The Death of Money

by James Rickards

  Spying operations such as TAO are far more sophisticated than the relatively simple sweeps of e-mail and telephone message traffic revealed by Edward Snowden in 2013.

  Wall Street is also improving its finance-related cyberabilities. On July 18, 2013, a securities industry trade organization sponsored a financial war game, called Quantum Dawn 2, that involved more than five hundred individuals from about fifty entities and government agencies. Quantum Dawn 2 was aimed principally at preventing attacks that would disrupt normal trading. While useful, this goal falls short of preparing for a more sophisticated type of attack that would mimic, rather than disrupt, order-entry systems.

  China is not the only major power fighting a financial war. Such warfare is being waged today between the United States and Iran, as the United States seeks to destabilize the Iranian regime by denying it access to critical payments networks. In February 2012 the United States banned Iran from the U.S. dollar payments systems controlled by the Federal Reserve and the U.S. Treasury. This proved inconvenient for Iran, but it was still able to transact business in international markets by converting payments to euros and settling transactions through the Belgium-based SWIFT bank message system. In March 2012 the United States pressured SWIFT to ban Iran from its payments system, too. Iran was then officially cut off from participating in hard-currency payments or receipts with the rest of the world. The United States made no secret of its goals in the financial war with Iran. On June 6, 2013, U.S. Treasury official David Cohen said that the objective of U.S. sanctions was “to cause depreciation of the rial and make it unusable in international commerce.”

  The results were catastrophic for the Iranian economy. Iran is a leading oil exporter and requires access to payments systems to receive dollars for the oil it ships abroad. It is also a major importer of refined petroleum products, food, and consumer electronics such as Apple computers and HP printers. Suddenly it had no way to pay for its imports, and its local currency, the rial, collapsed. Merchants sought scarce dollars on the black market at exchange rates that made the rial worth less than half its previous value, the equivalent of 100 percent inflation. A run on the Iranian banking system commenced, as depositors tried to get their rials out to purchase black-market currencies or hard assets to preserve wealth. The government raised interest rates in an effort to stop the run on the banks. The United States had inflicted a currency collapse, hyperinflation, and a bank run and had caused a scarcity of food, gasoline, and consumer goods, through the expedient of cutting Iran out of the global payments system.

  Iran fought back, even before the escalation of U.S. efforts, by dumping dollars and buying gold to prevent the United States or its allies from freezing its dollar balances. India is a major Iranian oil importer, and the two trading partners took steps to implement an oil-for-gold swap, whereby India would buy gold on global markets and swap it with Iran for oil shipments. In turn, Iran could swap the gold with Russia or China for food or manufactured goods. In the face of extreme financial sanctions, Iran was once again proving that gold is money, good at all times and in all places.

  Turkey quickly became a leading source of gold for Iran. Turkish exports of gold to Iran in March 2013 equaled $381 million, which was more than double those of the previous month. However, gold is not as easy to move as digital dollars, and gold swaps have their own risks. In January 2013 a cargo plane with 1.5 tons of gold on board was impounded by Turkish authorities at the Istanbul airport because the gold was deemed contraband. Various reports said the plane originated in Ghana, a major gold producer, and was heading for Dubai, a notorious transshipment point for gold and currencies from all over the world. Reports from the Voice of Russia speculated that the plane was ultimately headed for Iran. Regardless of the destination, someone, possibly Iran, was missing 1.5 tons of gold.

  Another source of gold bound for Iran is Afghanistan. In December 2012 The New York Times reported on a healthy triangular trade among Afghanistan, Dubai, and Iran using both legitimate transportation and illegal smuggling. The Times reported that “passengers flying from Kabul to the Persian Gulf . . . would be well advised to heed warnings about the danger of bags falling from overhead compartments. One courier . . . carried nearly 60 pounds of gold bars, each about the size of an iPhone, aboard an early morning flight.”

