The Road to Ruin

by James Rickards

  Coming so soon after the Cyprus debacle, the Greek version of ice-nine served as a cautionary tale. Depositors now realized their money in the bank was not money, and not theirs. Their so-called money was actually a bank liability and could be frozen at any time.

  The Brisbane G20 ice-nine plan was not limited to bank deposits. That was just a beginning.

  On Wednesday, July 23, 2014, the U.S. Securities and Exchange Commission (SEC) approved a new rule on a 3–2 vote that allows money market funds to suspend investor redemptions. The SEC rule pushes ice-nine beyond banking into the world of investments. Now money market funds could act like hedge funds and refuse to return investor money. Fund managers dutifully included glossy flyers in the mail and online notices to investors about this change. No doubt investors threw the flyer in the trash and skipped the notice. But the rule is law, and notice has been given. In the next financial panic, not only will your bank account be bailed in, your money market account will be frozen.

  Ice-nine gets worse.

  One solution to ice-nine asset freezes is to hold cash and coin. This was quite common prior to 1914, and again in the depths of the Great Depression from 1929 to 1933. In the modern version, cash consists of $100 bills, €500 notes, or SFr1,000 notes from the Swiss National Bank. These are the largest denominations available in hard currency.

  Coin could consist of one-ounce gold coins such as American Gold Eagles, Canadian Maple Leafs, or other widely available coins. Coin could also consist of one-ounce American Silver Eagles. Obtaining cash and coin in this fashion allows citizens to survive ice-nine account freezes. Global elites understand this, which is why they have started a war on cash.

  Historically, market closures were circumvented by the emergence of cash-and-carry “curb exchanges” where buyers and sellers met in the street to trade paper shares for cash. Regulators will want to suppress twenty-first-century digital curb exchanges to prevent price discovery and maintain the myth of pre-panic prices. Curb exchanges could be conducted online in an eBay-style format with settlement by bitcoin or cash delivered face-to-face. Title to shares can be recorded in a distributed ledger using a blockchain. Eliminating cash helps the suppression of alternative markets, although bitcoin presents new challenges to elite power.

  The second reason for eliminating cash is to impose negative interest rates. Central banks are in a losing battle against deflationary trends. One way to defeat deflation is to promote inflation with negative real interest rates.

  A negative real rate occurs when the inflation rate is higher than the nominal interest rate on borrowings. If inflation is 4 percent, and the cost of money is 3 percent, the real interest rate is negative 1 percent (3 − 4 = −1). Inflation erodes the dollar’s value faster than interest accrues on the loan. The borrower gets to pay back the bank in cheaper dollars. Negative real rates are better than free money because the bank pays the borrower to borrow. Negative real rates are a powerful inducement to borrow, invest, and spend, which feeds inflationary tendencies and offsets deflation.

  How do you create negative real interest rates when inflation is near zero? Even a low nominal interest rate of 2 percent produces a positive real interest rate of 1 percent when inflation is only 1 percent (2 − 1 = 1).

  The solution is to institute negative interest rates. With negative nominal rates, a negative real rate is always possible, even if inflation is low or negative. For example, if inflation is zero and nominal interest rates are negative 1 percent, then the real interest rate is also negative 1 percent (−1 − 0 = −1).

  Negative interest rates are easy to implement inside a digital banking system. The banks program their computers to charge money on your balances instead of paying. If you put $100,000 on deposit and the interest rate is negative 1 percent, then at the end of one year you have $99,000 on deposit. Part of your money disappears.

  Savers can fight negative real rates by going to cash. Assume one saver pulls $100,000 out of the bank and stores the cash safely in a nonbank vault. Another saver leaves her money in the bank and “earns” an interest rate of negative 1 percent. At the end of one year, the first saver still has $100,000, the second saver has $99,000. This example shows why negative interest rates work only in a world without cash. Savers must be forced into an all-digital system before negative interest rates are imposed.

