Here is an exclusive interview with James G. Rickards, a leading practitioner in the realm of capital markets, national security and geopolitics, on inter alia “quantative easing as a success,“ the currency wars of the past and the present, and the question why you are fighting every central bank in the world in case you own gold.
By Lars Schall
James G. Rickards is Senior Managing Director of Tangent Capital Partners (http://www.tangentcapital.com/), a registered broker-dealer and merchant bank, and Senior Managing Director of Omnis, Inc. (http://www.omnisinc.com/), a research and consulting firm in McLean, Virginia, USA. He is also co-head of Omnis’ practice in Threat Finance & Market Intelligence and a member of the Board of Directors. Moreover, he serves as Principal of Global-I Advisors, LLC, an investment banking firm specializing in the intersection of capital markets and geopolitics. Mr. Rickards is a seasoned counselor, investment banker and risk manager with over thirty-five years experience in capital markets including all aspects of portfolio management, risk management, financing, regulation and operations.
Mr. Rickards’ career spans the period since 1976 during which he was a first hand participant in the formation and growth of globalized capital markets and complex derivative trading strategies. He has held senior executive positions at sell side firms (Citibank and RBS Greenwich Capital Markets) and buy side firms (Long-Term Capital Management and Caxton Associates) as well as technology firms (OptiMark). He has directly participated in the release of U.S. hostages in Teheran, Iran in 1981 as well as in the 1987 Stock Market Crash and the 1990 collapse of Drexel. He was the principal negotiator of the government-Federal Reserve Bank of New York-sponsored rescue of LTCM in 1998.
Mr. Rickards is a graduate school visiting lecturer at Northwestern University and the School of Advanced International Studies. He has delivered papers on econophysics at the Applied Physics Laboratory and the Los Alamos National Laboratory. Mr. Rickards has written articles published in academic and professional journals in the fields of strategic studies, cognitive diversity, network science and risk management. He is a member of the Business Advisory Board of Shariah Capital, Inc., an advisory firm specializing in Islamic finance and is also a member of the International Business Practices Advisory Panel to the Committee on Foreign Investment in the United States (CFIUS) Support Group of the Director of National Intelligence.
Mr. Rickards holds an LL.M. (Taxation) from the New York University School of Law; J.D. from the University of Pennsylvania Law School; M.A. in international economics from the School of Advanced International Studies, Washington DC; and a B.A. degree with honors from the School of Arts & Sciences of The Johns Hopkins University, Baltimore, MD.
His advisory clients include private investment funds, investment banks and government directorates. Mr. Rickards is licensed to practice law in New York and New Jersey and various Federal Courts and has held all major financial industry licenses. He has been a frequent speaker at conferences sponsored by bar associations and industry groups in the fields of derivatives and hedge funds and is active in the International Bar Association. He has been interviewed in The Wall Street Journal and on CNBC, Fox, CNN, NPR and C-SPAN and is an OpEd contributor to the New York Times, Financial Times and the Washington Post.
James G. Rickards lives in Connecticut, U.S.A.
In addition to the following interview, I also want to recommend a comprehensive interview that I’ve conducted with Mr. Rickards in the past, “The central banks don’t consider it manipulation, they consider it part of their job,“ at:
Mr. Rickards, you’ve stated not so long ago: “Quantative Easing is dead, long live Quantative Easing.“ What do you mean by that?
What I meant was that formerly the QE program by which the Federal Reserve purchases intermediate-term treasury notes in the open markets, those in the three, five, seven and ten years maturity, that program is officially over June 30th, and I did expect that it will not be continued after June 30th – this is what I meant by: “QE is dead.“ However, the Fed has been doing this for almost two years, and at this point through the program they have acquired so many assets that their balance sheet is now almost $ 3 trillion. When they started this program it was less than $ 1 trillion, it was close to $ 900 billion, but today the balance sheet will approaching at the end of June $ 3 trillion, the exact number right now is about $ 2.6 trillion, but they will be buying some more assets between now and June 30th.
The point is when your balance sheet is that large you have securities that mature over time – two years ago, if you bought a two year note, that note is maturing sometime in the next few months, and when that happens the Treasury sends you the money, and then you can keep the money. But in the case of the Fed because they create the money in the first place if the system sends money to the Fed, that money goes out of existence, it actually reduces the money supply. But the Fed can choose to go out and buy more securities by using their reinvestment buying power. So even though they will not expanding their balance sheet they will be continuing to buy securities to keep interest rates low. So that is what I meant by: “Long live QE.“ In other words, they are going to continue QE, but in a different form.
