration, do you have any observations about the whole phenomenon of “too big to fail,” of the largest banks simply getting larger and larger and, in that respect, becoming unassailable?

Brent: It’s really true. You’ve seen these banks get bigger and bigger. I don’t have the market capture right in front of me, but they’re much bigger now than they were in 2008.

If you total up all the fines that the banks have paid between 2008 and 2016, it’s something like $300 billion. Now, name me another industry where that industry can pay $300 billion in fines, still be in business, and still have their profits going higher. You don’t pay $300 billion in fines if you’re treating your customers well. What other industry can do that to their customers, stay in business, and grow? It’s ridiculous.

Alex:  Yes, it’s crazy.

Brent:  On the face of it, it’s just absurd. Another example where this is becoming a problem is that as regulations have gotten more intense and more severe, part of the reason the big banks have gotten bigger is they’re the only ones that can afford to hire the lawyers to comply with all these rules and regulations.

The smaller community banks or regional banks, who didn’t have anything to do with the problems that caused 2008/2009, are the victims of it, because they’ve now had to implement new regulations and procedures, and they’ve had to hire ten lawyers instead of one lawyer, etc. They basically can’t compete against the big guys, so they either go out of business or they sell to the big guys, and the big guys just get bigger again.

Not only that, but then you’ve got a big national bank, perhaps, representing a small manufacturing facility in Dubuque, Iowa. The big national bank has no idea what goes on in Dubuque, Iowa. Maybe they can’t even make that good of a decision of whether that company deserves better credit, worse credit, or a loan.

You’ve gone away from community banks serving small businesses to these mega-banks trying to write rules and regulations that apply, black and white, to everybody, when it’s really a grey world.

I see big problems with all these regulations. I’m a free-market guy. I think the free market solves all the problems. People say, “Yeah, but if you don’t have regulations, then all these banks would have gotten away with murder.”

No, they wouldn’t have. They would have been bankrupt. They would have been gone, and the problem would have been solved. It’s a cute way of looking at it, but I still believe in capitalism.

Alex: This is an area, Brent, where you and I largely agree. The problem, as you explained it, feeds on itself. It’s raising the cost of entry into the market by creating all these regulations, so smaller businesses really can’t compete.

The problem with that, obviously, is if there’s no competition, then there’s nothing that’s going to be keeping these guys honest, if they can get away with it.

Brent:  Right.

Alex:  If we can circle back around to our earlier topic for just a minute, I think that it might be helpful for our listeners to know a little bit more about velocity of money and what it means. Not everybody understands that. You and I, in the industry that we’re in, we get that. We understand what that means.

As far as velocity of money, the last chart I looked at from the Fed, the current velocity of money, it hasn’t been this bad since maybe 1971 or ’72. It’s absolutely horrible. I think sometimes people wonder, “Since the last global financial crisis, we’ve printed up trillions of dollars. Those dollars have been injected into the economy, but we aren’t really seeing inflation.”

All the Keynesians are coming out, going, “Look, money creation doesn’t create inflation after all.” The part they’re leaving out is the whole velocity part. What does that mean? What happened there? We had all these trillions of dollars injected into the system, but we really haven’t seen much inflation. What’s going on with that?

Brent:  There will be people out there that will say, “What are you talking about? We’ve got inflation. House prices have doubled. The stock market has tripled. My Thanksgiving dinner cost me $150, rather than $89.”

I think there has been inflation, and while there has been some consumer price inflation, in general it’s been more asset price inflation than consumer price inflation. A big part of that is, again, the way the monetary system is designed.

The way it’s designed is the central banks give the banks the money. Then the banks give the money to main street. There’s not a system where it goes from the central bank to main street. The mechanism by which it goes to Main Street is loans, that money creation that we talked about earlier.

Again, if you look at all the QE (quantitative easing) that we’ve done, the bailout packages, etc., however you want to define those packages, it was done as a way where the central banks bought assets from the banks. In exchange for taking those assets from the banks, they gave the banks cash.

The banks did not then loan it out into the market, as the central banks were hoping that they would. You can make a big argument. Did they not loan them out because they didn’t want to, because they wanted to keep it for themselves and collect interest on it? They actually get paid by the central bank just to hold onto it.

Or was there no demand? Was the consumer so tapped out that there was no demand for the loans? I think that would probably be a whole other hour-long topic in itself.

Alex:  Yes.

Brent:  Regardless of whatever the reason is, that money did not flow to main street. That is what I was talking about earlier. As velocity fell, the reserves of the banks at the Fed increased. It’s almost a one-for-one correlation.

Now, a lot of people will say, “That’s why we haven’t had inflation. You shouldn’t worry that it’s not inflationary because it’s just in the banks.” Technically, that’s correct, but it’s very disingenuous, in my opinion.

The reserves at the Fed are what the banks use as collateral to make new loans. Even though they haven’t made new loans yet, they’ve got $2 trillion in reserves now that they didn’t have ten years ago. On a 10:1 reserve-to-loan ratio, they need to keep one unit of reserves for every ten they loan out. $2 trillion of reserves could become $20 trillion in new money.

Ten years ago, the monetary base was $800 billion. Now it’s $4 trillion. On reserves of $2 trillion, they could loan another $20 trillion into existence. The total banking system assets right now are around $15 to 16 trillion. They could essentially double the size of the banking system on those reserves that have been given to them in the last ten years. If and when that happens, that would be highly inflationary.

It’s kind of like a dam being built. We’ve had all this liquidity flowing towards main street, but the banks built up the dam. All that flow, all that money from the Fed, is just building up behind this dam. It kept getting bigger and bigger. Now there’s a big lake there. That’s the reserve. It’s become this huge lake.

If that dam ever breaks, or if they ever open the levies on that dam and start loaning it out, that can lead to even higher pressure of that flow coming up. That can lead to even higher inflation, if and when it happens.

I can’t tell you for sure it’s going to happen. I think it is going to start to happen, for reasons that we can get into in a little bit. Those reserves that have been built up, that everybody says, “See, these aren’t inflationary,” they’re the tinder for the inflationary fire that can come later.

Alex:  I totally agree. It’s interesting to me, because when there’s no velocity – in other words, people aren’t spending money and loans aren’t being made – then that creates what you were talking about, that big sucking sound in the flow of money. They have to continually add more dollars to the system to make up for that sucking sound, which is only making this lake bigger.

Brent: Exactly. You touched on the key to everything — the velocity of money. If the velocity of money picks up, then you’re going to have inflation, and maybe this flawed system can go on a little bit longer.

If they cannot get the velocity to pick up, then inflation is not going to pick up, growth is not going to pick up, and we’re going to be back to this deflationary death spiral. It all hinges on the velocity of money.

Alex:  Here’s another interesting aspect of that. What a lot of people don’t realize is velocity is closely tied to psychology.

Brent:  Absolutely.

Alex:  The thing that is guaranteed is that the psychology will not stay the same forever. It’s almost like a perfect setup. The psychology is going to shift at some point. When it does, we’re set up to unleash that gigantic dam.

Brent:  That’s exactly right. In many ways, inflation is more psychological than it is economics or math. It’s just pure psychology. This is where I think the Fed has really gone wrong, and I alluded to this in one of my recent presentations.

What I mean by that is if we go back a year, the Fed raised interest rates in December of 2015 and indicated they were going to raise two or three times in 2016. Well, got into spring of 2016; they didn’t do it. Got further into the spring, and they didn’t do it. Got into the summer, and they didn’t do it. Got into the fall, and they didn’t do it.

They were rapidly losing credibility. Not only that, but in Europe they tried negative rates. In Japan, they tried negative rates. All this talk of they were going to raise three times, and they couldn’t even raise once. They’re like the little boy who cried wolf. They kept saying, “It’s coming. It’s coming. It’s coming.”

In the summer and the fall, the Fed kept saying, “We’re going to go slow. We’re going to slow. We’re not ready yet.” But the market – and maybe that was psychologically driven – started to say, “You know what? Negative rates are ridiculous. Interest rates are at 5,000-year lows. We’re at negative-to-zero-percent interest rates. Do we really want to buy bonds at negative interest rates?”

I think the peak was in August or September. I think Austria issued an 80-year bond at a negative rate.

Alex:  Wow!

Brent:  It’s just absurd. Then there did start to be some growth prospects pick up. Some inflationary signals started to pick up. Then Trump won. Trump’s policies, I believe, are inflationary policies. I believe it for different reasons than a lot of other people believe it, but I believe they are inflationary policies.

In the last 60 days before the last Fed meeting of the year, rates really started to rise. Stock prices started to rise. Inflationary pressures started to rise. I think that allowed them to raise rates. In that way, I think the market front-ran the Fed and allowed the Fed to raise. I’m not sure the Fed wanted to raise, but I think they had to raise. That’s going back to the psychology.

I think for the last two or three years, with the Fed saying, “We’re going to keep rates low,” and other central banks saying, “We’re not only going to keep them low; we’re going to go negative,” this is their ivory tower, some PhD economics department psychology, telling them, “If we lower rates, people will borrow more.”

I think in the real world, the central banks are supposed to be the smartest people in the room. They’re supposed to be the financial geniuses. Well, the financial geniuses are telling me that things are so bad that we’re going to have negative rates. Why would I go take out a $1 million loan and build a new plant? Why would I hire that new person, if all the smart people in the room are telling me things are so bad that we have negative rates? I’m just going to wait, and when things finally get better, then I’ll hire.

I think that low rates and negative rates are actually deflationary, as opposed to the ivory-tower opinion that it’s inflationary. Now that rates started to pick up and the Fed raised, I think the market bailed them out. I think for them to keep this momentum that they’ve got, they have to keep on the raising-of-rates train.

I think if they now go back and say, “Oh, we’re not going to raise anymore. We’re going to slow down,” then they lose all momentum and we go back into that deflationary environment.

From a psychological perspective, if you’ve been sitting on this cash and you’ve been waiting for the time, you haven’t built that plant, you haven’t hired that person, or you haven’t invested in that new project because the rates are low and maybe even going lower, maybe even going negative. You’re saying to yourself, “I’m just going to wait until we get through this and things get a little bit better.”

Now if rates start to rise, maybe on the first rate rise you don’t do anything. But on the second one, you’re probably going to start going, “Maybe things are getting a little bit better.” By the time the third or fourth raise comes along, or by the time the market takes interest rates higher (even if the Fed doesn’t), now that CEO, asset allocator, or investor, says, “Holy cow, things are starting to take off. I need to make a move.” Then you start to see that velocity of money pick up. Then it becomes a self-fulfilling prophecy to the upside.

That’s where I think Trump comes in. I think Trump is such a wildcard that psychologically, he may change behavior in the market. Not because he’s magic and not because he’s our savior. Not because he’s this new-found hope that America is going to be great again.

He’s going to do things differently. Rightly or wrongly, he’s going to do things differently. He’s going to put some policies in place that I think are inflationary. I think if the central bank follows his “lead,” for lack of a better word, and continues this upward projection of interest rates, then we might get some change of behavior, and we might get that velocity of money to pick up. With all those reserves that have been built up, inflation could pick up rather quickly.

Jon:  Brent, can I ask you just one thing about Trump? You mentioned that you, like many people, see his policies as inflationary. I think for most people, they’re thinking about his plans for massive infrastructure spending. But you indicated you had a slightly different angle on this.

Could you explain why you think his policies are inflationary?

Brent:  Yes. This is probably where I start to differ from the typical market observer, or maybe even the typical gold investor, for lack of a better word. I don’t want to speak for anybody else. I’m certainly not trying to put words in anybody else’s mouth, but I think the common view in the precious metals community is one of the main reasons you buy gold is that fiat currencies are fundamentally flawed. The governments will print them to pay for their bad debts, and that currency will be inflated away, so you need to own precious metals as a way of protecting that purchasing power.

Over the long term, that’s certainly a very valid reason to own precious metals. It may be the top reason to own them. That said, I don’t think that it’s the best reason to own gold right now. I think it will be in the future.

Right now, I think that Trump’s policies are inflationary because I think they are going to lead to a stronger dollar. I think we’re going to be in a unique point in time where the stronger dollar leads to higher inflation. I know that sounds a little off or different. Let me explain to you why.

I believe that we’re going to get into an environment where the dollar, gold, and potentially even the Dow are going to rise together. I don’t think we’re there yet, but I think that’s what’s going to happen in the years ahead. But there’s a window of time that we need to go through to get to that place.

I think the strong dollar is here. Now, it may weaken a little bit over the next month or so, or maybe even over the next quarter. I don’t think it will, but if that were to happen, I think it would be a short-term thing.

I did this presentation over last summer. I called it, “Step into Liquid.” It listed all these different reasons that I thought the dollar would get stronger. I’m happy to share that with anybody that wants to see it.

I think the Trump policies are going to make that thesis that I had even stronger. Here’s the reason. Like it or not, the world is still on a fiat system. Like it or not, the dollar, as flawed as it is – and it’s extremely flawed – is still the world reserve currency. It will be the world reserve currency until the moment it’s not.

Regardless of how you view the dollar, institutions, countries, companies, corporations, people who trade, people who import and export, they need dollars to facilitate world trade. If you look at all the dollar debt in the world, we go back to this debt super-cycle. There are hundreds of trillions of dollar debt in the world.

Long story short, I think the supply/demand issue on the dollar is going to push the dollar higher. I’ll get into the reasons why here in just one second. A lot of times, people will say, “Yes, Brent, but they can print the dollar to oblivion. Therefore, they can give out all the supply that way.”

Absolutely true. But right now, they’re not doing it. In fact, they’re doing the opposite. They’re decreasing the amount of money in the world. They’re raising interest rates. They’re sucking all that money back into the US, as opposed to sending it out to the rest of the world. If they change course, then fine. But right now, they are not doing it.

If you go back to the supply/demand issue, like I said, there’s hundreds of trillions of debt in the world. Let me give you a few numbers. If you look just at the US debt, $20 trillion. The Fed owns $2.5 trillion of that. Let’s say it’s $17.5 trillion.

In addition to that, we talked about the loans in the banking system. The loans in the banking system are anywhere from $10 to 12 trillion. Let’s just call it $10 trillion. You put $10 trillion on top of $17 trillion. Now we’re at $27 trillion.

Now, outside the United States, entities, institutions, corporations – however you want to define them, outside the United States – have issued another $10 trillion of dollar-based debt. Put that $10 trillion on top of the $27 trillion we already have. Now we’ve got $37 trillion.

We haven’t even talked about US corporations at this point. So far, we’ve just talked about the US debt, the banking system, and the international entities’ debt. Let’s just use $37 trillion as an example. The average interest rate on the national debt is, I think, 2.25%. At $17 trillion, that would be, let’s say, $300 to 400 billion.

On the other $10 trillion that’s in the banking system, let’s just assume for the sake of argument that they can get the same rate as the risk-free rate of 2.25%, which is ridiculous. But let’s just pretend they can. That’s another $250 billion of interest payments.

Then we take the international $10 trillion. Again, let’s assume they can get the same rate as the US, world reserve currency, risk-free rate of 2.25%. There’s another $250 billion a year. Now we’re somewhere at $800 to 900 billion a year in interest payments alone for the dollar.

That is demand. That is $800 billion of demand for the dollar every year, just to pay the interest. Without the velocity of money picking up, where are people going to get $800 billion to pay the interest payments?

The point is that there’s a lot of demand for dollars. We haven’t even talked about the demand for trade, for new trade, for new businesses. But just in interest payments alone, we’re approaching $1 trillion a year in global demand for dollars.

Now let’s bring that back to Trump’s policies. It’s a combination of Trump’s policies and the Fed. The Fed, when they were providing QE and they were giving dollars to the world that would then either get loaned into the banking system or the banks would use them as collateral to make trades, more dollars were being provided to the world. The spigots were open, for lack of a better word.

