Sprott's Thoughts

Some Kind of Financial Calamity Is Inevitable: Jim Rickards, Author, The Death Of Money

Dear Reader,

Tekoa Da Silva writing today. I had the chance recently to speak with Jim Rickards, Portfolio Manager at the West Shore Group and author of the New York Times best seller Currency Wars. His new release,The Death of Money, is an exciting read, and is now available on Amazon. Read on for the full interview.

Photo Credit: Omnis, Inc.

Tekoa Da Silva: Jim, it’s a pleasure to have you here. What prompted you to write your new book,The Death of Money, and what are the international release dates?

I was lucky to receive an advanced copy and it is one of the most exciting financial books I have ever read.

Jim Rickards: Well, thank you Tekoa. The release date was April 3rd in the UK and around the world for the export edition but in the United States and Canada, it will be April 8th. But either way it’s available for preorder on Amazon now. So if anyone is interested, they can go find it on Amazon.

But yes, thank you. The Death of Money, the new book, it’s both a prequel and a sequel to Currency Wars and let me explain what I mean by that.

One of the parts of the Currency Wars that a lot of readers enjoy the most was the first two chapters where I described the financial war game that was conducted by the Pentagon in 2009 at the top secret weapons laboratory outside of Washington and one of the reactions I got from that, people say, “Well, gee, that was really interesting. But what were you doing and how did you get invited? Why were you the guy that they turned to design the game and all that?”

That’s a good question and then the new book, The Death of Money, I actually go back in time, back to 2003 and talk about my involvement in national security matters prior to the war game and when you read the description that appeared in 2003 to 2008, it becomes sort of more apparent what I was doing in 2009 with the Pentagon.

But the earlier part, this was also chapter one and chapter two of The Death of Money. It talks about the work by the CIA in connection with insider trading ahead of the 9/11 attack tragically.

That’s a controversial topic that the evidence for it is overwhelming. I lay out the case in the book. It’s very clear that there was insider trading ahead of 9/11 but I disassociate myself from some of the crazy sort of conspiracy theories. There are people out there who say this truly was planned by the US government.

That’s all nonsense but it was conducted. There was insider trading conducted by terrorist associates which if you think about it, terrorists have a social network just like anyone else. You got a mother, father, sister, brother, a cook, a driver, a safe house operator.

There were other people who knew about the attack and those people could not resist the temptation to trade on inside information and make some easy money and that all went on.

Then there’s something called “signal amplification” where a little bit of illegal trading, terrorist trading, turns into a much larger volume of innocent trading by people who don’t know about the attack but they just need a price action and they kind of piggyback on that.

So the CIA said, “Well, that’s interesting. What if it happened again? What if there was another terrorist attack?” Would the same thing happen? Could you see it? Could you trace it back to the terrorist and could you possibly prevent the attack and save lives?

So that was a project we did at CIA for a number of years and I was the co-project manager and talk about that. So that’s the prequel, if you will.

The sequel, the part that looks into the future, and is a continuation of Currency Wars, in Currency Wars, I have a lot of history. There were five chapters of history, really the history of the international monetary system from 1870 to 2010.

But you don’t need to do history twice. I thought it was very important to tell that story partly because I wanted to talk about gold and these days, if you mentioned gold in the context of the international monetary system, people sort of dismiss you. They marginalize you. They go, “Oh, he’s a gold bug,” or “He’s a nut,” or whatever.

I thought if I told the story through history and let people see how gold had been a very important part of the monetary system for a long period of time and up until fairly recently, up until the 1970s, that when you got to the topic in the modern context, it wouldn’t seem so strange. People could see that it actually was a viable part in the international monetary system.

But you don’t have to tell the history twice that’s in Currency Wars. I hope people enjoyed that but in the book, I didn’t want to repeat all the history. So what I do is I do a contemporary survey. I look at Europe, China, the China bubble, the earth through the lens of Germany, how Germany is really creating a new rank in Europe using financial means instead of military means with the emerging markets.

Then I take the story forward looking at the clash of the international monetary system which I expect and I explained why, and some other bad consequences and what investors can do to protect themselves.

So it’s a little bit like The Godfather 2 compared to The Godfather where it was a prequel and a sequel in the same film. This book is a prequel and a sequel to Currency Wars, with The Death of Money and I hope people enjoy it.

TD: Jim, I would like to ask you here about the markets. From a US-centric point of view, everything looks great. The stock market is up. Gold and commodities generally are down over the last few years. All of the major riots and protests, and the crackups in markets, are happening in really far away places. Is everything looking good ‘under the hood’ as well?

