• All private and foreign-owned gold held in custody at the Federal Reserve Bank of New York or depositories such as the HSBC and Scotiabank vaults in New York will be converted to the ownership of the U.S. Treasury and transferred to the U.S. gold depository at West Point. Former owners will receive suitable compensation, to be determined at a later time.
• All transfers of foreign holdings of U.S. Treasury obligations held in electronic book entry form in the system maintained by the Federal Reserve will be suspended immediately. Holders will receive interest and principal as agreed but no sales or transfers will be allowed.
• All financial institutions will record U.S. Treasury obligations on their books at par value and such securities will be held to maturity.
• Financial institutions and the Federal Reserve will coordinate efforts to purchase all new issuance of U.S. Treasury obligations in order to continue the smooth financing of U.S. deficits and the refinancing or redemption of any outstanding obligations.
• Stock exchanges will close immediately and remain closed until further notice.
• All exports of gold from the United States are prohibited.
This interim plan would stop the immediate crash in the Treasury bond market by freezing most holders in place and mandating future purchases by the banks. It would not offer a permanent solution and would at most buy a few weeks’ time within which to develop more lasting solutions.
At this point policy makers would recognize that the paper dollar as currently understood had outlived its usefulness. Its claim to be a store of value had collapsed due to a total lack of trust and confidence, and as a result its other functions as a medium of exchange and unit of account have evaporated. A new currency is now required. More of the same would be unacceptable; therefore, the new currency would certainly have to be gold backed.
Now the hidden strength of the U.S. financial position would be revealed. By confiscating foreign official and most private gold on U.S. soil, the Treasury would now possess over seventeen thousand tons of gold, equal to 57 percent of all official gold reserves in the world. This would put the United States in about the same relative position it held in 1945 just after Bretton Woods, when it controlled 63 percent of all official gold. Such a hoard would enable the United States to do what it did at Bretton Woods—dictate the shape of the new global financial system.
The United States could declare the issuance of a “New United States Dollar” equal to ten old dollars. The new dollar would be convertible into gold at the price of one thousand new dollars per ounce—equal to $10,000 per ounce under the old dollar system. This would represent an 85 percent devaluation of the dollar when measured against the market price of gold in April 2011, and would be slightly greater than the 70 percent devaluation against gold engineered by FDR in 1933, but not a different order of magnitude. It would be far less than the 95 percent dollar devaluation measured in gold that occurred under Nixon, Ford and Carter from 1971 to 1980.
Because of its gold backing, the New United States Dollar would be the only desirable currency in the world—the ultimate victor in the currency wars. The Fed would be ordered to conduct open market operations to maintain the new price of gold as described under the flexible gold exchange standard above. A windfall profits tax of 90 percent would be imposed on all private gains from the upward revaluation of gold. The United States would then pledge generous concessionary loans and grants to Europe and China to provide liquidity to facilitate world trade, much as it had done under the Marshall Plan. Gradually, those parties whose gold had been confiscated, mostly European countries, would be allowed to buy back their gold at the new, higher price. There is little doubt that they would choose to store it in Europe in the future.
Confidence would slowly be restored, markets would reopen, new prices for goods and services would be discovered and life would continue with a New King Dollar at the center of the financial universe.
Or not. This scenario of chaos followed swiftly by the ascent of a new gold-backed dollar emerging phoenixlike from the ashes is only one possibility. Other possible scenarios would include an unstoppable financial collapse followed by the widespread breakdown of civil order and eventually a collapse of the physical infrastructure. These scenarios are familiar from popular films and novels, like Cormac McCarthy’s The Road. The stories typically involve a post-apocalyptic survival tale in the wake of devastation caused by shooting wars, natural disasters or alien invaders. In principle, the destruction of wealth, savings, trust and confidence in the aftermath of a currency war and dollar collapse might be no less catastrophic than a hostile alien invasion. A person’s net worth would consist of those things she can carry on her back.
Another possible response to a dollar collapse would be government intervention of a type that is far more extreme and coercive than the executive action permitted by IEEPA and described above. Such coercion would more likely occur in Asia or Russia and may involve wholesale nationalization of capital stock and intellectual property, closed borders and redirection of productive capacity to domestic needs rather than export. The world would retreat into a set of semiautarkic zones and world trade would collapse. The result would be the opposite of globalization. It would be the Beijing Consensus without the free riding—there would be no one left to ride.
Conclusion
The path of the dollar is unsustainable and therefore the dollar will not be sustained. In time, the dollar will join a crowd of multiple reserve currencies, be subordinated to SDRs, be rejuvenated by gold or descend into chaos with both redemptive and terminal possibilities. Of these four outcomes, the use of multiple reserve currencies seems least likely because it solves none of the problems of debt and deficits, but merely moves the problem around from country to country in a continuation of the classic currency war. The SDR solution is being promoted by some global elites in the G20 finance ministries and IMF executive suites, yet to the extent that it simply replaces national paper currencies with a global paper currency, it risks its own rejection and instability in time. A studied, expertly implemented return to the gold standard offers the best chance of stability but commands so little academic respect as to be a nonstarter in current debates. This leaves chaos as a strong possibility. Within chaos, however, there is a second chance to go for gold, albeit in a sudden, unstudied way. Finally, there is just chaos, followed by something worse.
