The Psychology Of Money

Monetary debasement can only continue for as long as its users continue to accept fiat currency as the medium of exchange. To reject an established unbacked state currency for transactional purposes is a last resort, and naturally, in the general public there is great reluctance to do so. But, unless the government reins in its spending and balances its budget, the fate of its currency is for it to be eventually rejected and to become useless.

The path to valuelessness is uneven, faith being maintained in the currency until it is no longer tenable. The dilution of its purchasing power by the inflation of its quantity is one factor; faith in it is ultimately the overriding factor. The continual abuse of that faith is what leads to a currency’s demise. The first to be alerted are the users of foreign exchanges, and it is here that the dollar will face a destructive weakening. Foreigners own considerably more dollars and dollar-denominated assets than Americans own the equivalent of in foreign currencies. Having had the exorbitant privilege of issuing the world’s reserve currency for seventy-five years, most American ownership of foreign-related financial assets is denominated in their own dollars.

A year ago, many of my American friends argued that I was wrong to be bearish about the dollar because foreigners would always need to own them, and in the event of a worldwide financial or economic panic, they would increase their demand for dollars as a safe haven. It is an argument that is only valid so long as the dollar is not over-owned, but in a contracting global economy with diminishing international trade the dollar is needlessly owned and is already being sold down.

The history of fiat money breakdowns usually features a substantial fall in the currency’s purchasing power on the foreign exchanges before the domestic population becomes aware of what is happening to its medium of exchange. The fall in foreign exchange values is accompanied naturally by a rise in prices for commodities and raw materials. The Keynesian priesthood initially argues in favor of the benefits of a weaker currency, measured against other currencies and not so much against commodities, because it becomes more competitive for trade purposes, until, of course, the fall in international purchasing power creates embarrassing problems. The first of these is the withdrawal of the government’s principal source of finance that does not originate from its central bank: foreigners no longer retaining net dollar surpluses from the balance of trade to reinvest in government, corporate, and agency debt. The balance of payments no longer balances.

Meanwhile, government spending in excess of tax income still needs to be financed. In effect, the foreign holders of dollars are sending a clear message: “The interest I earn on my dollars fails to compensate me for potential capital losses, and so long as that is the case, I will continue to sell my dollars”. Though unwelcome, the only solution to a falling dollar becomes clear: a rise in interest rates will be necessary for the currency to be stabilized in the foreign exchanges.

This solution is only accepted by the Keynesian priesthood with the greatest reluctance and is seen as a last resort, in denial of the failure of their cherished beliefs. They start by intervening in the foreign exchanges, but to no avail. They may introduce price controls. They may suppress or confiscate key inflation markers, such as ownership of gold. All this is to no avail. The longer they delay, the higher must be the hike in interest rates to protect the currency. But with interest costs already a significant element in the government’s budget, higher interest rates make the situation for it even worse.

The government is ensnared in a debt trap, from which, in the absence of massive cuts in spending, there can only be one outcome: the bankruptcy of the government, and indebted businesses with accumulated malinvestments shut out of credit markets. These zombies form a substantial part of the US economy, as they do in Europe, the UK, and Japan, and a significant portion of bank credit (and therefore losses to the banks) is exposed to their inevitable failure.

Keynesians and MMT supporters tell us that a government that issues debt in its own currency cannot go bankrupt. They avoid telling us that the condition is only true so long as there is some value yet to extract from the diminishing purchasing power of its inflating currency.

At this juncture, let us take stock of the current situation facing the dollar and its immediate future:

• Hyperinflation of the dollar commenced in the second half of fiscal 2020 (March to September), a condition which is bound to continue, so long as Keynesian beliefs and the electoral mandate to prevent an economic slump at all costs persist.

• The $900bn covid temporary relief package, currently rejected by President Trump as too small, will be followed by further inflationary financing in 2021, which will of necessity be larger than that of fiscal 2H 2020. A moment’s thought on the evolving scale of the covid crisis should put all doubts to rest that this is the case.

• At the last count, foreign ownership of US dollar financial assets and cash deposits in the US banking system amounted to $28.5 trillion. The momentum behind the maintenance of the balance of payments is clearly diminishing and we can confidently expect further selling in the foreign exchanges to drive the dollar significantly lower.

• The fall in the dollar on the foreign exchanges will require an increase in interest rates to stabilize it. An increase in dollar rates at a time of growing economic difficulties goes against the Keynesian creed, will be unavoidable, and will seal the fate of government deficit financing. Being unable to refinance their debt, zombie corporations will begin to collapse, and a full-scale economic crisis ensues.

These developments are in process or can now be anticipated with a high degree of certainty. The only thing to add is that all other fiat currencies are affected by similar inflationary factors. For simplicity’s sake the ratio between the dollar’s purchasing power on the foreign exchanges and commodity markets is considered to be a separate topic, so as to not confuse the basic issues of a widespread currency failure.

To the current observable developments listed above, we can add the following bullet points, which are likely to evolve from them.

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Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information ...

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