THE GOLD CHRONICLES
with James Rickards and Alex Stanczyk
Implications of the USMCA between the US, Canada, and Mexico
The importance of Robert Lighthizer’s role in US trade negotiations
Update on tensions between Russia and Ukraine
Russia’s “buffer states” of outlying countries
How Russia’s gas pipelines running through Ukraine are critical infrastructure
Why Russia purchasing close to 30 tons of gold per month is a strategic move
How a decentralized permissioned ledger cryptocurrency sponsored by Russia and or China and settled in physical gold could be the next system used by sovereigns to settle net trade balances without using the US dollar
Why Switzerland could be an ideal location to settle net payments in gold
Update on Saudi Arabia stability, succession, and world relations
Thoughts on the G20 upcoming meetings and trade negotiations
Update on Fed monetary policy and interest rates
Physical Gold Fund presents The Gold Chronicles with Jim Rickards and Alex Stanczyk offering insights and analysis about economics, geopolitics, global finance, and gold.
Alex: Hello. My name is Alex Stanczyk, and welcome to another edition of The Gold Chronicles. Today is November 30th, 2018. I have with me again my friend and colleague, Mr. Jim Rickards. Welcome, Jim.
Jim: Thanks, Alex. It’s great to be with you.
Alex: Before we get into today’s podcast, please note that you may access an archive of our podcasts going back for three years at PhysicalGoldFund.com/Podcasts. If you watch this podcast on YouTube, please take a moment to Subscribe and Like as well as feel welcome to comment below the video. We do like to hear your comments. We want to hear what you think and any questions you might have that we are able to answer.
Jim, diving right into today’s topics, the first one up on deck is regarding a tweet from President Donald Trump this morning. He said he has just signed what he's calling “the most important and largest trade deal in U.S. and World History.” It consists of the United States, Mexico, and Canada working together to create and sign the U.S. Mexico Canada Agreement (USMCA). What are your thoughts on this, and what are the implications for U.S. trade going forward?
Jim: It is a big deal. I think for the president to take a little credit and kind of trumpet this is entirely appropriate, although I love the way he says it’s the greatest trade deal in the history of the world. Going back to Alexander the Great, he did his own version of globalization by conquering everybody, but he had a pretty good trading area. Yes, the USMCA is significant, and I wouldn’t underplay it.
First of all, it’s the U.S., Canada, and Mexico. Everyone talks about the U.S./Chinese bilateral trade relationship, which we’ll talk more about, but 80% of the Canadian population lives within 30 miles of the U.S. border. It’s their own country, but Toronto, Vancouver, Montréal, and several their big cities are just over the U.S. border. Take the car industry between Mexico, United States, and Canada’s that’s been integrated for a long time.
It is what NAFTA was intended to be, which is North American Free Trade Area. Trump got, as he puts it, a better deal from Mexico and Canada. More jobs for U.S. workers, and more inputs from the U.S. Remember, if Mexico is doing assembly, they're buying parts from someplace, and Trump said, why don’t you buy some of those parts from the U.S.? We’ll have some assembled in Mexico, import the cars, more jobs, and more input from the United States in the supply chain.
Likewise, Trump’s threat vis a vis Canada was to put tariffs on Canadian cars coming into the U.S. which would have killed the car industry in Canada. Trudeau knew that, so Trudeau and Chrystia Freeland, his foreign minister, did a good job of negotiating. They got a few points their way, but they didn't have that much leverage.
This is really the brilliance of Trump. He starts out with a goal, which is an effective way to do things. Some people just go into things not knowing what they're trying to do, but Trump has definite goals in mind such as definite numeric reduction in the U.S. trade deficit. The next thing he says before he even sets out on a negotiating path is, “Where’s my leverage? What's the Achilles heel of the party I'm negotiating with?” In Canada, it was easy - car imports - so he says, “Okay, if you don’t see things my way, we’ll put tariffs on your car imports.”
That’s done which does change things from NAFTA. The mainstream media can't wake up in the morning without thinking of new ways to criticize Trump, so they say, “It’s just NAFTA with a new title, it’s old wine in new bottles,” whatever. That’s not true. It’s not tearing NAFTA to shreds - a lot of NAFTA is retained - but there's a 323-page technical appendix to what this is with lots of provisions in it.
It’s important to remember who’s behind all this. Trump’s the policymaker and takes the credit, but Robert Lighthizer is the U.S. Trade Representative. He’s not a household name, most people have never heard of him, but he has ambassador rank, so he's Ambassador Lighthizer. The U.S. Trade Representative is a cabinet-level position, so this is somebody who, in the hierarchy of things, would be on a par with Secretary of Defense and Secretary of State in terms of serving the president.
Lighthizer is very smart, and I don’t mean just in the technical sense. He keeps out of the press, he doesn’t leak, people couldn’t pick him out of the lineup, you don’t see his face, you don’t hear about him. Lighthizer is very happy for Peter Navarro, who’s a special trade advisor, or Larry Kudlow, who is Director of the National Economic Council, to let them be in front of the cameras and take credit at press conferences.