The collapse of the dollar might be a particularly trying catastrophe of its own or occur as part of an even larger collapse of civilization. It might merely mark a turning away from the excesses of paper money or be a milepost on the way to a maelstrom. None of this is inevitable, yet all of it is possible.
It is not too late to step back from the brink of catastrophic collapse. Complexity starts out as a friend and ends up the enemy. Once complexity and large scale are seen to be the danger, the solution is a mixture of descaling, compartmentalization and simplification. This is why a ship whose hold is broken up by bulkheads is less likely to sink than a vessel with a single large hold. This is why forest rangers break up large tracts of timber with barren firebreaks. Every carpenter works by the phrase “The right tool for the right job.” Economists should be no less diligent than carpenters in selecting the right tools.
As applied to capital and currency markets, the correct approach is to break up big banks and limit their activities to deposit taking, consumer and commercial loans, trade finance, payments, letters of credit and a few other useful services. Proprietary trading, underwriting and dealing should be banned from banking and confined to brokers and hedge funds. The idea that large banks are needed to do large deals is nonsense. Syndicates were invented for exactly this purpose and are excellent at spreading risk.
Derivatives should be banned except for standardized exchange-traded futures with daily margin and well-capitalized clearinghouses. Derivatives do not spread risk; they multiply it and concentrate it in a few too-big-to-fail hands. Derivatives do not serve customers;
they serve banks and dealers through high fees and poorly understood terms. The models used to manage derivatives risk do not work and never will work because of the focus on net risk rather than gross risk.
A flexible gold standard should be adopted to reduce uncertainty about inflation, interest rates and exchange rates. Once businesses and investors have greater certainty and price stability, they can then take greater risk on new investments. There is enough uncertainty in entrepreneurship without adding inflation, deflation, interest rates and exchange rates to the list of barriers standing in the way of innovation. The U.S. economy as guided by the Fed has seen continual asset bubbles, crashes, panics, booms and busts in the forty years since the United States left gold. It is time to diminish the role of finance and empower the role of commerce. Gold produces the greatest price stability in prices and asset values and therefore provides the best visibility for investors.
The Taylor rule, named for its proponent economist, John B. Taylor, should guide monetary policy. The rule utilizes positive feedback loops by including actual inflation in its equation while offering simplicity and transparency. It is not perfect, but, to paraphrase Winston Churchill, it is better than all the others. The combination of the Taylor rule and a flexible gold standard should make central banking a boring occupation, which is exactly the point. The more drama that can be removed from central banking, the more certainty that will be provided to entrepreneurs, who are the real source of jobs and wealth creation.
Other suggestions to reverse the impact of complexity include elimination of the corporate income tax, simplification of the personal income tax and reductions in government spending. Opposition to ever larger government is not ideological; it is merely prudent. When the risk of collapse is in the scale itself, the first-order benefits of government programs are dominated by the invisible second-order costs. Smaller is safer.
What the recommendations above have in common is that they all shrink or simplify the financial system or, in the case of gold, build bulkheads against collapse. Critics will say that many of these proposals are backward looking to a time of less government and less complexity in banking, fiscal policy and monetary policy. They will be right and that is exactly the point. When you have moved to the negative marginal-return section of the complexity input-output curve, going backward is a good thing to do because society will be more productive and more robust to catastrophe.
If remedial policies are not adopted and events do spiral out of control, the Pentagon will inevitably be called upon to restore order in ways that the Treasury and Fed cannot. The threats envisioned in the Pentagon’s 2009 financial war game are becoming more real by the day. Secretary of Defense Robert Gates, upon being briefed on the financial war game, said it was “an eye-opening experience” that “reflected some shortcomings in the ability and willingness of different parts of the government to share information.” Gates did not mention the U.S. Treasury by name; however, my experience is that the Treasury and the Fed need to work more closely with the national security community to help the country prepare for what may lie ahead.
As I noted at the outset, a book on currency wars is inevitably a book about the dollar and its fate. The dollar, for all its faults and weaknesses, is the pivot of the entire global system of currencies, stocks, bonds, derivatives and investments of all kinds. While all currencies by definition represent some store of value, the dollar is different. It is a store of economic value in a nation whose moral values are historically exceptional and therefore a light to the world. The debasement of the dollar cannot proceed without the debasement of those values and that exceptionalism. This book has tried to offer fair warning of the dangers ahead and be a compass to help steer away.
