Jim Rickards and Alex Stanczyk, The Gold Chronicles June 2017
*In depth look at potential risks of cryptocurrency
*Why cryptocurrencies are still in their infancy and are not yet comparable to gold, US dollars, or other currencies
*Why ICO’s and crypto currencies are not protected from government regulation or enforcement
*How most cryptocurrency ICO’s are not compliant with international AML/KYC reporting frameworks
*Which tools regulators have for enforcement of breaches in regulation and why cryptocurrencies are not beyond regulatory reach
*How a distributed ledger works
*How Bitcoin mining works
*What is an Initial Coin Offering
*Trustless dis-intermediation still has chokepoints that regulators can act against
*Tax implications of cryptocurrency ownership
*North Korea Update
Listen to the original audio of the podcast here
Physical Gold Fund presents The Gold Chronicles with Jim Rickards and Alex Stanczyk sharing insights and analysis about economics, geopolitics, global finance, and gold.
Alex: Hello, this is Alex Stanczyk. Today I have with me Mr. Jim Rickards. Jim, welcome back to the podcast.
Jim: Thanks, Alex. It is great to be with you.
Alex: We have a number of different subjects today including cryptocurrency. We’re also going to talk about the G20, Syria, and North Korea.
Let’s start with cryptocurrencies. We have listeners who are interested in crypto but are not what I would consider seasoned crypto-enthusiasts. For the portion of the audience who are not highly technical, there’s a desire to know more about crypto in terms they can understand. We’re going to discuss that a bit today.
I would like to lay down a few thoughts to set a foundation for the topic. First of all, this is not about cryptocurrency bashing. I personally like the idea of a distributed ledger; it’s fascinating technology. The potential for the blockchain technology is quite interesting.
This also isn’t about whether gold is better than cryptocurrency or vice versa. The truth is, crypto is still in its infancy. It does not yet come close to gold in terms of practical application.
Gold’s market cap is in the neighborhood of $7.4 trillion as of the last estimates we received from our sources. Other currencies, Global forex for example, are multiple times this in size. All crypto combined is sitting at a market cap of about $112 billion. While the technology has great potential, cryptocurrencies themselves have a long way to go before global markets take them seriously as a money alternative with any depth and liquidity.
There’s been a lot of buzz surrounding crypto that, from my perspective, does not take into account the reality of the global regulatory landscape we live in today. For example, because it’s crypto or because it’s an ICO (Initial Coin Offering), if this ICO is in a country outside the U.S., there seems to be this belief that it’s somehow protected from regulatory reach.
One of the things I want to talk about today is that this is either a lack of understanding of how regulatory enforcement works on a global level, or possibly there may be a little bit of confirmation bias going on that’s blinding people to how things really work.
I want the listeners to keep in mind that I’m not pretending to be any kind of technical expert on cryptocurrency. What I’m addressing is what appears to me to be gigantic, gaping holes in the attention given to regulatory compliance and this idea that crypto is somehow beyond the reach of government.
Jim, I’m going to be asking you for your input on this in a moment. But for now, let me just add a little more foundation.
Right now, ICOs are popping up like crazy. It’s kind of like the Wild West. An ICO is a brand-new cryptocurrency people are pouring money into. My observation is that the majority of these ICOs may not understand the legal implications of what they’re doing in the area of what regulators could view as issuance of securities or, with a lot of them, being in noncompliance with international AML/KYC frameworks such as FATCA, CRS, and IGA. FATCA is the Foreign Account Tax Compliance Act, an intergovernmental treaty framework the U.S. has pushed. CRS is an OECD framework, and IGA is put forward by the UK.
These things all need to be taken seriously. There’s a host of regulatory bodies from several countries that are monitoring what’s happening in crypto. Even if they’re not aggressively pursuing enforcement actions, they’re well aware of activity in the space.
From the U.S. specifically, the regulators who have potential oversight are the SEC, the CFTC, and particularly the FinCEN. FinCEN stands for the Financial Crimes Enforcement Network.
All it would take would be for crypto to be classified as a primary tool for terrorist financing, and then all kinds of risks start to open up. I want to be clear here that I’m not suggesting crypto is a primary channel for these kinds of activities. What I’m saying is that if a regulator such as FinCEN claims that it is, that’s all it’s going to take for this to have serious potential repercussions.
At this point, some people who are familiar with crypto might make the argument that, just like gold, if it’s used in total isolation, it works, which I grant is true, but not for any serious liquidity. For example, you can bury gold in the backyard, but in serious quantity, who are you going to sell it to later and expect it to remain secret or safe during such a transaction?
With crypto, you can avoid digital exchanges by going point-to-point directly. You can try to avoid interfacing with anything that touches USD transactions. In doing so, your world of potential transactions and, importantly, options for liquidity and size diminishes substantially if an actor tries to take this isolation route.
Jim, considering that regulators could take the view that ICOs are acting as noncompliant financial services entities, what are your thoughts in this area in terms of the tools regulators bring to bear on U.S. dollar transactions in cryptocurrency or other risks you see here?
Jim: Thanks, Alex. That was a great introduction. The first thing I would say is that this is a huge topic. We say, “cryptocurrencies,” “blockchain technology,” “initial coin offerings,” “safe contracts” or “smart contracts,” and the various uses and legal regulatory regimes which I’ll talk a little bit more about.
