March 27, 2014; James Rickards: The Death of Money

Weekly Commentary • Mar 28 2014
March 27, 2014; James Rickards: The Death of Money
David McAlvany Posted on March 28, 2014

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: Our guest today, David, is Jim Rickards. We interviewed him a couple of years ago. He had worked with military sources and Pentagon types of sources on currency wars. At the War College, where they actually run through scenarios militarily, Jim Rickards was brought in to say, “Hey, that’s not the way war is always fought. You’ve taught us this. Let’s go ahead and run a scenario.” It’s very prophetic, when you look at Russia right now.

David: Well, absolutely. In terms of real-time events, we have that in Russia, Iran, Syria, and what we’ve orchestrated as currency wars and direct frontal assaults, if you will, using financial and economic weapons. Jim has written a new book, and I have to say, this is not a casual read, but it is a must-read. The Death of Money: The Coming Collapse of the International Monetary System. It can be pre-ordered on Amazon. I say pre-ordered because it is not released yet. It will be released here in about another two weeks. So I would get in queue immediately, and go ahead and get a first print. The Death of Money: The Coming Collapse of the International Monetary System.

I think why it resonates with me right now is that one of the projects we were working on over the last several months is the short film, What Is Real Money? Trying to answer the question of how you navigate the current changes in the international monetary system. This where our heads have been. What is Real Money? Of course, you can view that on line, or request a physical copy from our office, but the parallels here, and the overlap, is fantastic.

The Death of Money, The Coming Collapse of the International Monetary System, gets to some of the objections that are raised. Why can’t you have gold in the monetary system? Well, Mr. Rickards just tears those to pieces. And you look at some of the fundamental economic assumptions that are made by Wall Street, by the news media, as to where we are and where we are going. Progress, regress, I think he does a very admirable job of laying out what the risks are that we face, and really challenging some of the key assumptions that Wall Street operates on the basis of.

Kevin: One of the things that I really like about Jim Rickards is that he is saying, “Look, this is not the end of the world. This has happened before. But you have to be prepared for it, or it is the end of the world for at least your portfolio.” You had mentioned the video that is coming here in hard copy now, Dave, we can send it to our clients, called What Is Real Money? Our clients just need to call 800-525-9556 to go ahead and get a copy. They can request that copy, but we would also, like you said, encourage them to go to our website on the YouTube channel, or our website, and order The Death of Money. Just click on the icon there and it will take you to Amazon. And even if you don’t plan on reading the entire book, gosh, I’d buy the book just for Chapter 7, Dave.

David: I would, Chapter 7, Chapter 9. If you want the intrigue of an Ian Fleming novel, you certainly get that in the first several chapters.

Kevin: He is an entertaining writer.

David: So without further adieu, we want to welcome James Rickards. Welcome back to the McAlvany Weekly Commentary.

Jim, the demise of the dollar, of course, the implication is that with the change in the U.S. monetary system, we have a radical shift in the global monetary system, where we remain for the time being, the world’s reserve currency. Why don’t you summarize this for us, Jim?

Jim Rickards: Sure, David. My new book, The Death of Money: The Coming Collapse of the International Monetary System, and people hear the subtitle and they say, “Wait a second, you are talking about the system, it sounds like the end of the world.” And it is a big deal, but what I tell people is, “Well, no, the international monetary system actually has collapsed three times in the past 100 years.” It collapsed in 1914, again in 1939 and most recently in 1971.  And each time it wasn’t the end of the world, it didn’t mean that we all lived in caves and ate canned goods.

What it meant is a period of economic chaos, but the major financial and trading powers get together, sit down around the table, and rewrite what they call the rules of the game. And “the rules of the game” is a very old phrase, going back to the 19th century, about how the international monetary system works. Some people call it the reset. That’s a perfectly good expression, but basically, we’ll have a new system.

So what I try to do for the reader is, first of all, explain the state of the world today and what the dynamics are, and what the risks are, and why this collapse is coming. And you can see it coming. And then, beyond that, say, well, when it comes, what will the new system look like? When China, Russia, the U.S., Germany, and other euro members sit down to rewrite the rules of the game, what does this new system look like? And if you have that information you can actually begin to position yourself today to, first of all, survive the collapse, and then, ultimately, preserve wealth in the new system. So that is actually what I am doing, but the idea that the system is going to collapse, actually, it does happen every 30-40 years.

