THE GOLD CHRONICLES
with James Rickards and Alex Stanczyk
Power Triad Dynamics, USA, China, Russia
Why China is concerned about a Trump Presidency
Capital flows out of China continue at a robust pace
China will burn through all of its liquid reserves in one year at the current pace
Analysis of China’s three options
Which conditions could place the USA and China in a state of war over the South China Sea
Why gold moving into China is like going into a “Black Hole”
Physical gold flows from west to east are exacerbating tightness in physical supply, and could lead to strong price moves when the west steps back into the market
War on Cash and its impact on global systemic risk
India demonitization has been a disaster
End game plan for War on Cash is to force people into digital accounts
Solution to avoiding an all digital system is to get out of it, gold or silver
Breakdown of the SDR as sovereign money versus money for people
IMF permission requirements from countries to print SDR’s
Jon: Hello. I’m Jon Ward on behalf of Physical Gold Fund. We’re delighted to welcome you to the latest webinar with Jim Rickards and Alex Stanczyk in the series we’re calling The Gold Chronicles.
Jim Rickards is a New York Times bestselling author, the Chief Global Strategist for West Shore Funds, and the former general counsel of Long-Term Capital Management. He is currently a consultant to the US Intelligence Community and to the Department of Defense. Jim is also an advisory board member of Physical Gold Fund.
Hello, Jim, and welcome.
Jim: Good morning, Jon. How are you?
Jon: Great, thank you.
Jon: We also have with us Alex Stanczyk, Managing Director of Physical Gold Fund. Alex is an expert in the physical gold industry dealing with the logistics chain from refinery to secure transport and vaulting. He has lectured globally to investor, institutional, and government audiences on the role of gold both in the international monetary system and in investment portfolios.
Alex: Hi, Jon. It’s great to be here.
Jon: Alex will be joining me in the conversation with Jim, and he’ll be looking out for questions that come from you, our listeners. Let me say that your questions today are more than welcome. You may post them at any point during the interview, and as time allows, we’ll do our best to respond to you.
Jim, let’s start with a global question. You’re just back from a trip to China at a time when military tensions are rising in the South China Sea, and you’ve returned to find Washington and the media consumed with the question of Russia.
Stepping back from political dramas, would you summarize your current perspective on the triad of world powers: Russia, China, and the United States? How do you expect the balance of power between these three to shift in the coming years, and what impacts do you anticipate on world markets and the monetary system?
Jim: That is a huge question, Jon. It’ll give us a lot to talk about and chew on. The key phrase you used was ‘the balance of power,’ and you correctly identified the three most important players: China, the U.S., and Russia. There’s a lot there with the impact on markets, so let me unpack this for our listeners.
The starting place is the idea that there are only really three countries in the world of primary importance: the U.S., Russia, and China. The U.S. and China is easy for most people since they’re the first and second largest economies in the world.
You can debate what order they come in, but I use nominal GDP, which would put the U.S. first. Some analysts use what’s called purchasing power parity GDP, meaning adjusted for what you can actually buy with the money, which would put China first.
But that’s an academic debate; it doesn’t matter really. They’re the first and second largest economies in the world and the second largest bilateral trading relationship in the world, so clearly, they’re paramount.
Russia is a more interesting case as the 12th largest economy in the world. It’s not in the top two or three, but it is the largest landmass in the world, it is a nuclear power, it is the second largest energy producer in the world, and it is in effect an imperial power. So, by all measures, I would include Russia in the big three. Everyone else is either a secondary power, a tertiary power, an ally, or a proxy. They tag along with one of the big guys, but these are the three that really count.
I suppose a lot of our listeners may have played the Parker Brothers’ board game of Risk. If you know how Risk is played, it’s a geopolitical strategy game. You usually start with five or six players, but within a short period of time, you’re down to three. Two of those players – either explicitly or implicitly – realize that if they make an alliance and systematically crush the third player, that player will be wiped from the board, and then those two will turn on each other to win the game. It’s advantageous to go two against one at least in the short run. That’s a typical balance-of-power play.
For the last seven or eight years, certainly most of the Obama administration, the two-against-one dynamic has applied. From Washington’s perspective, it was China and the U.S. ganging up on Russia. Russia was sanctioned because of Crimea, the Ukraine, and their electoral practices.
Obama more or less said Putin had to go because he was on the wrong side of history. Trump has this reputation as a guy who insults people, but if you look at what Obama has said about Putin, it’s some of the most insulting language I’ve heard between two major heads of state. Putin returned the favor in the last election by the hacks, the releases, and all that stuff, which we don’t need to go into.
It’s ostensibly been China and the U.S. ganging up on Russia, but there was a major failure of U.S. foreign policy sort of behind the scenes. In actuality, the dynamic was Russia and China ganging up on the United States.
