CURRENCY WARS

James Rickards

Portfolio-Penguin, NY., paperback, 2011, 296 pgs., index, endnotes.

Reviewer comment:
I wrote this review 10 years ago, much has changed since then including the publication of many more books and much analysis,so both Rickards analysis and my thoughts have changed as well.

The author describes familiar financial history - but in a context that may be new to readers. For one, I lived through the chaos and economic volatility he describes but without grasping the 'big picture' - the context - the Currency Wars. I remember many frustrating discussions about what the FED was doing to alternately increase and decrease interest rates, generate booms and busts in the bond market, create and reduce inflation, change the value of the dollar relative to the German mark I needed to pay for imports, and so much more. And all this was but the second of the Currency Wars. I had studied the economic history of the U.S. (and the world) including of course that of the 20th century with its similar volatility, but had not seen the 'big picture' described here by Mr. Rickards in terms of a similar Currency War. but the important part of the book is the third section in which Rickards exposes the fallacies and propaganda underlying current monetary and fiscal policy. He explains the current currency war in terms of the conflict between mercantilism and globalism. As a means to help pay for their massive national debts all the major countries are trying to devalue their currencies at once, but of course that is not possible, since devaluation of a currency means increase in relative value of the other currencies. In the final section Rickards suggests several alternate futures. One is expansion of SDR's by the IMF, another is creation of new reserve currency based on basket of currencies or commodities, and another is greatly increased value of gold relative to all currencies. For a biography of Rickards one can Google and see a Wikipedia entry and other interesting articles. .

Preface -
In 1971 President Nixon imposed price controls, a surtax on foreign imports and banned the conversion of dollars into gold. The U.S. was in a currency war that destroyed faith in the U. S. dollar. Now we are in another currency war and there again is a crisis. But this time the situation will be worse because the world situation now is worse. Now the world is overflowing with financial instruments based on paper. Again, the crisis will hit first in the currency markets, but it will spread to stocks, bonds, and commodities. There will be self-expanding panic. S Sure president will have to take drastic action. Mr. Rickards describes some of the alternative measures that will be necessary and invoked. Paper currencies will collapse just as they always have. "Today the U.S. Federal Reserve, under the guidance of Chairman Ben Bernanke, is engaged in the greatest gamble in the history of finance." "The Fed is attempting to inflate asset prices, commodity prices and consumer prices to offset the natural deflation that follows a crash." "It must cause inflation before deflation prevails; it must win the tug-of-war." "This book is about the contest between inflation and deflation, the rope is the dollar." "The U. S. economy is resting on a knife's edge between depression and hyperinflation." "While Fed money printing on a trillion-dollar scale may be new, currency wars are not." " The book examines our current currency war through the lens of economic policy, national security and historical precedent."

PART ONE - War Games - a brief background from the author's personal experience in which he finds that government officials and analysts don't have a clue about what currency war is all about.

Chapter 1 - Prewar -
This chapter recounts the author's invitation to participate in a 'war game' conducted by DOD. He was one of the financial experts invited to bring their understanding of financial markets to bear on the content and course of the 'game'.

Chapter 2 - Financial War -
Here the author describes the course of the 'war game'. He strove to introduce financial activities and found that most of the DOD participants didn't understand what he was doing. He was attempting to bring about a 'currency war', but in a game lasting only two days he could not accomplish much.

Part Two: Currency Wars: Excellent description of the financial - monetary history since WWI but placed in the context of currency wars.

Chapter 3 - Reflections on a Golden Age
Mr. Rickards begins with this comment. "A currency war, fought by one country through competitive devaluation of its currency against others, is one of the most destructive and feared outcomes in international economics." The Brazilian finance minister has declared that such a war has begun. These international wars have their origin in domestic economic conditions. Mr. Rickards discusses the standard equation that defines GDP (national gross domestic product). It is GDP=C + I + G + (X - M) This means private consumption plus private investment plus government expenditure plus the net of exports and imports. I personally don't like the entire philosophical basis for this equation, but that is a subject for another essay. Mr. Rickards provides examples using named items and monetary numbers. He notes that these values are influenced (dependent) on the exchange rates between the many countries that now participate in both production and consumption. In order to keep the exchange rate of their currency favorable in relation to trading partners governments will engage in a variety of policies, such as protectionism. This has begun.
Mr. Rickards shifts to briefly describe the world when the Classical Gold Standard was in place - 1870 -1914. It was a period of stable prices - one with the beginning of globalization and technological improvements in communications and transportation. Mr. Rickards contrasts the real gold standard prior to World War One and the truncated and ineffective gold standard that was attempted in the 1920's.
Then he turns to the creation of the Federal Reserve 1907=1913. There was a bank panic in 1907 set about due to the failure of the Knickerbocker Trust, which had been speculating. .

Chapter 4 - Currency War I - 1921-1936
Mr. Rickards begins: "Currency War I began in spectacular fashion in 1921 in the shadow of World War I and wound down to an inconclusive end in 1936." This is the first book I have found that ties the events leading up to the Great Depression to the concept of 'currency war'. But the author's analysis and explanation of well known events places them in a new conceptual framework. He goes back to 1921 in asserting that Germany began the first round with its hyperinflation designed to improve its national competitiveness in the face of the huge demands for reparations. He notes that France then moved in 1925 by devaluating the franc to gain an export advantage over Great Britain and the United States. England then broke with the gold standard in 1931 to retaliate and regain position versus France. President Hoover, then in 1931, stopped German war payments.
Rickards writes: "In round after round of devaluation and default, the major economies of the world raced to the bottom, causing massive trade disruptions, lost output and wealth destruction along the way." Thus it is a valuable lesson for today, when governments are attempting or considering similar policies. He notes that the German Weimar Reichsbank method was exactly to buy bills from the German government to supply that government with the money required to fund budget deficits and spending. Sounds quite familiar, no? He comments that the popular view that this policy was related to the huge war reparations is a myth. Those reparations were payable in gold or foreign currencies then on a percentage of German exports, not valuated in German currency. Thus the reparations could not be inflated away. However, an increase in exports themselves and increased foreign tourism could reduce the effective burden. The domestic inflation inside Germany began to increase only gradually.
Rickards describes in detail just who benefited as well as who suffered catastrophic losses before the new currency was effective in 1924. Yes, many sections of the German public benefited or at least survived relatively intact. He notes also that as the inflation turned to hyperinflation the central bank had to increase money printing due to the demands of government workers and labor unions. He writes: "Economic historians customarily treat the 1921-1924 hyperinflation of the Weimar Republic separately from the worldwide beggar-thy-neighbor competitive devaluations of 1931-1936, but this ignores the continuity of competitive devaluations in the interwar period. The Weimar hyperinflation actually achieved a number of important political goals, a fact that had repercussions throughout the 1920's and 1930's" He describes these.
He moves on to the Geneva Conference at which major nations reinstated a gold exchange standard different from the gold standard that existed prior to the World War. But the currency wars continued. The new 'standard' had significant flaws. Currency wars shifted from manipulation of exchange rates to interest rates. For one thing not only gold but currency reserves played a role in the central banks' ability to make adjustments driven by political policy.
He makes a key point, "One of the peculiarities of paper money is that it is simultaneously an asset of the party holding it and a liability of the bank issuing it." This is a critically important fact overlooked by the public and mostly ignored by economists. Gold is only an asset. In the remaining pages of the chapter the author describes the Great Depression and its links to the currency war. He explains the reasons FDR stole the gold in private hands and then revaluated the dollar. Until then the currency war had been importing deflation into the U.S. With devaluation the U.S. exported deflation back to France and others, resulting in the Tripartite agreement of 1936. The currency war was gradually ended, but too late, as the resulting political changes, especially in Japan and Germany, led to the shooting war - World War II.

