Money, Currency Wars and the Future

Note: The following post formed the basis of a one hour presentation that I gave to work colleagues that had expressed some interest in the topic of money.

Disclaimer: I am merely an amateur enthusiast, and not an economist nor a financial advisor. Your millage may vary.

Preamble

As a result of the Global Financial Crisis in 2007, I took a much more rigorous look into investing, (hence this blog/presentation), which naturally led to the topics of inflation vs deflation, and the nature of money.  Many questions bugged me, such as: "Why to the RBA target 2-3 percent CPI, and why is that the sweet spot?", and "What does an economy 'running too hot' actually mean?".  I now think that I have a solid enough understanding to be able to answer most of these types of questions.  In this article, I hope to give you some of that understanding, although I don't intend to directly answer those questions!

What is money?

Let's start with a definition of money.  The best definition that I have heard for money is formalized obligation.  Obligations are simply IOUs.

So, where did money come from?  Despite the popular belief that money arose out of the barter system to solve the double coincidence of wants, money, as formalized obligation, simply evolved from less formal obligation, ie, informal obligation.

Informal obligation is the sense in your mind that either you owe somebody something, or they owe you something, as in "Thanks mate - I owe you one".  The formalization increases - but not quite to the point of money yet - once these obligations begin to be tracked over time, as in Brownie Points!

Let's consider brownie points between you and your significant other.  You buy you SO a great birthday present - you gain some brownie points.  You miss the mark with the birthday present and it isn't well received - you lose some brownie points.  Neither you or you SO actually keep track of the points formally, but both of you keep a rough ledger of who owes whom.

In the receiver's head, an IOU pops into existence - eg, "Wow, I had better get her a birthday present just a good as this one", and simultaneously, in the giver's head, a UOI, for want of a better term, pops into existence - eg, "I'm gonna get some tonight".  With some luck, later that night, the IOU/UOI pair might vanish from existence, as the debt is repaid.

Obviously, the lack of formalization can lead to disputes about exactly how much one person owes another.  One form of this is commonly known as not pulling your weight.  When a group decides that someone isn't pulling their weight they can raise this issue, however when the response is "Yes I am", the only way the issue can be resolved is to formalize the tracking of contributions and therefore obligations.

Another issue that can arise from the lack of formalisation of the IOU is the exact terms of the IOU.  Is there an expiry date?  Does the IOU bear interest?  Is the IOU transferable?

Have you ever been in the situation involving three people, where somebody both owed, and was owed, the same amount of money, and that person tried to remove themselves from any further obligations by linking the other two - "Hey, if Adam owes me $20, and I owe Zac $20, can we all just agree that Adam owes Zac $20?", and in the nod of heads, a primitive payment was made.

So, payments, in there simplest form, are simply a mechanism to adjust two obligation ledgers - to extinguish the IOU and the UOI, which are simply the two sides of the same obligation between the giver/receiver, lender/borrower or creditor/debtor.

The process of obligation formalization can be contractualization, tokenization, digitization, or serialization of this mental construct - the IOU/UOI pair.  The formalization into a contract can take various forms, from a Note, Bond, Cash Note or Coin, Casino Chip, or a digital record in database.  Once the obligation is formalized, we have money!

It is often said that money must be a) a unit of account, b) a medium of exchange, c) a store of value, however while this is true for a monetary system, it does not need to be true for a particular form of money.  That is, there is no need that the medium of exchange also be the medium to store value.  In fact, the monetary system will be more stable if these roles are kept separate.

Here are some examples of ye olde money:

Note the text: "We promise to pay the Bearer the Sum of One Pound Sterling" - unquestionably formalized obligation.

In Australia, before 1911 when the Bank Note Act was introduced, it was the private bank notes that circulated as currency.  After the Act was introduced, it was the national currency that circulated.  Importantly, the concept of bank IOUs as distinguished from government IOUs still exists in the world today, but as digital credits, it is much harder to distinguish between them.  Indeed, you probably don't even know that you exchange bank credit for government credit every time you withdrawal cash from the ATM.

The above bank notes are also the simplest form of a derivative.  None of these notes are a One Pound Stirling note.  They are Australian Pty Ltd bank IOUs for British Government IOUs.  Being derivatives, there are inherent risks involved.  Will the bank stay in business?  Will it honor it's promise to pay the bearer?  If the bank does honor it's promise, will the British government honor it's promise to pay "One Pound Stirling"?  One Pound Stirling of what?  That promise was long defaulted on!

Another risk within these bank note derivatives was whether on not the note would be accepted at face value by the market.  Given that the Bank of Paramatta only existed for FOUR years, would you hand over your goods for the face value of these notes?