One of the keys to U.S. foreign policy the last 50 or 60 years has been to make sure that Russia and China never form an alliance. Keeping them separated was key, but China and Russia have been deepening their alliance through the Shanghai Cooperation Organization – a military and economic treaty – and the BRICS institutions. The BRICS analogs to the IMF and the World Bank, critical infrastructure, bilateral trade deals, bilateral currency swaps, arms sales, etc.
There’s a long list of initiatives where Russia and China have really deepened their relationship. Who’s on the losing end of that? Obviously, the United States. The United States has withdrawn from the Middle East while Russia has stepped in on Syria and elsewhere, China is expanding in the South China Sea, and Russia is expanding on its periphery. They have each other’s back, and it starts to look like the U.S. is the odd man out in the game of Risk.
That is all about to change, and it will change at noon on Friday when Donald Trump is sworn in as the 45th president of the United States. He’s made it crystal clear that the new game is going to be Russia and the United States allying against China. Suddenly, China is the odd man out.
It’s ironic to see President Xi of China in Davos this morning giving a speech about globalization, but meanwhile, behind the scenes, there are all kinds of linkages going on between Russia and the U.S.
This has huge implications for markets. For one thing, the U.S. and Russia are the first and second largest energy producers in the world. Trump will also pivot away from Iran towards Saudi Arabia. Saudi Arabia is the third largest energy producer in the world. If you put the U.S., Russia, and Saudi Arabia in a loose alliance, they dominate the energy markets. They can cut you off, they can supply, they can make the price whatever they want.
Who needs energy the most? China. China has very little oil or natural gas. It does have coal, but if you’ve been to Beijing lately, you know it looks black at noon because the air is so bad and you can’t breathe it. Pulmonary disease is getting pretty common, so China can’t rely on coal beyond a certain point. They’re literally choking themselves to death with the pollution and air quality. So, Russia, the U.S., and Saudi Arabia acting jointly have China completely at their mercy.
Now, let’s bring it to the confrontation between Donald Trump and China, because perhaps that’s the particular consequence of this realignment I’ve described. Trump is the “art of the deal.”
You mentioned I just returned from my trip to China, and I do want to talk about that a little bit. It was a fascinating trip. One of the people I met with was a government official from one of the provinces near Nanjing. I got an email from that person last night saying, “Jim, what’s going on with Trump? You’re an American observer, we don’t understand.”
I heard this repeatedly in China from the elites, so these were top economists, institutional investors, government officials, not the everyday Chinese although I did speak to people on the street.
I was walking down The Bund in Shanghai. When people see you’re an American, they’ll just come up to you. They’re Chinese people who want to practice their English because they’ve been taking English lessons. They don’t have the opportunity to travel abroad, so they love talking to people just to practice English. It was great for me, because I had the opportunity to talk to students, drivers, and everyday people in addition to the elite.
There were two things I heard everyone: 1) they are scared to death of Trump because they don’t get it, they’re worried about what he’s going to do, they don’t understand him; 2) they’re all getting their money out of China as fast as they can. Everybody from major institutions to everyday citizens are getting their money out.
As a quick anecdote, I was speaking in Shanghai to an economic conference group of 40 comprised of the chief China economists of the major banks and brokers including Chinese officers of U.S. Banks, so J.P. Morgan, Citi, and some others. That was the core group, and then they had a conference for about 400 institutional investors and others. Top economists and institutions were my audience, and I was invited as one of the keynote speakers. I have a standard speaker’s fee, and they paid me by wired money from a trading company in Hong Kong!
It’s very clear that even the oldest money is trying to get out of China. China is trying to stop it with capital controls, but everybody is doing all these workarounds. They’re using offshore affiliates, invoicing tricks, and underpricing exports, so they can keep the money offshore. They’re doing whatever they can to get money out of China.
China has a really serious problem. They’re literally bleeding reserves. They’re down over $1 trillion, and it’s going out at a rate of about $80 to $100 billion a month. They’re going to be broke by the end of 2017.
The only point of telling this story is to show that I’ve seen it first-hand in terms of my dealings with people there. The two things I heard were: they don’t get Trump – they’re scared to death – and they’re getting their money out. There’s a lot of stress in China.
Coming back to this email sent to me by my friend who is a government official. I think it was in the Wall Street Journal this morning that hundreds or perhaps thousands of these emails are going out. Basically, the Chinese government has activated their network of government officials, Communist Party officials, saying, “If you know anybody in America who knows anything about Trump, ask them what’s going on.” Because as I said, they’re just baffled at this point.
That’s not surprising because I think even Americans are confused. If the American media can’t figure out Trump, it’s not fair to expect Chinese experts to understand it. I viewed the email I received as a tiny little sliver, my first-hand intersection with a much broader effort on the part of the Chinese to figure Trump out.
