Author: Vanessa Drucker

SEEKING OUT VULNERABILITIES

By Vanessa Drucker

Global Finance sat down with James Rickards, senior managing partner at boutique alternative investment firm Tangent Capital Partners and author of Currency Wars: The Making Of The Next Global Crisis .

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PHOTO: LUCA VENTURA

Global Finance: Will the US dollar remain the world's reserve currency? Could the Chinese renminbi replace it? Or even gold?

James Rickards: A reserve currency requires investable assets, like a range of bond maturities, dealers for market making, financing mechanisms like repos and hedging instruments such as futures, options and short sales. A rule of law is essential, too. China has many steps to go. But I do see a possible return to a gold standard—either through choice or necessity—brought on by a broad-based collapse in the dollar. A gold regime would pose some important questions: How would the ratio be pegged to paper money? [It need not be 100%.] And who would participate, the US or all major economies?

GF: Are you more concerned about inflation or deflation?

JR: The Fed has printed over $2 trillion in the past four years, but so far we have mainly deported inflation to China and other countries. We will continue to enact so-called "nominal GDP targeting," or QE3, while the rest of the world suffers collateral damage. Although powerful deflationary vectors are at work, like demographics and debt write-offs, these may be offset by policy inflation. The Fed wants to drive the velocity of these vectors higher. The problem is inflation could spike fast, since it is fundamentally a behavioral phenomenon, beyond policymakers' control. So we're now operating on a knife edge between deflation and hyperinflation.

GF: What do you see for Europe?

JR: The IMF will be able to fund a European bailout. First, they began to issue SDRs [Special Drawing Rights are a reserve asset whose value is based on a basket of currencies] in 2009. Next, they leveraged their balance sheet for the first time, with standby credit facilities. In 2009 the United States quietly committed $100 billion to the IMF, which can be drawn on any time. The IMF has become a proto world central bank, with a printing press. The next financial crisis will be more acute than the last, and the IMF will reliquify the system through the issuance of SDRs.

GF: Your recent book describes financial war games. What drew you to that subject?

JR: In 2008, the Pentagon approached me to participate in exercises using currencies, rather than kinetic weapons, like bullets and rockets. Not many people are conversant with the overlaps between economics and national security. We worked with a game design team to write the rules. The goal was to consider unexpected ways in which the United States might be attacked, and to help teach the Pentagon about dollar vulnerabilities.

GF: What do you consider the US's prime vulnerabilities to be?

JR: The main threat is that Ben Bernanke is printing so many dollars, leading to a loss of confidence in the dollar itself. The Fed acts as if it's working a thermostat; it's actually toying with a nuclear reactor, which could result in a catastrophic global systemic meltdown. We're also vulnerable to cyberattacks, particularly since criminal gangs have become involved. Now mutually assured cyberdestruction is an insufficient deterrent.

GF: Have any of these financial war games been utilized?

JR: Yes, our sabotage is no longer a pie-in-the-sky strategy. For example, the recent sanctions against the Iranian central bank demonstrate the power of the dollar as a reserve currency. Iran imports many goods for which they need dollars to pay. The price for dollars has doubled in the black market; we've injected hyperinflation; and their central bank has raised interest rates to 20% ahead of their March elections, leading to lower living standards, and thus boosting popular discontent.