Chapter 5 - Currency War II - (1967-1987)
Those of us who lived through the financial chaos of 1967-87 well remember the surface events in detail. But didn't recognize that those events were a part of a currency war. Mr. Rickards brings these events into a clear context. He first describes the international effort to create a new currency system with the Bretton Woods Conference of 1944. While this system managed to survive into the 1970's, the author notes, that the origins of a new currency war can be seen in the 1960's and dates it to 1967. He writes," The convergence of the costs of escalation in Vietnam and the Great Society in early 1965 marked the real turning away from America's successful postwar economic policies." The impact resulted in increasing inflation. It nearly doubled from 1.9% in 1965 to 3.5% in 1966, and expanded rapidly from there into the 1980's.
He writes, that the citizens' perception was similar to those in Weimar Germany that "their perception was that prices were going up; what was really happening was that the currency was collapsing. Higher prices are the symptom, not the cause, of currency collapse." This is something that I repeatedly stress. We are taught to think of the value of goods and services in terms of money - but we should always think of the value of money in terms of its purchase power of goods and services. The Bretton Woods system began to crack in 1967. The British devalued the pound. Like the British, the U.S. had trade deficits and inflation. Moreover, "under Bretton Woods the value of the dollar was not linked to other currencies but to gold". If the dollar was devalued that meant the price of gold must increase. This meant any smart government or speculator should start buying gold at the then fixed price. Gold was bought and sold on the London Gold Pool where its value was fixed. He notes, "The public attack on the Bretton Woods system of a dominant dollar anchored to gold began even the 1967 devaluation of the British pound. In 1965 President de Gaulle of France had delivered a speech denouncing the dollar and that year France began selling dollars and buying gold. Spain soon followed. But a general devaluation of all currencies against gold was seen as a great benefit for South Africa and the Soviet Union, something to be avoided. . Also, Germany (dependent on American military defense) supported the U. S. position. Nevertheless, by March 1968 the drain on U.S. gold reserves reached 30 tons an hour. Congress acted by eliminating the legal requirement that the dollar be backed by any gold. Typically, news media were claiming that the increasing volume of international trade required a larger supply of gold. Rickards shows that this is a common fallacy. It is not the quantity of gold that counts but its price relative to goods and services. But in 1969 the IMF created out of thin air the artificial currency called the Special drawing Rights" with the theory that a larger quantity of money was needed in international trade. Trouble and uncertainty continued through 1969 - 1971 with devaluation, reevaluations, inflation, SDRs the collapse of the Gold Pool, currency swaps, IMF loans and more. Still, the value of the dollar remained at one 35th of an oz. of gold. But finally, on August 15, 19712 President Nixon instituted wage and price controls, a surtax on imports and closed the gold window (meaning the agreement to sell gold) Thus the value of a dollar would henceforth be determined by its supply and demand in world markets. Nixon achieved his goal of steady devaluation of the dollar and the 10% surtax was the real policy to achieve it. Rickards describes what happened next as various countries responded with their own protectionist policies. They were soon at war with each other in terms of how much reevaluations would result in relative positions of each to each other. After a few months of hectic negotiations a new basis was created in the Smithsonian Agreement. The American public applauded, thinking it a great victory. But by two years the U.S. was in a deep recession. Rickards writes: "The lesson that a nation cannot devalue its way to prosperity eluded Nixon, Connelly, Peterson and the stock market in late 1971 as it had their predecessors during the Great Depression. It seemed a hard lesson to learn."
We might add that the lesson still has not been learned.
The currency war was not over. Between 1971 and 1981 the U.S. had three recessions, the value of the dollar fell from 1/40th of an ox. of gold to 1/612th of an ox. There was a 50% decline in the domestic value of the dollar. The author describes various foreign reactions and retaliations as well, such as Germany imposing capital controls in 1972 as the rout of the dollar drove the mark to excessive highs.
But the next section is titled "The Return of King Dollar." With the end of the Bretton Woods era the European countries began their lengthy move toward currency union. During this period both the U.S. dollar and gold were unstable. The new Chairman of the FED, Paul Volcker, who had been an official in Treasury, knew how to act. He manipulated interest rates, open market operations and swap lines successfully to reverse the dollar decline and reduce inflation. His efforts were matched by President Reagan's policy of low-taxes and government deregulation, which created a huge expansion of U.S. GDP. But the increase in the dollar's relative value naturally generated the usual cries from labor and protectionist industry for a cheap dollar. But now, without a fixed relationship to gold, the relative value of the dollar was set by supply and demand in the FOREX markets. The government would have to exercise different methods of intervention to drive the dollar value back down. But by then Germany and Japan would have none of it. The result was the Plaza Accord of September 1985 in which the foreign finance ministers met with the U.S. Treasury secretary to generate a dollar devaluation. But this 'fix' didn't work as planned. It was too successful, the dollar declined too much. So yet another meeting and 'accord' took place In Paris. The "Louvre Accord ended the second Currency War with the dollar devalued and the Yen and Mark rising. Nevertheless, there were other financial crises in Mexico, Asia, and Russia in the 1990's that were precursors to the next crisis.