Each thing I just mentioned is a big topic in itself, and they all fall under the banner of crypto. For those not familiar, this all originates with a certain kind of technology, a certain protocol called the blockchain.
Blockchain is basically a recordkeeping, a ledger. Right now, certainly for hundreds of years but still true today, if you bought a property from somebody, you’d show up at the closing (or your lawyer would) and the seller would have a deed. They would sign it over to you, and you or more likely your lawyer or a clerk or somebody would go down to the town hall and hand that to the town clerk.
The town clerk would literally write it down. Maybe they’d type it in a ledger, a land record, and put a stamp on it. They would give it back to you or mail it back to you so you could put it in your safe-deposit box. That deed would be your legal document representing your title to that land.
Think about all the steps I just described. The fact that there’s paper involved and it’s got to go through many hands: lawyer, clerk, the town clerk, back to you, buyer, seller, etc. It’s legally binding and recognized by the courts. It’s the way things are still done today.
These are public records. You can go to the town hall on your own and pick out a lot number and a block number. (That’s usually how they’re categorized, e.g., Block 22, Lot 15.) You could look it up, find out who owns it today, and who they bought it from all the way back to whoever, maybe the Revolutionary War for that matter. That’s an example of a ledger and a recordkeeping method to establish title.
The blockchain does a couple things. First, it’s completely digital, so forget the paper side of it. Second, it’s heavily encrypted with what’s called military-grade encryption, which is (at least as far as I know) unbreakable. If there’s any way to break it, I promise you, it is the most closely held secret of any government in the world.
People are certainly working on it all the time, but for all practical purposes – again, as far as I know – it’s unbreakable unless you give away your key. You have a certain alphanumeric code that is your key. As long as you keep that private and don’t give it away, then you’re the only one who can unlock the encryption.
It’s heavily encrypted; it’s digital; it’s virtually free to move it around. Most importantly, it’s distributed. ‘Distributed’ means that this ledger resides on thousands, millions, or potentially tens of millions of computers and servers all over the world.
That’s a big deal, because if there were a fire in the town hall and all those paper records I just described were destroyed, you’d have a heck of a time recreating all that. But if you literally blew up a computer that had this ledger on it, it wouldn’t matter. The same ledger exists on all these other computers. It’s the community as a whole that verifies it.
If one party says, “I own this certain asset” (it could be Bitcoin or any other asset which we’ll talk about in a minute) and the whole community says, “No, you don’t. We all have the same ledger, and we see that this went to a certain party from A to B, and Ms. B is the owner,” that’s that.
You have the benefit of digitization, encryption, and distribution. These three very powerful tools are the blockchain technology. Now, what can you do with blockchain technology? One thing – and this has been done – is to create a cryptocurrency. Bitcoin is the most famous or best known, but there are many of them out there.
I was involved with one working group, and we identified 90. That was some time ago, so I am sure there are many more than that. Some of them have larger amounts in circulation, larger followings, if you will, than others. Greater liquidity is the way I think about from an economic perspective, but they’re all out there.
How do you get some of this currency? How do you get a Bitcoin? Well, you can sell something and accept Bitcoin payment. I have a store on my website, The James Rickards Project, that accepts Bitcoin. You could pay me in Bitcoin for one of our goods, etc.
You can sell things for Bitcoin, and you can go buy a Bitcoin. You can take dollars or euros for that matter and go to a Bitcoin exchange (exchanges are popping up all over) to buy Bitcoin.
You can also mine them. The word ‘mining’ obviously is a reference to, or at least an analog of, gold mining. Of course, it’s nothing at all like gold mining. I’ve been in gold mines, and it’s one of the grittiest, most physical business you can imagine.
You have to drill cores and walk around in remote areas that are either freezing, equatorial swamps, or deserts. It’s a nasty business with all kinds of machines, backhoes, and all that stuff. Gold mining is a very hands-on, gritty business.
Mining Bitcoin or any cryptocurrency is quite the opposite. It takes massive computing power. To simplify it, the Bitcoin protocol is basically solving very difficult math problems that take a lot of number crunching, a lot of computing power, and a lot of energy.
By the way, one of the criticisms of Bitcoin is that the amount of energy being sucked up to create Bitcoin, to do this mining, is itself a waste. We’re burning a lot of coal somewhere in the atmosphere, or nuclear power or some other things people don’t like, to generate electricity so Bitcoin miners can go about their work. I’ll just leave that as an aside.
Some big Bitcoin mines are, at this point, a very large warehouse-sized facility with lots of servers and processing power going on. Some are being put in Iceland, because it’s cool in Iceland, and you generate a lot of heat with that much computing power. Also, energy is relatively inexpensive there, because they have geothermal and a couple other things. That’s the kind of Bitcoin mining.
These math problems I described get harder. Every time somebody mines a Bitcoin, the next problem gets a little bit harder. It grows exponentially to the point where the last few Bitcoins that ever get mined, the amount of processing power that goes into it, is going to be enormous.
As a miner, if you solve the problem, you get Bitcoin. That becomes your reward. I haven’t verified this myself, but I heard from third parties that today it costs about $1,000 to mine a Bitcoin. Bear in mind, we’re pretty far down the road with these things. Originally, it would have been far less than that. Now the Bitcoin are selling on exchanges for between $2,000 – $3,000. It’s volatile.
