Rickards: "Euro Creators Want to Force Common Fiscal Control"

The Greek crisis is no accident, says Jim Rickards, but is part of a long-running plan to bring Europe under central control.

Jim was general council at Long-Term Capital Management, a hedge fund that made massively levered bets in the late 90’s and eventually went south, exposing banks to over $1 trillion in potential losses. He was involved in negotiating a bailout in the aftermath.

The CIA has called on Jim to help investigate how stock markets might indicate impending threats.

He’s the author of Currency Wars and The Death of Money, and will be attending the Sprott-Stansberry Vancouver Natural Resource Symposium – which begins next week.

Jim has a new book, The Big Drop, available only to subscribers of his paid newsletter. You can find out more about it here.

What can Jim tell us about the Eurozone crisis and the outcome of Greece’s bailout talks?

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Henry Bonner: Jim, you were personally involved in negotiating the bailout of Long-Term Capital Management. Do you have any insights on the recent talks between Greece and the European Central Bank?

Jim Rickards: Yes, in all of these huge financial crises – whenever you are one of the responsible parties or on a team trying to negotiate a bailout – they all have certain things in common.

Of course, the amounts, the creditors, and the borrowers vary from case to case. Whether it was the bailout of LTCM in 1998, the rescue of Lehman Brothers, Bear Stearns or AIG in 2008, or the bailout of Greece in 2015, there are particularities but they all have similar dynamics.

Part of the dynamic is that it’s very, very difficult. People tend to work around the clock. Nerves get frayed. Tempers get short. But why do they keep going? Generally, the consequences of failure are much greater than the unpleasantness of powering through.

It’s difficult, but you’re very cognizant of the fact that something catastrophic is waiting right around the corner. In 1998, at LTCM it was very clear.  The Fed Chairman Alan Greenspan and Treasury Secretary Bob Rubin later testified that markets around the world would have collapsed. I think that the same was true last Sunday night when Eurozone leaders met to bail out Greece. Prime Minister Tsipras, Angela Merkel, and President Fraçois Hollande of France were up all night, basically negotiating for 24 hours. Everyone is aware that if the negotiations had failed, it would have been a catastrophic outcome.

I definitely see some similarities and it brings back some memories.

Henry Bonner: Do you think it’s likely the deal made on Greece will end the crisis? Or is this likely to continue until Greece eventually wipes out its debts?

Jim Rickards: Well, it’s very clear that even though the situation is resolved for the time being, they will return to negotiations and discussions.

The point is that, just looking at the maturity schedule of Greek debt, it was very apparent a year ago that July 2015 was going to be a critical month. There were large maturities coming due to the European Central Bank and the IMF, and they just didn’t have the money.

Now, the European Central Bank has re-opened lending to the Central Bank of Greece. That enables it to lend money out to Greek banks and allows those banks to re-open. Things are stabilized for now, but it’s not over. There are going to be more maturities coming due in the future.

Still, they have about a year of breathing room now. What they want to do is to come up with a more permanent solution so that they don’t have to do this again. Every time we go through this, there is some risk that negotiations will fall apart, that Greece will leave the Eurozone, that markets will begin to suspect other countries of wanting to leave the Eurozone as well, and the whole European project will begin to unravel. So they want to avoid getting close to that as much as they can.

So, what is the long-term solution now?

Greece does not have to pay off all of its debts.  You don’t have to pay off all of your debts; you just have to make your debts sustainable.

Sustainability means that your economy is growing faster than the rate of interest. If your debts are constant and your income is going up, then you’re in better shape financially. But if your debts are growing and your income is going down, you’re probably going to end up in bankruptcy.

So, it’s not a matter of having to pay off your whole debt. It’s a matter of making it sustainable relative to your growth.

Right now, it’s not sustainable, but there are a couple of ways out of that. One way is to grow your way out of it, which is what Germany is trying to push. People call it austerity, but they’re really trying to cause a reform of labor markets, regulations, taxes, and so forth to make their economy more appealing. That’s an opportunity to attract more capital and bring about a higher-growth environment.

Another way to do it, which probably will be necessary, is to write off some of the debt. The IMF has said that they don’t want to take any losses. The ECB has said they don’t want to take any losses. That means that the losses would have to fall on the other lenders of the Eurozone.

Whether or not you have the financial wherewithal to do it, it becomes a political issue. Workers in Germany say: ‘Why should we be paying for Greek pensions?’

What I suspect is that the ECB will use the next year to try and resolve Greece in a way that makes it sustainable.

Henry Bonner: Do you see the current Greek crisis as a sign of mismanagement of the Eurozone overall? Is there some flaw in the common currency system, or with having a European central bank?

Jim Rickards: Well, I wouldn’t call it mismanagement. I would say that it’s a process that has some difficulties.

