For fun we decided this is a good time to explain the function of money. We use it every day. It will also explain why we’re always going to hold some gold/crypto even if both assets went to zero (extremely unlikely in our opinion). “Money” is essentially a solution to the coincidence of wants. In simple terms, money eliminates the barter system and in theory is supposed to hold value over time (ideal situation). So we can walk through what money is and why you should never have 100% of your assets tied to one “type of money” be it the US Dollar, the Euro or even Gold.
Coincidence of Wants: Without money, you have a hard time making efficient markets and creating consistent trade. For example, it is unlikely to walk around during the day and find someone who is willing to fix your car in exchange for four Apple iPhones. Maybe this happens once in a blue moon, but it’s not a good system since you have to search for a person who wants the 4 iPhones in exchange for car repairs. With a standard accepted form of money, be it cash, gold, bitcoin or otherwise, you have at least created an asset that represents the medium of exchange. IE. if everyone accepts one of the forms of money, everyone “pegs” their services to this asset and the markets become a lot more fluid for trade/transaction. In our view, this is the most important use of money. If people accept any asset as money, it’s winning in a big way.
Onto Inflation: Small amounts of Inflation is not a big of deal. Why? Well anyone who owns assets (homes, stocks, etc.) will not be impacted by inflation. If the price of all goods rise, that means the price of your asset will rise as well (over the long-term). If people want to argue with this just look at inflation and compare it to the price of the average home (national comment, do not cherry pick) over 30+ years.
The next step is understanding the upside and downside of inflation. The *upside* of inflation is the part that no one talks about (mentioned above). If you buy a home for $200K, and put down a $40K downpayment and *borrow* $160K this means 80% of the home is borrowed money. Now if you are *borrowing* money do you want the debt to be inflated away or do you want deflation. Of course you want inflation. If the price of the home rises by 3% per year (in-line with inflation) and the debt amount remains flat, you’re making money. Why? It means the $160K you borrowed on day 1 is no longer worth $160K it’s actually worth less… inflation eats away at the money you borrowed.
The downside of inflation is the one that everyone is aware of. If you are unable to acquire assets and have all of your net worth in cash, it means you will be worth less at the end of the year. So if your average joe saves $10K in a year, he will have the buying power of around $9.8K by the end of the year (we’re making up an example). So by sitting on cash under his mattress he’s becoming poorer.
Since we like to summarize things in single sentences: 1) inflation incentivizes spending the money and 2) deflation incentivizes saving the money. If you knew that the price of food/water is going to go up 20% next year, you’d stock up. If you knew the price was going to fall 20% next year, you’d spend a minimal amount and wait (quite simple!)
What is the Ideal Money: Here we’re going to open up a debate. Something for everyone to think about. In our opinion, the ideal money is able to act as a form of money *world wide*, the value slowly erodes at a rate of 1% and there is no debt associated with the money. In an ideal world, there would also be a second type of money that is also accepted *world wide* and *maintains* its value exactly and has no debt associated with it.
Since we don’t live in an ideal world, the biggest component is world wide acceptance followed by a minimal inflation/deflation associated with it. Again. In our opinion, you want some inflation otherwise you can’t create *productivity*. With a minimal amount of inflation (1-2%), you force individuals to become 1-2% more productive per year to maintain their lifestyles. This seems reasonable since you want to incentivize talented people. The smartest people in the world should be incentivized to take on some debt and create products that will make the world a better place. The last thing you want to do is incentivize the smartest people to stop working entirely and go live on a private island.
By making sure the value of the money erodes slightly, you force smart people to think of ways to make the money more productive. Investing in new ideas, products, services etc. This drives up productivity and increases tax revenue for your country. If individuals in your country get richer, they pay more taxes (of course!) which is good for your government. As our wealthier readers know, mid-low income earners don’t actually pay anything in tax (they have deductions etc) while the wealthy pay the vast majority of all taxes.
Reserve Currency and Worldwide Problems in a Nutshell: Moving onto how the world operates today. Right now about 60-65% of all global reserves is the United States Dollar. The US Dollar is the reserve currency as the economy is the largest, we’re open to trade and we have a highly democratic organization (polar opposite would be something like North Korea). Even if a country has the largest GDP, they need to be a trusted trade partner and open to interactions otherwise there is no reason to use the currency worldwide.
If your country is the reserve currency it means one simple thing: you will act as a net importer of goods. Why? Well if everyone uses your currency as the trusted transaction vehicle, the demand for your currency is the highest. So if the US dollar is used for deals between the EU and South America, they would need to buy or hold US Dollars to make trades. Since it’s the global reserve currency, the value of the dollar remains strong and it becomes harder for the US to export items to other countries. This intuitively makes logical sense.
Enter COVID-19 and Shattered Supply Chains: Now we’re going deeper into the rabbit hole. This all seems fine until you have a massive global pandemic that causes businesses to freeze. These businesses are not making money and cannot pay their debt. Guess what. Their debt is likely denominated in US Dollars. Why? Well, if the vast majority of transactions are created using the US dollar, they need to have loans taken out in US dollars. Meanwhile everyone is trying to sell assets to covert into US dollars, making the dollar stronger.