Is this perpetual, even though maybe modified QE in your view by any measure successful – or does this depend on which side of the proverbial “printing press“ one does stand?
That’s a good question. In order to define success you have first to figure out what the goal was and see if you have reached that goal. And there is a lot of misunderstanding on that point. A lot of critics of the Fed have said that their goal was to monetize the federal debt in the form of printing money. Well, that is not the goal of QE, never was. The goal of QE was to keep interest rates low, and in particular the Fed wanted to create a situation with what they call negative real interest rates. A real interest rate is simply the interest rate that you have to pay, so it’s called the nominal interest rate minus inflation. For example, if the interest rate is 2 percent, but inflation is 4 percent, then the real interest rate is negative 2 percent, or 2 – 4. And when you have negative interest rates this of course encourages people to borrow, because they can pay back the debt in cheaper dollars – not only is the borrowing cost zero, it is below zero, and therefore you can pay back the debt in cheaper dollars, so you don’t have to pay back as much as you have borrowed in the first place in real terms. So that is the Fed’s goal.
Now you have to ask yourself how does the Fed measure inflation? They don’t actually use the inflation numbers that are reported every month. They use intermediate-term inflationary expectations. This is not the inflation of today, but the inflation that consumers and borrowers think might be in existence two, three, four, five years from now, because that is the one that really matters. If you borrow money for thirty years on a mortgage or you borrow money for five years for a car loan, and you’re trying to figure out the real interest rate you don’t use today’s interest rate, you use your expected interest rate over the next five years, or in the case of the mortgage the interest rate over the next thirty years. In order to do that, the Fed looks at what they call the TIPS spread – we have an interest rate in the United States called TIPS, which is Treasury Inflation Protected Securities. Those are protected against inflation. The interest rate on TIPS is only the interest rate you need to compensate for risk, but there is no inflation element build into it. With the other treasury notes you have to worry about inflation. So the Fed looks at ten-year rates and then they look at the ten-year TIPS rate to figure out the difference, and that difference, in theory, represents intermediate-term inflationary expectations. That is sort of what they are targeting.
So the whole point of QE is to buy notes in the five to ten years spectrum, keep those nominal interest rates low and keep the TIPS spread low as a way of keeping the inflation expectations low. And in that sense the Fed has been successful. People are continually amazed given the U.S. debt situation, the U.S. money printing situation and the potential high inflation why the interest rates are as low as they are. One reason is, the Fed is buying enough securities to keep the interest rates low. They don’t have to buy them all, they don’t have to monetize the debt, they only have to buy enough. On that measure I would say yes, QE has been a success and will continue to be a success, because as I have mentioned the balance sheet is so large that the buying power by itself is enough to buy sufficient securities to keep interest rates low.
The global commodity rally, that is now under pressure, seems largely liquidity driven via cheap borrowed money. Do you think that there’s a direct link between monetary policies in the United States and the Arab revolts via higher food and energy prices?
Two times yes. But let’s take the first part of the question: is there a link between monetary policies and higher inflation prices? I think the answer is absolutely yes. We have seen this many times in the past. For example, in the early 1930?s commodities prices collapsed around the world, and that was partly caused by too tight monetary policy, and in that case the Fed was not expanding monetary policy enough, and that too tight monetary policy was collapsing commodity prices and causing generalized deflation all over the world. In the 1970?s we saw then the opposite: we saw a very loose monetary policy. At the beginning of the 1970?s, oil was about $2 per barrel, by the end of the 1970?s it was $12 per barrel and soon on its way to $20. That was in part due to a very loose monetary policy by the Fed. There is clear evidence in this. We saw this again and again.
We see it again today. The only difference today is that we have a more globalized world, we have more economies participating in the world economy to compete with each other for exports and market share. Labor in Asia now competes with labor in the United States. All of that was not true, certainly not to that extent in the 1930?s and the 1970?s. Also, the world is on a de facto dollar standard – dollars make up 60 percent of global reserves and an even higher percentage in global trade, of course, the price of oil and other global commodities are set in dollars. When you have money printing, what is happening is that inflation is showing up, but it is not showing up in the United States at first, it is showing up all over the world – in China, Malaysia, South Korea, Thailand, Brazil and many other countries.