To be more specific, people point to this ‘flaw,’ saying ‘How can you have a common currency with a central bank on the one hand, but have separate finance ministries and fiscal policies on the other? How can you have one central bank and one currency when you’ve got 19 different policies?

‘Some countries could be prudent and run surpluses. Other countries could be profligate and accumulate deficits. It’s one thing to be profligate if you can print the money – the United States does that – but it’s another thing if you want to be profligate and you can’t print the money. And that’s how you end up like Greece.’

So the question is, well, ‘were they stupid? Why didn’t they think of that?’

Well let’s go back to the 1990’s, when all this was being worked on. They signed the treaty in 1992 but the Euro itself was not officially launched until 2000. So it really took 8 years to design this system and they had a lot of smart people involved. I knew some of them.

So the point is that the people designing it understood that there was a flaw. But they decided to go along with it, knowing that there would probably be a crisis. And the crisis would be a great catalyst to force the other half of their project to get done.

The prospect of a situation like Greece happening was always known.

There was the idea that it would be a ‘forcing strategy’ for a unified fiscal policy. There was no appetite in 1992 for a unified fiscal policy. There was appetite for a common currency, though. So, they thought, ‘let’s get one foot in the water and then figure out how to get the other foot in.’

The weakness was known from the start, and the theory was that you could use that to potentially force everyone into a unified fiscal policy.

We’re getting closer to that now. Greece now has to run its government according to German dictates. Greece has already outsourced its monetary policy to the European Central Bank, and now it’s sort of outsourced its fiscal policy to the German finance ministry. So you’re on a path to unified fiscal policy and ultimately the Eurobonds – bonds backed by full strength and credit of not just any one country but the entire Eurozone.

Germany did not want to unify the bond market until they got fiscal discipline across the board. So, rather than call it a flaw or mismanagement, I’d call it a multistep process where part of the process was done but some of the process was still occurring. So we’re on that path, but it’s a little bit choppier than a lot of people expected.

Henry Bonner: What is the most important issue for the world economy that you’re seeing now? What will you be telling attendees at the Vancouver Natural Resource Symposium this year?

Jim Rickards: I still think that the most important economic relationship in the world is the China-US relationship.

China and the United States have declared a truce in the currency wars. China has now unofficially pegged its currency to the US dollar at a rate of around 6.2:1. Although the Chinese economy is slowing down and China might want to juice its exports by depreciating the currency, it’s not doing that.

They’re on their best behavior, because there’s something else they want.

They want the Chinese Yuan included as part of the basket behind the IMF’s Special Drawing Rights (SDRs). China very badly wants to be included in the SDRs. I analogize it to being in a club – and China wants in.

Now, the US controls membership – we’re sort of the gatekeeper for that club. So, behind the scenes, we’re telling China, ‘if you want to be in the club, you have to act like a member. With regard to currency wars, that means no more currency manipulation. You have to peg your currency to the dollar.’ They’ve done this as a condition to getting in.

So there is a truce, but this is not the end of the currency wars. China has a history of being on their best behavior when they’re trying to join an organization. Take for example the World Trade Organization, where once they got in they began breaking the rules.

So I suspect that the currency wars between China and the US will come back next year. Meanwhile, China continues to accumulate gold. China has announced an increase in their gold holdings. I believe that the numbers they have shown are significant but not nearly as high as what they actually have.

So China is trying to look more like a normal country. One of the topics I’ll be talking about is the relationship between the Yuan and the Dollar, between China and gold, and ultimately the consequences for gold investors.

Henry Bonner: Is it very important to own gold now?

Jim Rickards: I think it’s always very important to own gold. I’ve recommended that investors have about 10% of their portfolio in the yellow metal.

I don’t think investors should go ‘all in’ on gold. If things just continue the way they are, with only a 10% allocation you won’t be hurt that badly, assuming gold continues to go down.

If I’m right and some catastrophic event is on the horizon, then that 10% would be your portfolio insurance.

I don’t like ‘paper gold’ – like futures, ETFs, or un-allocated gold storage from the London Bullion Market. These products allow the counter-parties to terminate the agreement by giving the investor a dollar value of their gains. But that would deprive you of any future gains. You might get cashed out just as the crisis was beginning and not be able to participate in the upside as the crises worsened.

The other reason to own physical gold, which I’ll also be talking about in Vancouver, is the prevalence of cyber-warfare.

Physical gold is a non-digital asset. You can’t attack it with cyber-warfare, so I think it has another insurance function for investors there. I look forward to talking about that in Vancouver also.

Henry Bonner: Thanks a lot Jim – see you in Vancouver.


Henry Bonner
for The Daily Reckoning

P.S. The Sprott-Stansberry Vancouver Natural Resource Symposium kicks off next week. We’ve arranged for you to listen in on every word that’s said, right here.