Jim Rickards and Alex Stanczyk, The Gold Chronicles October 2017
*Bullion Bank Scotia Mocatta
*How the Chinese are assembling strategic LBMA and Gold industry focal points of control
*Allianz Chief Economic Advisor Mohamed El-Erian on gold
*Why Central banks cannot control market volatility forever, and gold will return as a key safe haven hedge
*Currency Market Volatility
*Typical institutional portfolio allocations in gold
*Why increased weighting of institutional portfolios to gold could have an impact on USD gold price
*Janet Yellen’s Legacy
*20pct Chance of a Fed Rate Hike in December, market is currently pricing in an 80pct chance of a rate hike
*How the Fed is making decisions based on broken models
*Next pick for Federal Reserve Chairman
*Analysis of 6 hrs spent with HR McMaster, US National Security Advisor to the President, and Mike Pompeo, Director of the CIA on topics of US National Security
*Determining probability of a kinetic war with North Korea
*Key quotes “Prevent…by military means if necessary”, “last chance to avoid severe consequences”, “we are running out of time”, “accept and deter, is unacceptable”
*20pct Probability of Regime change in NK, 20pct Kim Jong-Un backs down, 60pct United States goes to war
*Inside view of Trump – good or bad decision maker
Listen to the original audio of the podcast here
Physical Gold Fund presents The Gold Chronicles with Jim Rickards and Alex Stanczyk offering insights and analysis about economics, geopolitics, global finance, and gold.
Alex: This is Alex Stanczyk, and I have with me today the brilliant Mr. Jim Rickards. Jim, welcome.
Jim: Alex, it’s great to be with you.
Alex: In our last podcast, we covered a lot of different topics. We talked about everything from technical mountain climbing to training with Navy SEALs as well as the mindset required when making assessment of counterparty risk. For those who are interested, you may access our entire archive of podcasts on our website at PhysicalGoldFund.com/podcasts.
Let’s dive into our topics here. The first one we want to talk a little bit about is gold. There’s an interesting bit of gold industry news this morning. It turns out that Scotiabank is in the process of selling its bullion bank, ScotiaMocatta.
For those of you not familiar with it, ScotiaMocatta is a market-making member of the LBMA. There are five full market makers of the LBMA that include the usual suspects such as Citibank, Goldman Sachs, J.P. Morgan, HSBC and UBS AG.
There are another eight called two-way market makers of which ScotiaMocatta is one. These bullion banks handle OTC trades in gold valued into the trillions of dollars. ScotiaMocatta traces its origins all the way back to one of the first bullion banks. It was founded by a gentleman named Moses Mocatta in 1671.
The rumor floating around is that the Chinese are being courted for the deal. I found it interesting to note this morning that Zero Hedge called the Chinese the world’s dumbest money because of this. To me, however, it lines up with an ongoing, long-term pattern of Chinese state-run banks buying LBMA strategic assets.
For example, they bought some of the largest vaults in New York and more of them in London. If they buy ScotiaMocatta, it’s going to be the second market-making member of the LBMA controlled by the Chinese. What do you think about all that, Jim?
Jim: I think it’s a very big deal and agree with you in terms of the implications. I hadn’t seen that particular news yet this morning, but I’m familiar with the LBMA, the institutions you mentioned, and the set up.
Yes, it’s a big deal. Step by step, China – if not taking over the gold market – is at least putting a pretty big stake in the ground in terms of its ability to not only compete but participate in the market making side-by-side with London. They’re going to steal the business from London.
I think they’re probably more than halfway there, because they have the Shanghai futures exchange, which includes a gold futures contract, and they have the Shanghai Gold Exchange, which is spot gold where you take gold in and get money or go in with money and buy gold. Their banks are among the largest gold dealers in the world.
I mentioned in a prior podcast that I was in Shanghai not long ago and met with two of the four biggest gold dealers in China, ICBC and another one of the top Chinese banks, and got some firsthand information from them. As the largest gold producer in the world, they generate more than twice as much as the next highest producer. They produce about 450 – 500 tons a year versus the next closest at about 250 tons a year. They’re also the largest gold buyer in the world as we’ve learned from our friends in Switzerland, the refiners who sell the gold. So in every respect, they’re the big foot.
It reminds me of the 1980s when I was in the U.S. government securities market as General Counsel and Chief Credit Officer at one of the largest securities dealers. The Japanese were the biggest customers. All the banks, the so-called primary dealers, were U.S.-owned with some owned by the UK or a couple of other countries, but the Japanese were the biggest customers. They did not have any primary dealers.
