A land of legends by the name of Lionel Messi and Diego Maradona! Could we include Pope Francis here too? He does get a near 2% admiration by the population of Argentina (on Statista) among former presidents and TV hosts.

Past is in the past though and a new sunrise, shines on one of the most beautiful countries and 3^rd largest economy of South America after Brazil and Mexico. Javier Milei defeats Sergio Massa in the 2023 Argentine general elections, after winning the run-off round by 3 million votes, and a decision of the latter to concede.

 

Who is Sergio Massa? Argentina’s Minister of Economics since 2022, he run for President in the 2015 elections, where he lost from Mauricio Macri, yet another Argentine favorite (again based on Statista). With media pinning current inflation numbers (more like hyperinflation of 143%) on current government policies (including Massa’s) and associating the bad economic stance on the country to dark politics of the past, Argentina voted for a different future, calling for drastic change and reformation measures.

 

Why is this a new era for Argentina though?

Well, Argentines are celebrating Milei’s victory by chanting “out with all of them”. If that doesn’t describe their views on past leadership, maybe Milei’s anarcho-capitalist campaign on reconstructing Argentina by shutting the Central Bank, dollarizing the economy and embracing decentralizing finance, can. Which is the reason why we’re writing about this. And if this is not painting a picture of what’s coming, take a 15% spending cut by shutting down ministries of culture, education and diversity, and also by eliminating public subsidies and there you have it.

 

Note on Argentina’s public subsidies:

In a study on “The Incidence of Subsidies to Residential Public Services in Argentina: The Subsidy System in 2014 and Some Alternatives” by CHRISTOPH LAKNER, MARIA ANA LUGO, JORGE PUIG, LEANDRO SALINARDI and MARTHA VIVEROS, they write:

“Though subsidies can be a tool to protect the poor, in Argentina they led to distortions and a large share have been absorbed by upper classes and non-residential consumers.

In 2015, electricity bills reflected less than 10% of production costs and lower tariffs have led to an increased demand of public services. Not only have energy and transport subsidies distorted both demand and supply, they have also not been efficiently targeted to the poor; instead, they have been distributed across all income groups, with the non-poor receiving the largest shares.”

Although we are writing about Argentina for its economic reformation plans primarily, we can’t fail to mention that the new administration will be seismically shocking social issues as well, like regulations on gun control, abortion, private education and the privatization of the health sector.

It’s also worth mentioning that worldwide through history, social distress/unrest always called for change, whether an extreme leftist movement (Marxist ideology of proletariat uprising) or extreme right (fascist/nationalist movements and demagogues with more devious plans than just the reformation of a country).

Now that we have a prelude, what is the context of today’s topic? Politics and social issues aside, we’ll only touch on the economic reformations i.e. the Central Bank shutdown, the dollarization concept, the huggzies on decentralized finance with a pro-Bitcoin stance and its integration into the economy (following El Salvador). Will he legally tenderize Bitcoin in the country like a prime beef cut? Remains to be seen.

 

Happening now and reasons leading up to this

 

To begin with, why don’t we try and put some context to the Argentine economy, and then see what makes these elections different from the rest, and why these economic reforms are of interest moving forward.

 

Argentina as of 2023 (at the time of writing this article):

Population	46 million
National Debt	Over $400 billion ($43 billion is owed to IMF)
GDP	Over $600 billion
Unemployment Rate	6.2%
Inflation Rate	143%
Interest Rate	133%
Poverty Rate	40%

 

As of late (since the country has been in economic turmoil for decades), Argentina was in a recession because of the pandemic like many other countries. In its 3^rd year of droughts, pain was felt on its agricultural sector affecting soy, beef and wheat to say the least. Based on the International Production Assessment Division of the US, production yield – measured in Tons/Hectare – dropped since 2021 like so:

• Wheat: from 3.4 to 2.3 and up to 2.7
• Rice: from 7.3 to 6.6 and up to 6.8
• Barley: from 4.0 to 2.9 and up to 3.6
• Corn: from 7.9 to 5.1 and up to 7.7
• Soybean: from 2.8 to 1.7 and up to 2.9

 

Argentina’s natural resources

 

First and foremost, any country’s best natural resource are its people. Argentines are beautiful people, highly educated and outspoken. Maybe a shocking political reformation like this one, is what the country needs so that Argentines can finally shine the way they should.

 

The country has the 3^rd largest lithium deposits (after Australia and Chile), with 70% not yet exploited.

• Lithium is used in batteries, a big component in the global energy transition, its used in medication treating bipolar disorders, it’s also used in glass/ceramics (stovetops, fiberglass) due to its corrosion resistance and durability.

 

Hydrocarbons

• The 2^nd largest shale gas formation (802 TCF) after China (1,115 TCF)
• The 4^th largest oil shale formation (27 billion barrels) after Russia, US and China
• Large initiatives were taken by previous administrations for green energy transition (solar and wind) as part of the global climate change efforts. Another interesting view of the new administration is that climate change is a “socialist lie”. Milei also said that should he come to power, a company could pollute a river without restrictions. I hope there is humor somewhere in this sentence that I don’t see, because if not, in the name of economic reformation people voted for future green babies with 4 fingers, a tail and no toes.