I guess it’s like gold mining. If I can mine gold for $800 an ounce and sell it for $1,200 an ounce, I can make some money. If I can mine Bitcoin for $1,000 and sell it for $2,000 – 3,000, obviously I can make money doing it. That’s the currency part of it.
Now, let’s talk a little bit about Ethereum and ICOs. I said there are many cryptocurrencies other than Bitcoins. These initial coin offerings are groups of developers not unlike any Silicon Valley startup. In San Francisco, San Jose, Silicon Valley, New York or anywhere in the world associated with Silicon Valley, you can find teams of developers. Maybe some of them have experience at one of the big, successful startups whether it’s PayPal, Uber or some of these new apps they’re working. You name it, there’s an app for it, of course.
They need to fund themselves, because they have salaries, overhead, rent, equipment costs, etc. no different than any other startup. The traditional way is to meet with venture capitalists, ask your mother or family and friends, knock on doors or do a private placement. There are traditional ways of funding any startup.
More recently, we’ve seen what they call crowdsourcing or crowdfunding where you throw it out there on a certain Internet site and get people to give you money. With original crowdfunding, they’d give you a T-shirt, a ticket to a movie if they could produce a film, whatever it might be.
These ICOs are really nothing more than crowdfunding or crowdsourcing. Here’s how it works: If I choose to subscribe to one of these, I send in hard dollars, $100 or $1,000 or whatever. In return, I receive one of these coins. They also call them tokens or some name like Dow and Mastercoin, for example.
I’ll get one of these coins or maybe a bunch of them because I put a lot more money in. What do I get for my coin? Here’s where it gets interesting. In a normal startup, I’ll sign a subscription agreement, send my money in to the promoter, and I’ll get shares, units, limited partnership interest, LLC member’s interest, stock, or something.
It goes on the ledger (a capitalist will say a cap table). From then on, I’m an equity holder. If the company fails, my equity goes to zero, tough noogies. If it succeeds, maybe I just bought into the next Google at $1/share and someday it’s at $1,000/share. That’s why people do it hoping for those big gains.
With the coin or token I get, it’s not really a share. I don’t get any voting rights or dividends. That’s where I’m jumping ahead a little bit to the regulatory regime you talked about, Alex, and where the securities laws get tricky.
If I’m the creator, the programmer, and the developer of this, I can define the token any way I want. It’s certainly possible that a token could walk and talk like a share of stock. The minute you tie the value of the token to the success of the enterprise, it’s probably a security.
For purposes of application of the ’33 Act and ’34 Act securities laws (the ones we’re familiar with in the U.S.) and similar securities laws in Europe, the UK, and Japan, the definition of a security is a little bit technical. It’s usually tied to some stake in the success or failure of the enterprise and defined as the earnings of the enterprise.
What if my token says, “No, Jim, you don’t get any stock. You get no votes. You have no equity in this thing. What you do get is to use the app for free,” or “You get to sell it to somebody else,” or “If the app is successful, you’re going to get certain privileges,” or “You can intersect something you’re doing with what we’re doing so these things are compatible in certain ways.”
I realize I’m being a little vague right now, but the area is vague, because there are a lot of ways to do this.
I might create a token that looks just like a security, in which case, unless I follow the private-placement rules 506(b), 506(c) and some other laws, I could be breaking the securities law if I’m not careful.
On the other hand, if the token is not much more than a token and the person buying it is hoping for the best – that the token becomes more valuable because they’ve got a front-row seat on the next new app and can sell it to somebody else – it might not be a security. It’s some kind of property right, it’s some kind of speculation, but it might not be a security. This is very new, very grey.
I can imagine traditional securities lawyers pulling their hair out over this trying to figure out what it is. I was involved in the very early days of the swaps market. Swaps and derivatives are commonplace today, but going back to the late ‘70s and early ‘80s when these things were literally being invented, I was international tax counsel at Citibank. We knew how to write them, but we didn’t know how to treat them in terms of tax treaties.
If you paid a swap payment, was that interest? Was it a dividend? Was it insurance premium? You could argue that it was any one of those things. We were operating in a grey area and have a lot more clarity around that today, but it’s the same thing with these ICOs.
What are these apps you’re funding used for when you buy a token in an ICO? One of the big applications today are what are called safe contracts. Because transfers through a distributed ledger are both encrypted and irrevocable, if not un-hackable or at least sufficiently widely distributed that they’re reasonably safe, it’s considered to have the potential to solve a trust problem in any transaction.
Go back to cavemen and cavewomen and imagine you just killed a mastodon. You’ve got some fresh meat, and I just picked a bunch of berries. We want to barter. I want to give you some berries, and you’re going to give me some of the mastodon meat. Well, what if I give you the berries first and you run away or you give me the meat first, and I run away? It might start a war or whatever.
It’s the “who goes first?” problem that applies even in modern times. Maybe in the 19th Century I’m going to buy something from you, I hand over the money, and you don’t deliver the goods. You keep my money and don’t deliver the goods, or vice versa.
