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Hard Assets Alliance was created as a cooperative of investment professionals who believe there's a better way to invest in precious metals. This is a guest perspective on the markets from one of these partners; we hope you enjoy it.
Dear Reader,
There are many state actors out there that are preparing to inflict as much damage as possible to the power grid and other critical infrastructure, including the stock market.
 
I would put Russia, China, Iran, North Korea and a few others at the top of the list. U.S. financial warfare has taken a heavy toll on Iran, but it certainly has good cyber-warfare capability.
 
They’re employing what they call Cyber Brigades that spend all their time basically hacking into critical infrastructure systems. It’s a good bet that all of these systems have already been penetrated.
 
No one can beat the U.S. in a conventional war right now. China, especially, is catching up, but it’s not ready at this time. That’s why they’re focusing on attacking America’s critical infrastructure vulnerabilities.

This is called an asymmetric response. They want to fight in the area where they can win or at least inflict enormous damage.

Look at all the crisis spots around the world. North Korea, the Persian Gulf, South China Sea, Syria. If any of them really start to escalate, you’re going to get an asymmetric response function.

You could see an attack of the U.S. power grid, creating chaos in the United States. Or an attack on the stock market or other form of financial warfare.

Point being, financial warfare is not the warfare of the future — it is already here. It’s going to become a bigger threat as time goes on, too.

Financial warfare is actual warfare conducted through banking and capital markets channels. It is not mere economic policy as in the case of so-called currency wars, trade wars or embargoes.

When nations engage in financial warfare, individual investors can be collateral damage. If China tries to attack the U.S. by closing the New York Stock Exchange, for example, it will be tens of millions of Americans who will suffer an immediate loss of wealth as prices plunge and accounts are locked-down or frozen.

Financial warfare attacks vary in their degree of sophistication and impact. At the low end of the spectrum is a distributed denial of service, DDoS, attack. This is done by flooding a target server with an overwhelming volume of message traffic so that either the server shuts down or legitimate users cannot gain access. In such attacks, the target is not actually penetrated, but it is disabled by the message traffic jam.

The next level of sophistication is a cyberhack in which the target, say a bank account record file or a stock exchange order system, is actually penetrated. Once inside, the attacking cyber brigade can either steal information, shut down the system or plant sleeper attack viruses that can be activated at a later date.

But in 2010, the FBI and Department of Homeland Security located such an attack virus planted by Russian security services inside the Nasdaq stock market system.

 


Here is a formerly classified map showing cyberattacks by the Chinese government against U.S. interests. Each dot represents an attack. Notice the concentration of attacks against technology targets in San Francisco, financial targets in New York and military and intelligence targets in the Washington-Virginia area.

The most dangerous attacks of all are those in which the enemy penetrates a bank or stock exchange not to disable it or steal information but to turn it into an enemy drone. Such a market drone can be used by attackers for maximum market disruption and the mass destruction of Americans’ wealth including your stocks and savings.
 
In this scenario, an attacker could penetrate the order entry system of a major stock exchange such as the New York Stock Exchange. Once inside the order entry system, the attacker would place large sell orders on highly liquid stocks such as Apple or Facebook.

Other system participants would then automatically match these orders in the mistaken belief that they were real trades. The sell orders would keep flooding the market and the selling pressure would feed on itself.

The result could be a market decline of 20% or more in a single day, comparable to the stock market crash of October 1987 or the crash of 1929. You would not have to trade anything or be in the market during the attack; you would be wiped out based on the market decline even if you did nothing.

Another type of highly malicious attack is to penetrate the account records system of a major bank and then systematically erase account balances in customers’ deposit accounts and 401(k)s.

If the attack extended to backup databases, you or other customers might have no way of proving you ever owned the deleted accounts.

During a financial war game exercise at the Pentagon a few years back, I recommended that the SEC and New York Stock Exchange buy a warehouse in New York and equip it with copper wire hardline phones, hand-held battery powered calculators and other pre-Internet equipment. This facility would serve as a nondigital stock exchange with trading posts.

Orders would be phoned in on the hardwire analogue phone system. This is exactly how stocks were traded until recently. Computerized and algorithmic trading would be banned as nonessential.

In the event of a shutdown of the New York Stock Exchange by digital attack, the nondigital exchange would be activated. The U.S. would let China and Russia know this facility existed as a deterrent to a digital attack in the first place. If our rivals knew we had a robust nondigital Plan B, they might not bother to conduct a digital attack in the first place.

Some analysts respond to such scenarios by saying that the U.S. has cyberwarfare attack capabilities that are just as effective as our enemies’. If Iran, China or Russia ever launched a cyberfinancial attack on the U.S., we could retaliate.

The threat of retaliation, they claim, would act as a deterrent and prevent the enemy attack in the first place. This is similar to the doctrine of “mutually assured destruction” or MAD, that prevented nuclear conflict between the U.S. and Russia during the Cold War.

This analysis is highly flawed and gives false comfort.

MAD worked during the Cold War because both sides wanted to avoid existential losses. In financial warfare, the losses may be existential for the U.S., but this is not true for Russia, China and Iran. Because they are far less developed than the U.S., their markets could be destroyed and it would have little impact on their overall economy or national security.

The technological warfare capabilities may be symmetric, but the potential damage is asymmetric, so the deterrent effect on China and Russia is low. There is essentially nothing stopping Russia, Iran or China from launching a “first strike” financial warfare attack if it serves some other national strategic purpose.

What can you do to preserve wealth when these cyberfinancial wars break out?

The key is to have some portion of your total assets invested in nondigital assets that cannot be hacked, wiped out or disrupted in financial warfare.

Such assets include gold, silver, land, fine art and private equity represented by a paper contract that does not rely on electronic exchange trading for liquidity.

For gold, I recommend you have a 10% allocation to physical gold if you don’t already.

As for alternative investments like fine art, there are many investments that will cost you less than $1,000 to get started.

As an investor, you have enough to be concerned about just taking into account factors like inflation, deflation, Fed policy and the overall state of the economy. These days you face another major threat — financial warfare, enabled by cyberattacks and force multipliers.

The time to take defensive action by acquiring nondigital assets is now.

Regards,

Jim Rickards

Jim Rickards is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He was the principal negotiator of the rescue of Long-Term Capital.

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Posted in: Economy