James Rickards, a partner at New York hedge fund JAC Capital Advisors and a frequent commentator and adviser in the US, was in town last week to tell investors that loose money is likely to end either in Weimar Republic-style hyperinflation or the revival of the gold standard.
It’s an entertaining pitch, good for keeping people awake at a conference (Rickards spoke at a Macquarie event in Hong Kong and filled the Four Seasons’ ballroom) and for plugging his book Currency Wars: The Making of the Next Global Crisis. But it doesn’t hold up.
Just because Brazil’s finance minister accuses the US of engaging in a “currency war”, to use Guido Mantega’s phrase, doesn’t make it so. Of course, loose US money does have negative effects on other countries, but accommodating Brasília is not part of the Fed’s statutory remit.
Rickards is on solid ground when he decries the indebtedness at the heart of developed countries’ woes and the 2007-09 financial crisis. And he is right that beggar-thy-neighbour currency devaluation is a self-defeating response.
However, ‘sound money’ is a recipe for avoiding a severe financial crisis, not necessarily one for escaping one.
Rickards argues that the US government’s strategy for returning to growth is to print money, devalue the dollar, export inflation to trading partners, and boost manufactured exports.
He says this won’t work, because the psychology among investors and companies is poor; that it will result instead in high inflation, not real growth. He accuses the Fed of arrogance, because the global financial ecosystem is too complex to be controlled, and its destabilising actions are bound to shatter an increasingly vulnerable economy.
He believes extreme or fat-tail events are increasing in frequency, which means the next crash will be soon and it will be even harder than in 2008. For example, the notional derivatives market is even bigger; banks are consolidated into fewer ‘too big to fail’ institutions. (He also claims we’re experiencing more earthquakes – don’t know where that one comes from. Empirical evidence?)
Those observations are accurate, but Rickards draws strange conclusions. He says it won’t be long before a critical mass of Americans begin to reject using the dollar, creating a cascade of rejection that blows up the system. The final result is likely to be a return to the gold standard, which will ultimately benefit the US because it has the most gold of any nation (over 8,000 tonnes).
So in a roundabout way, maybe the Fed should make Q3 even bigger?
This all makes sense for the survivalist set, and might have been more compelling a year ago.
Rickards’ argument falls down on the idea of behaviour and mood – that the Fed can print lots of money but it won’t get companies to invest or people to spend. He notes that Irving Fischer’s famous equation MV=PT (money*velocity=price*transactions) requires velocity, the ongoing recycling of dollars through banks. Rickards says you can triple the money supply, but infinity times zero is still zero.
However, velocity is no longer zero. US banks are lending again. They have restructured, having as a group dramatically reduced leverage and impairments, and boosted capital.
More profoundly, was the Fed trying to export America’s problems to Europe and Asia? Or was it trying to find a way to keep domestic households above water? I suspect the latter. Households faced unprecedented indebtedness, very suddenly, once real estate no longer served as a source of easy funding.
Maybe all the Fed could do to prevent an utter social breakdown was to make those debts as easy to service as possible.
Rickards' history does not suggest a man allergic to government bailouts. He served as general counsel at Long-Term Capital Management and represented the firm in negotiations around the firm’s rescue by the Fed. Many observers believe this government-arranged bailout played an important role in building moral hazard into the US financial system. The Fed acting to save investment banks and hedge funds in 1998 was acceptable to him, it seems, but acting to save millions of Americans from another Great Depression is not.
Rickards loves to extol the virtues of those periods when monetary policies were fixed to gold – the classic period of 1870-1914, or the Bretton Woods post-war period. He says the response to World War I’s debts was marked by currency wars, as was Nixon’s response to US fiscal profligacy.
But much of the folly of the 1920s and early 1930s stemmed in part from leading economies sticking to the gold standard. Rickards acknowledges this, noting that the Bank of England, under pressure from chancellor of the exchequer Winston Churchill to honour pre-war commitments to bondholders, pegged it at 1914 levels when in fact the pound was much weaker after the war. (Looking back, Churchill called this his worst mistake, “quite an admission for the man who planned the Gallipoli invasion,” quips Rickards.)
But it was the central bankers such as BoE’s Norman Montague who were true believers when it came to sticking with gold. (John Maynard Keynes on Montague: “Always absolutely charming, always absolutely wrong.”) My point being that fixed exchange rates or sound money policies do not necessarily work when everything else has gone haywire. If Ben Bernanke, who spent his youth studying the Great Depression, is guilty of mistakes, they don’t include going down the same road as Montague.
(And if we did return to a fixed-rate regime for currencies, poor old Montague teaches us that it’s hard to know at what price to set your peg; getting it wrong just makes problems worse.)
For the world’s biggest central banks, the currency is a side-effect. They have other mandates they must focus on, such as inflation or domestic output. This may make life uncomfortable for the likes of Brazil and Switzerland, and great powers don’t play fair. The biggest losers are Asian central banks who have formally or informally fixed their currency to the US dollar. But no one in Washington ever asked the Chinese to outsource their monetary policy to Uncle Sam.
More important is whether quantitative easing is able to keep the US afloat long enough for its political class to do something about the budget deficit. Bernanke and his peers have bought the West time. Rickards, once a beneficiary of a Fed rescue, might be of more help putting his intellect to work on why the financial system was allowed to get so out of control in the first place.