 

Agriculture

• Sector accounts for a quarter of the country’s exports.
• 4^th largest producer of soy worldwide.
• Produces maize (corn), wheat, cotton, sunflower seeds and more

 

Mining Portfolio

• $30 billion worth of mining portfolio via 113 projects, 26 of which are in production and under construction.
• Further to lithium and energy, Argentina has deposits of copper, aluminum, uranium (40K tons, ranking 19^th by reserves), iron, zinc, boron (used in fertilizers, insecticides, borax, fiberglass etc), potash (used in fertilizers)
• Argentina shares the same mountains with Chile, the largest copper exporter in the world (with revenue of $23 billion in 2022). To understand how behind in international trade Argentina is, it has large amounts of copper deposits like Chile, but exports none of it. That’s why 50% of the projects in the mining portfolio mentioned above, relate to copper.

 

Argentina’s debt

Attributed solely to economic mismanagement – we’ve written about Argentina’s debt in previous articles – so a generic characterization would be a serial defaulter. Since 2001, the country defaulted already 3 times on its national debt.

• 2001 in the middle of a financial crisis
  • Argentina was under military dictatorship (junta) from 1976-1983. New government reforms lead to hyperinflation of 200% by July 1989, president Alfonsin resigns.
  • 1990s saw fixing the exchange rate of its currency to USD, tax evasion and money laundering, lower tax revenues and large amounts of borrowing by president Menem.
  • Recession started in 1998, characterized as the great depression of Argentina, lasted for 3 years
  • Argentina defaults on $132billion
• 2014 in the middle of a battle against holdout creditors. 3 options were at play:
  • Pay creditors. Given the debt burden it was rejected by the government.
  • Negotiate a deal. Regarded as a win-win, but the political cost on the government would have been too big. Also rejected by the government.
  • Selective default. Which was chosen, and its economic/social implications are still felt to date.
• 2020 – middle of Covid 19 pandemic
  • Yet another debt restructure, failing to pay half a billion to its creditors, Argentina defaults on its payments.

 

So can a country can survive without a Central Bank?

Weirdly so yes it can. Central Banks became mainstream in the 17^th century. Prior to that, monetary policy was managed by the country’s Treasury. Though it was also a time when Gold and Silver were the currency, accepted and recognized across the board.

Taking this a step further, if a country doesn’t have its own currency (so it kinda outsources the situation) then what would the real implications be, if no Central Bank was present? Do Eurozone countries need a Central Bank since they outsource their currency to the ECB? Take Andorra and Monaco as an example, both in the Eurozone, without a Central Bank of their own doing just fine. Or Liechtenstein with the Swiss Franc for that matter. Tiny countries, I know, but doesn’t science begin with small controlled experiments, and based on their success decide on a True/False result?

This being said, the Central Banks have an independent role to play in a country’s economics, a weapon against manipulation and fraud by their own governments. Although this is dependent largely on the role of the Central Bank in the county and the control that the government has on its functions.

The three largest cases we could look into to review this, would be the US Fed, Europe’s ECB and China’s PBC. In the US, the Federal Reserve is authorized by Congressional law, so that a president can’t order the Fed to print money on a tantrum (for example billions of starched dollars, fresh off the press, and instead of being used to support the US citizens and a $34 trillion indebted economy, we see them being used abroad in wars/fights that have nothing to do with their own economic growth. Not judging of course, justified help should always be present by stronger countries to weaker ones, hopefully on the premise of human rights to freedom, rather than the fear of a bond selloff or monetary interests (more on this another time).

Also, on a random note, not sure if calling country leaders names (like dictators) ever served properly geopolitical relations, but a US president did call a Russian president a dictator, right before the Ukrainian war, and a US president did call a Chinese president a dictator, right before a potentially upcoming Cold War. Wait a minute… isn’t it the same president that keeps throwing the D word around, like popcorn on the head of the person sitting in front of you at the movies, that just won’t stop talking… Nahh, the name calling can’t be related to any international events…

So the Fed is authorized by Congress. The ECB is run as a result of an international treaty, with a Euro independent of national governments, raising the question again whether a Central Bank is needed or not. In China, the system is deliberately set up so that the president can indeed order the PBC to do things. A gift from a Marxist/Leninist ideology that may serve well or not, but serves nonetheless.

 

What is up with dollarization and how far back can we go to understand this?

1946 saw Peron come into power, inspired by nationalist movements in Europe, including Italy’s Mussolini. Together with a strong labour movement (he favoured the workers by increasing wages, welfare programs etc) and cutoff the country from international trade. Peronists are his legacy, in power for the majority of the past 2 decades (including the Kirchner husband and wife (2003-2007 president Nestor Kirchner and his wife Cristina Kirchner, president from 2007-2011, re-elected president from 2011-2015, and emerged again as vice president, in the last administration from 2019 to date).

This nationalist behaviour, combined with the decoupling from international trade and huge spending for the public, needed money. Government was printing money, because it could, to tackle with excessive fiscal deficits and the more it printed, the worse inflation became. Too much money pumped into the economy, chasing too few goods, is the definition of hyperinflation. Local stores would set a price for their products in the morning, and reprice them in the afternoon. That’s how quickly conditions changed. They worked for nothing because they earned nothing.