I said, “Wait a second. We’re the biggest customers, so we think we want to own some of the dealers. We want a front row seat. We don’t want to just be on the receiving end of bids and offers; we want to be actual market makers and insiders that deal directly with the Fed.” That was kind of understood, so within a couple of years, they ended up with five primary dealers.
China is similar. If you’re going to be the biggest customer, you don’t want to just be a customer; you want to be a dealer or a market maker. You don’t want to be disadvantaged; you want the inside price and don’t want to pay commissions, spreads, and so forth. That’s exactly what they’re doing.
Alex: I have to agree. Another interesting item in the gold space is something Mohamed El-Erian recently went on record with. For those not familiar, El-Erian is the Chief Economic Advisor of Allianz, a multi-trillion-dollar global finance titan. Some of you may know him from PIMCO that manages about $1.6 trillion where El-Erian was the CEO and Co-Chief Investment Officer. Allianz is the owner of PIMCO.
In an interview, El-Erian said that central banks can’t stay in the business of repressing financial volatility forever, and that gold will return as a safe haven hedging instrument. I thought that was an interesting comment. Jim, what’s your take on that?
Jim: I agree with that. You gave a brief overview of El-Erian’s resume, and you’re exactly right. As one of the largest financial institutions in the world, Allianz is a huge institution. They deal primarily in insurance rather than banking, but they have banking-like functions and own PIMCO, the world’s largest U.S. government bond investor. They also deal directly with the Federal Reserve.
But El-Erian is more than that. I put El-Erian in the category of the global super elite meaning he’s on G20 committees, he’s at the IMF World Bank meetings, and he’s a regular at Davos. He’s a really smart guy, but apart from having these important advisory roles in the institutions you mentioned, he is one of a handful of people alongside Christine Lagarde, Larry Summers, Bob Rubin, David Lipton, and others who really call the shots in the international monetary system.
I always date myself with these examples, but there was an old marketing campaign in the 1980s for a broker long gone called EF Hutton. The punchline was, “When EF Hutton talks, people listen.” Well, when El-Erian talks, I listen, because he is a true insider. He’s not just talking his book at Allianz; he’s actually conveying something that is no doubt in the air, as I put it, among the elites. So, I’d put a lot of weight on that. I think it’s very significant.
I think he’s right. Where are you going to go if they have to keep a lid on bond prices because governments are going broke and on stock prices because we can’t afford another meltdown?
I’ve actually observed the volatility in the currency markets. People keep saying, “Where’s the volatility?” I say, “Look at the euro/U.S. dollar cross rate.” The euro/U.S. dollar cross rate has had seven moves of 20% or more in the last ten years.
Again, people say, “Where’s the volatility?” I point them to the currency market, because the U.S. dollar and the euro are the two leading global reserve currencies. The U.S. dollar has the bigger share at about 60% and the euro is closer to 30% in terms of global reserves, but the two of them together are 90% of global reserves. They’re both supposed to be stores of value, and they both have PhD central bankers, so why should they be moving 20% against each other? There’s the volatility.
It is because central banks are fighting the currency wars but using bank policy to suppress volatility in the stock market, the bond market, and elsewhere. Something has to give. The best way to understand this – and this is a metaphor, but it’s also the same science – is to imagine two tectonic plates similar to the San Andreas Fault where a pacific plate and continental plate are butting up against each other.
You can see the San Andreas Fault and actually stand on it. I’ve done this out in the desert near Palm Springs where my guide took me to the San Andreas Fault. The point being, the day I was standing there, nothing was happening. Well, that’s fine, but it doesn’t mean it’s stable. It’s not moving that day, but it’s dynamically unstable. Eventually the pressure builds and builds until it snaps.
That’s what I see happening in financial markets and I think what El-Erian was referring to. When this snaps, there’s going to be an enormous run to gold. Based on what we talked about earlier with the Chinese acquiring dealer positions, exchange positions, and so forth, there’s not even close to enough gold to satisfy all the existing paper claims let alone future paper claims, so you would expect a very significant price spike.
Alex: The idea of institutions moving into gold has always been interesting to me based on the amount of gold in the typical institution portfolio according to certain individuals who are professional money managers or pension fund managers, etc. Shayne McGuire owns a very large pension fund, and in his book called Hard Money, he says that amongst his colleagues, they’ve typically got less than 1% weighted allocation to gold. His opinion was that if institutions moved more towards even a 2% – 4% allocation to gold, that would significantly drive the price just from that alone.
Jim: That’s exactly right. I know Shayne, he’s a great guy. He was part of a group that was instrumental and successful in getting UTIMCO, the University of Texas Investment Management Company, to do an allocation of gold. One of the big drivers who lobbied hard for that was Kyle Bass, a very well-known hedge fund manager and trustee at UTIMCO. They did buy $500 million worth of gold, which is a lot of gold, but it was still a tiny part of the overall portfolio. This is a huge, multi-billion-dollar portfolio involving the entire university system endowment and other state contributions.
