Dinar Speculator Chat: We Must Rethink Risk if We are to Survive this New Strange World
Charlie i can share an article that i read today that was spot on
Charlie Most of us at this point have heard about fiat currency vs an asset backed currency.
Charlie We understand that fiat currency is backed only by the full faith and credit of the American government.
Charlie While this is the popular understanding the reality is that the American government generates no money and so it has no ability to back or guarantee anything.
Charlie What we mean by backed by the American government is that it is backed by the American economy. That is, by the production of the American worker and entrepreneur.
Charlie So when someone accepts a US dollar in exchange for some good or service, they are implicitly validating their confidence that the US economy would continue to generate enough output to maintain, at least an effective (if not technical) condition of solvency in America.
Charlie we can say the same of just about any currency right now
Charlie the trust in the dinar is pegged to the trust in the dollar one can say too
Charlie That touches on an incredibly important aspect of fiat currency which is how we value it.
Charlie Most of us are familiar with purchasing power, which tells you how much you can trade for a given amount of dollars today. We see this in every store as each product has a price in dollars.
Charlie We also see the more general relative purchasing power as measured against other currencies.
Charlie We’ve all exchanged money for vacation where we trade dollars at some conversion rate for another currency. That conversion rate varies day to day but generally doesn’t move very much over short periods.
Charlie But there is another valuation to currency and that is its risk valuation.
Charlie Risk valuation is the price to be paid on a borrowed dollar given its current likelihood of decline in purchasing power.
Charlie We find the risk valuation built into interest rates.
Charlie And the relationship between risk valuation and interest rates is such that the higher the risk that the lender will receive less than they lent, either through counterparty default or declining purchasing power, the higher the interest required to borrow that currency.
Charlie However, interest rates have both a risk and cost of capital aspect to them. We can see the difference in the spreads between a US treasury and Corporate paper of the same duration.
Charlie The US treasury is ‘considered’ risk free and thus the respective interest is only a cost of capital component. So the spread between the Treasury and Corp paper is the risk cost associated with the Corp paper.
Charlie It is in the cost of capital aspect of currency valuation that has completely perverted the concept of money. Allow me to explain.
Charlie For the first time in history the world has negative interest rates as a normal course of business.
Charlie What used to be a subject for theoretical discussions of academia inside the walls of the top business schools is now very much a reality. I would suggest the concept of negative interests rates has not become anymore rational but that today’s system of global finance has become very irrational.
Charlie Let’s think about risk, cost of capital and interest rates.
Charlie The idea is that the price of risk is built into interest rates.
Charlie Now we discussed that major economy Sovereign debt like Euro or USD Notes are considered risk free debt.
Charlie And so interest rates represent a cost of capital only.
Charlie If those Notes are paying negative interest rates it suggests that the cost of capital, which is just the opportunity cost of that money, is negative.
Charlie Meaning if I didn’t lend this money to a borrower the next best return I could get on this money is actually a loss.
tudor not a good thing
Charlie If we look at Corporate paper like Nestle borrowing at negative rates, this actually suggests that the opportunity cost (or next best return) for the lender is a loss so great that it actually offsets all of the risk represented by the the borrower because we know that risk requires positive interest be paid. This tells us that the economy is severely broken in Europe. For in stable economies we have positive return opportunities.
Charlie None of this is arbitrary.
Charlie It means in order to get investors into Sovereign debt you need to pay them in accordance with other similar investments.
Charlie When economies are strong there are lots of similar investments that are paying higher and higher returns. Meaning Treasuries/Sovereigns need to increase rates to compete for capital.
Charlie This has a natural balancing effect that prevents an overheating of an economy. However, when the economy is bad there are very few, and currently it would seem in Europe, no similar investments that are paying even a positive return.
Charlie Meaning Euro ‘Treasuries’ can offer negative rates and still get investors.
Charlie As rates increase so does demand for that currency increase and results in a strengthening of that currency.
Charlie Alternatively, when interest rates move lower and further negative a fiat currency sees less and less demand thus weakening that currency, as has been the case with the Euro. This is how rates, the economy and currency strength are tied together.
Charlie What this means is that if an economy continues to decline a fiat currency’s purchasing power valuation can actually move to absolute zero (meaning it is worthless) and that rate of moving to zero is going to be your negative interest rate.
Charlie It would get to zero when an economy shows no possibility of a positive return investment.
Charlie What we find is that with asset backed currencies this actually cannot happen. Because an asset backed currency actually derives its value, or at least its minimum value, based on the underlying asset and so it isn’t dependent on the respective economy.
Charlie It has a minimum purchasing power valuation equal to the cost to produce or extract the underlying asset.
tudor as in gold and silver backed
Charlie how about oil too?
tudor natural gas and oil
Charlie just a thought
Charlie Because that will always be a positive figure you could never see negative interest rates with an asset backed currency. It is an impossibility, which until recently most would have agreed was the case for even fiat currencies.
tudor basically mineral backed
Charlie The point is that there is always at least one alternative investment with a minimum positive value for all asset backed currencies and thus must always have positive nominal rates. This is the biggest and most fundamental difference between fiat and asset backed currencies.
Charlie These negative rates that we see in Europe are a first glimpse of fiat currency destruction due to imploding economies.
Charlie And again the negative rates are nominal rates meaning they are negative by way of something beyond inflation.
Charlie Specifically they are moving to their natural minimum state of valuelessness because the economy is no longer strong enough to provide alternative investments for the fiat currency.
Charlie Fiat currency is shown then not to be a storage of value whatsoever. But only a representation of strength of its respective economy.
Charlie As the economy goes to zero so does the value of its currency. This point is exceedingly imperative to understand in our current global environment.
Charlie how is everyone liking this article so far? i found it wonderfully enlightening
tudor jit is a good one
ksdunlap i agree
Charlie What it means is that for all those who are nearing retirement or those who have large cash holdings you risk losing all of that value as we head into low growth and negative growth economies.
Charlie The idea that one can simply hold cash to preserve wealth is not an option. We tend to believe that in low economic growth periods that inflationary pressures are minimal and thus cash is a decent storage of value.
Charlie However, the situation in Europe based on the above discussion is telling us that actually even outside of inflation, fiat currency is not a storage of value. Even with zero inflation a fiat currency will lose all purchasing power in a contracting economy.
Charlie Given the amount of money printing that has occurred the inflation risk is huge on top of the economic contraction risk. These two tend to go hand in hand.
Charlie They feed on each other as central banks around the world believe they can stimulate economic growth with inflation.
Charlie What is currently taking place is massive inflation (i.e. increased money supply) with no economic improvement.
Charlie The worst of both worlds. It’s like losing on both legs of the spread.
tudor bound to crash in time
Charlie Let’s look at a chart to see if we can see some empirical evidence to support what I’ve said above. Specifically, evidence describing the relationship between economic growth and purchasing power.
Charlie sorry for delay i had to upload the chart
Charlie What see in the above chart is the percent change in dollar index (blue line) and the percent change in GDP (red line). Y
tudor got it
Charlie You can see that the change in dollar index moves around quite a bit but seems to follow a trend defined by the change in GDP or essentially the economy.
Charlie The GDP line looks very much like a trend line for the change in dollar index. Let’s actually compare to the real trend line of dollar index.
Charlie So we can see here the two trend lines (color coded to match) of the changes in dollar index and GDP.
Charlie Very clearly the trend lines are very similar, however, note that since 2008 a dislocation between the the two trend lines has occurred.
tudor blue shot up a lot
Charlie And this gets me to my main point of the article.
Charlie yes it did
Comments may be made at the end of Part 2 Thank You