David: You comment that, today, capital markets are directly related to strategic affairs, and you certainly began developing that idea in your 2011 published Currency Wars. You developed the idea further in The Death of Money, and that’s available in April. What is the epiphany you hope that readers will have as they read The Death of Money?

Jim: Well, I hope they understand that we are actually in a war today. It’s not a shooting war, it’s a financial war. And we’re in a couple of them, actually, one with Iran, and one that is now emerging, literally, in real time with Russia. Just to talk about the one with Iran, we haven’t fired any missiles at Iran, or invaded, nor should we, in my view, but we’ve been in a financial war with them for years. It started when the U.S. kicked Iran out of the dollar payment system. That is something we control through the Federal Reserve and through our banking system. The President has the authority to ban somebody from the dollar system, which we did. What that means is, you can ship oil, but you can’t get paid in dollars, because there is no way to transfer the dollars to you if you are not in the system.

So Iran said, “Fine, we’ll ship oil and get paid in euros.” There is a separate system in Europe, in Belgium, called SWIFT, and that is all currencies, including dollars, but also euros, and Swiss francs, and Japanese yen, and so forth. So Iran said, “We’ll ship oil and get paid in euros.” Well, the United States went to SWIFT and got our partners to kick Iran out of the SWIFT system. So now, again, Iran could ship oil, but they’d have to get paid in something like Indian rupees, in an Indian bank, a local currency, local deposit. They couldn’t get paid in any of the major reserve currencies. And then, of course, all you can do with rupees is buy stuff in India. So maybe you get a lot of curry, but there is a limit on that.

So this was having a serious impact on Iran. People in Iran started taking their money out of the bank, buying dollars on the black market so they could pay smugglers to bring goods into the country. This started a run on the bank, they had to raise interest rates to keep up the deposits in the bank, it was highly inflationary. So all of a sudden we were choking Iran financially, we caused a run on their banking system, super-high interest rates, inflation. This was moving in the direction of actually destabilizing the Iranian regime. Now, the President removed a lot of these sanctions last December when he began this dialogue, this détente, around their uranium enrichment program.

But my point is, we’ve been in a financial war with Iran for a number of years. Now, are they fighting back? Well, I point readers to what happened on August 22, 2013. The NASDAQ Stock Exchange, the second biggest stock exchange in the U.S., closed for half a day, for reasons that have never been explained. No one has ever come out and given a credible reason why that exchange failed. One certainly suspects that it could be Syrian hackers, Iranian hackers, or others who are behind it and that is the reason we are not hearing about what actually happened there. But this is the kind of tit-for-tat that has been going on.

Now, as it applies to Russia, obviously Russia just took Crimea. Left, right, center, nobody thinks that American troops should jump into Crimea and start a war there, but we immediately threatened economic sanctions, which is a form of financial warfare. But there is a big difference between confronting Russia that way and confronting Iran, which is that Russia can really fight back, and I said publicly that these economic sanctions are not going to go very far. Okay, maybe a few oligarchs won’t get to go to the Super bowl next year, but it’s not going to be much worse than that.

The reason is that if we escalate, Russia will escalate, and they have an ability to do that much greater than their military capability, and now we’re into something very analogous to the Cold War when we had enough missiles to destroy Russia, Russia had enough missiles to destroy us, but no one ever used them and nobody wanted to escalate tension between the U.S. and Russia because no matter what you did to the other guy, even if you shot your missiles first, they would always have enough missiles left over to shoot back and both sides would be destroyed. That was called Mutual Assured Destruction, MAD, or the MAD doctrine.

Well, now we’re into Mutual Assured Financial Destruction. If we escalate to Russia, they’ll escalate to us, and they have the ability to unleash their hackers and shut down the New York Stock Exchange. So, you get into these catastrophic financial warfare scenarios. Again, I don’t think the sanctions are going to go too far because the Russians will push back, but it’s a very dangerous world.

