A Look At Currency From The Debt Side
On Sept05, 2015 I sent out a mass email titled: “Memphis – The Rising USD, Look Out Below”. With some edits I am offering it again today as the principles that apply to currency do not change from year to year but are timeless. It will be good for review even to those who read it last fall because the reality is that the present day forces that are driving capital into the US and creating the strong dollar are going to continue for quite a while.

It is the strong dollar and the effect this is having on OTHER currencies that we will be pointing to today however we must also recognize the force that is driving this. The flowing of capital across the globe, the macro (big picture) transfer of energy, is creating the dollar’s rise. To state this differently, if we simply look at the US and miss the totality of what is happening all across the globe? We likely will totally miss it. We simply must look beyond the US if we hope to truly understand what will be playing out within. Fair enough?

Additionally, in attempt to make this discussion more relevant to the present day I have added a central bank quote from July2016 as it will further our understanding of currency here. Today’s look at currency and some of its many effects upon us is only a small snapshot of the whole for no one alive could absorb this topic in one massive download. It simply is too much. With that understanding, if I have missed a point here that seems important please offer it up so that we can discuss it further as this is a journey and we are all walking the same path as students in search for the truth. A truth that is not to be found just lying in plain sight.

from September 2015:
Memphis- The Rising USD, Look Out Below
Global Debt Is Driving Many Changes
Since the financial crisis of ’08 emerging market nations have added greatly to their debt load in the form of USD denominated debt. Little thought was given to the expanding balance sheets as the whole world was loving the party and feeding at the trough of the USD like there is no tomorrow but guess what? Tomorrow came. I appeared carrying a large banner with the letter “D” prominently displayed. Yes, deflation is the driver here as is always the case in a debt driven system that requires expansion.

As long as economies (thinking GLOBALLY here) are expanding (growing) then the added weight of this debt burden is not an issue. No cracks appear as long as the music is playing but that is no longer the case. Has the music stopped? No but it has slowed and is still slowing. The entire globe is encountering a contraction, a deflation, wherein now suddenly all this debt matters and adding GREATLY to the problem? (this cannot be overstated here) is the strong USD.

If a nation is to remain competitive relative to their neighbors this shakes out (after all the complexities of global interactions are settled) in the value of their money. The old adage that a lower relative currency value favors the domestic economy is true but what about the debt? Does this figure into the grand global equation? Today we will examine a nation’s currency peg from the all important perspective of their debt burden. Ready?!

Warning – Hard Times Ahead!
This type of comment has been repeated so often it has become common knowledge; what everybody knows that everybody knows. But is it even true, and if true, to what degree? And more importantly WHY is it true? What forces are at work here? We all have an opinion along these lines but how sure are you that YOUR “perspective” is grounded upon a truly firm foundation with evidence to support your beliefs? Here is a tip: if you are part of the crowd who jumps up to cheer and even wave an American flag when news comes out that the USD has again gotten stronger? You might oughta just sit down and study the matter out a little.

Along the lines of study, we need to ask is the information we allow into our heads well sourced and reliable? These things really do matter and if you’ve followed my blogs you already know how closely I guard what gets in! Like the old adage for computer programming: junk in; junk out and today I wish to resume our mental journey attempting to share some insights along the way. These insights (if in fact I can make such a claim) have been fought hard for; following just a few trusted sources that I then compare and contrast; keeping only that which stands up under close scrutiny.

Perfect and 100% spot on? Not likely, but as time goes by, my expectations are proving solid…thus far. Not making ANY special claims of guru status here or genius or any such stuff but rather that my own studies are holding true largely because I refuse to get lost in the daily “noise” of markets and news. It is such things as the trend(s) at work, an understanding of cycles, and a proper understanding of history, that should be our anchor here such that if we do “miss it by a mile” on some point we recognize that it was not the trend that failed but it was a failure to understand it’s proper application.