  For institutions, and corporations, the battle is already lost. It’s difficult enough for an individual to obtain $100,000 in cash. It’s practically impossible for a corporation to obtain $1 billion in cash. Large depositors have no recourse against negative interest rates unless they invest their cash in stocks and bonds. That’s exactly what the elites want them to do.

  The elite drumbeat against cash and in favor of negative interest rates is deafening.

  On June 5, 2014, Mario Draghi, head of the European Central Bank (ECB), imposed negative interest rates on euro-denominated balances held on deposit at the ECB by national central banks and major commercial banks. Those banks quickly imposed negative interest rates on their own customers. Goldman Sachs, JPMorgan, Bank of New York Mellon, and other banks all took money from clients’ accounts under the umbrella of negative interest rates.

  On December 8, 2014, The Wall Street Journal reported a story with the headline “BANKS URGE CLIENTS TO TAKE CASH ELSEWHERE.” The story said large U.S. banks had informed customers “they will begin charging fees on accounts that have been free for big customers.” Of course, a fee is the same as a negative interest rate; you have less money in the account over time—a rose by another name.

  On January 22, 2015, the Swiss National Bank imposed negative interest rates on Swiss banking system sight deposits in excess of SFr10 million.

  On January 29, 2016, the Bank of Japan voted to impose negative interest rates on commercial bank deposits at the central bank in excess of required reserves.

  On February 11, 2016, Federal Reserve chair Janet Yellen told a congressional hearing that the U.S. central bank was “taking a look” at negative interest rates. No formal negative rate policy has been implemented in the United States as of this writing.

  On February 16, 2016, former secretary of the treasury Larry Summers wrote a Washington Post column in which he called for elimination of the U.S. $100 bill.

  On May 4, 2016, the European Central Bank announced it would phase out production of the €500 note by the end of 2018. Existing €500 notes would still be legal tender, yet would be in short supply. This ban raised the possibility of buyers’ paying a premium in digital money, say €502, for available €500 notes. A premium purchase amounts to a negative interest rate on physical cash, a heretofore unheard-of result.

  On August 30, 2016, Kenneth Rogoff, Harvard professor and former chief economist of the IMF, published a manifesto called The Curse of Cash, an elite step-by-step plan to eliminate cash entirely.

  The war on cash and the rush to negative interest rates are advancing in lockstep, two sides of the same coin.

  Before cattle are led to slaughter, they are herded into pens so they can be easily controlled. The same is true for savers. To freeze cash and impose negative interest rates, savers are being herded into digital accounts at a small number of megabanks. Today, the four largest banks in the United States (Citi, JPMorgan, Bank of America, and Wells Fargo) are bigger than they were in 2008, and control a larger percentage of the total assets of the U.S. banking system. These four banks were originally thirty-seven separate banks in 1990, and were still nineteen separate banks in 2000. JPMorgan is a perfect example, having absorbed the assets of Chase Manhattan, Bear Stearns, Chemical Bank, First Chicago, Bank One, and Washington Mutual, among other predecessors. What was too big to fail in 2008 is bigger today. Depositor savings are now concentrated where regulators can apply ice-nine solutions with a few phone calls. Savers are being prepared for the slaughter.

  The ice-nine plan does not stop with savers. Ice-nine al
so applies to the banks themselves. On November 10, 2014, the Financial Stability Board operating under the auspices of the G20 issued proposals to require the twenty largest globally systemic important banks to issue debt that could be contractually converted to equity in the event of financial distress. Such debt is an automatic ice-nine bail-in for bondholders that requires no additional action by the regulators.

  On December 9, 2014, U.S. bank regulators used the provisions of Dodd-Frank to impose stricter capital requirements, called a “capital surcharge,” on the eight largest U.S. banks. Until big banks meet the capital surcharge requirement, they are prohibited from paying cash to stockholders in the form of dividends and stock buybacks. This prohibition is ice-nine applied to bank stockholders.

  The ice-nine in Cat’s Cradle threatened every water molecule on earth. The same is true for financial ice-nine. If regulators apply ice-nine to bank deposits, there will be a run on money market funds. If ice-nine is applied to money market funds also, the run will move to bond markets. If any market is left outside the ice-nine net, it will immediately become the object of distress selling when other markets are frozen. In order for the elite ice-nine plan to work, it must be applied to everything.

  Not even trading contracts can escape ice-nine. Parties to a trade with a failed firm are normally frozen in place if that firm files for bankruptcy. This standstill rule, called an “automatic stay,” is designed to avoid a mad scramble for cash and securities that enriches some and disadvantages others. The automatic stay in bankruptcy gives courts time to fashion an equitable asset distribution.

  In the 1980s and 1990s, big banks waged a relentless lobbying campaign to change the law so automatic stay provisions did not apply to transactions such as repurchase agreements and derivatives. When firms like Lehman Brothers went bankrupt in 2008, big bank counterparties used their early termination rights to help themselves to whatever collateral was on hand, leaving less sophisticated investors like local towns holding the bag on losses.

  On May 3, 2016, the Federal Reserve announced a formal rule-making process to apply a forty-eight-hour version of the automatic stay to the derivatives contracts of U.S. banks and their counterparties. This new rule was the codification of a 2014 agreement among eighteen major global banks, under the umbrella of the International Swaps and Derivatives Association, to give up their early termination rights. The 2014 agreement was the result of pressure applied by the G20’s Financial Stability Board in 2011. Importantly, the abandonment of early termination rights extends to the counterparties of the banks such as bond giant PIMCO and wealth managers such as BlackRock. Big banks and institutional investors will now be treated the same as small savers when ice-nine is applied. They will be frozen in place.

  The ice-nine solution is not limited to individuals and institutions. It even applies to countries. Nations can freeze investor funds with capital controls. A dollar investor in a nondollar economy relies on the local central bank for dollars if she wants to withdraw her investment. A central bank can impose capital controls and refuse to allow the dollar investor to reconvert local currency and remit the proceeds.

  Capital controls were common in the 1960s even in developed economies. Later, these controls largely disappeared from developed economies, and were greatly reduced in emerging markets. The relaxation has been partly at IMF urging, and partly because floating exchange rates make local economies less vulnerable to a run on the bank.

  Yet, in an extraordinary speech on May 24, 2016, David Lipton, first deputy managing director of the IMF, laid the foundation for an international ice-nine solution:

  The time has come to re-examine our global architecture. . . . What elements of the architecture are worth revisiting?

  We ought to consider whether the short term and volatility of capital flows are problematic. . . . Those flows, because of their reversibility, can be a useful disciplining force for debtors, creating the market incentive for positive reforms. But that reversibility also has costs, when capital flows suddenly stop. We should look again at whether the supervisory frameworks and tax systems of the source countries unduly encourage short-term, debt-creating flows.

  I know that . . . it is heretical to say so, but we ought to consider whether a more coordinated approach to capital flow measures and macro prudential policies in the capital destination countries may be warranted.

  Cutting through the jargon, this is a call for coordination between capital “source countries” (mainly the United States) and “destination countries” (emerging markets) to change tax and banking rules to discourage short-term debt and encourage equity and long-term bonds instead. In a liquidity crisis, equity and long-term debt are easy to lock down by closing brokers and exchanges. Residual short-term debt can then be locked down with capital controls on countries.

  At the other end of the spectrum from big banks, institutional investors, and nations is the humble ATM. Consumers have been lulled into believing cash is readily available by swiping their bank cards at ubiquitous cash machines. Is it really?

  ATMs are already programed to limit withdrawals on a daily basis. You may be able to withdraw $800 or even $1,000 in a day. But have you tried to withdraw $5,000? It cannot be done. If the daily limit is $1,000, banks can easily reprogram the machines to drop the limit to $300, enough for gas and groceries. It’s even easier to turn off the machines, as happened in Cyprus in 2012 and Greece in 2015.

  Getting cash from a bank teller is not a practical alternative to a disabled ATM. For more than modest amounts you will be flagged by a well-trained teller who will summon his supervisor for approval of your withdrawal. The supervisor will recommend that a “Suspicious Activity Report,” or SAR, be filed with the U.S. Treasury. SARs were intended to identify money launderers, drug dealers, and terrorists. You are none of the above. The report will be filed anyway. Banks fear regulators more than embarrassed clients. There is no upside for the bank to cut you a break. Your name will end up in a Treasury file next to members of the drug cartels and Al Qaeda.

  Even this self-help to acquire cash has limits because bank branches carry relatively small supplies of hundred-dollar bills. If a real run on cash emerged, customers would be turned away sooner than later. The hundred-dollar bill itself is a wasting asset because of inflation.

  This overview shows stock exchanges can be closed, ATMs shut down, money market funds frozen, negative interest rates imposed, and cash denied, all within minutes. Your money may be like a jewel in a glass case at Cartier; you can see it but not touch it. Savers do not realize the ice-nine solution is already in place, waiting to be activated with an executive order and a few phone calls.

  House Closed

  A typical reaction to the ice-nine overview is that it seems extreme. History shows the opposite. Closed markets, closed banks, and confiscation are as American as apple pie. A survey of financial panics in the past 110 years beginning with the Panic of 1907 shows bank and exchange closures with depositor and investor losses are not unusual.

  The Panic of 1907 originated in the great San Francisco earthquake and fire of April 18, 1906. Western insurance companies sold assets to pay claims. The selling put pressure on East Coast money centers and reduced liquidity among New York banks. By October 1907, the New York Stock Exchange index had fallen 50 percent from its 1906 high.

  On Tuesday, October 14, 1907, a failed attempt to corner the market in United Copper shares using bank loans was revealed. In a tight money environment, the lender bank quickly went insolvent. Then suspicion fell on a larger institution, Knickerbocker Trust, controlled by an associate of the speculators. A classic run on the bank developed. Depositors in New York and around the country lined up to withdraw cash and gold, which was legal tender at the time.

  At the height of the panic, on Sunday, November 3, 1907, J. Pierpont Morgan convened a meeting of the leading bankers in his town house on Thirty-sixth Street and Madison Avenue in Manha
ttan. Morgan famously ordered the town house library doors locked with the bankers inside. Morgan informed the bankers they were not allowed to leave until they worked out a rescue.

  Morgan’s associates oversaw a process by which bank books were quickly examined. A triage solution was agreed. Banks that were sound were expected to join the rescue fund. Banks that were insolvent were allowed to fail. In between were banks that were technically solvent but temporarily illiquid. They were required to pledge assets for cash in order to meet depositors’ withdrawals. At no point was there any thought of bailing out every bank in New York.

  It was expected that, in time, the panic would subside, deposits would return, and the pledges could be unwound at a profit to the rescuers. That is exactly what happened. By November 4, the panic subsided. Still, many depositors were wiped out. Importantly, the panic was contained and did not spread to every bank in the city. The process is no different from a quarantine of Ebola victims to stop the spread of the virus to a wider population.

  This rescue model used by Morgan was abandoned one hundred years later in the Panic of 2008. With the exception of Lehman Brothers, all major banks were bailed out by the U.S. Treasury and Federal Reserve without discrimination between the solvent and the insolvent.

  The Brisbane G20 bail-in template can be seen as a return to the principles of J. P. Morgan. In the next crisis, there will be blood. Insolvent institutions will be permanently closed and losses more widespread.

  Seven years after the Panic of 1907 came the Panic of 1914, on the eve of the First World War. The panic was triggered by an Austrian ultimatum to Serbia on July 23. This new panic was broader and lasted longer than the Panic of 1907.