David: You have the U.S. government, you have the Treasury Department, as you say, orchestrated devaluation in Iran, David Cohen from the Treasury Department states unequivocally that our sanctions are in order to bring about a countrywide debilitating economic event, again, the devaluation you described. Now, again, Cohen is not at the Pentagon. He’s not at the CIA. We see a different picture of who is running the playbook. Then, as you mention, SWIFT, the international money wire transfer system, we’re cutting them out. Doesn’t that communicate, Jim, to a variety of countries, the need to create a way around the current system, an alternate to SWIFT. That’s, again, just one more example of the Treasury Department setting in motion a number of potentially unintended consequences. Is it a stretch to think that dollar and U.S. market marginalization are a long-term consequence?

Jim: No, I think that’s exactly what is happening, and indeed, there have been a number of public statements on this coming from the BRICs, an acronym that stands for Brazil, Russia, India, China, South Africa. There are also other members of the G20 who maybe are not in the BRICs, but they are emerging market economies, and they’ve been speaking publicly, beginning in 2009, but with greater frequency since then about the need to get out from under the dollar system, the dollar hegemony.

Now, in the short run that is easier said than done. It is actually very difficult to do because you can use anything as a trade currency. If two countries are trading, and I ship my goods to you, and you ship your goods to me, and we both agree to accept each others’ currencies in payment, and once a year we total it up, and settle it up, maybe even in dollars. That’s fine, you can use anything for a trade currency, you can use baseball cards for a trade currency. But a reserve currency is different. To have a reserve currency you have to have investable assets. It’s like your savings account. If you save money, you say, “Okay, I need to put it somewhere. I could put it in the bank, I could buy stocks, I could buy real estate.” But you need to put it somewhere.

Well, when you’re a country, and you have your savings account, which is your reserve position, you need to have investable assets, and when you are talking about trillions of dollars, which you are in the case of China and Taiwan and Japan and others, the only market in the world big enough to accept those kind of capital inflows is the U.S. treasury market, so that is the reason that the dollar has this embedded advantage as the reserve currency.

However, the U.S. has abused that privilege. We’re printing trillions of dollars, we’re trying to cheapen the dollar, and countries are getting fearful, so they’re doing a number of things. One of them is talking about creating new reserve currencies. Interestingly, the BRICs announced that they are building their own internet backbone. It will start in Brazil, cross the Atlantic Ocean, touch South Africa, cross the Indian Ocean, touch India, then go around through Sumatra and come up to China, and then move over to Vladivostok and touch Russia. So it’s going to connect the BRICs only. It’s not going to intersect with Western Europe or the United States at any point. So that’s really the backbone of their own payment system, their own internet, etc. They’ve announced their own development bank, a lot of things like that.

And by the way, Crimea just got a new currency, the ruble. There is such a thing as regional reserve currencies, you don’t have to be a global currency. You can be a currency that is only of use in a particular region, but it could be Russia and its periphery in Eastern Europe and Central Asia. And the other thing that countries are doing is buying gold. In the last five years, Russia has increased its gold reserves 70%, China has increased its gold reserves several hundred percent. No one knows the exact number because it’s a secret, but we do have enough information from Hong Kong imports and mining output and other sources to estimate that their gold is now up to maybe 3-4 thousand tons relative to the 1,000 tons that they announced in 2009. So all these pieces are falling into place. Will it happen overnight? No, that’s unlikely, but over a 2-3 year period, absolutely, you’re going to see the diminution of the dollar, unless the U.S. changes course, unless we take steps to strengthen the dollar, but the Treasury and the Fed are trying to weaken the dollar.

David: Again, to the BRICs, we have reason to believe that we will retain reserve currency status. We have seen Barry Eichengreen suggest that there is maybe a basket of currencies that could in some way replace, or displace, partially, the U.S. dollar. But we have the BRICs, which have population, output, foreign currency exchange reserves. There are some things arguing for the dollar perhaps not being able to retain that status, at all.

Jim: That’s right, and the thing is, the dollar could be the global reserve currency, indefinitely, if the U.S. respected its own currency. There is a very powerful privilege the U.S. has, but along with privileges come responsibilities, and of the responsibilities is to maintain the purchasing power of the dollar. In fact, we’ve set out to weaken the dollar beginning in 2010. That was the beginning of the currency war that I described in my last book. Now, four years down the road and after all the money printing by the Fed, and more money printing on the way, and the Fed targeting inflation, which can very quickly get out of control, I’ve gone from saying, well, we started with a currency war, but now we’re looking at the death of money, the title of my new book. We’re looking at an actual collapse scenario.