I think we can figure out Trump. The key to Trump is that what you see is what you get. I heard a lot of people say, “Oh, he talks tough on trade and currency and all that, but when he gets into office, cooler heads with prevail. He’ll tone it down a little bit.”
No. That’s wishful thinking. Trump can be confusing as he does contradict himself and sometimes you don’t know exactly where he’s coming from, but there’s an amazing consistency in his closest advisors.
People like Peter Navarro, Dan DiMicco, and Robert Lighthizer are some of the key advisors on trade and finance. They’re all hard-shell opponents of absolute free trade, because there really isn’t any free trade. It’s all rigged; it’s just a question of who’s doing the rigging, who wins, and who loses. They understand that, so they’re going to take a very hard line on this.
Here’s the crack-up that I see coming. On the one hand, China is losing reserves at an enormous rate. This is what I call the three-two-one problem, which is that they’ve got $3 trillion of reserves left. Of the $3 trillion, $2 trillion are earmarked and about $1 trillion of that is illiquid, because they’ve invested in hedge funds, private equity funds, and gold mines in Zambia. It’s worth something, but it’s not liquid because they can’t get the money, at least not very easily. Good luck trying to get your money back from Henry Kravis if you invest in one of his private equity funds.
Another $1 trillion must be kept in a precautionary reserve to bail out the banking system since it is completely shot through with bad loans and is technically insolvent. They won’t have to bail it out tomorrow, but they’re going to have to bail it out sooner than later.
They have $3 trillion in reserves left. $1 trillion is illiquid and $1 trillion is earmarked to bail out the banking system. That only leaves $1 trillion of liquid reserves to prop up the currency, which they have been doing, but it’s costing them about $80 billion a month to do that.
That means they’re going to be broke in a year. If this continues, within one year, China will have no liquid reserves. Zero. They’ll be broke as far as their international payments obligations are concerned.
Clearly, they’re not going to allow that to happen. They can do the math as easily as I can, so they’re going to have to do something, but what are they going to do? There are only three choices, and this is what the great Robert Mundell, Nobel Prize-winning economist in the early ’60s, called the Impossible Trinity.
There are only three things you can do when you’re in this situation: 1) you can raise interest rates to make your currency more attractive so maybe some money comes in; 2) you can slap on capital controls so it’s not allowed to go out. It’s like a roach motel – it can come in but it can’t go out, or; 3) you can devalue the currency so you may still be losing it but at a slower pace. If you devalue enough, you’ll actually be attractive and people will want to put money in because the prices just got cheaper measured in, let’s say, U.S. dollars.
Let’s take those one at a time. Can China raise interest rates? No, that’s off the table because their companies are going bankrupt, they’re flooded with bad debts, their economy is slowing, and their exports are slowing. Raising interest rates will sink the economy, maybe throw it into a recession, cause massive bankruptcies in state-owned enterprises, and accelerate this economic slowdown. The job-creating machine is going to slow down, which throws into question the legitimacy of the Communist Party.
The Communist Party is illegitimate to begin with, but they gained at least some support by creating jobs. The Chinese are very volatile, so if the jobs machine slows down, they’ll riot, they’ll burn down banks, they’ll burn down real estate offices.
Look at Tiananmen Square. Although it turned into being about democracy and free speech, it started as an anti-inflation protest and then spun out of control. That’s the history of China, so they’re not going to raise interest rates.
Would they close the capital account? They’re trying to do that but not very effectively. I just gave an example of getting paid through a trading company in Hong Kong. That payment went out, so they didn’t close that part of the capital account!
On a more serious note, they’re not really doing what they need to do to close the capital account. They can’t because of having gone pretty far down the road to an open economy. There are tens of billions – if not more – of legitimate payments that have to be made every day for suppliers, vendors, foreign investments, and other transactions. They can’t shut down the whole thing, and if they just want to shut down part, that doesn’t really work because people are very creative and will figure out the workaround.
Also, the IMF doesn’t like it. Remember on October 1st, 2016, just a few months ago, the IMF included the Chinese yuan in the SDR saying it’s a global reserve currency. As we said on prior calls, it’s not really a global reserve currency but they’re pretending it is, and they have the IMF Good Housekeeping seal of approval.
One of the IMF conditions is that you must have an open capital account, so China is not going to close the capital account in reality, because they’ll anger the IMF and breach that deal. As I said, they’re trying but not very effectively, and that’s not really going to get them where they need to be.
If interest rate hikes are off the table and if they can’t close the capital account effectively, what’s left? Devaluation. Trump is screaming about devaluation. He says the Chinese are keeping the yuan too cheap. Well, they might be about to do a maxi devaluation, take it really down. So then, what is the rest of Trump’s wish list?