This happens on a much larger scale when you’re doing multibillion-dollar corporate takeovers. How do you handle all that? The answer is that through centuries of law and contracts, precedent and court cases, enforcement, and other things, we have developed tried and true ways of dealing with all these problems.
If the buyer and seller are remote and not face-to-face for a simultaneous exchange, you can use an escrow agent. You can use insurance, a third-party bank or a lot of different trust counterparties to solve that problem.
I worked on one of the biggest problems like this in history when we were obtaining the release of the Iranian hostages in 1979/1980. Iranian militants broke into the U.S. Embassy and took a bunch of Americans hostage around the time of the Ayatollah Khomeini and the Iranian Revolution after the fall of the Shah.
Because it was sort of spontaneous, they hadn’t really thought through where a lot of their money was. It turned out that a lot of it was in U.S. banks, so all that money was immediately frozen.
After a year or so of negotiations, the U.S. obviously wanted the hostages back. Iran had gotten enough propaganda value out of it, and they wanted their money back. The U.S. was not going to pay ransom, but took the attitude that, “It’s not really ransom; it’s your own money that we’ve frozen. We’ll just be giving it back to you if you give us back our citizens.”
That was the deal, but the problem was neither the Iranians nor the United States (there were other Western banks involved, but I’ll just say the United States) trusted the other enough to go first.
The U.S. said, “If we send you the money, you guys are going to take it, keep the hostages, and poke a stick in our eye.” The Iranians thought the same thing, “If we release the hostages, you Americans will never give us the money. How can we trust you?”
We solved that by saying, “The obvious way to solve it is to get an escrow agent.” You give the money to the escrow agent, he sits on it, observes the release of the hostages, and when the hostages are released, the money is forwarded to, in this case, Iran. They’re no longer trusting the United States; they’re trusting the escrow agent.
Then the problem was, who in the world was trusted by both sides? Who could the U.S. trust enough to send the money to in the first place, and who could the Iranians trust enough to know that they would get the money if they released the hostages? It turns out, the answer was Algeria, the Central Bank of Algeria. They were sufficiently Western and sufficiently Islamic that both sides were happy.
It’s a long story and an interesting one, but my point is, that’s how difficult it can be to solve this “who goes first?” problem in any exchange. With Ethereum and some of the apps being developed under some of these initial coin offerings, that problem is solved through the protocol.
That is, if I pay you, there is going to be some verification that you ship the goods. When that happens, you automatically get paid. You’re no longer relying on me to send you the money. You know the money is waiting for you once you ship the goods.
These are called safe contracts. A lot of people are working on apps for those. I question whether they’re not solving a problem that doesn’t exist in the sense that Amazon does quite a bit of business. When I use my credit card to buy something on Amazon, I don’t really worry that I’m not going to get my merchandise. If I don’t, I know I can get the credit card charge reversed.
It would be rare if that were not true, so I don’t consider there to be much of a problem. If there’s an improvement on that, maybe Amazon would buy the technology. Who knows? This is just an example.
I realize I’m going on at length here, but I’m trying to make the point that there’s the blockchain technology, there are cryptocurrencies, and there are ICOs issuing coins or tokens that could be currencies but are really property rights of some kind, hard to define, in a new app. The apps themselves are performing these kinds of ledger or safe contract role.
I don’t want to mush it all together, because I think there’s too much of that. People are kind of glib in the conversation, but I think it’s important to make all these distinctions so we’re not just throwing the word crypto around without a lot of content. We should know exactly what we’re talking about.
Alex: I think the idea with the whole trust lists thing is that it removes intermediaries. In particular, it removes banks as intermediaries and the focal point of control of the transactions.
That’s one of the things I was trying to get at here. Any of these cryptocurrencies you’re transacting in are cross-rate or cross-currency. In all forex, there’s a cross-rate. Either it’s USD/RMB, it’s USD/CHF (Swiss francs) or it’s USD/gold, for example. That means you’re converting these cryptocurrencies in and out of other types of currencies, and this is where your risk is at. This is where there is potential for regulators to control that.
Jim, talk a little bit about how SWIFT works and how anything that’s done, really in U.S. dollars, how that happens and how regulators can use that.
Jim: Let’s say I’m Deutsche Bank, the biggest bank in Germany. A lot of my business is in euros, but I deal in all major currencies. You’re sitting in New York and are Citibank, one of the biggest banks in the United States.
I have to send you $2 billion, because my dealers bought foreign exchange from your dealers or we had a bunch of transactions or customers wanted a little money. Whatever it is, I want to send you $2 billion. How do I actually do that?
One thing you don’t do is go to the ATM, get a bunch of cash, put it in FedEx, and send it. That’s obviously ridiculous, so we can cross that off the list. I could send you some kind of commercial paper, negotiable instrument, by courier, but that’s slow and pokey. It wasn’t so long ago that that’s the way things were done.
The way they do it now is to send a message through SWIFT (Society for Worldwide Interbank Financial Telecommunications). They don’t consider themselves a payment system, and they’re certainly not a bank or a financial institution. They compare themselves to the phone company and say, “We handle message traffic. To get in SWIFT, you must agree to abide by all the protocols of SWIFT.”