The Monetary Plane

Here we draw a distinction between the physical plane, consisting of real tangible goods, and the monetary plane, consisting of financial products, including cash.

Using our original definition of money, we can see that everything in the monetary plane is an IOU, or debt based, whereas the physical plane consists of real assets.  We also see that only way we know the worth of things in the monetary plane is by the magnitude of the number associated with it, whereas the items in the physical plane have a real value to the holder of the item.

Because the monetary plane uses nominal values, the unit and hence magnitude of these values are completely arbitrary, and without limit.

Spotting Deflationists From the Front of the Room

Rodney Johnson's recent newsletter article (Spotting Winner's from the front of the room - I can't seem to find a direct link to it) caused my partner to question some of our positions and beliefs.   Let me shoot down his arguments one at a time.

Johnson: I just got back from the Global Currency Expo... The theme of the conference was how to position investments as the dollar crumbles after so much printing and so much debt issuance.  ... the attendees ... listened to ... people talk about how the dollar will collapse. But then they had Harry and me bombard them with facts and statistics as to why it’s not true.

Johnson: You see, most every speaker there was using the typical check list to explain why the dollar is in dire straits. Has the government seemingly gone beyond the pale in terms of issuing debt to pay for profligate spending? Yep. Is the government – or its nefarious extension – printing money ad nauseum during a time of peace? Absolutely. Are there hard assets that can be purchased? Of course. Are there capital controls? None that can’t be overcome. Well there you go. The government’s killing the currency for its own ends and people of means can choose to leave the system. Nothing else to see or talk about here, the death of the dollar is a foregone conclusion… or not. 

Johnson: Those rules, the ones about debt, money printing, ease of capital movement, etc., are certainly important factors in determining the health of a currency. But they are not the only rules. There are others, which can trump – and have trumped – these criteria, and that’s what we pointed out from the stage.  While the U.S. is printing money, it is not showing up in inflation-inducing borrowing. That’s because the largest segment of our population, the boomer generation, is now in their saving phase – not their spending phase.  This is the same reason that extraordinarily low interest rates are not causing a boom in borrowing, and why those same low interest rates are not causing savers to flee deposit accounts. The money they have is meant for another time – retirement. So all of Bernanke’s efforts will fail to spark a meaningful recovery and fail to spark inflation as well.

So, his argument here is that savers can prevent hyperinflation by saving, and that the baby boomers are a large enough saving force to do so.  Unfortunately, saving large amounts of a failing currency may delay the collapse of that currency, but then the savers of the collapsing currency will be the worst affected by the collapsing currency, as their life savings will disappear before their very eyes.


Johnson: Just as important as the domestic situation is the current state of other large currencies. If an investor were to leave the dollar, where would he go? The euro, with its Cypriot bail-in and failing states of Italy, Portugal, Spain, Greece, and Ireland, along with 12% unemployment? Or perhaps to the yen, where the government of Japan has just announced plans to destroy its own currency? Boy, those sound like GREAT choices! 

Well the simple answer is "Gold for saving, Euro for spending".  It's somewhat ironic that a guy claiming to know how the world financial architecture works can write about the collapse of the US dollar and not once even mention gold.  No wonder he cannot see any GREAT alternatives.  Johnson also misses the point that the savings medium does not need to be the same as the transaction medium, nor does he understand the Euro.  The fact that the ECB did not bail out insolvent institutions makes the currency STRONGER than if they had, and proves that they WILL stick to their 2% CPI mandate - ie, price stability in the short to medium term. 

Johnson:  Finally, there is the idea that the U.S. dollar is losing its status as the currency of reserve. This is bantered about a lot, and many smart people point to economic reasons why the U.S. dollar will be knocked off its perch. The typical reasoning circles back to the money printing and the debt, and often includes the prospects for future growth. All of that makes sense, but I’ll add another element – security. In particular, the ability to project power around the globe with bone-crushing force. We have it.  No matter what one’s opinion of the wars in Afghanistan and Iraq, there is no doubt that they have allowed the U.S. military to develop into the most battle-tested and experienced fighting force on the planet. No other military has engaged in such warfare over the last decade

There is only a small degree of validity to this argument, in that the US can prevent a full on frontal assault on its dollar with military might.  Iraq and Libya learned this the hard way.  However the current attack on the US dollar is not a full frontal attack - it is a death by a thousand cuts.  Keep an eye on the news and you will see bilateral currency and oil deals going on all the time.  Keep an eye on the SWIFT data and you will see that the Euro already has more usage than the US dollar.  Also,  once it is obvious that its currency is failing, the US military will be completely useless, after all, how motivated will soldiers be if they start getting paid in monopoly money and they try to buy petrol with monopoly money.  The collapse will be as swift as the Russian one.