Social and financial collapses have happened many times but are easily ignored or forgotten. Yet history does not forget, nor do complex systems refrain from doing what they are wont to do. Complex systems begin on a benign organizing principle and end by absorbing all available energy while destroying the system itself. Capital and currency markets are complex systems and will collapse in the end unless they are broken up, contained, compartmentalized and descaled. Currency wars are ultimately about the dollar, yet the dollar today is just a jumped-up version of a former self due to derivatives, leverage, printing and the derogation of gold. It is not past time to save it. Still, the time grows short.
ACKNOWLEDGMENTS
My sincere gratitude to those who helped me with this book begins with thanks to Melissa Flashman, my literary agent, who was instrumental in moving Currency Wars from concept to project to reality. Her support never wavered and that was a comfort through long months of research and writing.
I owe thanks and gratitude to Adrian Zackheim at Penguin/ Portfolio for green-lighting this book and taking a chance on a first-time author. We both had the sense in 2010 that the currency wars had far to run. Unfortunately for the world economy, we were right. My editor, Courtney Young, editorial assistant Eric Meyers and the rest of the team at Penguin contributed expertly to the making of the book. Enormous thanks are owed to my copy editor, Nicholas LoVecchio, whose meticulous scrutiny added to the consistency and flow of the finished work. Thank you all for your skill and patience.
I am enormously grateful to my partners at Omnis in McLean, Virginia, for allowing me to bring Wall Street to the world of national security. Randy Tauss, Chris Ray, Joe Pesce and Charlie Duelfer are all American heroes of the quiet, unsung type. It is a privilege to work with them. Our prayers are with our late partner, Zack Warfield.
I thank my associates inside the national security community, who cannot be mentioned by name. You know who you are. America may not know your names, but she is lucky to have you in her service.
Thank you to the leaders at the Applied Physics Laboratory who allowed me to think outside the box while sitting inside the gates. Duncan Brown, Ted Smyth, Ron Luman and Peggy Harlow never rest in their threat assessments and forward-leaning thinking about how to counter those threats. They were kind to include me in their efforts.
I owe an enormous debt incurred over many years to my legal mentors Tom Puccio, Phil Harris, Mel Immergut, Mary Whalen and Ivan Schlager. Even lawyers need lawyers and they are the best.
Thank you to my economics mentors, John Makin, Greg “the Hawk” Hawkins, David Mullins, Jr., Myron Scholes and Bob Barbera. Given my heterodox theoretic approach to their field, I thank them for listening and sharing their thoughts and views.
Thanks also to my market mentors, Ted Knetzger, Bill Rainer, John Meriwether, Jim McEntee, Gordon Eberts, Chris Whalen, Peter Moran and Dave “Davos” Nolan. Davos and I shorted Fannie Mae stock at $45 per share in 2005 and lost money when it went to $65. Today it trades for 39 cents. Timing is everything.
With Washington, D.C., now the financial as well as political center of the universe, a book like this could not have been written without the support and encouragement of, and many sets of intellectual ping-pong with, those who are closest to the power. Thank you to Taylor Griffin, Rob Saliterman, Blain Rethmeier, Tony Fratto, Tim Burger, Teddy Downey, Mike Allen, Jon Ward, Juan Zarate and Eamon Javers for guiding me through the thickets of the New Rome.
When a military perspective was needed, one could do no better than turn to Brigadier General Joe Shaefer and Rear Admiral Steve Baker. Thank you both. When I met General Shaefer, he was the only active-duty general with an SEC license to trade securities options. Priceless. Thanks also to Greg Burgess of the Office of the Secretary of Defense for his vision and persistence in sponsoring the financial war game that makes up the first part of this book. I am indebted to Greg for inviting me to play and including me on the China team. Maybe we can play the game again when China has more gold.
The War Games chapters of this book would not exist without the efforts of the “Wall Street Irregulars” I recruited to join me on the global financial chessboard set up by the Pentagon. Thank you Steve Halliwell and Bill O’Donnell for your friendship, your willingness to
participate and for allowing me to tell your stories. We’ll meet again at Ten Twenty Post, where the war game really began.
Thank you to Lori Ann LaRocco of CNBC, Amanda Lang of CBC and Eric King of King World News for inviting me on your air to discuss the economic analysis that makes up so much of this book. There is nothing like live TV with smart anchors to force you to hone your thinking.
Thanks to the folks who took time to read various sections of the manuscript at different stages of completion and offered a thoughtful mix of questions, critiques and encouragement. They read not as economists but as concerned citizens with mortgages, children, bills to pay and a desire to make sense of a financial world turned upside down. Their comments made this a better book. Thank you, Joan, Glen and Diane.
There is simply no way to live with your spouse and write a book without the spouse becoming a huge part of the writing. You discuss it, debate it, argue about it, live it and breathe it. Thank you, Ann, for a thousand little things and the one big thing of helping me to be a better writer. All my love.
Jon Faust of the Johns Hopkins Center for Financial Economics and Sebastian Mallaby of the Council on Foreign Relations were both generous with their time in reading the manuscript and offering expert comments. Of course, the views expressed in this book are mine and not necessarily theirs. Thank you both.
Currency Wars: The Making of the Next Global Crisis Page 29