Chapter 6 - Currency War III - (2010 - ?)
By 2010, as the author writes, there were now three very powerful currencies dominating foreign exchange - the U.S. Dollar, the European Euro, and the Chinese yuan. Mr. Rickards wastes no space in declaring right off that they "are the superpowers in a new currency war, Currency War III, which began in 2010 as a consequence of the 2007 depression and whose dimensions and consequences are just now coming into focus. (written in 2011) He mentions the many other national currencies. But, he notes, the combined GDP of the 'big three' is almost 60% of world GDP". Just as shooting wars are conducted on many fronts, so also do currency wars take place in separate theaters. He cites, three, the dollar-yuan in Asia, the dollar-euro in Europe, and the euro-yuan in Eurasia. And the conflict also has expanded from national currencies to international institutions such as IMF, World Bank, BIS, UN, and the huge number of significant private players such as hedge funds, international corporations, and family offices.
As an example, Rickards cites: "To see that the battle lines are global, not neatly confined to nation-states, one need only consider the oft-told story of the hedge fund run by George Soros that 'broke the Bank of England' in 1992 on a massive currency bet."
And there are 'side shows' involving Brazil, Russia, Middle East and many parts of Asia. But the critical main conflict is between the dollar, euro and yuan. This will be a massive war. Whether it leads to a conflict such as WWI or is resolved peacefully, Rickards does not venture to write. But, he notes, it does threaten the collapse of the world monetary system itself.
Pacific Theater: Rickards writes: "The struggle between China and the United States, between the yuan and the dollar, is the centerpiece of global finance today and the main front in Currency War III." He outlines briefly the course of Chinese economic expansion. He provides an interesting perspective when writing that the yuan was not undervalued in 1983 but overvalued as the Chinese then were expanding imports to develop their infrastructure and export industries. Their expansion of exports came later, for which they then did devalue the yuan 6 times. The yuan went from 2.8 to the dollar in 1983 to 5.32 to the dollar in 1993. Then they devalued in 1994 to 8.7 to the dollar. The US treasury responded by calling China a 'currency manipulator' and China in turn changed to ratio to 8.28 to the dollar. Rickards summarizes the U.S. China relationship through the 1990's. He assigns 2002 as the year bilateral trade and investment became significant. That was also the year Chairman Greenspan pushed for extremely low interest rates. Greenspan's chief motivation was fear of deflation. And China was exporting its own deflation created by its cheap labor.
From study of Fischer's book "The Great Wave" and observation it seemed to me from about 2000 that the world was shifting from an era of inflation to deflation, triggered by all the fundamental causes - massive influx of billions of cheap laborers, massive reduction in costs of transportation and communications, massive increase in manufacturing and agricultural productivity.)
Rickards continues by describing the impact of continuing extremely low interest rates on the U. S. economy and especially on mal-investment by Wall Street and in the housing market. And Greenspan's fear of deflation was exceeded by that of the new FED governor, Ben Bernanke. Bernanke in 2002 explained how the FED could buy Treasury bonds and private equity by printing money, The policy he followed from 2008. Meanwhile the U.S. trade deficit with China expanded from $124 to $234 billion. But the Chinese central bank retains all the dollars Chinese exporters earn and provides only enough dollars to Chinese importers to pay for necessary imports. To do this the Chinese bank PBOC, printed new yuan. Thus both the FED and Chinese central bank were printing more and more currency. The PBOC invested its dollars right back in U.S. bonds. In 2005 and 2010 the PBOC brought the yuan down to 6.4 to the dollar.
(In my opinion this increase in the value of the yuan is also favorable now to China as it now wants to import more, especially oil, priced in dollars.)
Rickards comments that if the deterioration of U.S. balance of trade with China had occurred in a Bretton Woods gold system it would have moved all the US gold reserve to China. Just an example of the magnitude of the imbalance not fully appreciated by the American public. He then lists the significant shifts of US gold to other countries. He then summarizes the course of the Chinese- American relationship into 2011.
The Atlantic Theater: He calls the dollar-euro a relationship of codependence rather than conflict. Here the US policy is to preserve the euro

Chapter 7 The G20 Solution:
The chapter is a densely described history of the impact resulting from the creation of the 'G20" that is the recent institution comprising the heads of government and finance of the 20 selected countries. The G20 is an institutional vehicle through which the American government hoped to advance its agenda - to devalue the dollar versus other currencies. Rickards notes the components of the GDP are: consumption at 71%, investment at 12%, government spending at 20%, and net exports at minus 3%. The government effort to expand GDP in order to reduce unemployment and pay off government debt depends on increasing these components. But despite the several 'stimulus' packages it was failing to increase the first three. (We leave to another time discussion of this official measure GDP). So the American idea is to increase net exports to a positive number, via devaluation. But the resistance from other countries means currency war. One measure would be to increase Chinese domestic consumption with increased imports there from the U.S. while decreasing Chinese exports to the U.S. This is called 'rebalancing'. Unable to get direct Chinese agrement to this the U.S. activated its 'secret weapon' -called Quantitative easing - These 'bomb shells' hit the world economy and Rickards describes the results in too much detail to include here. A brief Rickards comment about QE: "It was the perfect currency war weapon and the FED knew it. Quantitative easing worked because of the yuan-dollar peg maintained by the People's bank of China. As the FED printed more money in its QE programs, much of that money found its way to China in the form of trade surpluses or hot money inflows looking for higher profits than were available in the United States. Once the dollars got to China, they were soaked up by the central bank in exchange for newly printed yuan. The more money the FED printed, the more money China had to print to maintain the peg." His analysis continues for several pages. By putting what we already know about QE into this context of the currency war Rickards reveals the answer to the question of why the massive money printing has not already created inflation in the U.S. - namely that it is exporting inflation to China. But the USG wanted increased domestic inflation. Meanwhile the inflation also was created in emerging market countries, much to their dismay. Suddenly a new 'front' in the currency war erupted when the Japanese yen rapidly rose in relative value due to the earthquake and tidal wave. The French finance minister, Christine Lagarde in 2011 engineered an international assault by central banks to force the yen back down by coordinated selling yen. But since then the tables have turned. The Japanese need not an expensive yen but rather a cheap yen. So now Japanese policy to devalue the yen is working in opposition to American policy.
This chapter is so full of important information and explanation of what is going on now in international monetary policy that I cannot summarize it. One must read the chapter.