As Deutsche Bank, I want to send Citibank $2 billion. I would do that by sending a message through the SWIFT system. Think of SWIFT as a giant digital switchboard. They have forms that can all be done online that go by the name MT (Message Traffic). There’s an MT101, MT102, 202, etc., lots of different kinds.
Here’s the thing about SWIFT. Assuming I’m an authorized participant, you’re an authorized participant, we both have the right protocols and passwords, we go on and fill out this MT form, somebody hits “Send” and Deutsche Bank just sent you $2 billion. That’s irrevocable. I can’t say, “Whoops, sorry, I pushed the wrong button,” or, “Oh, gee, I filled out the form.” Too bad; that’s on me now. If I actually do that (mistakes do happen), the bank must call the other bank to explain what happened. Maybe they can sort it out, maybe they can’t, maybe there’s a lawsuit. Who knows?
SWIFT says, “We have nothing to do with it. We’re not your referee or your escrow agent, we’re just the phone company. We connect the switchboard, and the message goes through.” That’s the way things are done today. It’s rather efficient and certainly a lot better than the way it used to be, but it still takes a lot to maintain SWIFT.
SWIFT is subject to government intervention and government control. It’s rare, and they don’t like it, because they like to keep out of politics. Obviously, there could be all kinds of squabbles among all the SWIFT members. They don’t like to get in the middle of that. However, there have been several instances most famous of which was in 2012/2013, right in there.
As part of U.S. sanctions on Iran because of the Iranian nuclear weapons and uranium enrichment programs, Iran was kicked out of the SWIFT system. The board of governors or the supervisory board of SWIFT said that Iran could not use the system. SWIFT didn’t really want to do it, but there was pressure put on them for that reason.
That was a big deal. Iran could ship oil, which they do, but they could not get paid in dollars, euros or any other hard currency through the SWIFT system, and they had no other way of doing it.
They could get Indian rupees deposited in an account in an Indian bank if they wanted rupees, but it’s kind of limited in terms of what they could do with that. They couldn’t transact in dollars, euros or anything else anybody really wanted.
Iran did workarounds, such as barter, and gold was a big part of it. They could put a bunch of gold on a plane, fly it to somebody and unload it, and there’s payment. There’s nothing digital about it and no way to interdict it other than shooting the plane down, but then the gold would just land on the ground. That’s the great thing about gold – it’s pretty much indestructible.
The point is, that was a real burden on Iran. It brought them to the negotiating table and led to an agreement under the Obama administration. I don’t want to do a deep dive on the agreement, but those financial sanctions were very effective. Today, North Korea is the one that’s kicked out. Again, it is rare and SWIFT doesn’t like to do it, because they like to keep out of politics.
The blockchain – particularly for applications created on the Ethereum platform – offers the kinds of transfers I’m describing with no trusted counterparties, no heavy infrastructure.
A lot of people are looking at this. JP Morgan is working on it, Blythe Masters (formerly head of commodities trading) is in a joint venture or enterprise with some other founders looking at it, Marc Andreessen, the Winklevoss twins, other major banks, the IMF, and Russia are all looking at it.
There’s good reason to be enthusiastic about the technology. I’ve voiced a lot of concerns, reservations, and some criticisms of various things going on in crypto and immediately get branded as, “You’re a Neanderthal, you’re from the Stone Age. What’s wrong with you? Baby Boomers, you don’t get it,” etc.
The fact is, I’ve been studying this for years. I’ve read the technical papers, and I do keep up with it. I’ve been involved, for example, by working with the U.S. Military in interdicting the use of cryptocurrencies by ISIS. I’ve seen ways this stuff can be interdicted, which I can’t really discuss in any detail since some of this information is classified. The point is, there’s more there than maybe some of the fans want to believe or tell themselves.
I’m not technophobic at all. Like you, Alex, I find it fascinating. I try to learn about it, but I’m not a cheerleader, either. I don’t get the pompoms out and say, “Go buy this stuff.” I think for people who do, it’s maybe self-interested, because if you own some, you probably want the price to go up. I would say Bitcoin doesn’t have a price; it has a cross-rate to other forms of money.
That aside, there’s a lot of self-interest and trolling involved. There are people who are a little overly enthusiastic and don’t see the dangers in all this. That’s why I think it really does pay to be thoughtful.
Alex: I agree. At the end of the day, what it comes down to is that any cryptocurrency that’s going to interface with another currency, for example if it touches the U.S. dollar ecosystem, that’s the chokepoint. Any wire transfer or transfer that’s sent in U.S. dollars around the world goes through an intermediary bank in New York City. Well, that is on U.S. soil, and they have complete control of that.
There’s a big difference between regulation and enforcement. Ultimately, lawmakers can pass any law they want, but if it can’t be enforced, it doesn’t really have any teeth. The reason banks and financial services entities all over the world are complying with extra-sovereign regulatory oversight is that the enforcement tools regulators have at their disposal do have teeth. Anyone who thinks that cryptocurrencies are outside the reach of that, aside from these direct transactions we talked about, are fooling themselves. By the way, this oversight compliance is costing them billions of dollars.