JR: No, I think the US economy is a disaster. I think that – it’s funny. People look at leading indicators. They see leading indicators. They’re up. Well, if you look at the leading indicators, one of the biggest components is the stock market.

So the stock market is up because the Fed is printing money. There’s nothing that Wall Street doesn’t like about zero interest rate. So we got the Fed printing money. That creates an asset bubble in stocks. Stocks are probably the leading indicator.

So hey, it’s all good. Well, it’s not good. We have 50 million Americans on food stamps, 26 million Americans unemployed or underemployed, 11 million Americans on disability and a lot of the disability claims are just a new form of extended unemployment or not real disabilities. Some of them are and I respect that but a lot of them are not.

Actually real wages have flattened. Household income is down. The hours worked are going down so even though maybe more people are getting jobs, all of them have fewer hours. If you have 10 people working 20 hours, that’s not as good as eight people working 40 hours.

So you might have more people working but everyone has few hours and lower wages whereas the purchasing power are – deficits are still continuing out of control. Our debt-to-GDP ratio is still going up. So I looked around and I see disaster and when it comes to the financial systems in particular, we’re set up for an even worse catastrophe than we have in 2008 and we go back to 2008, Tekoa. All we ever heard about was too big to fail, too big to fail.

Well, guess what. The five biggest banks in the United States in 2008, today those banks are bigger. They have a larger percentage of the assets of the banking system. They have much larger derivatives books and if you apply what I use which is complexity theory, to understand the risk in capital markets, you know that when you increase something in scale, the risk does not go up in a linear fashion. It goes up in an exponential fashion so the risk is – the size of the system is greater than ever before and the risk gets exponentially greater than ever before.

So we have a lousy economy. We have massive risk. We have the whole thing getting propped up like money printing by the Fed. This is naturally going to happen except this time, the next time, it will be worse than 2008 because it will be bigger than the Fed.

In 2008, you had your sequential failures. So you had Bear Stearns in March of ’08. You had Fannie and Freddie in June and July of ’08 and you had the Lehman Brothers and AIG and they kept failing and then Morgan Stanley was days away from collapse.

Goldman would have been right behind it. Citibank and Bank of America right behind that. Why did those dominos not keep falling? Why did all those firms not collapse?

Well, the answer is the Fed dropped the steel curtain between two of the dominos, between AIG and Goldman or Lehman and Morgan Stanley depending on how you want to look at this.

Imagine a bunch of dominos wind up. They were all falling one by one but somebody drops the steel curtain between two of them. Well, then the domino is going to hit the curtain and the rest of them are not going to fall down.

Well, that’s what happened. But look at the cost. The Feds had to print over $3.5 trillion but that’s just the tip of the iceberg. They get tens of trillions of dollars of swaps with the European central bank as the European central bank need their dollars to prop up their own banks to bail out their dollar liabilities.

The Fed and the FDIC and other government agencies, they guaranteed – the entire money market industry, they guaranteed every bank deposit in the United States. So in other words, they put out the fire but they used up all their capacity, all their balance sheet to do so.

So now what if there’s a liquidity crisis tomorrow or the next month or next year? What’s the Fed going to do? Take the balance sheet to eight trillion? They can’t. They’re out of room. The Fed is insolvent today.

So there’s no more capacity in the central banking system to bail out another disaster but a bigger disaster is right around the corner and the only way we’re going to be able to bail it out the next time is with the IMF. The IMF has the only clean balance sheet left in the system and that’s going to mean the SDR is the global reserve currency and that’s the end of the dollar.

TD: Do you feel that we’re going to see a major calamity or series of calamities before the IMF steps in and gets involved as you say using the SDRs?

JR: Well, there is a long term plan. It’s on the table to make the SDR the global reserve currency. Now, it’s not a secret. I mean this is on the IMF website.

You can go find it. There was a paper that came out in January of 2011 and it takes it step by step and I’ve mentioned that paper in the book. So you can go to the footnotes or the sources. It’s not hard to find.

So the power elites are the global financial elites, the financial institutions, treasury secretaries and professors and Wall Street titans and others who are on the system, they see this coming and they would like to – that’s not going to happen every night. I will just say it’s a ten-year plan. It’s a gradual plan, maybe longer.

But my point is we’re not going to make it that far. They’re not going to make it that far. Before we get that far down the road, this crisis will come. I don’t know if it’s next year or the year after but it’s not a ten-year – you don’t have ten years. We might have three years or four years, something in that magnitude.

