In Search of Snowflakes
by Jim Richards
However, let's talk about snowflakes for a moment because you might care about them. Perhaps you read the papers every day, and wonder, "What should I look out for? I'll give you three. All of which are all likely, in my view. These are not farfetched...
Credit Crisis in China: China, believe it or not, is in more of a credit bubble than the United States. The United States has got lots and lots of problems. But China is actually worse -- probably because they haven't been through this as many times as we have.
I think they're a little naïve about how bad this can get. They're over relying on the ability of Communist Party officials to keep a lid on it. I was out in the countryside south of Nanjing not too long ago, visiting some of these ghost cities. I was with some Communist Party officials and provincial officials who were behind it all. Everything I saw, construction as far as the eye can see, magnificent stuff, all empty. The stuff you've seen on TV, I've actually been out there and seen it firsthand.
But Beijing has their own problems, so whether it's wealth management products, shadow banking, real estate finance, crony capitalism of the worst kind, flight capital, oligarchs taking all they can like pigs at the trough and then funneling it out to Vancouver and Australia and Park Avenue, etc… and all of this going on on a massive, massive scale… this is going to collapse. And they're not really ready for it, and they don't really know how to deal with it.
Failure to deliver gold: I think this is almost definitely coming. So much of the gold market is "paper gold." So much of it is manipulation, and we no longer have to speculate about the manipulation. It's very well documented. But it all rests on some physical gold. I describe the market as an inverted period with a little bit of gold at the bottom and a big inverted pyramid of paper gold resting on that little physical gold.
So the total supply grows every year, and when you move gold bars from the GLD warehouse in London to the Chinese warehouse in Shanghai, the impact on the total supply is zero. But the floating supply shrinks. Now, what do I mean by the floating supply? The floating supply is the physical gold that is available [to back] paper transactions.
They're building vaults as fast as they can. They're negotiating with the Swiss Army. Over the years, the army's hollowed out some of these mountains in the Alps and built these extensive warehouses and storage facilities and tunnels that will withstand nuclear attack. But they're getting to the point where they don't think they need as many. So vault guys are in negotiation to lease the mountains, these nuclear bomb-proof mountains, from the army. He said, "We're building vault space as fast as we can. But we're running out of capacity."
I said, "Where's the gold coming from?" He said, "Well, UBS and Deutsche Bank and Credit Suisse, and customers are taking it out of the banks and giving it to us. " Now there's another example where the total supply is unchanged, but I've now reduced the floating supply because Via Mat is not doing anything with it.
So how does this end? Someday, probably sooner than later, somebody is going to show up and say, "I want my gold, please," and the custodian won't be able to give it to them. What if a major institution like John Paulson's hedge fund [prompted] a failure to deliver by a major dealer like HSBC or JPMorgan? That would be a shock wave. It would set off panic buying in gold, and inflation expectations would get out of control.
A geopolitical shock: People yawn and say, "Gee, haven't we had enough of those lately?" But it could be something like an assassination or something much more momentous than what we've seen so far. Or one of these things could spin out of control. When Russia invades Crimea, that's a snowflake. When the Islamic State declares a caliphate, that's a snowflake. When Libya completely falls apart and they stop pumping oil, that's a snowflake.
I make the point that a snowflake can cause an avalanche. But not every snowflake does. So a lot of snowflakes fall harmlessly, except that they make the ultimate avalanche worse because they're building up the snowpack. But one of them hits the wrong way and starts something and it spins out of control. And so sometimes people just have this idea that all these things are little things and we're waiting for the big thing. And that's actually not good science.
|One of them hits the wrong way and starts something and it spins out of control.|
So the thing that causes it might not be that different than the stuff we've seen, except that the system is getting more and more unstable, and it might not take that much. So with that said, an outright Russian invasion of Ukraine, I mean, that's kind of been discounted. I think people would be surprised if Putin doesn't invade eastern Ukraine at this point. And people would be surprised if the Islamic State doesn't kick the Kurds all the way back to [the regional capital of] Erbil.
So then you say, "Well, how bad can get it get?" Well, stay tuned. It can get worse. So I would give you those three: Chinese credit collapse, failure to deliver gold, and the geopolitical shock. And any one of them could start this cascade that I've described.
James G. Rickards is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He is the author of The New York Times bestseller Currency Wars, published in 2011. © 2014 Agora Financial, LLC