That last sentence is worth remembering because when we do “miss it” we (humans) seldom take responsibility but quickly find a way to explain away our failure. [come on, let’s be honest here!] Such behavior is kinda part of our DNA but it only leaves us open to more failures and that will simply not do in the discussion of money! A common denominator among highly successful people is that they have all had failures but they also recognized them and attempted to never repeat them! Like any human effort, when we study we need to then take what we have read and, If it is worthy, add it to our model of the world, BUILD upon it and make it our own.

Currencies – Opposing Forces Are Silently At Work
In preparing to take our discussion deeper let’s consider that we have nations the world over bleeding their foreign reserves and threatening to decouple (de-peg) their currency from a rising USD. There are at the same time other elements silently at work, other forces at play that are sometimes pulling in direct opposition. By opposition we simply mean that there are things on both sides of the equation here. Dropping a USD peg might help preserve their currency reserves and then reflect the true level of their economy, their GDP, but on the opposite side we have factors that might make dropping the peg PROHIBITIVE. Hang with me on that point for it is going to be our focus today. It all centers around the declared value “Nation A’s” currency relative to that of the USD and will serve us well if we look deeper.

There is much fear mongering (and ignorance) thrown about that usually speaks to “the sky is falling”. We are daily bombarded by bad news and almost always in the extremes such as suggesting that China is selling UST’s and is about to crash our economy. The list here truly is endless.

The truth here really matters; we need to be curious enough to search the matter out until we find the real answer(s). Are there some “real world” forces that are at play? If so what are they? And if so do these FULLY explain the actions, the global changes, that we see playing out? If not then people like me are just peddling a repackaged form of the same crap, more BS right?

Can Things Be Explained Without Using The Word – “Conspiracy”?
If pressed to give an answer many people, if not most, would argue that ultimately at the highest level it’s all boils down to just a big conspiracy and we are then left guessing who’s next to be screwed over. If we do not progress beyond such a mindset we will never see the world properly. If this describes you then I would suggest that you either wake up and begin to listen (really listen) or just go build a bunker and buy a bunch of beer-n-bullets cause you’ll never understand much about the world.

If that seemed harsh, here is one of the questions that I received last week from a reader. It is mild compared to the thinking of some but still served as the spark that led to my writing today’s blog:

“Memphis…Any speculation on what’s causing the [turmoil in emerging markets]? Is it the economic pressure felt around the globe or is it just another part in the plan or a combination of the two? I think it is the desire of many nations who have been held underneath the thumb of the USD to be their own man…”

Can we ALL make this leap to see the truth? I believe yes…..but. It requires that we find a way to evolve in our thinking and this is not easily done. The power of a normalcy bias is immense and prevents most people from ever growing. If we want more? If we want understanding? We must point to our own normalcy bias’ (recognize it) and then get past it when the EVIDENCE requires. I doubt one in one hundred readers will ponder this thought and yet the opportunity here is so clear to me; potentially life changing.

Here’s a small injection of truth: IN RESPONSE TO a rising dollar we see nations expending their foreign currency reserves, primarily held in USD, to support their own currency’s value. This then allows them to maintain their peg, their own relative value as expressed against another. This is not a deep economic concept here but is largely just a supply/demand event that allows them to maintain their pegged value relative to the rising dollar. In case that did not make sense let’s speak briefly to what a peg is…

Any given currency that is pegged to another means that they are effectively piggybacking on that other nation’s reputation in the global marketplace. Rather than prove to the world that their money is worth a value of “X” relative to the dollar they simply anchor it with a stated value, a percentage of the dollar. It is then fully just a definition, a decree, and this than meets the definition of fiat. A commonly misused word, fiat simply means “by decree” and is a declared value by gov’t that is held regardless of the market forces that may exist. Eventually tho these market forces, the business cycle, takes over and the peg is abandoned or broken.