I always recommend 10% gold for personal portfolio allocations and get a lot of pushback on that. People say, “Jim, you’re the guy saying gold is going to go to $10,000 an ounce. Why wouldn’t you have 100%?” The easy answer to that is you shouldn’t be 100% in anything, I don’t care what it is. That’s just not prudent. I think 10% is fine although some people say 5%, and that’s fine. If nothing happens to gold, or it goes sideways or down a little bit, you’re not going to get hurt with a 10% allocation. If it goes anywhere near what I’m expecting, then that will be enough to in effect insure the rest of your portfolio.
You can debate 10% or 5% all day long, but in fact, the institutional allocation is about 1.5%, not even 3%, and that’s not evenly distributed. It’s not as if every large institution has 1.5%; it’s more the case that some have 5% and some have 0%. Most institutions have zero, so with any kind of move at all, there’s not enough gold in the world at these prices to meet that kind of demand. They’ll get their gold, but at much higher prices, and there’s no reason for investors and our listeners not to position accordingly today. You can definitely see this coming.
Alex: Moving on, the next topic is going to be the Fed. Janet Yellen seems to be having a hard time coming to grips with the fact that inflation numbers in the U.S. are actually in a downward trend. Her response – besides blaming it on a series of different issues – is that all of this is transitory. It’s also not looking like she’s going to be reappointed, and that has to be weighing on her mind.
Jim, why does the Fed keep getting this wrong? And where do we go from here? Where do they go from here?
Jim: It’s a great question, and you’re exactly right. Probably the hardest thing for any of us, whether your Janet Yellen, me or anyone else, is to admit you’re wrong. You have a model, you worked hard, you did the math, you studied, you went to school, you did all this stuff, and it turns out that everything you believed is just wrong. That’s the situation she’s in.
The biggest thing they’ve got wrong is the so-called Phillips curve. For the benefit of listeners, Phillips curve is just a curve, a relationship or a distribution between a couple of factors. The basic idea is that there’s an inverse relationship between employment and inflation so that as unemployment goes down, inflation goes up, or as unemployment goes up, inflation goes down.
The theory is that as unemployment goes down, labor markets get tight and it becomes more difficult for companies to find workers. If I’m putting up a construction site, starting a new company or expanding my plant, I want to hire people, but they’re all working already. I can’t find anybody, so what do I do? I bid up wages. I offer to pay them more, and they’ll come work for me.
The theory continues in that if the economy can only grow in real terms (historically, we would have said 3% – 3.5% or today under the new normal maybe it’s 2%) and we start bidding up wages 3% – 5% to get the workers, anything over the maximum real rate of growth has got to be inflationary. If I pay you more than real growth, then you’re going to go out and spend the money and bid up prices of other things. It’s inflationary.
That’s the theory, but it is complete garbage and nonsense. It doesn’t work that way and there’s plenty of evidence to the contrary. Going back to the late 1970s, we had high inflation but we also had high unemployment, and we had back-to-back recessions in 1980 and 1981. We had a worse one in 2008, but prior to 2008, the worst recession since The Great Depression was the one in 1981 – 1982.
Those were the days in the late ‘70s and early ‘80s of 13% interest rates and 15% inflation along with high unemployment. They had to come up with a new word for it called stagflation. Weak growth was stagnation and rising prices was inflation, but here we had both which wasn’t supposed to happen, so they called it stagflation.
We have the opposite situation today. Unemployment is extremely low. It’s the lowest it’s been in at least in 17 years, and maybe we’d have to go back even further than that. We’re down to about 4.2% which we haven’t seen in a very long time, and yet inflation is low. In fact, not only is inflation low, it’s falling. We have disinflation although we’re not quite to the point of deflation.
These two examples completely refute the Phillips curve, so you would think that Yellen would just throw in the towel and come up with a new model, but she can’t do it. She’s been doing this too long. She’s ideological, overly academic, and detached from the real world. If I want to put on my behavior psychologist hat, this is what’s called cognitive dissonance, and she just can’t come to grips with it.
You’re right, Alex, about her list of factors. I wrote a column recently called Janet Roseannadanna, and it was a reference to the TV character Gilda Radner played in the late ‘70s called Roseanne Roseannadanna. The schtick was she would have this long list of complaints like, “Oh, my stomach hurts. I can’t get out of bed.” The punchline at the end of it was, “It’s always something.”
