Financial Warfare Is Real

In my 2011 book, Currency Wars, I gave a detailed description of the first-ever financial war game sponsored by the Department of Defense. This financial war game took place in 2009 at the top-secret Applied Physics Laboratory located about twenty miles north of Washington, D.C., in the Maryland countryside.

Unlike typical war games, the “rules of engagement” for this financial exercise did not permit the use of any kinetic weapons such as bombs, missiles or drones. The only weapons allowed were financial instruments including stocks, bonds, currencies, commodities and derivatives.

The game was played out over two days in the main War Room of the laboratory using six teams divided into the U.S., China, Russia, Europe, East Asia, and Banks & Hedge Funds. The contestants included about 40 players on the six teams and another 60 participants including: uniformed military, civilian defense officials, observers from the Treasury, Federal Reserve, CIA and other government agencies, think tanks, universities, and financial industry professionals.

In that original financial war game, a scenario involving Russia, China, gold and the destruction of the U.S. dollar was played out against a backdrop of geopolitical events, including the collapse of North Korea and a threatened Chinese invasion of Taiwan.

In May 2015, the Pentagon sponsored a new financial warfare session, which I was also invited to attend. This time the financial war took place inside a secure meeting facility at the Pentagon itself.

This new financial war game exercise was smaller and more focused than the one in 2009. We had about 20 participants. Our group included representatives from the diplomatic corps, military, think tanks, universities, CIA and the National Security Council. I was one of three individuals from the investment management community.

Our scenario this time was not global but was instead limited to a confrontation between China and the U.S. involving disputed jurisdiction in the South China Sea.

Six nations have claims in the South China Sea – China, Taiwan, Philippines, Malaysia, Vietnam and Brunei. These claims overlap to a great extent, setting the stage for disputes and possible war.

The South China Sea is rich in oil, natural gas reserves, fishing rights and other natural resources. The surrounding nations dispute with certain island groups – the Spratly Islands and the Paracel Islands – and are also using reefs, sunken vessels and landfill to create artificial islands, which they are populating with bases and military garrisons.

The U.S. has treaty obligations to the Philippines and Taiwan, which could result in the U.S. becoming engaged militarily in the event of a dispute with China. This volatile mix of disputed claims, natural resources and complex treaty networks has the ingredients needed to escalate into a Third World War.

All it would take to start a war is some spark, such as a collision at sea or an attack based on mistaken identity or misunderstood intentions. The occurrence of such a war is likely inevitable.

Our role was not to contemplate the use of aircraft carriers, submarines or missiles in such a confrontation. We were there to consider the use of financial weapons such as disruption of payments systems, cyber-attacks on banks and stock exchanges, and trade sanctions that could cut off supply chains and dry up energy imports.

One of the main topics of discussion was the use of sanctions involving access to the Society of Worldwide Interbank Financial Telecommunication, known as SWIFT. Contrary to the assumptions of many, SWIFT is not a bank or a financial institution itself. It is more like a phone company or internet service provider that facilitates communication among its members.

SWIFT has over 10,500 banks and asset managers as members and handles over 5 billion messages each year, amounting to trillions of dollars of payments from one member to another. SWIFT message traffic is literally the oxygen supply that keeps the global financial system alive.

In 2012, the U.S. and its allies successfully kicked Iranian banks out of the SWIFT system. This was extremely damaging to the Iranian economy and led to hyperinflation, bank runs, instability and social unrest until President Obama eased these sanctions in late 2013.

In our new financial war game, we asked, what would happen if the roles were reversed? Instead of the U.S. banning its enemies from SWIFT, what if China tried to “de-SWIFT” Taiwan or the Philippines? What if financial weapons developed by the U.S. were adopted by China and turned against the U.S. and its allies?

These and other interesting scenarios made for a long and lively day of discussions among our team of experts convened for this exercise in twenty-first-century warfare.

I learned two lessons that day. The first is that when nations engage in financial warfare, individual investors can be collateral damage.

The most dangerous attacks of all are those in which the enemy penetrates a bank or stock exchange, not to disable it or steal information, but to turn it into an enemy drone. Such a market drone can be used by attackers for maximum market disruption and the mass destruction of Americans’ wealth, including stocks and savings.

In this scenario, an attacker could penetrate the order entry system of a major stock exchange, such as the New York Stock Exchange, and place large sell orders on highly liquid stocks such as Amazon or Facebook.

If China tries to attack the U.S. by closing the New York Stock Exchange, it will be tens of millions of Americans who will suffer an immediate loss of wealth as prices plunge and accounts are locked-down or frozen.

I recommended that the SEC and New York Stock Exchange buy a warehouse in New York and equip it with copper wire hardline phones, hand-held battery-powered calculators and other pre-Internet equipment. This facility would serve as a non-digital stock exchange with trading posts.

The SEC would assign 30 major stocks each to the 20 largest broker-dealers, who would be designated specialists in those stocks. This would provide market-making on the 600 largest stocks, covering over 90% of all trading on a typical day.

Orders would be phoned in on the hardwire, analog phone system and put up for bids and offers by the specialists to a crowd of live brokers. This is exactly how stocks were traded until recently. Computerized and algorithmic trading would be banned as nonessential. Only real investor interest would be represented in this non-digital venue.

In the event of a shutdown of the New York Stock Exchange by a digital attack, the non-digital exchange would be activated. The U.S. would let China and Russia know this facility existed as a deterrent to a digital attack in the first place. If our rivals knew we had a robust, non-digital Plan B, they might not bother to conduct a digital attack in the first place.

The second lesson I learned was that future wars will be fought in cyberspace using digital technology applied to payments systems such as SWIFT, FedWire, MasterCard, Visa and Europe’s Target2 system.

The answer to both threats – collateral damage and digital warfare – is to have some hard assets in physical form that cannot be attacked digitally. These include physical gold and silver, land and fine art. These are the things that cannot be erased in a digital attack or frozen when payment systems are disrupted.


Jim Rickards
for The Daily Reckoning

The Daily Reckoning