Leap of Faith: Lack of Confidence in the Monetary System

Money is emotional. Because all value is subjective, money is worth what people feel it’s worth. They accept it in exchange for goods and services because they have faith in it. Economics is closer to religion than science. Without millions of individual citizens believing in a currency, money is coloured paper.’

The Mandibles

The Mandibles is a novel by Lionel Shriver I picked off the bookstore shelves recently.

It follows the Mandibles family in 2029, a time when the US government is battling against a debt crisis and economic collapse.

A group of countries are supporting a new global reserve currency, the bancor, to replace the US dollar.

As the US dollar loses value, so does the Mandible clan’s fortune.

WARNING: Here’s two reasons why the AUD could collapse in 2020

Shriver’s book may be a dystopian fiction, but it does have some elements of reality. Like the fact that our whole monetary system is based on confidence.

I’ve spent plenty of time here writing about the effects of interest rates, and in particular low interest rates on the economy. But this is also very much a confidence game.

In fact, confidence is everything.

Our whole system is based on a religious-like belief that governments will keep honouring their debts.

And on the firm conviction that not every depositor will run to the bank at the same time to withdraw their money.

You see, banks are only required to hold a fraction of their deposits, something that is called fractional reserve banking. That is, when you deposit money in your account, the bank keeps a part of it and then lends the rest. It’s the way our system creates money.

The basis for all of it is trust, and debt.

It’s why gold has such a pull. With gold, what you see is what you get.

But it’s why, every once in a while, we see the system shut down, because the belief system collapses. It’s something we’ve experienced plenty of times throughout history.

The crisis in 2008 eroded much of the confidence in the system, and restoring it is proving hard.

At the same time, there is plenty coming our way that will be testing our faith in the system.

There are asset bubbles and we are starting to see some liquidity trouble with the Fed’s repo interventions. There are monetary experiments from central bankers designed to ‘fix’ the economy but at the same time taking us into the path of negative rates.

And there is also a lot of debt.

From Yahoo News:

The global debt load has surged to a new all-time record equivalent to more than double the world’s economic output, IMF chief Kristalina Georgieva warned Thursday.

While private sector borrowing accounts for the vast majority of the total, the rise puts governments and individuals at risk if the economy slows, she said.

“Global debt — both public and private — has reached an all-time high of $188 trillion. This amounts to about 230 percent of world output,” Georgieva said in a speech to open a two-day conference on debt.

That is up from the previous record of $164 trillion in 2016, according to IMF figures.

Debt Hindering Growth…

The problem with all this debt is that at some point it starts hindering growth.

Hoisington Investment Management has been keeping an eye out on this. That is, on how much a dollar of debt generates in GDP growth. And let me tell you, this has been decreasing.

As you can see below, in 2017 each dollar of debt generated 42 cents of GDP growth. This is down from 47 cents 10 years ago.

The Rum Rebellion 11-11-19

Source: Hoisington Investment Management

[Click to open in a new window]

At the same time, China’s debt productivity is down by close to 40% in the last 10 years and Japan, the most indebted country in the world only generates 27 cent of GDP growth per every dollar spent.

Our dollars aren’t getting us very far.

But instead of reducing debt, we are creating more of it.

The other issue with debt is the higher the debt the higher the interest rate payments. Well, that is, in a normal world.

Will all this debt be pardoned? Well, negative interest rates are (in a way), an attempt at this.

Why spend your money when you can get you can get paid to take on debt instead? Even if that extra dollar of debt doesn’t get you as far.

And you can forget about compounding interest rates to increase your savings and wealth.

The monetary system is broken.

It will take a huge leap of faith to keep this going.


Selva Freigedo Signature
Selva Freigedo,
Editor, The Rum Rebellion

PS: I recently attended the Gold and Alternative Investments Conference (GAIC) in Sydney and there is a lot of interest in making access to gold easier. Check out my interview with Jodi Stanton, CEO of Send Gold and their initiative to increase gold’s liquidity here.

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