We’ve touched on securities law, counterterrorism, any money laundering, the Financial Crimes Enforcement Network (FinCEN), and all the things you mentioned, but there’s another 500-pound gorilla in the room, which is our friends at the IRS. A lot of people don’t realize that if you could go out and buy a Bitcoin for $200 – it’s shot up so much, but it wasn’t long ago you could get one for $200 – and today it’s worth $2,000, you can use it to buy something. You don’t even have to cash it in for dollars. You can buy a plane ticket or just about anything with Bitcoin.
In my example, you just had an $1,800 gain you have to put on your 1040 income tax return. Bitcoin is some kind of property. I query whether it’s a capital asset or not, but it doesn’t matter. It could be an ordinary account or capital gains, but you have a $200 basis, $2,000 of value of proceeds, and an $1,800 gain. You must put it on your tax return and pay the tax.
How many Bitcoin users are actually doing that? I don’t know the answer, but I’m guessing it’s not that many. All those who are not are tax evaders, at least if you’re U.S. citizens. If you’re a citizen of another country, that may be different, but for U.S. citizens at least, it’s got to go on your tax return. That’s the law. If you don’t do it, it’s intentional, willful, and possibly a felony. They didn’t get Al Capone for murder or bootlegging but for tax evasion.
Now, is there enforcement? I haven’t heard of much, but the IRS is a funny organization. They’ll see things like this and lie in wait. They’ll sit there and say, “Why chase after a couple of little guys? It’s all new. Why don’t we just wait and let it build up for years. Let the amounts involved get into the billions and then go scoop them all up at once.” They’d need a test case or some probable cause, but they’d serve a subpoena on the major Bitcoin exchanges and demand all their books, records, and identities of all counterparties. It would be resisted and end up in court where they’d probably get a court order enforcing that.
Well, suddenly the exchanges are giving up all this information. The Bitcoin fans might say, “So what? I’ve got a digital wallet. All they’re going to do is get a code they can’t crack.” Maybe, maybe not. The point is, you can kind of go from there. They can start to find purchases or they can subpoena the sellers. If it happens to be Amazon, they’re not a rogue organization, so they’re certainly going to comply with a subpoena. On and on it goes.
I’m not saying this is easy or happening tomorrow morning, but I’m saying we’ve seen this before. I was a tax lawyer, and one of my favorite cases in law school was when the IRS tried to impute the income of a house of ill repute, but the brothel didn’t keep any books and records.
Their defense was, “You can’t prove how much income we had, so you can’t assess us.” The IRS got the laundry bill, looked at how many times the sheets were cleaned, figured out the going rate, and came up with an income. The judge said, “That’s good enough for me in the absence of anything else.”
The IRS does not let the absence of information stop them. They will come up with the worst set of facts for you and put the burden of proof on you to prove otherwise. They’re pretty resourceful in that way. That’s another pitfall for the young crypto community to bear in mind.
Alex: We have a little bit of time left for a couple of other subjects, so let’s move into geopolitics. The G20 has a meeting coming up on the 7th and 8th in Hamburg, Germany.
There was a recent article that portrayed Germany and China linking up as globalization partners. I’m going to read a quote from a professor at the Chinese School of Journalism and Communication who is a Fellow for the National Academy of Development and Strategy of Renmin University:
“In the global context of increasing uncertainty due to the U.S. and Britain’s actions of antisocialization, isolationism, and nationalism, the G20 can forge ahead for more stable, more sustainable, and more responsible global economy only if the two groups of countries unite.”
Jim, what’s your take on this, and is there anything else happening regarding the G20 that you think is important to note right now?
Jim: Yes, I do, Alex. As you mentioned, it is coming up July 7th and 8th in Hamburg, Germany. G20 stands for “G” or “group” of 20 nations although it’s more like 24. They invite Norway, Spain, and a couple other hitters plus some multilateral participants: the IMF and the European Union. I call it “G20 and Friends.” They get about 30 key players at the table.
The leaders meet once a year. They used to meet twice a year, but as we get further away from the crisis, they’ve dialed that down to once a year. There are G20 meetings throughout the year at levels below the leadership or the President, if you will. The central banks, finance ministers, and other technical working groups meet a couple of times a year. The G20 never sleeps. Their work goes on around the clock even though these big summits only happen once a year.
A lot of people shrug and say, “What the heck does the G20 mean? It seems like a boondoggle.” I disagree. I have a long section in my book, The Death of Money, about the G20 where I make the point that it’s really the board of directors of the global economy. Think of the highly integrated, connected, densely networked global economy we have because of globalization and some of the things we talked about earlier such as digitization and so forth. It has a central bank, which is the IMF, and the IMF has a board of directors, which is the G20.
It’s actually a very powerful organization even though they don’t agree on every little thing. They have a rotating presidency. This year, it’s Germany, so that’s why the meeting is in Hamburg. Last year, it was China with the meeting in Hangzhou in September. The year before that was Turkey and so forth as it moves around.
This one in July is a very important one. You mentioned China and Germany. President Xi Jinping of China and Chancellor Angela Merkel of Germany are probably the two leading globalists, or pro-globalist, figures. They don’t have much else in common since China is communist and Germany is a pretty healthy democracy, but at least they are the two leaders who still espouse a traditional globalist view.
It’s funny, because they claim to love free trade, yet Germany and China have the largest trade surpluses relative to GDP of any major economy – embarrassingly large. The point being, they say they like free trade, but truthfully they like a rigged game that favors their exports whether it’s the GP or the GP1 at various points in time.