 

Argentines had to get creative.

Saving in the local currency, the Argentine Peso, with the numbers experienced over the last decade had little to no impact. So they started saving in USD a long time ago. A problem of its own though, since government controls allowed people to exchange only up to $200 a month at the official exchange rate. Currency black markets took advantage of the opportunity and Argentines illegally (but understandably) went with it, in an effort to hold some value in their money. To put things in perspective, the official rate for 1 USD was 360 pesos. Through black markets, 1 USD is 760 pesos.

Soybeans in Argentina have an export tax of 33%. If the export price is 1,000 dollars, the government takes 33% or $333, and the farmer the remaining $667. The farmer will exchange these dollars for pesos at the official exchange rate. When the dollar rate is bad, farmers have to make a decision between exchanging now at a bad rate, or exchanging later at a better price, or holding the produce in storage until a better price is at play. Dollars in the hands of people, empty coffers in the hands of the government.

Soy dollar (dolar soja) was the solution to this. Better exchange rate provided by the government specifically for soya sales and exports. In September 2022, the first plan brought in $7,5 billion in revenue, the 2^nd in December 2022 brought in $3 billion, the 3^rd plan in April 2023 brought in $5 billion and the 4^th plan in August 2023 brought in $2.1 billion.

 

So how do we dollarize the economy?

Countries did it in the past like Panama, Ecuador and El Salvador, though none of the size of Argentina and especially with a poverty rate at 40%. To dollarize you need a stable economy and build foreign exchange reserves. You need access to capital markets and prudent reductions in fiscal spend. You need internal trust – your own people need to trust that it’s the way forward with short term pain and long term gain. And you need external trust – outside lenders and investors trusting that there is potential in the plan. With Argentina defaulting so many times, no one wanted to lend them money. Except the IMF. The debt to the IMF is double the one of Egypt, the second largest IMF borrower. Following is Ukraine, Pakistan, Ecuador, Colombia and African countries.

 

Does Milei have the trust – both internal and external – willing to do whatever to reign down the problems at hand and make “Argentina great again” like Donald Trump said to him after his win?

We sure hope so, because other than the fact that Argentina is a beautiful country, and other than the fact that it has highly educated and smart people, it also has the potential to increase its output exponentially and become a solid partner in the world stage.

 

We discuss all of the above and more in our Capital Markets Training – for corporations and individuals

The information provided is strictly for informational use and is not meant in any way to be construed as investment advice. One should seek expert advice, as all investment strategies involve risk of loss.

 

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Contact us for a private conversation to discuss your case through the contact form or one of our emails at info@allfx–consult.com, partners@allfx-consult.com.

 

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If you owe your bank $100, you have a problem. If you owe your bank $1 million, your bank has the problem. It mattered I guess when this quote was popularized by Keynes, but I’m having a hard time wrapping my head around the number 300 trillion, let alone managing it. Global debt is an all-inclusive number though, comprised of sovereign debt, corporate debt and household debt. And since its unmanageable even by the best homo sapiens, we’ll take a closer look at the national debt in today’s discussion and the current situation surrounding it.

National debt is the total amount of outstanding borrowed sums (pending to be paid), accumulated over a nation’s history. Nations make money from tax revenue and they spend them for social welfare, infrastructure and to promote growth. When they spend more than they make, they accumulate deficits which are paid by borrowing. Borrowing comes in the form of bonds, which is a security issued with a maturity date, that pays back the loan plus an interest. The collective accumulated amount borrowed plus the promised interest constitutes the national debt.

 

 

Where does borrowing come from?

 

Borrowing can come from anywhere. It’s split into debt held by the public and debt held by the government (intragovernmental). The debt held by the public is held by state/local governments, pension funds, mutual funds, corporations, individuals and foreign nominal/legal persons. The debt held by the government is the amount of debt that the government owes to itself. It is held mostly by government trust funds like social security trusts and insurance trusts. In approximate proportion of 75% for public debt and 25% for government debt, both form the overall national debt. Denmark and the US have a debt ceiling in place.

Debt ceiling? A debt limit that – by law – cannot be passed. If the country reaches this limit, it can no longer get money via borrowing, it can no longer use debt to pay for obligations, fund social programs and services. And like in all things financial, there’s an irony to this as well. Denmark never reached its debt ceiling – almost did with the 2007 crisis – but they increased the limit so high, they can never possibly reach it again. The US reached theirs – 78 times to be exact since 1960 – and increased it, reached it and increased it again and again, you see where I’m going with this. The current US debt ceiling is at $31.4 trillion. The current US national debt is at $30.93 trillion. What’s next? 

 

Debt to GDP ratio 

 

Largely related to the 2007 financial crisis as well as the COVID 19 pandemic, the debt was accumulated to avoid defaults (bankruptcies), protect lives and retain unemployment at manageable levels. According to the IMF, global debt rose to $226 trillion in 2020. Compared to the global GDP, you get a 256% global debt to GDP ratio.