  As Iran expanded its gold trading, the United States was quick to retaliate. The U.S. Treasury announced strict enforcement of a prohibition on gold sales to Iran effective July 1, 2013. This enforcement was aimed at Turkey and the UAE, which had been the principal suppliers to Iran. The United States had already choked off Iran’s access to hard currency; now it was doing the same to gold. It was a tacit recognition by the United States that gold is money, despite public disparagement of gold by U.S. Federal Reserve officials and others.

  Gold was not Iran’s only alternative payments strategy. The most convenient was to accept local currency payments in local banks not subject to the embargo. Iran could ship oil to India and receive Indian rupees deposited for its account in Indian banks. The use of those rupees by Iran is limited to purchases in India itself, but Indian agents can quickly adapt to import Western goods with dollars and sell them to Iranians for rupees, at high markups to compensate for the time and trouble of reexporting the Indian imports.

  Iran also uses Chinese and Russian banks to act as front operations for illegal payments through sanctioned channels. It arranged large hard-currency deposits in Chinese and Russian banks before the sanctions were in place. Those banks then conducted normal hard-currency wire transfers through SWIFT for Iran, without disclosing that Iran was the beneficial owner, as required by SWIFT rules.

  Intelligence reports indicate that the amount of hard currency on deposit by Iran in Chinese banks alone is $27 billion. However, Iran’s ability to move these funds is circumscribed by China’s need to avoid attracting the attention of the United States in making the transfers. In April 2013 Iran requested that China make a “gift” to North Korea of $4 billion as part of China’s normal humanitarian aid flows to the Hermit Kingdom. Iran did not disclose to China that the gift was actually a payment for shipments of nuclear weapons technology from North Korea to Iran.

  In late 2012 the United States warned Russia and China about assisting Iran in such end runs around the sanctions, but no penalties were imposed on the Russians or Chinese and none seemed likely. SWIFT also had no appetite for enforcement because it did not want to exclude Iran from its system in the first place; it did so only under U.S. pressure. The United States did not come down hard on Russia or China because she had more important agendas to pursue with both, including Syria and North Korea.

  Iran also demonstrated how financial warfare and cyberwarfare could be combined in a hybrid asymmetric attack. In May 2013 Iranian hackers had reportedly gained access to the software systems used by energy companies to control oil and natural gas pipelines around the world. By manipulating this software, Iran could wreak havoc not only on physical supply chains but also on energy derivatives markets that depended on physical supply and demand for price discovery. These probes, described by U.S. officials as reconnaissance missions, are highly dangerous on their own. Neither the Iranian hackers nor the U.S. targets seemed to consider that such activities might accidentally trigger a market panic that even the attacker did not intend.

  Iran was not alone in bearing the brunt of U.S. financial warfare capabilities. U.S. financial sanctions aimed at Syria caused the Syrian pound to lose 66 percent of its value in the twelve months from July 2012 to July 2013. Inflation in Syria spiked to an annual rate of 200 percent as a result. The Syrian government was forced to conduct business in the currencies of its three principal allies—Iranian rials, Russian rubles, and Chinese yuan—because the Syrian pound had practically ceased to function as a medium of exchange.

  By late 2013, the financial damage in Iran led to an agreement between President Obama and Iranian presi
dent Hassan Rouhani, which eased U.S. financial attacks in exchange for Iranian concessions on its uranium enrichment programs. Iran had suffered from the sanctions, but it had not collapsed, and now it had met the United States at the negotiating table. In particular, sanctions on gold purchases by Iran were removed, enabling Iran to stockpile gold using the dollar proceeds from oil sales. President Obama made it clear that although sanctions were eased, they could be reimposed if Iran failed to live up to its promises to scale back its nuclear programs. Still, for the time being, Iran had fought the United States to a standstill in its financial war, despite enormous disruption to the Iranian economy.

