Currency Wars: The Making of the Next Global Crisis

by James Rickards

  “You know,” I began from my seat in the China cell, “it’s not like there’s a Geneva Convention here. Russia’s move is not far-fetched. The United States was on a gold standard until 1971 and a lot of people in this room remember it. Russia’s being provocative but they’re always provocative. Let’s go ahead and see how this plays out.”

  The white cell seemed a little stung. Steve was like a batter who gets called out on a close play at first base and I was like the first-base coach trying to protect his player from being ejected. The digital chat room had erupted with the equivalent of “Kill the ump!” The white cell asked for another caucus to consider their ruling. Finally the white cell leader took the microphone. At this point I was half expecting to hear, “Upon further review . . . ,” but in suitably bland bureaucratic language he confirmed Russia’s move would be allowed. The white cell clarified that the move was not “illegal” but “ill-advised.” I knew this was a polite way of saying Russia had done something stupid, but that was fine with me. Gold currency was now in the game; we would see how this evolved over the next two days.

  The rest of the moves made were announced in fine multilateral fashion. The United States made the obligatory announcement in support of free trade and the need to think about green energy alternatives. The Pacific Rim announced that Japan would provide aid to any Asian nations suffering short-term hardships in energy costs and also pledged to seek alternative sources of energy. The gray cell, wearing its IMF hat, announced financial support to any former Soviet bloc nations suffering as a result of the Russia-Japan deal. None of the teams had anything to say about the new gold currency on the scene. It was just there, a newborn eight-hundred-pound gorilla sitting in the war room waiting for someone to notice.

  At the end of move one, the white cell gave us the score. The United States had lost a small amount of power because it appeared that Japan had moved somewhat out of the U.S. orbit and the United States had not mustered an effective response. China gained a small amount of power essentially for doing nothing. Russia was heavily penalized for making what the white cell clearly regarded as a hostile move that showed a lack of cooperation with the rest of the world and had no immediate payoff. Net/net, Steve and I had collectively cost our teams some national power at the end of round one. However, we were playing what Russian Grandmasters call a deep game. There would be more moves to come.

  Now it was on to move two. This baseline scenario did not mesh with my ideas about currency wars as well as the scenario used in the first move. This move had to do with an economic collapse in North Korea and the global reaction, which was intended to combine both geopolitical and humanitarian motives. It was a plausible scenario, but a strange choice for a financial war game. North Korea was about as unconnected to the global financial system as one country could get. It was difficult at first to see how to work the gold and currency angle into the North Korea scenario.

  Sitting in our Chinese capital, I listened to my teammates earnestly discuss whether the United States might refuse to aid North Korea in order to let the situation deteriorate as a prelude to Korean unification. Since this was a risk-averse crew, they settled on a package of humanitarian aid coupled with some indication that China might support reunification at some future date on nonconfronta-tional terms.

  At an appropriate lull in the conversation, I turned to Harvard and said, “Look, it’s not too late to revisit this gold currency thing. We could announce some support for the Russian initiative combined with some intention to study it and possibly join in the future.”

  At this point Harvard began to lose patience. He clearly thought the issue had been buried and could be safely ignored. If China joined the Russian system, it would be swapping its dollar reserves for physical gold in order to back the new currency. Among other objections, Harvard thought the Russians had set the price too high. “Look,” he snapped back, “this whole thing makes no sense. Gold is not part of the monetary system and it’s not coming back no matter what the Russians do. They’re on their own. You want to use hard currency to buy gold at an inflated price; I’d rather keep the dollars—they’re much more valuable. Now let’s get back to North Korea.”

  As a renowned Asia expert, Harvard clearly relished the chance to dig in on complicated bilateral East Asian problems rather than pursue what he thought of as a pointless conversation about currencies and gold. Yet I had been trained since law school to argue both sides of an issue without pausing for breath, so I quickly turned his argument back on him just to keep the idea alive.