So investors need to prepare for that, and I talk about that in the book, and say, you know, you ought to have 10%, approximately, of your investable assets in gold. I don’t recommend half, I don’t recommend 100%, but at least 10%, maybe a little more if you want to get a little more aggressive on that, but if somehow the U.S. stands up and strengthens the dollar again, fine, gold might not go up that much, it might move sideways. But if these scenarios start to play out, we start to see the inflation and it runs out of control, and people lose confidence in the dollar, that collapse could happen very quickly. It might actually be too late to get your gold at that point, either because the price has skyrocketed, or you physically can’t get it. I mean, China is buying so much, other central banks are buying it: Mexico, Philippines, Kazakhstan, Vietnam, Argentina of all places. I describe them all in the book, and Russia, of course, is a big acquirer, or buyer of gold, they get it mostly from their own mines rather than importing it. But central banks, up until 2009, had been net sellers of gold. Then they stopped cold, and since then they’ve been net buyers, and their net buying is just getting larger. So if it’s good enough for China, it’s good enough for me.

David: That describes basically a personal gold standard until the rogue monetary system has sorted itself out. I think we would agree, gold serves a role as insurance, and I think the numbers you use to illustrate that as a hedge, if you had 20% gold exposure in a portfolio and calculate a 500% return, that 20% exposure insures 100% of your portfolio.

Jim: Correct.

David: And we’ve described gold as money. Maybe you can work this through with us. You’ve also described gold as money, and you still suggest, as much as 30% of your assets in cash. Maybe we can explore the asset allocation and the need for both gold and cash, and of course, we should include looking at land, managed funds, fine art, so in total, 50% of your allocations are to real stuff, but how do we square the demise of the dollar, the death of money, and still having a large exposure to cash, with that insurance offset. Help us wrap our minds around that.

Jim: The reason I have cash in my portfolio today, and that does surprise a lot of people, they say, wait a second, Jim. You’re the guy talking about the collapse of the monetary system, the demise of the dollar. Why would you want cash? The answer is, I might not want it for long, but I might want it in the short run for two reasons. Number one, and I explain this in the book, inflation is a threat and a risk and you need to be prepared for that, but so is deflation.

We’re in a very funny world where inflation and deflation are both on the radar and I compare this to a tug of war where two very powerful teams are pulling on the rope and if they are evenly matched, not much happens in the tug-of-war. If you’ve ever watched tug-of-war, not a lot happens at first, but eventually one side collapses and they get pulled over the line by the other side. Price indices, right now, are actually fairly stable. We’re not seeing a lot of inflation or deflation, but don’t mistake that apparent stability for actual stability, because beneath the surface there are very powerful deflationary forces and very powerful inflationary forces. If inflation takes off, you don’t want cash, I agree, but if deflation prevails, cash actually goes up in value. You might not get any interest on it, but the real value of money actually increases in deflation. So I like cash because it’s a good deflation hedge. If inflation takes off, you’ll have time to see that coming, and then pivot.

And the other thing about cash is, it gives you the liquidity and the ability to pivot into another asset class when we get a little more visibility. So we get down the road a little bit, we pay attention, if we see inflation taking off, we say, okay, maybe that’s the time to buy a little more gold, maybe that’s the time to buy more fine art, but at least you’ll be able to do that because you’ll have the cash, whereas if you had put all the cash into alternatives like these hedge funds, and I do like some hedge funds, not all of them, but some of them, that’s very difficult sometimes to get your money out. So if you place all your bets, you’re not going to be able to change your mind. So I like cash for two reasons: One, it’s a deflation hedge. Two, it gives you optionality to pivot into another asset class once we learn more. So, you probably don’t want cash for the long run, but in the short run it can be valuable.

David: That’s very consistent with the conversation we had with the British economist Andrew Smithers in December, looking at valuation metrics using Tobin’s Q and Shiller’s PE, he would say, “I don’t want anything but cash.” Maybe that’s a little extreme, but certainly the value there and that optionality you describe is pretty critical. The market’s appraisal today, tail risk. Tail risk depicts the probability of an event on a Bell curve, and the concerns in the financial market remain certainly fixated on deflation, with inflation being really a low, low probability outcome, and that’s if you’re talking about Wall Street’s view, the Fed, the Treasury’s view. Where would you place an inflationary outcome on the Bell curve, low or high probability?