Part Three :The Next Global Crisis: In these chapters we get into the real meat of the subject matter.

Chapter 8 - Globalization and State Capital:
The chapter is divided into five sections. The author begins with: "Historically a currency war involves, competitive devaluations by countries seeking to lower their cost structures, increase exports, create jobs, and give their economies a boost at the expense of trading partners." But there are other tools and methods available as well. Currencies may be manipulated to cause real harm. Attacks may come from non-states,. "The value of a nation's currency is its Achilles' heel." Everything is priced in terms of a nation's currency, destroy it and you destroy the nation's economy and society. "This is why the currency itself is the ultimate target in any financial war." Unfortunately American leaders give too little attention to this threat. "the forces of globalization and state capitalism, a new version of seventeenth-century mercantilism in which corporations are extensions of state power' must be understood.

Globalization: The new globalization is different from that of the 19th and 20th centuries. Now multinational corporations are no longer in reality national corporations with facilities or investments abroad. Instead they are really multinational - that is non-national - owing no allegiance to any nation state. (This is described by Philip Babbitt in Shield of Achilles.) "Globalization increased the scale and interconnectedness of finance beyond what had ever existed."

State Capital: "State capitalism is the in-vogue name for a new version of mercantilism the dominant economic model of the seventeenth through nineteenth centuries. Mercantilism is the antithesis of globalization." (This also was predicted by Philip Bobbitt in Shield of Achilles.) (In fact Professor Bobbitt described several scenarios in which this conflict of the 21st century could be conducted, but didn't structure it in terms of currency war.) Rickards describes the aims and methods of the original mercantilism. He notes that mercantilism was denounced by Adam Smith in favor of laissez-faire capitalism. Today, the public takes this capitalism for granted without that it is "exceptional in most times and places." Rickards cites the many examples of state capitalism, such as sovereign wealth funds, state-owned companies, aviation, energy and banks that have some public stock ownership but are actually state controlled.

Dubai: Rickards writes a colorful description of this remarkable financial center built from nothing, well initially on pearl diving and smuggling, of which the latter remains very significant. Now it is an international banking center and tax haven. It is the 'world's largest transhipment point for paper currencies." It is the new "Casablanca" the neutral center in the currency wars.

Moscow: Here Rickards focus is on Gasprom, the giant Russian natural gas monopoly that is using its power of control over NG as a political weapon against Ukraine and to influence Western Europe. He discusses the Russian efforts to block alternate delivery of natural gas to Europe, such as direct pipelines through Turkey. One of the interesting revelations Rickards provides is that in 2008 Russia was a major holder of Fannie Mae bonds. "By bailing out Fannie Mae, the Bush administration protected Russia's financial interests with U. S. taxpayer money even as Russia threatened U. S. interests on the energy front." There is much more in this section. The author describes the published Russian national security strategy. "In addition to the usual analysis of weapons systems and alliances, the strategy draws the link between energy and national security and considers the global financial crisis, currency wars, supply chain disruptions and struggles for other natural resources including water." "Russia also speaks openly of the dethroning of the dollar as the dominant reserve currency."

"Beijing: Rickards begins: "What is most striking about Chinese history is how often and how suddenly it has swerved from order to chaos through the millennia." (That the Chinese are well aware of this is evident from the exhibits in their large military history museum in Beijing for which please see the section on my web page http://www.xenophon-mil.org/xenophon.htm ) Rickards continues: 'In addition to normal population stresses, China is sitting on a demographic power keg in the form of twenty-four million 'excess males' - the result of the murder of newborn girls through infanticide and sex-selective abortion under China's one-child policy." (Moreover, the demographic charts show that China is growing old rapidly, before it becomes wealthy.) Rickards links Chinese demographic vulnerability to vulnerability due to the financial link to the U.S. (something they brought on themselves by linking the yuan to the dollar). He writes: "China depends on its currency reserves" to finance critical economic expansion. "What happens when the United States devalues those reserves through inflation? While inflation may make sense to U. S. policy makers, the resulting wealth transfer from China to the Unites States is viewed as a existential threat by the Chinese. Maintaining the real value of its reserves is one of China's keys to maintaining internal social control."
(Again, please note that by exporting its deflation to the U.S. for several decades the Chinese have been generating wealth transfer from the U.S. to China.)

Rickards continues: The U.S. China currency war is just getting started. He quotes a Chinese officer, ' Financial warfare has now officially come to war's center stage - a stage that for thousands of years has been occupied only by soldiers and weapons.... financial war has become a 'hyperstrategic' weapon that is attracting the attention of the world.'' Rickards continues: "China's main link with the global financial system is the U.S. government bond market." China deals in this bond market directly with the American primary dealers who in turn have direct lines to the Treasury. "China has direct lines from its central bank and sovereign wealth funds to the trading floors of the largest U.S. banks. China demands and gets the best bids on its bond sales in exchange for the massive volume of business it provides," And China has other than Treasury bonds, such as Fannie Mae, and other agencies. Rickards writes: "China's great fear is that the United States will devalue its currency though inflation and destroy the value of these Chinese holdings of U. S. Debt." Rickards describes some of the actions the Chinese are now undertaking. Changing the maturity of their bond holdings is one. Investment in commodities including gold is another.

Collapse: Rickards writes that what is particularly dangerous is a possible 'correlation' that is a currency war assault coming from several of the known actors at the same time. Such assaults coming from Russia, China and Iran simultaneously would cause financial markets to cease to function. He cites specific recent events by date as a sample of reports that China, Russia and Brazil are already "seeking an alternative to the dollar as a global reserve currency." (I have several shelves of books on these topics the earliest of which is Professor Carroll Quigley's Tragedy and Hope: A History of the World in our Time, published in 1966 in which he explained how and why the entire U. S. foreign and domestic policies are based and successful due to the dollar being the world reserve currency.

