Currency Wars: The Making of the Next Global Crisis

by James Rickards

  As with a lot of Wall Street folks I had recruited for help on national security projects, he grasped the situation immediately and could not wait to volunteer. After running it by his bosses at UBS, he called me back a few days later. “I’m in,” he said. “Just tell me where I need to be. This’ll be great to mix things up with the generals and intelligence people. Can’t wait.” And that was that.

  Steve was assigned to the Russia cell, of course. O.D. was assigned to the gray cell, representing the hedge funds and Swiss banks—another appropriate assignment. I was put in the China cell, along with a well-known Harvard academic, a highly cerebral RAND Corporation analyst and two other area experts.

  The financial war was just a few weeks away and it was time to lay some traps—something the military calls “conditioning the battle space.” I knew that Russia would begin the game with significantly less national power than the United States or even China. In fact, the national power assessment showed Russia having about only two-thirds the strength of the United States, with China somewhere between the two. As far as I was concerned, this just meant that Russia would have to play smarter and harder and do something unconventional to set the United States back on its heels. As an American concerned about the economic course we were on and our vulnerabilities to financial attack, I wanted the United States to suffer some kind of shock or setback in the game environment. That seemed like the best way to do our jobs for America and open some eyes at the Defense Department and in the intelligence community before a serious setback took place in the real world. The fact that Steve, O.D. and I were playing non-U.S. teams left us in a position to deliver a shock. The fact that we had less national power to start with just meant that we would have to be more creative—and more stealthy.

  Ten Twenty Post is a popular bistro in Darien, Connecticut, near where I live and not far from Steve’s home in Westchester County, New York. It’s also become a hangout for investment bankers from RBS and UBS in nearby Stamford. With its mahogany bar, brass fixtures, glass chandeliers and white tablecloths, it conjures up the look and feel of a classic French original. I suggested to Steve that we meet there for dinner one week before the game to work out a scheme to put the United States on the defensive.

  Over oysters, white wine and vodka toasts of Na zdrovyeh!, we reminisced a little about our Moscow adventures and then got down to business. I handed Steve a mock press release from the Russian Central Bank, something I had written earlier and used in a few articles and lectures. It said that Russia was moving its gold to Switzerland and starting a new bank in London. The bank would issue a new form of gold-backed currency supported by gold in the Swiss vaults. Initially Russia would own all of the new currency. But everyone would be free to deposit gold and receive similar currency. It had other technical features to make the plan feasible, such as lending and clearing facilities. The kicker was that, from now on, any Russian exports of oil or natural gas would have to be paid for in the new currency. U.S. dollars would no longer be welcome.

  “Jim, I’m worried about you—you’re starting to think like a Russian,” Steve said.

  “Coming from you, that’s high praise,” I replied.

  “Why are you using Switzerland and London in this?”

  “No one trusts the Russians not to steal the gold,” I said. “But they trust the Swiss and Brits, so if you do everything under their legal systems, people won’t be afraid to deposit gold.”

  “Right. Russia has been looking for a way out of the dollar system for years. They try to play by our rules and get screwed every time,” said Steve. “This is perfect for them.”

  “Now here’s the deal,” I said, leaning toward Steve. “If you play this move for Russia, I’ll get the Chinese team to go along. If you can’t get Russia to make the move, I’ll launch this idea from China myself. Either way we’ll work this into the game and try to sink the dollar. That will be a shock to the U.S. The Pentagon is paying to learn something from this. Let’s give them their money’s worth.”

  Steve took the mock press release, folded it and tucked it inside his jacket to study in detail at home. We finished our vodka and left ready to spring our sneak attack on the dollar.

  Now Steve, O.D. and the rest of us were ready to start the war. Over those two days, the game would quickly take on a life of its own and open a lot of eyes to how markets work and how financially vulnerable nations actually are.

  CHAPTER 2

  Financial War

  “The primary near-term security concern of the United States is the global economic crisis and its geopolitical implications.... Indeed, policies . . . such as competitive currency devaluations . . . risk unleashing a wave of destructive protectionism.”

  Dennis C. Blair,

  U.S. Director of National Intelligence,

  February 2009

  Day One

  As we arrived at the lab that rainy March morning for the war game, the first thing I noticed in the parking lot were rows of high-performance motorcycles—Kawasakis, Suzukis and the like. I guess physicists working on weapons design have their wild sides too, I thought. We were headed to Building 26, a new venue for us. We parked nearby and walked to the main entrance. Once inside, we cleared security, got our badges, dropped off our cell phones and headed upstairs. After months of meeting in seminar rooms and offices, we were being admitted to the Warfare Analysis Lab war room. The scene did not disappoint. Growing up in the Cold War, I routinely entertained visions of the war rooms used for nuclear war fighting from the classic films Dr. Strangelove and Fail-Safe. Now we were entering something similar, but would be fighting not with B-52s, but with currencies.

