Currency Wars: The Making of the Next Global Crisis (23 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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Globalization emerged not through the initiation of any new policies but through the elimination of many old ones. From the end of World War II to the end of the Cold War, the world had been divided not only by the Iron Curtain separating the communist and capitalist spheres but also by restrictions imposed by capitalist countries themselves. These restrictions included capital controls that made it difficult to invest freely across borders and taxes that were imposed on cross-border payments made on investments. Stock markets limited membership to local firms and most banks were off-limits to foreign ownership. Courts and politicians tilted the playing field in favor of local favorites, and enforcement of intellectual property rights was spotty at best. The world was highly fragmented, discriminatory and costly for firms with international ambitions.
By the late 1990s, these costs and barriers had mostly been removed. Taxes were reduced or eliminated by treaties. Capital controls were relaxed, and it became easy to move funds into or out of particular markets. Labor mobility improved and enforcement of legal rights became more predictable. Stock exchanges deregulated and merged across borders to create global giants. The expansion of the European Union politically and economically created the world’s richest tariff-free market, and the launch of the euro eliminated countless currency conversions and their costs. Russia and China rose as protocapitalist societies eager to adopt many of the new global norms they saw emerging in Western countries. Economic and political walls were coming down while, at the same time, technology facilitated ease of communication and improved productivity. From the point of view of finance, the world was now borderless and moving quickly toward what legendary banker Walter Wriston had presciently called the twilight of sovereignty.
Infinite risk in a borderless world was the new condition of finance. Globalization increased the scale and interconnectedness of finance beyond what had ever existed. While issuance of bonds was traditionally limited by the use to which the borrower put the proceeds, derivatives had no such natural limit. They could be created in infinite amounts by mere reference to the underlying security on which they were based. The ability to sell Nevada subprime mortgage loans to German regional banks after the loans had been bundled, sliced, repackaged and wrapped with worthless triple-A ratings was a wonder of the age.
In a globalized world, what was old was new again. A first age of globalization had occurred from 1880 to 1914, roughly contemporaneous with the classical gold standard, while the period from 1989 to 2007 was really the second age of globalization. In the first, the wonders were not the Internet or jets but radio, telephones and steamships. The British Empire operated an internal market and single-currency zone as vast as the European Union. In 1900, China was open to trade and investment, albeit on coercive terms, Russia had finally begun to throw off its late feudal model and modernize its industry and agriculture, and a unified Germany was becoming an industrial colossus.
The effect of such developments on finance was much the same at the turn of the twentieth century as at the turn of the twenty-first. Bonds could be issued by Argentina, underwritten in London and purchased in New York. Oil could be refined in California and shipped to Japan on credit provided by banks in Shanghai. The newly invented stock ticker brought near real-time information from the New York Stock Exchange to “wire house” brokerage offices in Kansas City and Denver. Financial panics with global repercussions did occur with some frequency, notably the Panic of 1890, involving South American defaults, and the rescue of the leading London bank, Baring Brothers. This first age of globalization was a time of prosperity, innovation, expanding trade and financial integration.
In August 1914, it all collapsed. A London banker, surveying the scene from the window of his City club early that summer and contemplating the pace of progress in his time, could not have imagined the run of tragedy that would ensue over the next seventy-five years. Two world wars, two currency wars, the fall of empires, the Great Depression, the Holocaust and the Cold War would pass before a new age of globalization began. In 2011, globalized finance is omnipresent; whether it is here to stay remains to be seen. History shows that civilization and the globalization it presents are no more than a thin veneer on the jagged edge of chaos.
State Capital
 