Johnson: Along the way, we have developed unparalleled techniques for gathering intelligence (like drones) and surgical strikes (by special forces). What does this have to do with the reserve currency? Think back to how the U.S. dollar got that position in the first place – it was immediately after the Second World War and we were the strongest country to emerge from the conflict. 

Er, no.  The reason the US dollar was adopted as the international reserve was not because the US military was the strongest, it was because the US currency was the strongest, because it was backed by gold and the credibility drawn from the ultra productive US manufacturing industry.  And where is that credibility today?  Hahahahaha!!!  That's where.

Johnson: Those who are counting down the glory days of the U.S. dollar are in for a big surprise… it’s going to get stronger.

The US dollar will collapse, just as all currencies have before it.  In the mean time, it may temporarily get stronger, as investors trade via US dollars to get out of the derivative markets, bonds, etc into gold.

Asset money vs Debt money

Historically, money has flip-flopped between being asset based and being debt based.

Asset based monetary systems, aka hard money, favor the net producer and saver, as the purchasing power of savings is preserved well in a hard (not easily inflated) money system.

Debt based monetary systems, aka soft money, like today's irredeemable fiat system, favors the net consumer - i.e, the "I'll have it now and pay you later (unless I default)" type of person.

Both hard and soft systems are barbarous relics that will go down in history as belonging to the monetary dark ages.

Unfortunately, we are still in the monetary dark ages.  The good news though is that the day of monetary enlightenment will soon be upon us.


This enlightened monetary system will have two halves - the debt half and the asset half - the soft half and the hard half - the yin and the yang - the debtor's fiat, and the saver's gold.

Welcome to Freegold.

Should Australia join the Euro?

Well, that may sound like a pretty silly question with all the Euro mess hoo-hah at the moment.  With riots in Greece and Spain, and "austerity" such a dirty word, why would any country want to join the Euro?  And to be clear, by joining the Euro, I mean completely dropping the AUD as legal tender, and making EUR legal tender in Australia.  Well, 17 countries have joined the Euro.  Why?  Surely, a nation must have a good reason to give up it's national currency, and all the political privileges that go with it.  Was it an experimental whim doomed to failure, or are their deeper rationales at play?

Why join a currency union?

On the surface, the primary reason to join a currency union is to facilitate better and more efficient trading relationships.  Trading contracts within a currency zone are simply simpler.  They do not need to consider, exchange rates, relative interest rates, hedging, etc.

Under the surface, a damn good reason to join a currency union is because your currency is about to collapse.  This reason alone will cause the Euro to grow over time.  It is the same reason that the UK will soon join the Euro, and somewhat related to why Greece will never leave the Euro.

Beyond political reasons, I cannot think of one reason why a country would not want to join a currency union.

Real money vs Casino chips

This is a story about a casino - a very busy casino. So successful was this casino, that most of its patrons never needed to leave. They ate at the casino's restaurants, and they slept in the casino's hotels. They even brought up their kids in the casino (they went to school there!).

Because they almost never left the casino, the patrons hardly ever used real money.  They paid their food and rent bills with the casino's "chips" (ie, the high tech plastic tokens used for gaming machines, poker tables, and all other casino services). Very convenient.

In fact, the tokens were so convenient that patron rarely cashed in their chips for real money.  So infrequent were the patron's trips to the cashier, that one day the casino decided to shut their cashier down altogether.

Well, the patrons realized that this meant that they would be trapped in the casino, as all their chips - and some patrons has amassed quite a hoard - could never be wagered or spent outside the casino.

So the patrons started heading for the exit, (which took some finding mind you - it was well hidden), as they thought that the casino would eventually go bust if it wouldn't redeem patron chips for real money, and if the casino did go bust, everyone's chips would become worthless.

Without patrons, the casino could not survive, so it had to do something to stop the exodus.  The casino played the only card that it could. It reset all the games and machines to pay out big. Some paid out as much as 20% each time you played.

It worked!  The exodus stopped, and the patrons returned to the gaming machines.  With the casino paying out so much, they wagered much more than before.

Over time, two things happened..

China sells oil in yuan

Recently, I spoke about symptoms and early warning signs of hyperinflation.

Well, the US dollar losing it's petrodollar status would be one of those...

Some quotes from: Dollar no longer primary oil currency as china begins to sell oil using yuan

For the first time since the 1970's, when Henry Kissenger forged a trade agreement with the Royal house of Saud to sell oil using only U.S. dollars, China announced its intention to bypass the dollar for global oil customers and began selling the commodity using their own currency.