Can these numbers be reduced? How fast and how? More borrowing to pay past borrowing? And if not, what are we to make of this masterpiece?

 

What do these numbers mean in a context that we can understand?

The World Bank conducted a study in July 2010 called “Finding the Tipping Point-When Sovereign Debt Turns Bad”, that placed lines not to be crossed by countries. If crossing the line is only for short term periods like small recessions, it shouldn’t have much of an effect on productivity. If crossed and extended for longer periods like decades, economic growth is likely to be hindered. Based on its samples of advanced and developing countries, between 64%-77% debt to GDP was found to be a proper estimate.

Talking of hindered economic growth is one thing. Entering the realm of country defaults is a different story. Another study conducted by Hirschmann Capital, with information taken since the 1800s, showed that 51 out of 52 countries that passed the 130% debt to GDP ratio, defaulted one way or another.

 

So if countries today crossed the line by a longshot, why don’t we see them defaulting already?

To put things in perspective, a country will choose to default when the gains of not paying its debt exceed the cost of default. That is if the country has a choice. Here is a broad classification of defaults:

• Disorderly default – “Violent”, with no time to prepare both for the banking sector or the citizens who are unable to react. Described by the collapse of all financial transactions, bankruptcy of banks and a steep increase in unemployment. Cyprus almost went through this back in 2013, if not for a bail-out program from the Eurogroup, the EU and the IMF of €10 billion, in exchange for impossible obligations (like tapping in people’s bank deposits).
• Orderly default – Happens for the same reasons as the disorderly default, but this is a strategic choice of the country filing for it. There is a consensus reached between the lender and the borrower, with milder consequences to the economy and its people. It allows for a quicker comeback to the international markets. There is time to set things right unlike the disorderly default, and unemployment is much less severe.
• Selective default – Partial default of payments and loans. Selecting to default on one or more obligations, but continue to pay some. In general, its characteristics are similar to the orderly bankruptcy.

Greece is an example of a country that defaulted as a result of the 2007 financial crisis, while other European countries facing similar numbers didn’t. Partial reasoning? the ability of a country to pay its debts relative to its ability to raise surpluses. Belgium and Italy as an example, were also hit by the crisis and had high debt ratios but were able to raise surpluses while Greece wasn’t. Another indication that economic output/production is imperative. A country consistently spending more than it earns, is on a downhill spiral. Passed the point of no return, odds are that a restructuring, devaluation, higher inflation or outright default is inevitable.

In the early 2000’s (which was also the beginning of the housing bubble), emerging markets were urged to take on credit from advanced countries to finance their operations. With very low interest rates to provide cheap money and attract borrowers, emerging markets jumped on the train to what they thought was the answer to their problems.

 

Taking Zambia as an example, the country is largely dependent on copper mining and rain-fed agricultural production. Zambia ranks 6th in the world in terms of Copper production (2nd in Africa after the Democratic Republic of Congo) and depends on weather to support its agriculture. Its external debt was so large relative to its output that it became unsustainable, and it became the first African country that defaulted on its payments during the pandemic.

Chinese creditors hold 1/3 of Zambia’s debt (or approximately $6 billion). The creditors include Industrial and Commercial Bank of China, Jiangxi Bank and China Minsheng Bank. Some say Zambia is a test case, with the world eyeballing how China handles debt restructuring as well as the precedent this case sets, for other countries in risk of default to follow.

 

IMF among others, point out the following “remedies”, relative to lowering debt: 

1. Productivity and economic growth – produce more than you spend or better yet, spend so that you can produce.
2. Surprise burst in inflation – which reduces the nominal value of the debt and increases tax revenue due to higher prices.
3. Austerity measures – Cut spending, increase taxes, accept any tomatoes thrown your way
4. Debt relief – Debt restructure and gold revaluation maybe?*
5. Financial Repression a.k.a. macroprudential regulation – government policies that redirect funds intended to go somewhere else, to the government. Helped countries reduce debt after the end of WW2 and is coming back due to the large amounts of current debt. It includes tighter connection between banks and government, pension funds/domestic banks lending the government, regulation of cross border capital moves, higher reserve requirements, prohibition of gold purchases (Gold Reserve Act of 1933).
6. Default

 

*Is gold revaluation an option?

 

The term “gold revaluation” over the years fell victim to speculations and conspiracy theories. The outcome is a biased approach (depending on who benefits from such action and who loses). Not to be confused with the gold revaluation account held by central banks (where they can realize profits from the rise of gold price relative to the cost of buying it). Although related because, if you use gold revaluation to register unrealized gains and write off debt in your balance sheet, you’re in the foothills of a gold standard system. And if that’s the case and you check the relationship between money in circulation relative to the gold held in reserves (which is what the gold standard is suppose to do), you will find that the backing percentage is very low.