He wants help on North Korea because of the North Korean nuclear program. The North Koreans are getting closer to miniaturizing their nuclear devices. You have to make it small to fit it on a warhead, and they’re getting closer to being able to do that; they’re perfecting their ICBM (intercontinental ballistic missile) technology. Again, they’re not there, but they’re trying really hard and making progress. They’re getting closer to the point where they can nuke Seattle.
The U.S. is not going to let that happen, which means we might have to bomb North Korea to shut down the program. Who has more influence over North Korea than China? The answer is nobody, so Trump is saying to China, “Help us out with North Korea,” but China can’t do it.
The reason is, if China gets aggressive with North Korea, North Korea will open the border and let a million starving North Korean refugees flood into Manchuria, which is also destabilizing to the Communist Party. So, they can’t help there.
What else does Trump want? Trump is trying to use Taiwan and the “One China” policy as a trump card – no pun intended – but he’s playing with fire talking about revisiting the “One China” policy.
The first thing you learn in China is that Taiwan is non-negotiable. They consider Taiwan as much a part of China as we consider California part of the United States. Californians may have different political views, but no one thinks they’re not part of the United States. Calling for Taiwan independence would be like China saying, “We think California should be independent of the United States,” so that’s a non-starter.
The third area is the South China Sea. Rex Tillerson, the designated Secretary of State, talked in his confirmation hearing about these Chinese artificial islands being constructed, saying they should be denied access to those islands.
I don’t necessarily disagree, but the time to say that was five years ago, not now. They’ve built up those islands, are putting down landing strips and military bases, and are surrounding them with Chinese warships.
The U.S. has the power to stop that, but you’re talking about a blockade of some sort, which is an act of war. The Chinese said, “Don’t go there, because that will put us in a state of war.” Do you want a shooting war with China? That’s kind of scary, but the point is that’s where it’s heading, and the Chinese can’t back off without losing face.
The South China Sea is also existential. The reason they’re taking it over is not for oil, although there is some oil there, but it’s for protein. They want the fish to feed their people. It’s one of the largest fishing areas in the world, and they don’t want the Filipinos and Vietnamese and others depleting the protein.
So, Trump is looking for help on North Korea, Taiwan, South China Sea, and currency manipulation, but China can’t help with any of them because they’re just stuck. They have other issues, namely their own survival, yet Trump is not backing off. Maybe I could explain it to Trump just the way I explained it to our listeners, but I don’t know that it would change anybody’s mind.
We’re looking at a major confrontation between China and the United States. It’s going to play out in currency wars, trade wars, and maybe a shooting war the way things are going, either with North Korea or with China.
What does that do for gold? All these geopolitical vectors are extremely good for gold. It could slow down the economic growth and we could see the dollar get a lot stronger, which is a headwind for gold, but remember, there are two things that drive gold: one is a weaker dollar, and the other is geopolitical issues that cause a flight to quality.
By the way, Trump came out Friday in an interview in the Wall Street Journal and said the dollar is too strong. Anthony Scaramucci, one of his main economic spokesmen at Davos, said the same thing: the dollar is too strong.
With Trump and one of his major spokesmen saying the dollar is too strong, it means they want a weaker dollar. What does a weaker dollar mean for gold? It means higher dollar gold prices.
Even though China may be devaluing, and that’s going to cause a confrontation with Trump, Trump is telling Europe, Japan, and China (even if China doesn’t respond) that we need a weaker dollar.
We have two major tailwinds for gold – a weaker dollar coming and geopolitical risk escalating – all in the larger context of this alliance between Russia and the United States against China. This is going to get very ugly, very fast.
When I returned from China, I went to Washington and met with a bunch of top national security people at a private dinner in Georgetown on Thursday night. This is escalating and spinning out of control. I’ll give you two quick points, because I can talk technicals all day, but a lot of times, human reaction is the most valuable to me and where I learn things.
When I gave my presentation in China, we had a translator. I was speaking in English and most of the audience was listening in Chinese. As we sat down, one Citibank economist from England shook my hand and said, “Great presentation, Jim, but you are a Chinese translator’s nightmare because you speak too fast,” which is probably true. So, who knows what they were hearing.
I had about 20 slides, and my second-to-last slide was my model portfolio indicating 10% gold as my standard recommendation. When I put that slide up, about 50 people in the room jumped out of their seats, whipped out their iPhones, and took pictures of the slide. They didn’t have a handout or a copy, but they were like, “I want a picture of that, because I want to in effect write it down and see what’s going on.”
I hear a lot of positive things about gold and learned some very interesting things from them. There were four of us at the table, but I met with three of the most powerful Chinese gold dealers. I can’t mention specific names of their banks, but two people were from one of the largest banks in China and one person was from one of the other largest banks in China. They are the head of precious metals for those banks, so these are the people who move the gold in China.