Lighthizer keeps out of it, but he's the real power; he's the one the president listens to. You can tell that he has the president’s respect, because the president has never dinged him on Twitter. Trump will go after his friends as quickly as his enemies. Mitch McConnell is getting 50 judges approved, and Trump will say something that'll get McConnell showed up. Although I think McConnell’s pretty used to it at this point, you never see President Trump dinging Lighthizer.
As another insight, Lighthizer has a house in Palm Beach where Mara Lago is, and there are a lot of weekends or a Thursday or Friday morning when the president will say, “Hey Bob, I'm going down to Mara Lago. You want to ride in Air Force One?” Lighthizer will say yes, they get on the plane, and they have a two-hour one-on-one with no distractions or visibility from the press.
They have a special relationship, and Lighthizer also did this for Ronald Reagan. He wasn’t USTR, but he was top trade advisor to President Reagan and is running the Reagan playbook with the Chinese. At the time he was with Reagan in the early 1980s, the problem was Japanese auto imports. Detroit was falling apart, they couldn’t make a good product, while the Japanese had very high-quality automobiles at very low price points.
They were killing Detroit, and Lighthizer got Reagan to put extremely high tariffs on Japanese autos which left the Japanese with a choice. On one hand, it took away their price competitiveness, because a tariff on top of the price made Detroit suddenly competitive, but what they were really saying to the Japanese was, “Look, if you make a better car, make them here.”
This forced the Japanese to put their auto factories in the United States such as in Tennessee, South Carolina, Mississippi, Alabama, Ohio, and elsewhere. The Japanese did that because they, in effect, started paying the tariffs. They jumped over the tariff wall, put their plants in the United States, and they’ve done very well ever since.
What we got out of it were hundreds of thousands of high-paying jobs and good benefits. They're not union jobs, because getting around the unions was another part of it. Lighthizer’s job wasn’t to help the unions but to help American workers, and it did.
Now 35 years later, the same playbook is being applied to China by saying, “You want to make cars? Fine, make them in the United States. We’re going to slap tariffs on you, and that’ll give you incentive to come here.” People in wealthy zip codes driving around in BMWs saying, “I've got a German car,” and I say, “No you don’t. You have a South Carolina car.” That’s where they make them.
Lighthizer is very seasoned, very smart, has the respect of the president, stays behind the scenes, and is the most powerful voice in all this. He's with the president right now down in Buenos Aires getting ready for the big dinner coming up with President Xi. They have a playbook, and they have seasoned people to run it.
The Chinese are going to find out the hard way that you can either work with Lighthizer and the president or you can accept the consequences. It’s not like we don’t have enough cars in the United States. Of course, it’s not just cars. That was the Japanese playbook, but today it’s iPhones, electronic components, textiles, and a lot of other goods including manufactured goods that are affected by this.
Trump had a big victory with Canada and Mexico, and he's on his way to another victory with China, but not soon. This whole Chinese thing is really going to drag out. One footnote on the USMCA, the new NAFTA, is that it does not end U.S. tariffs on steel and solar panels, and Canada and China were the two major sources of U.S. solar panels.
I wouldn’t buy anything from China. You couldn’t give it away as far as I'm concerned, but the Canadians do have particularly good quality, and a 30% tariff was put on those. But that’s not included, so there's still some unfinished business with Canada. That’s going to get back to our dairy products in places like Vermont and Wisconsin being able to get into Canada, etc.
There is still some unfinished business, but USMCA is a big breakthrough, and the president deserves a lot of credit. It shows that the brains behind the operation is Lighthizer, and he's also on point with China.
Alex: In signing this deal and Trump being the negotiator and businessman he is, this probably gives us some pretty good momentum moving into the G20 for his preparations to talk with the prime minister, etc., from China.
Jim: I think that’s right. Of course, all eyes are on this Saturday dinner. The China story has been overreported. I'm not saying it’s not important; of course it’s important. But it’s all you would hear about. To me, the bigger stories are the ones not being reported. I'm more intrigued by what's not happening than what's happening.
What's not happening is the president is not meeting with Mohammad Bin Salman, the crown prince of Saudi Arabia and at least as of now the next king. We’ll talk a little bit more about that later. Trump’s also not meeting with Vladimir Putin. He was planning on it and wants to but isn’t because of what's happened in the Kerch Strait between the Black Sea and the Sea of Azov involving a military naval confrontation with Ukraine.
Ukraine has retaliated by declaring martial law on themselves, but I don't know what good that does. They’ve also just announced a ban on Russian men between the ages of 16 -18 and 60 years old entering the Ukraine. I thought that was a bit ridiculous, because if the Russians want to go into Ukraine, they’ll just walk in. Eastern Ukraine is two breakaway provinces that are de facto under the control of Russia. Maybe you can't get off the plane in Kiev, but you can certainly walk into Donetsk or the eastern areas of Ukraine. I don't know why they cut the age off at 60, because I think you can cause a lot of trouble even if you're over 60.
These are things Ukraine feels they must do, but it’s all for show. The real question is, can the Ukrainian Navy stand up to the Russian Navy? The answer is no. I saw a Democratic politician the other day saying we should give the Ukrainians ship-to-ship missiles - basically, missiles that can sink ships - so they can stand up to the Russians.