Jim: Well, I would start out with the fact that the Bell curve is completely an incorrect way to understand the degree of distribution of events in a dynamic system. So the first thing I will say, one of the reasons that I disagree with Wall Street, the Fed and the Treasury, by the way I’ve met with all of them, I meet with Fed officials, I’ve given briefings to Senior Treasury officials behind closed doors. Obviously, I’m a portfolio manager, I’m on Wall Street, I talk to brokers and research people all the time, so I’m very familiar with their models and all I can say, I explain this in my new book, The Death of Money, and I also explain it in Currency Wars, all the models they are using are wrong, they’re just wrong.

And you say, well, gee, how could they be so wrong? But you think about the Fed, they haven’t seen the last three bubbles, the bubble, the housing bubble, the Lehman bubble, they didn’t seen any of them, they don’t see these crises coming, when they arrive they underestimate the severity of it, when they get a handle on the severity, they underestimate the duration of it, and then when the duration goes on longer, they use the wrong remedies, and you say, how could they be wrong all the time? Are they dumb? And of course, they’re not dumb. They’re smarter than I am, they have like 170 IQs, but they have the wrong models, and if you have the wrong model, you’re going to get the wrong result every time.

And that’s the problem with Wall Street, that’s the problem with the regulators in the Fed and the Treasury. They have models that do not reflect reality. Now, what does reflect reality? It’s not the bell curve, it’s the power curve. The power curve is a different degree distribution and when people talk about the fat tail, or tail event, I call that pinning the tail on the bell curve, you know like pin the tail on the donkey. If you have to take a curve and reshape it to account for events, it’s not the right curve. The thing about the power curve is that the extreme events occur with greater frequency than the bell curve would predict.

The power curve actually does correspond to reality because these things, the bell curve says six standard deviations should only happen once every 10,000 years, 13 standard deviations should only happen once since like the beginning of time, but in fact, these bad events happen every 5, 6, 7 years. So that tells you the bell curve is not the right way to understand the data and the degree distribution. But the power curve fits perfectly. You don’t need to stick a fat tail on it because the tail is off the X axis to begin with.

So that’s the first thing. You’ve got to get the model right and you’ve got to get the degree of distribution right. But having said that, one of the things you get out of power law analysis and critical state dynamics is that the worst thing that can happen is an exponential function of scale, scale meaning the size of the system. So let’s say I triple my derivatives book, I triple all the derivatives in the system, which we’ve done, by the way. Derivatives are now over 100% of global GDP, approaching 100 trillion dollars.

So I triple the size of the system. How much did the risk go up? Well, if you go to Jamie Dimon and Matt Zames, the guys at J.P. Morgan, they’ll say it didn’t go up at all, or barely at all, because it’s long, short, long, short, long short, you’ve got both sides of the book, and the gross risk, if you net it down, is a tiny little number. There’s not much risk at all. Well, that’s completely wrong, because the risk is not in the net, it’s in the gross. The risk is only in the net when everything’s fine, when you don’t have to worry about risk. If someone defaults to you, they don’t default on your net exposure, they default on their gross exposure, to you, and so the risk is in the gross, not the net. That’s the first place that Wall Street is wrong.

So then you go to sort of the person walking down the street, common sense, and say, “Hey, if I triple the system, how much did the risk go up?” Well, intuition might say, well, it tripled, three times the system means three times the risk, a linear function. That’s also incorrect. The correct answer is that it’s an exponential function. If you increase the scale three times you’ve increased the risk by a factor of 10, or 100, or 1,000, by some exponential function, and that’s what we’ve done, and that’s why the next collapse, I’m a big student of history, and I love history as a teacher, but the next collapse is actually outside of history because the scale of the system is unprecedented, which means the collapse will be unprecedented. It will be bigger than the Fed.

David: That brings up to last week’s bank stress test. We completed them, 29 out of 30 passed with flying colors. Fill out the real picture there. You’ve got leverage via derivatives exposure, which is allowing for capital ratios to look cleaner than reality. Let’s do a James Rickards stress test. Would the banks pass your stress test?