The gold revaluation we’re referring to, is mostly Rothbardian (see Murray Rothbard’s gold revaluation ideas) who popularized the possibility. Imagine returning to a gold standard system and fixing (pegging) the gold price per ounce, based on the quantity of gold central banks have in reserves relative to circulating money. Similar to 1933 in the US, when the government confiscated gold at the current price ($20.67 per ounce) and then immediately revaluated it to $35 per ounce (gold Reserve Act). Should the same concept happen today, from $1,800 it could reach anywhere between $10,000 to $50,000/ounce. Why? As explained by Jim Rickards, author of “The New Case for Gold” if the global gold reserves are 34,564 tons (as far as we know, since central banks don’t disclose the full numbers), to reach a peg of 20-40% of M1, you would need to price gold astronomically high. 40%? M1?

M1 is a measure of money supply (measuring from M0-M3). M1 is also known as narrow money, all the currencies and assets that can be easily converted into cash. The further you go on the M scale, the broader the money it measures and the less liquid (easily convertible to cash) the assets are. Rickards explained that 20-40% of M1 is historically a workable percentage used, when money was pegged to gold in the past (see image). The law in the US from early 1900s to 1950s said that gold price multiplied by the amount of gold in reserves had to amount to 40% of total money supply (Federal Reserve Act of 1913). Due to the Vietnam war and the need for money, they had to curtail the law, but 40% worked just fine. He also said that the Bank of England in the 1800s managed a successful gold standard when Britain became dominant power after the fall of Napoleon and until WW1 with 20% gold backing the money supply.

At $1,850/ounce, gold reserves relative to money supply is extremely low. If we consider M1 in the US hypothetically at $10T (with 8,000 tons of gold reserves), the gold is backing approx. only 4.75% of M1. The value of gold to back 40% of M1 would need to be approx. $15,600. If you take Rothbard’s approach of 100% backing, the value of gold should be approx. $39,000/ounce. What?

 

Here’s how it works out*:

 

M1 (hypothetically is 10 Trillion) / Tons (8,000) = $1,250,000,000 (Price per ton)

$1,250,000,000 (Price per ton) / 32,000 (Ounces per ton) = ~$39,000 (Price per ounce)

$39,000 (Price per ounce) x 40% = ~15,600 (Price per ounce)

At $1,850 (Current price of gold per ounce), backing is 4.75% (39,000 x 4.75%)

*For accurate calculations you will need to replace the hypothetical numbers with current ones. The above is meant to explain gold revaluation, and does not reflect our opinion on whether it is a viable strategy or not.

According to the World Gold Council 

Worldwide Total Gold Reserves by Region = 31,422.57 tonnes = 34,564.827 US tons 

• America =  8,133.46 (North America) + 614.68 (South America) = 8,748.14 
• Europe = 11,776.29 (Western Europe) + 3,433.59 (Central & Eastern Europe) = 15,209.88 
• Asia = 3,332.62 (East Asia) + 878.72 (South Asia) + 809.30 (Central Asia) + 731.28 (South-East Asia) = 5,751.92 
• Middle East, North Africa, Sub-Saharan Africa = 1,460.46 (Middle East & North Africa) + 172.28 (Sub-Saharan Africa) = 1,632.74 
• Oceania = 79.89 

 

Last but not least, there is a reason credit/debt is not taught the way it should to youngsters in schools. Keeping the majority financially illiterate is the way to maintain and distribute wealth how the minority sees fit. You can be the person that gets a loan to buy a house to live in and have constant cash outflows, or the person that gets a loan to buy a house, then rents it to someone else and has cash inflows.

In one of Kiyosaki’s appearances, he mentioned that during the financial crisis the banks gave him tax free money (credit), somewhere around $300 million to buy property because they knew he would turn them into cash inflows. So where everyone was defaulting on their payments and losing their homes, he was finding dirt cheap properties that are now worth whatever they are worth, producing cash flow and making him even more rich. That’s $300 million out of $700 billion injected into Wall Street through the TARP program. Story for another day but think of how much wealth was produced from the left over $699.7 billion.

Debt/credit may not be as bad a your grandparents said it is. As long as you put it to good use.

The information provided is strictly for informational use and is not meant in any way to be construed as investment advice. One should seek expert advice, as all investment strategies involve risk of loss.

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Contact us for a private conversation to discuss your case through the contact form or one of our emails at info@allfx–consult.com, partners@allfx-consult.com.

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Yet another Munger word of wisdom on describing his perception of risk, was “show me where I’m going to die, so I’ll never go there”. A bit dark, but it fits quite well in introducing today’s discussion, since history does have a habit of repeating itself. And what better way to use history, if not to be able to anticipate the good, the bad and the ugly and act accordingly? You see, what we consider normal in our timeline, might be at the end of its own timeline in a much broader context. Given the shift in the balance of power among nations and their economies, this generation’s normal might now be due for a change. This article is a by-product of upcoming posts, that will outline and briefly look into the historical record of reserve currencies.

Why reserve currencies?

Because when there are major global developments, tensions, conflicts, wars, unexpected turmoil that might push down on the strong and lift up the rest, whispers of rising powers, who they might be and the chances of a change of scenery, are gaining ground. Possible shifts like this, imply a possible change in the global reserve currency as well. Or do they?

What are reserve currencies?

Held in large quantities by foreign central banks and major financial institutions, reserve currencies facilitate transactions, investments and given that global trade is measured in trillions, they make the world go round faster, relatively cheaper and most importantly safer.

