Thursday, August 4, 2016

Currency Games Scream Major Risk!

One of the most important things to remember about the global currency system is that by design it is fairly closed. This means relative value tends to merely shift back and forth between the four major currencies that dominate the system, this is the main reason currencies appear more stable than they really are. After writing many articles about the currency markets that warned of volatility ahead my concerns have not diminished over time. This is one area where the average citizen tends to overlook or not understand the deep ramifications of holding their wealth or savings in a currency that may drastically rise or fall in value. The truth is that such moves directly impact your position in where you rank in relationship to all the other people on the planet in terms of wealth.

A Very Important Chart In Understanding The Dollar
The chart to the left is very important because it highlights just how much four major currencies dominate the world stage. The pound, the euro, the yen, and of course the dollar make up a huge majority of the global currency market. The remaining currencies remain small bit players in the overall scheme of things. The status gained by the dollar being deemed the "reserve currency" by which all others are weighed and in some way pegged does not make the dollar infallible or guarantee it will remain strong, but the liquidity of such a large market does add a resilience to the American dollar. The way the global economy is structured the dollar is the linchpin of global finance thus, it has guaranteed itself a place at the table until dethroned.

Unstable currency markets can be a precursor to massive shifts in value and a sudden drop in confidence. It is logical to think that in such a situation insiders would be the big winners. Most people go about their day with little thought to the fact that we are all pawns in the "currency game" and subject to its bizarre feedback loops.  John Maynard Keynes said, By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. As the central banks print like crazy to control interest rates on bonds they devalue the currency. While there are not many Bond Vigilantes there are a slew of  Currency Vigilantes and they are ready to make their presence known.

It would be wise not to underestimate the amount of risk currency fluctuations inject into the economy through the derivatives market and other factors such as the carry trade. Many highly leveraged bets have been placed that depend on currencies as a stable foundation. The explanations and reasons often given to explain currency moves are at times so illogical they seem laughable. It seems analyst are always quick to justify any move or fluctuation with the theory of the day rather than with a long-term appraisal based on the economic health of the economy a currency represents.

Currently, many of the people following this subject are growing rather skeptical as to the future of our system of fiat money. The whole system is based on faith that other people will be willing to accept it even though it is not backed by anything other than a promise from the government that has issued it. Simply put Fiat money is a currency established as money by government regulation or law. The term derives from the Latin fiat ("let it be done", "it shall be") used in the sense of an order or decree. It differs from commodity money and representative money it that is is not backed or able to be converted into a hard asset such as gold.

This means that at some point the general public might find they are holding nothing more than paper promises of rapidly declining value if the currency markets begin to reflect diminished confidence in the system central banks have created. As the currency games continue to ratchet ever higher it is becoming more apparent that we are standing on shifting sand. It is difficult to ignore the truth that the world is changing at a rapid pace and each day when we awake what existed yesterday may have vanished during the night. Countries and governments can come and go, the recent coup attempt in Turkey is an example of the fragility facing nations across the world.

A key problem with fiat money is that it is prone to abuse by those in power, the ability to simply print money to cure your economic problems is way too seductive, this makes it an accident waiting to happen. The schemes bankers have used for years to hide and transfer debt are coming under attack as stress builds over time and our system ages. Today we find promises have accumulated and been stacked one upon another, this is evident when we look at the entitlement systems governments have created, social security, pension funds, and in many far less obvious examples. At the first sign that faith is beginning to erode in any one of the four major fiat currencies, the assault upon that currency might culminate in a reset of the entire economic system across the globe.

Today many people have indicated the only time it will be acceptable for the central banks to raise the interest rate is after their negative affects have become clearly evident. By then it most likely will be too late to avoid a massive economic reset. It should be noted that this will not please many people who will feel deeply abused and totally betrayed if this scenario were to play out. The citizens in a country using a rapidly depreciating currency would face hyperinflation and most would be financially ruined. The bottom-line is that while many people go about their daily lives giving little thought to currency valuations they leave themselves open to the whims of those that control, manipulate and play in this important area of the global economy.

Ten percentage points higher or lower against a foreign currency can have a great deal of impact on how your net worth stacks up against someone across the world. This rapidly becomes apparent to anyone doing a great deal of travel or buying foreign goods. It also highlights why all of us should be very concerned where we stand when the smoke clears from the currency wars before us. While most people remain totally oblivious to these dangers do not underestimate the forces in play or the great risk of economic damage through contagion. When all is said and done do not be surprised if the "currency games" bring into focus the fact that debt does matter. This will destroy current Modern Monetary Theory that attempts to sidestep this core economic principle.

Footnote; Your comments are encouraged. Other recent articles concerning what is happening in the currency markets are listed below, also in the archives, you will find several articles dealing with why inflation will win out over deflationary forces.

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