I thought to myself, “Great, that’s just what we need; a Russian vessel being sunk by an American cruise missile.” I don’t think that’s the way to deescalate, so Ukraine’s kind of stuck. Are the Russians bad guys? Sure. But they always have been in certain ways and certainly when it comes to their periphery, the territory.
There is strategic thinking behind this. If you look at it on a map, particularly a topographical map, Russia doesn’t have any natural boundaries or borders between it and potential invasion. There are the Ural Mountains, but all the important stuff such as Saint Petersburg, Moscow, and the Crimea at this point are all west of the Ukraine mountains, which means that it’s just a big plain. From the Netherlands to Moscow is just a big plain.
Napoleon and Hitler proved you can roll over it. You might have your hands full when you get to Moscow, but there's nothing stopping an invasion. Russia has always had buffer states. They say, “Maybe we’re vulnerable from a topographical or geographical point of view, but if we have a bunch of states like Poland, Ukraine, Romania, Georgia, Estonia, Latvia, and Lithuania around us, you’ve got to come through them first to get to us. That gives us a little buffer and a little time.”
Most of that has been lost now because of the fall of the Berlin Wall in 1989, the dissolution and breakup of the Soviet Union in 1991, and a period of about ten years of disorganized chaos in Russia when they were pretty weak. The U.S., NATO, and European allies contributed to the liberation of a lot of those countries along with obviously the sacrifices and bravery of their own people. They broke away from the Soviet Union, and they're not coming back.
The two or three areas where control was ambiguous or at least uncertain were Ukraine and Georgia. This goes back to 2007 when Russia invaded Georgia. They didn't take the whole country, but they took the northern half of it. Now it’s just a mess in Ukraine where Ukraine had a functioning democracy and elected a pro-Putin president. Prior to that, they had more western presidents.
There was a modus vivendi that Ukraine was still nominally western-looking to the west, but they had a leader who was close to Putin, so both sides were relatively happy. They probably should have left it that way, but in 2014 the U.S., UK, CIA, and MI6 got involved in this Colour Revolution and chased the leader out of town to exile in Moscow. They got a more favorable leader, and Putin said, “Wait a second. I finally got a friendly guy in there, and you depose him. Where’s your commitment to democracy?”
From there, Putin said, “Okay, two can play,” so he took Crimea, destabilized eastern Ukraine, the U.S. threw on sanctions, and it’s been escalating ever since. I'm not saying he's a nice guy, but everybody wants to make Putin the bad guy. They say, “Putin started this when he took Crimea,” to which Putin says, “No, you started it when you destabilized Ukraine. Taking Crimea was my answer to that.” We've been in this escalating scenario ever since.
Trump would probably love to meet with Putin, but there's a whole angle here with the Mueller investigation and Michael Cohen, the president’s former lawyer, giving testimony about Trump and his so-called lieutenants or associates talking to Russians about hotel and skyscraper development long after it looked like he was going to get the nomination or join the primary season. My first thought is, the guy is a hotel builder. What's he supposed to do? Trump himself said this morning, “Well, what if I lost? I can't miss a business opportunity.”
I don't want to get into the legalities and ethics of it, but the problem with people in Washington is they're so political 24/7. They’ve had their entire careers either in elective office, staff positions, bureaucracy, or the Pentagon. For decades, they’ve had no experience in the real world of business. They don’t know what it’s like to negotiate building a skyscraper or hotel and trying to finance it. Of course you ingratiate yourself with the leaders of these countries; that’s what you're supposed to do.
I worked at Citibank for ten years, and the country head of every branch in the world told you your job is to ingratiate yourself with the elites. Don’t try to make loans, because we've got loan officers for that. Get to know the finance minister, the prime minister, etc.
It was Trump’s own version of hotel diplomacy, but of course, you read the Washington Post that says this is a smoking gun conspiracy, blah blah. We’ll see how it plays out. I think Trump will handle it well, but it’s a pretty bad time to go meet with Putin when there are all these supposed revelations popping out in the Washington Post and all that.
As far as Russia, Alex, you know a lot more about the navy than I do, but there was a video of a Russian destroyer or maybe something larger that just rammed a Ukrainian tugboat. The boat’s siting there in the strait, and here comes this vessel. I do a lot of sailing, and I'm watching it thinking, “He's going to hit that guy.” Sure enough, it did hit the tugboat. I guess if you're going to hit anything, a tugboat’s a good choice, but the point being, I think Trump could have gotten past that, because there's a lot we need to discuss with Russia including arms treaties and sanctions. Can the two of us get together, at least hold hands, and confront China in certain ways? There's a lot of important business, but this Mueller thing has been clouding the issue for two years.
Alex: Do you think this is possibly leading up to a Russian push towards more territory in Ukraine?
Jim: Yes. The gloves are off. If Ukraine says, “We’re going to declare martial law, your people can't come here, we’re trying to beef up our navy, we’re going to assert our rights in the Sea of Azov” and all that, this opens the door for Russia to escalate. The problem is, if you're going to pick a fight, don’t pick one with the school boxing champion.