Lindsey Williams: "The most significant day in the history of the American dollar, since its inception, happened on Thursday, Sept. 6. On that day, something took place that is going to affect your life, your family, your dinner table more than you can possibly imagine."

"On Thursday, Sept. 6... just a few days ago, China made the official announcement. China said on that day, our banking system is ready, all of our communication systems are ready, all of the transfer systems are ready, and as of that day, Thursday, Sept. 6, any nation in the world that wishes from this point on, to buy, sell, or trade crude oil, can do using the Chinese currency, not the American dollar.
...
This announcement by China is one of the most significant sea changes in the global economic and monetary systems
...
The ramifications of this new action are vast, and could very well be the catalyst that brings down the dollar as the global reserve currency, and change the entire landscape of how the world purchases energy.
...
"Crude oil is the standard currency of the world. Not the Yen, not the Pound, not the Dollar. More money is transferred around the world in crude oil than in any other product."
...
These duo actions by the two most powerful adversaries of the U.S. economy and empire, have now joined in to make a move to attack the primary economic stronghold that keeps America as the most powerful economic superpower. Once the majority of the world begins to bypass the dollar, and purchase oil in other currencies, then the full weight of our debt and diminished manufacturing structure will come crashing down on the American people.
...
The world changed last week, and there was nary a word spoken by Wall Street or by politicians who reveled in their own magnificence as this event took place during the party conventions. A major blow was done on Sept. 6 to the American empire, and to the power of the U.S. dollar as the world's reserve currency. And China, along with Russia, are now aiming to become the controllers of energy, and thus, controllers of a new petro-currency.

Interesting times indeed..

Outsmarting hyperinflation

Very few people understand inflation, and of those, only some expect a hyperinflationary scenario. Of this small crowd, some think that the best way to "win" from a hyperinflationary scenario is to buy a big expensive house with a large mortgage.  The idea is that your debt gets inflated away and you end up with a house, essentially for free.

Now, I'm not going to profess to know how hyperinflation will turn out, but I would like to present a scenario for your consideration.

Let's look at the how those with a large mortgage will fair. Let's focus on the percentage of disposable income going to mortgage repayments, and how that will change during hyperinflation.

Support Socialism - Save in Fiat

Your country needs you!

Your government has commissioned an exorbitant number studies, at great expense, to prove, beyond any reasonable bureaucratic doubt, that socialism is the way forward for this once great nation.

You must volunteer to support socialism, before we force you to. Save in fiat today.  

 

It is only through the continued support of the fiat collecting savers that your government can continue to grow beyond the limits enabled by taxation alone.

The benefits of saving in fiat are: 1) Help prevent price inflation by not spending fiat. The importance of hoarding fiat cannot be understated, and even more so as price inflation becomes apparent. 2) Help prevent tax increases. By surreptitiously supporting your government, blatant tax increases need not be imposed. 

We are in the midst of a currency war. Other nations are no longer supporting your government's growing overspend by collecting our fiat - it is now up to you.

Ask not what your currency emitter can do for you, but what you can do for your currency emitter.

If you do not take up the challenge, there will be only one option, and that is not to cut spending to limits of our current income - that would be disastrous for this country. We have made promises to the underprivileged, the highly privileged, and all our friends in between, and we must keep our promises.  No, the only viable option would be to print those promises. Can you now see the importance of you not spending excess money?

It is your duty to be the last man standing at your post in this war. Abandoning your currency will be considered an act of treason. Saving in anything other than fiat will be considered desertion.

Your country needs you . Your currency needs you. Socialism needs you.

Exponential Inflation vs Hyperbolic Inflation

Chris Martenson has an interesting article entitled Our Money is Dying over at Peak Prosperity.  In it, he talks about the "inflationary spectrum", which consists of:

1. Non-inflationary price increases
2. Simple inflation
3. Loss of confidence in money
4. Hyperinflation, and finally
5. Currency destruction.  

See the article for a description of each.

Rather than seeing a single "inflationary spectrum", I instead see two quite distinct inflationary forces - one that is exponential, and one that is hyperbolic.  Let's briefly take a look at an exponential and hyperbolic functions (graphs):

The shapes, slopes, and positioning of the graphs come in many forms.  The key difference between exponential and hyperbolic, as explained by Wikipedia, is that:

• exponential growth grows to infinity as time goes to infinity (but is always finite for finite time),
• hyperbolic growth has a singularity in finite time (grows to infinity at a finite time).

Put another way, hyperbolic growth trajectories have a D-Day - a day of reckoning.

Now, relating this back to inflation, I have a crude (yet instructive) Inflation formula: