The Road to Ruin

by James Rickards

  The IMF and Federal Reserve rather than the U.S. Treasury provided rescue funds in the 1997–98 crisis. The crisis began with the Thai baht depreciation in July 1997. The IMF gave emergency loans to Korea, Indonesia, and Thailand in the first phase of that global liquidity crunch.

  The crisis abated in the winter and spring of 1998, then burst into flames in late summer. Russia defaulted on its debt and devalued the ruble on August 17, 1998. The IMF prepared a financial firewall around Brazil, then seen as the next domino to fall.

  The world was shocked to learn the next domino was not a country, but a hedge fund—Long-Term Capital Management. The IMF had no authority to bail out a hedge fund. The task was left to the Federal Reserve Bank of New York, which supervised the banks that stood to fail if LTCM defaulted.

  In an intense six-day period, September 23–28, 1998, Wall Street, under the watchful eye of the Fed, cobbled together a $4 billion bailout to stabilize the fund. Once the bailout was closed, Fed chair Alan Greenspan assisted the banks with an interest rate cut at a scheduled Federal Open Market Committee (FOMC) meeting on September 29, 1998.

  Still, markets did not stabilize. The newly recapitalized LTCM lost another half-billion dollars in a matter of days. Wall Street bailed out a hedge fund; now who would bail out Wall Street? The Fed intervened again. Greenspan cut rates in a rare unscheduled announcement on October 15, 1998. That was the only occasion in the past twenty-two years as of this writing when the Fed cut rates without a scheduled FOMC meeting.

  Markets got the message. The Dow Jones Industrial Average rose 4.2 percent, its third-largest one-day point gain in history. Bond markets normalized. The bleeding at LTCM finally stopped. The Fed’s unscheduled rate cut was an early version of a policy European Central Bank (ECB) head Mario Draghi described in June 2012 as “Whatever it takes.”

  The new practice of papering over recurrent crises peaked in the fall of 2008 when U.S. regulators guaranteed every bank deposit and money market fund in America. The Fed printed trillions of dollars to prop up U.S. banks and arranged tens of trillions of dollars of currency swaps with the ECB. The ECB needed those dollars to prop up the European banks.

  Unlimited liquidity worked. The storm passed, markets stabilized, economies grew, albeit slowly, and asset prices reflated. By 2016, the policy of flooding the world with liquidity was widely praised.

  Had the ice-nine approach of 1907, 1914, the 1930s, and Bretton Woods been replaced with a monetary warming that now threatened hurricanes? Were there limits on what elastic money could do? In late 2016, the world was on the verge of finding out.

  Extraordinary policy measures used in 2008 had mostly not been unwound by 2016. Central bank balance sheets were still bloated. Swap lines from the Fed to the ECB were still in place. Global leverage had increased. Sovereign-debt-to-GDP ratios were higher. Losses loomed in sovereign debt, junk bonds, and emerging markets. Derivatives passed one quadrillion in notional value—more than ten times global GDP.

  Global elites gradually realized their monetary ease had simply spawned new bubbles rather than affording a sound footing. The stage was set for another collapse and the elites knew it. Now they doubted their ability to run the same playbook.

  The Fed expanded its balance sheet from $800 billion to $4.2 trillion by 2015 to quench the 2008 crisis. What would it do the next time? A comparable percentage increase would leave the balance sheet at $20 trillion, roughly equal to the GDP of the United States.

  Other central banks faced the same dilemma. The hope had been that economies would resume self-sustained growth at potential output. Then central banks could withdraw policy support and go to the sidelines. That didn’t happen. Instead growth stayed anemic. Markets looked to central banks to keep the game going with easy money. Seven years of complacency had lulled markets to sleep regarding risks of leverage and nontransparency.

  In the summer of 2014, elites began to sound the alarm. On June 29, 2014, the Bank for International Settlements (BIS) issued its annual report. It warned that markets were “euphoric” and said, “Time and again . . . seemingly strong balance sheets have turned out to mask unsuspected vulnerabilities.”

  The BIS report was followed on September 20, 2014, by another warning from the G20 finance ministers meeting in Cairns, Queensland. Their communiqué said, “We are mindful of the potential for a buildup of excessive risk in financial markets, particularly in an environment of low interest rates and low asset price volatility.”

  Just a few days later, a powerfully connected think tank in Geneva, Switzerland, the International Center for Monetary and Banking Studies (ICMB), issued its annual “Geneva Report” on the world economy.

  After years of being reassured by policymakers that the world was deleveraging, ICMB offered this shocking synopsis: “Contrary to widely held beliefs, six years on from the beginning of the financial crisis . . . the global economy is not yet on a deleveraging path. Indeed, the ratio of global total debt . . . over GDP . . . has kept increasing . . . and breaking new highs.” The report referred to the impact of excessive debt on the world economy as “poisonous.”

  Warnings continued. Shortly after the Geneva Report, on October 11, 2014, the IMF added its own alarms. The head of the IMF’s powerful policy committee said capital markets are “vulnerable to ‘financial Ebolas’ that are bound to happen.”

  Nor could the U.S. government turn a blind eye to the developing storm. The U.S. Treasury’s Office of Financial Research in its annual report to Congress issued on December 2, 2014, warned that “financial stability risks have increased. The three most important are excessive risk taking . . . vulnerabilities associated with declining market liquidity, and the migration of financial activities toward opaque and less resilient corners of the financial system.”

  On December 5, 2014, BIS again warned about financial instability. Claudio Borio, head of the monetary department at BIS, with reference to extreme volatility and the abrupt disappearance of market liquidity, said, “The highly abnormal is becoming uncomfortably normal. . . . There is something vaguely troubling when the unthinkable becomes routine.”

  These warnings emerged in 2014 as it became clear monetary ease would not restore growth. This first wave of warnings was followed by more explicit warnings in annual reports and meetings for subsequent years. Expansion of leverage, asset values, and derivatives volume continued unabated.

  The warnings were not for investors, most of whom are unfamiliar with the agencies involved and the technical jargon used. These warnings were intended for the small number of elite experts who read them. Elites were not warning everyday citizens; they were warning one another.

  The BIS, IMF, G20, and other international monetary agencies were issuing warnings to a small group of finance ministers, sovereign wealth funds, banks, and private funds such as BlackRock and Bridgewater. They were given time to adjust their portfolios and avoid losses that would overtake the small investor.

  The elites were also laying a foundation so when crisis struck they could credibly say, “I warned you.” This despite the fact that most investors scarcely knew of the warnings when they were sounded. This foundation makes it easier to enforce the ice-nine solution. Because investors ignored clear warnings, they would have no one to blame but themselves.

  By late 2016, the stage was set. Systemic risk had grown to alarming levels. The symptoms were seen not only in the U.S. financial system, but also in China, Japan, and Europe. The ice-nine apparatus was ready to seize SIFI banks, freeze money market funds, close exchanges, limit cash, and order money managers to suspend redemptions by clients.

  In advance of a global freeze, elites had warned certain cronies and insulated themselves from criticism. Only one question remained. Would ice-nine work? There was no doubt about governments’ capacity to impose ice-nine. Still, would citizens acquiesce as they had in 1914 and 1933, or would there be a descent to disorder?

/>   If money riots broke out, authorities were prepared for that too.

  The United States has been under a state of emergency declared by President Bush in Proclamation 7463 on September 14, 2001. The state of emergency has been renewed annually since 2001 by Presidents Bush and Obama. The state of emergency grants the president extraordinary executive powers, including martial law.

  This is not the stuff of conspiracy theorists. States of emergency and similar powers are authorized by acts of Congress and executive orders. These actions have expanded in a steady stream since the Truman administration. Major extensions of these power were ordered by Presidents Kennedy and Reagan to reflect cold war realities.

  Emergency powers have been tested continually through exercises in every administration. During one exercise in 1956, President Eisenhower ordered a simulated nuclear attack on the Soviet Union based on the progress of the exercise to that point.

  While statutes authorizing martial law were created with nuclear warfare in mind, they are not limited to that circumstance. They can be applied to any emergency situation including money riots in the event of a financial system breakdown and ice-nine asset freeze.

  In addition to broad emergency powers applicable to any emergency, dictatorial powers have been given to the president by Congress to respond specifically to financial crises. These powers have been expanded over the decades beginning with the Trading with the Enemy Act of 1917 through the International Emergency Economic Powers Act of 1977 (IEEPA).

  The president has authority under IEEPA to freeze or seize assets and institutions if there is a threat to national security with a foreign connection. In globalized markets every financial crisis has a foreign connection. Systemic crises threaten national security if allowed to go unchecked. Therefore the bar to use of IEEPA’s confiscatory powers is quite low.

  Treasury Secretary Hank Paulson and Fed chairman Ben Bernanke have repeatedly said they lacked authority to seize Lehman Brothers during the Panic of 2008. This is false. There was ample authority under IEEPA. Either Treasury’s lawyers didn’t think of it or Treasury chose not to use it.

  The use of these emergency economic powers and martial law is a more coercive version of the ice-nine plan to freeze accounts in place. Ice-nine is intended to buy time and restore calm while elites work on plans to allocate losses and reliquefy the system with IMF special drawing rights. If events spin out of control faster than elites expect, more radical measures may be needed. Such measures may involve property confiscation. States of emergency and IEEPA enable outright confiscation by the state. If resistance is encountered, martial law powers backed up by heavily militarized local police, the National Guard, and regular military forces will carry out the president’s executive orders.

  Emergency measures will not be used in a containable financial crisis of the kind we saw in 1998 and 2008. Yet that is not the kind of crisis we are facing. The next financial crisis will be exponentially larger, and impossible to contain without extraordinary measures.

  As the next crisis begins, and then worsens, measures described here will be rolled out, one by one. First come asset freezes and exchange closures. Then confiscation backed up with armed force. The question arises—will everyday citizens stand for it?