That is because of the exchange-rate mechanism. These countries are trying to keep their currencies low relative to the dollar, which means they have to buy dollars by printing their local currencies in their local markets. The result of that is they are creating a flood of other currencies. That is why the inflation is showing up around the world and not in the United States. Little by little that is changing. We are at a point where a lot of those countries are starting to revalue their currencies upward. This will limit the inflationary pressure in their own countries, but it means that the inflationary pressure will now come back to the United States in the form of higher import prices when we buy foreign goods. This process will take some time to play out, but it will ultimately force the inflation back into the United States. With that all said, there is no doubt that the easy monetary policy of the Fed is responsible for higher commodity prices around the globe.
Now, given that, yes, this is absolutely one of the contributing factors to the unrest in Northern Africa, the Middle East, but also in some parts of China, which haven’t grown to the extend elsewhere, but the fact that they are happening at all is significant. Sure, there are many other factors, for instance large numbers of unemployed young adults. But rising food prices is sometimes what it takes to get the people out on the streets. The longing for freedom and liberty and the unemployment situation actually have been persisting for a longer period of time, but the rising food prices may be that sort of proverbial straw that breaks the camel’s back which causes civil unrest to come alive. So the Fed is doing a lot of damage, not only to the U.S. dollar and the global economy, but I would also say that they are actually provoking a lot of unrest around the world.
Would you then also say that war and monetary policies are in general intertwined subjects or at least could be?
There is no question that they can be. Again, we saw this in the 1930?s, there was a long sort of currency war fought by the major powers from the 1920?s to the 1930?s, which had to do in part with the debt situation coming out of World War I. In Germany you had massive reparations to pay to France and Great Britain, many others had massive war debts that were used to finance the war costs by Great Britain and France to the United States, so you had a world in debt, the whole world was in debt to each other, and that was what precipitated these currency wars, these beggar thy neighbor currency devaluations of one against the other, and finally all major currencies devalued against gold, which happened in stages between 1931 and 1936. But none of the economic problems were solved, the real solution would have been just to forget about the debt, but that did not happen until very late in the process and only in stages, and by then when it did happen a lot of the damage was done in Germany with the rise of the Nazi Party, which lead directly to World War II. So that sort of currency war turned into a shooting war.
Therefore, I think that one can’t underestimate the potential for these global international economic effects to turn into actual violent warfare. That did not happen in the second currency war during the 1970?s and the early 1980?s, but there is always that potential, yes. First, you have a currency war in which the countries try to devalue their currencies against each other, but that usually doesn’t work – all advantage is only temporary in that situation. Then you go into trade wars. What the countries cannot achieve with the currency devaluation they try to do in the form of tariffs, capital controls, embargos, unfair trade practices etc. But that also tends to fail. It might protect certain industries in the short-run, but it tends to reduce world trade and growth, and that causes even more economic stress. Finally, countries will always find excuses for conflicts that can absolutely lead into military conflicts. Those are things that I think the central bankers underestimate.
Now that you’ve mentioned the “Currency Wars“ of the past, let us look at the current one of our time. Isn’t the real battle royal in that “Currency War“ the one between gold and all fiat currencies, especially the U.S. dollar?
That’s where it will end up. I agree that this is the endgame. You start out by devaluing with each other, but that ends up in failure, and so you need something to devalue against – and gold is always the last resort, because gold is the one thing that doesn’t devalue on its own. For example, if the U.S. devalues the dollar against the Chinese currency, and then the euro devalues against the dollar, U.S. exports might be helped, but the dollar devaluation could be hurt by the euro devaluation, so as I have said no one is really further ahead and you’re not getting the inflation that you want. But one way you can always get inflation is the devaluation against gold – or even maybe the devaluation against gold is the inflation. Anyway, the purpose of this is to cheapen the currency, help exports and lift commodity prices across the board.
This has happened two times, of course. In 1933 President Roosevelt devalued the dollar against gold, and in 1971 Richard Nixon did the same thing. I think it will happen again. The currency war is playing out for a while, but they don’t really get what they want and so at the end of the day they have to devalue against gold. For instance, you will see a lot of up and down between the euro and the dollar, the cycle is repeating over and over and over, back and forth, and as a trader you can make a lot of money on the swings between the euro and the dollar, but as an investor it really doesn’t matter very much. My analogy for this is that the passengers on the Titanic can go to a higher deck or to a lower deck, but they can’t go all off the ship. The life boat, if you will to pursue that metaphor, is gold. That is the one thing they can all devalue against. I think this is where it all will end up.