Foreign exchange reserves are a way to meet foreign obligations, as well as appreciating a national currency when needed. A country uses its reserves to buy its own currency and increase its value when there is a risk of devaluation, so holding a substantial amount of foreign currency is the way to go.

The more demand for transactions in a specific currency, the more liquid it becomes. This provides easier access to capital for domestic firms since it can be acquired cheaper than it would, without the demand increasing its value. Other than the currency itself, investors tend to also hunt for securities denominated in the currency, like bonds that tend to be a safer bet in getting their investment back. Borrowing for the country becomes easier, allowing for investments, increased productivity, growth.

Important to note that with a strong currency, it becomes more expensive for foreign companies to buy a domestic product. It is also cheaper for domestic companies to buy foreign goods. By default then, imports increase and exports decrease, which raises the country’s trade deficit. A manageable downside though since an economy’s core doesn’t rely only on one variable.

The larger and stronger an economy gets, the more interlinked it becomes to the global economy. According to the World Bank:

When other sovereign nations are using your currency as their own, when over 65 countries peg their currency to yours, and when over 90% of forex trading involves your currency, you know you dominate. On the other side, when your GDP starts to decline at the same time that the GDP of competing countries is on the rise (with outlook of surpassing you) and/or when you are repositioned as a major partner in the global arena (EU exchanged more goods with other partners in 2021 compared to the US), you know that times might be changing.

Notwithstanding that the sanctions of the war in Ukraine, relative to the freezing of more than half a trillion dollars of Russian reserves, begs the question. Should a country hold all it’s eggs in one basket and be subject to economic paralysis if it doesn’t comply with everyone else’s decisions? This senseless war is an extreme case and the international community correctly took action but we’ve seen what people/countries would do, to protect their interests. Could the inward shift – becoming less dependent on global supply chains – be reflected on the currency reserves as well?

The USD global reserves peaked in the year 2000 at 70% (from 0% in early 1900) and had a 10% decline by 2021. Small increases in global reserves in EUR, GBP, JPY, CNY, AUD, CAD are taking portions of the 10% but nonsignificant to challenge the USD yet. History wants dominant countries and their reserve currencies, to hold that position for 100 years on average. If that’s true and the US took over Britain in 1920 (some argue it was during or after WW2 in the 1940s), then the US has held that position for 80-100 years already. Is the geopolitical scenery, the decline in GDP, the rise of the GDP of competing countries and this “average timer”, a signal for an upcoming change?

For thousands of years to the end of WW2 that saw an almost bankrupt Britain and a shift in dominance from the British pound to the United States and the US Dollar, countries and their currencies were fighting for the spot at the top of the podium. Breath in – the Byzantines and their solidus/hyperpyron gave way to the Italian Florin and Ducat, that briefly gave way to the Portuguese Real, followed by the Spanish Real and Spain’s colonial ambitions, who then gave way to the Dutch and their Guilder, who were pushed out by the French and their Livre, who lost to Britain and the British Pound who finally gave rise to the United States and the US Dollar – breathe out.

And in all of the above, the country standing at the top of the podium was constantly challenged leading to conflicts and wars, the necessary funding of these wars, retreats and abdications, debasement (see image) of the currencies, ultimately leading to the fall of one empire and the rise of another.

Debasement from what though?

From common metals like bronze and copper to precious metals like silver and gold, the mint (construction) was specific to the territory/country. The weight and the content of the metal varied and at times of scarcity, with the precious metal in the coin hardly recognizable.

Before we delve into the actual reserve currencies, their timelines, the significance of understanding what happened in the past to help us anticipate what might be coming in the future, here’s some conversation starters (or conversation enders depending on whom you ask)…

Barter was a system of exchange, that dates back thousands of years. Goods and services were exchanged for other goods and services, and that concluded a transaction. Simple.

Metals (precious as well as common) were used for bartering. Going back to 200 BC as an example, Bronze was heavily used as a medium of exchange, not so much for its value, as much for its crafting qualities (easily turned into tools or something else). The evolution of Bronze as a medium of exchange can be seen in the following steps (see image)

 

We could go even further back to the Chinese, the Lydians, the Greeks and times where only agricultural products were used for trade. In our example though we can see clearly the evolution of first having a rough medium of exchange accepted for trade, to a more fair (measured and weighted) unit of the same, to an easier to handle, transport and store coin. Cattle, general livestock, or grain were messy, required care, maintenance, space. Metals were preferred because they lasted longer and could be easily stored or carried around for miles through the trade routes.

Trade routes at that time, were all land locked. Traders were still exploring to find safe passages and it wasn’t until approx. 110 BC that the Silk Route was established connecting China and Southeast Asia with Africa and Europe. Trade routes via sea, were recorded during the Age of Discovery/Age of Exploration. That was when European countries wanted to explore the world in the 1400s. It opened up a world of opportunities as well as brutal competition, which led to the discovery of the Americas as well as new trade routes to India and the Far East.

All of the above are characteristics of the evolution of the early trade to the monetary systems we understand today. From the minting of the coins, to their value outside the boundaries of the nation (since more precious metal content in the coin made it sought after for trade), allowed new empires to rise, on the demise of another.