Jim: No, the stress tests the Treasury is doing are a joke. They are done for propaganda reasons to kind of reassure people and build confidence and get people putting their money in the banks, and so forth, but a stress test is only as good as the assumptions and only as good as the model behind the test. And so you do two things. First of all, they use these value-at-risk models, which for the reasons we just went through, they use a bell curve, or normal distribution, and that doesn’t correspond to reality if it’s pseudo-reality, so you can throw that out, but beyond that, they say, “Okay, we’re not done, we know that the value-at-risk model has the floor so we’re going to do a stress test.”

And what do they do? They pick a certain event. They’ll take the 2008 crisis, they’ll take 9/11, they’ll take the Long Term Capital Management Crisis of 1998, they’ll take the stock market down 23% one day on October 19, 1987. They’ll take those extreme events and say to the banks, “How would your book of business perform if this happened? And we’re going to be really severe, we’re going to add 20%. And then they see what the answer is.” Well that’s flawed, and here’s why. Every one of those examples I gave you is an historical example, and even if you put some top-spin on it, it’s top-spin on an historical case. But I just explained how in a dynamic system, with power law degree distribution, you are outside of history. If you make the system bigger than it’s ever been before, the worst thing that can happen is not anything you’ve ever seen before. It’s something you can’t even imagine. It’s beyond experience. It’s outside of history. So that’s why stress tests are junk.

David: 100 trillion was where we started, year 2000, 2001, in terms of gross derivative exposure, and I think at one point it exceeded 1 quadrillion, maybe slightly less than that today. This is what you’re saying, is that it’s outside of history, the gross numbers and the risk associated with it can’t be accounted for on any historical metric.

Jim: Correct.

David: Well, you know, we reflect on price signals and sort of market efficiency. We look at the stock market being near all-time highs, and certainly the cheerleaders are out in full force. Can we trust what the market is telling us?

Jim: No. And the reason is the following. I’m a big believer in price signals. In fact, the first two chapters of The Death of Money actually involve a CIA project where the CIA, and I was a co-director of this project, was trying to use market signals to identify the next 9/11 type attack. And there was insider trading ahead of 9/11. I document that in the book, and it’s not one of these crazy conspiracies, the U.S. government did 9/11, that’s garbage, I don’t believe that at all. But insider trading started with terrorist associates. You know, terrorists don’t exist in a vacuum. Everyone has a mother, father, sister, brother, safe house operator, driver, cook, whatever, but there is somebody in the terrorist social network who knows about the attack and can’t resist the temptation to bet on a sure thing. So that was how the insider trading started. But that whole project was about taking market signals, so I’m a big believer in free markets, I’m a big believer in the fact that markets give you valuable information that you can use to make smart investment decisions and allocate assets.

But here’s the problem. We don’t have free markets any more. All the markets are manipulated. So therefore, all the data that comes out of them, these are not pure market signals, this is just a kind of propaganda coming out of a manipulated market. Starting with the Fed, because markets around the world, by and large, are dollar-based. I understand there are other markets in Japan and the euro, but everything in the world tees off the dollar and the U.S. government bond market. When you manipulate U.S. dollar interest rates, you are directly or indirectly manipulating every market in the world.

And it’s worse than that, because you start out with one degree of manipulation, but guess what? Then the Fed actually takes market information to make their next decision, but the market information they’re getting, is itself, distorted by the prior manipulation, so it’s really drinking your own Kool-Aid, it’s a recursive function or feedback loop where first I make a decision, I manipulate markets, then I look at market data to make my next decision, but that data is distorted, I do another manipulation, it just gets worse and worse and you wonder why you can’t get out of it.

So the Fed is looking in a mirror. They think they’re looking out a window, and they’re actually looking in a mirror. I explain how this works in the book, but things are so far gone now that there is no end to it. They just have to do manipulation on top of manipulation. So I am a believer in free markets, and I do believe in the value of market signals, but when the markets are this badly manipulated, the signals are misleading you and it’s the blind leading the blind.

David: My favorite chapter was number 7. You explained nominal growth via inflation, combined with controlled interest rates, giving you the equivalent of higher real growth, but without an economy which is necessarily improving. It seems like magic and showmanship from the Fed. Maybe you could comment on that.

