Monday, December 26, 2016

Economic Relativity In Relationship To Currencies

German-born theoretical physicist, Albert Einstein developed the general theory of relativity which remains one of the two pillars of modern physics alongside quantum mechanics. In 1905 with the theory of special relativity Einstein proved that the laws of physics are the same for all non-accelerating observers, and he showed that the speed of light within a vacuum is the same no matter the speed at which an observer travels. As a result, he found that space and time were interwoven into a single continuum known as space-time. Events that occur at the same time for one observer could occur at different times for another. This geometric theory of gravitation has stood the test of time and remains the current description of gravitation in modern physics.

The definition of relativity is based solidly on the relationships or values determined by the laws of nature. Often we find the qualities of relativity extend to other parts of our lives and the universe as well such as economics. While mankind has developed certain ways to temporarily mask and confuse the truth, be assured that certain relationships should be considered the norm, history has shown time and time again that after we deviate from the so-called norm things tend to revert back to what has been established as a baseline. This is important because we exist in a world where the state of real value is always dependent on, or determined by a commodity or an item's relationship to something else such as supply or demand.

Factors Influencing Where To Place Wealth
Because investing in tangible assets often is accompanied by drawbacks such as high "entry or exit" fees or at risk of being damaged and ravaged by time, we find that money or currencies have become the way most people tend to place a value on tangible items. When we talk about tangible items we are referring to the touchable, material, or the physical and real world that surrounds us. An issue that should not slip by unnoticed is that both debt and a number of paper assets has grown massively over recent decades and especially in recent years. The material world of tangible items by its nature has been far more restrained in its growth, in short, the amount of tangible goods has not matched the growth of paper assets. This is key to understanding the true risk of inflation going forward!

Considering just four currencies constitute the bulk holdings representing the wealth of the world it is logical to look for a relationship between them to determine relative value. Assuming all other factors remain the same we then find that if the central banks controlling these currencies move in lockstep their values to each other should remain "relatively" constant moving within certain limits. Overall that has been the case even if a person were to argue otherwise and point to moves occurring over years. A generally accepted fact is a great deal of the value of "cash" is derived from a very important quality which is frequently forgotten, having cash which is relatively stable compared to many commodities and tangible assets translates into liquidity and flexibility to exploit opportunities. This means the holder of cash has an effective option to purchase more volatile assets if and when they become cheap. Thus, a willingness to hold cash has often been the simplest way to take advantage of markets in flux.

It is important to remember the global currency system world leaders have created is fairly closed. By this, I mean relative value merely shifts back and forth between the four major currencies that dominate the system with little ability to escape. The crux of this is the term "escape" in that wealth flowing into these "paper symbols of wealth also known as fiat money" often finds resistance into converting back into tangible assets. As pointed out above holding tangible assets has drawbacks which most people find difficult, confining, or somewhat limiting. The fact that tangible assets carry the negative attribute or quality of having to be insured, maintained, or at risk of being visibly and physically by time tends to reinforce the illusion currencies and paper assets are more desirable and stable than they really are.

The benefit of a currency system that accommodates trade, and easily allows the exchange of goods and services has come to outweigh reality and truth in value discovery. In many ways, currency can be considered a commodity and problems develop when governments and central banks overreach and break the link of trust and faith. Central banks don't want us to see they have designed and put in place a false market that is more or less "fixed within limits" and not a rapidly "self-adjusting" system. All is well until it becomes clear to the masses they have been deceiving as to the real value of our currency. When the bond of faith is broken major conflict arises because central banks will be punished as fiat money is shunned. The "master key" to our currency system is stability. Those in power have created the myth the currency balance can be maintained and that no currency of a developed nation can fail.

All this is important because the "perceived value" of money and currencies holds great sway over what something is worth and its value. Recent claims that a false economy has disrupted the forces of true price discovery make this very important if you believe we will eventually convert or return to the norms of the past. I continue to believe the primary reason that inflation is not more prevalent is that society is pouring such a large percentage of wealth into intangible products or goods, this is because physical assets are often difficult to protect and oversee. This imbalance is a red flag that a readjustment period may soon occur. If faith drops in these intangible "promises" and wealth would suddenly shift into tangible goods seeking a safe haven inflation could soar.

Unrestrained Growth In Intangibles Is An Issue
Like many of those questioning the ability of Modern Economic Theory to control the cycles of boom and bust, I worry about the massive debt being accumulated by governments and the rate that central banks have expanded the money supply. Those touting a deflationary scenario tend to focus on the idea the forces of unpaid debts would massively depress prices. In fact what we may see develop is a battle of these two forces, however, I want to point out it is important to remember that debts can go unpaid and promises left unfilled which creates a massive problem in predicting how an economic crisis will play out.

As we have seen from the economic crisis of 2008 and following many other unsettling developments legal actions can continue to drag on for years. While the legal system ponders solutions chaos can assault markets. Major disruptions can result from major shifts in value and even more so in the world today where derivatives lurk just out of sight waiting to wreak havoc on our far too fragile economic system. One fact remains front and center and that is 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 many of the super-rich insiders will again be the big winners.

Feeding into this mix are opinions such as Jeremy Grantham's recent take on bubbles and his thoughts that we may only revert partway to what we consider the norm and that may be over many years. He suggests the current market may end in a whimper rather than a bang. He mentioned seeing the election of Donald Trump as an outlier event with possibilities of tariff wars and general global political uneasiness to follow the surprise rally we have seen. Overall his view of what lies ahead is not all that jolly and he concedes that 15% to 25% bear markets can always occur. He also states that the probable "mean-reverting" paths he envisions will not bode well for pension funds at others looking out towards a 20-year horizon.


  1. The above spam.or rather comments have been left in place and not deleted so as to give us HOPE!
    Yes we can also be winners if we turn to this clown for guidance. LOL.

  2. Inflation ? What inflation ? Have you considered the (deflationary) impacts of (ageing) population demographics in advanced economies and further advances in automation aka Artifical Intelligence/ Machine Learning ?

  3. David, just noticed your comment. the inflation about to be unleashed will overpower forces from demographics and is centered in governments amortizing debt to half way meet promises they have made.
    I say "half way " in that they will do the minimum and try but fail to make everyone happy.