Past a nation’s investment in itself i.e. innovations, technology, education (also required traits at older times), things remained the same relative to who’s on top. Productivity/output, competitiveness in global trade, military competences, and the recognition of currencies as reserve currencies declared the winner. Getting there is one thing, staying there is another. There’s an old saying “a bird in hand is worth two in the bush”. You should be content with what you have rather than risk losing it all for something bigger, which is what happened every single time. No risk, no reward though and this risk is what formed the world as we know it today.

So, what were the main attributes of the years 1200 onwards relative to global reserve currencies? How did empires rise and fall and what where the characteristics of their currencies? What is the relevance today and what lessons can we possibly learn from it?

Stay tuned! #foreignreserves #reserve_currencies

The information provided is strictly for informational use. It is not meant in any way to be construed as investment advice. One should seek expert advice, as all as investment strategies involve risk of loss.

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Lets look into all these together!

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Recession or no recession? It’s always a hit and miss, listening to the experts and their forecasts on what’s going on with the markets, and their take on how things should be run by the central banks and governments.

It’s also notable that people who sat on the chairman seat of a central bank, are people that once criticized their predecessors for doing what they thought correct.

Today they face the same criticism and “expert opinion” by everyone, maybe rightly so, maybe because of the pain felt while all markets tumble and fall.

• If I bought 10 Apple stocks in August at a price of $174 (total of $1,740), at today’s price I would be losing $351
• A fund that bought 4 million Apple stocks, would have paid $696 million, and would be losing $140 million
• When tech stocks, chip stocks, media stocks, energy stocks, sector ETFs, sovereign bonds, all part of a portfolio are losing hundreds of millions of dollars each, it piles up and numbers can get scary. That’s when the blaming starts and questions like “data driven Fed, are you listening?” begins.

The IMF’s global economic outlook just came out, in part with reassuring elements of reading properly what central banks around the world are doing, but also with looming forecasted numbers of what to expect in the coming months and years.

According to their numbers, about a third of the world’s economies are facing 2 consecutive quarters of negative growth. That is the definition of recession. They also repeat that unlike your normal inflationary pressures of an overheating economy, external factors are the main drivers of the double-digit inflation we are experiencing in different parts of the world. A pandemic and its disruptions to the global supply chains, a senseless war and its disruptions to energy and food, geopolitical alliances and tensions, trade wars and embargos.

External, because under normal circumstances, inflationary pressures are caused by high demand and a low unemployment rate. Credit is more easily accessible through low interest rates, debt is increasing within its own expansionary/contractionary cycles, until the next central bank intervention, that will cool down the situation.

And although unemployment rates are indeed low and the spending power of people is strong thus requiring the said intervention, at the same time these external factors beg the question – can the central banks tame this newfound beast using the good old traditional ways?

To a certain extent the force is strong with the central banks but the fear and uncertainty of governments around the world, causes them to panic and overextend the tools they have in their disposal to fight. A central bank deals with monetary policies (money supply) while the government deals with fiscal policies (taxes and government spending). When the two try to steer a difficult situation at the same time, it’s like two people trying to drive a car with two steering wheels. It’s just not going to work.

A panic mode recently seen in the UK, which nearly caused a doom loop – when the price of sovereign bonds falls below a critical level and could destroy one of the biggest and oldest financial centres of the world. To fight the rising cost of living and the double-digit inflation, two policies came out. The first on September 8, was to cap the energy bill for a household at 2,500 pounds and would reportedly cost the government 70-100 billion pounds in the first year alone. It would be funded via bond issuance. The second on September 23, was to cut taxes of individuals and companies, also to be funded via government borrowing. Its cost was calculated at 45 billion pounds by 2027.

The tax cut announcement came a day after the 50 basis point rate hike. International markets panicked, investors lost faith in the GBP, and started a massive sell-off of assets denominated in the British Pound, while at the same time exchanging the currency for safer ones (like a strong dollar). On September 26, the British Pound hit a low of 1.03 against the dollar. When pension funds – that hold half of people’s savings – were getting margin calls and asked by the Investment Banks for more collateral on their leveraged positions, they also began a massive sale on their gilts (UK government bonds) to meet their obligations. With a rising supply and little demand, the market was already in a trajectory to disaster.

The Central Bank of England stepped in and promised to buy 65 billion worth of the supplied bonds to stabilize the market, until October 14th. Although it did prevent a doom cycle, money flew fast out of the FTSE as well. The government revised and stopped the tax cut plan but it goes to show that testing the markets has its limits.

Economists are debating whether what we’re dealing with, is an 80s Volcker situation all over again. Maybe it is, maybe not, but Paul Volker – the Fed chair at the time – was dealing with an inflation built-up over a period of +15 years following the Vietnam war, recessions, the Bretton Woods collapse, stagflation, a debt close to a trillion dollars (today’s debt is over $30 trillion) and much more. To put things in perspective, debt to GDP ratio was a little over 30% in the 80s, in contrast with over 120% today. In March 1980, inflation rate in the US was at 14.8% and interest rates were already high, in failing efforts to cool it down. Volcker raised the rates to 20% and engineered 2 recessions. It wasn’t until 1983 that inflation went down to 3%, that a period of growth had began for the US economy. Volcker was also booed and hissed for his brute-force – 20% interest rate is bound to cause a lot of pain – but today is regarded as a hero for many well-known investment advisors with billions in AuM.