Now, rates are going up. It’s costing more money. Not only are we not providing new dollars to the rest of the world, but we are saying it costs more to service the ones that there already are.

Trump is talking about putting up border tariffs, where any goods coming into the US would have to pay some kind of a tax. That means prices are going higher. That means even though the dollar would get stronger, the prices of commodities would go up. Now we’ve got a potentially stronger dollar and some higher prices.

Also, if you think about it, he has said that he would like to build the wall with Mexico, for example. Mexico, they’re not going to want to pay for the wall, but he’s going to try to negotiate tougher treaties with them. Whether he can do it or not, I don’t know, but he’s going to try to negotiate tougher treaties. In other words, he wants to send less dollars to them and more of their stuff to us.

The point is that he wants to provide less dollars to the world and more dollars to the US here. That’s a strong-dollar positive. Let’s suppose rates continue to go up – and I think they might. They might not, but I think for the central banks of the world to have any chance, I think we need rates to rise. That’s the only way to get the velocity of money going.

If rates go up here, and they stay flat in Japan or Europe, or they go even more negative in Japan or Europe, asset allocators should bring more money to the US just to park it in dollars and get some kind of an interest payment, rather than zero interest payment. That alone makes the dollar more expensive.

Then another Trump policy is he wants these corporations, who have these big cash balances, to bring that cash back to the US. The reason they don’t is that right now there is very unfavorable tax treatment. If he says, “Listen, you bring the cash back. We’ll charge you a one-time 10-15% tax on it, rather than the current 40% rate,” I can imagine a lot of people are going to bring that cash back.

That makes the dollar stronger. Then the interest rates go up even higher. More capital is drawn to the US. Not only that, but as the dollar gets stronger, if we go back to the $10 trillion that the international entities own, it’s even harder…

Basically, they took out big loans, and they were involved in currency speculation at the same time, thinking their currencies would appreciate against the dollar. Now it’s gone sideways on them. Now they’re upside down. The dollar is getting more expensive. It’s even harder for them to service that debt. They go into a decline, which makes us look even better on a relative basis, which makes the dollar go even higher.

Alex:  It’s a self-feeding process, isn’t it?

Brent:  You can get into the vicious circle, where the dollar goes higher. Unless the Fed reverses course and starts providing more dollars to the rest of the world, then you get into the situation where the dollar gets even stronger.

Then you think of a place like China, which is going through its own credit crunch, and is one of the biggest owner of treasuries. There’s all this money trying to get out of China. When the money leaves China, China has to take the yuan that’s trying to get out and give them dollars.

The way that they get the dollars to give the people that are leaving is to sell their treasuries to provide the dollars. If they sell the treasuries – and they’re the biggest owner of treasuries – then that pushes yield up on treasuries. Now interest rates are even higher, and the dollar goes higher again.

The point is that there are all these different forces. Because the world still uses the dollar as the world-reserve currency, and because the world still uses dollars to operate, there’s a supply/demand imbalance.

It’s very similar to the gold argument. Let’s say the argument with gold is that there’s not that much out there, and when the world realizes that you need gold, the demand is going to overwhelm the supply.

Then you say, “Yeah, but they can just print more.” You can’t print more gold, but you can sure print more shares of GLD, and you can certainly, out of thin air, create more options and futures contracts on the COMEX.

A lot of times, the gold community will talk about the fact that ETFs and the COMEX provides “paper gold,” which keeps the price from going exponential. Again, that’s a conversation we could spend two hours on.

The same kind of dynamics currently exist for the dollar. They can do that. They could print and provide as much currency as the world needs. But right now, they’re not doing it. Until they start doing it, demand is overwhelming supply, or I think will overwhelm supply.

That’s my whole “Trump is inflationary” perspective. I hope I made sense. I know I was rambling for a long time.

Alex:  No, it makes total sense. Brent, I think you do some of your best work when you’re ranting there like that! That’s a really good argument for a strengthening dollar.

Part of your thesis is that a strengthening dollar is actually going to cause its own destruction at some point, or its own demise at some point. Do you want to talk about that?

Brent:  Yes, right. It’s like taking steroids. It makes you stronger in the short term, but it also might kill you.

Alex:  Right. Explain this. How does this happen? What does it look like when the strengthening dollar causes its own demise?

Brent:  I think it doesn’t happen right away. I don’t think it takes much longer for the pain to start showing up in other places around the world. I could be very wrong on this, but for now, let’s assume that I’m right that rates start to rise in the US, the Fed continues on a path of raising rates, and we start to get a little bit of inflation in the US as a result.

If we take that as an assumption for right now, I think the pain starts to show up in China very quickly. I think the pain starts to show up in emerging markets very quickly. I think it’s not too long in Europe before they start to feel pain as well, because they’ve got a number of problems, Greece and Italy probably being two of the biggest ones, not to mention dealing with Brexit.

What I think happens is the dollar starts to escalate in price pretty quickly. A couple of Trump’s cabinet picks have made comments about how the strong dollar could hurt us short term, and the dollar actually sold off on that news. At one point, he said something like, “It’s nice to have a strong dollar for bragging purposes. For other than that, it doesn’t really do us a whole lot of good.”

There’s all this innuendo that Trump wants a weaker dollar. I think he has more negotiating power with a stronger dollar. I think these foreign countries and these different trade groups, he’s talking about getting us out of these different trade treaties, I think these trade partners are going to start to complain about the strong dollar. I think the IMF will probably start to complain about the strong dollar.

Without some kind of a policy – and not just talk… Trump can say something, and the dollar might trade down for a couple weeks, or a month or so. But unless he actually does something to weaken the dollar, the market is going react and it’s going to rebound.

I think it probably doesn’t take much more than a year or two years before a bunch of the trading partners, the IMF, some of the monetary authorities start to talk about how the strong dollar is not conducive to world trade and world growth. They may even have another Plaza Accord type…

I think without them having some kind of a Plaza Accord type of agreement, or some kind of a coordinated devaluation – everybody devalues against gold or something like that – I think it just goes until the strong-dollar grips the world.

That’s why I say I think the dollar and gold rise together. As these problems start to pop up, I think gold and the dollar will start to rise together as a safe-haven flight to both of those assets. Ultimately, the dollar debts will have to get bigger during all of this as well. For the velocity of money to pick up, debt has to grow.

We’re already way in over our heads on debt. The debt will have to get even bigger. Eventually, people will realize the debts can never get paid off. The currency in which all these debts are issued is going to have to be worthless. That’s when gold separates itself. Maybe at that point, people give up on fiat currency altogether. Then maybe we go from the strong dollar to a weak dollar because people just flee the currency.

That’s how I see it playing out. I would think that in the next 12 to 24 months, the strong dollar is going to start to hurt the global economy. I think initially they will try to do these small half-measures, at best. They’ll try to talk it down. I think eventually they’re going to have to do something more dramatic and permanent in order to combat the strong dollar.

Here’s the great thing about this argument. If I’m completely wrong and they reverse course, and they try to inflate away the dollar right now, I own a lot of gold and I should do very well in that environment as well.

I think it’s my job to try to stay as impartial as possible, and try to figure out what’s going to happen. It’s all about probabilities. Even if I think the probability of something happening is only 1%, I think it’s part of my job to figure out, “We know we think there’s only a 1% chance this is going to happen, but if that 1% chance was to happen, what would have to happen for that 1% to happen?”

I think part of my job is to think through that and focus on that 1%, even though I don’t think it’s going to happen, so if that does happen, I’m not totally caught off guard and I kind of understand the reasons why it’s doing that.

I think that’s one thing I would recommend to anybody. I think sometimes it’s very easy to get caught in an echo chamber. It doesn’t mean that the echo chamber is wrong. The echo chamber that you’re in may be 99% right.

But you don’t learn a lot in the echo chamber. You can learn a lot by listening to that 1%. Even if you vehemently disagree with them, listen to that 1%. Try to figure out where they’re coming from and figure out what kind of crazy scenario would have to happen for that 1% to happen. That way if it does happen, you’re not totally caught off guard.

Alex: Outstanding. You know what, Brent? I think we’ve got a new nickname for you. You are “The Tenth Man.” I don’t know if you’ve heard of the tenth-man principle. The idea there is if there’s a board of directors and the board consists of 11, and you’d be the 11th man. Ten out of the eleven all think one way. It is your duty to disagree and take the opposite position.

Brent:  There you go.

Alex:  I think that’s really great about the way you look at things, and look for things that everybody else really isn’t looking at. This has been a great discussion with you today. I want to be respectful of your time. I really appreciate you taking the time to talk to us about these things.

Brent:  I appreciate you inviting me to come on. I love talking about this stuff.

Listen, I’ve been wrong a lot of times in my life. I’m going to be wrong a lot more times. I like talking to people like you and others that can agree with me on some things and disagree with me on some things. Just talking through it helps crystalize some things, but it also helps figure out where you might be wrong in some things.

I think the one thing I would say is when I really started studying this stuff and really started digging in, the reason that it brought me to gold – and I know you probably agree with this, as well – is that regardless of which way this goes, the flaw in the monetary system exists. That is a fact. It’s a mathematical fact.

Alex:  It’s math.

Brent:  Regardless of which way it goes, whether it goes south because of the deflationary forces, or whether it goes south because of the inflationary forces, gold cannot be deflated away, and gold cannot be inflated away. Gold is a constant. It’s an element.

That is the one part of your portfolio that, regardless of which way this resolves itself, will still be standing at the end of the day. I think that’s why it has to be the anchor of everybody’s portfolio, regardless of which way you think it plays out.

Alex:  Totally agree. Brent, thanks so much for being with us today. We greatly appreciate your time. We’ll have to do it again sometime.

With that, Jon, I’m going to hand it over to you.

Jon:  Thank you, indeed, Brent Johnson, for sharing your insights with us this today, and thank you, Alex Stanczyk. Most of all, thank you to our listeners for joining us in this first episode of Global Perspectives.

Let me encourage you to follow Brent and Alex on Twitter. Brent’s handle is @SantiagoAUfund, and Alex’s handle is @AlexStanczyk. Goodbye for now, and we look forward to joining you again soon.

 

Listen to the original audio of the podcast here

Global Perspectives: February, 2017 Interview with Alex Stanczyk and special guest Brent Johnson

 

You can follow Alex Stanczyk on Twitter @alexstanczyk

You can follow Brent Johnson on Twitter @SantiagoAuFund

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This Podcast is not an offer to sell, nor a solicitation of an offer to purchase, any security. This Podcast is intended for general education and information purposes only, and may include broad discussions of markets, geopolitics, monetary policy, and geoeconomics. Nothing in this Podcast constitutes investment, legal or tax advice, nor an evaluation of or prospectus for any particular investment or market, including gold. This Podcast should not be relied upon to make any investment decision. You are encouraged to seek the advice of qualified financial, legal and tax advisors before making any investment decisions.

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Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles January 17th, 2017

Jim Rickards and Alex Stanczyk, The Gold Chronicles January 17th, 2017

Topics Include:

*Power Triad Dynamics, USA, China, Russia
*Why China is concerned about a Trump Presidency
*Capital flows out of China continue at a robust pace
*China will burn through all of its liquid reserves in one year at the current pace
*Analysis of China’s three options
*Which conditions could place the USA and China in a state of war over the South China Sea
*Why gold moving into China is like going into a “Black Hole”
*Physical gold flows from west to east are exacerbating tightness in physical supply, and could lead to strong price moves when the west steps back into the market
*War on Cash and its impact on global systemic risk
*India demonitization has been a disaster
*End game plan for War on Cash is to force people into digital accounts
*Solution to avoiding an all digital system is to get out of it, gold or silver
*Breakdown of the SDR as sovereign money versus money for people
*IMF permission requirements from countries to print SDR’s

Listen to the original audio of the podcast here

The Gold Chronicles: January 17th, 2017 Interview with Jim Rickards and Alex Stanczyk

 

The Gold Chronicles: 1-17-2017:

Jon:  Hello. I’m Jon Ward on behalf of Physical Gold Fund. We’re delighted to welcome you to the latest webinar with Jim Rickards and Alex Stanczyk in the series we’re calling The Gold Chronicles.

Jim Rickards is a New York Times bestselling author, the Chief Global Strategist for West Shore Funds, and the former general counsel of Long-Term Capital Management. He is currently a consultant to the US Intelligence Community and to the Department of Defense. Jim is also an advisory board member of Physical Gold Fund.

Hello, Jim, and welcome.

Jim:  Good morning, Jon. How are you?

Jon:  Great, thank you.

Jon:  We also have with us Alex Stanczyk, Managing Director of Physical Gold Fund. Alex is an expert in the physical gold industry dealing with the logistics chain from refinery to secure transport and vaulting. He has lectured globally to investor, institutional, and government audiences on the role of gold both in the international monetary system and in investment portfolios.

Hello, Alex.

Alex:  Hi, Jon. It’s great to be here.

Jon:  Alex will be joining me in the conversation with Jim, and he’ll be looking out for questions that come from you, our listeners. Let me say that your questions today are more than welcome. You may post them at any point during the interview, and as time allows, we’ll do our best to respond to you.

Jim, let’s start with a global question. You’re just back from a trip to China at a time when military tensions are rising in the South China Sea, and you’ve returned to find Washington and the media consumed with the question of Russia.

Stepping back from political dramas, would you summarize your current perspective on the triad of world powers: Russia, China, and the United States? How do you expect the balance of power between these three to shift in the coming years, and what impacts do you anticipate on world markets and the monetary system?

Jim:  That is a huge question, Jon. It’ll give us a lot to talk about and chew on. The key phrase you used was ‘the balance of power,’ and you correctly identified the three most important players: China, the U.S., and Russia. There’s a lot there with the impact on markets, so let me unpack this for our listeners.

The starting place is the idea that there are only really three countries in the world of primary importance: the U.S., Russia, and China. The U.S. and China is easy for most people since they’re the first and second largest economies in the world.

You can debate what order they come in, but I use nominal GDP, which would put the U.S. first. Some analysts use what’s called purchasing power parity GDP, meaning adjusted for what you can actually buy with the money, which would put China first.

But that’s an academic debate; it doesn’t matter really. They’re the first and second largest economies in the world and the second largest bilateral trading relationship in the world, so clearly, they’re paramount.

Russia is a more interesting case as the 12th largest economy in the world. It’s not in the top two or three, but it is the largest landmass in the world, it is a nuclear power, it is the second largest energy producer in the world, and it is in effect an imperial power. So, by all measures, I would include Russia in the big three. Everyone else is either a secondary power, a tertiary power, an ally, or a proxy. They tag along with one of the big guys, but these are the three that really count.

I suppose a lot of our listeners may have played the Parker Brothers’ board game of Risk. If you know how Risk is played, it’s a geopolitical strategy game. You usually start with five or six players, but within a short period of time, you’re down to three. Two of those players – either explicitly or implicitly – realize that if they make an alliance and systematically crush the third player, that player will be wiped from the board, and then those two will turn on each other to win the game. It’s advantageous to go two against one at least in the short run. That’s a typical balance-of-power play.

For the last seven or eight years, certainly most of the Obama administration, the two-against-one dynamic has applied. From Washington’s perspective, it was China and the U.S. ganging up on Russia. Russia was sanctioned because of Crimea, the Ukraine, and their electoral practices.

Obama more or less said Putin had to go because he was on the wrong side of history. Trump has this reputation as a guy who insults people, but if you look at what Obama has said about Putin, it’s some of the most insulting language I’ve heard between two major heads of state. Putin returned the favor in the last election by the hacks, the releases, and all that stuff, which we don’t need to go into.