Jim: I am so happy to hear you say you like Chapter 7, because I think that is the most challenging chapter. I wouldn’t have difficulty believing that people found Chapter 1 intriguing, or Chapter 2 kind of interesting, or Chapter 9 is about gold. They are likely to be popular. But I thought Chapter 7 was a little technical, and I said, “Boy, I hope the reader can power through that,” so I’m glad you enjoyed it. But yet, the bottom line there is, everybody in Washington is walking around congratulating themselves, patting themselves on the back, because the deficit has been cut in half in the last three years. Well, it actually has been cut in half, it has dropped from about 1.4 trillion dollars to about 700 billion dollars, so they have cut the deficit in half.

But guess what? The debt-to-GDP ratio, which is a separate equation, is still going up. In other words, even when you cut the deficit from 10% of GDP to 4% of GDP, you are still adding 4% of GDP, and if the economy is only growing at 2%, then the amount of debt you’re adding on relative to total GDP is increasing the debt-to-GDP ratio, which means you’re still on the road to Greece. You’re on the road to becoming Greece, where your debt burden is non-sustainable because you can’t grow the economy fast enough to pay the interest to roll over the debt to keep the whole game going, and then eventually the bond market pukes and interest rates skyrocket and your economy collapses, and you end up like Greece, except the U.S. and others who are bailing out Greece – who’s going to bail out the U.S.?

The answer is, nobody, except the IMF, and they’re going to have to print SDRs to do it, and that will be the end of the dollar. So that’s how that all connects. But the basic point of Chapter 7 is that I give these formulas, and they are very simple formulas. This is not calculus or anything overly demanding, but it is accurate. I didn’t dumb it down, but I do state it in very simple language. I give the formulas for determining whether debt is sustainable or non-sustainable.

I don’t say we should never have a deficit. I don’t say that all debt is bad. What I say is that some deficits can be okay, and some debt can be okay, if you put the money to good use and if it is sustainable, and I explain how to determine that mathematically, and what I see is that we’re still on the path to a non-sustainable debt. We’re still on the path to Greece. And so I’m not comforted by the fact that the deficit has come down because our economic growth is so weak that the deficit relative to growth is still too high.

David: In Chapter 9 you spend a good deal of time discussing gold. One of the key observations you make is that gold is a constant, real money. You quote J.P. Morgan: “Gold is money, nothing else.” It’s more accurate, therefore, to see the fluctuation in value in other assets, or various fiat currencies, where they are taking more or less gold in exchange for those assets. That really defines, or redefines, perception of gold volatility. Maybe you can help our listeners understand that. We certainly don’t have that as a normal frame of reference for gold, but perhaps it’s the more healthy one.

Jim: Well, that’s right. It’s really a question of what is your yardstick. How do you measure something? So, if I ask you to measure a football field and I give you a yardstick, you’re going to go out and say, “Hey, it’s a hundred yards.” But if I give you a 1-foot ruler, you’re going to say, “Well, it’s 300 feet.” In other words, how we measure things affects how we talk about them, how we understand them. Now, the world measures everything in dollars, and they treat gold as a commodity, and they say gold went up 1%, $13 an ounce. Or it went down 2%, $26 an ounce. We’re always talking about gold measured in dollars, and I say let’s turn that around, let’s talk about dollars measured in gold. Let’s treat gold as our yardstick, as our unit of measurement, hold it constant, and then ask ourselves what is happening to the dollar relative to gold.

And then you start to see the world differently, because when people say gold went up, I actually don’t think that gold went up, I think the dollar went down, because it takes more dollars to buy an ounce of gold. Or if people say gold went down, I say, well, no, gold is constant. What happened was that the dollar went up, because it takes fewer dollars to buy an ounce of gold. And this is the way to kind of come up with a unified understanding of all currencies, really treating that gold is a form of money rather than a commodity because there are certain days when gold went up in dollars, but it went down in yen, because those are two different currencies, it just means that the yen went down more relative to the dollar, than the dollar went up compared to gold. So, gee, did gold go up or down? It’s up in dollars, down in yen, so did gold go up or down?