You can go through the motions and posture, but Russia is working hard to negate the only leverage Ukraine has. Russia dominates the world of natural gas. They deliver a high percentage, in some cases 60%-70% or more, of the natural gas that goes into western Europe to keep houses warm, keep factories going, and run various industrial applications. If Russia turns off that tap, a lot of Europe will be freezing in the dark, and a lot of factories will close down literally.
Those pipelines run through Ukraine. There have been disputes about this when the Ukrainians didn't pay their bills. Some of this goes back to 2006-2007, but even more recently. Russia will literally turn off the tap and cut the gas supplies to Ukraine, but Ukraine can do that in reverse. Ukraine can either turn off the tap or if Russia says, “We’re not giving any more gas to Ukraine, but we want you to keep sending it to Poland or Germany,” Ukraine can divert that gas to Ukrainian applications and cut off the Poles.
There are all kinds of gas wars going on, and that’s where Ukraine does have a little bit of leverage. Again, in this escalation scenario we’re talking about, if Ukraine did something like that, we could see Russian troops coming in and turning the taps back on. What's the U.S. leverage then? Trump can't even talk to Putin for 15 minutes in a private hotel room in Buenos Aires. How are we going to confront Russia and Ukraine when we've given up?
By hitting Russia so hard with financial sanctions, travel bans, seizing assets, etc., we've already thrown everything we can at the Russians short of an act of war, so if Russia escalates, what are we going to do? There's not much we can do. We can kick them out of Swift, but that’s a good way to start World War III, so that’s not going to happen.
This is typical of Putin, because Putin’s two favorite sports are chess and martial arts. Obviously he's a very smart guy, but he knows a little bit about turning an opponent’s aggression against them, turning strength into weakness from the U.S. perspective. He can say, “You have thrown everything you can at me, but I'm still standing. Now if I do something, you’ve got nothing left.”
Alex: It makes sense. In fact, when I saw Russia basically capturing those three ships, the first thing that occurred to me was that he's testing response. I agree with you. With everything that’s happened, every time something has anything to do with Russia, the media is all over it, and they try to turn it onto a negative circus. Basically, Trump’s ability to do anything at a negotiating level is removed, and now it’s just down to, well, they're going to do what they're going to do, and we’re going to have to do what we have to do later.
Jim: Meanwhile, as you know better than anyone, they're buying 30 to 40 tons of gold per month. Not year, but month, and they haven't quit. I've mentioned before that between 2014 and 2017, Russia’s reserves were drawn down by $200 billion. They went from $500 billion to $300 billion in their reserves, and that put a lot of stress on the economy. They couldn’t refinance corporations, so they did it by reducing their dollar assets without ever selling an ounce of gold.
And they never stopped buying. Even as their total reserves were going down, their gold reserves were going up. They would buy 10, 15 or 20 tons a month even as the reserve position was melting. Now that their reserve position is growing again, it’s back over $400 billion, because the price of oil is higher. I know it’s down recently, but it’s higher compared to the $24 it was in 2015.
The Chinese and Russians are doing the same thing. The difference is the Chinese are sneaky about it and pretend otherwise. The Russians are very transparent. They update the Central Bank of Russia website once a month like clockwork, and Putin says, “We’re getting out from under the dollar.” Others want to do the same thing and will join quickly, but he's taking concrete steps.
Alex: What's so interesting to me is that they're clearly setting themselves up to be able to operate financially even if they're on complete financial lockdown. In other words, if things go to a kinetic level or become much more hostile and they're completely locked down financially from whatever western systems are controlled, they can still operate.
It blows my mind that so many people miss this about gold. People often say, “Gold’s no longer money; gold no longer backs any monetary systems,” etc., but what they miss is that gold is money for sovereigns in time of serious conflict.
Jim: That’s absolutely right, and this is much further along than people understand. You just described the situation perfectly, but a lot of people hear that and say, “Oh, they're working on it. In ten years, who knows.” Forget ten years. They're almost ready to go in about ten months. I recently guest lectured a very elite team of strategic thinkers from the U.S. Army War College, and this is one of the things I drilled down on. I actually showed them what's going on.
Imagine the following. In fact, you don’t have to imagine it, because it’s happening. Russia builds a cryptocurrency. (I’m not talking about bitcoin, so please don’t go out and buy bitcoin. That’s going to be a dead end.) Russian creates their own cryptocurrency, a new ruble or PutinCoin or whatever. China does the same thing, and they link up. I call it an Internet, but it’s completely segregated from the main Internet. They just run cables and satellite relays between Shanghai and Moscow, and boom, there you are. They make what's called a stable coin pegged to a certain benchmark and not meant to fluctuate.
The benchmark is the Special Drawing Right (SDR) from the IMF. Everyone may say, “It’s going to be a gold-backed yuan,” but no it isn't. China doesn’t have anywhere near enough gold. And it’s not going to be a gold-backed ruble. Both countries have awful rule of law. If you transacted, what’s your recourse? Who are you going to sue? Do you really want to be in China’s court? I don’t think so. But in these digital currencies, you could have a distributed ledger pegged to the SDR.
Because there's a dollar equivalent, from there, you are de facto pegged to the dollar price of gold. The point is, it is a stable coin. Then you invite others to join this network. Obvious candidates would be to start with the pariahs like Turkey, Iran, and North Korea, but Brazil and South Africa has expressed interest, and Venezuela would come in.