  The U.S.-Iranian financial war of 2012–13 illustrates how nations that could not stand up to the United States militarily could prove a tough match when the battlefield is financial or electronic. Just as the United States found its allies in Europe and Turkey, Iran found hers in Russia, China, and India. Iran’s allies spoke openly about building new non-dollar-based banking and payments systems. Dubai had carved out a role accommodating both sides in this war not unlike Switzerland in World War II. The United States had wanted to drive Iran out of the dollar payments system, and it succeeded. But in a case of “be careful what you wish for,” an alternative non-dollar-based payment system is now taking shape in Asia, and gold has proved to be an effective financial weapon on its own.

  This cat-and-mouse game among China, Russia, Iran, the United States, and North Korea involving cash, gold, weapons, and sanctions illustrates how financial weapons have moved to the fore in strategic affairs.

  ■ The Cyberfinancial Connection

  Interest in financial war is hardly confined to Andy Marshall’s office in the Pentagon. In late September 2012 the Kingdom of Bahrain played host to a private, invitation-only summit of international monetary experts to discuss the geopolitics of currencies and reserves. The three-day exercise included scenarios such as the U.S. dollar’s collapse and the rise of regional reserve currencies such as the Chinese yuan and Russian ruble. Participants included European legislators, think-tank scholars, prominent journalists, and capital markets experts.

  On October 12, 2012, the Federation of American Scientists conducted a financial war game in Washington, D.C., involving alternative scenarios of a shooting war between Israel and Iran. Participants were given conventional military scenarios and then asked to assess the financial impact and show how financial weapons might be used as a force multiplier.

  On October 25, 2012, the Boeing Corporation conducted a financial war game during an offsite conference in Bretton Woods, New Hampshire. The conference was held at the historic Mount Washington Hotel, famous as the site of the 1944 Bretton Woods conference that established the international monetary system, which prevailed from the end of the Second World War until President Nixon closed the gold window in 1971. Although Boeing is a corporation and not a sovereign state, its interest in financial warfare is hardly surprising. Boeing has employees in seventy countries and customers in 150 countries, and it is one of the world’s largest exporters. Boeing’s Defense, Space and Security division builds and operates the most sensitive, heavily classified platforms for U.S. national security operations. Few if any companies in the world have as large a stake as Boeing in the possibility and implications of financial warfare.

  That same month, on October 30, 2012, the National Defense University completed a one-year virtual financial war game involving contributions of six leading experts from academia, think tanks, and major banks. The sponsor for the exercise was the U.S. Pacific Command, and its findings are contained in a highly sensitive 104-page final report.

  In August 2013 the Swiss Army carried out one of the most elaborate financial war games of all, called Operation Duplex-Barbara. In this exercise, Swiss troops defended their country against imagined French mobs and militias swarming over their border to recover money allegedly stolen by the Swiss banks.

  Even this extensive activity and analysis of financial warfare does not encompass the full extent of the threat. Cyberattacks on U.S. infrastructure, including banks and other financial institutions, are growing and can take many forms. In one troubling instance on Christmas Eve 2011, a computer file containing personal identification information on a senior U.S. government official was hacked, and the information was downloaded. The information was then used in an effort to deplete the official’s personal bank account. The official was Mary Shapiro, then the chief regulator of all U.S. capital markets.

  On April 23, 2013, a Twitter account maintained by the Associated Press was hacked and used to distribute a false message that the White House had been the target of a terror attack and that President Obama had been injured. This false message came just days after the Boston Marathon terror bombing and the dramatic manhunt and shootouts with the terror bombers. The Dow Jones Industrial Index immediately plunged more than 140 points, briefly wiping out $136 billion in wealth before recovering once the message was exposed as a fake. A pro-Syrian hacker group backed by Iran called the Syrian Electronic Army claimed credit for the attack. The hackers’ success and the market reaction demonstrated that markets are on a hair trigger and are easily crashed and manipulated by various means. It was an instructive episode for other potential attackers.