Anyway, we’ve got these two big globalists, Merkel and Ji, holding hands, and we also have the two most powerful nationalists, who are Trump and Putin. I think that’s going to be the big story coming out of G20.
This is the first face-to-face meeting of Trump and Putin. Of course, you can’t go online, turn on the TV or radio or pick up a newspaper without hearing, “Russia, Russia, Russia,” “Russian collusion,” “Russian interference with the elections,” “Hillary lost because of Russia,” and all this other nonsense. America seems to have a Russia paranoia or fixation going on.
Some of that, at least in my view, is attributable to the fact that if you’re a globalist, you really want to keep Trump and Putin separated. You really want these guys at each other’s throats, because they are the two most powerful nationalist leaders in the world. If the two of them ever do set out a common agenda or strike up a good working relationship, that’s going to give a powerful boost to the anti-globalist nationalist forces.
You’ve got the two leading globalists, Ji and Merkel, and the two leading nationalists, Trump and Putin, who are going to be meeting on the sidelines. The G20 has a formal agenda and formal plenary sessions with a class photo and all that stuff, but a lot of the most important action happens on the sidelines in these little bilateral and trilateral meetings where two or three leaders go off to the side and work on some deals.
These are busy people. It’s not like they see each other all the time, so this is a good opportunity for that. BRICS (Brazil, Russia, India, China, South Africa) always have a minisummit on the sidelines of the G20. They do have their own BRICS summit at a different time of year, but since they’re all in the G20, it tends to be a good opportunity for a little BRICS summit.
The other bilateral relationship I’m watching is called Mackerel, after the fish, involving Emmanuel Macron and Angela Merkel. Macron and Merkel mashed together gets Mackerel. Despite some early warnings, it looks like Merkel is in pretty good shape for the election on September 24th and appears to be cruising to reelection as Chancellor. Although he’s a lot younger, Emmanuel Macron was just elected as the President of France in a very convincing way.
Their mantra is More Europe. I think this is the friendliest, most productive, potentially most important period of Franco-German relations going back almost to Konrad Adenauer and Charles de Gaulle. You’d have to go back to the ‘50s and early ‘60s to find greater Franco-German cooperation.
Alex, you know from prior podcasts that I’m very bullish on Europe and the euro. I have been and still am. When a lot of economists – Paul Krugman and others – were running around with their hair on fire saying Europe is falling apart, I was the one saying, “No, they’re going to stick together. Greece is not getting kicked out, and Spain is not going to quit. The euro is strong and getting stronger.” Things have played out exactly along those lines, but that doesn’t mean it’s all good.
There are some problems and reforms needed in the European Union. They need unified banking regulation, which they’re getting, but above all, they need unified fiscal policy. They’ve had unified monetary policy since the Maastricht Treaty in 1992 and the rollout of the euro in 1999/2000, but they need unified fiscal policy.
Germany has not wanted to backstop that until Merkel saw some kind of fiscal discipline. It goes by the name ‘austerity,’ but she would call it ‘prudence.’ She’s saying, in effect, “Germany is not going to underwrite Greek debt, Spanish debt, Italian debt or Portuguese debt unless we see some evidence that all you countries are getting your house in order in terms of debt-to-GDP ratios and deficits as a percentage of your GDP.”
That’s been happening in a very positive way, so now I think Germany is ready to take the next step. There’s been some talk about a fiscal parliament, common fiscal policy, a euro-zone finance minister, and a unified budget.
These are all very significant advances that will solve the problem of the euro once and for all, because you’ll be combining fiscal and monetary policy the same way we do in the United States. It looks like Macron is in favor of all that, and he’ll find a willing partner in Merkel. That’s a big deal too.
So, I’m watching the Trump-Putin relationship, China and Germany, which you mentioned, always keeping an eye on the BRICS, and I think Mackerel will be another thing well worth watching.
Alex: It’s going to be interesting to see how this all plays out. We have just a few minutes left for two quick topics we want to hit. Let’s move on to Syria. A few days ago, a U.S. F/A-18 Hornet, which is a first-tier fighter bomber, shot down a Syrian Su-22 that had dropped some bombs near the American-backed fighters south of Tabqa.
The American commanders on site indicated that the aircraft was shot down in compliance with standard ROE (Rules of Engagement) and that they had notified Russian forces prior to engaging the aircraft. They do that to mitigate any chances of accidental escalation.
Afterwards, a statement from the Russian Ministry of Defense warned that any aircraft or objects in flight west of the Euphrates, which includes Coalition and American aircraft, would be followed by Russian air-defense systems as targets.
I reckon the whole situation over there is confusing to most. There are so many forces in place, so many different factions, so many different motivations. I know this is a huge topic, but just in a few minutes, would you talk about your view on the events, the players, and possible outcomes?
Jim: Obviously, this is serious. During the Cold War, Russia (the Soviet Union at the time) and the United States were armed to the teeth with thermonuclear weapons and intercontinental ballistic missiles and also commanded control systems that could have completely destroyed life on the planet. Somehow, we got through that time with no Russian or American ever firing a shot at each other.
