The Collapse of the International Monetary System and the Petrodollar, Part I

The Collapse of the International Monetary System and the Petrodollar, Part I

Although it is a crucially important topic, it often doesn’t get the coverage it deserves.

I’m talking about the sociopolitical effects of the coming collapse of the international monetary system—which frequently plays second fiddle to the financial discussion.

While the financial implications are no doubt important and will be severe, the sociopolitical consequences will likely be more important and more severe.

And if you have any lingering doubts about the inevitability of a reshuffle in the international monetary system, you won’t after you read The Death of Money by Jim Rickards. I consider it essential reading.

While the book goes into unparalleled detail, it’s easy to read and makes a compelling case based on solid facts and history. Jim has a unique perspective because he’s the only person that I can think of who gets it on gold and economics, but yet still has regular access to some of the highest-level policymakers (otherwise known as central planners).

As Jim shows, the collapse of the international monetary system is not an unprecedented event—it’s happened three times in just the past 100 years (1914, 1939, and 1971)… periods that were all followed by intense turmoil.

Jim says the system is now blinking red again. No matter which snowflake it is that causes the inevitable avalanche, the time is short to take protective measures.

One proven way to protect yourself against this potential turmoil and risk is through international diversification, a strategy that Doug Casey helped pioneer and which this site is dedicated to.

And now, I’m very happy to bring exclusively for International Man readers my conversation with Jim Rickards. It’s below; you won’t want to miss it.

Nick Giambruno: As you detailed in The Death of Money, the international monetary system has collapsed three times in the past 100 years. And now you say the system is blinking red again. Please explain why.

Jim Rickards: Sure. There are two reasons. One’s sort of more anecdotal; the other is much more rigorously scientific. The first reason is that the international monetary system has collapsed three times in the past 100 years, in 1914, 1939, and 1971. It’s been over 40 years since the last collapse. These things do seem to happen every 30 or 40 years. That’s just based on experience. That seems to be the useful life of the international monetary system. Now, that doesn’t mean that it will collapse like clockwork tomorrow morning. I’m not saying that. I’m just saying that the evidence is that we should expect this or at least not be surprised if it happens sooner than later.

On a more scientific basis, capital markets are best understood as a complex, dynamic system; and these systems are prone to collapse periodically based on scale and metrics and some catalyst.

“Scale and metrics” is just a fancy way of saying the size of the system. And if you look at what has happened since 2008, we heard over and over about “too big to fail.” Since 2008, the five largest banks in the United States are now actually bigger. They have a larger percentage of the total banking assets, which means the risk is more concentrated into fewer hands, and the derivatives books are also much larger. If it was too big to fail in 2008, it’s even worse today.

One of the lessons of complexity theory is that the greatest catastrophe that could happen is a function of systemic scale. It’s not a linear function; it’s an exponential function. This means that if you double or triple the system, you are not doubling or tripling the risk. You are increasing it by a factor of 10, or perhaps 50 or 100 or more, depending on the exact dynamics.

So we’ve set ourselves up for an unprecedented and catastrophic collapse—something worse than has ever been seen in history, and that’s just based on the fact that the system is bigger than it has ever been in history.

Now, people look back at 2008 and say, “Maybe this kind of collapse can happen, but the Fed can rise to the rescue as they did the last time.” But that’s where the analysis falls down, because the Fed used up all their dry powder—they printed almost $4 trillion of new money. Having done that to paper over the last crisis, and having most of that still on the books, what are they going to do now? There’s a limit to what they can do. They can’t take the balance sheet to $8 trillion or $12 trillion. Legally they can, but as a practical, political matter, as a matter of confidence, there’s a limit.

So the next crisis, when it comes, will be bigger than anything in history, and it will be bigger than the ability of the Fed and the other central banks to put it out. The Fed is leveraged 80 to 1, and they’re insolvent on a mark-to-market basis. And the other central banks are no better off. The only clean balance sheet left is the IMF, which is only leveraged three to one, so that’s where the liquidity will come from.

Nick: That leads into my next question. You’ve talked about three possible outcomes for the coming restructuring of the international monetary system. One being an orderly transition to the SDR, which is issued by the IMF; two, a return to the gold standard of some sort; and three, a disorderly collapse. Now the last time we spoke, we talked about the petrodollar system. Do you think a breakdown in the petrodollar could be the snowflake that causes an avalanche into #3, a disorderly collapse?