In 2009 you have said on air at CNBC: “When you own gold you’re fighting every central bank in the world.” What has lead you to that conclusion?
Well, there are about 160.000 tonnes of gold in existence, that would be all gold that was ever mined, whether it’s jewelry, central bank reserves, industrial applications or artistic applications, etc. That is approximately all the gold ever mined. About 30.000 tonnes of that gold is in the hand of central banks, which is not quite 20 percent of all the gold. They are able to use that to manipulate the price of gold through central bank sells, central bank releasing of gold, or not selling it, but simply holding on to it. There is good evidence that central banks have pursued all those different policies from time to time. As an investor, even as a very large investor in the area in the tens or hundred of millions, which is pretty large, or even upwards to billions for some big institutions, those amounts are still relatively small compared to central bank gold holdings. So you’re a little bit in the short-run at the mercy what central banks choose to do. Although fortunately right now what I see is that central banks are not unhappy with the price of gold going up.
There were times in the past when they wanted to keep the lit on the price of gold to avoid inflation. But now is not one of those times. Now is the time when the Federal Reserve in fact wants inflation because they desperately want to reduce the real value of the U.S. debt and a depreciation of the dollar is one way to do that. So they do want the price of gold go up. However, they don’t want it to go up too quickly. They want an “orderly adjustment,“ that is the exact word that they use – orderly as opposed to disorderly. What does that mean? It means that gold goes up 10 or 15 percent a year, which it has by the way, of course, ten years in a row. If it increases that way they do not mind it, because it cheapens the dollar which is what they want. But what they don’t want is to see it maybe double in six month period or a spike, because that might cause a panic buying of gold, a panic dumping of the dollar, and that can get out of control.
My point is simply that I think gold is a very good asset to own, I think it does preserve wealth and will go up in value, although it is not really going up in value – what happens is, of course, that the dollar is going down, nevertheless you will protect yourself against the collapse of the dollar. So investors should own it to some extend and in dollar terms it will go higher, but don’t speculate that it will happen too fast because the central banks are on the other end of the trade and they don’t want that to happen.
Mr. Rickards, a huge chunk of the foreign gold reserves located at the New York Fed belongs to Germany. What are your thoughts related to the German gold reserve in custody at the NY Fed? Let’s assume you would be the head of the Deutsche Bundesbank with the best interests of the German people in mind – and also keeping in mind that we’re heading to currencies backed by gold: what would you do then in that respect?
It depends on the German gold policy. If Germany wants to leave the monetary policy to the U.S. and is willing to accept whatever policy plans the U.S. comes up with, they should probably leave it where it is. That is a question of confidence. But if Germany wants to pursue its own policies or perhaps have a more gold backed euro or maybe even go back to a Deutsch Mark, then they should bring it to Germany and store it in secure vaults under control of the Deutsche Bundesbank. The reason for this is: as long as it is stays in the United States it is vulnerable to confiscation by the United States. So you really don’t have the control over your own monetary policy as long as your gold is in other hands. During the Cold War, given the Russian threat, I am sure it made sense and was a smart move to have the German gold in New York. But today I would rather be concerned about the Federal Reserve printing presses than about Russian tanks, and thus I would like to have it in Frankfurt.
How do you react to all that “precious metals are in a bubble“ talk? Is this rather amusing for you to observe and to hear?
Yes. It tells me that people who are making that claim are not really familiar with the gold market. It’s funny how there are a certain number of people whom I would consider as true gold experts, but most people on Wall Street, for example, may have some analytical skills, but they are not real experts in gold, they seem to go from trend to trend – one month we see them talking on TV about tech stocks, the next month they are talking about corn or ethanol, and the month after that they are talking about gold. Those people tend to flip from topic and topic. They use for that the very same analytical techniques and are not really prepared to understand that much about gold.
Having said that, I want to argue that gold is definitely not in a bubble. Here is why: First, the trade is very, very uncrowded. I talk to large institutional investors all the time, and they have zero allocation in gold or very small, maybe one percent or one and a half percent. You look at these portfolios and they have 50 percent stocks, 40 percent bonds, the rest hedge funds. To me gold is the most under allocated asset in the world. If gold would simply go up from one percent to two percent in portfolios, there is not enough gold in the world anywhere near current market prices to support that shift. There is an enormous potential to go up just on a extremely modest allocation in the direction of gold.