I applied that to Yellen. When prices kept going down, she first said, “There’s a cell phone price war.” Then she said, “Medical costs are government administrators, so they’re not responsive to monetary policy.” Then she said, “The strong dollar is lowering import prices,” and on and on. She gave a long list of reasons, but all of it was to deny the fact that the prices were going down.
Having said that, the upshot of all this is my forecast that the Fed will not raise interest rates in December, which is very out of consensus but also very bullish for gold. Using hedge fund futures and implied probability, the consensus forecast right now is that there’s an 80% chance of an interest rate hike in December.
My model gives it about a 20% chance. What I expect is that as we move down the timeline over the next two months between now and the December meeting, the markets will get the wakeup call and converge on that 20% level. When you have an expectation of a rate hike and the Fed doesn’t hike, that’s ease relative to expectations. That kind of easing is very bullish for gold.
Alex: Very good. You heard it here first. This is pretty typical of Jim Rickards. He looks at things and connects dots that typically the markets are usually catching up to a month or two after the fact. I suspect that this is probably going to turn out no different.
Another thing I was reminded of while you were talking about Janet Yellen basically being in an echo chamber coming from academia, etc., is the many conversations we’ve had regarding PhD economists. I don’t want to make it sound extreme, but it’s almost like a religion. It seems like a dogma to me.
I recall when you had spoken about Copernicus. All the scientists of the day believed a certain thing, but they were all wrong. Copernicus was right. Their models were wrong, but it was dogma they were clinging to because of the echo chamber they were in.
Jim: I don’t want to be 100% categorical about PhD economists, because there are a few good ones out there. My friend Gail Fosler, based in Washington, is really good on business cycles. I thought the best economist was John Makin who was a friend of Gale and I. Sadly, John passed away a couple of years ago, but boy do we need him now. John had an uncanny ability to call business cycles.
That said, there are a couple of economists I’m fans of, but not many. Basically, I consider PhD in economics to be a disability when it comes to understanding the economy. Of course, right now as we record this, we’re in the midst of the final beauty contest for the next Chairman of the Fed.
I think our listeners know about the five finalists. Would Janet Yellen be reappointed? Would President Trump pick Jay Powell who is a governor now and already on the board? Plus, there are three outsiders: Gary Cohn, head of the National Economic Council, Kevin Warsh, former governor (he has a couple of appointments and is also Chief Economist to Stan Druckenmiller’s family office which was formerly Duquesne, one of the most successful hedge funds in history), and the last one is John Taylor, professor at Stanford University and author of the Taylor Rule, which is a formula for setting monetary policy.
I’ve said for the better part of the year beginning last January that it’s going to be Kevin Warsh, so I’m sticking with that, but they set up these betting markets. It’s an interesting horse race, because not a month ago, Warsh was leading, but then it’s like, “Here comes Seabiscuit.” Suddenly Jay Powell shot ahead because Steve Mnuchin, Secretary of Treasury, got on his side. Then John Taylor met with the president. The president interviewed all the candidates, and apparently it was a great meeting. Trump loves John Taylor, and that gets leaked by the West Wing, so all of a sudden John Taylor’s odds are up. Gary Cohn was ahead last summer but fell back after criticizing the president publicly – not a good idea if you’re looking for a promotion. No one really thinks Janet Yellen is going to be reappointed.
It’s a horse race. We’ll know literally within days, because apparently the president is going to make this decision before he heads off to Asia in early November. My forecast is Kevin Warsh. I’ve said this since last January, and there’s good reason to believe that’s true, but we’ll see.
One of the things I like about Kevin is that he’s not an economist, he’s a lawyer. Maybe I’m showing some bias because I’m a lawyer myself, but he’s also an MBA and an investment banker, so I’m not saying he walked out of a law firm. He’s got plenty of financial chops, and he was on the board of governors already. He was not the Chairman, but he was there in 2008 – 2009 during the worst of the financial crisis. He was part of Ben Bernanke’s inner circle in dealing with the crisis. Whatever you think of what Bernanke did, Warsh was there on the front line.
I know from my own experience in 1998 with Long-Term Capital Management when I negotiated that bailout, we were hours away from shutting every stock and bond market in the world. That’s how dangerous it was and how close it came. When you’re in that position, you actually get to see the whites of their eyes, so to speak. You know how dangerous it is, all the things that are going wrong or could go wrong or almost went wrong, and how close the world can come to hitting a wall at 70 miles an hour.
Warsh had that experience in 2008, not just as an academic or a market participant, but as a true insider. If it happens again – which we all know it will – I find that when lawyers turn to economics, they tend to be very good at it, because legal training is all about problem solving. It’s a benign form of brainwashing. I had six years of law school, because I got a second law degree, but no one goes through three years of law school without your brain coming out a little different at the other end. It’s kind of like a North Korean reeducation camp. They train you to look at both sides of every problem and force you to keep an open mind, and that’s valuable in economics.