The first thing they told me is don’t believe what you hear about Chinese purchases falling down. The said it’s as busy as ever with the Chinese buying gold as fast as they can. They said, “What you read in the press is not true. We’re bringing it in as fast as we can.”
I heard from a top logistics person and other people that the People’s Liberation Army moves the gold in armored car caravans. Alex is going to jump in here in a minute, but Alex and I have been to Switzerland where they’re sending the gold to China, so we have pretty good information there, but I’ve just been in China on the receiving end and talked to the top people there.
I asked, “Why is it that the army and the paramilitaries always move the gold? Why can’t you move it yourself?” And they said, “We’re not allowed to have guns.” It’s an obvious thing when they say it, but it really struck me. I was like, “Yes, you’re right, you’re not allowed to have guns.”
What good is a bank armored car if you can’t have armed guards? So, one reason they use the military to move gold around is because the banks can’t have their own armored car services with armed guards. They just can’t have guns.
The way it works is that a plane will leave Zurich, Switzerland – it could be any cargo carrier, Chinese airline, Swiss airline, whatever – with a Brink’s consignment on board from Argor or PAMP or one of the big Swiss refiners. That plane lands in Shanghai, but when the gold comes off, Brink’s is done with it. There’s no Brink’s in China because of what I just mentioned, which is that they can’t carry guns, so it goes into either a paramilitary or a military convoy, and then it goes to the vault. I thought that was interesting.
I learned something else. I said, “Okay, I have a pretty good handle on Chinese gold purchases. I know from geological surveys what their mining output is and I think I know how much gold is going to China. What I don’t know about is Shanghai Gold Exchange’s sales which are pretty transparent. How much of that is private versus how much is the government?” I was guessing 50-50, 70-30, whatever. What they told me – and these guys are the dealers – is that it’s 100% private. The government operates through completely separate channels.
The government does not operate through the Shanghai Gold Exchange. When they want gold, they order it themselves, bring it in through their agents, take it themselves, and vault it. None of what’s going out of Shanghai Gold Exchange is going to the People’s Bank of China or the State Administration of Foreign Exchange. They have their own channels.
That hit me right between the eyes, because it means they have more gold than I realized. I know China is getting gold as I’ve heard from other sources, but if that’s not coming from the Shanghai Gold Exchange, it’s coming straight in through government channels and all the Shanghai Gold Exchange is private consumption, then China is basically hoovering up all the gold they can get their hands on. This is completely consistent with what we’ve heard in Switzerland and what I heard from other sources in Shanghai.
I just shake my head. Why institutions think they don’t need physical gold or they shouldn’t be getting it now while they still can is surprising to me, because the shortages are going to get worse and worse.
I don’t care what the COMEX or ETFs are doing. That’s the paper gold market. I understand it sets the price, and the price is the price. We’re getting closer and closer to the point where physical gold shortages are going to cause a crack-up. There are going to start to be failures to deliver around the system, and once that gets out – which it will – look for a super spike in the price of gold.
It was an extremely interesting trip. I met a lot of great people along the way and had great conversations, but there is enormous angst about Trump. I said, “There’s good reason for that, because he means what he says.” I’m looking at trade war, a currency war, geopolitical instability. Trump’s not inclined to back off, the Chinese are confused, they’re buying gold hand over fist, and Trump’s pledge the other day that the dollar is too strong says one thing.
That’s one reason gold is going up. It rallied very strongly today. I was writing a column this morning and said, “Gold made it to $1206,” then I looked at my screen and it was $1216. It went up $10 an ounce in the time I was writing the article, so that’s what’s going on out in the real world.
I’ll stop there, Jon. I know Alex has some commentary and we want questions from listeners, but it was a fascinating trip. There are huge geopolitical plays going on. None of the news is good. I think I got the forecast accurate, but unfortunately, it’s not a very pleasant scenario. It’s all going to start to play out at noon on Friday when President Trump is sworn in. I would say fasten your seatbelts.
Alex: I’m going to continue this conversation in regards to the gold market. Something you said just a few minutes ago, Jim, is that the shortages are going to continue and probably get worse. I think you’re right on the mark in regards to that.
A lot of the market is well aware of how gold has been moving from the West into the East, largely into China and India. The demand from China going back over the last five to eight years has been continually getting stronger.
If people are familiar with the gold story and follow the gold markets, they might already know this, but there are a lot of people who are looking at gold who have never really considered it before. Something that’s important to point out is that gold going into China is like going into a black hole. Once gold goes into China, I don’t expect that we’ll be seeing it any time soon, and maybe never, because China does not sell its gold into the market.