It’s ostensibly been China and the U.S. ganging up on Russia, but there was a major failure of U.S. foreign policy sort of behind the scenes. In actuality, the dynamic was Russia and China ganging up on the United States.

One of the keys to U.S. foreign policy the last 50 or 60 years has been to make sure that Russia and China never form an alliance. Keeping them separated was key, but China and Russia have been deepening their alliance through the Shanghai Cooperation Organization – a military and economic treaty – and the BRICS institutions. The BRICS analogs to the IMF and the World Bank, critical infrastructure, bilateral trade deals, bilateral currency swaps, arms sales, etc.

There’s a long list of initiatives where Russia and China have really deepened their relationship. Who’s on the losing end of that? Obviously, the United States. The United States has withdrawn from the Middle East while Russia has stepped in on Syria and elsewhere, China is expanding in the South China Sea, and Russia is expanding on its periphery. They have each other’s back, and it starts to look like the U.S. is the odd man out in the game of Risk.

That is all about to change, and it will change at noon on Friday when Donald Trump is sworn in as the 45th president of the United States. He’s made it crystal clear that the new game is going to be Russia and the United States allying against China. Suddenly, China is the odd man out.

It’s ironic to see President Xi of China in Davos this morning giving a speech about globalization, but meanwhile, behind the scenes, there are all kinds of linkages going on between Russia and the U.S.

This has huge implications for markets. For one thing, the U.S. and Russia are the first and second largest energy producers in the world. Trump will also pivot away from Iran towards Saudi Arabia. Saudi Arabia is the third largest energy producer in the world. If you put the U.S., Russia, and Saudi Arabia in a loose alliance, they dominate the energy markets. They can cut you off, they can supply, they can make the price whatever they want.

Who needs energy the most? China. China has very little oil or natural gas. It does have coal, but if you’ve been to Beijing lately, you know it looks black at noon because the air is so bad and you can’t breathe it. Pulmonary disease is getting pretty common, so China can’t rely on coal beyond a certain point. They’re literally choking themselves to death with the pollution and air quality. So, Russia, the U.S., and Saudi Arabia acting jointly have China completely at their mercy.

Now, let’s bring it to the confrontation between Donald Trump and China, because perhaps that’s the particular consequence of this realignment I’ve described. Trump is the “art of the deal.”

You mentioned I just returned from my trip to China, and I do want to talk about that a little bit. It was a fascinating trip. One of the people I met with was a government official from one of the provinces near Nanjing. I got an email from that person last night saying, “Jim, what’s going on with Trump? You’re an American observer, we don’t understand.”

I heard this repeatedly in China from the elites, so these were top economists, institutional investors, government officials, not the everyday Chinese although I did speak to people on the street.

I was walking down The Bund in Shanghai. When people see you’re an American, they’ll just come up to you. They’re Chinese people who want to practice their English because they’ve been taking English lessons. They don’t have the opportunity to travel abroad, so they love talking to people just to practice English. It was great for me, because I had the opportunity to talk to students, drivers, and everyday people in addition to the elite.

There were two things I heard everyone: 1) they are scared to death of Trump because they don’t get it, they’re worried about what he’s going to do, they don’t understand him; 2) they’re all getting their money out of China as fast as they can. Everybody from major institutions to everyday citizens are getting their money out.

As a quick anecdote, I was speaking in Shanghai to an economic conference group of 40 comprised of the chief China economists of the major banks and brokers including Chinese officers of U.S. Banks, so J.P. Morgan, Citi, and some others. That was the core group, and then they had a conference for about 400 institutional investors and others. Top economists and institutions were my audience, and I was invited as one of the keynote speakers. I have a standard speaker’s fee, and they paid me by wired money from a trading company in Hong Kong!

It’s very clear that even the oldest money is trying to get out of China. China is trying to stop it with capital controls, but everybody is doing all these workarounds. They’re using offshore affiliates, invoicing tricks, and underpricing exports, so they can keep the money offshore. They’re doing whatever they can to get money out of China.

China has a really serious problem. They’re literally bleeding reserves. They’re down over $1 trillion, and it’s going out at a rate of about $80 to $100 billion a month. They’re going to be broke by the end of 2017.

The only point of telling this story is to show that I’ve seen it first-hand in terms of my dealings with people there. The two things I heard were: they don’t get Trump – they’re scared to death – and they’re getting their money out. There’s a lot of stress in China.

Coming back to this email sent to me by my friend who is a government official. I think it was in the Wall Street Journal this morning that hundreds or perhaps thousands of these emails are going out. Basically, the Chinese government has activated their network of government officials, Communist Party officials, saying, “If you know anybody in America who knows anything about Trump, ask them what’s going on.” Because as I said, they’re just baffled at this point.

That’s not surprising because I think even Americans are confused. If the American media can’t figure out Trump, it’s not fair to expect Chinese experts to understand it. I viewed the email I received as a tiny little sliver, my first-hand intersection with a much broader effort on the part of the Chinese to figure Trump out.

I think we can figure out Trump. The key to Trump is that what you see is what you get. I heard a lot of people say, “Oh, he talks tough on trade and currency and all that, but when he gets into office, cooler heads with prevail. He’ll tone it down a little bit.”

No. That’s wishful thinking. Trump can be confusing as he does contradict himself and sometimes you don’t know exactly where he’s coming from, but there’s an amazing consistency in his closest advisors.

People like Peter Navarro, Dan DiMicco, and Robert Lighthizer are some of the key advisors on trade and finance. They’re all hard-shell opponents of absolute free trade, because there really isn’t any free trade. It’s all rigged; it’s just a question of who’s doing the rigging, who wins, and who loses. They understand that, so they’re going to take a very hard line on this.

Here’s the crack-up that I see coming. On the one hand, China is losing reserves at an enormous rate. This is what I call the three-two-one problem, which is that they’ve got $3 trillion of reserves left. Of the $3 trillion, $2 trillion are earmarked and about $1 trillion of that is illiquid, because they’ve invested in hedge funds, private equity funds, and gold mines in Zambia. It’s worth something, but it’s not liquid because they can’t get the money, at least not very easily. Good luck trying to get your money back from Henry Kravis if you invest in one of his private equity funds.

Another $1 trillion must be kept in a precautionary reserve to bail out the banking system since it is completely shot through with bad loans and is technically insolvent. They won’t have to bail it out tomorrow, but they’re going to have to bail it out sooner than later.

They have $3 trillion in reserves left. $1 trillion is illiquid and $1 trillion is earmarked to bail out the banking system. That only leaves $1 trillion of liquid reserves to prop up the currency, which they have been doing, but it’s costing them about $80 billion a month to do that.

That means they’re going to be broke in a year. If this continues, within one year, China will have no liquid reserves. Zero. They’ll be broke as far as their international payments obligations are concerned.

Clearly, they’re not going to allow that to happen. They can do the math as easily as I can, so they’re going to have to do something, but what are they going to do? There are only three choices, and this is what the great Robert Mundell, Nobel Prize-winning economist in the early ’60s, called the Impossible Trinity.

There are only three things you can do when you’re in this situation: 1) you can raise interest rates to make your currency more attractive so maybe some money comes in; 2) you can slap on capital controls so it’s not allowed to go out. It’s like a roach motel – it can come in but it can’t go out, or; 3) you can devalue the currency so you may still be losing it but at a slower pace. If you devalue enough, you’ll actually be attractive and people will want to put money in because the prices just got cheaper measured in, let’s say, U.S. dollars.

Let’s take those one at a time. Can China raise interest rates? No, that’s off the table because their companies are going bankrupt, they’re flooded with bad debts, their economy is slowing, and their exports are slowing. Raising interest rates will sink the economy, maybe throw it into a recession, cause massive bankruptcies in state-owned enterprises, and accelerate this economic slowdown. The job-creating machine is going to slow down, which throws into question the legitimacy of the Communist Party.

The Communist Party is illegitimate to begin with, but they gained at least some support by creating jobs. The Chinese are very volatile, so if the jobs machine slows down, they’ll riot, they’ll burn down banks, they’ll burn down real estate offices.

Look at Tiananmen Square. Although it turned into being about democracy and free speech, it started as an anti-inflation protest and then spun out of control. That’s the history of China, so they’re not going to raise interest rates.

Would they close the capital account? They’re trying to do that but not very effectively. I just gave an example of getting paid through a trading company in Hong Kong. That payment went out, so they didn’t close that part of the capital account!

On a more serious note, they’re not really doing what they need to do to close the capital account. They can’t because of having gone pretty far down the road to an open economy. There are tens of billions – if not more – of legitimate payments that have to be made every day for suppliers, vendors, foreign investments, and other transactions. They can’t shut down the whole thing, and if they just want to shut down part, that doesn’t really work because people are very creative and will figure out the workaround.

Also, the IMF doesn’t like it. Remember on October 1st, 2016, just a few months ago, the IMF included the Chinese yuan in the SDR saying it’s a global reserve currency. As we said on prior calls, it’s not really a global reserve currency but they’re pretending it is, and they have the IMF Good Housekeeping seal of approval.

One of the IMF conditions is that you must have an open capital account, so China is not going to close the capital account in reality, because they’ll anger the IMF and breach that deal. As I said, they’re trying but not very effectively, and that’s not really going to get them where they need to be.

If interest rate hikes are off the table and if they can’t close the capital account effectively, what’s left? Devaluation. Trump is screaming about devaluation. He says the Chinese are keeping the yuan too cheap. Well, they might be about to do a maxi devaluation, take it really down. So then, what is the rest of Trump’s wish list?

He wants help on North Korea because of the North Korean nuclear program. The North Koreans are getting closer to miniaturizing their nuclear devices. You have to make it small to fit it on a warhead, and they’re getting closer to being able to do that; they’re perfecting their ICBM (intercontinental ballistic missile) technology. Again, they’re not there, but they’re trying really hard and making progress. They’re getting closer to the point where they can nuke Seattle.

The U.S. is not going to let that happen, which means we might have to bomb North Korea to shut down the program. Who has more influence over North Korea than China? The answer is nobody, so Trump is saying to China, “Help us out with North Korea,” but China can’t do it.

The reason is, if China gets aggressive with North Korea, North Korea will open the border and let a million starving North Korean refugees flood into Manchuria, which is also destabilizing to the Communist Party. So, they can’t help there.

What else does Trump want? Trump is trying to use Taiwan and the “One China” policy as a trump card – no pun intended – but he’s playing with fire talking about revisiting the “One China” policy.

The first thing you learn in China is that Taiwan is non-negotiable. They consider Taiwan as much a part of China as we consider California part of the United States. Californians may have different political views, but no one thinks they’re not part of the United States. Calling for Taiwan independence would be like China saying, “We think California should be independent of the United States,” so that’s a non-starter.

The third area is the South China Sea. Rex Tillerson, the designated Secretary of State, talked in his confirmation hearing about these Chinese artificial islands being constructed, saying they should be denied access to those islands.

I don’t necessarily disagree, but the time to say that was five years ago, not now. They’ve built up those islands, are putting down landing strips and military bases, and are surrounding them with Chinese warships.

The U.S. has the power to stop that, but you’re talking about a blockade of some sort, which is an act of war. The Chinese said, “Don’t go there, because that will put us in a state of war.” Do you want a shooting war with China? That’s kind of scary, but the point is that’s where it’s heading, and the Chinese can’t back off without losing face.

The South China Sea is also existential. The reason they’re taking it over is not for oil, although there is some oil there, but it’s for protein. They want the fish to feed their people. It’s one of the largest fishing areas in the world, and they don’t want the Filipinos and Vietnamese and others depleting the protein.

So, Trump is looking for help on North Korea, Taiwan, South China Sea, and currency manipulation, but China can’t help with any of them because they’re just stuck. They have other issues, namely their own survival, yet Trump is not backing off. Maybe I could explain it to Trump just the way I explained it to our listeners, but I don’t know that it would change anybody’s mind.

We’re looking at a major confrontation between China and the United States. It’s going to play out in currency wars, trade wars, and maybe a shooting war the way things are going, either with North Korea or with China.

What does that do for gold? All these geopolitical vectors are extremely good for gold. It could slow down the economic growth and we could see the dollar get a lot stronger, which is a headwind for gold, but remember, there are two things that drive gold: one is a weaker dollar, and the other is geopolitical issues that cause a flight to quality.

By the way, Trump came out Friday in an interview in the Wall Street Journal and said the dollar is too strong. Anthony Scaramucci, one of his main economic spokesmen at Davos, said the same thing: the dollar is too strong.

With Trump and one of his major spokesmen saying the dollar is too strong, it means they want a weaker dollar. What does a weaker dollar mean for gold? It means higher dollar gold prices.

Even though China may be devaluing, and that’s going to cause a confrontation with Trump, Trump is telling Europe, Japan, and China (even if China doesn’t respond) that we need a weaker dollar.

We have two major tailwinds for gold – a weaker dollar coming and geopolitical risk escalating – all in the larger context of this alliance between Russia and the United States against China. This is going to get very ugly, very fast.

When I returned from China, I went to Washington and met with a bunch of top national security people at a private dinner in Georgetown on Thursday night. This is escalating and spinning out of control. I’ll give you two quick points, because I can talk technicals all day, but a lot of times, human reaction is the most valuable to me and where I learn things.

When I gave my presentation in China, we had a translator. I was speaking in English and most of the audience was listening in Chinese. As we sat down, one Citibank economist from England shook my hand and said, “Great presentation, Jim, but you are a Chinese translator’s nightmare because you speak too fast,” which is probably true. So, who knows what they were hearing.

I had about 20 slides, and my second-to-last slide was my model portfolio indicating 10% gold as my standard recommendation. When I put that slide up, about 50 people in the room jumped out of their seats, whipped out their iPhones, and took pictures of the slide. They didn’t have a handout or a copy, but they were like, “I want a picture of that, because I want to in effect write it down and see what’s going on.”

I hear a lot of positive things about gold and learned some very interesting things from them. There were four of us at the table, but I met with three of the most powerful Chinese gold dealers. I can’t mention specific names of their banks, but two people were from one of the largest banks in China and one person was from one of the other largest banks in China. They are the head of precious metals for those banks, so these are the people who move the gold in China.

The first thing they told me is don’t believe what you hear about Chinese purchases falling down. The said it’s as busy as ever with the Chinese buying gold as fast as they can. They said, “What you read in the press is not true. We’re bringing it in as fast as we can.”

I heard from a top logistics person and other people that the People’s Liberation Army moves the gold in armored car caravans. Alex is going to jump in here in a minute, but Alex and I have been to Switzerland where they’re sending the gold to China, so we have pretty good information there, but I’ve just been in China on the receiving end and talked to the top people there.

I asked, “Why is it that the army and the paramilitaries always move the gold? Why can’t you move it yourself?” And they said, “We’re not allowed to have guns.” It’s an obvious thing when they say it, but it really struck me. I was like, “Yes, you’re right, you’re not allowed to have guns.”

What good is a bank armored car if you can’t have armed guards? So, one reason they use the military to move gold around is because the banks can’t have their own armored car services with armed guards. They just can’t have guns.

The way it works is that a plane will leave Zurich, Switzerland – it could be any cargo carrier, Chinese airline, Swiss airline, whatever – with a Brink’s consignment on board from Argor or PAMP or one of the big Swiss refiners. That plane lands in Shanghai, but when the gold comes off, Brink’s is done with it. There’s no Brink’s in China because of what I just mentioned, which is that they can’t carry guns, so it goes into either a paramilitary or a military convoy, and then it goes to the vault. I thought that was interesting.

