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Modern Money

The really big issue confronting the world at the moment besides all the political posturing is the state of money. There is not a currency on the planet that has been properly managed since the close of the second world war.

Money is key. The value of money and the way money is used is a fundamental issue when it comes to valuing anything else, and that includes real estate. And the cost of money affects all borrowing, and since 95% of all real estate transactions involve some form of borrowing, that cost is also going to be crucial when considering what is going to happen to house prices.

We are threatened with digital currencies controlled by governments. I cant think of a worse way forward. Governments simply cant be trusted with money. They behave like carefree teenagers with a big bonus. Money needs to be treated with respect, not carelessly trashed.

The standard old chestnut that comes up every time we broach this subject is the history of the stewardship of the Federal Reserve over the US dollar. Over the course of the 110 years they have been asked to look after it the dollar has lost 97% of its value. That has to be the worst stewardship in modern history. Just for a moment think how rich Americans would be if the currency hadnít lost all that value.

All that printed money thatís been wasted, thrown to the wind, could have been used to invest in the countryís businesses. Just think what that would have produced.

I shall want to return to the subject of money in a later blog, but for the moment let us just look at what has been happening over the course of the last three or four years.

Letís start with France.

There is a common complaint in France coming from those who actually produce the wealth in the country. It goes like this. A third of people work for the government. A third of people get pay-cheques from the government, and the final third pay for it all.

To me, that sounds like a recipe for disaster and massive disaffection amongst those who are supporting the whole tottering edifice.

If we look back through history, civilisations grow and prosper until the state machine grows too large for the struggling workers to support, and it collapses under the weight of the dependencies. Europe and the USA are both perfect examples of systems that are unsustainable in their present form for that very reason.

In both those regions the political systems are conspiring to help those societies to crash. That will be yet another subject I will leave aside for the moment. Letís just concentrate on the money.

The reserve currency is the dollar, which means that foreign trade is usually transacted using dollars. That means the dollar is used everywhere, not just in the USA.  That means there are a lot of them being used by other countries. That helps keep the value of the dollar high. It also means there are a lot of them sloshing around the financial system.

The short term situation outlook for the dollar is strong. The intention is to keep raising interest rates to try and slow the US economy and cut back inflation. To that end the Fed will continue raising interest rates. That will, in the short term, make US bonds an attractive safe form of income.

However, longer term things look very different. As we all know, the current US administration has decided to cut Russia out of the Swift payments system. Since Russia is a great trading country with massive energy resources and agricultural products to sell to the world, if people want to buy that energy and those goods then they need money to do so. They will naturally keep buying. They will naturally no longer be using dollars. This means the requirement for dollars for foreign trade is going to shrink.

Saudi Arabia has decided to sell its oil in local currencies. That means two of the largest suppliers of oil are no longer selling it in dollars. The petro-dollar is history. Expect over the course of the next two to three years the need for dollars in foreign trade is going to crash. I dont have the resources to try and work out what this will do to the value of the dollar over the course of the rest of this decade, but it will weigh heavily on that currencyís value.

A knock-on effect of this is that there will be less need for a centralised financial centre to deal with these currency movements. That will affect the London financial markets, and that is the UKís main earner of foreign currency. So expect the UK to suffer from this change as well.

With the current UK government leaning towards reneging on the split from the EU the rest of the city of Londonís foreign earnings are likely to move to Frankfurt. That will knock the UK back into the middle ages.

I cant stress too strongly the vulnerability of the UK in all this. I will try and spend the next blog lumping together all the bad news there is about the UK at the moment.

Russia has a massive store of resources that it can sell to the rest of the world. Russia is not about to go broke any time soon. On the contrary, it is in the process of backing the rouble with commodities, and what this means is, gold+.

It looks as though China is about to back the renminbi with gold as well, and boost the Shanghai gold exchange. You should note that China, once secretive about its gold reserves, has started publishing them. There has to be a reason for that. That will deal another blow to the UK gold market. The UK government has already sent out signals loud and clear that gold stored in the vaults in London is no longer safe, but can be weaponised. That is a most serious blow to London continuing as a centre for finance.

And I havenít even mentioned bitcoin. As a currency it is currently useless. Itís value is too volatile to be useful for trade. At the moment it can only realistically be used as a store of value, much in the same way as gold. I dont see that changing in the near future. However, I also dont see those with their heads screwed on properly abandoning the currency any time soon. Those of us who bought some time ago long since decided that bitcoin goes into cold storage and stays there.

And then thereís what is called the carry trade. Letís set the scene.

The Japanese yen is an international currency. The Bank of Japan is still holding Japanese interest rates around 1%. Interestingly the Federal Reserve has interest rates around 5%. So how does the smart set make money by doing next to nothing? Borrow money in yen and invest in US Treasuries, collecting that 4% difference from using someone elseís money. Most of us have used arbitrage to make money at some time in our lives. I did rather well the other way round back in the eighties, borrowing money from various banks in the UK and investing in Japanese unit trusts. When Iíd exhausted my first round of borrowing I simply leveraged my positions. Itís a very easy way to make money.

ButÖ What happens when these positions unwind? Someone is always on the other side of these positions. If you are invested in the dollar and the dollar starts falling, your once great carry trade starts to look worrying. Does it reach the stage where you might one day be under-water with regard to the trade? If so, what does that do to your ability to repay those yen you borrowed? And if you cant pay back the yen, what does that do to the Japanese financial system? And, of course, when the trade starts to look dodgy there is going to be a mass exodus from US Treasuries, which is going to affect the US financial system. After all, the US is largely funded by foreign buying of Treasuries. It is the largest debtor country on the planet.

The amount of credit which is involved in these kinds of transaction is insanely high. If only part of the system starts to go bad there is going to be one almighty crash. Once  again, that puts the London banking system in the firing line, because so much of this tangle of cross borrowing and arbitrage investing is underwritten by so-called spreader banks, rather a lot of which operate from Londonís square mile.

And dont letís forget emerging country borrowing for development reasons. Borrow on the commercial markets in dollars. Sounds good, except when your local currency starts to sag while the dollar is appreciating, and you now have a debt you cant pay back. There are a dozen or so countries facing precisely that situation right now.

In other words just about everybody is involved in a whole lattice-work of inter-connecting deals, and all of it is done on credit, which means one credit is depending upon another, and if/when the whole lot starts to unravel we are likely to be left with a massive pile of IOUs which will wipe out trillions of dollars worth of what was previous thought of as assets.

The alternative? Borrow from China. Then if you cant pay back China doesnít care, they just walk in and calmly take your assets instead. Itís called (politely) debt diplomacy.

i cant work out how all this will develop. Iím not sure anybody can, but it is one almighty mess. With a game of musical chairs maybe 10% of the players will not be able to find a chair when the music stops. In this particular game, when the music stops hardly anybody is going to be able to find a chair. So much money in this fiat system is compromised. All is well while the music plays, but sooner or later things go ominously quiet.

What is happening at the moment is that the USA, which has the most to lose in this financial game, has started a trend which is going to sideline the dollar system. This new trend may only take two or three years to get going, and not much longer to start to affect the way you live and count your wealth. You have time to prepare. If you stick with the old system, you are going to get a lot, lot poorer.

Fiat currencies cant survive for much longer. They will be attacked by commodity-backed currencies at least by the end of this decade, and maybe a lot sooner.

Next week I will take a look at the countries with the best store of commodities. And that is going to show up the old countries in rather a bad light. Who are the new dependent countries? Tune in again next week to find out.


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