I saw an article the other day that some was smuggled out, but China doesn’t sell its gold on the world market. It sells it internally, and any gold that is sold from the private sector, per the law in China, must be sold to the People’s Bank of China, which is the China central bank.
I also concur with what you’re saying in regards to when Chinese official buying is going on. This is the Chinese central bank. As I’ve suspected for many years, they don’t report those figures. I mentioned it in an interview I did a couple of years ago, that I don’t think we really had any kind of official way to measure the central bank’s demand.
The important part of the whole black hole issue is that over the years, the West has been selling off. You can measure this by looking at gold flows from countries like the United States and the U.K. where the majority of gold is held for the largest Western ETF gold funds in the world. Just watch where it goes as that gold is drawn down.
When those big ETFs sell off, the gold leaves the United Kingdom, goes through Switzerland, gets re-refined into one kilo bars (we call it four nines fine meaning 999.9 parts per thousand pure, which is the Chinese requirement), and those bars get shipped over to China.
There has been a lot of speculation that at some point those bars would come back on the market. We’d see big 400 ounce bars reintroduced into GLD inventory, things like that. It hasn’t happened, so it’s good proof that what’s really happening when the West sells off its gold is that it’s moving through Switzerland into China.
An interesting dynamic has been occurring since the end of Q4 2016 to today. Yesterday, GLD had its first gold inflows and inventory since November 2nd For those not familiar with it, GLD is the flagship Western gold ETF run by bullion banks. Bullion banks are some of the largest banks in the world. The five market-making members of bullion banks are HSBC, Goldman Sachs, Citibank, J.P. Morgan, UBS – the regular suspects there.
The reason this is so interesting is that one of my colleagues recently mentioned to me that the GLD inventory is way down. This is true if you measure it from the peak of 2016, but the truth is that as the USD gold price passed through $1180 or so, the previous two times it did this, the inventory was a hundred tons less than when it did this time.
Said another way, it means that GLD had a hundred-ton buffer that authorized participants didn’t sell or didn’t release into the market, which tells me that bullion banks were considering gold oversold and that it was going to reverse, which is exactly what it did from the last time we had our webinar last month and were talking about this.
Then what accounts for the rise in the USD gold price back to the $1200 if GLD inventory wasn’t moving and the West wasn’t buying? It means that the slack was picked up by other major, non-Western demand spheres – we’re talking China and India – before the West started buying again. And that’s just been in the last couple of days.
Why this is important is that GLD is a pretty good proxy for measuring Western demand and Western buying. In particular, it measures hedge funds and speculators. When you have a lot of speculative buying or hedge funds entering the market looking for price gains on the price of gold moving, they typically use GLD as the vehicle to do that.
In 2016, there was a big run up in the gold price driven mostly by Western speculators. That obviously went up to a peak. These hedge funds all exited towards the end of 2016, and that brought the gold price back down to around $1129.
Here’s the interesting part: strong hands took the gold price back up to about $1200 with pretty much no help from hedge funds. What that means to me is that Western speculators weren’t involved in bringing this price from $1129 back up to $1200.
Yes, there is a market vector where the USD is a strong lever on the gold price. You can measure that by watching the USD price when the U.S. dollar is strengthening and all other currencies are weakening against it, and vice versa. That’s a strong vector.
The indication here is that this has happened without a lot of help from Western speculators. This means that inventory was running down and moving into China – into the black hole, so to speak. All the gold that went over there is not going to be available the next time the hedge funds, etc. are jumping back into the market. I suspect most of that went predominantly to China, because India was off by some 400 tons from normal demand in 2016.
If the beginning of 2016 is any indication of tightness in the market, I think what it means to us is that when Western speculators do step back into this market and that gold is not available, it could be pretty energetic.
Jon: Thanks, Alex. That’s a captivating analysis of the gold story.
Jim, at the end of our last podcast we began a discussion about the war on cash. I know your time today is limited, but would you give us an update on this phenomenon and perhaps place it in a wider context of global systemic risk?
Jim: In my most recent book, The Road to Ruin that came out November 15th, I have a large section on the war on cash, and this has been going on for some time. I expected it to get worse, but I did not expect it would get so bad so quickly.
Literally the week my book came out was when Prime Minister Modi of India announced that the two largest circulation bills in India, the 1000-rupee note and the 500-rupee note, were no longer legal tender. He just woke up one morning and said they’re illegal.
He said if you have them and want your value, come on down to the bank, hand them in, we’ll put money in your account, and if you need a little currency, we have a new 2000-rupee note.
It sounds good but was a complete fiasco. About 80% or more of the Indian economy is run with paper currency. That’s 1.1 billion people, and they’re over 80% cash. It’s just the way a rural, agrarian society works.
Now, there is a middle class of 200 to 300 million people, and yes, they have their debit cards and credit cards, their iPhones and PayPal, and all that other good stuff. That’s fine for them, but what about the other almost billion people left out in the cold?