You don't have the U.S., that’s the big giant, but the whole idea is to get out from under the U.S. Now you have a private Internet and a distributed ledger with a PutinCoin or a XiCoin with stable value equal to the SDR. It fluctuates against the euro and dollar, but so do the euro and dollar. That’s not unusual.
Now you start trading. North Korea sells weapons to Iran, Iran sells oil to China, China sells infrastructure projects to Russia, Russia sells technology to China, Turkey gets in on the act, Brazil’s selling soybeans to everybody, and you denominate everything in these new coins or tokens. What you're doing is denominating them in SDRs, but your medium of exchange is a private coin in a private network.
Then you do what countries have always done, which is you just keep tabs. You don’t pay for everything in real time. Maybe the vendors do, but the countries run a balance of payments with each other, surplus or deficit, and periodically settle up. It could be monthly, quarterly or annually, but there's a catch. You settle up in gold equivalent to one PutinCoin or whatever and just fly the gold around. Put it on a pallet on an airplane. The nice thing about gold is it’s got great density, so you get a lot of value on a small pallet. The plane lands in Moscow and Putin sticks it in his vault or the plane lands in China and they stick it in the vault in Shanghai.
Notice that everything I just described does not involve the dollar. Digital coins, private network, stable value, gold settlement, extensive trading network, and the dollar’s not even in the mix. That’s what they're doing.
Alex: They can even figure out what they think their net payments are going to be and keep some amount of gold in their own account in that nation. They wouldn’t even necessarily have to fly it. If it was a lot, they might want to, but historically, a lot of that’s been settled with gold that’s already sitting there.
Jim: That’s right, and for that matter, you could put this gold depository in Switzerland. The Russian gold, Chinese gold, and Iranian gold all goes to Switzerland, and they do what the Fed does - just change the nameplates. Here's gold, and now it’s yours. Nobody trusts Russia or China, but everybody trusts Switzerland. So that’s right; you could have a central gold depository in Switzerland, and it would be a very efficient system. It’s coming. Like I said, they're already working on everything I just described.
Alex: Back to Putin for just a second. I saw a picture of him sitting right next to the crown prince of Saudi at the G20. The Saudis had some really interesting things going. Last year we did a podcast around the time when the crown prince essentially came in and went on a huge program of reformation. He promptly rounded up and arrested different family members from the House of Saud and froze and confiscated hundreds of billions of dollars of assets.
It was a huge shakeup. If you're interested in getting the history on that, go back to our archive at PGF The Gold Chronicles Nov 2017. Recently, Saudi has been pouring tens of millions of dollars into PR. They’ve hired firms in the United States and UK trying to fight back against this recent situation of a journalist named Khashoggi that appears to have been captured, tortured, and murdered at the hands of Saudi Arabia. We’re not absolutely certain, but it’s looking that way. What are your thoughts on Saudi/U.S. relations? Where are we going with this in the future?
Jim: Going back to the shakedown operation, it’s crazy that instead of putting all these oligarchs, princes, and multibillionaire royal family members in a prison, they put them in a Ritz Carlton. They basically turned the Ritz Carlton into a high-end prison, but they were confined, nonetheless. A couple of folks I know happened to be there and could just get their little iPhone camera out, scan a little bit, don’t be too obvious, and see princes sleeping on the floor, men in black walking around with M4 automatic weapons, and all this stuff.
I remember thinking at the time that it was good news/bad news. The good news was most of the money he was trying to get back was probably improperly stolen to begin with, so in a sense they were just recouping for the state what had been stolen from the state.
He took a third, so if you were worth $30 billion, he’d say, “Give me $10 billion, and I'll let you out.” Most people took the deal, but some people didn't and are still confined. One of the holdouts was Prince Al-Waleed who might be worth closer to $40 or $50 billion, who knows, but he had to pay up.
It was sort of nasty and not legal by western standards, but this is typical Arab behavior. I don’t want to paint with a broad brush, but when we look at the history of Arabia, the Bedouins, and House of Saud family prior to the first third of the 20th century, they never had economic growth or technology unless you want to go back to like the 10th century, so they stole from each other.
The way they got wealth was to steal somebody’s sheep, goats or camels or took their water. This would start a feud, a bunch of people would get killed, and then there’d be a peace treaty of sorts. It was never about growth; it was about taking, so this was an updated, 21st century high-tech version of what they had always done culturally.
Mohammed bin Salman (MBS) is trying to grow the economy and has some projects, but I remember when they did this thing with the princes of royal family in the Ritz Carlton, I said, “You better come out on top. You better make this work, because if you don’t, you’ve just made more blood enemies and created more blood feuds than have existed in that peninsula in 500 years. You better not screw up, because you just bet the ranch on this.”
Well, he did screw up with this Khashoggi murder we referred to. As General Mattis said, I don’t think anyone’s seen the smoking gun, but we can draw our own conclusions. The CIA has estimated - that’s their word - that the crown prince was behind it. I'll leave that to those intelligence channels, but it certainly looks that way.
