Before It All Ends Badly, They’ll Do This to Money
After millennia of financial and economic strife, central bankers and politicians have finally figured it out.
There was never any need for recessions, bankruptcies, unemployment, or bear markets.
All you have to do is print and spend enough money to cure all such ills. There’s an easy way out after all!
No doubt you’re chuckling at the idea. But let me ask you this — how does the current delusion actually fail?
I mean, attempts to fight off the economic and financial crisis are working surprisingly well. We have the worst economic shock in history by many measures. Here in the UK, you have to go back 300 years to find the same hit to GDP. Long before Australia was even settled by us evil doers.
Stocks are doing fine compared to unemployment. And the unemployed are getting pay cheques these days.
Where does this charade end? When does the music stop? What’ll the reckoning look like?
Usually that moment is triggered when someone stops paying their debts. That’s what sparked the Subprime crisis, the Asian Financial crisis, and countless others. Someone defaults, kicking things off.
For a company to go bust, it needs to default on debt. That’s the point at which things fail in our modern economy. Mostly because leverage is part of almost every firm’s operations these days.
That leverage has a rather good side, by the way. It’s a big part of our prosperity. It allows firms to operate on a larger scale and at cheaper prices than they otherwise could. More stuff for less money for consumers.
But the downside is the risk of failure. Firms can go bankrupt if they borrow.
That is of course no big disaster, necessarily. The assets of a bankrupt firm remain — the planes, the warehouses, and the machinery. What changes in bankruptcy is who owns them and how they are used.
The old owners mismanaged the business — took on debt they couldn’t repay. The new owners after the bankruptcy use the same resources for a new and better purpose. Or they go bust too, reassigning the resources until they get used productively.
But in our modern post-COVID-19 world, things look very different.
Central banks and governments are keeping the firms that would go bust alive by helping them to roll over their debt. They can borrow more money to pay back the debt that comes due. So, they can’t go bust.
This ‘rolling over of debt’ sounds nefarious — like a dodge. But only if you believe in repaying your debts slowly over time. Few firms actually do that — they usually manage their debt levels carefully and roll over their debt all the time. Just as governments do.
The question is not when and how fast to repay debt, but what level of debt is optimal. That’s what the field of corporate finance is about.
The trouble is, the optimal level of debt is not the same during a pandemic…hence the crisis. But back to the topic — companies rolling over their debt. Or failing to do so.
The difference right now is how easy governments and central banks are making it to refinance. The consequence is that even the likes of the cruise ship company Carnival can refinance itself. It doesn’t go bust. It always finds a bond buyer to refinance its debts, even if it has to be the central bank itself.
This is great news, at first. The employees stay employed and the business survives. It’s like a patient on life support.
But what’s wrong with it? What are the negative consequences?
There are some obvious ones. Small businesses without access to central banks are in trouble. That’s why the small-cap index in the US is dramatically underperforming the big firms in the NASDAQ and S&P 500 indices.
But the real pain is outside the stock market. So, it matters less to central bankers, no doubt.
But let’s think more broadly and simplify a little to expose something else. What I really fear, deep down.
If printing money and lending it out to every company at risk of failure is good economic policy, why haven’t we been doing it all along? Why has anyone ever gone bankrupt? Why have we had recessions?
If you can keep companies going indefinitely, through any crisis, by assisting them to roll over their debts, which staves off bankruptcy, why not do so forever?
What is wrong with it? Where is the reckoning?
I’m not sure. But there are a few possibilities worth exploring.
The economy is constantly undergoing change
Part of the answer is a type of stagnation. Which is tough to explain.
The economy is constantly undergoing change. Blacksmiths become welders and horsepower becomes a measure for combustion engines.
This involves turmoil for blacksmiths and horse-related industries, of course. Including the failure of their businesses. But it is also the measure of progress in the sense of prosperity. Because of the productivity gains and living standards.
Given how much poo the police horses produce, and the smell, I can’t imagine London before cars…no doubt I’ll say the same of electric cars in a few years’ time…
But what happens if you keep the blacksmiths from having to change? What if you encourage the horse-related industries to survive by rolling over their debts? What if nobody goes bust?
I think you get economic stagnation. You lose the efficiency gains and prosperity which the turmoil of the economy allows.
If resources aren’t freed up, they can’t be put to alternative and more productive uses. They can’t be reassigned to make better things in better ways. Productivity stops going up — the source of GDP growth.
In a world like this, it’s tough to find booms and economic gains. Because resources are being used for unproductive things — in attempts to prevent failure instead of allowing new booms.
So perhaps the reckoning comes in the form of poor economic growth. A bit like in Japan, where companies are kept on life support in notoriously odd ways.
Given my lockdown life consists of a steady stream of nursery rhymes for my newborn daughter — I didn’t realise they actually work until three months ago — I can’t help thinking about all this in terms of nursery rhymes.
Just as the ‘Ring a Ring o’ Roses’ rhyme is about the Black Death, I can’t help wondering whether the ‘They all rolled over and one fell out’ song is actually about a debt crisis. With bond markets rolling over and someone falling out.
The question is, who will it be? Who fails in a world where money printing saves all?
Top of the list of casualties is the value of money. If more of it is being printed, and it’s being put to unproductive uses as described above, well that suggests stagflation. And that would be a reckoning!
But there’s another obvious way the reckoning could play out. It’s the prediction our own Jim Rickards gives in his newsletter Strategic Intelligence Australia.
Before the system reaches its reckoning, it could be reset. And we could begin again, with a new system.
This might sound obscure or vague. But it’s so common historically speaking that it has a name — a currency reset.
Our subscribers at Strategic Intelligence Australia already understand exactly what that is, how it happens, and why. They also know how to potentially profit from it and protect their wealth.
