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Jim Rickards on Inflation and Currency Wars

Jim Rickards on Inflation and Currency Wars

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Published by Ron Hera
Jim Rickards is one of the most astute intellectuals today in economics, financial markets and monetary systems, as well as an increasingly outspoken critic of the Federal Reserve’s monetary policies. The debasement of the U.S. dollar—the world reserve currency—through QE2, and due to monetary expansion resulting from low interest rates, is exporting U.S. inflation abroad, disrupting economies in Asia, South America and elsewhere. In addition to putting upward pressure on food prices globally, with potentially disastrous consequences, inflation is a hidden tax on savings and wages and, as prices rise, the living standards of most Americans will decline. Currency wars, caused by the Federal Reserve’s policies, could lead to trade wars or, in the worst case, to economic and political chaos as has been seen in Tunisia and Egypt.
Jim Rickards is one of the most astute intellectuals today in economics, financial markets and monetary systems, as well as an increasingly outspoken critic of the Federal Reserve’s monetary policies. The debasement of the U.S. dollar—the world reserve currency—through QE2, and due to monetary expansion resulting from low interest rates, is exporting U.S. inflation abroad, disrupting economies in Asia, South America and elsewhere. In addition to putting upward pressure on food prices globally, with potentially disastrous consequences, inflation is a hidden tax on savings and wages and, as prices rise, the living standards of most Americans will decline. Currency wars, caused by the Federal Reserve’s policies, could lead to trade wars or, in the worst case, to economic and political chaos as has been seen in Tunisia and Egypt.

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Published by: Ron Hera on Apr 24, 2011
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Hera Research, LLC
7205 Martin Way East, Suite 72Olympia, WA 98516U.S.A.+1 (360) 339-8541 phone+1 (360) 339-8542 faxhttp://www.heraresearch.com/
1
Interview: Jim Rickards onInflationand Currency Wars
By Ron HeraFebruary4, 2011©2011 Hera Research, LLCTheHera Research Newsletter  (HRN) is  pleasedto presentaneye opening interviewwithJames G. Rickards,Senior ManagingDirector of Tangent Capital Partners, amerchant bank specializing in alternativeasset management solutions, and also Chief Operating Officer of Oro Capital Advisors,LLC, a commercial real estate advisory firmand Tangent Capital affiliate. He is acounselor, economist and investmentadvisor with 35 years experience in globalcapital markets.Mr.Rickardshas held senior executive positions at Citibank, RBS, Long-Term CapitalManagement and Caxton Associates. In 1998, he was the principal negotiator of the rescue of LTCM sponsored by the Federal Reserve Bank of New York. His clients include private funds,investment banks and government directorates in national security and he is an advisor on globalcapital markets to the U.S. Office of the Director of National Intelligence. He is a frequentspeaker at conferences on derivatives and hedge funds and is active in the International Bar Association. He has been interviewed in The Wall Street Journal and the Economist, hasappeared on CNBC, Fox, CNN, BBC and NPR and is an Op-Ed contributor to the FinancialTimes, New York Times and the Washington Post.Mr. Rickards, who is a visiting lecturer at the Kellogg School and the School of AdvancedInternational Studies, has deliveredpapers on econophysics at the Applied Physics Laboratoryand the Los Alamos National Laboratory and has written articles on cognitive diversity, network science and risk management. Mr. Rickards holds an LL.M. (Taxation) from the New York University School of Law; a J.D. from the University of Pennsylvania Law School; an M.A. ininternational economics from the School of Advanced International Studies and a B.A. (withhonors) from The Johns Hopkins University.
Hera Research Newsletter (HRN):
Thank you for taking the time to speak with us today. Let’s talk about the Federal Reserve’s quantitative easing program (QE2). Is there a risk ofpriceinflation?
Jim Rickards:
I think there is a definite and highly significant danger of inflation coming from QEandQE2 specifically. Alot of people have said, in fact, the Fed has said,that,if you look at the key priceindices,the Producer Price Index (PPI),Consumer Price Index (CPI),and thePersonal Consumption (PC) price deflator,theyare very, theyuse the phrase, “well behaved”.For the past year and a half, the critics,and I would include myself,have been saying that thissituationis dangerous and unstable. TheFed has
 