Jim: Well, it could be; that’s a good question, Nick. I make the point that the snowflake doesn’t really matter. What matters is the fact that the snow is built up, and the avalanche is just a matter of time. I think it’s important to clarify that this is not just a kind of colorful metaphor—comparing the international monetary system to a snowpack and a potential avalanche. The dynamics and the mathematics are exactly the same.

The point being, when you see a very large snowpack built up on a mountain that’s windswept and unstable and you know it’s going to collapse, and then here comes the snowflake which disturbs a few other snowflakes, and that starts a slide and it gains momentum and it starts to shoot, and then the whole thing comes loose and then you have an avalanche. What do you blame? Do you blame the snowflake, or do you blame the instability of the mountainside? I would say that the snowflake is irrelevant. If it wasn’t the one that did it, it could have been the one before or the one after, or the one coming a week from now. What matters is the instability of the system.

So back to the capital markets and the financial system—the blunders have already been made. The instability—the snow, if you will—has already piled up. We’re just waiting for the snowflake. Now, it could be a lot of things. It could be a bullion dealer or a bullion bank that fails to deliver physical gold on demand because there’s a physical gold shortage. It could be a financial institution failure. It could be a prominent suicide. It could be a natural disaster as we saw in Fukushima. It could be a lot of things, but in the end, it doesn’t matter. What matters is the fact that the system is unstable and it’s going to collapse. We need prepare for this and expect it sooner or later.

Nick: It seems that the monetary elites understand this to some degree and would prefer an orderly transition to the SDR over time. Is there anything that you see that could derail this so that we would instead get a disorderly collapse as an outcome, instead of the SDR?

Jim: Sure. And getting back specifically to the petrodollar, there are three big vectors in the world today that are all pushing against the dollar, undermining confidence in the dollar and leading to some new kind of international financial system, or what the elites call “the rules of the game.” The first one is the one you mentioned, which is the petrodollar. This goes back to the 1970s with Henry Kissinger and the Saudi rulers. They worked out a deal whereby the US agreed to guarantee the continued rule of the House of Saud and guarantee the security of the kingdom, in exchange for which they agreed to price oil in dollars.

Now there’s no particular reason why oil has to be priced in dollars. It can be priced in Japanese yen, Swiss francs, or pounds sterling. We also have the euro and other currencies. Oil could also be priced in gold. It could be priced in a lot of things. But when you price it in dollars, that means you need dollars whether you want them or not, whether it’s your national currency or not, because everyone needs oil. A country might not want to transact in dollars, but if oil is priced in dollars and you need oil, then you have to get dollars. This is a very powerful prop under the dollar.

What’s happened in recent months is that President Obama stabbed Saudi Arabia in the back by engaging in a kind of détente with Iran, where clearly Iran is being anointed as the regional hegemonic power. Iran’s nuclear ambitions are being green-lighted. They still have their nuclear reactor, which produces plutonium, which is only good for one thing, which is building atomic bombs. Their centrifuges are still spinning, and they’re still enriching uranium. There might be some kind of a deal announced later this summer or early fall, but none of it will deter Iran from its nuclear ambitions, and the United States does not expect it to do that. And so taking all that together, if you’re Saudi Arabia, the US reneged on its half of the deal. We reneged on the part of the deal that says we guarantee the security of the kingdom, so Saudi Arabia may renege on its side of the deal, which is supporting the dollar. They may begin to price oil in other currencies, as I mentioned. So that’s one very important prop under the dollar that’s about to be removed.

Editor’s Note: Stay tuned for the final, part II of this interview where Jim and Nick will discuss what Russia and China are doing and could do to collapse the dollar-based international financial system as well as the sociopolitical effects of a dollar collapse in the US. Be sure you get the free IM Communiqué, so you’ll get part II right when it comes out.

See here for Part II

Nick Giambruno

Nick is Doug Casey’s globetrotting companion and is the Senior Editor of Casey Research’s International Man. He writes about economics, offshore banking, second passports, value investing in crisis markets, geopolitics, and surviving a financial collapse, among other topics. He is a CFA charterholder. In short, Nick’s work helps people make the most of their personal freedom and financial opportunity around the world. To get his free video crash course, click here.

Tags: petrodollar, geopolitics, economic collapse,