  “You think we’d be paying too much for the gold?” I asked.

  “Right,” he said. “Way too much.”

  “So why don’t we sell our gold to Russia?”

  This was not just the lawyer’s instinct but also the trader’s. Every market has a bid side where someone is willing to buy and an offer side where someone is willing to sell. Market making is the art of price discovery between the bid and the offer. Someone may start out as a buyer, but if something is really priced too high she immediately becomes a seller. It was just this kind of dispassionate ice-water-in-the-veins mentality that typified the best traders I had ever met. I was calling Harvard’s bluff. If the price was too high to buy, then we should sell. I waited to see if he would take the bait.

  “Fine,” he said. “Let’s dump it all, sell all the gold to Russia for dollars and euros and diversify our foreign exchange position.”

  He may have said this just to shut me up, but it was fine with me. We had just tightened the noose around the U.S. dollar’s neck. The rest of the team quickly concurred and I promptly convened a summit with Russia to give them our offer. Steve and I met for the third time and, as I expected, Russia agreed to buy all of China’s gold, about one thousand metric tons, in exchange for currency from Russia’s foreign exchange reserves. This trade was ideal from Russia’s perspective because it was a huge purchase with minimal market impact. In ordinary gold trading, a large bloc trade of as little as ten tons would have to be arranged in utmost secrecy in order not to send the market price through the roof, but now Russia had pulled off the largest single gold purchase in history with no immediate adverse market impact at all. I was sorry to see China out of the gold game, but I was pleased to see Russia moving the ball down the field.

  Now it was back to the war room and our third plenary session. We went around the room, with each team spokesperson reporting its response to the North Korean scenario. As expected, the United States and the Pacific Rim pledged humanitarian aid, as did China, which furthermore made some conciliatory noises about potential reunification since the North Korean regime was clearly on its last legs at this point. Russia joined in the humanitarian aid chorus but also took a harder line by sealing its border with North Korea. Then, almost in passing, Russia announced that it had acquired all of China’s gold and was adding this to its own preexisting hoard in support of the new gold-backed currency.

  The white cell was visibly perturbed. Russia was playing its own game by its own rules. As far as Steve and I were concerned, Russia had been playing by its own rules for a thousand years, so this was a typically Russian course of action. At this point, the eight-hundred-pound gorilla could no longer be ignored and the adjudication came quickly. There was very little change in the national power of China, the United States or the Pacific Rim as a result of round two. This made sense because North Korea, while volatile and dangerous, was isolated, so no one gained or lost much relative power when the North Koreans decided to rock the boat—it was everyone’s problem. But the white cell then reported, sheepishly, “It appears Russia has taken concrete steps toward launching a credible alternative to the dollar in international trade. Its prospects are highly uncertain, but we have decided to award Russia additional points for its currency-related moves.” Steve and I looked at each other from across the war room. This was far from vindication, but it was hard to resist a slight smile.

  It was now the end of day one. We were havi
ng a good war so far, but it had been a long day. We decided to find a local restaurant, have a few drinks and dinner, and then head back to our hotel early to catch up on the news and get ready for day two. It is one of the paradoxes of working inside a secure location that you have no idea what is going on in the outside world. Someone may be in the nerve center of intelligence analysis or weapons development, but, because of limited access to cell phones, news apps and the desiderata of twenty-first-century connectedness, he would be the last one to know if stock markets were collapsing. As market participants and news junkies, we were now as hungry for information as we were for food. We got directions to a not too fancy place nearby that the lab staff had recommended, and Steve and O.D. chatted and tapped on their BlackBerrys while I drove in the general direction of Fort Meade, Maryland. We found the place without too much difficulty but were surprised to find the parking lot full and people jamming the second-story balcony outside the restaurant at 5:30 on a Tuesday afternoon.

  “Ah,” said O.D., drawing on his O’Donnell family roots and putting on an Irish accent for the occasion. “It’s Saint Paddy’s Day—the place has probably been packed since noon.”

