Editor’s Note: This is our second review of the book Currency Wars by James Rickards, a counselor, investment banker, risk manager, and an advisor to the Department of Defense, U.S. Intelligence Community & global hedge funds. Our first review was published on December 10, 2011 under the title, Avalanches, Nuclear Reactors & Financial Markets – A Complexity Theory View by James Rickards
This is a period of intense turmoil in financial markets. The origin of the turmoil has been and remains the European Monetary Union. This
week, the Euro broke down. It has already fallen by 12% from its summer
highs. Forecasters predict another 10% decline against the dollar in
the first quarter of 2012. Gold broke down as well this week.
The collateral damage is going global. Recently, the Indian Rupee fell
in a steep vertical decline against the U.S. Dollar from about 44 to 53,
a 20% drop. All emerging market countries are beginning to see flight of capital and loss of wealth. Stories abound of wealthy Chinese trying desperately to leave China to migrate to Vancouver, Sydney, Tampa, essentially wherever they can move with their money. China appears to be headed towards a hard landing.
In this turmoil, the U.S. Dollar stands tall and firm, a veritable mountain of strength. This is why the U.S. Dollar gets massive inflows of capital from all over the world. This is a good thing, because financial stability demands the existence of at least one risk-free asset in the world. That is the U.S. Treasury market and underlying that is the U.S. Dollar.
If the US remains the solitary bastion of safety in a turbulent financial world, then one can see a time when a large portion of the world’s capital becomes resident in the U.S. Dollar. This would be the classic case of everyone piling on one side of a large boat.
This could be when the U.S. financial system, Treasuries, Stocks & Dollar, reaches a critical stage, or the state in which the U.S. financial system becomes vulnerable to a Phase Transition in the jargon of Complexity Theory.
This is when even a small event can begin a chain reaction within the U.S. Financial System, just like a small snowfall or a single snowflake can cause an avalanche.
Jim Rickards describes such an avalanche, a phase transition, otherwise known as a catastrophe, in the Section titled Chaos in Chapter 11 of his book Currency Wars.
Mr. Rickards begins the section with:
- Perhaps the most likely outcome of the currency wars and the debasement of the dollar is a chaotic, catastrophic collapse of investor confidence resulting in emergency measures by governments to maintain some semblance of a functioning system of money, trade and investment.
He then describes in detail (about two pages long) how a financial catastrophe can begin with a small trigger, then gain speed & mass to become a huge chain reaction that causes a global financial meltdown in just 2 days. He describes how all measures by government agencies to stop the meltdown, the Fed., the U.S. Treasury, global central banks, end up like pouring gasoline on the fire.
- As the panic courses through Europe for the second day, all eyes slowly turn to the White House. A dollar collapse is tantamount to a loss of faith in the United States itself. The Fed and the Treasury have been overwhelmed and now only the president of the United States can recover confidence.
Frankly, much of the above has been written and discussed for years. A large constituency in America and the World is expecting this, expecting a collapse of the United States in a cauldron of financial inferno.
But they will be disappointed. Because, the United States does not break down. Instead, in the scenario depicted by Jim Rickards, the United States emerges as the center of the next global financial system.
This scenario is the reason for this article. It is based on a financial “nuclear” weapon the president of the United States has. The weapon is IEEPA.
What is IEEPA?
The acronym stands for International Emergency Economic Powers Act of 1977. Jim Rickards calls it “a little-known nuclear option of immense power“. He writes:
- …IEEPA, passed during the Carter Administration as an updated version of the 1917 Trading with the Enemy Act. President Franklin Roosevelt had used the Trading with the Enemy Act to close banks and confiscate gold in 1933.
The use of IEEPA is subject to two preconditions, as Jim Rickards tells us:
- There must be a threat to the national security or the economy of the United States, and
- the threat must originate from abroad.
There is some after-the-fact notification to Congress, but in general the president possesses near dictatorial powers to respond to a national emergency.
An Executive Order by the President of the United States under IEEPA
At 6:00 p.m. New York time on day two of the global dollar panic depicted by Jim Rickards, the president gives a live address to an anxious world audience and issues an executive order consisting of the following actions, all effective immediately:
- The president will appoint a bipartisan commission consisting of seasoned veterans of capital markets and “eminent economists” to study the panic and make suitable recommendations for reform within 30 days.
- All private and foreign-owned gold held in custody at the Federal Reserve Bank of New York or depositories such as the HSBC and Scotiabank vaults in New York will be converted to the ownership of the U.S. Treasury and transferred to the U.S. gold depository at West Point. Former owners will receive suitable compensation, to be determined at a later time.
- All transfers of foreign holdings of U.S. Treasury obligations held in electronic book entry in the system maintained by the Federal Reserve will be suspended immediately. Holders will receive interest and principal as agreed but no sale or transfers will be allowed.
- All financial institutions will record U.S. Treasury obligations on their book at par value and such securities will be held to maturity.