Chapter 9 - The Misuse of Economics:
In this chapter Rickards shifts to some of my favorite general themes. He begins by noting that 'in the late 1940's economics divorced itself from its former allies in political science philosophy and law and sought a new alliance with the hard sciences of applied mathematics and physics. It is ironic that economics aligned with the classic physics of causality at exactly the time physicists themselves were embracing uncertainty and complexity.... Economists were the new high priests of a large part of human activity, - wealth creation, jobs, savings and investment - and came well equipped with the equations, models and computers needed to perform their priestly functions."
(Wonderful, I could not say it any better, although I have been saying this for years. But I don't think it began in the 1940's, rather it gained ascendancy then but was developing in the 1930's. But not only me, Fischer devotes an appendix to the same idea in The Great Wave.)
He continues, " Economists promised that through fine tuning fiscal and monetary policy, rebalancing terms of trade and spreading risk through derivatives, market fluctuations would be smoothed and the arc of growth extended beyond what had been possible in the past." ... "However, the Panic of 2008 revealed that the economic emperors wore no clothes." .. "With few exceptions, the leading macroeconomists, policy makers and risk managers failed to foresee the collapse and were powerless to stop it except with the blunt object of unlimited free money." We have to give Alan Greenspan credit for admitting this in his new book.. But I have many books by authors who did predict both the housing bubble and subsequent crash. Rickards cites "the publication of Paul Samuelson's Foundations of Economic Analysis as the arbitrary dividing line between the age of economics as social science and the new age of economics as natural science." OK, but Samuelson is the principal expounder of Keynesian economic theory in post war U.S. Sad to say we, along with a generation or two of students had to be exposed to his Economics as undergraduates. Rickards compares post 1947 market collapses with those prior to 1930 and writes there is nothing to show that the new 'economic science' had any success in effecting classic market problems. "In fact, there is much evidence to suggest that the modern practice of economics has left society worse off when one considers government deficit spending, the debt overhang, rising income inequality and the armies of long-term unemployed." "Signal failures of economics have arisen in Federal Reserve policy, Keynesianism, monetarism and financial economics. "

The Federal Reserve:
It is the most powerful central bank in history and dominant force in the U.S. economy. "From its creation in 1913, the most important Fed mandate has been to maintain the purchasing power of the dollar; however, since 1913 the dollar has lost over 95% of its value." (Well, that is the official party line, but in reality the FED was created by the alliance of progressives and international bankers to enable unlimited expansion of the currency based on government debt secured by the income tax.) Rickards writes about a comparison with the Roman denarius and the Byzantine solidus claiming that they each retained their purchasing power for centuries. I disagree, yes, they retained their silver and gold content respectively, but purchasing power of any silver or gold coin varied in local markets over the wide area and during centuries. The same goes for the famous Venetian gold coin which was maintained for centuries at its initial fixed weight of gold. But the local buying power of such a coin would vary, for instance, between Venice, Barcelona, Amsterdam and everywhere else according to local supply and demand.
Nevertheless, Rickards' point is valid. He continues by showing that the impact of this devaluation of the dollar had greatly different effects on different sectors and individuals over time. He continues, "The effect of creating underdeserving winners and losers is to distort investment decision making, cause misallocation of capital, create asset bubbles and increase income inequality." We have a couple of shelves of books that explain this is detail. He shifts to write, "Another mandate of the Fed is to function as a lender of last resort. In the classic formulation of nineteenth-century economic writer Walter Bagehot, this means that in a financial panic, when all bank depositors want their money at once, a central bank should lend money freely to solvent banks against good collateral at a high rate of interest to allow banks to meet their obligations to depositors." (Please note the stated conditions in comparison with recent FED action.)
Rickards notes that the FED failed in 1929-30. And again in 2008 it acted as if there was a liquidity crisis when what took place was actually a solvency and credit crisis. Short term lending can help with the former but not with the latter. Rather than the FED actions, the typical action of the FDIC to close insolvent banks should have taken place, but the 'too big to fail' banks are integral parts of the FED money manipulation process itself. Now Rickards get the picture when he writes: The FED actions was " consistent with the Fed's actual mandate dating back to the Jekyll Island - to save bankers from themselves." BRAVO. But Rickards persists in thinking that events are examples of FED ignorance or failures, when they are in fact essential elements in the progressive agenda. He does note the 1978 added Congressional mandate to the FED to prevent unemployment, a pure Keynesian theory and policy. But the FED even failed in this. In this case I agree it was a failure in progressive terms, but due to the intrinsic misdiagnosis in Keynesianism. But Rickards has more: "To these failures of price stability, lender of last resort and unemployment must be added the greatest failure of all bank regulation."
He cites the report of the Financial Crisis Inquiry Commission which fingered regulatory failure as the primary cause. His quotation from the report is indeed damming. Not content with this Rickards moves to the FED balance sheet itself. Yes, the FED is a bank with a balance sheet showing assets and liabilities. I skip the definitions of these terms. Rickards' summary: ' As of April 2011, the FED had a net worth of approximately $60 billion and assets approaching $3. trillion." A 2% decline in the assets in a financial crisis would create a capital loss of $60 billion, equal to the FED net worth. Bankruptcy any one? Rickards writes that this had already occurred but the FED won't admit it. The proverbial 's*** hits ****' will come when the FED tries to sell bonds. Instead the FED tried to obtain permission from Congress to sell its own bonds but failed. Instead, the FED and Treasury agreed that the FED could suspend its payments of its profits on interest from bonds normally made to the Treasury. Rickards writes that this is a sign of how desperate the situation is.
The FED is issuing IOU's to the Treasury to appear not insolvent. In reality the FED is transferring its liability to the Treasury. Rickards reminds the reader that the Treasury is a public institution while the FED is a private bank owned by its member banks - is this not illegal?. Moreover, "The United States now has a system in which the Treasury runs nonsustainable deficits and sells bonds to keep from going broke. The FED prints money to buy those bonds and incurs losses by owning them. Then the Treasury takes IOU's back from the FED to keep the FED from going broke. " Well, I must note that the FED takes IOU"s from the Social Security Trustees as well. Monetarism: This is a theory associated originally with Milton Friedman. Basically, it claims that changes in the money supply are the most important cause of changes in GDP. These changes are comprised of actual 'real' changes and imaginary 'inflationary' changes. Together these result in the 'nominal' changes officially announced. (Fischer, in The Great Wave showed this theory is incorrect.) However, it is true that FED printing money to expand money supply produces imaginary 'inflationary' as well as some actual 'real' economic expansion.
Rickards provides us with the classic equation - MV=Py. Where M equals money supply, V equals velocity of money, P equals price level and y equal real GDP . I will refrain here from discussing the absurdity of this equation due to so many varieties of M and the inability to measure V. Rickards' attempt to explain these variables is not clear at all. Well they are not clear and have changed since the 1930's, so it is not his fault. After some efforts to describe Friedman's ideas for policy he catches on about this amorphous V. He asks; 'What if V is not constant? He then writes: 'It turns out that velocity is the great joker in the deck, the factor that no one can control..... " Well it is worse than that V cannot be measured, it is an abstract fudge factor that replaces quantity that is Credit- debt in the system. It takes the place of credit because the establishment does not want to finger massive real expansion of effective money supply due to debt. Rickards makes a valiant effort by giving official figures for V - 2.12 in 1997, 1.80 in 2008, 1.67 in 2009. But none of these numbers is the result of measurement - they are all derivative numbers resulting from a change in the equation to V equals Py/M. But it is M that is changing, and changing because change in the amount of credit=debt included in the real money supply.
Rickards' himself writes: "When consumers pay down debt and increase savings instead of spending, velocity drops as does GDP, unless the FED increases the money supply. So the FED has been furiously printing money just to maintain nominal GDP in the face of declining velocity." But why introduce this fictional velocity into the story -it is the paying down of debt that reduces the amount of credit inside the money supply and exactly the FED has been helping the Treasury to increase the money supply via expanding Federal debt to replace private consumer debt. To repeat, the FED has been printing money in the face of decreasing private consumer's debt, not velocity. The next few pages of Rickards's explanation is correct for the wrong reasons. He writes:' to revive the economy, the FED needs to change mass behavior, which inevitably involves the arts of deception, manipulation and propaganda." How true, but for the following pages he describes an effort to increase this imaginary V - velocity, when the real effort is to increase the quantity of private consumer debt in the money supply. The so-called 'wealth effect' is not a spending of more cash on hand due as a result of feeling more wealthy from increased stock or housing assets, but a willingness to go further into debt via using credit to finance consumption. To generate cash from any increased value of stocks or housing one would have to SELL the asset. That is neither the objective nor the result. Rather it to increase BORROWING against the asset and this is just what happened during both dotcom and housing bubbles. And this is exactly what the FED actually does. as Rickards writes: 'Negative interest rates create a situation in which dollars can be borrowed and paid back in cheaper dollars due to inflation. The Fed's plan was to encourage borrowing through negative interest rates and encourage spending through fear of inflation." (But there is no fear of inflation - it is simply observation that savings is worthless in contrast to the normal propensity to have today rather than tomorrow ( the time value of money).
Rickards rightly connects the FED policies and Bernanke- Krugman justifying theory with currency war. But I wish he would drop 'velocity' out of the picture and focus on the quantity of debt created by credit. He concludes this section on a high note. "The danger is that the FED does not accept these behavioral limitations and tries to control them anyway thought communication tinged with deception and propaganda. Worse yet, when the public realizes that it is being deceived, a feedback look is created in which trust is broken and even the truth, if it can be found, is no longer believed. The United States is dangerously close to that point." AMEN bro..