  The APL war room is large, with electronic battle stations and observation posts for about a hundred participants and observers. The rectangular room has four wall-sized screens at the front end and banks of smaller fifty-inch plasma video screens mounted on the walls along both sides to patch in additional participants from remote locations or to display additional graphics. The seating is tiered with a central trapezoid-shaped table for twelve on the lowest level closest to the wall screens; the trapezoid is flanked by four banks of long tables, two on each side, at a slightly higher level laid out in a chevron pattern around the center. In the rear, on an even higher mezzanine level, are rows of additional observer stations laid out across the room perpendicular to the main tables below. Finally, at the back of the room, opposite the large screens, are tinted glass windows hiding a separate chamber with five additional battle stations and some standing room. I discovered later that this separate chamber was used by senior military observers who wanted to watch the game in progress unbeknownst to the other players.

  There was a podium and microphone at the front to the right side of the screens, where representatives of each cell could announce their moves and respond to moves of other cells. Every battle station was equipped with a laptop linked to groupware that enabled each player to provide continuous silent commentary on game progress even while others were describing their moves and motives. Adjacent to the war room was a technical support room that controlled the screen projections and monitored the groupware supporting the running commentary.

  Down a corridor from the war room were separate large meeting rooms that had been outfitted as the “capitals” of the warring states. These were equipped with a single wall screen each and separate groupware shared only by the members of each team and accessed through additional sets of laptops for the team members. Other rooms had been set aside for summit conferences and bilateral negotiations if cells wanted to conduct private meetings away from the war room. All of the facilities—the war room, the capitals and the summit conference venues—were equipped with workstations for lab staff acting as facilitators, analysts and neutral observers of the proceedings. Although we were autonomous actors, it was hard to shake the feeling that we were also lab rats in the purview of APL’s larger mission.

  We had a chance to get acquainted with the other players at a buffet-
style breakfast served up by the lab. Then we filed into the war room and took our assigned places. The members of the white cell, the referees, were seated at the large trapezoid in the center. The five combatant teams, Russia Cell, U.S. Cell, Pacific Rim Cell, China Cell and Gray Cell (the “all other” group), and some Pentagon and intelligence community observers were seated in the chevron layout around the white cell.

  Thanks to the secure Warfare Analysis Lab website, codenamed WALRUS, we had all been supplied in advance with thick packets of briefing books. One was the game overview, which provided the relative “national strength” of each team with a detailed rationale behind it. The overview included the instruction that “player cells may select actions from game menu and/or ‘innovate’ their own actions.” I was all for the innovation.

  We also received “Baseline Scenario” briefing books, which described the near future economic world of 2012, in which we would be playing the game, and a “Mechanics” book, which was basically a rulebook. I recalled how my brothers and I used to fight over the rules in Risk as kids and often had to dig the Parker Brothers rulebook out of the game box to settle disputes. Now we had a war game rulebook, but this would go quite differently. I wanted to break as many rules as I could to help the Pentagon understand how capital markets really work in an age of greed, deregulation and bad intent. Wall Street was like the Wild West in the best of times, but with globalization and too-big-to-fail government backing, it was now even more out of control.

  After a few hours of instruction, orientation and snap training on the groupware, we broke out to our separate capitals to work on move one. This broadly involved a long-term trade agreement between Russia and Japan that would reduce the availability of Russian oil and natural gas to the rest of the world. The big idea in move one was that Russia would leverage its natural resources to improve its foreign currency reserve position. Of course, there was no coordination between the scenario the lab had produced and the wild card Steve and I were secretly ready to play, but this was a pretty good fit. Russia could exempt Japan from its gold currency deal and still placate China by inviting it to join in its plan to sideline the dollar. I sat in our simulated Chinese capital listening to my Harvard and RAND teammates discussing how to punish Japan for deviating from the Washington Consensus free trade paradigm, but my mind was elsewhere, literally waiting for the phone to ring. A few minutes later, our lab observers informed us that a communiqué had come in from Russia requesting a summit conference. This was good news; it meant Steve had convinced his teammates to let him play the gold wild card.

  Before my team could digest the news, I offered, “Hey, guys. My friend Steve Halliwell is playing the Russian cell—I’m guessing he’s behind this. Okay if I attend the summit from our side?”

  They quickly agreed and off I went down the hall to one of the designated summit conference rooms, where Steve was waiting. A lab facilitator was there, so I had to play dumb even though I knew what Steve was going to propose.

  “Jim, we expect U.S. pushback on our deal with Japan, and frankly we’re tired of the U.S. using its dominant position in the dollar-based trading system to call the shots. There’s a better way. None of our currencies is ready to replace the dollar—we all know that. But gold has always been money good. It’s just a matter of time before the world gets to some kind of gold standard. There’s a huge first-mover advantage here. The first country that moves to gold will have the only currency anyone wants. Here’s our proposal.”