When a crisis comes, they’re going to have to accelerate the SDR. They’re going to have to take this ten-year plan, ten-year gradual plan and turn it into a two-minute drill, turn it into a kind of a two-year or three-year emergency plan and roll it out very quickly, which they did in 2009 by the way. It was when I noticed. I talked about these SDRs. The SDR is a special drawing right. It’s world money, printed by the IMF.

The Fed has a printing press. They can print dollars. The European Central Bank has a printing press. They can print euros. Well, the IMF has a printing press also. They can print these SDRs and there’s nothing new about them.

They’ve been around since 1969. Hundreds of billions of dollar equivalent of the SDRs have been issued. The last issuance was in 2009. I mean nobody noticed. That’s because no one really understands this stuff or at least the people who do work in the IMF, they don’t have an interest in criticizing it. But certainly even various smart investors are unfamiliar with this. It’s very technical.

But it’s actually not that hard to understand. It’s just an IMF printing press. They print world money and so when there’s a crisis, it’s going to be bigger than the Fed, bigger than the central banks. The Fed is leveraged, Tekoa.

They’re leverage at 80 to 1. The Fed is insolvent on a mark to market basis. Now the Fed doesn’t actually mark to market. They hold their assets at a cost.

But if you did mark them to market the way you would with a hedge fund for example, their capital would be wiped out. They’re insolvent and I actually had a conversation with the member of the Federal Open Market Committee who admitted this to me privately.

So now I’ve reached a conclusion on my own but she confirmed it. So she had gotten insolvent. The central bank, they’re not going to be able to do more.

Interestingly, the IMF has a pretty clean balance sheet. They’re leveraged three to one. I said the Feds leveraged 80 to 1. The IMF has only leveraged three to one. So they’ve got some head room to print these SDRs and they will.

But once they do that, once they started selling SDRs, I mean SDR becomes the lead global reserve currency.

TD: What has your research shown in terms of how quickly perception can change on a currency? This process seems to have been taking a very, very long time. You and others have been speaking about this for years. Will it occur over, say, a three to ten-year period?

JR: Well, it shows that it can happen very quickly. Now, there are underlying forces. It takes a while for the scale of the system to build up which we’ve been doing. We’ve been doing it all along but particularly since 2008, I mean the total gross national value of derivatives. Today it’s now in excess of global GDP.

Global GDP is about 70 trillion and the total notion of value derivative is considerably greater than 70 trillion. So it’s already that the banking system is bigger than the entire global economy.

Every penny of it represents an obligation from party A to party B. So that’s how – it can’t possibly get repaid. Everyone thinks they can unwind it. Well, they’re a little bit in a panic. We will find out that everybody wants their money back all at once and it will be impossible to do. So that’s the state of play. But it takes a while to get that big. It takes a while to build up these tensions.

One analogy is an avalanche. So how does an avalanche start? Well you have a mountain side and then it starts to snow and the snow builds up and builds up and it gets pushed around by the wind and melted by the sun and frozen at night and it’s shaped.

Finally it becomes very, very large or very, very unstable and it’s poised to collapse. Here comes the snowflake and the snowflake disturbs a few other snowflakes. That starts a little slide and that turns into a chute. Then it turns into sort of a snow waterfall and then the whole thing breaks loose, collapses. The avalanche comes and wipes out the village and kills a bunch of people.

Well, that might have taken a very long time to build up. Years in some cases but when it collapses, it collapses very quickly and it only took one snowflake.

By the way, don’t blame the snowflake. The danger is in the mountain itself and the snow pack and the mountainside is – that’s where the danger is.

That’s the way I see financial panic. People I talk to say, “Well, Jim, I understand your analysis of risk. I understand how the risk gets built up and how it can be catalyzed, et cetera. But when is it going to happen?”

Everyone – as if to say, Jim, we’re going to ride the stock market right up until the day – before the panic and then I’m going to sell my stuff and buy gold and I’m going to be smarter than everyone else.

Of course that’s not how it works in the real world. You will find out that the panic has started before you can do anything and you won’t be able to get gold. Your stocks will be crashing or you will be in denial. That’s the way things actually play out.

But the problem is that it happens before you know it and you have to be prepared in advance. So just the way an avalanche can build up for a long time but happened all at once, by the same token, financial instability can build up over a long time but then happen all at once. When it happens, there’s no time to prepare yourself.

