Currency Wars: The Making of the Next Global Crisis (2 page)
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Authors: James Rickards
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BOOK: Currency Wars: The Making of the Next Global Crisis
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Worse yet, none of this happens in a vacuum. If the Fed’s policy manipulations were limited to the U.S. economy, that would be one thing, but they are not. The effects of printing dollars are global; by engaging in quantitative easing, the Fed has effectively declared currency war on the world. Many of the feared effects of Fed policy in the United States are already appearing overseas. Printing dollars at home means higher inflation in China, higher food prices in Egypt and stock bubbles in Brazil. Printing money means that U.S. debt is devalued so foreign creditors get paid back in cheaper dollars. The devaluation means higher unemployment in developing economies as their exports become more expensive for Americans. The resulting inflation also means higher prices for inputs needed in developing economies like copper, corn, oil and wheat. Foreign countries have begun to fight back against U.S.-caused inflation through subsidies, tariffs and capital controls; the currency war is expanding fast.
While Fed money printing on a trillion-dollar scale may be new, currency wars are not. Currency wars have been fought before—twice in the twentieth century alone—and they always end badly. At best, currency wars offer the sorry spectacle of countries stealing growth from trading partners. At worst, they degenerate into sequential bouts of inflation, recession, retaliation and actual violence as the scramble for resources leads to invasion and war. The historical precedents are sobering enough, but the dangers today are even greater, exponentially increased by the scale and complexity of financial linkages throughout the world.
Baffling to many observers is the rank failure of economists to foresee or prevent the economic catastrophes of recent years. Not only have their theories failed to prevent calamity, they are making the currency wars worse. The economists’ latest solutions—such as the global currency called the SDR—present hidden new dangers while resolving none of the current dilemmas.
Among the new dangers are threats not just to America’s economic well-being but to our national security as well. As national security experts examine currency issues traditionally left to the Treasury, new threats continually come into focus, from clandestine gold purchases by China to the hidden agendas of sovereign wealth funds. Greater than any single threat is the ultimate danger of the collapse of the dollar itself. Senior military and intelligence officials have now come to the realization that America’s unique military predominance can be maintained only with an equally unique and predominant role for the dollar. If the dollar falls, America’s national security falls with it.
While the outcome of the current currency war is not yet certain, some version of the worst-case scenario is almost inevitable if U.S. and world economic leaders fail to learn from the mistakes of their predecessors. This book examines our current currency war through the lens of economic policy, national security and historical precedent. It untangles the web of failed paradigms, wishful thinking and arrogance driving current public policy and points the way toward a more informed and effective course of action. In the end, the reader will understand why the new currency war is the most meaningful struggle in the world today—the one struggle that determines the outcome of all others.
PART ONE
WAR GAMES
CHAPTER 1
Prewar
“The current international currency system is the product of the past.”
Hu Jintao,
General Secretary of the Communist Party of China,
January 16, 2011
General Secretary of the Communist Party of China,
January 16, 2011
T
he Applied Physics Laboratory, located on four hundred acres of former farmland about halfway between Baltimore and Washington, D.C., is one of the crown jewels of America’s system of top secret, high-tech applied physics and weapons research facilities. It operates in close coordination with the Department of Defense, and its specialties include advanced weaponry and deep space exploration. Lab officials are proud to tell visitors that the earth’s moon and every planet in the solar system has a device developed at APL either on its surface or passing nearby.
he Applied Physics Laboratory, located on four hundred acres of former farmland about halfway between Baltimore and Washington, D.C., is one of the crown jewels of America’s system of top secret, high-tech applied physics and weapons research facilities. It operates in close coordination with the Department of Defense, and its specialties include advanced weaponry and deep space exploration. Lab officials are proud to tell visitors that the earth’s moon and every planet in the solar system has a device developed at APL either on its surface or passing nearby.
