Confidence Is Everything – Alternative Currencies Could Wreak Havoc

Argentina has an interesting relationship with the US dollar. The official currency is the peso, but Argentineans also like to store US dollars.

The reason for this is that the country has suffered bouts of hyperinflation.

The austral, the Argentinean official currency back in the 90s, became so devalued that that people flocked into US dollars to preserve the value of their money. It was a vicious cycle, the more dollars people bought, the more the austral devalued.

It lost so much value that it had to be replaced by the peso.

Now any time the population loses confidence in the currency, they exchange their money into US dollars to preserve value.

A couple of observations about this.

First, fiat currencies are only backed by confidence. Once that confidence is lost it’s hard to regain it.

Second, when people see the value of their money erode, they will look for an alternative store of value.

We are living in an interesting time, as more alternative currencies are popping up.

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In the last decade we have seen the rise of bitcoin and other global digital currencies.

Some cities are even issuing their own currencies: Barcelona, Belfast, Dubai…

And more recently, some large tech companies are looking at getting into the space. Like Facebook, with Libra.

By the way, when I talk about alternatives I am not only referring to digital currencies here.

There is also more talk about looking for gold alternatives. Recently, Malaysia’s prime minister flogged the idea of a gold-based East Asian currency.

Speaking of gold, have you seen Greg’s recent research on gold? You can access it here.

Advantages of having your own currency

Having your own currency has its advantages.

It is a way to get funding, you get to make your own rules and of course, in many cases, it gives you a printing press.

The US dollar is dominant here. It gets a lot of perks as the world’s currency used in international trade.

But my point is that cryptos, gold, and even Libra — no matter how you feel about it — give people an alternative.

It could be why we heard several attacks against cryptos and Libra this week.

US President Donald Trump recently tweeted:

Trump twitter - 19-07-19

Source: Twitter

[Click to open in a new window]

During the Congressional committee, US Federal Reserve Chairman Jay Powell said:

Libra raises serious concerns regarding privacy, money laundering, consumer protection, financial stability. These are concerns that should be thoroughly and publicly addressed.

US Treasury Secretary Steven Mnuchin recently labelled cryptos a ‘national security threat’.

And even IMF’s Christine Lagarde said in April that cryptos are ‘clearly shaking the system’.

I mean, I think cryptos are quite interesting, and in particular blockchain. My only hesitation with them is that I think they are moving us closer towards a cashless society.

But cryptos could be becoming a threat because they provide an alternative to the current system.

Major global central banks are testing the zero bounds. In the latest expansion, they haven’t been able to return to normal rates.

Even now at record low unemployment, the US Federal Reserve Bank is looking at an interest rate cut.

When the next recession hits, we could be looking at negative rates.

Negative interest rates act like a tax on your money. It punishes savers and rewards spenders. This coupled with inflation could see the value of your money erode.

You may be hearing that inflation is extinct, but inflation isn’t dead.

We may not be seeing inflation translating into wages, but we are certainly seeing price increases in other areas, like health care, asset prices and energy costs.

But the problem with negative interest rates (as we are seeing in Europe and Japan) is that when they hit, people start stashing cash at home.

The IMF recently published a paper how to ‘solve this problem’ of imposing negative rates by making cash less appealing to use. I wrote about it a few months back in Markets & Money.

Here is what I wrote:

‘[T]he IMF proposes, you could divide the money supply in two: Cash and e-money.

In practice, there are now two currencies.

E-money is only used electronically, and pays, let’s say, a negative 5% interest.

You can still use cash, but it has an exchange rate against e-money.

Every time you want to deposit cash into your bank account, you have to exchange it to e-money. The conversion is 1 to 0.95…that is, for every $100 in cash you deposit you get 95 e-money…so you lose 5% of it.

Stores also have two different prices. One is for payments in e-money, the other is for payments in cash.

And…you guessed it, paying in cash would be more expensive.

So, effectively, there is no benefit to people holding cash.

We are heading towards negative interest rates and more money printing. But alternative currencies could wreak havoc on this plan.


Selva Freigedo,
Editor, The Rum Rebellion

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Selva Freigedo is a research analyst for The Rum Rebellion.

Born in Argentina, her passion for economic analysis started at a young age. Her father was an economist for the Argentinean governments and the family used to discuss politics and economics at the dinner table.

Argentina is a country with an unusual economic history. Growing up there gave Selva first-hand experience on different economic phenomena such as hyperinflation, devaluation and debt default.

Selva has also lived in Brazil, Spain and the USA.

Back in 2000 she was living in the US as the dot com bubble popped…
And in 2008 she was in Spain as the property market exploded and then collapsed…

She has seen first-hand what happens when bubbles burst.

Selva joined Fat Tail Investment Research’s team in 2016, as an analyst. She now writes from her vantage point in Australia, where she settled in 2015.

The Rum Rebellion