Today, the Fed is dealing with hiking rates (already 5 times) from near zero, on a consecutive aggressive approach. Its dealing not only with a peaked, overheated economy but also with these external factors, all of which have an unpredicted future. Who knows when the war will end, what the world’s energy map will look like, what geopolitical effects on trade/tensions will be left behind?

Already tensions between countries are causing a turmoil to entire sectors. The second semiconductor US ban on China combined with hindered demand, has all stocks in the sector testing their lows. Most chip companies (and their clients like Apple and Microsoft) are listed on the S&P 500 and/or Nasdaq, bringing the indices down with them on a daily basis.

Similarly to Europe’s attempts to gain independence for its energy needs, China being dependent on global supply chains across the board will only push the rising giant to look how to internally complete the puzzles. China does have problems with a falling Yuan, the real estate sector (which takes up 20-25% of its GDP), the zero COVID policy restrictions that exert pressure on supply chains, and an aging demographic. Irrespective of the setbacks, with the Chinese government fighting corruption and its capital market reform, it’s still a superpower on the rise.

Deglobalization is now more alive than ever, since net exporters of valued products will first look inwards to support their own citizens, and then sell what’s available to the highest bidder. Opec + already proved that the cartel’s interests align with their profit, not with the households that will be affected by a 2-million-barrel supply cut. They already tasted the sweet $120+ per barrel earlier this year, why would they continue with an $80 price. And on that note, the United States SPR – Strategic Petroleum Reserve – is depleting while the eighth EU sanctions package is targeting even more Russian petroleum companies (as well as Russia’s manufacturing, aerospace, electronics, chemicals, crypto-asset wallets etc).

Closer to home, the EU is still trying to tackle with the Energy problems with Germany and the Netherlands pushing for joint gas purchases so that member states don’t outbid each other. The region is also evaluating caps on energy bills but with rational concerns raised by its members. Placing a cap on import increases fears of other regions around the world willing to pay more and outbidding the EU states. And what about increased demand? If the government is subsidizing a cap on my energy bill, I wouldn’t think twice to use more and it’s something that many would take advantage of.

Back to the IMF report, it considers that the war in Ukraine, the global higher cost of living from energy/food disruptions, and the slowdown in China are the main forces that currently push the markets in a volatile and fearful mode. We can measure how volatile and uncertain the market is through the “fear index”, CBOE’s VIX index currently above 30, indicating a level of extreme uncertainty. A level below 20 is what we would consider normal behavior. The three largest economies i.e. the United States, the EU and China are quote “going into a stall”.

The forecast looks into a stubborn global inflation peaking in late 2022 at 8.8% and dropping to 4.1% by 2024. That’s 2% above a country’s average target, but its also not a double digit, money hungry inflation rate. Hard to tell, but there’s some wishful thinking placed on the numbers, relative to how the external factors will settle around the globe and their aftermath.

The US dollar is keeping strong, affecting Emerging and Developing countries that hold debt in USD and find it difficult to pay their loans. Commodities are down, stock and bond markets are down around the world, secular (non-cyclical) sectors and cash are given more weight than they might deserve.

In all of this mayhem, investors are trying to guess the terminal rate, how long it will stay there and when the Fed will pivot. A crucial stage when fighting inflation because the terminal rate is when the Fed says enough, and its ready to test the theory by stopping the hikes and keeping interest rates at a level. When ready, it will loosen its tightening policy and start dropping the rates to boost growth and help stimulate the economy. If the rates drop too soon, it will push inflation back up and it might take a while before it corrects itself. If too late, the tight economy in a recessionary mode will take longer to recover.

The bond yield curve is already inverted. This means that the short term bonds are paying more than the long term bonds. Why? Under normal circumstances, bond holders get paid more interest if they buy long term maturity bonds due to the unpredictability of the long period. Short term pay less because they expire earlier. When there’s uncertainty in the markets, long term bond holders shift to short term bonds, causing the yield curve to flatten and then invert. If you can’t picture the chart, then think of the spread, the difference between the two yields. The closer the spread gets to 0, the flatter the curve. The second it goes below 0, you have an inverted curve.

Why is this important? Because inverted yield curves predicted every single recession over the years. If the inverted yield persists for a longer period, this would be yet another indicator that the economy is in a recession. Central banks take different maturities into consideration when looking at the yield curve, like the 2 year vs 10 year, or 2 year vs 30 year or an even shorter term like the 3 month T-bill.

Source: US Treasury

If it walks like a duck, sounds like a duck and looks like a duck, shouldn’t we call it a duck? The acknowledgement of a “very slight recession” in 2023 is either an understatement of what’s happening, or an overestimate of the ability of a person to actually recognize… a duck.

The information provided is strictly for informational use and is not meant in any way to be construed as investment advice. One should seek expert advice, as all as investment strategies involve risk of loss.