The Applied Physics Lab was set up in haste in 1942, shortly after the Pearl Harbor attack, to bring applied science to the problem of improving weaponry. Much of what the U.S. military was using in the early days of World War II was either obsolete or ineffective. The lab was originally housed in a former used-car dealership, requisitioned by the War Department, on Georgia Avenue in Silver Spring, Maryland. It operated in secrecy from the start, although in the early days the secrecy was enforced with just a few armed guards rather than the elaborate sensors and multiple security perimeters used today. APL’s first mission was to develop the variable time, or VT, proximity fuse, an antiaircraft fuse used to defend naval vessels from air attack, later regarded, along with the atomic bomb and radar, as one of the three greatest technology contributions to U.S. victory in World War II. Based on this initial success, APL’s programs, budget and facilities have been expanding ever since. The Tomahawk cruise missile, Aegis missile defense and one-of-a-kind spacecraft are among the many advanced weapons and space systems developed for the Defense Department and NASA by APL in recent decades.
In addition to weapons and space exploration, there has always been a strong intellectual and strategic side to what the Applied Physics Laboratory does for the military. Preeminent among these more abstract functions is the lab’s Warfare Analysis Laboratory, one of the leading venues for war games and strategic planning in the country. The lab’s proximity to Washington, D.C., makes it a favorite for war-fighting simulations and it has played host to many such games over the decades. It was for this purpose, the conduct of a war game sponsored by the Pentagon, that about sixty experts from the military, intelligence and academic communities arrived at APL on a rainy morning in the late winter of 2009. This war game was to be different from any other that had ever been conducted by the military. The rules of engagement prohibited what the military calls kinetic methods—things that shoot or explode. There would be no amphibious invasions, no special forces, no armored flanking maneuvers. Instead the only weapons allowed would be financial—currencies, stocks, bonds and derivatives. The Pentagon was about to launch a global financial war using currencies and capital markets instead of ships and planes.
At the dawn of the twenty-first century, U.S. military dominance in conventional and advanced high-tech weapons systems and in what the military calls 4CI, for command, control, communications, computers and intelligence, had become so great that no rival nation would dare confront her. This does not mean wars are impossible. A rogue nation such as North Korea might escalate an incident into a major attack without heed to the consequences. The United States might be drawn into a war involving others such as Iran and Israel if U.S. national interests were affected. Apart from these special situations, a conventional military confrontation with the United States seems highly unlikely because of the United States’ ability to suppress and ultimately decimate the opposing side. As a result, rival nations and transnational actors such as jihadists have increasingly developed capabilities in unconventional warfare, which can include cyberwarfare, biological or chemical weapons, other weapons of mass destruction or now, in the most unexpected twist of all, financial weapons. The financial war game was the Pentagon’s first effort to see how an actual financial war might evolve and to see what lessons might be learned.
The war game had been many months in the making, and I had been part of the strategy sessions and game design that preceded the actual game. Although a well-designed war game will try to achieve unexpected results and simulate the fog of real war, it nevertheless requires some starting place and a set of rules in order to avoid descending into chaos. APL’s game design team was among the best in the world at this, but a financial game required some completely new approaches, including access to Wall Street expertise, which the typical physicist or military planner does not have. My role was to fill that gap.
My association with the lab started in December 2006 in Omaha, Nebraska, where I was attending a strategy forum hosted by U.S. Strategic Command, or STRATCOM. I presented a paper on the new science of market intelligence, or what intelligence experts call MARKINT, which involves analyzing capital markets to find actionable intelligence on the intentions of market participants. Hedge funds and investment banks had been using these methods for years to gain information advantage on takeovers and government policy shifts. Now, along with my partners, Chris Ray, a seasoned options trader and risk manager, and Randy Tauss, recently retired after thirty-five years with the CIA, we had developed new ways to use these techniques in the national security realm to identify potential terrorist attacks in advance and to gain early warning of attacks on the U.S. dollar. Several members of the APL Warfare Analysis Lab had been in attendance at the Omaha event and later contacted me about ways we might work together to integrate MARKINT concepts with their own research.