And I explain to the reader that what you can do is, if you hold gold constant, you can see that what actually happened is the currencies were bouncing around, and gold is your yardstick. So, I think gold is money, I think that is my constant, and again, when I hear that gold went up, I just think to myself, the dollar went down. So, if you start to see gold going to $2,000, and then $3,000, and then $4,000 an ounce, which I do expect, a lot of gold investors are going to be congratulating themselves, saying, “Gee, I was so smart, my gold is really going up.” I have gold, I’m just going to shake my head and say no, what’s happening is, the dollar is collapsing.”

David: Yeah, and this brings us to one last point as we wrap up. Warren Buffet is notoriously anti-gold, but maybe he is just neutral, but Munger is certainly more anti, and yet, he moves to hard assets. He has this theme of “I’m investing in America.” And when he bought a railroad here recently, I sort of pictured the pragmatism of a World War II bombardier, hoping for the day’s success, but he’s still sitting on top of his helmet. There’s still a cautionary tale in there. What does that mean for him to buy a hard asset, and still be sort of anti-gold. Certainly his father was a gold bug, he just didn’t inherit it.

Jim: Warren Buffet never has a good word to say about gold, and maybe if I had 80 billion dollars in stocks I wouldn’t either because it would cost Warren Buffet 10 billion dollars to say something good about gold because everyone would run out and buy gold and sell their stocks, so there are probably good, practical reasons why he doesn’t do it. But I always say when it comes to multi-billionaires, watch what they do, not what they say. And what Warren Buffet did a couple of years ago, he went out and bought the Burlington Northern Santa Fe Railroad. And he didn’t just buy stock, he bought the whole thing, and took it private.

So he has no more exchange risk, because you could close the New York Stock Exchange tomorrow and as we said, maybe Putin’s hackers will, it won’t affect his holding. He owns this whole railroad. He’s not looking for liquidity, he wants the asset. Well, what is a railroad? A railroad is nothing but hard assets. It’s track, right of way, mining rights adjacent to the right of way, switches, yards, signals, rolling stock, it’s all hard assets. How does a railroad make money? It moves other hard assets as freight: Corn, wheat, coal, steel, oil, whatever. A railroad is a bundle of hard assets that makes money moving other hard assets around. So it’s the ultimate hard asset play.

So when I saw Warren Buffet buy the railroad, I didn’t think, “Oh gee, Warren Buffet likes transportation stocks.” I thought, “Warren Buffet is dumping paper money and buying hard assets.” And maybe we can’t afford to go out and buy a railroad, but we can buy gold, and that’s our sort of railroad, that’s our hard asset.

I actually was able to get this insight from studying the hyperinflation of the Weimar Republic in Germany in 1922, and everyone has focused on the losers. Who were the losers? Well, the middle class. Anybody with savings, retirement income, pensions, annuities, insurance policies, fixed incomes. These were the losers. But there were a lot of winners. Who were the winners? Winners were people who had factories. If you have a factory and you own it, who cares what the currency is? The currency could go to a gazillion-to-1, which it did, but a factory is still a factory. Or if you had gold, it still had value. So there were a lot of winners in that crisis, and those winners went around and bought up the losers, and this created a German industrial class that ultimately backed Adolph Hitler.

But, Warren Buffet is preparing for that day, and it wasn’t just the railroad he bought, he also bought a very large amount of oil, I think tar sands up in Canada recently, and of course he’ll move some of that oil on his own railroad. So Warren Buffet is doing everything possible to dump paper money and buy hard assets in energy and transportation, and if it’s good enough for Warren Buffet, it’s good enough for me, so if I buy hard assets in the form of gold and fine art, it’s the same thing, and any of your listeners can do that, as well.

David: We have so much more to talk about and we’ve simply run out of time, so to continue the conversation, I would say, go to Amazon, request the book, it will be on pre-order for the next several weeks. The Death of Money: The Coming Collapse of the International Monetary System. If you haven’t read currency wars, that is certainly one to get around to. Don’t neglect it, it should be in the library, but The Death of Money, I think, is absolutely critical for many of the issues that we have covered today, and again, would like to cover, but have run out of time for.

We appreciate your time, your contribution, both of these books. I’m sure this will also be a bestseller, and we wish you well. Thank you for your contribution to the conversation today.

Jim: Thank you, David.

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