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3-The best of the times the worst of the times;The Changing Value of Money-Competitive devaluations

Updated: Jun 22, 2021

The Changing Value of Money (the currency risk)

During History all fiat currencies(when they issue cash and bonds-which are promises to receive currency) devalue or die and that is because printing a lot of currency and devaluing debt is the most expedient way of reducing or wiping out debt burdens. When the debt burdens are sufficiently reduced or eliminated, the credit/debt expansion cycles can begin all over again

There are four way that policy makers can use to bring debt and debt-service levels down relative to the income that are required to service one’s debts:

  • Austerity (spending less): This is deflationary and doesn’t last long because it’s too painful to be accepted

  • Debt defaults and restructurings: these are also deflationary and painful because the debts that are wiped out or reduced in value are someone’s assets; as a result defaults and restructurings are painful for both the debtor who goes broke and has their assets taken away and for the creditor who loses the wealth arising (it has to write down the debt.

  • Transfers of money and credit from those who have more than they need to those who have less than they need (e.g., raise taxes to redistribute wealth) is politically challenging but more tolerable than the first two ways and is typically part of the resolution

  • Printing money and devaluing it: In comparison to the others, printing money is the most expedient, least well-understood, and most common way of restructuring debts. In fact it seems good rather than bad to most people because it helps to relieve debt squeezes, it’s tough to identify any harmed parties that the wealth was taken away from to provide this financial wealth (though they are the holders of money and debt assets), and in most cases it causes assets to go up in the depreciating currency that people use to measure their wealth in so that it appears that people are getting richer.

Said it again, the goal of printing money is to reduce debt burdens. How ?

Increases in the supply of money and credit both reduce the value of money and credit (which hurts holders of it) and relieve debt burdens. How this newly created money and credit then flow determines what happens next. We can have;

a) beneficial devaluations If this debt( new money and credit) finance good project and so is productive for companies. this causes rising real stock prices (i.e., the value of stocks after adjusting for inflation)

b) destructive devaluations ones that damage the credit/capital allocation system further. this hurts the returns of “cash” and debt assets so the new money flows out of these assets and into inflation-hedge assets and other currencies. That leads to a self-reinforcing decline in the value of money.

We are probably at the late stage of the long term Debt Cycle where Countries around the world will use competitive devaluations to reduce their out of control Debts to avoid default. Of all measures seen above Inflation is the most effective(and peaceful) weapon that is being used during History to avoid the chances of a real war and/or revolution and I think it will be used this time again. The signal is already here. States are now creating incredibly large budget deficits due to covid-19. This is the beginning.

We are already seeing commodity prices going up and production costs increased because of shortages caused by supply chains' disruption. Once these costs will be passed to consumers then the mood of the people will probably change.

However, It won't be a Demand driven inflation(economic growth) but a monetary inflation instead(currency devaluations)

However, I suspect we will first have a stagflation wave and then inflation. This is because Governments are NOT increasing nominal Interest rates to a level above inflation to cool the economy. This probably means that they want Inflation to happen. If Interest rates are, let's say, 2% and inflation is 4 % then the REAL INTEREST RATE is -2% and this means that the purchasing power of money is reduced of 2% every year. (ie cash, savings and Wealth is being destroyed). Stagflation (inflation without economic growth) will destroy business and increase unemployment)

When people will come to realize that they are being secretly robbed the mood will change and their inflation expectation will change too. Everyone will increase spending money instead of saving knowing that tomorrow cash will value less. When we will see the velocity of money in the economy increasing that will be the beginning of the inflation wave.

How bad I will be I do not know. Something similar happened during the 70' and we ended up seeing interest rates and inflation around 20%.

The problem this time is that European countries no longer have their National debt printed in national currency so they can't use this tool(devaluation of money) any more. That means that a national sovereign debt crisis can bankrupt European countries that have big debts...

History tell us that when a debtor refuses to pay the creditor bad things happen

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