Secondly, there are ways to measure if gold was in a bubble. You simply take the official gold supply numbers, multiply that by the market price and compare that number with the money supply. If you do that within the United States, you would come to a result of 17 percent. But in 1980, when gold was at $850 per ounce, that number was actually over 100 percent. In other words, at that point gold was so high that every holder of a dollar could have gone to the Fed, cashed in for gold and the United States still would have gold left over. In that situation, where the market value of gold is higher than 100 percent of the money supply, that is arguably a bubble. But we are nowhere near that number today, it is not 100 percent, it is about 17 percent. The two things together tell me that we are not in a bubble.
What would be the most important signals (beyond positive real interest rates) that the end of the bull market in gold is near?
Well, I gave you two metrics to explain why gold is not in a bubble. I would watch them also when we get closer to a bubble territory. For example, gold at $7000 an ounce with the current money supply and the current supply of gold, then we would be back where we were in 1980, and that might indicate a bubble. But we have plenty of room between $1500 and $7000. And remember also: a bubble can always overshoot.
What is your opinion related to the decision of the University of Texas endowment which bought $1 billion of physical gold?
That is very significant, because obviously it is a large endowment with access to the best financial minds of the world, very well advised, and they took that decision, which I believe is a good decision, they will make money on it, and I think it will open a door. It will make it more respectable for other endowments to do the same. There is a little bit like a herding mentality among asset managers and endowment managers, and even if they think there is good case for gold they don’t want to buy it because they fear to be embarrassed or marginalized at conferences as gold nuts. But when a very well advised and respectable endowment of that size such as the University of Texas endowment buys gold it sends a signal to others that they should looking at it. That increases the trend of purchasing gold, which of course is very bullish for the price.
The most interesting story in the future for me is the point in time when the Middle East countries will no longer sell their oil and natural gas for paper money. When do think will they be paid for it with precious metals?
Well, this is all part of an evolution away from the dollar. It has a number of ways to go. I do think that what may happen is that gold will be used as a pricing mechanism. In other words, Middle Eastern and also Russian natural resource exporters may begin to price their goods in units of gold, but accept dollars, but the problem, of course, is that the amount of dollars won’t be fixed. Simple example: right now oil is, I use rounded off numbers, around $ 100 a barrel and gold is around $1500 an ounce, so it takes 15 barrels of oil to purchase one ounce of gold.
By the way, if you look at the oil to gold ratio it has been very constant for a very long period of time. Of course, the price of oil has moved between $30 per barrel and $150 per barrel, and the price of gold has moved between $200 an ounce and $1500 an ounce, but if you look at the ratio, it always hovers around that 15 or 16 to 1 ratio, and that tells you something about the real intrinsic value of commodities.
But be that as it may, you could have a situation where somebody in Saudi Arabia says: From now on a barrel of oil will be 1/15 of an ounce of gold. Now, if you want to pay me in dollars that’s fine, but you have to do the dollar-gold conversion (to figure out how many dollars you owe me in a world of an increasing gold price) that means that you have to pay more dollars for a barrel of oil. So even if they accept dollars you can still have a world where it’s priced in gold, but gold is convertible to dollars and you can pay with dollars but you have to pay a lot more.
I think that is one of a number of solutions on the table. Another one is of course the SDR. The IMF is trying to promote the use of SDR as a basket of currencies. But none of this is feasible yet. It will require some years to study, it will require a conversion process and some pre-announcement for the market. But the bottom-line on the whole thing is: the exporters of natural resources and manufactured goods in the Middle East, in Russia, China, Brazil, they all have indicated deep, deep dissatisfaction with the current international monetary system and the role of the U.S. dollar in particular, so I think you will see some shifting away from that in the years ahead.
And what are your thoughts in that regard related to the war in Libya?
I think that is a small matter within the monetary system, but very important from an energy perspective. People have underestimated the ability of Colonel Gaddafi to remain in power, and part of the reason why they have underestimated it is because they may have been unaware of the fact that he has, as the Financial Times and others have reported, over 100 tonnes of physical gold. And interestingly, his gold is not in New York, it is in Tripoli, and he is actually able to use it to pay his troops. Even though he is now out of the international financial system and his paper assets have been frozen, he still enjoys some freedom with that physical gold.