Globalization was not the only geopolitical phenomenon developing in the late twentieth century; state capitalism was another. State capitalism is the in-vogue name for a new version of mercantilism, the dominant economic model of the seventeenth through nineteenth centuries. Mercantilism is the antithesis of globalization. Its adherents rely on closed markets and closed capital accounts to achieve their goal of accumulating wealth at the expense of others.
Classical mercantilism rests on a set of principles that seem strange to modern ears. The main forms of wealth are tangible and found in land, commodities and gold. The acquisition of wealth is a zero-sum game in which wealth acquired by one nation comes at the expense of others. International economic conduct involves granting advantages to internal industries and imposing tariffs on foreign goods. Trading is done with friendly partners to the exclusion of rivals. Subsidies and discrimination are legitimate tools to achieve economic goals. In its most succinct form, the mercantilist takes the view that trade is war. Success in mercantilism was measured by the accumulation of gold.
Although mercantilism had its roots in the Hundred Years’ War of the fourteenth and fifteenth centuries, it reached new heights with the formation of the East India Company in England in 1600 and the Dutch East India Company in the Netherlands in 1602. While these companies operated as private stock companies, they were given wide-ranging monopolies supported by the power to raise armies, negotiate treaties, coin money, establish colonies and act in the place of the government in dealings in Asia, Africa and the Americas. Scholars have focused on the private features of these firms, such as stock ownership, dividends and boards of directors. However, given their quasi-sovereign powers, they are more properly understood as extensions of the sovereign with private owners and managers. This arrangement bears comparison to regional Federal Reserve Banks in the United States, which are privately owned but act as a financial arm of the government.
It was only in the late eighteenth century, with the industrial revolution and the publication of
The Wealth of Nations
by Adam Smith, that a more modern form of laissez-faire capitalism with private ownership and banking arose. Yet through the twentieth century, despite the success of private enterprise, state-controlled businesses still prevailed in societies dominated by communists, fascists, oligarchs and many other antidemocratic forces.
What we today take for granted as the dominant financial paradigm of private capitalist free enterprise and entrepreneurship is, in fact, exceptional in most times and most places. Private enterprise may have the greatest claim to efficiency and wealth creation, but these are not universally held values. Capitalism’s claim to dominance in the future of global trade, finance and technology would seem to have no stronger historical basis than the claims of monarchy, imperialism, communism and other systems in their day.
Companies that appear private but have nearly unlimited state resources behind them, such as China Petroleum and Chemical Corporation (known as Sinopec), are able to bid on natural resources, buy competitors and invest in equipment without regard to short-run financial impacts. They are able to gain market share by selling below cost. They do not have to worry about losing access to capital markets in times of economic distress. Such entities need not fear investigation by their own government if they bribe dictators and their troops to protect their interests. This neomercantilism is the power of the state dressed up as a modern corporation: old wine in new bottles.
Exemplars of this new breed of enterprise are sovereign wealth funds, national oil companies and other state-owned enterprises. These entities are plentiful in Russia, China, Brazil, Mexico and other emerging markets. Western Europe also has its state-owned megacorporations. EADS, the European aircraft, defense and space giant, has publicly traded shares but is majority owned by a consortium that includes French and Spanish government holding companies, a Russian state-controlled bank and Dubai Holding. The Italian oil company Eni, owned 30 percent by the state, is another example—just one among many. Americans are tempted to throw stones at these state-owned entities and call them unfair competition, only to be reminded that in 2008 the U.S. government bailed out Citibank, GE and Goldman Sachs. The United States has its own state-sponsored enterprises; it is really not that different.
To understand globalization and state capitalism, a different, non-U.S. perspective is needed. Intelligence analysts are trained to avoid “mirror imaging,” which is the tendency to assume that others see the world as we do. In trying to discern the intentions of adversaries, mirror imaging can be a fatal flaw. Threat analysis requires the analyst to put herself in the shoes of Russians, Chinese, Arabs and others to understand not just the differences in language, culture and history but also the differences in motivation and intent. When Russian leaders think of natural gas, they see not only export revenue but also a stranglehold on the industrial economy of Europe. When Chinese strategists consider their holdings of U.S. government bonds, they understand they have a weapon that can either destroy the U.S. economy or blow up in their faces. When Arab rulers move down the path to modernity, they are acutely aware that they are placing themselves in a reactionary and religious vise that can crush them. A twenty-first-century Grand Tour through Dubai, Moscow and Beijing will help us to see ourselves the way billions of Arabs, Asians and Russians see us—and to understand that the dollar’s destiny is not entirely in American hands.
Dubai
 
If
Casablanca
were filmed today, it would be called
Dubai
. The classic film centers around Rick’s Café Américain, where the owner, played by Humphrey Bogart, offers drinks, music and gambling, with intrigue on the side. The exotic setting was Morocco during World War II. What defined
Casablanca
was its neutral mélange where enemies could mingle at ease. Nazis, refugees and gunrunners sat at adjacent tables to drink champagne and sing “As Time Goes By.”
So it is in Dubai, an island of relative calm surrounded by wars in Afghanistan and Libya, instability in Iraq and Lebanon, transition in Tunisia and Egypt, and bitter enmity between Israel and Iran. It is the ultimate bad neighborhood. In place of Rick’s, there is Atlantis, an over-the-top resort on the artificial Palm Island, itself dredged from the seafloor and laid out in a palm shape so vast it can be seen from space. Inside Atlantis are the best restaurants in town, where Israeli agents, Iranian provocateurs, Russian hit men, Saudi arms dealers and local smugglers sit side by side, escorted by tall, leggy blondes who look distinctly out of place in the desert.
What they find in Dubai is what Rick’s customers found in Casablanca—neutral turf where they can meet, recruit and betray one another without immediate fear of arrest. Dubai is conducive to international intrigue. The weather is excellent from October through March. Dubai is in the midst of a danger zone, surrounded by Mumbai, Lahore, Tehran, Istanbul, Cairo, Khartoum and the pirate dens of Somalia. It has excellent air and telecommunications links with the world. It is famously overbuilt—it boasts the world’s tallest building and plenty of postmodern glitz to dazzle visitors from more traditional and repressive societies.
All this glamour and intrigue are also accompanied by some Hollywood-style violence. In March 2009, a Russian warlord was shot dead in the upscale Marina section of Dubai, near some of its best beaches and hotels. Two suspects, one Tajik and one Iranian, were arrested and gave confessions implicating a member of the Russian Duma acting on orders from the strongman of Chechnya, Ram-zan Kadyrov. In a touch straight out of Ian Fleming’s
The Man with the Golden Gun,
the victim was shot with a gold-plated pistol smuggled in by a Russian diplomat.
An even more spectacular murder took place in January 2010, when Israeli surveillance agents and hit men—working in teams, traveling on fake passports, wearing disguises and using heavily encrypted cell phones—assassinated Mahmoud al-Mabhouh, a senior Hamas operative, in his Dubai hotel room as he waited to complete an arms deal with his Iranian suppliers. Dubai has a low crime rate, but when it comes to terrorists with enemies, even the desert is not safe.
Historically Dubai thrived on two activities, pearl diving and smuggling. Today pearl diving is a small business carried on in part as an attraction for tourists. Smuggling is bigger than ever. The long wharf on the Creek, the old part of Dubai, is piled high with electronics, appliances, spare parts and other goods headed for Iran. The amount of gold and currency inside boxes marked with Sony or HP logos is anybody’s guess. Across Baniyas Road, which runs alongside the wharf, are Iranian banks where letters of credit can be arranged on the spot to finance the shipment of goods—without regard to U.S. trade sanctions. On the Creek itself are the dhows—beamy, high-prowed wooden sailing vessels with large lateen rigs ready to embark on the voyage across the Persian Gulf to Bandar Abbas and other ports on the Iranian coast. In Dubai, smuggling is not even vaguely disreputable; it is a way of life.

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