  These events point toward the most dangerous kind of financial attack, one that combines cyberattacks and financial warfare in the ultimate force multiplier scenario. In this situation, a cyberattack is not used to disable U.S. capital markets; instead the cyberinvaders take control of order-entry software to spoof sell orders by major financial institutions. The intended financial collapse is similar to the rogue hedge fund scenarios, except that no cash or capital is required. The computer is programmed to mimic an out-of-control broker trying to unload trillions of dollars in stocks, bonds, and derivatives.

  This scenario is a larger, more targeted version of the August 1, 2012, Knight Capital fiasco, in which a software error caused a computer to go berserk and flood the New York Stock Exchange with phony orders. Knight accumulated $7 billion in unwanted stock positions in a matter of minutes and suffered $440 million in losses to unwind them. While the disaster was taking place, no one at Knight could identify the problem’s source and no one thought to pull the kill switch. Finally the NYSE, in self-defense, blocked Knight from its systems.

  An even greater fiasco occurred on August 22, 2013, when the NASDAQ Stock Market was paralyzed for three hours due to computer and communications problems that have never been publicly explained. An attack from Iran’s Cyber-Defense Command has not been ruled out. In August 2012 Iran’s cyberforces destroyed 30,000 computers of oil behemoth Saudi Aramco with the Shamoon digital virus, and Iranian efforts at cyberfinancial warfare are ongoing.

  In these financial warfare scenarios, an attack could be so large that the NYSE would be overwhelmed and have to close down entirely. The ensuing panic would produce hundreds of billions of dollars in paper losses.

  * * *

  While thinkers in the national security community have expressed concerns about financial war, officials at the U.S. Treasury and Federal Reserve routinely pour cold water on the threat analysis. Their rejoinder begins with estimates of the market impact of financial war, then concludes that the Chinese or other major powers would never engage in it because it would produce massive losses on their own portfolios. This view reflects a dangerous official naïveté. The Treasury view supposes that the purpose of financial war is financial gain. It is not.

  The purpose of financial war is to degrade an enemy’s capabilities and subdue the enemy while seeking geopolitical advantage in targeted areas. Making a portfolio profit has nothing to do with a financial attack. If the attacker can bring an opponent to a state of near collapse and paralysis through a financial catastrophe while advancing on other fronts, then the financial war will be judged a success, even if the attacker incurs large costs. All wars have costs, and many wars are s
o destructive that recovery takes years or decades. This does not mean wars do not happen or that those initiating them do not find advantage despite the costs.

  Consider the following calculations. If China lost 25 percent on the value of its reserves as the result of a financial war with the United States, the cost to China would be about $750 billion. A fleet of twelve state-of-the art Ford-Class aircraft carriers, comparable to the envisioned U.S. carrier force, would cost over $400 billion to build and deploy once all construction, operating, overhaul, and other life-of-the-vessel costs were taken into account. The costs of securing those aircraft carriers with destroyers, submarines, and other support vessels, as well as the land-based systems and staff needed to operate the fleet, raise the costs to a significantly higher level. In short, the economic cost of confronting the United States in financial warfare may not be higher than confronting it at sea and in the air, and the damage inflicted may be even greater. China does not have a fleet of state-of-the-art aircraft carriers, but it does have cash and computers, and it will choose its own battlespace.

  China could protect its reserves against asset freezes or devaluation in the event of a financial war by converting its paper wealth to gold—an option it is now pursuing aggressively. Every gold bullion acquisition by China reduces its financial vulnerability and tilts the trade-off between portfolio losses and armament costs in favor of financial war. China’s possible intentions may be inferred from its status as the world’s largest gold buyer.

  The U.S. Treasury and Federal Reserve view also fails to account for intertemporal effects. An attack that is costly in the short run can be quite profitable in the long run. Whatever losses China might suffer on its portfolio in a financial war could be quickly reversed during peace talks or in a negotiated settlement. Seized accounts could be unfrozen, and market losses could be turned into gains, once conditions normalized. Meanwhile China’s geopolitical gains in areas like Taiwan or the East China Sea could be permanent, and it is the U.S. economy that might suffer most in such a contest and take years to recover.