Keynesianism::
Rickards cites Lord Keynes as the intellectual founder of modern 'neo-Keynesianism. But Rickards absolves Keynes from the post WWII gobbledegook of equations, graphs, models and the rest of the new 'scientific economics'. Rickards wants to focus on what he believes is the key flaw now in Keynesianism, 'the multiplier effect'. This theory claims that a dollar of government spending will generate more than a dollar of total economic output. "The multiplier is the Bigfoot of economics - something that many assume exists but is rarely , if ever, seen." BRAVO. This is related to the theory of 'aggregate demand' - that is the total spending and investment in the national economy. So Keynesian theory claims that if and when private consumption is low the government can spend money to increase aggregate demand. Keynes well knew ( he was an official in the British treasury) that government has no money. Governments must create the money it spends or confiscate existing money from private owners ,or borrow it from those owners or foreigners. Printing money will create economic expansion but much will be illusionary (inflationary) Taking money from the private sector via taxes or borrowing cannot increase spending beyond what the owners could spend. The Keynesian theory is that a dollar taken from a private owner, while reducing that individual's potential to spend, will nevertheless generate additional spending by others that more than offsets this reduction. Naturally administration, establishment Keynesian economists produced studies that purported to show that the Obama massive deficit spending was generating a 1.54 positive multiplier.
But Professors John Taylor, John Cogan and their associates soon showed that the multiplier was actually less than one, (.96 falling to .48) so the federal dollars were decreasing the total economy. Other economists reported similar results to those of Taylor. Rickards continues with description of the actual results as they became apparent by 2010. He again establishes a link: "The increased debt from the failed Keynesian stimulus became a cause celebre in the currency wars." A country defaults to foreigners via devaluation of its currency, it defaults to its own citizens via inflation. Since a huge amount of U.S. government debt was held by foreigners devaluation would generate more currency war. "Vulnerability to foreign creditors is now complete." If any major crisis now requires significant federal deficit spending we are in big trouble. "Bank closings, gold seizures, import tariffs and capital controls would be on the table." "America's infatuation with the Keynesian illusion has now resulted in U.S. power being an illusion.".

Financial Economics:
Here Rickards switches to discussion of the group of prize winning economists at Chicago and Yale: the financial engineers such as Markowitz, Miller, Sharpe and Tobin, and later Scholes, Merton and Black. These folks came up with mathematically based analysis of the stock and options markets and published ideas that is theories. "None of these ideas has done more harm than the twin toxins of financial economics known as 'efficient markets' and the 'normal distribution of risk'. Rickards writes: "The idea behind the efficient market is that investors are solely interested in maximizing their wealth and will respond in a rational manner to price signals and new information." (Of course this leaves out the entire history of the world during which countless individuals and whole societies pursued any thing but maximizing their wealth) . It presumes that all investors will make decisions based on public information already factored into market prices. (What about the vast sums spent to acquire information BEFORE it becomes public knowledge?) "The idea of normally distributed risk is that since future price movements are random, the severity and frequency of price swings will also be random." The result of this is that events and price distributions will conform to the standard Gausian bell shaped curve, with most events centered around the mean. But Nassim Taleb shows that the distributions do NOT conform to the Gausian bell shaped curve, they had 'fat tails' in which the 'Black swans' lurk.
Rickards again: "Based on an enormous body of statistical and social science research, it is clear that markets are not efficient, that price movements are not random and risk is not normally distributed.". Rickards describes the attacks coming from behaviorists. especially the famous duo, Daniel Kahnerman and Amos Tversky. Rickards comments that the twin theories of market efficiency and random prices contained in the Value at Risk method have already escaped the 'lab' and infected the entire financial structure including Wall Street, leading to the series of collapses from 1987 on, There are many books that describe various aspects and segments of this story. 'Value at Risk' theory in practice led not only the banks and investment houses but also their regulators and the credit evaluation industry astray to say the least. Rickards concludes: "The destructive legacy of financial economics, with its false assumptions about randomness, efficiency and normal risk distributions is hard to quantify, but $60 trillion in destroyed wealth in the months following the Panic of 2008 is a good estimate." True enough, but I have to note that much of that 'wealth' was phony, fantasy and the illusion created by the very same false theories, thus it was not 'lost' but simply evaporated.

Washington and Wall Street - The Twin Towers of Deception:
Rickards jumps right to the point. "By the start of the new currency war of 2010, central banking was based on on principles of sound money but on the ability of central bankers to use communication to mislead citizens about their true intentions. Monetarism was based on unstable relationships between velocity and money that made it ineffective as a policy tool, Keynesianism was applied recklessly based on a mythical multiplier that was presumed to create income but actually destroyed it. Financial economics was a skyscraper erected on the quicksand of efficient behavior in capital markets. The entire system of fiscal policy, monetary policy, banking and risk management was intellectually corrupt and dishonest, and the flaws persist to this day." Wow, so what else is wrong? :)

Chapter 10 - Currencies, Capital and Complexity:
So the fundamental cause of financial, economic dislocations persist, as Rickards opens this chapter. "Despite the theoretical and real-world shortcomings of both the Keynesian multiplier and the monetarist quantity approach to money, these are still the dominant paradigms used in public policy when economic growth falters." Yes, Lord Keynes and Dr. Friedman still are the mentors guiding all USG (that means FED) policy decisions. The government debt is growing, the economy is not expanding fast enough it at all, Debt can only be repaid via inflation or devaluation. Currency war via devaluation of the dollar remains the favored solution. But there are alternative economic theories being considered by those studying behavioral economics and complexity theory. Rickards favors the concepts included in complexity theories. Without mentioning that complexity was at the heart of the Austrian school of Ludwig von Mises and Fredrick Hayek, Rickards proceeds to enumerate its basic concepts. But these are expressed in a different manner. First, complex systems are not organized 'to down' but from the bottom, the evolution of their fundamental parts. Second, the action of the system cannot be observed or analyzed from the top. Third, complex systems require exponentially greater amounts of energy to continue functioning. Fourth, complex systems are vulnerable to catastrophic collapse. A result, when according to the third point the system reaches a level requiring massive, unavailable additional energy it is likely to collapse.

Behavioral Economics and Complexity:
Rickards turns to discussion of the ideas of Robert Merton, who has investigated the role of human behavior in economic processes. One of these is the so-called 'self fulfilling prophecy'. This claims that even a false statement, if believed sufficiently to be true, can become true because the statement itself creates behavioral change that makes it true. (Well this is a variation on Machiavelli's doctrine of appearances). The example of this in the economy is a run on a solvent bank generated by false rumor that itself makes the bank insolvent. After Merton, Rickards cites the work of Daniel Kahneman, Amos Tversky, Paul Slovic and other psychologists. Rickards observes that rather than use the insights of behaviorist economics to improve conditions the ruling clan such as Bernanke and Geithner are using it as another tool to manipulate the public. One example is the FED effort to raise 'expectations' about coming inflation when there is none, while holding interest rates artificially low and attempting to devalue the dollar. He writes that there have been many other propaganda campaigns to make the news appear favorable. The result in the reverse, loss of public trust.

Complexity Theory::
Rickards contrasts real complexity with simply complicated. A complicated entity is passive and static. A complex system is dynamic and changing due to continual purposeful changes of its component parts. And these components are diverse so change and respond differently under different stimuli. Moreover, they are connected and interdependent so changes in one influence various changes in others. The agents in a complex system also adapt - that is they learn. The agents also have emergent properties and the system has phase transitions. Emergent properties means that taken together separate elements many display properties not seen in each individually. These properties are powerful and unexpected so unpredictable. Relative to economic affairs, the human is a complex system itself, with emergent properties such as consciousness. So a group of humans is an even more complex system. Phase transitions are changes of state, such as when water turns to ice or water vapor. A system can be 'unstable' when changes in the actions of one or few elements trigger a phase transition in the whole system. Rickards uses the famous examples of snow avalanche or the disturbance of a pile of sand by addition of one more grain. For economics, the example is the impact on a market when one sell creates a stampede of selling. Rickards cites the now famous discussion of 'black swans' by Nassim Taleb. He applauds Taleb's destruction of the concept of the normal distribution - Gausian bell shaped curve - as a way to understand risk. Further on Rickards discusses what are real 'black swans'. First he relates all this to complexity theory and the 'power law'. He notes that financial systems are tremendously complex.
Again, these pages are too full of critical description and analysis for me to summarize. They must be studied.

Complexity, Energy and Money:
Rickards writes: "Using behavioral and complexity theory tools in tandem provides great insight into how the currency wars will evolve in money printing and debt expansion are not arrested soon." He expects the US Treasury and FED first to win some victories and then to loose the war. The initial victory will be the success in inducing inflation into the US resulting in foreign countries being forced to revalue their currencies and a devalued dollar. But the international retaliation will be the end of the dollar as world reserve currency (something many countries already want). The dollar will depreciate gradually, but when the system reaches its critical change of state the world financial system will collapse. (This is predicted by many other authors, but not with Rickards' analytical categories including currency war.) Rickards includes tables that illustrate an interesting phenomena. This is the manner in which critical information triggers a reaction in increasingly large numbers of actors depending on the size of the groups. His point is that in certain circumstances tiny changes in initial conditions can lead to catastrophically different results. Then he throws the bomb. "The history of Currency Wars I and II shows that currency wars are last ditch responses to much larger macroeconomic problems. Over the past one hundred years, these problems have involved excessive and unpayable debts." His description continues. This same phenomena is what John Mauldin describes in his Code Red and other books and essays as the 'bang moment' when debt suddenly reaches such a size relative to an economy that it triggers a massive reaction - Rickards' change of state.
Dider Sornette discusses the same situation in elaborate mathematical terms in his Why Stock Markets Crash.. The subtitle is Critical Events in Complex Financial Systems. Sornette is a geophysicist who is applying the study of complex systems to the stock market, but unfortunately the book was published in 2003, so missed the 'big one'. Rickards turns to Eric Chaisson and Joseph Tainter for more detailed application of their complexity theories. Chaisson takes his view back to the beginning of the universe in his Cosmic Evolution. This is carrying complexity theory beyond my ken. But we have Tainter's The Collapse of Complex Societies, and will review it as well. Tainter is an antropoligist - archeologist so we have yet another contribution from outside the discipline of economics.
What we are seeing is increasing application by scientists who are not economists (therefor not wedded to the establishment Keynesian economic theory) of complexity theories developed and useful in their disciplines to financial collapses. We might attribute this to the huge impact of Keynesian monetary policy on public life in general and individual's financial situations in particular. That something must be done cries out to the public, and the failure of establishment economics is manifest. But I must note that the reality of complexity was already established by Ludwig von Mises and the Austrian school of economists in the 1920's.

Chapter 11 - Endgame - Paper, Gold or Chaos?
Rickards correctly notes that 'few economists or policy makers at the IMF or global central banks would subscribe to the complexity - based, money-as-enegy model outlined in the previous chapter." Obviously true, but one does not need to go so far as to equate energy and money to see problems. Recognition of complexity alone would suffice. Rickards for sees four possible outcomes.
One is creation of multiple currencies as the basis for world financial reserves.
A second is expansion of SDR's as a new fiat currency.
A third is return to use of gold.
And a fourth is chaos.
First the section on Multiple Reserve Currencies. The author recounts the history of the dollar since Bretton Woods and its diminishing role in international commerce in recent years. He turns to Barry Eichengreen who is a proponent of a 'world of miltiple reserve currencies'. Rickards present Eichengreen's views but claims they are too optimistic. A basket of currencies would still be a fiat basket with no real support.

Special Drawing Rights:
Rickards views this topic as full of mystery and confusion. SDR's are another fiat money created out of 'thin air', this time by the international institution, the IMF. He admits that SDR's do have some of the functional aspects of 'money'. His lengthy analysis must be studied and understood. Rickards is skeptical and not in favor. He even quotes Lord Keynes about the way in which destruction of a currency can destroy a society.
Personally, I don't see this happening. Considering how the Euro is already being resisted due to its infringement on the national sovereignty of European states, it seems impossible that the even more heterogenous world-wide society of states would stand for the loss of their sovereignty to a world monetary authority.
Return to the Gold Standard: Rickards notes the issue is highly controversial. He believes that both the 'pro' and 'con' camps are currently too rigid. He describes Bernanke's and Keynesian negative appraisal of gold in some detail, but disagrees. His discussion runs on for many pages in which he clearly supports the concept of a 'gold standard' as a monetary base. He calculates that under current conditions the dollar price of gold would be $3,500 an ounce.
But gold is still a 'fiat' money. All official monies are fiat monies, since the monetary worth of a quantity of gold or whatever else is designated as 'money' is still set by some authority.

Chaos:
Rickards writes: Perhaps the most likely outcome of the currency wars and the debasement of the dollar is a chaotic, catastrophic collapse of investor confidence resulting in emergency measures by governments to maintain some semblance of a functioning system of money, trade and investment.' Clearly he poses this apocalyptic outcome as a stark alternative to his favored solution. But he is by no means alone in foreseeing even social collapse. The 'complexity' authors discussed above foresee this also. Then there are many authors for example. William Bonner, Financial Reckoning day: Peter Schiff, The Real Crash; Robert Wiedemer, Afershock; John Mauldin, Endgame and Code Red: and Martin Weiss, Crash Profits; who have been predicting collapse with varying degrees of evidence. These and many more are discussed in the recommended reading list. Referring to complexity theory, Rickards writes that such a collapse might be triggered by a very small incident, an international political incident for instance. He describes some of the typical interventionist policies governments would invoke in an effort to mitigate such collapse..

Conclusion:
Rickards writes: 'The path of the dollar is unsustainable and therefore the dollar will not be sustained. Over time, the dollar will join a crowd of multiple reserve currencies, be subordinated to SDR's, be rejuvenated by gold or descend into chaos with both redemptive and terminal possibilities." He believes that a return to a different gold standard and chaos are the most likely outcomes. In this he is certainly not alone. Books predicting chaos are legion. But he also offers positive recommendations for active measures to avoid these alternatives. First, is to break up the big banks and reinstall the separation between depository, commercial banks and the investment banks. Second, is to prohibit banks to trade securities for themselves, such trading should be done by brokers and hedge funds. Third, is to band derivatives except in special cases. Fourth, is to adopt a flexible gold standard. Fifth, is to adopt the Taylor rule for monetary policy.

Afterward:
Rickards notes that writing history in the midst of dynamic, changing events is difficult. He has focused on the fundamentals that drive the international monetary system. He hopes that understanding the real system will help readers. He claims that events subsequent to his original forecasts have shown him to be correct. One of these is the increasing role and power of the IMF to become the real world central bank as an agent of the government leaders in the G20. The IMF has been using SDR's to expand its balance sheet. It has participated in the 'bailout' of Greece. He predicts that future monetary crises will require further expansion of the IMF creating SDR's. He claims the book is a good guide to future activities of China and Russia. However, he believes that since his original writing a real Currency War has begun in 2012 with the American driven sanctions on Iran. The U.S. was initially successful. However, he writes: "The results of the U.S. - led financial war on Iran were a classic case of 'being careful what you wish for'." There have been significant reactions. "The alternative arrangements had an unintended consequence that went far beyond Iran.' "In late March 2012, BRICS held a summit at which it resolved to study the creation of a new multilateral bank that would facilitate lending and payments among emerging markets and create a currency other than the dollar as its medium of exchange." Finally, he writes: "There is nothing today that suggests the currency wars will end anytime soon. The Federal Reserve and the U.S. Treasury persist in their efforts to cheapen the dollar. This book has explained how these competing claims cannot be reconciled and how they will cause increasing stress and volatility.".