With the story of the California teenage stowaway who flew to Hawaii April 20 via a jet’s wheel well, cable news pundits have bantered plenty about perceived weaknesses in airport screening procedures. But rather than the shortcomings in full-body scanners that leave nothing to the imagination, the Achilles’ heel of U.S. security may instead be something dispensed every day at airport foreign exchange kiosks the world over. The U.S. dollar, despite a very modest rebound from its 2011 low against other major currencies, has remained weak for several years. If the dollar, the world’s leading reserve currency, were to fall, it could bring down the global monetary system.
That warning is the key theme of The Death of Money: The Coming Collapse of the International Monetary System, the latest book by market strategist James Rickards, published by Penguin imprint Portfolio. Rickards has more than 35 years of experience in finance. Presently he is a portfolio manager at West Shore Group, a Haddonfield, New Jersey–based investment fund firm set up in 2013; senior managing director at Tangent Capital, a New York–headquartered merchant bank that provides services to managers of alternative assets; and an adviser to the U.S. intelligence community on international economic and financial threats. In 1998, as general counsel of Greenwich, Connecticut–based Long-Term Capital Management, he was the chief negotiator for the highly leveraged hedge fund firm during its $3.6 billion bailout by a consortium of 14 Wall Street banks and supervised by the U.S. Federal Reserve of New York after suffering $4.6 billion in losses.
“The system is actually reaching criticality,” Rickards says in an interview with Institutional Investor. By that, he means that a variety of factors threaten the role of the dollar as the world’s leading reserve currency, including persistent dollar weakness against other currencies, the inability of the U.S. to grow sufficiently to prevent its debt levels from rising as a proportion of gross domestic product and the building of gold reserves in China and Russia. Meanwhile, banks are loading up on what Rickards views as dangerous derivatives, subjecting the global financial system to an increasing level of hidden risk. Rickards says that instead of focusing on what he calls a“failure of imagination” on the part of the Treasury and the Fed, U.S. officials need to institute a plan to move forward with a new international monetary regime.
One purpose of war is to degrade the enemy’s will and economic capacity. Surprising as it may sound, wealth destruction through a market attack can be more effective than sinking enemy ships, when it comes to disabling an opponent. Financial war is the future of warfare, and no one works harder to see the future than senior Defense Department official Andy Marshall.
Seated at a table in a secure Pentagon conference room on a rainy fall morning in September 2012, Marshall moved forward in his chair. Around the table were three prominent investment managers, three SEC officials and several think-tank experts, along with members of Marshall’s staff. Our carefully selected group was there to discuss financial war.
“That’s interesting,” Marshall said. What prompted his comment, after an hour of complete silence on his part, was our discussion of China’s stockpiling of gold and its possible use as a financial weapon in undermining the dollar’s exchange value.
Andy Marshall is called “Mr. Marshall” even by associates as a sign of respect, and at 92 years of age, he has earned the deference. His official title is Director of the Office of Net Assessment in the Office of the Secretary of Defense. Unofficially he is the Pentagon’s chief futurist, the man responsible for looking over the horizon and assessing threats to U.S. national security long before others even know they exist. Marshall has held this position since 1973, through eight presidential administrations.
His involvement in national security strategy goes back even further, to 1949, when he joined the RAND Corporation, the original think tank. The list of his former associates and protégés includes Herman Kahn, James Schlesinger, Don Rumsfeld, Dick Cheney, Paul Wolfowitz and other giants of national security policy over eight decades. Only the late Paul Nitze is comparable to Marshall in terms of the depth and breadth of his influence on strategic affairs in the period since World War II.
If Marshall is less known to the general public than the figures to whom he is compared, that is quite by design. He almost never gives interviews or speeches; nor does he appear in public, and his writings are mostly classified. In a meeting, he has a sphinxlike demeanor, listening for long periods in complete silence, occasionally uttering a few words that show he has absorbed everything and is now thinking three moves ahead.
While most Americans have not heard of Andy Marshall, the Chinese military have. Marshall was a leading theorist of the late-20th-century “revolution in military affairs,” or RMA, which presaged radical changes in weaponry and strategy based on massive computing power. Precision-guided munitions, cruise missiles, and drones are all part of RMA. People’s Liberation Army General Chen Zhou, the principal author of several recent Chinese strategic white papers, told The Economist, “We studied RMA exhaustively. Our great hero was Andy Marshall in the Pentagon. ... We translated every word he wrote.”
Marshall is no stranger to potential confrontation with China. In fact, he is the principal architect of the main U.S. battle plan for war with China in the western Pacific. This classified plan, called “Air-Sea Battle,” involves blinding China’s surveillance capabilities and precision missiles, followed up with massive air power and naval attacks.
On this occasion, Marshall was not being briefed on kinetic weapons or air-sea tactics. He was hearing about sovereign wealth funds, stealth gold acquisition, and potential threats to national security caused by U.S. Federal Reserve policy.
China has over $3 trillion of investments denominated in U.S. dollars, and every 10 percent devaluation in the dollar engineered by the Fed represents a $300 billion real wealth transfer from China to the U.S. It is not clear how long China will tolerate this raid on its accumulated wealth. If China were not able to defeat the U.S. in the air or on the sea, it could attack through capital markets.