TD: Jim, you also speak about the last-ditch effort by the Fed and central banks in terms of marking up the price of gold to, let’s say, a theoretical price of $7000 an ounce. Silver might be at $100. You mentioned a few other potential prices in The Death of Money.

Would that mean the citizenry in the West would find themselves in similar situations to emerging country citizenry, where food and energy take up 50% of an average income, for instance?

JR: Well, if you get that kind of inflation, then what will happen, of course inflation – everyone from John Maynard Keynes and on recognizes that inflation is a hidden tax. So suddenly if countries are suffering deflation and I’m a central banker, deflation is a central bank’s worst nightmare, so I try to fight it with inflation.

The Fed is actually trying to get inflation. They’ve been trying to get inflation up since 2008. The problem is it’s not working and they tried everything.

They did QE1, QE2, QE3, Operation Twist, forward guidance, currency wars, nominal GDP targeting. The Fed has done all these things and they still can’t get the inflation.

That shows you how powerful and persistent the underlying deflation is. So if the central bank is desperate for inflation and they can’t get it and deflation starts to take over, there’s always one way to guarantee inflation which is simply to re-price gold, basically cheapen your currency instead of trying to devalue your currency against other currencies which is what the currency war is all about. That never works because the other guy just devalues his currency too.

So you’re devaluing your currency against another currency. You can devalue your currency against gold and that does work because gold can’t fight back. You can’t print gold. Gold can’t cheapen itself. It’s just gold.

So that way, you get instantaneous inflation. You can say the price of gold – the Fed could go into a room, close the door, walk out 20 minutes later after a vote and say, “Ladies and gentlemen, the price of gold is now $7000 an ounce.”

They could make that stick. If they were working with the treasury and using the gold at Fort Knox, it’s a way to make a two-way market and stand up to the market. Then all of a sudden, guess what, gold would $7000 an ounce.

Now of course that would represent kind of an 85 percent devaluation of the dollar which is highly inflationary and that would wipe out savings, insurance policies, annuities, retirement.

Now the government would probably have to do some kind of social welfare rescue but they would do it selectively. They would protect the people they want to protect whereas other people maybe the wealthier people would see their wealth wiped out. Maybe poor people would get some kind of assistance.

But now you’re in domestic social engineering, the risk of social unrest. There’s a very fine line between financial panic and social unrest. I actually expect of something. It’s what I call the “money riots” where people would be a bigger, worse, more dangerous version of what we saw in Greece in 2011 and 2012. But you have that kind of social instability.

That’s what happens when you debase the currency. That’s what happens when you steal people’s savings through inflation.

TD: Jim, is that sort of a possibility in your mind or is it inevitable?

JR: Well, some kind of catastrophe is an inevitability not because I have a crystal ball but because I understand the dynamics of conflict systems and scaling metrics and the network effects in the relationships. So you can look at that. You can see that the collapse is coming.

Now exactly how it plays out, here are several possibilities. It could go from extreme deflation to hyper inflation which is what we just talked about, followed by social unrest or maybe there’s a collapse of confidence in the dollar first and social unrest in any inflation follows.

There could be a sort of neo-fascist response or using executive orders and martial law to keep society under control. It could play out in a number of different ways and I don’t want to say that – I mean I don’t have a crystal ball but you can see a collapse coming.

It’s not too late to prepare now. If you wait too long, it may be too late. You may not be able to prevent it but you can survive it and that’s the point of the book.

TD: In the circles that you travel in – I guess you could call them the global financial elites, very high net worth individuals, groups -- what do you see them doing now?

JR: Well, they’ve got their fingers crossed. I mean the idea that they know what they’re doing and they’re in control is nonsense. You need to look no further than the Federal Open Market Committee.

Now yesterday or the other day Janet Yellen came out and they got rid of this – they had the 6.5 percent unemployment threshold for raising interest rates and they threw it away. So that no longer applies.

I went back and looked. The presidents had 15 different policies since 2007. If you count – as I mentioned QE1, QE2, QE3, Operations Twist. They had forward guidance for 2014 and then there was another one for 2014, another for 2015. They had a 2.5 percent inflation threshold, the 6.5 percent unemployment threshold.

Then they threw the unemployment threshold out. So you go through all these iterations. It’s very clear that they’re making it up as they go along but they don’t know what they’re doing.

Neither does anyone else. Neither do the other central banks. We are all guinea pigs in the central bank experiment. So however, they have to put a good face on and the markets like it. The market is just saying, “Please lie to me. I don’t really want to face the truth, about how dangerous this all is.”

The central bankers are saying, “Well, we have to lie to you because if we told you the truth, we would start to panic ourselves.”