The problem with Yellen is that she looks at things one way and is not good at balancing different views. I consider that a disability. I think Warsh would be a great choice or the others, too. I know Jay Powell from working with him when I was in Wall Street and he was at the Treasury. I don’t know John Taylor personally, but there’s every reason to believe he would be a great choice. Whether it’s Powell, Warsh or Taylor, there are three good choices on the table. Again, my expectation is Warsh.
Alex: That brings us to our last topic which I’ve been looking forward to discussing with you, Jim. Yesterday, you attended a meeting with a select group of people where I understand you had access to H. R. McMaster, the U.S. National Security Advisor, as well as Mike Pompeo, Director of the CIA.
Among the topics the meeting dug into was U.S. national security interest issues. Jim, what are your key takeaways from this meeting?
Jim: Yes, I was in Washington yesterday and spent six hours over the course of the day from late morning to late afternoon with Mike Pompeo, Director of the Central Intelligence Agency, and General H. R. McMaster, National Security Advisor to President Trump.
They’re two of the big four. I would say the other two would be Rex Tillerson, Secretary of State, and Jim Mattis, Secretary of Defense, who advise the president on matters of war and peace.
I talked a few minutes ago about the bailout of LTCM, and I’ve had other big challenges in my career, but I have to say that this is the hardest problem I’ve ever worked. I’m talking about North Korea and the prospects of war and peace; it’s absolutely the hardest problem I’ve ever worked. There are a lot of moving parts and partial information which is always true in intelligence work. You never have all the information. If you did, it would be easy. The challenge of intelligence analysis is reaching solid conclusions or estimates with partial information.
I concluded some months ago and did a series of interviews in August and September saying we would be in a war with North Korea by early to mid-2018. Whether it’s a preventative war, which means you’re trying to stop them from developing their program, or a preemptive war which means, “Hit them before they hit you,” that’s an interesting distinction. Either way, the U.S. would start it. We would attack North Korea, it would be bloody and messy, it would not be a walkover, it would not be shock and awe. It would be a really bad situation, and it was coming.
I subscribe to Bayesian statistics and mathematics among disciplines such as behavioral psychology, complexity theory, and others. One of the things you do as a Bayesian is to update, so as I went through the months of September and October, I said, “Okay, I have the hypothesis, I tested it, I’ve given it this probability,” but you get new information every day. The new information goes into the equation and updates it, so you have to keep an open mind. You have to do exactly what I said Janet Yellen doesn’t do, which is to be nimble and flexible and willing to say, “You know what? Here’s what it was, but new stuff came in. I’ve updated, I’ve lowered the probability, and I’m now in a different place.”
You have to be willing to do that. John Maynard Keynes famously said, “When I get new facts, I change my mind. What do you do, sir?” That’s a good rebuttal for people who call you a flipflop. I’m not a flipflopper, but I’m willing to update.
The point is, I said, “What if I’m wrong? What if I got this wrong? What if I’m missing something?” so I reached out to some CIA analysts and other people. It’s like you’re not quite sure if they handed in their badge or not, but as one guy put it, “They still send me pictures and ask me what I see,” so I reached out to people who are very plugged in including CIA operatives, subject matter experts, scholars, and people very immersed in the field. What I was hearing consistently is (to quote Steve Bannon), “They got us. It’s too late.” It would have been nice to stop this capability six or eight or two years ago, but they’ve got nuclear armed missiles. Whether they’re reliable ICBMs, they’re at least intermediate range missiles. Whether they have ten of them, they have at least one they can use, launch on warning, etc.
It’s too late. If we launch this attack, they’d lob one over Tokyo or Seoul. The poor Japanese, I don’t know why they’re the ones always getting nuked. We dropped two bombs on them, and North Korea is getting ready to shoot another one. The casualties would be too high, the costs would be too high, so we’re going to have to engage in a long, drawn-out policy of deterrents and containment not unlike what we went through with the Soviet Union during the Cold War.
I was hearing this a lot as well as updated information. One expert said, “They don’t have to test a missile in space to ruggedize it. They can put it in a wind tunnel with a rocket engine at the other end, and that gives you all the heat and vibration you want.” I said, “You know more about wind tunnel testing missiles than I do. That’s an interesting bit of information.” And I kept going.
Until the night before I went into this meeting with Pompeo and McMaster, I had come around and said, “Yes, maybe Bannon was right, they got us. There’s not going to be a preemptive war.” My takeaway was that there’s going to be a war, it’s just a different kind of war. If we don’t attack North Korea because they can nuke us, they’re going to attack South Korea and rely on their nuclear deterrent to keep us from doing anything. At that point, we might as well fold up our tent in the Western Pacific.