Since the prior three paragraphs pack a ton of information into a single place, think about the following process: 1) US dollar is reserve currency, 2) companies and countries globally use the US dollar for the majority of transactions – international trade, 3) since interest rates have been low a lot of these companies have a lot of debt, this debt is naturally denominated in US dollars as this is the currency needed for trade, 4) COVID-19 causes the global economy to pause/halt for 3-6 months so far, 5) companies and individuals have to scramble for money to pay off their debts so they sell everything in exchange for USD; 6) this means the demand for the dollar goes up making the debt even more expensive for the foreign country and finally 7) the US government steps in to print a TON of money to try and devalue the dollar and prevent the death spiral from continuing.
On crypto twitter (and gold twitter), you’ll see the meme “Money printer go Brrr”. Now you understand why they are printing the money. The government is attempting to stabilize the global economy by printing the difference in lost GDP. We can argue about the *correct* way to do this but the step by step should make it clear.
What This Means for You: We’ve done our best to explain money in a short post. If you think about the investment risks present in your life you think about the following: 1) stock market corrections, 2) single company investments that could go bankrupt, 3) sudden drop in demand on levered investments like real estate, 4) sudden loss of property due to a natural disaster – need for insurance and 5) business competition and potential career loss.
Few (if any) think about sudden currency devaluation. We don’t think about it in the United States since we’re the reserve currency at this point in time. Countries like Argentina, Venezuela, Lebanon and many others would understand this risk. So. You as an individual should never have 100% exposure to a single currency. US Stocks, US Bonds, US currency are all based on a single nation. Instead you want to own a form of money that isn’t tied to the same nation. You can do this by buying a small amount of fiat (government currency) in other nations and by buying an asset like gold and bitcoin which is not tied to any sovereign entity. Gold, Bitcoin etc. are insurance against Fiat collapse in your country.
For some historical context, reserve currencies last for ~100 years or so. Gold (since it is not tied to a government) has been around for many hundreds of years and Bitcoin is a new “digital gold” that has been around for just over 10 years (a drop in the ocean). While many will laugh at the 100 year comment, the last major worldwide pandemic was also about 100 years ago in 1918-1919 with the Spanish flu. For fun, the US dollar has been the reserve currency for around 76 years if we use the Bretton Woods agreement as the official start of the US dollar becoming the world’s reserve currency.
Moving onto Fiat Money: Fiat money is government backed currency. Since most governments are in debt (just see the US debt clock website: https://www.usdebtclock.org/world-debt-clock.html). It is clear that there is potential for the currency to collapse. From a “business perspective”, taxes are a contribution to your government for the services they provide (school, infrastructure, defense etc.), think of it as a subscription based payment for residing in the country/state.
With this in mind, it means that countries with high debt/GDP ratios are at risk. Check out this simple website: https://worldpopulationreview.com/country-rankings/debt-to-gdp-ratio-by-country. As you can see the countries that had high debt/GDP ratios are also the ones at risk for default (general comment) as Lebanon saw currency collapse, Italy has been on the brink the last few years and the Cyprus collapse is well known.
Non-Fiat Money: This basket includes metals and crypto currency. Gold, silver, copper, palladium etc. can be used as a form of money as it dates back hundreds of years. Crypto currencies can be used as money in niche instances (also not backed by a government). The strongest counter argument to crypto currencies has been their reliance on adoption. IE. unlike gold/silver/copper which have real world use cases, crypto currencies need to rely on pure adoption to drive growth. Unlike commodities which can have underlying demand (used for industrial equipment).
Using gold and bitcoin as comparisons, gold is hard to transport, can be faked (see the latest China scandal) and is arguably less secure (easier to steal). Bitcoin is significantly easier to transport, cannot be faked but does not have a real world use case beyond “transfer of value/store of value”. IE. if people stop using bitcoin entirely (we think next to no shot of this happening), there is no other use case. Gold can be used for industrial applications even if it’s no longer used as a store of value or type of money.
The Broad View: With a basic understanding of the two types of money: fiat and non-fiat, it is difficult to see a complete collapse of fiat money in our lifetime. It would require a complete global overhaul. That said, it is extremely likely that we see continuous “fiat currency collapse”. IE. 1-5 countries default and their currencies collapse. This leads to *some* ownership of non-fiat currencies over a long period of time. Also. If the global collapse occurs, you’ll own the insurance which is non-fiat money.
Feels Like a Turn: With the summary of money out of the way and why everyone reading this should own some gold/crypto, we’re ending on a positive global note. It has been a tough year but we feel like we’re hitting a turning point. We’d be lying if we said we thought it would get this bad but here we are.
The good news? As of July 4, 2020, it seems that we’re starting to hit a bottom in terms of *morale*. More bankruptcies will occur, however, it feels like we’re starting to get comfortable with the end result (high single digit to double digit unemployment for the near/medium term). The last stage of grief is setting in and the majority have accepted the results. This will lead to corporate restructuring by the end of the year (Q4 or so) and then we’re back to rebuilding (likely a 2-3 year rebuild similar to 2008-2011 where it took three years to really get some confidence back).
Make no mistake, more bankruptcies will come. And. We’re prepared for it this time and don’t have unreasonable expectations. That is the key to rebuilding.