So again, I just think that they’re hanging on by the skin of their teeth. There’s a lot of wishful thinking. There’s a lot of denial. There’s a lot of hiding behind these models which are badly flawed but they give people false comfort because they can believe in them even though they don’t correspond to reality. So the entire state of affairs is extremely fragile.

TD: Outside of picking up a copy of Currency Wars, and then preordering the copy of The Death of Money, what can people do now in terms of preparation? Should they take drastic measures in changing their financial lives or can they take this one bite at a time in terms of preparing?

JR: Well, I think there’s a very simple hedge that people can do which is to put 10 percent of your investable assets into gold. Not 90 percent, not even 50 percent. But just put 10 percent in gold.

That way, if you want to invest in other liquid assets, enjoy the ride and maybe your stocks will go up and if we have a sound dollar and some of these drastic outcomes don’t materialize because the government changes its policy and does a few things to make the dollar stronger, your gold may go southwards or down a little bit. But you will make plenty of money on the rest of your portfolio.

But if I’m right and I expect that I am based on the analysis that I described in the book, the rest of your portfolio collapses, your gold is going to go up two, three, four, five times.

So if you have 10 percent of your portfolio in gold and it goes up 500 percent, that’s going to give you 10 percent times 500 percent. That’s 50 percent return.

But it’s going to give you 50 percent portfolio insurance. So yeah, you may be losing money on stocks and other things but you will be making it up on gold. The way I explain it Tekoa, let’s say – I ask people if they have a house and they say, “Yes, I do.”

I say, “Well, do you have fire insurance?” and they say, “Of course I do.” I say, “Well, do you want your house to burn down?”

They go, “No! Of course not. I don’t want my house to burn down.” Well, aren’t you wasting your money on the fire insurance? They go, “No, because it might burn down and I want to be ready.”

That’s the insurance concept and the same thing. You don’t want the system to collapse. You don’t want a financial catastrophe but if it does happen, you’re sure going to want that gold to preserve some of your wealth and so I think that’s something that’s very simple.

This is more – there are more techniques that people can use and I describe them in the book or other asset classes that I think will help protect people in various scenarios including land and fine art and even cash for a while. Maybe not forever but cash is very good in deflation. Cash actually becomes more valuable and gives you a lot of optionality to take into another asset class as you get more visibility and more information.

But anybody can put 10 percent gold. Let’s say you have 100 million. Put 10 million in gold. If you have 100,000, put 10,000 in gold and if you have 10,000 in savings, go buy one gold coin. That might be more like 13 percent but that’s OK.

Put the gold coin in a safe place and that will give you some protection against the inflation, against the meltdown that’s coming. So I think that there are some practical things that people can do.

TD: Might that also include hard assets that are available through the public exchanges?

JR: Well, it depends how you own them. I mean the classic case is Warren Buffett. Warren Buffett never has a good thing to say about gold. But I would say don’t listen to what people say. Watch what they do. A couple of years ago, Warren Buffett went out and he bought the Burlington Northern Santa Fe Railroad and he didn’t just buy shares. He bought the whole railroad, took it private.

So the New York Stock Exchange could crash tomorrow and Warren Buffett wouldn’t care because he owns that railroad. He’s sort of in the clear.

Now what’s a railroad? A railroad is nothing but hard asset. It’s rail. It’s right away. How does the railroad make money?

Well, in those hard assets. You know, corn, wheat, coal, steel, iron, oil, et cetera. So a railroad is nothing but a bunch of hard assets that makes money moving hard assets. So when I looked at that acquisition the way I analyze it, is Warren Buffett is dumping paper money and buying hard assets. He wouldn’t put it that way but that’s what he’s doing, getting rid of paper money and buying hard assets.

The dollar could completely collapse. What does he care? Because he owns the railroad. That is how the German industrial survived the Weimar hyperinflation in 1922 and it will cause this wipeout because they were relying on savings and insurance annuities but people who owned gold or factories or hard assets survived just fine and brought up all the other assets to maybe one that was bankrupt.

So Warren Buffett is prepared for the dollar collapse because he’s getting out of dollars into hard assets. Investors can do likewise. Gold is the easiest the way to do it but if I’m going to be in the stock market, I would certainly look for energy companies, transportation companies, things that are akin to what Warren Buffett has done.

TD: Jim Rickards, Portfolio Manager at the West Shore Group and author of best seller Currency Wars and now the new release of The Death Of Money. Thank you for sharing your comments with us.