So it was not a surprise when I received a call in the summer of 2008 to join a global financial seminar sponsored by the Office of the Secretary of Defense and hosted by APL. It was scheduled for that September, its stated purpose to “examine the impact of global financial activities on national security issues.” This was one of a series of such seminars planned by the Defense Department to be held throughout the late summer and fall of that year as preparation for the financial war game itself. Defense wanted to know if such a game was even possible—if it made sense. They needed to think about the appropriate “teams.” Would they be countries, sovereign wealth funds, banks or some combination? They also needed to think about remote but still plausible scenarios for the players to enact. A list of expert participants had to be developed and some recruitment might be needed to reach out to those who had not been involved with war games before. Finally, rules had to be established for the actual play.
To protect the top secret work that goes on inside the lab, the security procedures for visitors there are as strict as at any U.S. government defense or intelligence installation, starting with advance clearance and background checks. Upon arrival, visitors are quickly sorted into two categories, “No Escort” or “Escort Required,” reflected in different-colored badges. The practical impact of this has mainly to do with trips to the coffee machine, but the implicit understanding is that those with the No Escort badges hold current high-security clearances from their home directorates or government contractors. BlackBerrys, iPhones and other digital devices have to be deposited at the security desk to be retrieved upon departure. X-ray scanners, metal detectors, multiple security perimeters and armed guards are routine. Once inside, you are truly in the bubble of the military-intelligence complex.
At the September meeting, there were about forty attendees in total, including a number of distinguished academics, think tank experts, intelligence officials and uniformed military. I was one of five asked to give a formal presentation that day, and my topic was sovereign wealth funds, or SWFs. Sovereign wealth funds are huge investment pools established by governments to invest their excess reserves, many with assets in the hundred-billion-dollar range or higher. The reserves are basically hard currency surpluses, mostly dollars, which governments have earned by exporting natural resources or manufactured goods. The largest reserves are held by oil-producing countries such as Norway or Arab states and by manufacturing export powerhouses such as China or Taiwan. Traditionally these reserves were managed by the central banks of those countries in a highly conservative manner; investments were limited to low-risk, liquid instruments such as U.S. Treasury bills. This strategy offered liquidity but did not provide much income, and it tended to concentrate a large amount of the portfolio in just one type of investment. In effect, the surplus countries were placing all their eggs in one basket and not getting very much in return. Because of the drastic increase in the size of reserves beginning in the 1990s, partly as the result of globalization, surplus countries began to seek out ways of getting higher returns on their investments. Central banks were not well equipped to do this because they lacked the investment staff and portfolio managers needed to select stocks, commodities, private equity, real estate and hedge funds, which were the key to higher returns. So the sovereign wealth funds began to emerge to better manage these investments; the earliest SWFs were created some decades ago, but most have come into being in the past ten years, with their government sponsors giving them enormous allocations from their central bank reserves with a mandate to build diversified portfolios of investments from around the world.
In their basic form, sovereign wealth funds do make economic sense. Most assets are invested professionally and contain no hidden political agenda, but this is not always the case. Some purchases are vanity projects, such as Middle Eastern investments in the McLaren, Aston Martin and Ferrari Formula 1 racing teams, while other investments are far more politically and economically consequential. During the first part of the depression that began in 2007, sovereign wealth funds were the primary source of bailout money. In late 2007 and early 2008, SWFs invested over $58 billion to prop up Citigroup, Merrill Lynch, UBS and Morgan Stanley. China was considering an additional $1 billion investment in Bear Stearns in early 2008 that was abandoned only when Bear Stearns neared collapse in March of that year. When these investments were decimated in the Panic of 2008 the U.S. government had to step in with taxpayer money to continue the bailouts. The sovereign wealth funds lost vast fortunes on these early investments, yet the stock positions and the influence that came with them remained.
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