That’s how I went into the meeting with Pompeo and McMaster. Six hours later, I walked out and said, “We’re going to war,” because I heard it straight from the horse’s mouth.
I have to say as an aside, apart from the substance, I cannot tell you how refreshing it was to hear top policy makers speak in their own words for hours on end. It wasn’t being filtered by CNN or the Washington Post. They’ll cover it by throwing in a quote here or there and fill up all the space between the quotes with their own spin, fake news, and everything.
There’s another side worth mentioning. Both of them were extremely complementary to President Trump. They said, “He’s got our back.” When you’re a three-star general, that’s a major statement. When you say someone’s got your back, you mean he’s got your back. Same thing with the Director of the CIA. They’re running assets, paramilitaries, clandestine operations, spies, people in denied areas, and people risking their life every day, so when you say, “The president has got our back,” that’s a major statement.
They said, “He’s giving us all the authorizations we need.” That has to do with when you run cover ops, and you must get something signed by the president. They actually do it in physical copy. They drive it over to Langley, the director puts it in a safe in his office, and then goes and does all kinds of hair raising stuff. If he gets called out, he just opens the safe and says, “Look, that was authorized by the president.” They don’t want a replay of what happened with the Church Committee in the 1970s. Trump has been very willing to sign those authorizations, they’re conducting the ops, and they’re preparing militarily.
Getting back to our point, I’m going to read some exact quotes from when I was at the meeting and took notes. I have them in front of me. Here’s a quote from Mike Pompeo, CIA Director:
“The president has made it clear that he will prevent North Korea’s ability to hold America at risk, by military means if necessary.”
The two key parts of that sentence are “prevent,” meaning they’re not going to get there, and “military means if necessary,” meaning war.
By the way, Pompeo put a date on it of March 20th, 2018. Why do I say that? He said five months, and yesterday was October 19th, 2017. Those are his words, not mine. He didn’t say the war starts in exactly five months, but he said:
“It would be imprudent to assume it would take more than five months for North Korea to gain the capability.”
Waiting more than five months risks them having the capability we’re trying to prevent, and therefore, war would come on March 20th if not sooner.
Another exact quote from Pompeo was:
“Trump has instructed the CIA to ‘prevent Kim from having the capacity to threaten the United States.’”
Again, the key word is “prevent.” Now let me turn to McMaster, National Security Advisor. I’ll quote him as saying:
“This is Kim’s last chance to avoid severe consequences.”
That was a reference to the ongoing diplomatic efforts. He’s like, “If Kim wants to verifiably give up his weapons development program, or if diplomacy bears fruit, we can avoid it. Absent that, no, it’s coming.” I also quoted McMaster saying:
“We’re running out of time.”
That’s consistent with Pompeo’s five months. Here are the two most important quotes from McMaster. He said:
“Accept and deter is unacceptable.”
Just to shorten that, “Accept is unacceptable.” “Accept” meaning accept North Korea as a nuclear arm power, and “deter” meaning deter them from using their power. No, he said, “Accept and deter is unacceptable,” meaning we’re not going to pursue a policy of deterrence and containment. We’re going to prevent Kim from building the nuclear arsenal, which is what Pompeo said.
A final quote is in reference to the April 6th, 2017, meeting at Mar-a-Lago between Xi and Trump. Again, an exact quote:
“China has a great deal of coercive power on North Korea. What’s worse, that or war?”
In other words, China is really putting the screws to North Korea. That feels bad if you’re Kim, and maybe it’s uncomfortable for China, but the quote, “What’s worse? That or war?” means war is the alternative. I was stunned, because we’re so used to Washington figures’ elliptical speech, euphemisms, buzzwords, saying nothing. Here we have two serious guys.
Pompeo has had a military career. He was first in his class at West Point. You might say, “First in class at West Point, that’s pretty good,” but he was also first in his class at Harvard Law School and Editor in Chief at the Harvard Law Review. So, I’m like, “Wait a second. If you told me you were first in your class at West Point, I’d be impressed. If you told me you were editor of the Harvard Law Review, I’d be impressed. If you told me you were both, I’d be blown away.” Well, that’s Mike Pompeo.
McMaster has a highly decorated, distinguished military career. Again, as a three-star general, he’s been in the fight in more ways than one and is a totally serious player. They were blunt, they were candid, they were unambiguous. We’re heading for war.