  Steve handed me a reworked copy of the mock press release I had given him at the Darien bistro the week before. It was all there: the new gold-based currency, a London bank of issue, the ability to expand the new money supply by depositing gold, the English and Swiss rule of law, clearance and settlement facilities and a true market price. Russia would demand payment in the new currency for natural resource exports going forward. The dollar would be pushed to one side.

  “We can do this alone,” Steve continued, “but it works much better with China and maybe others. The more of us who join in, the harder it will be for the U.S. to fight it. You can do the same thing with your manufactured goods that we’re doing with oil and natural gas. Are you with us?”

  “Look, let me go back to China and I’ll let you know,” I said. “I’m not authorized to agree to anything; I just came to get the message. We’ll discuss it and I’ll call you with our answer.”

  Back in the Chinese capital, my teammates had been diligently working out a response to the scenario we had been presented. The overall sense was to do nothing. The Russia-Japan natural resources deal affected not only those two parties but also Europe, to the extent it might lead to reduced supplies of Russian natural gas. The United States would have to coordinate the response because it was in the best position to pressure Japan. China’s posture would be to keep its head down and let the others work things out.

  Then I played the Russian wild card by briefing my teammates on Steve’s proposal.

  It’s difficult to describe their reaction. “Nonplussed” is probably the best word. They had difficulty processing any economic scenario that had the word “gold” in it.

  “That’s ridiculous,” our Harvard guy said. “It has nothing to do with the scenario we were given and it makes no sense anyway. Gold is irrelevant to trade and international monetary policy. It’s just a dumb idea and a waste of time.”

  The RAND guy was a little more intrigued and asked a few questions but clearly was not prepared to move in the Russian direction. I urged my teammates to take the plunge with Russia and set the United States back on its heels, but they were not persuaded. They were soon back to drafting their noncommittal communiqué on the original problem.

  “Okay,” I said. “I have to get back to Russia on this. Can I call a summit to give them our answer?”

  “Sure, go ahead,” said Harvard. “We’ll keep working on the scenario.”

  Pretty soon Steve and I were back in the summit conference room.

  “Look, Steve, I can’t get my guys to go along. I’ll keep working on this over the next few rounds, but you’re on your own for now. I can’t blame you if you pull the plug on this; I really thought China would see the benefits and we’d do this together.”

  “It’s fine,” he said. “The Russia team really likes this. They think it’s about time someone stood up and showed what a scam the dollar system is. Too bad you can’t join us, but we’ll go ahead anyway. Let’s see what happens.”

  By the time I got back to China, our team had finished drafting the statement representing our move for this turn of the game. It boiled down to saying nothing and doing nothing. It was the perfect academic solution and would teach the Pentagon exactly nothing. Now it was time to go back to the war room to announce our moves along with the other cells.

  War room meetings were plenary sessions, what in Pentagonese are called “brief backs,” with all the teams and observers gathered together. One representative of each cell would take the podium, describe his cell’s policy response and the rationale behind it, answer some questions from the other cells, and turn the podium over to the next cell. The lab staff had assisted each cell in the instant preparation of slides with maps, bullet points or other illustrations to throw up on the wall screens. The groupware chat functions were going full bore with twenty or more simultaneous and overlapping discussions, only some of which were responsive to others and all of which came scrolling across the screens in front of each player. It was like Twitter without the avatars and virtual wallpaper. If you felt someone was making a brilliant move or a ridiculous move, or you wanted to pose a question, you just said so. Each player could participate as much or as little as she liked while the entire stream-of-consciousness digital scroll was preserved for future evaluation by Pentagon planners.

  The China brief was predictably boring given the proclivities of the team and my failure to excite much interest in gold-backed currency. We meekly accepted the scripted Russia-Japan energy dea
l but made some comment about accelerating China’s efforts to increase energy diversification.

  Russia went next. The brief started with some happy talk about continuing to work with China on a joint venture pipeline, but then veered into the announcement about demanding gold-backed currency for future energy shipments. An official summary of the war game prepared much later referred to this move as “aggressive” and “threatening,” but the immediate response was more in keeping with the absurd style of Dr. Strangelove. The white cell asked for time to caucus once the Russian presentation was complete. From their position at the center of the room, they made a ruling that the Russian currency move was “illegal” and would have to be struck from the game record. Steve and I were incredulous, as were Steve’s Russian teammates who had endorsed the idea.

  “What do you mean, ‘illegal’?” Steve demanded. “This is war! How can something be illegal!”

  It was exactly what I had feared. Not only did the player selection discourage out-of-the-box thinking, but even when we could inject an unconventional move we were ruled out of bounds. I felt compelled to add my voice to Steve’s even though I was playing a different cell.