I learned something else. I said, “Okay, I have a pretty good handle on Chinese gold purchases. I know from geological surveys what their mining output is and I think I know how much gold is going to China. What I don’t know about is Shanghai Gold Exchange’s sales which are pretty transparent. How much of that is private versus how much is the government?” I was guessing 50-50, 70-30, whatever. What they told me – and these guys are the dealers – is that it’s 100% private. The government operates through completely separate channels.

The government does not operate through the Shanghai Gold Exchange. When they want gold, they order it themselves, bring it in through their agents, take it themselves, and vault it. None of what’s going out of Shanghai Gold Exchange is going to the People’s Bank of China or the State Administration of Foreign Exchange. They have their own channels.

That hit me right between the eyes, because it means they have more gold than I realized. I know China is getting gold as I’ve heard from other sources, but if that’s not coming from the Shanghai Gold Exchange, it’s coming straight in through government channels and all the Shanghai Gold Exchange is private consumption, then China is basically hoovering up all the gold they can get their hands on. This is completely consistent with what we’ve heard in Switzerland and what I heard from other sources in Shanghai.

I just shake my head. Why institutions think they don’t need physical gold or they shouldn’t be getting it now while they still can is surprising to me, because the shortages are going to get worse and worse.

I don’t care what the COMEX or ETFs are doing. That’s the paper gold market. I understand it sets the price, and the price is the price. We’re getting closer and closer to the point where physical gold shortages are going to cause a crack-up. There are going to start to be failures to deliver around the system, and once that gets out – which it will – look for a super spike in the price of gold.

It was an extremely interesting trip. I met a lot of great people along the way and had great conversations, but there is enormous angst about Trump. I said, “There’s good reason for that, because he means what he says.” I’m looking at trade war, a currency war, geopolitical instability. Trump’s not inclined to back off, the Chinese are confused, they’re buying gold hand over fist, and Trump’s pledge the other day that the dollar is too strong says one thing.

That’s one reason gold is going up. It rallied very strongly today. I was writing a column this morning and said, “Gold made it to $1206,” then I looked at my screen and it was $1216. It went up $10 an ounce in the time I was writing the article, so that’s what’s going on out in the real world.

I’ll stop there, Jon. I know Alex has some commentary and we want questions from listeners, but it was a fascinating trip. There are huge geopolitical plays going on. None of the news is good. I think I got the forecast accurate, but unfortunately, it’s not a very pleasant scenario. It’s all going to start to play out at noon on Friday when President Trump is sworn in. I would say fasten your seatbelts.

Alex:  I’m going to continue this conversation in regards to the gold market. Something you said just a few minutes ago, Jim, is that the shortages are going to continue and probably get worse. I think you’re right on the mark in regards to that.

A lot of the market is well aware of how gold has been moving from the West into the East, largely into China and India. The demand from China going back over the last five to eight years has been continually getting stronger.

If people are familiar with the gold story and follow the gold markets, they might already know this, but there are a lot of people who are looking at gold who have never really considered it before. Something that’s important to point out is that gold going into China is like going into a black hole. Once gold goes into China, I don’t expect that we’ll be seeing it any time soon, and maybe never, because China does not sell its gold into the market.

I saw an article the other day that some was smuggled out, but China doesn’t sell its gold on the world market. It sells it internally, and any gold that is sold from the private sector, per the law in China, must be sold to the People’s Bank of China, which is the China central bank.

I also concur with what you’re saying in regards to when Chinese official buying is going on. This is the Chinese central bank. As I’ve suspected for many years, they don’t report those figures. I mentioned it in an interview I did a couple of years ago, that I don’t think we really had any kind of official way to measure the central bank’s demand.

The important part of the whole black hole issue is that over the years, the West has been selling off. You can measure this by looking at gold flows from countries like the United States and the U.K. where the majority of gold is held for the largest Western ETF gold funds in the world. Just watch where it goes as that gold is drawn down.

When those big ETFs sell off, the gold leaves the United Kingdom, goes through Switzerland, gets re-refined into one kilo bars (we call it four nines fine meaning 999.9 parts per thousand pure, which is the Chinese requirement), and those bars get shipped over to China.

There has been a lot of speculation that at some point those bars would come back on the market. We’d see big 400 ounce bars reintroduced into GLD inventory, things like that. It hasn’t happened, so it’s good proof that what’s really happening when the West sells off its gold is that it’s moving through Switzerland into China.

An interesting dynamic has been occurring since the end of Q4 2016 to today. Yesterday, GLD had its first gold inflows and inventory since November 2nd  For those not familiar with it, GLD is the flagship Western gold ETF run by bullion banks. Bullion banks are some of the largest banks in the world. The five market-making members of bullion banks are HSBC, Goldman Sachs, Citibank, J.P. Morgan, UBS – the regular suspects there.

The reason this is so interesting is that one of my colleagues recently mentioned to me that the GLD inventory is way down. This is true if you measure it from the peak of 2016, but the truth is that as the USD gold price passed through $1180 or so, the previous two times it did this, the inventory was a hundred tons less than when it did this time.

Said another way, it means that GLD had a hundred-ton buffer that authorized participants didn’t sell or didn’t release into the market, which tells me that bullion banks were considering gold oversold and that it was going to reverse, which is exactly what it did from the last time we had our webinar last month and were talking about this.

Then what accounts for the rise in the USD gold price back to the $1200 if GLD inventory wasn’t moving and the West wasn’t buying? It means that the slack was picked up by other major, non-Western demand spheres – we’re talking China and India – before the West started buying again. And that’s just been in the last couple of days.

Why this is important is that GLD is a pretty good proxy for measuring Western demand and Western buying. In particular, it measures hedge funds and speculators. When you have a lot of speculative buying or hedge funds entering the market looking for price gains on the price of gold moving, they typically use GLD as the vehicle to do that.

In 2016, there was a big run up in the gold price driven mostly by Western speculators. That obviously went up to a peak. These hedge funds all exited towards the end of 2016, and that brought the gold price back down to around $1129.

Here’s the interesting part: strong hands took the gold price back up to about $1200 with pretty much no help from hedge funds. What that means to me is that Western speculators weren’t involved in bringing this price from $1129 back up to $1200.

Yes, there is a market vector where the USD is a strong lever on the gold price. You can measure that by watching the USD price when the U.S. dollar is strengthening and all other currencies are weakening against it, and vice versa. That’s a strong vector.

The indication here is that this has happened without a lot of help from Western speculators. This means that inventory was running down and moving into China – into the black hole, so to speak. All the gold that went over there is not going to be available the next time the hedge funds, etc. are jumping back into the market. I suspect most of that went predominantly to China, because India was off by some 400 tons from normal demand in 2016.

If the beginning of 2016 is any indication of tightness in the market, I think what it means to us is that when Western speculators do step back into this market and that gold is not available, it could be pretty energetic.

Jon:  Thanks, Alex. That’s a captivating analysis of the gold story.

Jim, at the end of our last podcast we began a discussion about the war on cash. I know your time today is limited, but would you give us an update on this phenomenon and perhaps place it in a wider context of global systemic risk?

Jim:  In my most recent book, The Road to Ruin that came out November 15th, I have a large section on the war on cash, and this has been going on for some time. I expected it to get worse, but I did not expect it would get so bad so quickly.

Literally the week my book came out was when Prime Minister Modi of India announced that the two largest circulation bills in India, the 1000-rupee note and the 500-rupee note, were no longer legal tender. He just woke up one morning and said they’re illegal.

He said if you have them and want your value, come on down to the bank, hand them in, we’ll put money in your account, and if you need a little currency, we have a new 2000-rupee note.

It sounds good but was a complete fiasco. About 80% or more of the Indian economy is run with paper currency. That’s 1.1 billion people, and they’re over 80% cash. It’s just the way a rural, agrarian society works.

Now, there is a middle class of 200 to 300 million people, and yes, they have their debit cards and credit cards, their iPhones and PayPal, and all that other good stuff. That’s fine for them, but what about the other almost billion people left out in the cold?

Well, there were long lines at banks, the economy shut down, there were riots, supermarket shelves were stripped. They even screwed up worse than that considering they printed the new 2000-rupee note the wrong size. It didn’t fit in the ATM machines, so they had to shut down all the ATM machines in India and rip the guts out – the physical machinery, not the programming – and change it so that it would dispense these new 2000-rupee notes. It was a complete and utter disaster.

Right after that, Venezuela said the 100-bolivar note is worthless. It was already kind of worthless anyway around 6 cents or something like that, but whatever the value was, it wasn’t worth very much. Those notes had to be handed in.

Of course, they always say this is designed to get rid of the black market, tax evaders, and terrorists. They continuously have this list of excuses, but the truth is, it’s aimed at everyday people and designed to force them into digital payment systems so they can be slaughtered with negative interest rates, confiscation, freezes, etc.

This is not confined to just a few countries. It already happened in various ways in Cyprus in 2013, Greece in 2015, we’ve just seen it in India and Venezuela in recent weeks, Australia has started a parliamentary debate about getting rid of the Australian $100 note, Europe got rid of the 500-euro note last year, and there are calls in the United States to get rid of the $100 bill. This is not going away. The pressure is going to continue, and we expect to see more of it.

Again, it’s forcing people to basically put their savings into some digital form such as a bank account or maybe a money market fund. By the way, I consider the phrase “money market fund” to be one of the great misnomers of all times, because it’s not money. People think it’s money, but it’s really a mutual fund of a particular kind where you must call your broker and have them sell your shares and wire the money to your bank account.

It sounds easy. That’s what people do on a day-to-day basis, but what happens if the brokers close? What happens if exchanges close? What happens if the bankers close? What happens if the fund suspends redemptions? There are so many ways for that to go wrong. It’s not even close to money, but they call it “money market funds” because it makes people feel good, I guess.

The cash component of your portfolio is definitely at risk. It’s being forced into a digital form so that it can be frozen or confiscated in various ways. There really is no solution except to get out of the digital system.

How can you get out of the digital system and still have some form of money? My answer would be gold or silver. Gold is excellent for larger stores of wealth, and silver is excellent for, in effect, walking-around money or transactional money if you’re in a power grid outage, social unrest, or a natural disaster.

People tell me all the time, “You can’t eat gold.” Why would you want to eat it? If I want to buy food, I’d rather give you paper money and keep the gold. But in extremis, when paper money is not around or it’s not valuable, you can’t get it, or you’re locked into a digital system which is frozen, I guarantee that people will sell you food or whatever you need for gold or silver. Silver is practical for that purpose.

My recommendation has always been 10% of your portfolio. Not all in, not 50%. If things get to the levels that I expect – and I fully do – gold at $10,000 an ounce, silver at $100 an ounce or more, and these other extreme scenarios are playing out, then 10% of your portfolio will in effect insure the rest of your portfolio.

You can do more if you like, that’s an individual choice, but I’m comfortable with the 10% recommendation. That way, if things go the other way, which is always possible – a deflationary vector cannot be ruled out; gold could go low – you won’t be hurt too badly if you have 10%.

Even there, I would caution that a lower dollar price for gold doesn’t mean a lower real value for gold. The real value of gold could be going up. In a highly deflationary world, you might find that gold is going down from $1200 to $900 but everything else is going down even more, so gold would actually preserve value better than stocks and bonds and some other trades.

Don’t get too hung up on the nominal price; focus on the real price. Right now, the real price is rallying very strongly. Expect that to continue, but even if it goes the other way, a lower nominal price would be indicative of deflation, which could mean a higher real price, so you win either way.

People say to me, “I don’t understand gold,” or “Gold is a barbarous relic. How could you put any of your portfolio into gold?” And I just say, “How could you not?” How can you sleep at night not having some of your wealth in a non-digital form where it can’t be wiped out by Vladimir Putin or frozen by some future administration?

Yes, the war on cash is alive and well. It’s getting worse and coming to a country near you. I expect the U.S. will join in sooner rather than later. The only alternative is to get out of the digital payment system, and that means some tangible asset.

You can have land and fine art and natural resources – those are all good portfolio allocations – or non-digital contractual assets like private equity funds or venture capital funds, etc., but you definitely want some gold and silver.

Jon:  Thanks, Jim. Alex, let’s take at least one or two questions from our listeners now.

Alex:  We have about five minutes left. One question that has come in is from Andrew C., and he says, “I love the work and the podcasts.” I think his question is in regards to whether the IMF SDR is essentially money for people, or if it’s more money for sovereigns.

His question directly is, “If IMF becomes the entity that bails out central banks by printing SDRs, is this effectively the IMF printing U.S. dollars, JPY, British pound, RMB, and euro directly? And if so, does the IMF need the permission from countries’ central banks to do this?”

Jim:  Great question. Maybe I can break it into a couple of parts. First, when the IMF issues SDRs, they need a vote from their executive board, but presumably they would all be on board. They’re not going to do this on a normal sunny day. They’re going to do it the next time there’s a liquidity crisis of the kind we saw in 2008, which I do expect sooner rather than later.

In that crisis, the next one will be bigger, and the central banks won’t be able to bail us out the way they did the last time. Everyone is going to turn to the IMF for the bailout, and the IMF will accommodate by massive multi-trillion SDR printing.

They don’t need central bank approval to do that. No doubt there will be some phone calls behind the scenes and they’re going to talk to whoever it is – Janet Yellen or Mario Draghi or whoever – but they’re a separate institution. They can act on their own, and they will.

When they do this, are they printing up bundles of yen and dollars and sterling? No. They’re printing up SDRs. People think the SDRs are backed by those other currencies, but they’re not. There is a so-called reference basket. I don’t think “basket” is the right word, but people call it a basket.

As of last October, there is a five-currency basket: dollars, yen, euros, sterling, and Chinese yuan that’s related to the SDR, but that basket only exists for the purpose of calculating a cross rate.

You may ask, “What’s an SDR worth? How many dollars is it worth? How many yen is it worth?” There’s a way to do that calculation, and those five currencies are in the calculation, but it’s really a math problem.

I get an email from the IMF every day with that day’s SDR fixing. Right now, it’s about $1.50 or a little bit less. That’s why those currencies are there, but when you print SDRs, you’re just printing SDRs.

The second part of the question is do they go to us? No. People don’t get them. Countries get them. Basically, there are 189 members of the IMF, and they all get them in accordance with their shares in the IMF. It’s like stock in a company. The U.S. is about 16% of the votes at the IMF, so if they printed 10 trillion SDRs, the U.S. would get 1.6 trillion SDRs and so on. Everyone would get their share based on their vote.

It gets interesting from there, because a lot of countries will get SDRs and say, “Thanks, but I don’t really need SDRs. I need euros or dollars, because I have trade deficits, or I have external financial obligations I can’t finance, or my corporations can’t roll over their debt, they’re going bankrupt. I need to bail them out,” etc.

There is a trading desk inside the IMF. If you have SDRs you don’t want and you need these other currencies, you can swap them. You can sell SDRs for the other currency to pay your bills, but they’re coming from existing supplies. They’re not newly printed dollars; they’re just dollars that are there from the United States or elsewhere.

That’s how countries get liquid currencies, but it’s not that the IMF is printing dollars and euros; it’s that they’re printing SDRs and people who get them can, in fact, sell them through a trading desk in the IMF to get dollars.

Who’s the buyer? If I’m Hungary or Zimbabwe or anybody and I want to sell SDRs because I need something else, who’s buying those SDRs? One buyer is China, and China is buying the SDRs because they’re trying to get out of dollars.

There’s a big game of musical chairs going on here behind the scenes, and these values can fluctuate. I don’t need to get too down in the weeds in terms of a technical lecture and how the SDRs work, but one thing is certain: this will be inflationary.

I don’t care if you call it SDRs or banana peels; if you print 10 trillion of something and give it to all these countries in a way that they can spend it, then that’s going to be inflationary, and that’s extremely bullish for gold. It’s super bullish for gold.

