China, Gold, and the Dollar Part 1

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This is Part 1 of my interview series with Craig R. Smith, gold and monetary expert and co-author of the book Inflation Deception.   If you want to get a clear-eyed view of where we're headed, this interview series will do it.  

James R. Gorrie, Managing Editor

James:  Your book, Inflation Deception reads almost a horror story, doesn’t it?

Craig:  You know, the whole concept of a couple going through life and how they woke up one day and didn’t realize that     they had been robbed by the very government that they thought was there to protect them.  It reads like a novel but unfortunately, it’s a nonfiction book.

James:  I want to relate the book to current items in the news. Question one, with the increase in money supply, is the US  going to bail out Europe? Is that something that you see?

Craig:  I do, as a matter of fact. Obviously, there’s going to be more money necessary to go to the IMF to take care of Europe. I found it rather revealing when during that testimony, Secretary Geithner said that there was no reason to be concerned about the money that Congress appropriates to the IMF because, “The IMF loans are backed by gold.”

I found that fascinating because if we shouldn’t have to worry about the money we lend to Europe because it’s backed by gold, shouldn’t Americans be requiring that all the money that they lend to the Federal Government to waste the $58,000 per second they borrow, be backed by gold?

To answer your question, yes, we’re clearly going to help bail out Europe. We’re going to do it on the basis of we believe it’s now a global economy and so as Europe goes, so goes America and vise versa.

James:  What do you make of China being given direct access to the US treasury, which is unprecedented in our history? They can buy or not buy as many treasury bills as they like.  They currently hold about $1.3 trillion. What do you think that means, that they’re given direct access as well as access to enter the US banking market?

Craig: It would call for speculation on my behalf to answer that, James, but I can give you my opinion on it because there is obviously no data that we can look at to see how to answer the question. It’s pretty apparent now that with $1.3 trillion worth of reserve they’re trying to now hold in the form of treasury bills, we have to be rather sensitive to the needs of China for the fear that if they were to liquidate their position, and $1.3 trillion became available on the market today, like any other commodity, the US dollar would suffer a dramatic drop in value.

I suspect part of it is a direct result of needing to be accommodative to make sure that we are taking care of China’s needs, especially in light of the fact that China has recently entered into agreements between Russia and especially between Japan where they will now exchange each other’s currencies for goods and services versus having to turn to the traditional US dollar.

For example, before, when Russia would sell oil to China, China would have to buy US dollars and pay the Russians in the form of dollars. Now it appears that China is very comfortable with accepting Russian rubles. You take that dollar equation out and it’s really going to put a lot of strain on our US system.

James:  I agree. If we’re backing the money we’re sending to bail out Europe with gold, if that’s the case, China has an awful lot of gold and is buying an awful lot of gold. At the same time, we’re effectively letting them determine how, when, where, and what they buy without letting anyone else know in terms of our treasury bills. It seems to me that there are other things afoot there.

You did make the point in your book that China is moving away from the dollar. My suspicion might be – and you can tell me if I’m wrong – but my suspicion seems to be also it’s in our benefit that no one else knows how much China is not buying.

Craig: I agree with you completely. I think that secrecy or nondisclosure is going to be very important to maintain our trade relationships with China. Just to clarify, the reason why Geithner says we’re to be comfortable with all the loans we’re making to the IMF is because if the IMF defaults, they’ll pay us in gold.

I find that interesting because if you do look at the purchases of China as it relates to gold, clearly the Chinese are looking to issue a new currency that’s backed by gold. It only makes sense at this particular time because there’s a race to the bottom on all currencies.

Quite frankly, the world is looking for a universally accepted currency in a form by which nations can no longer export their inflation. Let’s be honest about it. The inflation we’ve had in America, we’ve exported to other countries that use the US dollar.

I’m very concerned about China, not just because of the clandestine nature of our trade agreements with them, but also because China is not a free market, capitalist system. It is a state controlled economy.

The Chinese are still communist. That takes on a totally different dynamic when you look at a communist nation’s economy versus a democratic nation’s economy. They are two very different animals.

To try and assume they have the same characteristics, I think, is a very strategic flaw in the way that our trade representatives in America deal with China. I think they’re making some very serious mistakes.

James:  With the global slowdown and the debasement of the US dollar, the Euro, and probably the yen, the speculation seems to be that the Yuan will be the only major currency left.  But if the yuan will be backed by gold, won’t that have a recessionary implication to it? In other words, the inflationary trends and the amount of dollars out in the world today is what allows our level of spending to occur both here and in Europe as well.  If there’s a gold restriction or if the currency is backed by gold, whether it’s the dollar or the yuan, isn’t that necessarily recessionary in itself?

Craig:  Indeed it is. That’s the whole point. You’ve just brought it all to a conclusion. In America today, since 1971 when Richard Nixon closed the gold window, we have continued to support and almost propagate a future welfare state. You could not expand the welfare state like we did in America from the time of Franklin Roosevelt to the time of Lyndon B. Johnson while maintaining the gold standard.  That’s why Nixon was forced to close the gold window in ’71. If you look at the Great Society programs in ’64, it forced the hand of Richard Nixon to close the gold window because we had to create money out of thin air to keep the welfare state going.

With that concept in mind and with entitlements being the number one drag on our budget deficits, clearly when China puts a currency out there that doesn’t allow us to create money out of thin air, it is not only going to have a recessionary impact on us, it is going to have basically unintended forced austerity on us.

We are going to have no choice. We’re not going to be able to just print money or borrow money to make entitlement payments, to create welfare payments, or unemployment payments.  You’re absolutely right. It could have a very serious recessionary impact. I would argue that it could even have a depressionary impact on us, which would absolutely have to be followed by a huge amount of inflation, because who is going to want our dollars when you have a competing currency out there that’s stable with gold?

It’s a very difficult issue going forward. That’s why I think America again is going to have to weigh its military options, it economic options, and make sure that we’re letting the world know that if they want the peace and safety they get from the US military, they’re going to have to work with us economically.

We saw this happen with Japan. How many years did we pay for Japan’s defense and they paid nothing for it? Maybe it’s time for us to start requiring some kind of payment back to keep the world a safe place.

See Part 2 of this interview in next Friday’s edition of Absolute Wealth. JRG.

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