James Rickards: World Currency System Moving Towards Catastrophe

“The world currency system is riding down the road to catastrophe.” Those were the words from James Rickards during a recent interview on Wall Street Journal, senior managing director of Tangent Capital Partners and author of the book Currency Wars: The Making of the Next Global Crises. “The world already has entered a currency war that began in 2010 on the heels of the Federal Reserve’s massive easing program. Since then, plenty of nations have joined in, including Brazil, Switzerland and Japan.”

Japan has been devaluing significantly their Yen over the past two months as we wrote here. There is a new competitor in the room. The most recent news, as reported by Bloomberg, is that Venezuela just decided to weaken the exchange rate by 32 percent to 6.3 bolivars per dollar starting February 13th. The currency war has clearly and openly started.

In order to exactly understand what is going on, we need to go back to an earlier interview Jim Rickards gave to Bloomberg. In it, he explained the following:

What the Fed is trying to do is get inflation. They have tried already everything: QE, Operation Twist, communications … but everything has failed. They now try to cheapen the dollar and import inflation from abroad. It’s not because the Fed tries to do so, that it works. The aim of the Fed is to take the dollar down 20 to 30%.

There are two catalysts for the currency war to hit and lead to a weaker dollar. First, if the US trading partners will decide to let their currencies go stronger, we will begin to import inflation through the exchange rate mechanism. The other point is that, based on the quantity theory of money, the Fed can create inflation whenever it wants.

The quantity theory of money looks as follows: M x V = p x Y. It is an equation in which the monetary base times the velocity of money equals price inflation times real GDP. Central banks use this equation for their monetary policies. It is the reason why one of their focus points is to influence the psychology (mood) of people: if people “feel” that everything is going well, they will spend more, raising the velocity of money and resulting in a higher gross GDP. Given the fact that the economies are not really producing more, for sure not in the in US and Japan, it implies that the central bank efforts to create inflation could very well result in a much higher inflation rate than targeted. While aiming for 2%, the result could very fast be 6%.

Furthermore, on Yahoo! Finance, in another interview, he referred on to a speech Ben Bernanke gave at the end of September in Tokyo on an IMF event. He warned the other countries by saying the following:

“You have two choices. You can fight the currency wars in which case we are continuing printing to create inflation. Or you let your currency appreciate, and you will not get the inflation (in which case the country’s exports will go down). What Bernanke said between the lines is: We will continue printing until the dollar gets weaker, so your choices are inflation or higher export prices.”

Those are pieces of information one needs in order to understand the current situation. The central banks of both the United States and Japan are trying to import inflation in order to get their economies growing through a weaker currency. They do so instead of trying to boost their exports.

The result in the dollar and the yen are shown in the following chart, courtesy Wall Street Journal:

dollar yen euro 2012 gold silver experts

Jim Rickards says that the European Central Bank  is actually doing the right thing: easing for liquidity reasons rather than to depress its currency. “The euro has risen to a 14-month high against the dollar as a result, and he thinks it can keep ascending.” (source MoneyNews)

Based on the dire state of the world currency system, it should be clear why Jim Rickards expects gold to trade in a range between $3,000 and $10,000. He adds to it: “We’re not going to get there all at once.” Indeed, based on the news out of Venezuela, it is obvious that lower dollar, higher gold could take some time. From the Venezuelan point of view, the holders of their currency are losing significant purchasing power while holders of gold are simply preserving it.

Are you holding paper based money or physical gold / silver? The choice is yours, so are the consequences!



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