Well, there were long lines at banks, the economy shut down, there were riots, supermarket shelves were stripped. They even screwed up worse than that considering they printed the new 2000-rupee note the wrong size. It didn’t fit in the ATM machines, so they had to shut down all the ATM machines in India and rip the guts out – the physical machinery, not the programming – and change it so that it would dispense these new 2000-rupee notes. It was a complete and utter disaster.
Right after that, Venezuela said the 100-bolivar note is worthless. It was already kind of worthless anyway around 6 cents or something like that, but whatever the value was, it wasn’t worth very much. Those notes had to be handed in.
Of course, they always say this is designed to get rid of the black market, tax evaders, and terrorists. They continuously have this list of excuses, but the truth is, it’s aimed at everyday people and designed to force them into digital payment systems so they can be slaughtered with negative interest rates, confiscation, freezes, etc.
This is not confined to just a few countries. It already happened in various ways in Cyprus in 2013, Greece in 2015, we’ve just seen it in India and Venezuela in recent weeks, Australia has started a parliamentary debate about getting rid of the Australian $100 note, Europe got rid of the 500-euro note last year, and there are calls in the United States to get rid of the $100 bill. This is not going away. The pressure is going to continue, and we expect to see more of it.
Again, it’s forcing people to basically put their savings into some digital form such as a bank account or maybe a money market fund. By the way, I consider the phrase “money market fund” to be one of the great misnomers of all times, because it’s not money. People think it’s money, but it’s really a mutual fund of a particular kind where you must call your broker and have them sell your shares and wire the money to your bank account.
It sounds easy. That’s what people do on a day-to-day basis, but what happens if the brokers close? What happens if exchanges close? What happens if the bankers close? What happens if the fund suspends redemptions? There are so many ways for that to go wrong. It’s not even close to money, but they call it “money market funds” because it makes people feel good, I guess.
The cash component of your portfolio is definitely at risk. It’s being forced into a digital form so that it can be frozen or confiscated in various ways. There really is no solution except to get out of the digital system.
How can you get out of the digital system and still have some form of money? My answer would be gold or silver. Gold is excellent for larger stores of wealth, and silver is excellent for, in effect, walking-around money or transactional money if you’re in a power grid outage, social unrest, or a natural disaster.
People tell me all the time, “You can’t eat gold.” Why would you want to eat it? If I want to buy food, I’d rather give you paper money and keep the gold. But in extremis, when paper money is not around or it’s not valuable, you can’t get it, or you’re locked into a digital system which is frozen, I guarantee that people will sell you food or whatever you need for gold or silver. Silver is practical for that purpose.
My recommendation has always been 10% of your portfolio. Not all in, not 50%. If things get to the levels that I expect – and I fully do – gold at $10,000 an ounce, silver at $100 an ounce or more, and these other extreme scenarios are playing out, then 10% of your portfolio will in effect insure the rest of your portfolio.
You can do more if you like, that’s an individual choice, but I’m comfortable with the 10% recommendation. That way, if things go the other way, which is always possible – a deflationary vector cannot be ruled out; gold could go low – you won’t be hurt too badly if you have 10%.
Even there, I would caution that a lower dollar price for gold doesn’t mean a lower real value for gold. The real value of gold could be going up. In a highly deflationary world, you might find that gold is going down from $1200 to $900 but everything else is going down even more, so gold would actually preserve value better than stocks and bonds and some other trades.
Don’t get too hung up on the nominal price; focus on the real price. Right now, the real price is rallying very strongly. Expect that to continue, but even if it goes the other way, a lower nominal price would be indicative of deflation, which could mean a higher real price, so you win either way.
People say to me, “I don’t understand gold,” or “Gold is a barbarous relic. How could you put any of your portfolio into gold?” And I just say, “How could you not?” How can you sleep at night not having some of your wealth in a non-digital form where it can’t be wiped out by Vladimir Putin or frozen by some future administration?
Yes, the war on cash is alive and well. It’s getting worse and coming to a country near you. I expect the U.S. will join in sooner rather than later. The only alternative is to get out of the digital payment system, and that means some tangible asset.
You can have land and fine art and natural resources – those are all good portfolio allocations – or non-digital contractual assets like private equity funds or venture capital funds, etc., but you definitely want some gold and silver.
Jon: Thanks, Jim. Alex, let’s take at least one or two questions from our listeners now.
Alex: We have about five minutes left. One question that has come in is from Andrew C., and he says, “I love the work and the podcasts.” I think his question is in regards to whether the IMF SDR is essentially money for people, or if it’s more money for sovereigns.
His question directly is, “If IMF becomes the entity that bails out central banks by printing SDRs, is this effectively the IMF printing U.S. dollars, JPY, British pound, RMB, and euro directly? And if so, does the IMF need the permission from countries’ central banks to do this?”
