Currency Wars: The Making of the Next Global Crisis (6 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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I woke up at 6:30 a.m. feeling a little groggy from the Guinness, but it was nothing two cups of coffee couldn’t cure. I packed quickly and decided to check the news online before I stowed my laptop away. There was no time to get through the stack of e-mails that awaited me each morning, so I decided just to check the Drudge Report for a quick headline fix. Since I had been news deprived the day before and would be again today, it was a fast way to catch up with the world.
I clicked on the Drudge bookmark, waited a few seconds for the page to come up and then stared in complete disbelief at what I saw. In typical Drudge style, there was a huge headshot of a single individual dominating the center of the page. This morning it was Vladimir Putin. The banner headline underneath declared that Russia was calling for an end to the dollar and was looking for some alternative reserve currency, one possibly backed by tangible goods including gold.
These types of headlines have become commonplace in the past year, but in March 2009 it was still a new idea and one that a lot of people were just hearing about for the first time. It was easy to ridicule Putin as a chauvinist or headline seeker, but I knew that work on a dollar replacement had already been discussed in Europe and China and at the IMF. This was just Putin getting out ahead of the crowd and making known Russia’s displeasure with the dollar-based hegemony imposed on the world by the United States—exactly what Steve and I had discussed over oysters and white wine the week before. There could not have been a better validation of our game moves if we had written the Drudge article ourselves.
I threw my laptop in my briefcase and ran down to the lobby, trying to get the same Drudge banner on my BlackBerry screen. Steve and O.D. were waiting for me.
“Hey, guys, have you seen Drudge this morning?” I yelled out from a distance. “You won’t believe it.”
I handed the BlackBerry to Steve, who studied the screen and passed it to O.D.
“Amazing,” said Steve. “Those guys at the lab will think we planned the whole thing, like we had inside information. Let’s get over there and show them what’s going on in the world.”
We arrived at the lab, rushed through security as quickly as possible and raced up the stairs of Building 26 to the war room.
Folks were having coffee and quietly chatting about events from the day before. I was fairly certain that the serious military and academic types around us had more important things to do each morning than read Drudge, so our scoop was still under wraps for the moment. I went into the technical support room adjacent to the main war room. The tech room had its own wall-sized screen to preview or troubleshoot what was going on in the war room. I asked the video tech if he could put the Internet up on the big screen and gave him the Web address for Drudge. Within a few seconds our friend Putin was on the screen, larger than life, throwing down the gauntlet at U.S. dollar hegemony. With a few more clicks on the control panel, the Drudge banner now appeared in the war room itself, while the lab staff helpfully printed out the story behind the headline and made sure a copy was placed among the rulebooks and scenarios sitting at every battle station.
Harvard was not amused. He thought Steve and I were being ridiculous and now he thought pretty much the same thing about Putin. But most of the participants were kind enough to give us some kudos for driving the game toward the next big thing before it happened.
Once the Putin buzz died down, it was back to the war game and move three, the final move in the game. This scenario involved the election of a proindependence candidate in Taiwan and an effort to reverse Taiwan’s increasing economic integration with mainland China. There was not much left to do on the gold currency front by now. Russia had made its move, China had refused to go along and the United States acted indifferent, although this seemed strange because in the real world any move toward gold by Russia would have been met with a much more robust reaction by the United States. The U.S. cell was composed entirely of academics, think-tankers and uniformed military, and had no market experience at all, so I had to assume they just didn’t get it when it came to an assault on the dollar. Like most experts I’d spoken to, they probably assumed the dollar would always remain dominant and did not think much about alternative scenarios.
[conditioned or contingent?]
 