  In our quest to shake the world financial system to its core, we had completely forgotten about Saint Patrick’s. I’m part Irish; my mother’s side are Thorntons. With that as my pedigree, O.D. and I dubbed Steve an honorary Irishman and we made our way up the outdoor stairs, through the crowd on the balcony and pushed inside the equally crowded dining room to find a table by a window with a nice view of the surrounding Maryland countryside. We sat down, ordered three pints of Guinness and some entrées and started our own “brief back,” as the Pentagon would put it.

  “You know the problem with this game?” asked O.D.

  “What’s that?” I said.

  “There’s no market. I mean the white cell can tell us if we gained or lost ground, but there’s no price system to measure the impact of what we’re doing.”

  O.D. was right. A trader could have the best trading idea ever, but losing money on a trade is nature’s way of telling you something’s wrong. The best traders always got out of a losing trade, cut their losses and sat back looking for the next good opportunity. It would always come around eventually. Bad traders would rationalize the loss, assume the market didn’t understand how smart they were, put on more of the trade in larger size, in effect doubling down, and usually go on to lose more money until some senior risk manager forced them out of the position. Whatever the strategy, it was the price signals that kept traders honest and gave traders the market feedback needed to validate their theories.

  Still, it was hard to be too upset about what we didn’t have. This was the first time the Department of Defense had ever run a financial war game and they were getting it done over some internal opposition. I was glad they were doing as much as they were. At least they were forward leaning, which was more than I could say about some of the civilian agencies. When I’d warned other government officials about the dangers of financial warfare launched by adversaries, the typical response was along the lines of “Oh, they would never do that—it would cost them money and they’d be shooting themselves in the foot.” They said this as if military hardware didn’t cost money, as if aircraft carriers were free. These officials failed to grasp the fact that the costs of a financial war might be far less than the costs of an arms race and possibly be much more effective at undermining U.S. power than a military confrontation. The Pentagon deserved a lot of credit for taking this as far as it had. There would be time to add bells and whistles later in some future game.

  We ordered another round of Guinness, finished our meal and then headed back to Columbia, Maryland, where we were staying. It had been a long day and we had a 7:30 a.m. start on day two. We agreed to meet in the lobby in the morning and drifted off to our rooms.

  Day Two

  I woke up at 6:30 a.m. feeling a little groggy from the Guinness, but it was nothing two cups of coffee couldn’t cure. I packed quickly and decided to check the news online before I stowed my laptop away. There was no time to get through the stack of e-mails that awaited me each morning, so I decided just to check the Drudge Report for a quick headline fix. Since I had been news deprived the day before and would be again today, it was a fast way to catch up with the world.

  I clicked on the Drudge bookmark, waited a few seconds for the page to come up and then stared in complete disbelief at what I saw. In typical Drudge style, there was a huge headshot of a single individual dominating the center of the page. This morning it was Vladimir Putin. The banner headline underneath declared that Russia was calling for an end to the dollar and was looking for some alternative reserve currency, one possibly backed by tangible goods including gold.

  These types of headlines have become commonplace in the past year, but in March 2009 it was still a new idea and one that a lot of people were just hearing about for the first time. It was easy to ridicule Putin as a chauvinist or headline seeker, but I knew that work on a dollar replacement had already been discussed in Europe and China and at the IMF. This was just Putin getting out ahead of the crowd and making known Russia’s displeasure with the dollar-based hegemony imposed on the world by the United States—exactly what Steve and I had discussed over oysters and white wine the week before. There could not have been a better validation of our game moves if we had written the Drudge article ourselves.

  I threw my laptop in my briefcase and ran down to the lobby, trying to get the same Drudge banner on my BlackBerry screen. Steve and O.D. were waiting for me.

  “Hey, guys, have you seen Drudge this morning?” I yelled out from a distance. “You won’t believe it.”