Sure, there were lots of other wars with allies, proxies, and so forth (Vietnam, Angola, Cuba) and there were revolutions and assassinations. I’m not saying there wasn’t bad stuff going on. There was, but there wasn’t a single time when Russians and Americans shot at each other. That was not by accident. It was because the two sides knew that the first shot could escalate and end up destroying the planet. Nobody wanted to go there.
I think those lessons are still understood, but what you’re describing, Alex, is a little scary and dangerous. There’s good reason to believe that some of this is posturing. Shooting down a Syrian jet is not posturing – somebody got blown out of the sky on that one – but the Russian complaints may be just to hold up their end and show some support for Syria.
This is going to get worse, though. Right now, Russia and the United States have a common enemy, which is ISIS. The Russians support Assad, we support the rebels. We support the Kurds, the Turkish want to destroy the Kurds. There are a lot of conflicting cross-currents, but the one thing everyone agrees on is to destroy ISIS.
What happens when ISIS is destroyed? The threat will never be completely wiped out, because they’ll just go underground and conduct terror. However, in terms of a state or holding territory, they’re not quite mopping up in Mosul, but that’s getting close to being done. Then Raqqa is next and then cleaning up the Euphrates River Valley.
At some point, ISIS won’t exist as a state. Then the U.S.-backed rebels and Kurds on the one hand and the Russian-backed Syrian army on the other are going to be face-to-face in the battle for Damascus.
This is a good example – North Korea is another one; Ukraine is another one – of why the Russians and the U.S. should be talking to each other, improving relations, building bridges, and opening lines of communication. Instead, we’ve got this Washington DC beltway circus of Hillary’s whining about why she lost the election, which is nonsense, and for some reason, if you talk to the Russians, you’re colluding to beat the Democrats.
We should be talking to the Russians every day. I like to say that it’s smart to talk to the Russians, but it’s dumb to lie about talking to the Russians. I don’t know why Jared Kushner couldn’t fill out his forms correctly. There’s been a lot of amateurish work and inexplicable bad behavior by some Trump administration officials for no good reason, because we should be talking to the Russians.
Hopefully, we’ll get past some of this hysteria, build bridges to Russia, and help to alleviate some of the tensions you’re describing.
Alex: Yes, I very much agree.
Our last item is North Korea. Recently, there were exercises in South Korea involving over 100 F-16 fighters. Also, U.S. F-35s have been deployed to South Korea, and there have been several defense briefings in Guam where they station a lot of the B-52s for power projection in that theater.
On our last podcast, you said something that really struck me. You expect that the U.S. will be at war with North Korea by 2018. What are your current thoughts on what’s going on in North Korea?
Jim: There’s no change in that assessment. I pointed out that in March 2003, we jumped off on the road to Baghdad and invaded Iraq. I’ll use General James Mattis, today’s Secretary of Defense, as an example. At that time, he was commandant of the 1st Marine Division. In 2002, he was told, “Get ready. We’re going into Iraq. Get your guys ready.”
The point is, you don’t go to war overnight. There’s at least a year, perhaps longer, of preparation. Now, just because you start the preparation doesn’t mean you pull the trigger. To me, 2017 looks like 2002 in Iraq. We’re going to try sanctions, diplomacy, and engaging with allies.
Notwithstanding that, the orders have been passed to get ready, particularly the Navy, the Strategic Air Command, certainly other special operators, and others. We’re on the path to war, and I expect it in 2018.
The only question is, what could change that outcome? There are really only two things:
- Kim Jong-un gives up his nuclear programs and missile programs in a verifiable way. I don’t expect to see that happen, because he thinks that’s essential to his own survival.
- Somehow Russia and China put enough pressure on North Korea to get them to do it anyway. I don’t see Russia doing that partly for the reason we just discussed, which is that the U.S. is barely talking to Russia. That’s too bad, because there are issues of war and peace at stake.
As far as China is concerned, Trump sent a tweet the other day. I sent a tweet in response saying, “This is the most important tweet the President has ever sent.” I’m paraphrasing because I don’t have it in front of me, but he said, “It looks like China is not having much success changing North Korean behavior. Too bad, but at least they tried,” or words to that effect.
He wasn’t overtly, blatantly criticizing China, but in a pretty clear way he was saying, “Okay, I gave you guys a chance. You didn’t do anything, so time’s up. Now we’re going to turn on North Korea ourselves.” That’s how I read it, and I think that’s the right interpretation.
China has not been able to do anything, we’re barely talking to Russia, and Kim Jong-un will not be deterred. We’re not going to risk Los Angeles, based on his good intentions, if he ever has any. The only thing left to do is to go in and take it out.
Some people have pointed out that they have a lot of antiaircraft capability. The significance of Guam is that long before fighter attack aircraft and other forces get into theater and long before the Nimitz-class aircraft carriers get within range of North Korean anti-ship missiles, we will have suppressed all of that with our long-range bombers, the B-52s and the B-2s.
I think the war will start out of Guam using very heavy bombing before we then come in with carriers and some of the smaller, nimbler aircraft.
Alex: Unless doctrine has changed since I was in the military, that’s standard procedure. They’ll gain control of the battle space, particularly the air space, first, and then move from there.
Alex: Jim, I appreciate the discussion today. It’s been very insightful, as always, and I look forward to doing it again next time.
Jim: Thank you, Alex.
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