We set about preparing our responses to the problem at hand. China reiterated its “One China” policy and warned other nations not to support the Taiwanese initiative. Japan tried to promote an Asian Free Trade Area that would welcome both China and Taiwan as a way to obviate their divisions. The United States emphasized military cooperation with Taiwan but urged that such cooperation in the future would be conditioned on Taiwan’s reducing its confrontational stance. Only Russia continued to play the alternative currency wild card by trying to woo OPEC members in the gray cell to join its gold plan and by suggesting to China that it would be more inclined to take their side in the Taiwan dispute if China supported the new currency. I had to hand it to Steve and his teammates; they played their cards for all they were worth even if no one else was particularly paying attention.
Just when it looked like the game would wind down anticlimactically, O.D. played a wild card of his own. Speaking on behalf of the gray cell, he announced that the Japanese coast guard had interdicted large shipments of nearly perfect counterfeit hundred-dollar bills, called supernotes by U.S. Treasury officials. Supernotes are produced by North Korea’s infamous Bureau 39, the state-sponsored racketeering agency set up in 1974 by Kim Il Sung to conduct money laundering, counterfeiting, drug smuggling and other acts usually perpetrated by criminal groups, in order to raise hard currency for the regime. O.D.’s move had a nice historical resonance with countries that had engaged in financial warfare by counterfeiting the currency of their enemies and flooding enemy territory with the counterfeits in order to cause distrust of legitimate bills and contribute to an economic collapse. During the U.S. Civil War, a Union sympathizer and Philadelphia stationery shop owner named Samuel Upham printed over $15 million in counterfeit Confederate bills, about 3 percent of the total amount in circulation. Many of these were carried south by Union soldiers and did undermine confidence in the real Confederate currency. O.D.’s counterfeit dollar discovery was a distant echo of this earlier episode of currency warfare.
O.D. also reported that Swiss banks had been scammed by deposits of these supernotes, which seemed to be flooding in from all over the world. The Swiss banking losses and the large size of the interdicted shipment were enough to cast doubt on the value of U.S. currency held abroad, mostly in the form of one-hundred-dollar bills. Dollars were now reported to trade on the black markets at a discount to their face value on world currency markets. The cash portion of total dollar holdings is small relative to the much larger amounts held in electronic form in banks, so the effect of the proliferating supernotes was not catastrophic. Still, it was one more swipe at the dollar and a nice parting shot from O.D.
Finally, the white cell seemed to be impressed with Russia’s tenacity on the alternative currency, especially its overture to OPEC, and awarded the country additional national power points. This was a complete turnaround from day one, when Russia’s play had been ridiculed. China was awarded more points mostly for doing nothing. It was a case study in how to win a zero-sum game just by keeping your head down while everyone else blundered around. The United States lost national power, partly because of Russia’s dollar assault, but also because it appeared that East Asia was coalescing around a China-Japan bloc that would eventually include most of the region and exclude the United States from its key decisions on trade and capital flows. In the end, China gained the most by doing the least while Russia and East Asia gained slightly and the United States was the biggest loser.
The rest of the session was taken up with debriefings. It had been a fascinating two days on top of all the work that had gone into the preparation. It is genuinely helpful to U.S. national security when so many experts, with varied perspectives and some from distant locations, gather under one roof to exchange ideas and give the military new ways of understanding potential threats. When the Treasury and Fed did scenarios, they usually thought about bursting bubbles and market crashes, not state-sponsored financial wars. Former Fed chairman Alan Greenspan liked to say that the Fed had no expertise in stopping bubbles and that its resources were better utilized cleaning up the mess after a bubble had burst. That Greenspan view works only for messes of a certain size. For the really big messes—those involving civil unrest, food riots, looting, refugees and general collapse—the Fed has no answer and societies inevitably turn to the military for solutions. So the military had a large stake in understanding the potential for economic catastrophes. We had at least given the Pentagon some framework for thinking about an economic surprise attack. My hope was that they would not need it; my concern was that they would.
Over the next few weeks, with the recollections of the financial game fresh in my mind, I couldn’t help but be reminded that a real currency war had already broken out and was being fought hard around the world. In March 2009, no one was yet using the term “currency war”—that would come later—but still all the signs were there. The Federal Reserve’s first quantitative easing program, so-called QE, had begun in November 2008 with the not so hidden goal of weakening the dollar on foreign exchange markets. The Fed’s cheap-dollar policies were having their intended effects.
Over the two years following the war game, stocks and gold both rose over 85 percent. Some analysts were initially baffled by the positive correlation of stocks and gold until they realized that exactly the same thing had happened in April 1933 when FDR smashed the dollar against sterling during the “beggar-thy-neighbor” currency wars of the Great Depression. The massive price gains in stocks and gold in 1933 and 2010 were just the flip side of trashing the dollar. The assets weren’t worth more intrinsically—it just took more dollars to buy them because the dollar had been devalued.
In the world outside the war room, trashing the dollar was the easy part. The hard part was calculating what would come next, when exporters like China, Russia and Saudi Arabia tried to protect their interests by raising prices or avoiding U.S. dollar paper assets. That’s when the currency wars would really heat up, yet that was still in the future from the perspective of the war game in 2009.
One lesson of the war game for the Pentagon was that, even if the dollar collapsed altogether, the United States still had massive gold reserves to fall back on. It is an intriguing fact that almost all of the U.S. gold hoard is located not in civilian bank vaults but on military bases—Fort Knox in Kentucky and West Point along the Hudson River in New York. That says something about the connection of national wealth and national security.
The 1930s currency devaluations led quickly to Japan’s invasions in Asia and Germany’s attacks in Europe. The 1970s currency devaluations led quickly to the worst period of inflation in modern history. The United States was now entering a period of financial danger, similar to the 1930s and the 1970s. The Pentagon’s financial war game was ahead of its time, but only slightly, and seemed like part of the preparation for more dire days ahead—more of a beginning than the end to a new world of financial threats.
PART TWO
 
CURRENCY WARS
 
CHAPTER 3
 
Reflections on a Golden Age
 
“We’re in the midst of an international currency war.”
Guido Mantega, Finance Minister of Brazil,
September 27, 2010
 
 
 
“I don’t like the expression . . . currency war.”
Dominique Strauss-Kahn, Managing Director, IMF,
November 18, 2010
 
 
 
 
A
currency war, fought by one country through competitive devaluations of its currency against others, is one of the most destructive and feared outcomes in international economics. It revives ghosts of the Great Depression, when nations engaged in beggar-thy-neighbor devaluations and imposed tariffs that collapsed world trade. It recalls the 1970s, when the dollar price of oil quadrupled because of U.S. efforts to weaken the dollar by breaking its link to gold. Finally, it reminds one of crises in UK pounds sterling in 1992, Mexican pesos in 1994 and the Russian ruble in 1998, among other disruptions. Whether prolonged or acute, these and other currency crises are associated with stagnation, inflation, austerity, financial panic and other painful economic outcomes. Nothing positive ever comes from a currency war.
So it was shocking and disturbing to global financial elites to hear the Brazilian finance minister, Guido Mantega, flatly declare in late September 2010 that a new currency war had begun. Of course, the events and pressures that gave rise to Mantega’s declaration were not new or unknown to these elites. International tension on exchange rate policy and, by extension, interest rates and fiscal policy had been building even before the depression that began in late 2007. China had been repeatedly accused by its major trading partners of manipulating its currency, the yuan, to an artificially low level and of accumulating excess reserves of U.S. Treasury debt in the process. The Panic of 2008, however, cast the exchange rate disputes in a new light. Suddenly, instead of expanding, the economic pie began to shrink and countries formerly content with their share of a growing pie began to fight over the crumbs.

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