  I handed the BlackBerry to Steve, who studied the screen and passed it to O.D.

  “Amazing,” said Steve. “Those guys at the lab will think we planned the whole thing, like we had inside information. Let’s get over there and show them what’s going on in the world.”

  We arrived at the lab, rushed through security as quickly as possible and raced up the stairs of Building 26 to the war room.

  Folks were having coffee and quietly chatting about events from the day before. I was fairly certain that the serious military and academic types around us had more important things to do each morning than read Drudge, so our scoop was still under wraps for the moment. I went into the technical support room adjacent to the main war room. The tech room had its own wall-sized screen to preview or troubleshoot what was going on in the war room. I asked the video tech if he could put the Internet up on the big screen and gave him the Web address for Drudge. Within a few seconds our friend Putin was on the screen, larger than life, throwing down the gauntlet at U.S. dollar hegemony. With a few more clicks on the control panel, the Drudge banner now appeared in the war room itself, while the lab staff helpfully printed out the story behind the headline and made sure a copy was placed among the rulebooks and scenarios sitting at every battle station.

  Harvard was not amused. He thought Steve and I were being ridiculous and now he thought pretty much the same thing about Putin. But most of the participants were kind enough to give us some kudos for driving the game toward the next big thing before it happened.

  Once the Putin buzz died down, it was back to the war game and move three, the final move in the game. This scenario involved the election of a proindependence candidate in Taiwan and an effort to reverse Taiwan’s increasing economic integration with mainland China. There was not much left to do on the gold currency front by now. Russia had made its move, China had refused to go along and the United States acted indifferent, although this seemed strange because in the real world any move toward gold by Russia would have been met with a much more robust reaction by the United States. The U.S. cell was composed entirely of academics, think-tankers and uniformed military, and had no market experience at all, so I had to assume they just didn’t get it when it came to an assault on the dollar. Like most experts I’d spoken to, they probably assumed
the dollar would always remain dominant and did not think much about alternative scenarios.

  * * *

  [conditioned or contingent?]

  * * *

  We set about preparing our responses to the problem at hand. China reiterated its “One China” policy and warned other nations not to support the Taiwanese initiative. Japan tried to promote an Asian Free Trade Area that would welcome both China and Taiwan as a way to obviate their divisions. The United States emphasized military cooperation with Taiwan but urged that such cooperation in the future would be conditioned on Taiwan’s reducing its confrontational stance. Only Russia continued to play the alternative currency wild card by trying to woo OPEC members in the gray cell to join its gold plan and by suggesting to China that it would be more inclined to take their side in the Taiwan dispute if China supported the new currency. I had to hand it to Steve and his teammates; they played their cards for all they were worth even if no one else was particularly paying attention.

  Just when it looked like the game would wind down anticlimactically, O.D. played a wild card of his own. Speaking on behalf of the gray cell, he announced that the Japanese coast guard had interdicted large shipments of nearly perfect counterfeit hundred-dollar bills, called supernotes by U.S. Treasury officials. Supernotes are produced by North Korea’s infamous Bureau 39, the state-sponsored racketeering agency set up in 1974 by Kim Il Sung to conduct money laundering, counterfeiting, drug smuggling and other acts usually perpetrated by criminal groups, in order to raise hard currency for the regime. O.D.’s move had a nice historical resonance with countries that had engaged in financial warfare by counterfeiting the currency of their enemies and flooding enemy territory with the counterfeits in order to cause distrust of legitimate bills and contribute to an economic collapse. During the U.S. Civil War, a Union sympathizer and Philadelphia stationery shop owner named Samuel Upham printed over $15 million in counterfeit Confederate bills, about 3 percent of the total amount in circulation. Many of these were carried south by Union soldiers and did undermine confidence in the real Confederate currency. O.D.’s counterfeit dollar discovery was a distant echo of this earlier episode of currency warfare.