CURRENCY WARS: Jim Rickards on the Four Horsemen of the Dollar Apocalypse

Benzinga Radio spoke with Tangent Capital senior managing director Jim Rickards about some fascinating ideas advanced in his new book, Currency Wars. A quick rundown of CURRENCY WARS:

“There are three parts of the book. The first one is called War Games, and it's basically an account of a financial war game that was conducted by the Pentagon in 2009. This was the first time the Pentagon did a war game that was strictly financial: the countries involved could only fight with currencies, stocks, bonds, and derivatives. I was part of the game design team, writing the rules, et cetera. We tried to show the Pentagon how the financial markets actually work and how the United States could be disadvantaged depending on what other countries were doing. There were a few interesting twists and turns, particularly involving gold. The second part of the book is history with a purpose. I knew that the point of the book, at the end, was to get in to contemporary developments in the international monetary system and where I think it's going – in order to understand that, in addition to analytics and economics, I thought it was important to provide historical perspective. I write the history of the two currency wars of the 20th century. The third part of the book is more analytical; it includes a chapter on economics, a chapter on complexity theory, and a final chapter that explains where the international monetary system is going.”

On the book's analysis of gold in the US and the international monetary system:

“It's very common to think of the world in an oil space or energy space. We look around the world and we say, 'Who has the oil? Who needs it and who uses it?' I decided to do the same thing with gold. It presented the world in a very different light. I began to see that for all our financial problems, the US is a gold superpower: the US has the largest reserves of any single nation, we are one of the ten largest producers in the world, and we also have the largest custody of other nations' gold. Combining the gold we have, the gold we have custody of, and the gold we produce, the US was in a very strong position in gold space. The other gold superpower is the Euro system. You look at the world very differently when you say, if paper money were to collapse, and you had to go back to a gold standard either as a matter of planning or on an emergency basis, who would really be calling the shots? And the answer is the United States.”

Hugh Hendry said recently that if you really think hyperinflation is on the way, you should be long bonds, because that hasn't shown up yet.

Well, there is a lot of confusion on that point. If you look at the money supply, or base money, in the last two years, the Fed has more than tripled it. It started out at around $800B in 2007 and today, it's almost $3T. So, there's been an enormous expansion in the money supply. A lot of people have been concerned about inflation, but we haven't actually seen it. It hasn't shown up in the data--in CPI and PPI. So, to that extent, I think some of the commentators are correct, but there are a couple of problems with that. Number one: our inflation was simply exported to China. Remember, at the same time that the Fed was expanding the money supply, China was maintaining a peg to the dollar. A lot of those dollars were finding their way to China, either to buy exported goods from China, or as foreign direct investment--so called "hot money," chasing returns. So, when the dollar showed up in China, China had to print their currency, the yuan, to soak up the dollars. So, the faster we printed dollars, the faster they had to print the yuan. So, the inflation was actually showing up in China. Now, more recently, since they broke the peg--the Fed set out to break the peg; they wanted China's currency to go higher--what's happened is that China's currency has gone higher to deal with their inflation problem. But, that just means the inflation is going to come back to the United States, particularly in the higher prices for imported goods. So, there has been a lag, and there has been a little bit of moving the inflation around the world through the exchange rate mechanism, but at the end of the day, these dollars are going to find their way back to the US, exactly as they did in the 1970s. That is what caused Nixon to close the gold window. The other thing that is going on is that there is enormous deflation coming out of the depression that started in 2007. The natural state of affairs in a depression is deflation because people don't consume, they are trying to deleverage, they are saving to pay off debt, debt is being defaulted upon, asset values are declining, etc. For all of those reasons, you end up with deflation. But, the Fed offsetting that with inflation, coming from policy. What you have is powerful deflationary forces being offset with powerful inflationary forces. The net is close to zero. When you look at the index alone, it seems very well behaved. That is misleading, because underneath that well-behaved index are these very powerful forces. It's going to tip one way or the other. I compare it to a tug of war--I'm not sure which team is going to collapse first, but eventually, one of them will. The outcomes would be: if the Fed just says, "Whatever it takes;" i.e., if they target nominal GDP, that's just a fancy word for saying that they aren't going to worry about inflation. They are just going to print as much money as it takes to get nominal GDP high enough to pay off nominal debts and let inflation rip. That's where there is some danger of morphing into hyperinflation. But, the Fed might throw in the towel and say, "You know what, we're never going to get out of this by printing money. We're never going to get out of this with more debt. What we need to do is just take our medicine--let asset prices find their level, let the system implode to some extent, at least in terms of asset prices, and then reboot the economy and start over, get some growth." If they do that, you're going to see deflation. So, what I like to do is come up with investments that work well in both environments--inflation and deflation. By the way, bonds do very well in deflation up to a point. For example, if you have a 2 percent nominal return on 5 percent deflation, that's actually a 7 percent real return, which is sky high. So, you can do very well there. The problem is, of course, default--that your real return turns into zero if the borrower actually can't pay you back. People are familiar with the fact that gold does well in inflation, but they're not as familiar with the fact that gold does very well in deflation also. During the Great Depression, when a lot of asset prices were collapsing, gold actually went up 75 percent. The best performing stock on the NYSE during the Great Depression was Homestake Mining, which was a gold miner and a proxy for gold. So, there are certain investments--like land, fine art, and gold--that do well in both environments. Those are the ones you should look for, since we're not quite sure how all of this is going to play out.