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And if the glass is half empty?

13 Sep 2021 8 month(s) ago

A pessimistic look at the financial system.

Those investors who want to be pessimistic have lots of evidence on their side. There are conventional defensive options, such as buying gold, investing in tangible assets, hoarding cash, or, more recently, looking at cryptocurrency. Trouble is, when the system is under threat, judgements made about what is the best play inside that system end up resting on assumptions that can easily turn out to be wrong. When Ukraine’s monetary system collapsed in the 190s, people turned to sugar and bricks as currency. Who could have predicted that?

What is not in doubt is that the problems are getting deeper. There is a three-way battle looming over the future of money and the stakes could scarcely be higher. Conventional money, mainly debt created by banks — the ‘folding stuff’ is only a tiny proportion of the total — is in trouble. Total global debt is now so large relative to the world economy it cannot be serviced, which is why monetary authorities have resorted to dropping interest rates. When they almost hit zero, the next step was quantitative easing (QE): printing money by getting the central bank to buy back government and corporate bonds and putting them on its ‘balance sheet’. QE was a strategy invented by Japan and we only have to look at that country’s dismal economic performance over the last three decades to see how effective it is likely to be.

Quantitative easing is only postponing the reckoning, which will most likely come in the form of massive inflation — or rather consumer price inflation rather than the asset inflation we have already experienced (especially houses in Australia).

It is a dire situation but not new. For thousands of years societies have seen their debt get out of control. The usual response is periodic debt forgiveness of some sort, but when the banks are private, as they are in most developed economies, you cannot do that without causing the whole system to collapse (it may be more viable in China where banks are state owned).

The out of control debt problem is why two other forms of money have emerged. One is cryptocurrency, decentralised, cross border digital coinage that purports to offer a different way of transacting. They are intended to be an alternative to money dependent on fiat (government edict). It is claimed fiat currencies have been debauched — irrefutably the case, although mainly by banks rather than governments — and something else needs to take their place. 

So far cryptocurrencies such as Bitcoin have not been effective as a new form of transaction. Instead, they have become another type of financial asset investors in the big financial institutions use to diversify. Those institutions have the biggest pool of ‘fiat’ money and are presumably hedging their bets. They know well enough that the system is in trouble.

The third type of money superficially seems like a way out of the looming disaster, but the implications could hardly be more sinister. It is central bank digital currency (CBDC), money issued, controlled and surveilled by the central bank. The central banks aspire to work together. The risk is of ending up with one currency for the whole world.

The concentration of power this would imply would be unprecedented in human history and is certain to be abused. Yes, the central bank type of money would have no interest rate on it, which would avoid the problem of unsustainable debt cycles.

But the control over how people use their money would be total, as the General Manager of the Bank for International Settlements, Augustin Carstens, commented:

‘We don’t know who’s using a $100 bill today and we don’t know who’s using a 1,000 peso bill today. The key difference with the CBDC is the central bank will have absolute control on the rules and regulations that will determine the use of that expression of central bank liability, and also we will have the technology to enforce that.’

CBDCs would open the door to complete technocratic totalitarianism, in other words. Unsurprisingly China, already a totalitarian state, loves the idea and is the fastest mover. China already has its social credit system of mass surveillance in place, and a central bank currency will complete the subjugation of its population. The country has banned Bitcoin and is moving ahead aggressively with its centrally controlled digital yuan. It is becoming harder to use physical cash in the country.

Contrary to what most Western commentators seem to believe, China is in deep financial trouble. The nation’s money supply (M2) is, absurdly, more than double its economy (GDP); typically the ratio is about one-to-one. The reason is that China’s banks have massively over-loaned to infrastructure, construction and building. It was how the economic ‘miracle’ was achieved. But Chinese banks are now broke and the government can only keep them afloat by printing money and shoving it on to their balance sheets. 

In the end, the only way out will be to write off the debt, which China could theoretically do. But it would be an earthquake in the nation’s financial system and result in large parts of its economy becoming closed off. The leadership’s thinking may be that the best way to manage the shock is to, at the same time as cancelling debt, move China’s monetary system to the central bank digital currency (while also hoarding foreign exchange to buy the raw materials on which the country depends).

In the West, no such option exists, short of nationalising the banks. But if the central banks win in their push towards digital currency and wallets, the loss of ordinary financial and personal freedoms will be shattering. People will yearn for the days when they could use simple cash — you know, fiat currency. Conventional money may be in trouble, but beware the central bank alternative. That way enslavement lies.


Reader note: This is general reporting only and should not be considered in any way to be investment or tax advice. It does not take into consideration the investment objectives, financial situation or particular needs of any particular investor. For more information please read our disclosure statement.


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