The problem is, because he's in his early 30s, he's coming off as a hothead. On one hand, he's the modernizer. He let women drive, and he announced big projects as all part of vision 2030. They were going to turn this into a real country instead of an oil pumper, but now he's gone too far. The royal family knows it, and they're looking around for alternatives.
The reason I'm giving all that background is when you turn to Trump and you're the Washington Post or all these other left-wing publications, you're like, “Oh, Trump’s horrible. He won't denounce Khashoggi. He kind of maybe did it, maybe didn't, he's equivocating,” etc., as if Trump didn't know what happened and wasn’t willing to hold him accountable. But you have to think of these things from the U.S. perspective. We’re not out to do any favors for anybody in Saudi Arabia; we’re out to do favors for ourselves. The U.S./Saudi Arabia relationship is critical to cutting off oil to China, to confronting Iran, and to building up alliances with Israel.
Russia, Saudi Arabia, and the United States together produce almost 40% of the world’s oil. The U.S. is number one, by the way. We came up from behind, but in round numbers, the U.S., Saudi Arabia, and Russia produce about ten billion barrels a day. The U.S. is now slightly above that, but those 31-32 billion barrels are 37% of global output.
The relationship could hardly be more important, so you can't blow up the relationship. You don’t push MBS aside until you have something to replace him with. You might not like him or hold him in high regard, you might think he screwed up, but this is no time to go public with that. You either have to give him a chance to make some kind of amends (I don't even know what they would be, because this is pretty horrific) or - and I think this is what's going on - you give the royal family time to come up with an alternative so that when they do pull the rug out from under MBS, there’ll be somebody who can come forward.
This is an example similar to the famous line from The Godfather script, “Keep your friends close and your enemies closer.” If MBS has now become a liability more so than an enemy, keep him close and get his mind at ease until he gets whacked.
I see Trump being publicly critical but not blowing up the relationship for two reasons:
The relationship is too important to blow up, because it’s bigger than one man.
Give the royal family time to produce a replacement.
They have one son of Abdul Aziz who was the first king of Saudi Arabia of the Al Saud dynasty going back to the 1930s. I don't know the exact numbers, but he had something like 45 wives and 75 or 80 children, most of whom by now are deceased or too old and not functional or whatever. But there's one half-brother, one son of the original king who’s 71 years old. He must be one of the babies in the family, but he seems perfectly capable of taking over, and I think that consensus is forming.
Meanwhile, MBS is not the king; he's the crown prince. King Salman is ailing. Reports are he's still the king, but he's not well, so his days are numbered. I see a setup either where the king is induced to dethrone his own son, make him not the crown prince, and bring in this other guy or the king dies.
But there's another step. The line of succession is not automatic like in the UK, for example. MBS does not automatically become the king even though he's the crown prince and sort of the king in waiting. There would be a family council, a sit-down, where the coup happens and they bring in this other 71-year-old younger son of Abdul Aziz to be the next king.
They could be setting up for that. It’s a deep game, but I think Trump is doing a good job of not blowing up the relationship for the sake of one ne’er-do-well.
Alex: Let’s move on to the G20. One of the major issues I've been seeing come up is the trade war everybody’s talking. Trump has been talking about the tariffs. He's already imposed some, and he's threatening to impose more.
In the past, Trump has called China a currency manipulator. I think he's backing off that rhetoric a little bit and, in my opinion, he's doing that just to position himself for future negotiations. One of the interesting things people miss about Trump is that he's pretty bombastic or outspoken, but I think it’s all a game to prep for further negotiations.
There are also the issues of the confrontations that have continued in South China Sea, there's Taiwan, the one nation policy, and there's the steel dumping thing. However, to me, some of the biggest issues are intellectual property theft and cyberespionage. We did a piece about cyberespionage in our last podcast where we talked about how, at a factory level, the Chinese were embedding little microchips on motherboards that are in servers in sensitive areas in U.S. infrastructure.
I saw an article stating that the chief technology officer of Cisco verified that the largest telco is out of China, and they actually have points of presence (POP), which are Internet nodes, in the United States that route traffic. They’ve been routing U.S. domestic traffic in the U.S., from the U.S., and meant from the U.S., using what's called BGP routing to send all of that traffic to China and then bringing it back to the U.S. where it’s supposed to go.
Those kinds of things are happening. Then there's the issue of intellectual property theft, which by some estimates is as high as $600 billion a year worth of U.S. intellectual property being stolen. What do you think are the key things we need to be focusing on for G20? What do you think is going to happen with this dinner on Saturday night? Where is all this leading to?
Jim: The short answer is nothing’s going to happen with this dinner. Now, could there be what's called a mini-agreement where Trump delays the activation of the tariffs and China agrees to keep talking about section 301? Section 301 has to do with penalties for theft of intellectual property and tariffs we've got on the solar cells and steel and consumer electronics at this point. That’s the big one. China’s thrown tariffs on a lot of our stuff, and they're buying soybeans away from the United States.
A lot of people don’t understand what a tariff is and how these tariffs work. Under the trade laws of the ’74 Act and ’62 Act and Administrative Procedures Act, you announce them, but then you have to have a 30- or 60-day comment period when affected parties get to comment. Then you get 30 days to construe the comments, tweak your policy a little bit, and it goes into effect.