©2010 Hera Research, LLC
2 been pointing to the price indices and sayingthatyou can’t find inflation under a rock, you can’t findinflation with a microscope, so what are you worried about?
HRN:
Why do you think the situation is unstable?
Jim Rickards:
There is a lot of inflation, but it is beingoffset by deflation. I compare it to an armwrestling match. If you’ve ever seen an arm wrestling match with two really powerful participants,nothing really happens for a long time. The two arms just kind of sit there, then all of a sudden it starts totip, then one guy just breaks andhisarmis slammeddown onthe table. Just because nothing ishappening at the surface doesn’t mean that a lot of things aren’t happening below the surface.In adepression, such as the one that began in 2007, you have very, very strong deflationaryforces.I call it anatural deflation that’s being offset by policy inflation. So the fact that the price indices are aroundzerodoesn’t mean that they’re well behaved, it just means that they’re masking the two tectonic forces that are pushing against each other.
HRN:
Do you thinkdeflationwillwin, or will it beinflation?
Jim Rickards:
For the past year and a half,I’ve wonderedwhich wayit’sgoing to tip. If I’m right aboutthose two forces, one of them is going to prevail at the end of the day and,onwhich oneit’s going to be, Ireally reserve judgment because I could argue it both ways.I amnowcoming down on the side of inflation because the inflation is becoming very, very apparent.So, the first thing is that the well behavedindicesaremasking more than they’re tellingusbecause,below the surface,therearepowerfuldeflationary andinflationary forces fighting each other.
HRN:
Why do you think inflation willwin?
Jim Rickards:
It’s been known since the1950’s, asMilton Friedmanpointed out, inflationary effectsoccur with the lag. The fact that you saw QE in 2009 and inflation didn’t show up until the end of 2010really should not give you a lot of comfort because an18 to24 month lag isnormaland wouldbeexpected. Sure enough, right on schedule, 18 months after QE1 was announced in mid-2009 we’restarting to see the inflation.
HRN:
What doesinflation inforeigncountrieshave to with QE2?
Jim Rickards:
There are some new forces in play sinceFriedman did his seminal work and,of course,it’sthe resultof globalization. What has been happening is that what would otherwise have beenU.S.inflationisshowing up in China and Taiwan and Korea and places like that because of the exchange ratemechanism.I put this under the heading of currency wars.In effect, China has been importing all of our inflation through the peg between the dollar and the yuan.
HRN:
How does the yuan-dollar currency peg cause inflation in China?
Jim Rickards:
Just think about the mechanics of it. There’s a lot of deleveraging going on, which iswhere the deflation comes from, so the Fed goes out and prints a whole bunch of dollars and spreads themaround. Americans take a lot of those newly printeddollars and buy foreign goods so the dollars go toChina, but China doesn’t want the yuan to appreciate becausethey want to maintain the peg, or at leastthey have until very recently. So, what do they do? They have to buy up the dollars. Well, in order to buy up the dollars they have to print yuan and basically give the yuan to the exporters in exchange for thedollars. Well, that’s basically flooding China with yuan and so theFed’s printing press wasbeingsterilized in America by the Chinese whowereflooding their own country with their own local currency.So, through the exchange rate mechanism,andthrough the peg between the dollar and the yuan, our 
 
©2010 Hera Research, LLC
3inflation was showing up in China and now it’s showing up in Vietnam, South Korea, Taiwan and other  places.
HRN:
CantheU.S.keepexporting its inflation?
Jim Rickards:
Like I said, inflationin theU.S.was being offset by natural deflation andthere is atimelagbefore inflation shows up.Ithas takena while for inflation to show upin Chinabecause theyalso hadalag.U.S.inflationwas being exportedthrough the currencyexchange ratemechanism, butall goodthings come to an end. These things are now coming to an end fortwospecific reasons. Number one, thetime lag just works its way through,andI think commodity prices, input prices,are wherethe inflation isreally starting to show up anditwill work its way through the supply chain and eventually show up inretail.Number two, the Chinese have now thrown in the towel on the appreciation or revaluation of theyuan and the reason for that is inflation.
HRN:
So,theChineseyuanwillrise versus the U.S. dollar?
Jim Rickards:
Inflation is just another form of revaluation. What do you do when you revalue your currency? Well, you increase your cost structure relative to other countries. You make your goods moreexpensive from the view of aU.S. purchaser, let’s say. Well, inflation does the same thing, inflationincreases your cost structure. So, inflation and revaluation are the same thing economically with one veryimportant difference; revaluation you can control, but inflation very quickly gets out of control. TheChinese, once they saw the inflation, said, well, look, this is going to happen anyway, our cost structure isgoing up and there’s nothing we can do about it. Our choice is between control and lack of control and,of course,they’re control freaks,sothey’re going to go with control, which means they’re going to gowith the revaluation and try to stay ahead of the inflation.
HRN:
Do theChinesehave any other option?
Jim Rickards:
They thought they had an ability to keep a lid on their domestic inflation through pricecontrols. We all know that price controls always ultimately fail, but they can work in the short run,especially if you have a more coercive society and I would put China in that category.Whether there wasgoing to be a black market or offshore money or the inability to enforce their rules at the local level,Ithink they quickly realized price controls were a losing battle.
HRN:
What about otherexport nations, like Brazil?
Jim Rickards:
TheFed is flooding the world with dollars and, asformerU.S.Treasury SecretaryJohnConnally famously said in the 1970’s, “it may be our currency, but it’s your problem”. Raising interestrates, currency debasement and capital controlsarealltoolsin the toolbox that exporters can useto dealwithFed monetary policy andQE2. We’re seeingcapital controlsin Brazil, for example. Brazil couldn’treally control the appreciation of the real, there was just too much demand, too much hotmoney flowinginto emerging markets,Brazil in particular. So there wasn’t much they could do about it from a currency point of view, so they’re puttingin capital controls. The next step down that road, you pretty quickly gofrom currency wars to tradewars and trade wars lead to tariffs and then export quotas. We’re seeing alittle bit of that in China with rare earth elements (REEs),although there’s another agenda withrespect toREEshaving to do with encouraging manufacturers to put their plants in China so they can get guaranteedaccess to theREEs.
HRN:
Willthe revaluation of the yuan and capital controls in other countries causeprices to rise in theU.S.?

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