But with the topic breaking out in the news, it’s time to revisit some of what all our Fat Tail Media readers should know, right here in The Daily Reckoning Australia.
A currency reset is what happens when the global financial system maxes out. That can happen in many different ways, depending on what the current currency system looks like.
In a debt-based currency system, as we have now, the amount of debt gradually rises until it is simply not palatable. We’re at that point in much of the world. Hence the 0% interest rates and 100-year government bonds to forestall the problems this much debt creates.
Once we hit too much debt, the world’s leaders turn to a currency reset to rejig the system. More on what this means below.
Gold-based currency systems max out on trade deficits. The fixed exchange rates that gold standards imply tend to lead to trade imbalances over time. This in turn leads to gold moving across borders in one direction, until a currency reset changes the rules of the game again.
A common currency system, like the euro’s, features a similar currency reset for the same reason — fixed exchange rates between those on the common currency.
For fixed exchange rate regimes however, they’re fixed, the reset comes in the form of a devaluation for those who are struggling — against gold or by leaving the currency union. More on that below too.
Fiat reserve currency systems, as we also have now, tend to provide the reserve currency issuing nation with an exorbitant advantage. But that leads nations astray over time as they abuse the advantage — it turns out to be a double-edged sword.
The prospect of losing the reserve status unceremoniously is a dangerous one. Which is what creates the need for a more ceremonious change in how the financial system works — a currency reset. Bretton Woods and the Nixon shock were examples of this.
All in, we had five or six currency resets in the last century, depending on how you count them. I think another one is drawing near. And it isn’t just me.
University of Texas professor James Galbraith put it like this:
‘So the whole financial system will have to be reset. This is not an ideological point but a practical necessity for re-establishing a functioning economic system.’
He was focusing on the level of debt for his reasoning.
Over in Italy, there are concerns over a repeat of the 1992 currency reset. Which Britain also played a rather important part in.
Bloomberg recalls the story from back then:
‘On the September night in 1992 when George Soros famously broke the Bank of England, it wasn’t just the British pound that crashed. The Italian lira cratered too, the last of its numerous 20th century devaluations.
‘One veteran who is still at the Finance Ministry in Rome recalls a colleague researching “bankruptcy” and “failed state” amid the chaos as resentment swelled at the indifference of European allies, notably Germany.’
The fascinating thing is that the article doesn’t mention what Britain and Italy actually did. They broke free from the ERM — the precursor to the euro, under which countries still had their own currencies, but the exchange rates were fixed as if they already had the euro. This created the same problems as a gold standard and proper common currency.
Italy only escaped this system temporarily and became a founding member of the euro. The UK recognised the ERM as an ‘Eternal Recession Machine’ and departed permanently. Italy’s economy stagnated in the euro; the UK’s grew outside it.
As the Brits see it, Brexit is just phase three. The Church left in 1534, the currency in 1992, and now parliament is leaving too.
But back to the topic.
Do you see that a currency reset is a good thing? In the end, at least. It’s a tumultuous moment, but only because the existing system has run its course. The chaos would be worse if the existing system were allowed to continue to break down. That bodes hyperinflation, usually. Or some other breakdown.
Instead, you can opt for a currency reset.
It’s a bit like board games. When you play Monopoly with your family, you don’t kick off where the last game ended. It is resets back to zero each time. Otherwise the losers would refuse to play.
But what sort of currency reset is on the horizon?
The economist Galbraith is expecting a debt jubilee — huge debt forgiveness. Wiping the slates clean, as they call it. That’s what happened for thousands of years when economies hit their current imbalances, with too much debt. The Rosetta Stone records one such debt jubilee.
Another option, coming out of the IMF, is for its SDRs to become the global reserve currency instead of the US dollar. An SDR is like a bag full of different currencies, tied up and labelled ‘1 SDR’. They derive their value from what’s in them but can be used as a type of international money.
That’s plan A, as I see it. It allows an orderly transition away from the US dollar into a version of the world favoured by…is there a term for it which doesn’t sound kooky? Globalists, elites, internationalists…
Interestingly, when the idea of a global reserve currency was raised by a certain JM Keynes at Bretton Woods, he wanted it to be backed by gold. But that’s likely just a sign of the times — most currencies were gold backed before then.
Expecting a return to gold as the next monetary system is Jim Rickards. He’s been warning of a currency reset recently in his book Aftermath. The thing is, his previous books predicted the currency wars, the gold bull market, and plenty more rather accurately. Not to mention predicting Trump and Brexit, without having to write books about them…
Cryptocurrency enthusiasts argue that a cryptocurrency like bitcoin should replace the US dollar as the global reserve currency in the next currency reset. It’s a form of currency that’s outside the control of nations and their governments. Its supply is limited by definition, and it is easy to transfer. It ticks the boxes, in other words.
What fascinates me is how quickly debates about currency resets turn into ideological ones. Gold bugs favour gold as a reserve currency. Patriotic Americans favour keeping the US dollar. Anti-Americans want a multi-polar world. Creative thinkers think it should be energy-backed, somehow. And crypto enthusiasts favour cryptocurrencies.
Perhaps it’s just a case of everyone talking their own book. But my message for you today is simple.
All international currency systems have an inbuilt bias in them. Which leads to a tendency towards something — too much debt, persistent trade imbalances, reliance on institutions that can be co-opted, and much more.
This tendency leads them to be maxed out eventually as well. They’ll stop working eventually. And then we’re back to a currency reset again. That’s why they’ve always happened historically.
And we’re due one soon.
The key to investing in such times is to currency reset proof your portfolio.
Until next time,
PS: Check out this exclusive newsletter that warns of a global monetary reset taking place in early 2021 and how you can protect your wealth. Click here to learn more about Jim Rickards’ Strategic Intelligence.