  This question has not arisen in the United States since 1933 when President Franklin Roosevelt confiscated citizens’ gold bullion. In the depths of the Great Depression, and a nationwide run on the banks, Americans accepted the gold confiscation as a price they had to pay to restore order. There was great faith in the newly elected Roosevelt, and a sense of purpose in pulling the country away from catastrophe.

  Since then, nothing quite so dramatic as gold confiscation has occurred. Market crashes have come and gone. Investor losses have been legion. Still, no widespread seizures have been ordered. The response to crises in the United States has been to cut rates, print money, and reliquefy the system. When necessary, institutions are closed surgically without mass freezes. The ice-nine approach would be new to almost every American alive.

  Examples from abroad are less sanguine, and more sanguinary. During the 1997–98 global financial crisis, riots in Indonesia and Korea left many dead. There was literally blood in the streets. Since the 2008 financial crisis, there have been violent protests in Greece, Spain, and Cyprus that have resulted in a few deaths.

  Surveys show Americans are far less trusting of government, banks, and media than they have ever been. Political polarization in America has grown to extreme levels. Income inequality has reached levels not seen since 1929. A sense of shared purpose in presidential leadership is gone. In the next crisis, as confiscatory solutions are employed, the popular response is less likely to be passive acceptance and more likely to involve resistance.

  Elites are prepared for this also.

  Mount Weather, Virginia, and Raven Rock Mountain, Pennsylvania, are two of the most important government sites most Americans have never heard of. In the event of global war, catastrophe, or widespread money riots, U.S. civilian and military leadership will deploy to those locations to continue government operations on an emergency basis.

  Mount Weather is located off a state highway in Loudoun County, Virginia, near the Blue Ridge Mountains. Mount Weather is operated by the Department of Homeland Security, and is home base for the FEMA National Radio System. It is known in official circles by its code name, “High Point Special Facility.”

  Mount Weather contains a network of underground bunkers known as Area B to distinguish it from the aboveground facilities called Area A. During the 9/11 attacks in New York and Washington, the congressional leadership was moved by helicopter from Capitol Hill to Mount Weather’s Area B.

  Raven Rock Mountain is located in Adams County, Pennsylvania, not far from the Maryland border and the presidential retreat at Camp David. Raven Rock is the main military operations center in the event of nuclear attack or other catastrophe that interferes with normal Pentagon operations. The primary command facility is codenamed Site R, and nicknamed “the Rock.”

  Raven Rock is the military counterpart to Mount Weather. In the event of a collapse in order, civilian leadership will evacuate to Mount Weather, while military leadership evacuates to Raven Rock. Together, these two facilities, about thirty miles apart and densely connected by secure communications channels, will replace Washington, D.C., as the seat of government power.

  The Department of Homeland Security conducts classified exercises to practice the use of Mount Weather. The most recent exercise was called Eagle Horizon 2016, conducted on May 16, 2016. Past versions of Eagle Horizon have included dirty bomb attacks, cyberattacks, and other forms of terrorism. The exact scenario for Eagle Horizon is classified, but could have included a global bank collapse with resulting money riots around the world.

  Both Mount Weather and Raven Rock Mountain are operated pursuant to a highly classified plan called the Continuity of Operations Plan. This is a classified plan for continued operations of the U.S. government during attack, financial collapse, or natural disaster. President George W. Bush activated the Continuity of Operations Plan during the 9/11 attacks, although this was not publicly acknowledged at the time.

  This combination of emergency facilities and emergency powers is designed to withstand any military, natural, or financial shock. The United States government is ready for a catastrophe. The American people are not.

  A global financial crisis, worse than any before, is imminent for reasons explained in this book. A liquidity injection of the kind seen in 1998 and 2008 will not suffice because central bank balance sheets are stretched. There will be little time to respond. Ice-nine account freezes will be used to buy time while global elites convene an international monetary conference. They will attempt to use special drawing rights (SDRs) issued by the IMF to refloat the system.

  SDRs might work. But a more likely outcome is that citizens will see through the sham of
resolving a paper money crisis with more paper money. Investors will grow impatient with ice-nine. They will want their money back. The money riots will begin.

  Sovereigns don’t go down without a fight. The response to money riots will be confiscation and brute force. Governing elites will be safe in their hollowed-out mountain command centers. Private elites will fend for themselves in their yachts, helicopters, and gated communities, which will be converted to armed fortresses.

  There will be blood in the streets, not metaphorically, but literally. Neofascism will emerge, order responding to disorder, with liberty lost.

  T. S. Eliot had a vision of the modern condition in his 1922 poem The Waste Land:

  Who are those hooded hordes swarming

  Over endless plains, stumbling in cracked earth

  Ringed by the flat horizon only

  What is the city over the mountains

  Cracks and reforms and bursts in the violet air

  Falling towers

  Jerusalem Athens Alexandria

  Vienna London

  Unreal

  Money riots seem unreal. Yet they come.

  CHAPTER 2

  ONE MONEY, ONE WORLD, ONE ORDER

  Massive progress has been made in the last five years thanks to the crisis. I hope, personally, that it’s not going to take another crisis to make yet more progress.

  Christine Lagarde, IMF managing director Davos, Switzerland, January 22, 2015