Unstable Stability

A decree backed by a promise backed by a lie backed by a fraud - a closer look at modern fiat currencies

(Source: Getty Image)

Bill Bonner, reckoning today from Youghal, Ireland...

Hearts that are broken and love that's untrue
These go with learning the game
When you love her but she doesn't love you
You're only learning the game

~ Buddy Holly

The gist of the ‘stable’ coin concept is that you ‘link’ or ‘back’ one thing with another thing – like a parent guaranteeing his child’s first auto-loan. Alas, as we saw yesterday, promises were made to be broken.    

Putting this in perspective, we are at the beginning of a debt deflation. The Fed is AWOL. And Mr. Market is running the show. He’s marking down and writing off debts that can’t be paid – most prominently those of zombie businesses and crypto finance companies. He’s also discounting the collateral value of stocks, bonds, and soon we predict, real estate too. 

Bloomberg reports on the housing situation:

A housing correction will reach from “coast to coast” in the US, but it will fall short of a crash, according to Mark Zandi, chief economist at Moody’s Analytics.

With the Federal Reserve introducing the biggest increase in interest rates in years to combat rising inflation, home prices will likely fall in the housing markets that are most “juiced,” says Zandi. Regions with signs of significant speculation, namely in the Southeast or Mountain West, can expect the pendulum to swing back. Cities and states due for a correction include Phoenix and Tucson in Arizona, the Carolinas, northeast Florida, and above all, Boise — “the most overvalued market in the country,” per Moody’s analysis.

Going Bust

In the short run, this deflation is focused on asset prices. But the fall in housing prices will bridge it over to consumer prices too. And not in a good way. As prices fall, more and more ‘credits’ will drop below the value of their ‘debits.’ A business will only be worth, say, $1 million… but will have $2 million in debts.  Households will be ‘upside down’ and lose their homes. Businesses will go into Chapter 7 or Chapter 11.  

But sovereign nations have more options; they can break their promises and get away with it.  

Yes, we are just ‘learning the game.’ And the game of currencies is a ruthless one.  Legal tender is a government monopoly. And as in heavyweight wraslin’… or on-line dating… what you see is not always what you think it is.

There are de facto links, market links, legal links and contractual links. All the members of the European Union, for example, rolled their different national currencies into one central currency – the euro. This gave dodgy borrowers in southern Europe a big boost; they’re able to sell bonds in a currency backed by German savers.  

This link is thought to be solid…and stable. But what if the Greeks can’t pay their debts? Then what?

In the case of Argentina, linking the peso to the dollar was nothing more than a political promise.  When the Argentines couldn’t pay their debts in dollar-linked pesos, they discarded the link.  

Broken Promises

In our lifetimes, the most important monetary link was broken 51 years ago. Sixty-one US Treasury secretaries, over 180 years, had crossed their hearts, hoped to die, and solemnly promised to redeem the US dollar for gold. Then, with no act of Congress, no debate, and no notice, on August 15th, 1971, the Nixon Administration simply closed the “gold window” at the Treasury department. The gold-backed dollar had become inconvenient.

Even before that, there was substantial precedent for changing the rules of the game…and ripping off the public. The ‘continentals’ of the American Revolution… the “Graybacks” of the Confederate States… and Franklin Roosevelt’s gold confiscation of 1933 – each time, promises were broken.  

Now, all the world’s major currencies are linked. They all use the dollar as a reserve currency. All follow more or less the same fiscal and monetary policies… and all try to keep their currencies fairly stable with one another so as to avoid a trade disadvantage.

But all central bankers are now dreadfully “behind the curve.” All their countries owe far too much money. They are like a group of mountain climbers roped together… too high… too cold… and facing a storm.  

If the Greeks slip, the Germans may come to their aid. And if the Japanese slip, Tom Dyson, our investment director, expects the US to come to the rescue. Japan is the most crazily over-indebted nation of them all. If it loses its footing, it is likely to pull the whole team down. Here’s Tom:  

To bail out the Japanese government, the Fed will print dollars to buy Japanese government bonds. Essentially, the US government will assume the debt of the Japanese government.

Yes, it’s ‘one for all and all for one.’ Governments will print money to save each other’s bonds. Then, currencies and credits... dollars and pounds…. Germans and Italians… all roped together; they will be stable, until they aren’t stable.  

There are rules. There are agreements. There are guarantees, promises, contracts and treaties. But at the end of the day, links… like hearts… break.  

But what about gold? Surely, there is a link we can depend on, no?  

Tune in on Monday.

Regards,

Bill Bonner

Joel’s Note: The phrase “it’s turtles all the way down” is an old expression pertaining to the problem of infinite regression. If (in this example) a flat earth rests on the back of a turtle… the obvious question begs itself… what does the turtle rest on? Another turtle, of course. And that turtle? Why, yet another. And another. Hence, “It’s turtles all the way down.”

We’re now in a situation, financially speaking, where “it’s fiat all the way down.” The promise of one fiat currency – itself a floating abstraction – being “backed” by another fiat currency, is hardly reassuring. Just like our long, tall stack of turtles, it’s a problem of infinite regression. The answer works, in other words… until it doesn’t. So goes the system. And the system is under stress.

Here’s Tom, again, from this month’s report to Bonner Private Research members:

"The mechanics of the global monetary system are complicated. But the best way to think of it is like a circulatory system with capital moving around like blood moves around a body. What happens in Japan affects the whole system – and can collapse the whole system. In medicine, they call this a “contagion.” 

It’s one thing when a crypto currency fails… or an NFT goers belly up… or even when a high-flying tech stock crashes back to earth. But what happens when a sovereign currency loses the confidence of the masses… when contagion takes hold?

There’s a lot more to this story… and a lot of ways things can go wrong. Right now, Tom and Dan are adhering to a strategy focused on capital preservation. There are tactical trades to be made along the way, as opportunities present themselves, but priority number one is avoiding the “big loss.”

The set up for investors at the moment is highly precarious, to say the least. Don’t go it alone. If you aren’t already a Bonner Private Research member, you might want to think about joining up today…