- Financial institutions and the Federal Reserve will coordinate efforts to purchase all new issuance of U.S. Treasury obligations in order to continue the smooth financing of U.S. deficits and the refinancing or redemption of any outstanding obligations.
- Stock exchanges will close immediately and remain closed until further notice.
- All exports of gold from the United States are prohibited.
This interim plan would stop the immediate crash in the Treasury bond market by freezing most holders in place and mandating future purchases by the banks. It would not offer a permanent solution and would at most buy a few weeks’ time within which to develop more lasting solutions.
The Long Term Result
The real result of this exercise according to Jim Rickards argues:
- Now the hidden strength of the U.S. financial position would be revealed. By confiscating foreign official and most private gold on U.S. soil, the Treasury would now possess over seventeen thousand tons of gold, equal to 57% of all official gold reserves in the world. This would put the United States in about the same relative position it held in 1945 just after Bretton woods, when it controlled 63% of all official gold.
What would this mean?
- Such a hoard would enable the United States to do what it did at Bretton Woods – dictate the shape of the new global financial system.
This is the new financial version of the old British cry – The King is Dead, Long Live the King. In this case,
- The United States could declare the issuance of a “New United States Dollar” equal to ten old dollars.
This would not just be a name change or a reverse split like Citibank exchanging 10 old shares for one new share worth 10 times as much. The New United States Dollar would be backed by gold. In this Rickards scenario,
- The new dollar would be convertible into gold at the price of 1,000 new dollars per ounce. Or equal to 10,000 old dollars per ounce of gold under the old dollar system.
This is clearly a devaluation of the old dollar. The strange part is that this devaluation would be par for the course for the USA and for the world:
- This would represent an 85% devaluation of the dollar when measured against the market price of gold in April 2011, and would be slightly greater than the 70% devaluation against gold engineered by FDR in 1933, but not of a different order of magnitude. It would be far less than the 95% dollar devaluation measured in gold that occurred under Nixon, Ford and Carter from 1971 to 1980.
The irony is that such a massive devaluation would not be harmful to the New U.S, Dollar. Instead, Jim Rickards argues:
- Because of its gold backing, the New United States Dollar would be the only desirable currency in the world – the ultimate victor in the currency wars.
This would be the New King Dollar, the currency that would rule as the center of the financial universe.
What about other countries? What about global trade?
Jim Rickards suggests:
- The United States would then pledge generous concessionary loans and grants to Europe and China to provide liquidity to facilitate world trade, much as it had done under the Marshall Plan. Gradually, those parties whose gold had been confiscated, mostly European countries, would be allowed to buy back their gold at the new, higher prices.
- Confidence would slowly be restored, markets would reopen, new prices for goods and services would be discovered and life would continue with a New King Dollar at the center of the financial universe.
What makes this Scenario feasible? – our own view
There is no other country on earth that could do this or get away with this. In contrast, the United States has already done this twice in the past, in the Roosevelt Administration and in the Nixon Administration in 1971. We think it is eminently feasible for the United States to do this again, at least in the next 10 years or so:
- No other country on earth has the broad, deep and flexible financial system that the United States has. We witness the real problems, the deep fissures and the utter rigidity of Europe’s financial system every day. China’s financial system is both non-existent globally and deeply troubled internally. The United States is the only country capable of building the next version of the global financial system, obviously on its own terms first and later on favorable terms for its allies.
- Europe will go along after vociferous protests as it did in the 1970s. Europe demonstrates every day, every week that it cannot function on its own. A system established by the United States and accepted by Europe would become the de facto global system. China, which depends on exports to Europe and America, will have no real choice but to go along.
Then there is that unspoken foundation of American power – the global dominance of the U.S. Military:
- Today, even more so than in the 1970s, the United States military is the predominant global power in the world. It is also the one military capable of projecting its power in all corners of the world. China, by its own admission, will not come close to matching the US militarily in the next 10 years.
The reserve currency of the world has always been the currency of the predominant global military power. The United States Military has been that power and will remain so for the near future.
This is why, in our opinion, his scenario of a New King Dollar is feasible.
An Alternative Scenario
The entry of China and Russia into the global financial system is relatively new. Already, we hear of increasing unrest in China and we have begun to see protests in Russia. A global financial collapse and severe devaluations of currencies might lead severe unrest in other countries as well. These countries have a longer tradition of socialism, of nationalization of corporate entities in difficult times.
Jim Rickards considers this as another possible response to a dollar collapse:
- Another possible response…would be governmental intervention of a type that is far more extreme and coercive….Such coercion would more likely occur in Asia or Russia and may involve wholesale nationalization of capital stock and intellectual property, closed borders and redirection of productive capacity to domestic needs rather than export.
What would this do?
- The world would retreat into a set of semiautarkic zones and world trade would collapse. The result would be the opposite of globalization.
We think, most countries in the world would prefer the first scenario depic
ted by Jim Rickards rather than the second.
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