Even when you get over those procedural hurdles and can put it into effect, you don’t have to do so right away. It’s on standby like a Sword of Damocles, if you will.
We’re getting through that right now where some tariffs announced in May and June are just now getting to the end of the comment period. They are in a place where they could be put in effect at any time, and Trump could say, “We’ll hold off.” It’s really a gun-to-the-head strategy, i.e., we’ll hold off for now, we won't pull the trigger, but we expect to see some results from you.
That could happen, so it’s not much of substance, but it would buy time. That’s very typical of the Chinese negotiating approach, which is to buy time and lie. Trump’s approach is to find the leverage and go for the jugular. These conflicting strategies are not a big deal or an end to the trade wars or anything that’s going to resolve any of these issues. They might come out of it with nothing, but if they want a little something for show, it could be along the lines I'm describing.
I don’t think the market’s going to buy it, though. It’s funny watching the stock market go up and down along with Trump’s tweets or statements. Trump will say, “I really do want to do a deal with the Chinese,” and the stock market will go up 500 points. The next day, he’ll say, “I don't know. I'm going to throw these tariffs on anyway, the heck with it,” and the market will go down 500 points.
You can't fight the market. I'm not telling people to buy stocks or go short or any of this stuff. I'm just saying it’s amusing - except it’s more than amusing, because there's so much money involved - to watch the market react to what is obviously a Kabuki performance by Trump. This is how he keeps his negotiation opponents off guard and everybody guessing. He confuses the heck out of everybody. You never know what he's going to do, so you're thinking, “What do I have to do to keep this guy happy?” This is the Trump art of the deal so to speak.
To see the market take it seriously is a little absurd, but that’s how markets work. Let me explain what's actually going on. I'm not going to repeat everything I said about Robert Lighthizer, but everything I said about Canada applies to China. He's on point, he's a tough negotiator, and he's taking the hard line. Peter Navarro’s the guy with his hair on fire, but he's taking the hard line. Larry Kudlow’s been tranquilized, so he's now sort of with the Trump team even though he hates all this, and it’s the same thing with Mnuchin.
They're going to go in there and insist on a lot more, but I know the Chinese are not going to give it. This is more than a trade war. Go back to January when the trade wars started and I said this is not going to be resolved easily. It’s going to escalate a lot and affect world trade and markets. Wall Street kind of shrugged and said, “No, it’s posturing. Xi’s got to strut, and Trump’s got to strut, and they're not going to let this get out of hand,” and all that stuff.
Eleven months later, it obviously looks like the forecast of a long, drawn-out, costly trade war is a lot closer to the mark than the idea that they're just posturing, and the market has begun to wake up to that. The market’s thinking, “Maybe this is for real. Maybe this is going to drag out.”
I think they've gone from dismissing it too lightly to starting to take it seriously. That being the case, will they have this final communique on Sunday? At some of these international meetings, they don’t even have a final communique. They can't even agree on some happy talks, but let’s assume there is one. If it doesn’t have anything of substance or even if the deal is very superficial along the lines I described, I think the market’s going to say, “You know what? This is going to get a lot worse.”
It’s also gone beyond trade wars. I've always made links between currency wars and trade wars. They can be separate, but usually it starts with a currency war and ends up as a trade war. That doesn’t mean the currency war is over; it just means that you're now fighting two wars at once. China’s doing that. They have devalued the yuan from around six to the dollar to seven to the dollar in about seven months. That’s a big devaluation of almost 20% devaluation.
I’ll explain how the math works. Let’s say China has a product they sell for $100 into the U.S. Trump slaps on a 25% tariff, and all of a sudden it’s $125 to the U.S. buyer accounting for the 25% tariff. Then China devalues the currency 20%, which lowers the unit labor cost, so the price goes down to $80. Slap the 25% tariff on, and now you're back to $100, which is where you started.
The money gets divided differently. The Chinese manufacturer has to pay the tariff, but they take it out of the hides of their workers, and now their currency’s not worth as much.
They don't cut their pay; they’re paid the same amount in yuan, but it’s just it’s been devalued 20% or 25%. Trade wars are fought using the currency wars when you don’t have enough trade war tools. That’s already been going on and goes back to the point about Trump getting ready to call them out on the currency wars again.
But this is even bigger than that. Go to Mike Pence’s speech a few weeks ago that they’re now calling the Pence Doctrine, which I think is interesting, because Trump is president. The Pence Doctrine basically says, “We have a currency war, a trade war, theft of intellectual property, and penalties, but this is all part of a much bigger struggle for supremacy in the 21st century. We’re not going to let China dominate 5G, and we’re not going to let China buy U.S. companies.”
I used to say you couldn’t buy IBM, but you could buy an ice cream company. Now I'm not so sure about the ice cream company. They seem to be shutting China out of everything. Huawei can just lose our number, because they're not going to sell anything in the United States and they're starting to get kicked out of other countries in the sense that they won't buy their stuff either because of all the trapdoors, backdoors, and stolen technology we mentioned.
Add in the South China Sea, freedom of navigation, and relations with Japan. There's a whole long list of things that go way beyond economics. Some critics have described it as a new cold war, and I think that’s not far from the case. Those are all additional reasons why the trade war is not going to be over, because it’s part of a bigger war that’s far from over.
