As investment professionals gathered at the 2014 CFA Institute Middle East Investment Conference in Jordan — against a backdrop of ongoing civil war in neighboring Syria and unfolding events in Ukraine — James Rickards, partner at Tangent Capital Partners and author of the book Currency Wars: The Making of the Next Global Crisis, left them in no doubt that in order to prosper today, investors must acknowledge that varying degrees of economic warfare are an integral part of the global markets.
Rickards invited the audience to consider two somewhat controversial thoughts as part of their strategy development. First, they could one day find themselves in a scenario in which the US dollar is no longer unilaterally held as the global reserve currency, and second, in today’s technology-driven world, tensions between traditional allies and shifting alliances can quickly escalate into economic “incidents,” with knock-on effects for investors that may have previously been unthinkable.
Coming at a time when 60% of global reserves are held in US dollars, Rickards is aware such suggestions may seem unrealistic to some. As a case in point, he cited his well-documented participation in a financial war game for the US Pentagon in 2009. Here he outlined a scenario in which Russia and China acquired a stockpile of gold, deposited it in a Swiss vault, and had a London bank issue a new currency, backed by the gold — which then allowed Russian natural resource exports and Chinese manufacturing exports to be priced in the new currency. In essence, two of the biggest players on the geopolitical stage had just abandoned the dollar. To compound the impact, other countries were then able to join the new currency either through trade or by depositing gold in the London bank and drawing the currency against it.
Observers at the time ridiculed the scenario as fanciful, but Rickards has since used this case study to highlight actual behavior by Russia and China in subsequent years. Particularly, since 2009, Russia and China have increased their gold reserves by 70 percent and several hundred percent, respectively. Furthermore, they continue to seek opportunities not only to work together but also to align with countries that many would have previously expected to align with the United States — Saudi Arabia being just one example here.
For 45 years, Rickards says, Henry Kissinger’s “petrodollar” deal, which set the price for Saudi oil exports in US dollars, has effectively served as a currency support. But the United States’ recent engagement with Iran — interpreted by Saudi Arabia as an attempt to position Iran as the hegemonic power in the Middle East — has created serious mistrust. With China desperate to move from coal to oil and Saudi Arabia looking for new export paths, Rickards urges us to watch both Saudi Arabia and Russia carefully, as they could potentially collaborate to secure agreements with China that could materially affect the price of oil in future.
Moreover, if Saudi Arabia no longer believes that the United States will guarantee its national security against Iran, what guarantees are there that Saudi Arabia will continue to price oil in US dollars? Rickards sees such a shift as unlikely but one that investors would be naïve to think could never happen.
Adding cyber-warfare to the mix, Rickards says, levels the playing field even further. Although the United States has the most powerful military force on earth, China, Russia, Iran, and numerous others are known to possess hacking capabilities on par with US resources. For Rickards, such incidents as the Syrian Electronic Army hacking the Associated Press’s Twitter feed saying the White House had been attacked and the president was injured (resulting in the US stock market falling 150 points in seconds) and the still unexplained half-day closure of the NASDAQ on 22 August 2013 serve as isolated but very real examples of economically relevant incidents that would have previously been unthinkable. If these scenarios had escalated, they could have had devastating consequences for all concerned.
In reality, Rickards does not foresee an imminent decline into all-out financial war but rather describes today’s climate as a financial echo of the Cold War, in which the players are all sufficiently armed to obliterate their enemies and face an underlying temptation to shoot first in the hope of destroying the enemy’s arsenal before they can use it. Thankfully, such drivers are thus far countered by recognition that any attack would be countered so swiftly and severely that, in reality, nobody wins and everybody loses.
In Rickards’s view, recent events in Ukraine provide a clear example of this. Although one of the first steps Russia took after moving into Crimea was to introduce its own currency, the rouble, swiftly drawing economic sanctions from the United States, neither side, Rickards says, has any intention of venturing into full economic battle. In theory, the United States could remove the two biggest Russian banks (Sberbank and VTB) out of the dollar payment system and lobby European allies to remove them from SWIFT (Society for Worldwide Interbank Financial Telecommunication), an action similar to the sanctions previously levied against Iran. Russia could then retaliate by dumping its US Treasury obligations, causing US interest rates to rise and harming the stock market, while also refusing to pay dollar debts and freezing US company assets in Russia, which include an extensive satellite program. The potential consequences of truly punitive sanctions against Russia are very real for the US administration.
So, how do investors navigate a climate in which currencies are potentially unstable and the Fed and central banks stand accused of becoming printing presses? Rickards’s take is simple: Keep a keen eye on geopolitics, and do not lean too heavily on accepted practices — especially if everyone else is.
The Sixth Annual CFA Institute Middle East Investment Conference will take place in Kuwait on 10 February 2015, bringing together international thought leaders, policymakers, industry experts and key market participants from across the MENA region to consider a central theme: Investing in New Realities.
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