Gold is the pile of poker chips in next global crisis

(April 5, 2016 - by James Rickards)

China and Russia are preparing for the next crisis by buying up gold, says author James Rickards

Author James Rickards maintains that gold remains the real underpinning of the international monetary system. Governments may disparage it, he says, yet many of them have held on to gold — and China and Russia have been acquiring more.

Rickards is the author of “The Death of Money” and “Currency Wars.” His new book, “The New Case for Gold GCM6, +0.93%  ,” was published today. He answered two questions from MarketWatch. Answers have been edited for length. An excerpt of his book follows.

Q: You say another monetary collapse will be triggered by a collapse of confidence in the U.S. dollar. What specifically makes you see this collapse on the horizon?

A: Capital markets and economies are complex systems. Collapse in complex systems is an exponential function of systemic scale.

The crisis in 2008 was centered around “too big to fail” banks. Since 2008, those same banks have grown larger, control a larger percentage of all banking assets in the U.S., and have much larger derivatives books. This makes the risk of collapse and the potential size of the collapse much greater than anything seen since the Great Depression, perhaps longer. Meanwhile, little of the policy support used in 2008-2009 has been withdrawn. This means that the risk of collapse is greater and the means to truncate collapse are used up and not available.

The only clean balance sheet and source of liquidity left in the world is the International Monetary Fund, which can make an emergency issuance of Special Drawing Rights. China’s quid pro quo will be the marginalization of the dollar. This will cause a diminution in confidence, which will rapidly cascade into a full-scale crisis of confidence.

Q: You see the ratio of gold holdings to a country’s GDP as the source of power when the rules of the monetary system get rewritten. Why does China need to own lots of gold in order to have a big seat at the table? Why wouldn’t all that Treasury debt it holds suffice?

A: The oldest joke in banking is that if I owe you $1 million, I have a problem, but if I owe you $1 billion, you have a problem. This is because I can always default and leave you holding worthless paper. Since the U.S. owes China $2 trillion, the problem is theirs, not ours.

The U.S. will default on this debt by inflation (it’s the American way). China realizes this and is acquiring gold as a hedge against inflation in its dollar-denominated assets.

This excerpt from “The New Case for Gold” is entitled “Shadow Gold Standard”

Countries around the world are acquiring gold at an accelerated rate in order to diversify their reserve positions. This trend, combined with the huge reserves held by the U.S., Eurozone and the IMF amount to a shadow gold standard.

The best way to evaluate this shadow gold standard among various countries is to use the ratio of gold to the gross domestic product, (GDP). This Gold-to-GDP ratio can easily be calculated using official figures and compared across countries to see where real gold power resides.

The big winners—the real center of gold power in the world—are the 19 nations that make up the Eurozone and issue the euro. Their gold as a percentage of GDP is over 4%. The United States’ ratio is about 2.7%. Interestingly, Russia’s ratio is also about 2.7%. Russia only has one-eighth the amount of gold the U.S. has, but their economy is only one-eighth the size of the U.S. economy, so the ratio is comparable. However, Russia is one of those nations acquiring more gold and seems set on passing the U.S. and matching the Eurozone. Japan and the U.K. are major economies but their gold ratio is anemic; about 0.7%.

The most interesting case is China. The official gold reserves of China are reported as of July 2015 at 1,658 tons. Yet we know from various reliable sources including mining production and import statistics that their actual gold stock is closer to 4,000 tons. It is also entirely possible that China has considerably more than 4,000 tons of gold.

China, like Russia, is acquiring gold so that they have a comparable ratio to the U.S. and Europe. This ratio will be critical when the monetary system collapses since it will form the basis for any monetary reset and the new “rules of the game.”

In any monetary reset, countries will come together and sit around the table. One can think of that meeting as a poker game. When you sit down at the poker table, you want a big pile of chips. Gold functions like a pile of poker chips in this context. This doesn’t mean that the world automatically goes to a gold standard. It does mean that one’s voice at the table is going to be a function of the size of its gold hoard.

There are only about 35,000 tons of official gold in the world. The phrase “official gold,” means gold owned by central banks, finance ministries, and sovereign wealth funds. This does not including gold jewelry and gold held in private hoards.

This means that China’s acquisition of over 3,000 tons of gold in the past seven years represents approximately 10% of all the official gold in the world; a huge shift in gold reserves in favor of China. This explains China’s non-transparency. The gold market is liquid, but thinly traded. If China’s intentions and actions were fully disclosed, the price of gold would likely be much higher.

China is trying to acquire enough gold so that when the international monetary collapse comes and the world has to re-cut the deal, they’ve got a prime seat at the table.

Countries like Canada, Australia, and U.K. with small gold-to-GDP ratios will be seated away from the table, along the walls. These small gold powers will essentially be spectators in the global monetary reset and will have to content themselves with whatever system the U.S, Europe, Russia and China devise.

In this scenario, Germany will speak for Europe, so the new system will be based on a U.S.-German-Russian-Chinese monetary condominium administered by the IMF. These major gold powers are already preparing for this outcome.

Adapted from “The New Case For Gold” by James Rickards, in agreement with Portfolio, an imprint of Penguin Publishing Group, a division of Penguin Random House LLC. Copyright © James Rickards, 2016.