I see two endgame scenarios. One involves going to a gold standard, which I’m not predicting, but if they did, then that would mean gold at $10,000 an ounce. It has to be $10,000 an ounce, because any lower price is deflationary, which is the last thing they want. There’s math behind that.

If they don’t go to a gold standard, they’re going to have to go to SDRs, which is inflationary, which means the dollar price of gold will go up. Gold goes up either way in this scenario.

There are some efforts at a private SDR market, what the IMF calls M-SDR. M stands for “market.” That market is taking off. They have a ten-year plan to do that, but in my view, they’re not going to get that far. This crisis will come before they finish their ten-year plan, and then they’re going to have to go to SDRs on an emergency basis rather than a gradual basis. That’s just going to be the response to the next financial panic.

Jon: I’m sorry, everyone, we’d love to hear more of your questions, but today, as you understand, Jim is in huge demand from many sources for his insights, and we’re very privileged to have him each month for this long.

Thank you, Jim Rickards, and thank you, Alex, also for your insightful analysis today. It’s always a pleasure and an education sharing this time with both of you. Most of all, thank you to our listeners for spending time with us today.

Let me encourage you to follow Jim and Alex on Twitter. Jim’s handle is @JamesGRickards, and Alex’s handle is @AlexStanczyk.

Goodbye for now, and we look forward to joining you again soon.

 

Listen to the original audio of the podcast here

The Gold Chronicles: January 17th, 2017 Interview with Jim Rickards and Alex Stanczyk

 

Learn more about Jim Rickards new book, The New Case for Gold at http://thenewcaseforgold.com/

You can follow Alex Stanczyk on Twitter @alexstanczyk

You can follow Jim Rickards on Twitter @JamesGRickards

You can listen to the Gold Chronicles on iTunes at:
https://itunes.apple.com/us/podcast/the-gold-chronicles/id980027782?mt=2

You can Listen to the Global Perspectives on iTunes at:
https://itunes.apple.com/ca/podcast/physical-gold-fund-podcasts/id1056831476?mt=2

You can access transcripts of our interviews at:
http://physicalgoldfund.com/category/transcripts/

You can subscribe to our Youtube channel to access these interviews and more at:
https://www.youtube.com/channel/UCXRWzw0vaNgCwo7nTMEAwkA

 

By listening to this podcast or reading its associated transcript (collectively, this “Podcast”), you agree with the following.

This Podcast is not an offer to sell, nor a solicitation of an offer to purchase, any security. This Podcast is intended for general education and information purposes only, and may include broad discussions of markets, geopolitics, monetary policy, and geoeconomics. Nothing in this Podcast constitutes investment, legal or tax advice, nor an evaluation of or prospectus for any particular investment or market, including gold. This Podcast should not be relied upon to make any investment decision. You are encouraged to seek the advice of qualified financial, legal and tax advisors before making any investment decisions.

This material is provided on an “as is” and “as available” basis, without any representations, warranties or conditions of any kind. In particular, information provided by third parties in this Podcast has not independently evaluated or confirmed. Furthermore, we take no responsibility to update this Podcast to reflect any changes in any of the information presented. Physical Hard Assets Fund SPC and Physical Gold Fund, its officers, directors, employees or associated persons will not under any circumstances be liable to you or any other person for any loss or damage (whether direct, indirect, special, incidental, economic, or consequential, exemplary or punitive) arising from, connected with, or relating to the use of, or inability to use, this Podcast or the information herein, or any action or decision made by you or any other person in reliance on this information, or any unauthorized use or reproduction of this Podcast or the information herein.

The Gold Chronicles: January 17th, 2017 Interview with Jim Rickards and Alex Stanczyk

Jim Rickards and Alex Stanczyk, The Gold Chronicles January 17th, 2017

Topics Include:

*Power Triad Dynamics, USA, China, Russia
*Why China is concerned about a Trump Presidency
*Capital flows out of China continue at a robust pace
*China will burn through all of its liquid reserves in one year at the current pace
*Analysis of China’s three options
*Which conditions could place the USA and China in a state of war over the South China Sea
*Why gold moving into China is like going into a “Black Hole”
*Physical gold flows from west to east are exacerbating tightness in physical supply, and could lead to strong price moves when the west steps back into the market
*War on Cash and its impact on global systemic risk
*India demonitization has been a disaster
*End game plan for War on Cash is to force people into digital accounts
*Solution to avoiding an all digital system is to get out of it, gold or silver
*Breakdown of the SDR as sovereign money versus money for people
*IMF permission requirements from countries to print SDR’s

 

 

Learn more about Jim Rickards new book, The New Case for Gold at http://thenewcaseforgold.com/

You can follow Alex Stanczyk on Twitter @alexstanczyk

You can follow Jim Rickards on Twitter @JamesGRickards

You can listen to the Gold Chronicles on iTunes at:
https://itunes.apple.com/us/podcast/the-gold-chronicles/id980027782?mt=2

You can Listen to the Global Perspectives on iTunes at:
https://itunes.apple.com/ca/podcast/physical-gold-fund-podcasts/id1056831476?mt=2

You can access transcripts of our interviews at:
http://physicalgoldfund.com/category/transcripts/

You can subscribe to our Youtube channel to access these interviews and more at:
https://www.youtube.com/channel/UCXRWzw0vaNgCwo7nTMEAwkA

 

By listening to this podcast or reading its associated transcript (collectively, this “Podcast”), you agree with the following.

This Podcast is not an offer to sell, nor a solicitation of an offer to purchase, any security. This Podcast is intended for general education and information purposes only, and may include broad discussions of markets, geopolitics, monetary policy, and geoeconomics. Nothing in this Podcast constitutes investment, legal or tax advice, nor an evaluation of or prospectus for any particular investment or market, including gold. This Podcast should not be relied upon to make any investment decision. You are encouraged to seek the advice of qualified financial, legal and tax advisors before making any investment decisions.

This material is provided on an “as is” and “as available” basis, without any representations, warranties or conditions of any kind. In particular, information provided by third parties in this Podcast has not independently evaluated or confirmed. Furthermore, we take no responsibility to update this Podcast to reflect any changes in any of the information presented. Physical Hard Assets Fund SPC and Physical Gold Fund, its officers, directors, employees or associated persons will not under any circumstances be liable to you or any other person for any loss or damage (whether direct, indirect, special, incidental, economic, or consequential, exemplary or punitive) arising from, connected with, or relating to the use of, or inability to use, this Podcast or the information herein, or any action or decision made by you or any other person in reliance on this information, or any unauthorized use or reproduction of this Podcast or the information herein.

Transcript of Jim Rickards and Alex Stanczyk – The Gold Chronicles December 15th, 2016

Jim Rickards and Alex Stanczyk, The Gold Chronicles December, 2016

Topics Include:

*Fed hiked interest rate by .25% as expected
*Fed is expecting 3 more rate increases for 2017 which would bring it to 1.25%
*Yellen has indicated she would lean into Trump’s stimulus if it looked like inflation was getting out of hand
*Trump’s plan calls for $1 trillion in spending, tax cuts, and less regulation. This is a recipe for much higher inflation
*Monetary policy has reached the end of its capability
*Why markets are entering a period of irrational exuberance
*Factors that could impede Trump from having a free hand to implement his economic policy
*The actual numbers of Trump’s fiscal stimulus is going to be far lower than the market is expecting
*Gold is priced in various currency crosses versus gold, price variations are actually currency value fluctuations versus gold
*USD/Gold moves for the last several months have been inverse to USD strength. All major currencies have been declining versus the USD, including gold
*Assessment of Trump’s picks for his administration staff
*India War on Cash / War on Gold has accelerated
*War on Cash has extended to Argentina, Australia
*Description of the “Bail-In” playbook
*Why owning gold makes sense even when there is a risk of government confiscation, and why multi-jurisdictional diversification is one tool to do so
*Gold conversion during periods of crisis
*How to get the most value out of your gold holdings if there is a crisis
*Crisis are temporary events, they have a lifespan, the most important is how value is preserved during a crisis and who has the most valuable assets on the other side of the crisis

 

Listen to the original audio of the podcast here

The Gold Chronicles: December 15th, 2016 Interview with Jim Rickards and Alex Stanczyk

 

The Gold Chronicles: 12-15-2016:

Jon:  Hello. I’m Jon Ward on behalf of Physical Gold Fund. We’re delighted to welcome you to the latest webinar with Jim Rickards and Alex Stanczyk in the series we’re calling The Gold Chronicles.

Jim Rickards is a New York Times bestselling author, the Chief Global Strategist for West Shore Funds, and the former general counsel of Long-Term Capital Management. He is currently a consultant to the US Intelligence Community and to the Department of Defense. Jim is also an advisory board member of Physical Gold Fund.

Hello, Jim. You’re in Berlin today, I believe.

Jim:  I am, Jon. Thank you. It’s nice here in Berlin, and it’s nice to be with you and the audience.

Jon:  We also have with us Alex Stanczyk, Managing Director of Physical Gold Fund. Alex is an expert in the physical gold industry dealing with the logistics chain from refinery to secure transport and vaulting. He has lectured globally to investor, institutional, and government audiences on the role of gold both in the international monetary system and in investment portfolios.

Hello, Alex.

Alex:  Hi, Jon. It’s great to be here, as well.

Jon:  Later in this podcast, Alex will be looking out for questions that come from you, our listeners. Your questions today are more than welcome, and as time allows, we’ll do our best to respond to them.

Well, here we are just one day after the last meeting of the Federal Open Market Committee in 2016, and as predicted, rates are up. Jim, are there any surprises in yesterday’s pronouncements from the Fed, and could you perhaps tell us a little bit about the implications for gold?

Jim:  There were a lot of surprises. Of course, the rate hike itself was no surprise as it was fully anticipated. We said this to listeners on this podcast months in advance, and others did, as well.

I saw one survey on Tuesday, just a day before the rate hike, of 120 economists, and 120 out of 120 expected a rate hike. So, this was probably the most heavily anticipated rate hike in history, and also right at 25 basis points. That’s what happened, so absolutely no surprise there.

But it’s never a question of simply taking the words at face value. If you watched Janet Yellen’s press conference with the FOMC statement and combine that with a little nuance, believe it or not, you get a lot more out of watching the video live than even reading a transcript just because body language can tell you something.

First, the obvious one that has been widely reported is that the Fed estimates, the FOMC members in their forecast, said they expected three rate increases in 2017. That’s in addition to the one yesterday, so we had the one yesterday and three more in 2017. That would get the Fed funds rate up to one and a quarter. Their prior forecast going back to last September was for two, so that by itself was a big deal.

Beyond that, reading behind the lines a little bit, Yellen was fairly explicit about Donald Trump’s fiscal policies, the Fed’s reaction to fiscal policy, her views on inflation, what she thought the economy was going to do, and even on her own status as chairman, all of which was fascinating.

I thought she was very blunt. I had formulated this thesis before, but yesterday really cemented my view that we are looking at a head-on collision between Donald Trump and Janet Yellen. I’m actually writing an article on this and still working on the subtitle, but maybe “The Clash of Titans” or “King Kong versus Godzilla.” Take your pick on who’s who, but Yellen and Trump are on a collision course. I think that was in the air.

Trump probably started the fight during the campaign with his remarks about wanting to fire her, and fired back in kind yesterday. Of course, he can’t legally fire her, but that doesn’t stop Trump from making the rhetorical gesture.

Just to be specific and put a little color behind those remarks, it was interesting, because I thought the questions were planted. That is not unusual for policymakers. I’ve certainly written questions that were intended to be asked in public by well-known officials.

Sometimes you get a call with the invitation, “Do you have any questions for…?” whether it’s a senator or a policymaker, and then fill in the blank. They don’t always get asked, but occasionally you are invited to submit those questions.

When Steve Liesman of CNBC stood up, I felt he was spoonfeeding her softballs about Trump’s fiscal policy and inviting her to respond, and I thought the response was fairly tough. Markets run these trends anyway; there were no trend reversals. Stocks are up, interest rates are up, bonds are down, gold is down. People call it the Trump trade. Some of it started before the election and accelerated as a result of the election, even more dramatically today.

Yellen was sort of hitting that head-on, but in particular, she was asked about the impact of fiscal policy, i.e., “Did fiscal policy affect the Fed’s thinking?” It clearly did. Not much has changed in the economic data between last September and now, but with the earthquake electorally in terms of the election of Donald Trump, his cabinet selections, and what he wants to do with fiscal policy, the Fed is looking at that.

Now, what has Trump actually said? We remarked earlier that because Trump is such a controversial figure, a lot of people had difficulty getting past his personality and demeanor during the campaign to look at his policies. Once it was clear that he was elected president, people got past that and looked at the policies. What he has called for is extremely stimulative. He wants $1 trillion of additional spending, tax cuts on top of the $1 trillion of infrastructure spending, and he wants less regulation.

Taking it at face value, if you throw that kind of additional spending on an economy that’s already close to capacity… You can debate labor force participation, but unemployment is 4.6%, this expansion is eight years old, and it’s not clear how much additional slack there is in the economy. There’s certainly some, but not that much. If you put $1 trillion of spending and tax cuts on an economy that’s already operating at or near capacity, you’re going to get inflation. Keynesianism 101 says that if people don’t spend, the government will.

People, in fact, have not been spending. Gains in income have been scarce, but if people get them, they tend to pay down debt or save the money. They don’t go out and spend it. We’re in a little bit of a liquidity trap, but if you hand over the checkbook to the government and tell the government to spend the money, they’ll do a very good job of it. That’s what governments are good at.

Yellen is looking at this and saying, “Okay, with $1 trillion of spending, tax cuts, the economy near capacity, and unemployment at 4.6%, you’re definitely going to get inflation.” What she said was they’re going to lean into it; they’re not going to let that inflation take off.

Per Steve Liesman’s question, she also made the comment that not all fiscal policy is equally stimulative. She said certain kinds of spending add to productivity – like spending on education, re-training, and certain limited kinds of infrastructure – but other kinds of spending don’t add to productivity. They might add to spending, but they don’t make people more productive.

Clearly, in my view, she was talking about the kinds of tax cuts that Trump is proposing. Trump wants to cut the personal income tax rate from about 40% to around 33%. Half the people in the United States – 50% of the people in United States – pay no income tax. You could cut income taxes to zero and it would have no impact on that half, because they don’t pay any income taxes to begin with. In other words, those kind of tax cuts only apply to upper income individuals.

I don’t want to debate the policy; listeners can decide that on their own. But what she was saying as an economist is that if the wealthiest people get the tax cut, they have a very low propensity to consume. When you give rich people a tax cut, they don’t go out and buy another TV. They already have ten TVs, three houses, eight cars, and everything else. They’re not really going to spend it. They might invest it or they might just save it, but it doesn’t necessarily do a lot in terms of adding to the productivity of the economy.

It’s a bit of a giveaway, at least in Yellen’s view, versus some other kinds of fiscal stimulus that might add to productivity. Again, I’m not saying I agree with all that, but I’m just trying to interpret the way Janet Yellen thinks about it

She’s saying if you inject that kind of money into the economy in the form of tax cuts but don’t do anything to add to productivity, you’re just going to get inflation or even worse, maybe stagflation. The Fed is not going to let that happen.

This is the answer to the helicopter money question. What is helicopter money? The image is that the Fed prints out money, puts it in helicopters, throws it out of the helicopters, it lands on the ground, and people scoop it up and go out and spend it. It’s a colorful metaphor, but of course, that’s not actually what helicopter money is.

Helicopter money is a combination of fiscal and monetary policy. The elites have been calling for this for a long time independent of Trump’s election. People like Larry Summers and other economists including Janet Yellen herself have been saying that monetary policy has reached the end of what it can do. Monetary policy is running out of impact, running out of juice so to speak, and they need to combine it with fiscal policy.

At some level, that would mean larger deficits, the deficits would be covered by borrowings or by bond issues, the Fed would then buy the bonds (in effect, monetize the bonds), put them away, and not sell them. You’d have money printing, but it would be going directly into government spending, not just into the banks, and the banks would give it back to the Fed as excess reserves. That’s what helicopter money is.

Now, the question is, when do you use helicopter money? The classic formulation that was first articulated by Milton Friedman and later repeated by Ben Bernanke – and I’m sure Janet Yellen agrees – is that helicopter money is something you use when you have deflation. If you get into a deflationary trap, which is very destructive of government finance, increases the real value of debt, and makes debt defaults more likely, you might use helicopter money to get out of deflation.

But Yellen is sitting there saying we don’t have deflation; we have inflation. Inflation is low, but she sees it going a lot higher because of the constraints in the labor market. Remember, Janet Yellen is a big believer in the Phillips curve. The Phillips curve says there’s a tradeoff between employment and inflation. Up to a certain point, you can in effect print money to stimulate the economy and not get inflation, because more people are getting jobs, you’re bringing people back into the workforce. But when you get to the point of nobody left to come back into the workforce regardless of the reason – labor conditions are tight structurally, demographically, or otherwise – and you keep printing money, you’re going to get inflation.

That’s where Yellen thinks we are. I don’t personally agree that that’s where we are, but my view doesn’t matter; what matters for understanding policy is what she thinks. She’s saying we don’t need helicopter money. We have rising oil prices, inflation is accelerating, unemployment is low, and there’s not much slack in the labor market, so this is not a circumstance when you would use helicopter money.

For those who expected it, she really slammed the door yesterday when she talked about Trump’s stimulus. Again, she said this is not the kind of stimulus that adds to productivity; it is the kind of stimulus that will perhaps cause inflation. We, the Fed, are not going to allow that to happen. We want inflation to be a little higher, but not a lot higher. We don’t think deflation is a problem, we don’t think these are the circumstances when you can use helicopter money, and we’re going to lean into it.

That was a very big deal, because she is, in effect, challenging Trump saying, “If you use fiscal policies to stimulate the economy, we will use monetary policy to make sure that that stimulus doesn’t go too far, at least as far as nominal price increases are concerned.” That was one challenge or one confrontation with Trump.

The other one was even more interesting, a little bit of “inside baseball.” Janet Yellen’s term as Chairman of the Board of the Federal Reserve Board expires next January — let’s call it February 1st, 2018 – not that far away, a little over 13 months. Trump ran around on the campaign trail saying he’s going to fire Yellen, which he can’t, but it’s clear that he won’t reappoint her. When her term is up, someone else is going to be chairman.

A lot of people think that’s the end of Janet Yellen, but she’s also a governor of the Fed in addition to being the chair, and governors have 14-year terms. Her 14-year term as governor goes until 2028, and she hinted at least at the fact that even if Trump does not reappoint her as chairman, she may stay on the board as a governor and be a thorn in his side basically depriving him of his ability to fill that seat.

Traditionally, when a chairman’s term is up and they don’t get reappointed, they leave the board even though their governor term goes on a lot longer. Ben Bernanke was an example. When President Obama did not reappoint Ben Bernanke and picked Janet Yellen at the end of 2013, Bernanke resigned and left the board. He didn’t hang around as a governor, although he could have.

This hasn’t happened since 1949. Marriner Eccles was the chairman at the time and was not reappointed by President Truman as chairman, but he stayed on the board for three years until 1951. By saying that, Yellen was saying, “I might just sit in my seat and be a pain in your neck and not give you the opportunity to reshape the board as much as you think.”

I felt she confronted Trump in two ways: Number one, I heard her say she’s not going to do helicopter money and that if we get the kind of stimulus Trump is talking about on the fiscal side, the Fed will tighten even more. Number two, she might hang around even if she’s not reappointed as chair just to be a vote for more rate increases and deprive Donald Trump of the ability to fill that seat.

Both of those things are hawkish. The FOMC was already hawkish by increasing the projected rate increases from two to three, so this was a super hawkish message coming out of the Fed, and that’s how markets interpreted it.

Bonds down, gold down, that’s all easy to understand. Positive real rates is when the nominal interest rate is significantly higher than the rate of inflation. A simple example is that if you get up to 3% on a ten-year note and inflation is about 2% or less, your positive real rate is 1% or more.

That’s a headwind for gold, no question about it, because gold doesn’t have a yield. That’s another issue. Gold in my view is not supposed to have a yield because it’s money, but people allocating assets don’t think of it that way.

They think, “I can buy stocks, I can buy bonds, I can buy foreign currencies, I can buy gold, and if I can get positive real returns of 1% or 1.5% and nominal returns of 3% or more versus zero on gold, why would I have gold? I’d buy bonds.” That’s why gold is down so significantly, particularly today when it had a very large drawdown. A very hawkish Fed equals headwinds for gold.

I’ll finish there, because I know we have a lot more to discuss, but maybe later in the podcast, we can come back to how this is going to actually play out. The scenario I described of the Trump trade, stocks up, bonds down, gold down, and interest rates up is subject for a major reversal.

Not right away, but maybe by the end of February or early March, I think things are going to play out very differently than I just described. For now, they are the way I described, this is what markets expect, and the Fed did nothing to steer anyone away from that view yesterday. In fact, they were pretty clear that they think rates are on a very steep upward path.

Jon:  Thanks, Jim. Let’s build on that, because one of the stunning consequences of the election has been a dramatic buoyancy in the financial markets. The DOW has shot up some 1200 points following Mr. Trump’s victory.

I wanted to ask you if this is a case of irrational exuberance, or does the new administration give reason for economic optimism and therefore, of course, pessimism for the future dollar price of gold. What are your thoughts on this?

Jim:  I do think it’s a case of irrational exuberance, and I’ll explain why. The phrase “irrational exuberance” in reference to the stock market came from Alan Greenspan. It stems from stock prices going up and looking at them saying, “There’s really no good reason for this, there’s no fundamental reason for this; it’s just a case of your four-year trend following momentum.”

Alan Greenspan coined the phrase in December of 1996. The stock market peaked on January 1st, 2000. It was three full years before reality caught up with the stock market. Even though Greenspan was worried about irrational exuberance in 1996, the market went up for three more years. For me to sit here today and say, “Yes, I think it’s irrational exuberance,” doesn’t rule out the fact that just because things are irrational doesn’t mean they can’t get more irrational. We all know that about markets.

Let me put a finer point on that by taking the markets one at a time. Why are stocks going up? It’s fairly straightforward. What are Trump’s policies? He’s talking about lower taxes, less regulation, and lots of spending.

As a stock market investor, you say, “Lower taxes? That means consumers are going to have more money in their pockets, so I’m going to buy consumer non-durables. You’re going to spend money on defense? Let’s buy Boeing, Lockheed, Raytheon. You want to spend more money on infrastructure? Let’s buy John Deere and Caterpillar. You want to get rid of Obamacare? Let’s buy pharmaceuticals. You want to get rid of Dodd-Frank? Let’s buy banks.” It’s buy, buy, buy.

When you look at the Trump program, it’s hard to find a sector in the stock market that you wouldn’t want to buy, because all his policies individually are good for one or more of these sectors. You can say, “Good for pharmaceuticals, good for banks, good for construction, good for defense contractors, good for consumers, what’s not to like?” The problem is, will any of it really happen?

This is what the markets expect, this is what Trump has called for, but let’s take a minute and think about the cold, hard reality of what I just described. First, the policy of lower taxes, less regulation, and more government spending was Ronald Reagan’s policy. That was exactly what Ronald Reagan championed, and what he ultimately delivered, but there are a lot of caveats or footnotes around that.

When Ronald Reagan said that, interest rates were 20%. They had nowhere to go but down. They were as high as they had been since the Civil War. Paul Volcker took them there to destroy inflation. Inflation wasn’t quite killed off – it took another couple of years to do it, and interest rates remained at high levels – but that was as high as they ever got. They basically had nowhere to go but down, and they did go down a lot, which obviously was great for the bond market.

Inflation was between 14% and 15% when Reagan was sworn in. It had nowhere to go but down, and it did go down for 20 years after that. By 1983, it was into the single digits, by the 1990s, it was extremely low, and by 2000, it was zero or negative. Where’s inflation today? It’s about 1.5% with nowhere to go but up.

And finally, the stock market was at decade-long lows. Remember the first two years of the Reagan administration, 1981 and 1982, we had the worst recession since the Great Depression. In fact, all the way up until the financial panic of 2008, that ’81–’82 recession was the worst recession since the end of World War II. The economy went through a very rough time.

The Reagan boom years that everyone remembers were real during 1983, 1984, 1985, and 1986. The economy grew enormously, but it grew from a position of coming out of the worst recession since the end of World War II, interest rates that had nowhere to go but down, etc.

The other thing Reagan had going for him was the 35% debt-to-GDP ratio of the United States. He had massive headroom and could be a big spender and run large deficits, which he did.

The idea that Reagan was fiscally conservative is just not true. Reagan was a big spender and took the debt-to-GDP ratio from 35% to 55% by the time he left office. Take the 20-point increase divided by 35, which is where he started, and that’s approximately a 60% increase in the debt-to-GDP ratio.

Let’s compare everything I just said to where Trump is today. Interest rates are close to zero with nowhere to go but up, inflation is close to zero with nowhere to go but up, and the economy is not in a recession; it’s in the eighth year of an expansion. That means a lot less bang for the buck.

People are familiar with the Keynesian multiplier:  For every $1 of government spending, we get $1.50 or $1.40 of additional GDP. They spend a dollar on a defense contract, the defense contractor hires a worker, that worker gets a job, he hires a babysitter, and the babysitter takes a taxi cab home. That’s velocity. The $1 gets turned into more than $1 of goods and services, and the economy grows. That’s the Keynesian multiplier.

When you’re at capacity, in the eighth year of an expansion, you get diminishing marginal returns. Unlike the speed of light, the multiplier is not constant. It can change and does change. In current conditions, the multiplier could actually be negative. For $1 of government spending, you might get maybe 90 cents or 95 cents of additional GDP. In fact, that’s very likely.

This is all theoretical. There’s a lot of evidence to back it up, but you never know where you are at a point in time. You should let the economy play out, go back and look at the data, and then you can compute it after the fact. It’s not like a speedometer where you can just look at it and tell how fast you’re going. You have to estimate it theoretically.

Again, given capacity constraints of the eighth year of a recovery, it’s very likely that we’re in negative territory. This means $1 of government spending doesn’t even get you $1 of GDP. It gets you maybe 98 cents, because people are using the money to pay off debt or they’re saving it or they’re not spending it one way or the other.

We’re in that territory, so we’re not going to get a pop from declining interest rates or declining inflation, from disinflation. We’re not going to get a pop from the Keynesian multiplier, so even if Trump did what he said, it’s not going to have the same effect as Reagan, because our initial conditions are completely different.

Beyond that, it’s looking less and less likely that Trump is going to be able to do what he said. This is not a question of reneging on promises; it’s a question of political reality. Paul Ryan and Mitch McConnell – the Republican leadership in the House and the Senate –know these numbers as well as I do. Paul Ryan probably dreams about them in his sleep.

Just think about what the Republicans did for the last eight years. They fought Obama and the White House tooth and nail on budget deficits, debt ceilings, the fiscal cliff, and shutting down the government.

Remember all those debates? Remember Ted Cruz standing up in the Senate in 2011 threatening to shut down the government? They did actually have short shutdowns. Remember the fiscal cliff, the refusal to raise the debt ceiling so that the Treasury could issue more debt? Remember Joe Weisenthal and his $1 trillion platinum coin and all that stuff? That’s all you heard in 2010, 2011, and 2012. You haven’t heard about it the last two years, because the Democrats and the Republicans did a deal to take it off the table for the election cycle. Now it’s back.

Having fought Obama tooth and nail over the debt ceiling, now that the Republicans are in charge of everything, how are they going to raise the debt ceiling? They’re going to look like complete hypocrites.

Don’t get me wrong, they probably will, because hypocrisy never stopped a politician from doing anything. My point is, they’re not going to be very credible or let spending go wherever it wants or raise the debt ceiling $1 trillion so that Steve Bannon, Trump’s senior advisor, can build roads, bridges, tunnels, airports, and all the other stuff they want to do.

Mitch McConnell has said that tax cuts have to be revenue-neutral. By the way, Mitch McConnell is the Senate Majority Leader and can singlehandedly stop the Senate in its tracks. Nothing will happen in the Senate unless Mitch McConnell wants it to happen. If he says – and he did say – that tax cuts must be revenue-neutral, that means if you want to cut taxes on the wealthy from 40% to 33%, you have to compute how much it’s going to cost you and you have to make it up someplace else.

Now, they could do a lot of things. They got rid of the three-martini lunch a long time ago, but they could get rid of deductions, they could get rid of home mortgage interest deductions, and they could get rid of charitable deductions.

There are other things they could do. The biggest target is probably converting taxes on carried interest for private equity managers from capital gains to ordinary income. It’ll only get things so far, but here’s the real point: it kind of doesn’t matter what they do.

To say revenue neutral, there’s no stimulative impact. If I’m going to cut taxes over here and raise them just as much over there so that the impact on the deficit is zero, where’s the stimulus if I’m raising them as much as I’m cutting them? There isn’t any stimulus. All you’re doing is saying, “This guy gets a bigger piece of the pie, and somebody else gets a smaller piece of the pie,” but you’re not making the pie bigger. That right there takes away the stimulus effect of the tax cuts as far as spending is concerned.

We have $20 trillion in debt and the U.S. debt-to-GDP ratio is 104%. Do you think they’re going to throw another $1 trillion on top of that and take the debt-to-GDP ratio past 110%? We’re going to look like Italy before long.

I think what Trump is going to find is that he’ll have to prioritize and pick and choose. He’ll get some things through Congress that will be popular, and he’ll at least have the appearance of keeping some of his campaign promises, but the actual numbers, the actual stimulative effect of what’s going to happen, will be far less than the stock market is anticipating.

They’re going to find out that maybe you can have roads and bridges and maybe you can have defense spending, but you can’t have both. Maybe you can have tax cuts for the rich, but you’re going to have to increase them over here.

The hard reality is such that you’re not going to get anywhere near the fiscal stimulus from Trump that the stock market is expecting, and the whole inflation trade is not going to materialize. Go back to what I said at the beginning of this call.  The Fed has already said they’re going to lean in. The Fed threatened to not engage in helicopter money because we don’t have deflation and they’re worried about inflation.

The rhetoric is that happy days are here again, we’re going to have the Trump reflation trade, buy stock, sell gold, sell bonds, etc. That’s the rhetoric and the market thinking, but the reality may be quite the opposite.

The reality may be that you get far less fiscal stimulus than you expect, and furthermore, you get a far tighter monetary policy than you expect. If you do that, it’s a combination for a recession – far from going into a ninth year of expansion.

The Fed is always behind the curve. If the Fed is sitting there waiting for evidence to show up, by the time it shows up, it could come as a very unpleasant surprise when you look at, say, first quarter GDP at the end of April or the March employment report, which will also come out in the beginning of April.

By the way, I have a very high probability that the Fed will actually raise interest rates in March. We’ll get that out there for the listeners.

Take the March rate hike on top of the one we just had yesterday, on top of projected rate hikes, all of which is very much tightening monetary conditions, then maybe by the end of February, the stock market will get a wakeup call, “Oh, gee, we’re not going to get the deficit spending we were expecting.” The market must correct for that, so it goes down, and that’s tightening financial conditions.