The threats discussed with Andy Marshall that day were entirely consistent with Chinese military doctrine. Unrestricted warfare doctrine, including financial war and cyberwarfare, has roots as far back as 1995. That year, Major General Wang Pufeng, former director of strategy at Beijing’s Academy of Military Science, published a paper called “The Challenge of Information Warfare.” After paying tribute to Andy Marshall in the paper’s opening lines, Wang went on to write: “In the near future, information warfare will control the form and future of war. We recognize this developmental trend of information warfare and see it as a driving force in the modernization of China’s military and combat readiness. This trend will be highly critical to achieving victory in future wars.”
The People’s Liberation Army of China made this doctrine even more explicit in a 1999 book entitled Unrestricted Warfare [ed. note: by Senior Colonel Qiao Liang and Senior Colonel Wang Xiangsui]. Unrestricted warfare tactics include numerous ways of attacking an enemy without using kinetic weapons such as missiles, bombs or torpedoes. Such tactics include the use of weapons of mass destruction that disperse biological, chemical or radiological elements to cause civilian casualties and terrorize populations. Other examples of unrestricted warfare include cyberattacks that can ground aviation, open floodgates, cause blackouts and shut down the Internet.
Recently, financial attacks have been added to the list of asymmetric threats first articulated by Wang and others. Unrestricted Warfare spells this out in a chapter called “The War God’s Face Has Become Indistinct.” It was written not long after the 1997 Asian financial crisis, which cascaded into the global financial panic of 1998. Much of the distress in Asia was caused by Western bankers suddenly pulling hot money out of banks in emerging Asian markets; the distress was compounded by bad economic advice from the Western-dominated IMF. From an Asian perspective, the entire debacle looked like a Western plot to destabilize their economies. The instability was real enough, with riots and bloodshed from Indonesia to South Korea. The ill will escalated to the point of name-calling between Malaysian prime minister Mahathir Mohamad and hedge fund maven George Soros in an infamous confrontation at the IMF annual meeting in Hong Kong in September 1997.
The Chinese were less affected than other Asian nations by the panic, but they studied the situation and began to see how banks, working in conjunction with the IMF, could undermine civil society and possibly force regime change. One of their responses to the crisis was to accumulate massive dollar reserves so they would not be vulnerable to a sudden “run on the bank” by Western lenders. The other response was to develop a doctrine of financial war. The lessons of the 1997–’98 crisis were summarized by two Chinese military leaders in a passage [ed.: from Chapter 2, “The War God’s Face,” in Unrestricted Warfare] both poetic and prophetic: “Economic prosperity that once excited the constant admiration of the Western world changed to a depression, like the leaves of a tree that are blown away in a single night by the autumn wind.... What is more, such a defeat on the economic front precipitates a near collapse of the social and political order.”
The Chinese are ahead of us: their doctrine of strategic financial warfare emerged in 1999 in response to the 1997 Asian financial shock. In comparison, U.S. thinking about financial warfare did not take recognizable shape until ten years later, in 2009, in response to an even bigger shock, the global financial panic of 2008. By 2012, both China and the U.S. had engaged in extensive efforts to develop strategic and tactical financial warfare doctrines. It was in this context that our group was summoned to brief Andy Marshall and his team on the emerging threat.
Financial warfare has both offensive and defensive aspects. Offense includes malicious attacks on an enemy’s financial markets designed to disrupt trading and destroy wealth. Defense involves early detection of an attack and rapid response, such as closing markets or interdicting enemy message traffic. Offense can consist of either first-strike disruption or second-strike retaliation. In game theory, offense and defense converge, since second-strike retaliation can be sufficiently destructive to deter first-strike attacks. This line of reasoning was the same doctrine Andy Marshall helped develop in nuclear-war-fighting scenarios during the Cold War in the early 1960s. The doctrine was called Mutual Assured Destruction. Now a new doctrine of Mutual Assured Financial Destruction was emerging. To Andy Marshall, financial weapons were new, but deterrence theory was not.
The distinction between offensive and defensive capabilities in financial warfare is not the only dichotomy. There is also a distinction between physical targets, such as exchange computers, and virtual targets, such as business relationships. Virtual targets involve business conduct based on trust. A seemingly honest entity can gain trust through patient, repetitive trading, then suddenly abuse that trust by flooding a trading system with malicious, manipulative orders.
Physical targets consist of a vast network of servers, switches, fiber-optic cable and other message traffic channels, as well as the exchange premises themselves. It is not difficult for exchange engineers or enemies to see that disrupting one link in this electronic chain through sabotage or hacking can cause chaos and force a market closure, at least temporarily. More extensive attacks can shut down markets for weeks or even months, depending on the extent of the disruption.
The financial meltdown in 2008 was not an act of financial warfare, but it did demonstrate to U.S. officials the complexity and vulnerability of the global financial system. Approximately $60 trillion of wealth was destroyed from the peak in October 2007 to the trough in March 2009. If such a catastrophe could be caused by instruments as innocuous as mortgages, imagine how much more harm could be caused by malicious market manipulation orchestrated by experts who knew exactly how the system behaved.
Thanks to Marshall and others, there’s a growing awareness that a well-orchestrated cyberfinancial attack could be as disruptive as any traditional military assault.
Excerpted from The Death of Money: The Coming Collapse of the International Monetary System by James Rickards, in agreement with Portfolio, an imprint of Penguin Random House. Copyright © James Rickards, 2014.