The only other talk I heard that I found interesting and factored in was assassination. It’s not a funny topic, but Pompeo made a funny remark. Someone asked him, “Would we be engaged in the assassination of Kim Jong-un, a kind of regime change without a war?” Pompeo replied:
“I don’t want to comment on that, because in case an accident should befall him, I wouldn’t want anyone to think that was a coincidence.”
It was very elliptical. In other words, “I get it. It’s illegal for the United States Intelligence Services to assassinate anybody, but that doesn’t mean somebody else couldn’t do it if we asked for a favor.” So, you take my point.
I also talked to a CIA operative who told me that he’d been working on a program for a device to cause Kim to have an unfortunate accident. It was a device that is not being employed because it would have been too much collateral damage, but it told me that, as we say in Wall Street, “They were working the order.”
Here’s my lineup right now: I would give a 20% probability to regime change, meaning Kim has an untimely death and some changes there. I would give a 20% probability (that’s probably high, but I’ll say 20%) that Kim gets the message, backs down, stands down, and we avoid a war because he gives up his program. I give a 60% probability to war started by the United States preemptively or preventatively before March 20th, 2018, and I give a 0% chance to, “We just live with it. They get the weapons and we don’t do anything, we just contain it.”
Again, four possibilities, and I would give them probabilities of 20, 20, 60 and 0 in that order:
- A regime change including assassination
- Kim stands down
- We go to war
- We accept a nuclear-armed North Korea
So, I’m back where I started, but at least I can credit myself for questioning my own assumptions and incorporating a lot of contrary views.
Alex: Regarding the second category, Kim stands down, I read a really interesting article recently. I had not known this about North Korea, but apparently the entire country has this situation where they basically worship him and his now passed father. It was a really amazing article that indicated there’s one city over there – I think it’s Pyongyang – that’s essentially dedicated to the worship of these two individuals.
It’s kind of like the U.S. is the boogeyman that Jong-un has constructed as the great enemy of the people. They’re all unified behind that idea, so him backing down sounds like a tough scenario.
Jim: I agree with that, Alex, and that’s why I put a 20% probability on it. I was like, “Eh, should it be 10%?” You never want to be 0% or 100%, because that’s just not good science, but I was stretching to 20%. The only reason I got there was because the likelihood of war that I was hearing was so clear and unambiguous that maybe even Kim gets the message? That’s why I gave it a little higher probability.
Maybe he will stand down, but I agree with you, that’s the hardest thing for him to do. They have an official ideology called Juche. It’s not quite communism, it’s kind of totalitarianism, but it incorporates exactly what you just described, which is the cult of the individual and the personal worship of the Kim family.
You referred to his father, and that’s right, but you really need to go back to the grandfather. Kim Jong-un is the third generation. It goes back to Kim Il-sung who is the founder of this Kim dynasty. What’s interesting is that Kim Jong-un reminds me more of his grandfather than his father.
If you go online and dig out some pictures of the grandfather when he was about 30 years old, there’s a striking resemblance to his grandson Kim Jong-un. He acts and looks more like his grandfather than his father.
The Korean War is not over. I’m talking about the war that was fought from 1950 to 1953. It’s not over, there was never a treaty. There was an armistice, which is just an agreement to stop shooting, but it’s not more than that. It’s an agreement to stop shooting, meaning you can change your mind and start shooting anytime you want, so this war is not over.
Kim Jong-un considers it unfinished business. I’d say his top priority is personal and regime survival, and the second priority is the reunification of the Korean Peninsula on his terms. He’s pursuing both, and he thinks the way to get both is with nuclear weapons. I heard it from the National Security Advisor, who sits right down the hall from the president, that it’s not going to be allowed to happen.
My expectation – and I would price and organize portfolio accordingly – is that we will be in a shooting war with North Korea before the end of March 2018.
Alex: Here’s a question about Trump. The sort of narrative going on right now in the mainstream media is that Trump is dangerous, he makes bad decisions, and the people close to him are always trying to contain him in his bad decisions. What feeling did you get about that when talking to Pompeo and McMaster? Did you get the impression that they’re trying to run around containing the president, or do you get the feeling that they are confident he is making good decisions here?
Jim: It was more the latter. I was trying to pass along specific quotes that had to do with war and peace, but as I said, this was six hours. Pompeo said the president asks great questions.
By the way, Pompeo personally briefs the president every day. There’s a document called the PDB, the President’s Daily Brief, that is compiled overnight on a daily basis by the CIA and is top secret. I’ve seen them; they come in a nice leather binder. Someone gets in a car and drives from Langley to the White House which is a pretty short drive. They have copies for seven or eight people who get it. Obviously, that includes the Secretary of Defense and Secretary of State, but it’s not widely distributed because it’s highly classified. They walk in and brief the president.