You might have extremely tight financial conditions by March or April, in which case everything is going to go in reverse. Stocks are going to go down, the Fed is going to have to go dovish, that’s going to be bullish for gold, bonds are going to go up again, and rates are going to come down.

But not yet. I think it’s very important that we understand the timing and the sequence. I’m not saying you should go out and short stocks; that would be like standing in front of a train that’s coming down the tracks at 100 mph. That would be crazy to do today.

Let’s define the Trump trade. The Trump trade is stocks up, interest rates up, bond prices down, gold down, and stronger dollar. I would expect all those things to continue for a while at least through the end of the year, maybe into early next year. Probably not later than the end of February when I would look for all those things to go into reverse for the reasons I mentioned. I don’t want to just make claims, I want to explain the analysis based on the reality of higher interest rates and tighter monetary policy.

Think about what the strong dollar does. It’s deflationary. If you have a stronger dollar, that means an American who wants to buy French wine, go on a Swiss vacation, or even buy clothing from China in Costco, all those things will cost less if the dollar is worth more. That’s deflationary.

How does the Fed get to inflation with a strong dollar that’s causing deflation? They can’t. These are the conundrums, these are the paradoxes we’re confronting, but none of this will be apparent today except for our listeners.

I would expect it will become apparent by the end of February, March going into April. Every one of these trades is going to go into reverse, and that’s where gold will go up, the dollar will go down, and interest rates will start to come down.

Just to have a little pop quiz for the listeners, does anybody knows what interest rates were on the ten-year Treasury note with maturity at the end of 2013? They were over 3%. Today, it’s about 2.6% or maybe a little higher than that.

Interest rates were higher three years ago than they are today. If you went out and bought ten-year Treasury notes at the end of 2013, you got a nice 3% yield in the meantime, and you still have capital gains because rates are about 2.6%. They’re lower than they were when you bought them. That means the price of the bond goes up.

All you hear today is, “The bond bubble has burst, interest rates are going up, bond prices are going down, blah, blah, blah.” Sorry, their actual yields are lower than they were three years ago, and gold prices are higher.

Yes, the short-term trends have been negative for bonds and gold. Rates higher, bond prices down, gold down, stock up, I get all that. It’s not a lot of fun if you’re sitting on gold, but I would suggest that people keep it in perspective and understand that gold prices are up on the 21st century, they’re up on the year. They’re not up as much as they were, but they are up. They were up over this time period. Certainly, bond prices are up in the last three years. You have to put these things in perspective.

I don’t think March or April is that far away. By the time we get to the spring, we might see a complete reversal in all these trends. But for now, the trends are intact and the Trump trade is alive and well.

Jon:  Thanks, Jim. That’s a very full answer, very rich in information.

Alex, you watch all this and the markets, the equity and bond markets, through the lens of physical gold. Looking back on recent events, how do you see what’s been happening?

Alex:  I have a couple of views on this. I’d like to remind everybody that there are times when gold moves quite a bit, and sometimes people get a little concerned about the price. I would remind you that the prices we see are based upon currency crosses versus gold. What I mean is that gold doesn’t do anything.

I saw a news article the other day that said, “Trump loves gold, but gold doesn’t love Trump.” I thought to myself, “That is really one of the dumbest headlines I think I’ve ever seen,” because gold doesn’t love anybody. It’s an inert material. It doesn’t have a fancy for certain things.

Gold is just gold. A troy ounce of gold is a troy ounce of gold now, and it will be a thousand years from now. It will be in the United States or in Germany or in any other country; it doesn’t matter. It doesn’t move, it doesn’t go anywhere, and it doesn’t do anything. It just is, so when you’re seeing prices expressed in U.S. dollars for gold or British pounds or euros, what you’re really seeing is fluctuations in those currency values against gold.

Listening to what Jim was saying, I think he’s totally right. The words I would use to describe the situation is temporarily over-optimistic. In my view, equities and the U.S. dollar have been getting much stronger for all the reasons Jim mentioned and possibly a couple more.

There’s this narrative going on about how the U.S. economy is going into the future, but we should also look around the world. The turbulence we’re seeing in the EU right now and around the world is all contributing to the U.S. dollar strength, so these moves are all based on U.S. dollar strength.

There are a lot of things that push on the price of gold. On occasion, the U.S. dollar has the strongest push, and that’s exactly what’s been happening. Even in the last two days, the U.S. dollar is up strongly while every major currency in the world including gold is down versus the dollar.

Back it up even further to the beginning of October when gold in U.S. dollar terms was doing great. If you lined up a two-month chart of the U.S. dollar next to gold, you would see an extremely obvious pattern. The U.S. dollar has been getting stronger and gold has been getting weaker, but the interesting thing is that U.S. treasuries have been moving almost lockstep with gold. So has the euro, JPY, the British pound, and Swiss franc. These are all moving inverse to the U.S. dollar. This tells us that currencies around the world are just repositioning versus the dollar, and the U.S. gold price is a direct reflection of this.

I concur with what Jim says. The dollar has to weaken from this current strengthening cycle. If it keeps getting stronger like this, we’re going to be looking at serious emerging market crises, and it must reverse. What I think is going to happen is that as much of this starts to reverse, a lot of these things are also going to go in the other direction.

Jon:  Thanks, Alex.

Jim, I’d like to ask you for a brief thought about one other aspect of this election drama we’ve just lived through. Donald Trump campaigned as the champion of an unheard working class against the corruptions of the political and financial elite.

When you look at his cabinet choices that assembles the wealthiest cabinet in U.S. history, you look at his plans to reduce banking regulations, and you look at the continued reign of Goldman Sachs at the Treasury, can you see any daylight between Trump and the elites? What do these hiring decisions mean for the markets looking forward?

Jim:  I can see some daylight. I’m not as tough on this regarding Trump as some of his critics or even some of his supporters.

Your question is probably more aimed at Trump’s supporters: are they disappointed or upset at some of these appointments, and do they feel it’s the same old, same old? It’s like that song by The Who, Won’t Get Fooled Again. “Meet the new boss, same as the old boss.”

I view it a little bit differently. First, I am impressed with the caliber of the talent. Independent of the pedigree or where people worked once upon a time in their career, I think Trump is picking extremely talented, smart, competent people for the cabinet.

Garry Cohn is moving from Chief Operating Officer of Goldman Sachs to head of the National Economic Council, which is a very powerful job. They’re actually in the White House as part of the senior staff with the ear of the president. For example, when the president goes to G20, it’s the National Economic Council and the head of it who prepare his briefings and positions on things like currency wars or bailout versus bail-in, etc., and just directing economic policy in general.

As I mentioned, Cohn was Chief Operating Officer of Goldman Sachs. Probably the president’s closest advisor outside of his children and son-in-law is Steve Bannon who at one time worked at Goldman Sachs. The Secretary of the Treasury is Steve Mnuchin who also worked at Goldman Sachs.

You might say, “Wait a second, isn’t this a Goldman Sachs government?” Yes, they may have worked there, but Cohn is different; he’s Goldman Sachs to his DNA. The other two, Bannon and Mnuchin, worked there for part of their careers but moved on.

A lot of people come and go, so not everyone is there for life. They certainly get some great training, build a great network, and get some skills, but Bannon went on and had a big career in Hollywood.

He started doing media deals and started his own investment bank. He did media deals as an investment banker and made a ton of money. He bought the rights to Seinfeld, the comedy show, after the first season. It wasn’t a big hit in the first season, he stepped in and bought the show, and then, of course, it was the most popular TV show of the 1990s. He made a lot of money there.

Mnuchin also went out on his own as a private equity dealmaker, bought some banks, and made a lot of money that way. They’re super talented guys who have made a ton of money, they’re Wall Streeters – however you want to define it – but I don’t really think of them as part of a deep, dark Goldman Sachs conspiracy where one firm controls the government.

Goldman Sachs is full of Republicans and Democrats who do have a finger in every pie. I will say everywhere you turn, you’ll find Goldman Sachs alumni. Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, worked there. Bob Rubin, Secretary of the Treasury during the Democratic Clinton administration, and Hank Paulson, Secretary of the Treasury during the Republican Bush administration, were both former heads of Goldman Sachs. They tend to be everywhere, but they tend to be quite talented. They’re Republicans and Democrats, conservatives and liberals.

I don’t see Goldman Sachs as this homogeneous malevolent force, particularly if you haven’t been there your whole career. Cohn has, so he’s maybe in a little bit of a different category. The others were there for a while, but they did a lot else in their career. I view it more as a question of talent.

The title of my new book is The Road to Ruin: The Global Elites’ Secret Plan for the Next Financial Crisis. When I talk about the global elites I’m not talking about CEOs and bankers; I’m talking about policymakers. People like Christine Lagarde and David Lipton at the IMF, or Michael Froman, now the U.S. Trade Representative, formerly on the National Economic Council, or central bankers like Mario Draghi or Janet Yellen, or academics like Larry Summers or Ken Rogoff, or public intellectuals like Adair Turner and Anatole Kaletsky.

Those are the people I refer to when I use the phrase global elites, because they’re running the international monetary system, institutions like the World Bank, the International Monetary Fund, the Bank for International Settlements, the Financial Stability Board, the sherpas in the G20 process, central bankers, and finance ministers. That’s the group I’m talking about specifically. They’re the ones who are advocating the SDR and are getting ready for the next financial crisis.

Investment bankers are important, they play an important role, but I really think of them as more about talent. I think Trump is getting some very good talent and some very good advice. I don’t quite buy into the Goldman Sachs conspiracy theory. It’s a powerful institution with a lot of problems. As far as Goldman Sachs itself as a company, what they do, that bears watching, but I think you have to take the individuals one at a time.

As far as his other appointments, as President-Elect Trump would say, “I have my generals.” General Flynn at the National Security Council, General Mattis at the Pentagon, and others who are getting various appointments in the Intelligence Community and other roles. They’ve talked about General Petraeus as perhaps having a role, Admiral Rogers maybe for Director of National Intelligence. Not all of these appointments have been announced and not all these seats have been filled yet, but he’s really relying on military people.

Just a word there:  I have been privileged to have a lot of exposure to the military, particularly senior officers, working with majors and colonels and generals. I’ve met a few four-star generals, but I work closely with two-star and three-star generals, brigadiers, major generals, and lieutenant generals. You would have a hard time finding a smarter group of individuals. I’ve worked with Wall Streeters, Nobel Prize winners, PhDs and academics, and I’ve worked with the military. Our senior military officers – I’m talking about the top tier – these men and women, they have PhDs, they speak five languages, they have two master’s degrees. They have all that education, plus they’ve been on active duty on five continents.

When you’re an area commander, a central commander, African commander, European commander, you’re like a super-ambassador. You deal with your peers, you deal with heads of state, you deal with ministers of defense and other senior cabinet officials, CEOs in the places you go. They’re super competent, but they also have a culture.

The military culture is “Can do. Never complain, get it done, mobilize whatever resources you need.” They don’t make excuses between each other. They have a very direct, very blunt style. That’s the kind of military culture. There’s a lot to admire there.

Another example is Wilbur Ross. I’ve met him a few times. He’s a very nice guy, super successful, and a shrewd dealmaker. So, I look around this cabinet and what I see is not a group of elites. I guess if you’re a billionaire and you belong to certain clubs, you’re part of the elite, but I define it a little more narrowly. My definition of elites runs to likeminded people using really bad economic models to run the financial system off a cliff.

As far as the others are concerned in the Trump cabinet, I see a lot of talent, a lot of smart people, and I don’t see the conspiracy that some others see. It’s nice fodder for the websites. What do they call Goldman Sachs? The Vampire Squid. It was Matt Taibi at Rolling Stone who came up with that phrase.

Goldman is a powerful institution; I have no illusions about it. They do have a finger in every pie, but I don’t quite buy the vampire squid theory, and I don’t think it’s a conspiracy. I think Trump has some very talented people.

Jon:  Thanks, Jim. In particular, it’s a very helpful distinction you made about how precisely you’re defining the financial elites.

And now, Alex, I’m sure you have many questions from our listeners. We have a little time left, so let’s use it to hear those questions.

Alex:  We did have a lot more material planned for this discussion, including the situation that’s going on in India, and I’m just going to very briefly touch on that.

For those of you who don’t know, there was a demonetization declared on November 8th by India’s Prime Minister. It has created a tremendous amount of turmoil. Almost 98% of the country’s transactions are done in cash, so this has been a huge issue. We referred to this in previous discussions as the war on cash, and it sort of morphed now into the war on gold over there.

We don’t have time to dive too deeply into that at all, but just be aware that it is happening, and we’ll try to cover it more in-depth maybe if it’s still an issue in the next podcast. We have a bunch of great questions right now.

Jim:  Alex, I’m sorry, if I could just interrupt for 30 seconds. I hope we do cover it in the next podcast. You’re absolutely right about India, but this thing is spreading faster than I can keep track of.

After that, we had a demonetization in Venezuela. They declared the 100 bolivar note no longer legal tender. Demonetization is a fancy word for “Your money is not money anymore.” A president or a head of state or a prime minister wakes up and says, “Your money is not money anymore.”

It happened in India, it happened in Venezuela, and it’s now being proposed in Australia. It came up yesterday that Australia may abolish the $100 AUD note. This is bouncing around from country to country. It’s gone way beyond India, although India is the most egregious case.

Let’s make a note that is a good one for the next podcast.

Alex:  Yes, absolutely. We talked about it the last time and said that these are not isolated cases; this is all part of a larger sort of plan. This is not a big conspiracy theory or anything like that. Jim has talked extensively about it. It’s all documented. We know from the last G20 meetings, the initiative there. The end-result that they’re trying to get everybody into is basically digital accounts and no cash so it’s easier to control.

Moving on to our questions, as I’ve mentioned, we have a lot of good ones.

The first question comes from a gentleman by the name of Chris M. If I’m not mistaken, I believe he’s from the U.K. His question starts out with a bit of preface: “In the U.S., the FDIC compensation scheme is in place to compensate small savers with money in banks. In the U.K., the Financial Services Compensation Scheme is the equivalent, and it’s likely to be raised to £85,000 soon.”

His questions are, “Isn’t it possible that in the event of a systemic banking crisis – worse than 2008, for example – that the U.K. government, saddled with public debt of 90% to GDP, might not be in a position to honor these promises to compensate savers?” There’s a second part to it: “May the only courses of action be a partial payout and bail-ins in order to salvage the situation?”

Jim:  Anything is possible, so you can take any scenario you want and I’m not going to say it can’t happen. Too many weird things have been happening. We don’t have to guess about what a bail-in is because the G20 told us.

In November 2014, from Brisbane, Australia, the G20 meeting working papers had a blueprint for what a bail-in is. It doesn’t mean they can honor it in every case, but we know what it is. They do intend to honor the insured deposit. Any amount in excess of the insurance is absolutely at risk.

I don’t know every limit in every country, but I know for the European Monetary Union, it’s 100,000 euros. In the United States, it’s $250,000. I take it from Chris’s question that in the U.K., it’s somewhere south of £85,000, which I guess would be roughly equivalent to $100,000.

The amounts vary, but it is the intention of the G20 to protect you to that extent. A lot of people have more than that, but it doesn’t mean they’re super rich. People say, “If you have $500,000 or 500,000 euros in the bank, doesn’t that make you rich?” Maybe, but you could also be a businessperson, and that could be your working capital.

You could be a car dealer or a restaurant operator with that much in working capital to meet payroll. The money is in the bank, but it doesn’t mean it’s all your personal net worth. It could be there to satisfy accounts payable, payroll, working capital, or any other thing you might have in the business.

That money is at risk in the event that a particular bank becomes a subject of a bail-in. The intention would be to take amounts more than the insured amount, convert it into equity in the new bank, bearing in mind that the equity in the old bank got wiped out.

