Since ancient times, money has meant several things to several civilizations. The history of money is quite old and dates back to period before Christ. The concept of money revolves around its use as a medium of exchange for goods and services. It started in the form of the barter and later evolved into commodity money and later into fiat money which is where we are today.
The idea of money keeps changing as technology evolves and therefore it is necessary to evaluate the impact of the recent economic events on the value of money. As we are aware, the world is going through a pandemic which is taking a huge toll on the economy and society as a whole. While the world equity markets may be cheering a recovery, job losses have been huge leading to extensive stimulus measures which have been a repeated nature of the monetary and fiscal policy over the past decade. Whenever there is a crisis, the central banks around the world gather and create a storm of liquidity to let all boats ride the tide. It is in this context that we evaluate how the global economy which is hardly growing in spite of such significant stimulus measures, is also impacting the value of money or the currency which represent the fiat money today.
Historically anything that can be used as a medium of exchange, store of value and a unit of account is called as money. Money needs to have a few characteristics to be called money. Those are:
- Limited Supply
Money has its existence from times before Christ. It started with barter where in goods and services were exchanged. However, to exchange these goods and services a yardstick is important to determine relative value and therefore the concept of money came into being. Initially many things became money from volcanic rocks to sea shells to even cows. But some of these didn’t have the necessary characteristics of money and hence they were changed. Later metals and even precious metals began to be used as money (commodity money) and as technology progressed the need for greater flexibility was felt which led to fiat money which are currencies, notes, etc that we use today in our day to day transactions. We are now looking at even electronic money in form of crypto currency. All these were used at different times as the nature of economy and technology dictates change.
Traditionally commodity money did well for some time. But as nations began to grow and with the onset of the industrial revolution, the need for growth capital increased leaps and bounds with technology aiding productivity growth and developments in healthcare leading to population growth, the world was able to see higher growth rates and a major development cycle ran in spite of the world facing two world wars in the process. That led to the removal of the peg from the gold and silver and money became fiat money (currency) after 1971 when Nixon broke the peg with the dollar. It led to high inflation and commodities boom as the dollar was immediately devalued. As interest rates rose and energy production grew, inflation started decreasing. There is a difference between currency and money. Here are a few differences:
- Money is a store of value, currency need not store value
- Money is intangible while currency is tangible.
- Money has intrinsic value while currency has no intrinsic value
- Money refers to the actual value of goods and services while currency is a medium to purchase goods and services.
Our article here is mostly concerned with fiat money which is mostly used as a medium of exchange.
As we know fiat currency has only been in use throughout the globe for the past few centuries. However, it has been a bad store of value. The best performing currency over the last century has been the swiss franc which has lost only 80% of its value. The dollar has lost 97% of its value over the last century. While inflation has been key reason for the loss of purchasing power, one also needs to see the debt that these issuing countries have as it has a big impact on the currency. The only one time there has been increase in the purchasing power has been the great deflation period of 1929-1937. Deflation helps in increasing purchasing power as it makes cost of goods and services cheaper but also leads to increase in debt burden.
As you can see the purchasing power of the dollar has been lost over the past 100 years while the debt has been building up and has now reached 27 trillion dollars. The only way to reduce it is to inflate it away as there is no way this can be made whole through natural economic growth. The USA is already having trillion dollars deficits with little or no growth in taxes and GDP.
Source: US FRED
The only way to pay for this debt is to therefore inflate it away through loss of purchasing power and devaluation of dollar. As the dollar loses purchasing power, creditors are going to move out of dollar debt. We have already seen China sell USA treasuries along with Russia. While some of it may be due to political reasons, there is no such compulsion to sell unless these countries think otherwise. Besides these countries have been adding to their gold reserves which indicates that there is no such compulsion to sell. This implies that at some point in next few years, USA will not be able to sell its debt and monetize its deficits. That leaves all the heavy lifting on the Fed which will cause more of its devalued dollars only to buy those treasuries and maintaining the artificial lid on yields and maintain artificial value of the dollar which will hurt it more. The Japanification of the USA is more or less complete. (Japan’s Central Bank holds 4.5 trillion dollars’ worth of its debt as compared to its GDP of 4.7 trillion dollars.) The USA created 22% in money supply in just one quarter to fight the pandemic induced recession. This is only adding to faster devaluation. Other countries and EU are not far behind. Every country is right now involved in some fiscal or monetary stimulus to try to get out this pandemic induced recession. However, even before the recession there was a trade war and a currency war going on, which was indicating the difficulty these economies face. Most countries and regions are involved in some sort of operation in weakening their currency. Germany benefitted because of its weaker neighbours that ensured a weaker Euro. Most developed countries have now reached the end of their monetary policy as the rates are already negative indicating creditors paying to the debtors for buying their debt. The only option left is the fiscal stimulus which will come in the form of central banks creating money and monetizing deficits. This is supposed to be a short-term solution which is now getting extended as economies are still weak and pandemic still on going. Modern monetary theory is been proposed as a solution which is nothing but fancy money printing for the governments to manage their deficits.
But all this will only reduce the value of the underlying currency. As can be seen, Gold is up against most major currencies indicating the loss of purchasing power this year.
A glance at the following headlines which indicates that even the Central Banks have acknowledged their failing fiat currency and the monetary system in general.
Source: Bank of England
As can be seen above, most central banks are now rooting for a different form of currency especially a digital currency. While the idea is been debated, it has already seen some form of implementation in China where trials are been carried out. The idea of a digital currency holds much sway for a central bank because it brings it near to the consumer, has more access and control over the data and can help them in implementing their policies much easily due to less intervention in transmission. However, that would also mean repeating the same mistakes of the past. As has been seen in the past decade, increasing the ease of money availability doesn’t create more jobs or increase economic activity.
We are at the end of our monetary system. It is no more stable and stimulating as it once was. In fact, monetary policy seems to have reached its end with only a helicopter drop left to implement. The idea of negative interest rates hasn’t delivered either. Since its implementation, the Eurozone has seen no inflation. The current system is highly unstable with direct and indirect bailouts been carried out in different economies daily. Some would say it is because of the pandemic but the fact remains that most zombie companies would have defaulted long back had it not been for the umpteen efforts of the central banks to bailout them every single time. Most shale companies would have defaulted in 2016 had it not been for the co-ordinated global liquidity that bought the recovery on borrowed time. In 2020, we are now seeing higher number of defaults in the energy sector. Whatever recovery we are seeing is mostly felt in the financial markets which are propped up by central banks coupled with a weak dollar giving a reprieve to emerging market economies battered by the pandemic and global commodities market which in turn is giving a false sense of recovery. The choice is simple: Save the dollar and let the markets fall or save the markets and let the dollar fall. The choice is clear at the moment.
In a healthy economic environment, recessionary periods help to clear dead wood and stop fires from erupting. However, central banks have stopped this process and created a hazardous environment while acting as fire fighters themselves. The same central banks have lost control of the monetary policy and are now looking for alternatives. Whatever that will be will only make matters worse. As we enter a new decade, the question still remains. What happened to the sound money? If central banks continue with their slow-motion hyperinflationary policies by increasing money supply and bailing out corporates, how long before currency loses value? What then will be investing logic to support retirement? Will digital currencies become our future currency? There are many questions and few answers. Investors need to keep a close eye on these developments because we have seen in the last period of the hyperinflationary experiment, everybody becomes a billionaire eventually but can’t put food on the table.
-By Vishal Vora, Nishant Maheshwari
Disclaimer: The above article is based on views expressed by the authors and are meant for information purpose only. Readers are requested to take investment decisions by consulting financial advisors.