The Director of the CIA doesn’t have to do that. If you’re on a career path in the CIA, one of the prestigious jobs is the briefer, meaning you’re the person who gets to brief the president. The president doesn’t have to take the briefing; sometimes they’ll take it once a week or twice a week. Obama was famous for not taking these briefings, for blowing it off.
Jim: Obama did not get briefed by the Director. Trump is the opposite. He takes it every day, and he gets briefed by Mike Pompeo personally. We were in Langley in Northern Virginia just a few blocks from the White House, and Mike said, “I’m here every day, and I brief the president personally. The president asks great questions. He challenges us. If he has a doubt about something, he makes us go back and look at our assumptions. If there’s room for improvement, we make the improvement.”
I got the sense of a good dialog, mutual respect, good interaction, a process working the way it’s supposed to work. I didn’t get the sense that Pompeo did adult supervision in a daycare center which is how Senator Corker put it.
Same thing for McMaster. Again, when a three-star general says, “He has my back,” that’s an expression of confidence and a relationship of deep trust. That’s not an expression of someone who doesn’t think well of the person or feels he’s got to rein them in.
Trump is Trump, and Trump is not going to change. People say, “Why doesn’t he stop tweeting?” He’s not going to stop tweeting; 70-year-old guys don’t change. It’s not going to happen. To an exterior audience, Trump can be vulgar, shoot from the hip, ostentatious, name calling, a little bit egocentric, a little bit spoiled. Yes, that’s all true. I’m not going to dispute any of that, but so what? That’s not the substance of what we’re talking about.
We’re talking about war and peace. As I said, I heard from two of the big four, and what I heard were complements, respect, and a good, mutual working relationship. I did not hear an adversarial relationship or one where they felt they had to run a kindergarten.
Alex: That’s good to know. Wrapping it up with this, the comment of, “He’s got our back,” is incredibly important and very close to my heart.
About a month ago I was doing some training in Colorado where I spent time with some former Navy SEALs, and we were talking about how a lot of people in the military think. During one of the downtimes, one of them said to me that they just didn’t feel like some of the former administrations cared. The military felt like they were expendable, that they were possibly going to be thrown into combat situations and torn to pieces, and that these administrations just didn’t really care.
He said something that struck me like a blow. He said, “What could be worse than a generation of Americans growing up, and the leadership of America doesn’t have their back; they’re willing to throw our lives away? What could be worse for a free nation than that?” That was like, “Wow, good point.”
Jim: That’s very powerful, Alex. I’ll add to that briefly and say that I’ve traveled quite a bit in my career. I used to go to places that I would not go back to today without an armored car and a platoon or something. In the early 1980s, I walked unarmed by myself in the streets of Khartoum and Omdurman in Sudan. I walked the streets of Karachi in Pakistan, Lahore, which is in Northern Pakistan closer to the frontier, and I felt completely relaxed.
I knew there were bad people around, but Reagan was president, and I felt like, “You won’t mess with me, because I’m an American and Ronald Reagan has my back.” I wasn’t in the military, so it’s not like I could call in a helicopter evacuation. I just felt that in general they knew you were an American, and they weren’t going to mess with you because somebody was going to mess with them.
I haven’t felt that since. As we got into the ‘90s, and certainly during the Obama administration, I wouldn’t go back to Karachi without an entourage. It’s too dangerous, and I don’t think they do have your back. Having said that, it’s a new administration. You’re exactly right about the depth of feeling and importance of that and how it affects everything you do.
I’ll mention two more things on Pompeo and McMaster. Now I’m putting words in their mouth a little bit, but everything I said earlier were direct quotes. I heard disdain from Mike Pompeo for General Clapper, former Director of National Intelligence. To be clear, Pompeo did not use Clapper’s name. He used the phrase “formers,” meaning former Director of CIA and former Director of National Intelligence. We all know who they are, John Brennan and James Clapper.
I had some interactions with Clapper myself, and let’s just say I’m not a fan. I’ll leave it at that. Again, that’s something you don’t get from the media.; you only get it from being in the room. Pompeo made a disdainful remark, and I heard the same thing from McMaster. He said, “Wishful thinking is not a strategy.” Then in a separate part of the conversation – I’m paraphrasing here, because I don’t have the exact quotes in front of me – he said, “We didn’t have a strategy, we had a fantasy,” referring to our approach to North Korea.
I would add that to this clear message of no more wishful thinking, no more fantasy, no more hoping for the best. It will be Kim stands down, he’s removed or we go to war.
Alex: Jim, I appreciate your time today. It’s been a great discussion, and I very much look forward to doing it again next month.
Jim: Me too, Alex. Thank you.
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