They're going to have dinner, maybe or maybe not smile for the cameras, but the idea that it’s going to be any big breakthrough is a stretch. That means on Monday, we could expect a very negative reaction from the stock market.
Alex: Jim, we haven't talked about the Fed in a long time. It’s been a number of podcasts we've gone through mostly hitting geopolitics, some gold, etc., but how about an update on what the Fed is up to and what we could look forward to from them for the next quarter or so?
Jim: One reason we haven't discussed the Fed is until a couple of days ago, they weren’t doing anything. You know my Fed model, and I want to emphasize that my Fed model comes from the Fed. I think about this stuff all the time.
I don’t mind talking to people who sit in the room, whether it’s Powell or Yellen or Bernanke, but I have one source in particular who is the most informed, influential, and highly-placed source inside the Fed other than the chairman. He's not a governor or the chairman, but he sits two doors down and does all the wordsmithing, all the descriptions, all the orchestration behind the policies and therefore has to understand the policies better than anyone else.
He explained this to me, and it’s simple. I have no idea why the markets don’t get it, why more people don’t write about it or talk about it, but I’ve had very good forecasting results as an outcome of seeing this.
The Fed is out to raise interest rates four times a year, 25 basis points each time, every March, June, September, and December like clockwork. That’s the baseline. Just four times a year, 25 basis points each time, until they get to about 3.5% or maybe higher depending on conditions, so 3.5%-4%.
They’ve never said this publicly, but the reason they're doing it is because they want to get interest rates high enough so that when the next recession comes, they can cut them enough to get out of the recession. The research is clear. Larry Summers and others have done a lot of this. That number is about 4%.
How are you going to cut rates 4% to get out of a recession if you're at 2.25%? The answer is you can't. If we hit a recession tomorrow, they would cut 2.25%, hit zero, and be in the same situation Bernanke found himself in in 2008.
Now what do they do? They cut anymore, but if they don’t cut, they can't get out of the recession. The answer is QE4 or QE5, but they don’t want to go there. They will if they have to, and they've said so, but they don’t want to go there. What they do want to do is get rates to 4% so they can cut 4% and get out of the recession without going to QE4.
That’s what they're doing and why they're doing it. Notice that nothing I just said has anything to do with the “neutral” rate. Neutral rate is, first of all, an invention. It’s one of those egghead theories nobody can quite pin down, so there's widespread disagreement over what the neutral rate is.
I say if you can't even agree on what the neutral rate is, have you thought about the fact that maybe there is no such thing as a neutral rate? Maybe there are too many factors too intertwined from a complexity perspective that anything such as the neutral rate, even in theory, doesn’t really mean anything. There are too many other things such as psychology, velocity, and labor force participation to pin it on one thing.
The recent big stock market rally was up 600 points. What was that all about? It was about a speech Jay Powell gave to the Economic Club of New York when he said, “We’re very close to the neutral rate.”
If neutral rate means, like Goldilocks, it’s not too hot, not too cold, but just the exact rate needed to maintain economic growth without stalling the economy or giving it too much juice (as if there was such a thing), Wall Street said, “If he's close to the neutral rate and gets to the neutral rate, he's going to stop raising rates. That’s sooner than we thought, because the last time Powell said something about this, which was a few months ago, he said we’re really far from the neutral rate.” But that was off the cuff. That was not a prepared speech or one that my friend had written.
So he says we’re really far from the neutral rate and markets go, “Oh, man, he's going to be raising rates forever,” and then this week he said we’re really close to the neutral rate. Well, that was nothing more than a do-over. That was just Jay Powell correcting in a formal setting something that he said off-handedly and probably got wrong the first time. Remember, Powell’s a lawyer, not an economist, so he doesn’t have this in his DNA.
By the way, I read the speech before he was done delivering it, and 80% was about risk management having nothing to do with interest rate policy. This little blurb was in there on the front, so the market said, “He's going to stop raising rates. We thought it would take longer, and therefore, the rate is going to be lower, he's a dove, discount factors are lower, so stocks go up.” Then they slept on it and said, “Maybe that’s not what he meant.”
What I'm telling you is it is not what he meant. He may have meant that, but that has no bearing on interest rate policy. The idea that they're going to stop at 2.5% or 2.75%, because that’s the theoretical neutral rate, is nonsense. They're going to go to 3.5%-4% for the reason I mentioned.
They pause for reasons that have nothing to do with the neutral rate. They pause if there is a severe stock market crash, job losses or extreme disinflation. Look for those three things. If you see one, certainly if you see two of them, they're going to pause. But if you don’t, they're going to keep raising until they get to 3.5%-4%.
The market is slow to realize that, but they will. If you combine the delayed reaction to higher rates than they thought, plus a bad outcome at Buenos Aires in G20, those are two major headwinds for stocks at least in the weeks ahead.
Alex: Very good. For those of you who have been looking for another update on the Fed, there you have it.
That wraps up our time today. Jim, I want to thank you, as usual, for participating. What a great discussion. I think we covered some really good material.
Jim: Thank you very much, Alex.
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