The bail-in playbook is simple:  equity goes to zero, deposits in excess of the insured amount can be converted into anything they want including equity in a new bank, so you involuntarily go from being a depositor into being a stockholder. Bondholders take a haircut.

A haircut just means you don’t get 100 cents on a dollar. You might get 40 or 60 cents. Whatever it takes to fill the hole in the balance sheet is how much the bonds will get haircut. All of that happens before any government money is used.

As for the insured amount, could the government be in a position where they can’t honor the obligation? That shouldn’t happen, because they can always print the money. The question really is, what’s the money worth?

In other words, I might pay you your £85,000, but if I have to print the money to do it, the purchasing power might be worth half. I’ll give you all the nominal money, but you might discover that it’s not worth as much as you think.

Alex:  We’re very tight on time, but there are still a couple of really good questions. If we could ask you to stay maybe five minutes over time, Jim, and quickly address some of these to make a three-minute or a five-minute clip for each one.

Before I jump into them, just a quick hello to Susan K. She’s asking when will the gold price bottom? We talked a little bit about that before. If you’re looking at gold, December-January-February timeframe might be a good window.

There are two questions here. One is from Robert O. who asks, “If the world’s currency cash-holders have lost the war on cash, how do you expect those much fewer gold owners to be able to win the war on gold? Would it be wise in your opinion to join in on this losing proposition?”

Jim:  I hear this a lot in different forms. People say, “Yes, I hear you, Jim and Alex. I understand gold preserves wealth and will protect me against inflation and the war on cash, but what good will it do me if the government is just going to come and take my gold?” When I hear that, I think of it as an excuse by somebody who doesn’t really want to own gold to begin with and is looking for reasons to justify that.

What happened in 1933 in the United States? President Roosevelt, by executive order, made gold illegal in the hands of U.S. citizens. He made it contraband, like drugs or smuggled goods, and said everyone had to hand in their gold. If you didn’t, you could go to jail, and there were fines equivalent to $100,000 in today’s dollars.

That’s what’s referred to as the Great Gold Confiscation. Wouldn’t they just do it again? Well, there’s a little bit of nuance there. That is what happened, but when they handed in their gold, they got $20 an ounce which was the price of gold at the time.

The Fifth Amendment of the U.S. Constitution says the government can take your property, but if they do, they must give you just compensation. For example, if the government is putting through a highway and says, “Sorry, we have to put the highway through your farm because that’s where the road goes. We’re taking your land by eminent domain, but we’ll give you a check for the value of the land,” the government can do that.

The government can take your gold at any time they want, but they must pay you for it. They can’t just come break down your door and seize it. That would be a violation of the Constitution. I don’t know what the law in India is; maybe they can break your door down and seize it for tax evasion, but not in the United States.

Roosevelt did give them $20 an ounce, but he was sneaky. He knew he intended to raise the price of gold in effect devaluing the dollar, which he did. He took it from $20 an ounce to $35 an ounce, which was a 75% increase in the price of gold if you want to think of it that way, or inversely, a 40% devaluation of the dollar.

I’ve always called it a confiscation because he didn’t know exactly $35 at the time. He ended up there, but he was thinking, “I’m just going to raise the price of gold until I get some inflation,” which he eventually did.

If you force people to sell it to you at $20 an ounce, but you know secretly that you’re going to raise the price, that’s a form of theft. It’s just dishonest. He wasn’t honest with the American people. That’s why I call it a confiscation.

For the record, they did get $20 an ounce. The problem is they didn’t get $35 an ounce, which is where he ultimately took it. That was the deception, that’s what was wrong. The $20 an ounce did fulfill the requirements of the Constitution, of the Fifth Amendment, because they got just compensation. We were on a gold standard, and that’s what the price of gold was.

Imagine the same thing today. The government is so desperate they want to come and get your gold. Well, they have to pay you for it. They could do it, I’m not ruling it out, but they must pay you for it. But there’s a big difference – we’re not on a gold standard today. The price of gold can be whatever it can be. It can go down, it can go up. There is no fixed price of $20 an ounce or even $1000 an ounce.

Imagine a world where the government is going to do this. A world in which the government is so desperate that they want to confiscate all the gold is a world that’s already out of control. It’s a world where the price of gold is probably well on its way to $10,000 an ounce.

To confiscate gold today consistent with the Fifth Amendment, because there’s not a fixed price, they can’t do the bait and switch that Roosevelt did. They would have to pay you the market price, and it’s extremely likely that the market price in that state of the world would be well above $5000 an ounce.

If you buy gold at $1100 or $1200 an ounce and the government takes it at $5000, I would say mission accomplished. At least you got your $5000. That’s an extreme scenario I don’t see happening, but it certainly could.

The difference between then and now is the government would have to pay you the market price, and since we’re not on a gold standard, it would be something more like a true market price, probably much higher than it is today.

Alex:  I can also add to that for our international listeners. Oftentimes as much as 50% of our audience is international. We have a wide range of people from different walks of life from professionals, doctors, attorneys, airline pilots, people who run money professionally, fund managers, etc. all over the world.

One of the things I can tell you from our background in gold and our experience in dealing with this over decades is that the way multigenerational wealth is preserved many times is not just by diversification but by what we call jurisdictional diversification. That means if the gold is in places not just in your own jurisdiction but spread out across several jurisdictions, extreme events happening at any one particular jurisdiction may not affect other jurisdictions.

The question must be asked. If you have wealth that’s preserved from generation to generation, we’re talking over a span of maybe a hundred or more years, inevitably, in any jurisdiction, there are wars, economic turmoil, and perhaps drastic changes in government, so how is wealth preserved? The answer is that they don’t put all their eggs in one basket jurisdictionally, so to speak. That’s another area to perhaps think about and take a look at.

Jim, if you have time, there’s one important question I think people need an answer to. This is coming from Bradley W., and I’m going to briefly summarize his question.

He says he attends all our podcasts, has read all your books, is a subscriber to your various newsletters, and he listens to most of your interviews. His one nagging question – and I suspect he’s not the only one who’s worrying about that – is if he holds 10% of his portfolio in gold and there is a systemic lockdown like what you’ve been speaking about, then how does he convert his gold to something of value?

What are the options at that point, and what are your views on that?

Jim:  He doesn’t have to convert his gold to something of value, because it’s already in something of value. The gold itself is valuable. Of every scenario I can think of, that would be the one where I would most want gold.

In a scenario where you can buy and sell freely, or sell an asset and get dollars for it, turn the dollars into euros, move the money around, the system is working, the infrastructure is up, gold will do everything it’s supposed to do and the dollar price of gold could go a lot higher and will go a lot higher based on the declining dollar.

I think what Bradley was getting at is, “What’s the bottom for gold?” The bottom for gold is the top for the dollar. When the dollar peaks, that’s the lowest dollar price for gold. That’s all it is, it’s a seesaw. One is the inverse of the other. If you say, “What’s the low dollar price for gold?” I’m going to say, “When does the dollar peak?” The answer is it’s pretty soon.

The way to do the analysis is always to think through the alternatives. Say, “Why can’t the dollar go to 120 on the index?” Take the dollar to 120 on the index and you’re going to have massive deflation in the U.S. economy. That’s going to increase the debt-to-GDP ratio, and the U.S. is going to have a sovereign debt crisis. That’s why that can’t happen, which means the dollar has to back off at some point. I think we’re getting close to that point.

When you do scenario analysis, you don’t just focus in on one thing; you look at all the alternatives and think of the reaction functions and how things are actually going to play out.

The scenario where the banks are locked down, what I call “ice-nine” in my new book, is when you can’t get money out of the banks, the ATMs are shut, the exchanges are shut, maybe there’s social unrest, maybe there are problems in the power grid – a really dire scenario. That’s when I want my gold more than ever.

In that world, you’re not looking to exchange it for some other store of value. You probably have the best store of value out there along with fine art or land or a couple of other things. I would say you don’t want to exchange it.

You could spend it. Remember, people always find money. For the best example, go back to the Great Depression in 1933. There were parts of the United States where there was no money. They were just out of money. The banks were closed, people were unemployed, the economy was flat on its back, and they had no money. What did people do? They made up money.

I don’t know if you’ve heard the expression, “Don’t take any wooden nickels.” That comes from the Great Depression. People made circular wooden coins, stamped them with values, put the names of local merchants on them, and put them into circulation.

You could go down to a drug store and buy drugs with the wooden coins, and then the drug store owner would pay his employee with the wooden coins. They literally made money out of wood, and that’s where the expression wooden nickel comes from.

My point being, people will always come up with some kind of money. People might say, “Why would I want gold? I can’t eat it.” My answer is “Why would you want to eat it? Eat food, don’t eat gold.” They say, “I can’t spend it.” My answer is “Yes, you can.”

When you don’t need it, you’re not going to be able to spend it, but when you do need it, you will absolutely be able to spend it because people will invent money. If you have the real thing, you’re going to be the richest guy in town.

Alex:  Just to add a little bit to that, we’ve always said that gold and silver is money of last resort. In a complete breakdown of ability to transfer money around, there is always that.

One last thing, keep in mind that these things are temporary events. They’re not forever events. It’s like a hurricane that comes in and causes a lot of chaos and damage, but it doesn’t last a week, a month, a year, or two years. There’s a period of time where that’ll happen.

At the same time, the most important thing is, how are you preserving your value? When it’s over, whoever has the most value is going to have the best options. I think that’s probably the most important thing to keep in mind.

Jim, I want to thank you for your time. It’s always an excellent discussion with you. I love to do these podcasts, and based upon the feedback we get from our listeners, I’m sure it’s very much appreciated.

With that, we’re going to turn it over to Jon.

Jon:  Thank you, Alex, and thank you, Jim Rickards. It’s always a pleasure and an education having these conversations with the both of you. Most of all, thank you to our listeners for spending time with us today and hanging in there quite a bit over time.

Let me encourage you to follow Jim and Alex on Twitter. Jim’s handle is @JamesGRickards, and Alex’s handle is @alexstanczyk.

Goodbye for now, and we look forward to joining you again soon.

 

Listen to the original audio of the podcast here

The Gold Chronicles: December 15th, 2016 Interview with Jim Rickards and Alex Stanczyk

 

Learn more about Jim Rickards new book, The New Case for Gold at http://thenewcaseforgold.com/

You can follow Alex Stanczyk on Twitter @alexstanczyk

You can follow Jim Rickards on Twitter @JamesGRickards

You can listen to the Gold Chronicles on iTunes at:
https://itunes.apple.com/us/podcast/the-gold-chronicles/id980027782?mt=2

You can Listen to the Global Perspectives on iTunes at:
https://itunes.apple.com/ca/podcast/physical-gold-fund-podcasts/id1056831476?mt=2

You can access transcripts of our interviews at:
http://physicalgoldfund.com/category/transcripts/

You can subscribe to our Youtube channel to access these interviews and more at:
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By listening to this podcast or reading its associated transcript (collectively, this “Podcast”), you agree with the following.

This Podcast is not an offer to sell, nor a solicitation of an offer to purchase, any security. This Podcast is intended for general education and information purposes only, and may include broad discussions of markets, geopolitics, monetary policy, and geoeconomics. Nothing in this Podcast constitutes investment, legal or tax advice, nor an evaluation of or prospectus for any particular investment or market, including gold. This Podcast should not be relied upon to make any investment decision. You are encouraged to seek the advice of qualified financial, legal and tax advisors before making any investment decisions.

This material is provided on an “as is” and “as available” basis, without any representations, warranties or conditions of any kind. In particular, information provided by third parties in this Podcast has not independently evaluated or confirmed. Furthermore, we take no responsibility to update this Podcast to reflect any changes in any of the information presented. Physical Hard Assets Fund SPC and Physical Gold Fund, its officers, directors, employees or associated persons will not under any circumstances be liable to you or any other person for any loss or damage (whether direct, indirect, special, incidental, economic, or consequential, exemplary or punitive) arising from, connected with, or relating to the use of, or inability to use, this Podcast or the information herein, or any action or decision made by you or any other person in reliance on this information, or any unauthorized use or reproduction of this Podcast or the information herein.

The Gold Chronicles: December 15th, 2016 Interview with Jim Rickards and Alex Stanczyk

Jim Rickards and Alex Stanczyk, The Gold Chronicles December 15th, 2016

Topics Include:

*Fed hiked interest rate by .25% as expected
*Fed is expecting 3 more rate increases for 2017 which would bring it to 1.25%
*Yellen has indicated she would lean into Trump’s stimulus if it looked like inflation was getting out of hand
*Trump’s plan calls for $1 trillion in spending, tax cuts, and less regulation. This is a recipe for much higher inflation
*Monetary policy has reached the end of its capability
*Why markets are entering a period of irrational exuberance
*Factors that could impede Trump from having a free hand to implement his economic policy
*The actual numbers of Trump’s fiscal stimulus is going to be far lower than the market is expecting
*Gold is priced in various currency crosses versus gold, price variations are actually currency value fluctuations versus gold
*USD/Gold moves for the last several months have been inverse to USD strength. All major currencies have been declining versus the USD, including gold
*Assessment of Trump’s picks for his administration staff
*India War on Cash / War on Gold has accelerated
*War on Cash has extended to Argentina, Australia
*Description of the “Bail-In” playbook
*Why owning gold makes sense even when there is a risk of government confiscation, and why multi-jurisdictional diversification is one tool to do so
*Gold conversion during periods of crisis
*How to get the most value out of your gold holdings if there is a crisis
*Crisis are temporary events, they have a lifespan, the most important is how value is preserved during a crisis and who has the most valuable assets on the other side of the crisis

 

 

Learn more about Jim Rickards new book, The New Case for Gold at http://thenewcaseforgold.com/

You can follow Alex Stanczyk on Twitter @alexstanczyk

You can follow Jim Rickards on Twitter @JamesGRickards

You can listen to the Gold Chronicles on iTunes at:
https://itunes.apple.com/us/podcast/the-gold-chronicles/id980027782?mt=2

You can Listen to the Global Perspectives on iTunes at:
https://itunes.apple.com/ca/podcast/physical-gold-fund-podcasts/id1056831476?mt=2

You can access transcripts of our interviews at:
http://physicalgoldfund.com/category/transcripts/

You can subscribe to our Youtube channel to access these interviews and more at:
https://www.youtube.com/channel/UCXRWzw0vaNgCwo7nTMEAwkA

By listening to this podcast or reading its associated transcript (collectively, this “Podcast”), you agree with the following.

This Podcast is not an offer to sell, nor a solicitation of an offer to purchase, any security. This Podcast is intended for general education and information purposes only, and may include broad discussions of markets, geopolitics, monetary policy, and geoeconomics. Nothing in this Podcast constitutes investment, legal or tax advice, nor an evaluation of or prospectus for any particular investment or market, including gold. This Podcast should not be relied upon to make any investment decision. You are encouraged to seek the advice of qualified financial, legal and tax advisors before making any investment decisions.

This material is provided on an “as is” and “as available” basis, without any representations, warranties or conditions of any kind. In particular, information provided by third parties in this Podcast has not independently evaluated or confirmed. Furthermore, we take no responsibility to update this Podcast to reflect any changes in any of the information presented. Physical Hard Assets Fund SPC and Physical Gold Fund, its officers, directors, employees or associated persons will not under any circumstances be liable to you or any other person for any loss or damage (whether direct, indirect, special, incidental, economic, or consequential, exemplary or punitive) arising from, connected with, or relating to the use of, or inability to use, this Podcast or the information herein, or any action or decision made by you or any other person in reliance on this information, or any unauthorized use or reproduction of this Podcast or the information herein.

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