Jim: Great question. Maybe I can break it into a couple of parts. First, when the IMF issues SDRs, they need a vote from their executive board, but presumably they would all be on board. They’re not going to do this on a normal sunny day. They’re going to do it the next time there’s a liquidity crisis of the kind we saw in 2008, which I do expect sooner rather than later.
In that crisis, the next one will be bigger, and the central banks won’t be able to bail us out the way they did the last time. Everyone is going to turn to the IMF for the bailout, and the IMF will accommodate by massive multi-trillion SDR printing.
They don’t need central bank approval to do that. No doubt there will be some phone calls behind the scenes and they’re going to talk to whoever it is – Janet Yellen or Mario Draghi or whoever – but they’re a separate institution. They can act on their own, and they will.'
When they do this, are they printing up bundles of yen and dollars and sterling? No. They’re printing up SDRs. People think the SDRs are backed by those other currencies, but they’re not. There is a so-called reference basket. I don’t think “basket” is the right word, but people call it a basket.
As of last October, there is a five-currency basket: dollars, yen, euros, sterling, and Chinese yuan that’s related to the SDR, but that basket only exists for the purpose of calculating a cross rate.
You may ask, “What’s an SDR worth? How many dollars is it worth? How many yen is it worth?” There’s a way to do that calculation, and those five currencies are in the calculation, but it’s really a math problem.
I get an email from the IMF every day with that day’s SDR fixing. Right now, it’s about $1.50 or a little bit less. That’s why those currencies are there, but when you print SDRs, you’re just printing SDRs.
The second part of the question is do they go to us? No. People don’t get them. Countries get them. Basically, there are 189 members of the IMF, and they all get them in accordance with their shares in the IMF. It’s like stock in a company. The U.S. is about 16% of the votes at the IMF, so if they printed 10 trillion SDRs, the U.S. would get 1.6 trillion SDRs and so on. Everyone would get their share based on their vote.
It gets interesting from there, because a lot of countries will get SDRs and say, “Thanks, but I don’t really need SDRs. I need euros or dollars, because I have trade deficits, or I have external financial obligations I can’t finance, or my corporations can’t roll over their debt, they’re going bankrupt. I need to bail them out,” etc.
There is a trading desk inside the IMF. If you have SDRs you don’t want and you need these other currencies, you can swap them. You can sell SDRs for the other currency to pay your bills, but they’re coming from existing supplies. They’re not newly printed dollars; they’re just dollars that are there from the United States or elsewhere.
That’s how countries get liquid currencies, but it’s not that the IMF is printing dollars and euros; it’s that they’re printing SDRs and people who get them can, in fact, sell them through a trading desk in the IMF to get dollars.
Who’s the buyer? If I’m Hungary or Zimbabwe or anybody and I want to sell SDRs because I need something else, who’s buying those SDRs? One buyer is China, and China is buying the SDRs because they’re trying to get out of dollars.
There’s a big game of musical chairs going on here behind the scenes, and these values can fluctuate. I don’t need to get too down in the weeds in terms of a technical lecture and how the SDRs work, but one thing is certain: this will be inflationary.
I don’t care if you call it SDRs or banana peels; if you print 10 trillion of something and give it to all these countries in a way that they can spend it, then that’s going to be inflationary, and that’s extremely bullish for gold. It’s super bullish for gold.
I see two endgame scenarios. One involves going to a gold standard, which I’m not predicting, but if they did, then that would mean gold at $10,000 an ounce. It has to be $10,000 an ounce, because any lower price is deflationary, which is the last thing they want. There’s math behind that.
If they don’t go to a gold standard, they’re going to have to go to SDRs, which is inflationary, which means the dollar price of gold will go up. Gold goes up either way in this scenario.
There are some efforts at a private SDR market, what the IMF calls M-SDR. M stands for “market.” That market is taking off. They have a ten-year plan to do that, but in my view, they’re not going to get that far. This crisis will come before they finish their ten-year plan, and then they’re going to have to go to SDRs on an emergency basis rather than a gradual basis. That’s just going to be the response to the next financial panic.
Jon: I’m sorry, everyone, we’d love to hear more of your questions, but today, as you understand, Jim is in huge demand from many sources for his insights, and we’re very privileged to have him each month for this long.
Thank you, Jim Rickards, and thank you, Alex, also for your insightful analysis today. It’s always a pleasure and an education sharing this time with both of you. Most of all, thank you to our listeners for spending time with us today.
Let me encourage you to follow Jim and Alex on Twitter. Jim’s handle is @JamesGRickards, and Alex’s handle is @AlexStanczyk.
Goodbye for now, and we look forward to joining you again soon.
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