Much of the ignorance (misconceptions) about what a peg “is” can be put to rest by simply understanding this one truth: There is nothing divine, nothing pure, nothing to be highly esteemed, regarding a currency peg. Any peg is simply an attempt by man to declare, to decree, by fiat, what their money shall be worth in relation to all others. All, yes ALL, pegs eventually come under pressure and this happens in relation to the extent that the defined value diverges from a nation’s true economic output.

A final point on conspiracy, I appreciate that dark men lurk in the shadows seeking to rule over humanity. Conspiracy exists all thru our world but there are certain immutable forces of nature that cannot be “controlled”. Among these are the laws of physics and closely tied to THAT, the laws of economics. Manipulation can exist but only to an extent so next time you hear someone say: “It’s just math!”? This is what they are saying. It can all be proven on paper and has therefore not been arrived at thru conspiracy. Hope that helps…

Curious Minds Only May Apply – Why We Ask Why
Why? The why here is EVERYTHING to us if we want to learn how to fish vs. trusting that someone will hand us a daily fish. In this discussion the “why” was clearly defined for us by Adam Smith in his work: The Wealth Of Nations. It is the “invisible hand” as defined by Smith’s business cycle that is silently working thru out the globe and this same invisible hand is that force which causes all of our attempts to manipulate to eventually fail. Just as certainly as the way physics tells us how an object will move, the business cycle tells us how capital will behave.

Imagine a wave working across your field of vision; moving in its natural flows of high to low and back again with amplitudes (heights) that vary in strength. Now imagine that we inject mankind into the equation who (in his/her infinitely greater wisdom) decides that it would be much preferred to eliminate these natural movements; to smooth out these (pesky) highs and lows in preference to a straight line with an ever so slight upwards slope! The very fabric of nature tells us that this is not a natural outcome but one that would require much effort to maintain.

[note: to appreciate the motivations of central planners it is essential to know this: the thing which they fear most is deflation as it runs contrary to an ever expanding money supply, the lifeblood of their business. Armed with this knowledge we can then appreciate their every action as it is ultimately in support of this prime directive!]

This picture would then be the ideal of nearly all modern day economists; a slowly expanding economy that is finally free of the old boom and bust cycles. Within this model we can also include the discussion of a currency peg. Modern day convention (adopted after coming off a gold standard) is that it is best to have such things “fixed” as in, set in place, as this is believed to promote stability and advance commerce. If however we wish to operate effectively in the real world and seek a full understanding of the reality of markets then we must ask questions. One such obvious question that needs to be asked might be this:

“If a fixed currency peg is truly the ideal model, then why do we see market forces the world over putting increasing pressure for this fixed value to then move?”
As we have mentioned earlier the answer here has been known for many years (centuries actually). Our modern day thinkers (yes politicians get a pass here) [some of you will get that later] have in large measure simply chosen to abandon these realities. The recently appointed (Nov2015) Central Bank Governor of Egypt, who devalued the Egyptian Pound by about 13% in Mar2016, did an amazing job of pointing to this reality with his recent remarks. This quote is loaded with insight for us:

“…the focus on defending the [Egyptian] pound over the past five years was a grave mistake…authorities can no longer delay measures that would control the use of foreign currency…We have two choices: either keep the pound stable or get factories working…The exchange rate should reflect market and economic forces. I will take what I think are the right decisions, in my view, and bear the responsibility.”

~ Tarek Amer, Governor of the Central Bank of Egypt
(speaking to Egyptian press on Sunday July 03, 2016)***
[note: if we look closely at his closing remark we find evidence to what I mentioned earlier about modern day conventional thinking as he clearly admits that he may take some flack for departing from the accepted norm. I have often stated that it is in the extremes we see nations abandon their many idealistic programs and policies in preference for what? To do what is in their own best interest as a sovereign state. You may try to prove me wrong on this point but it is very likely that you’ll discover that the time is simply not right yet as we have yet to reach the needed “extreme”.

There are many factors that force this outcome to hold true and perhaps most notable among them is that any politicians chief objective is always what? To keep his/her job. As in all discussions then it is the human element, our interactions with each other that cause history at all levels to always repeat. Imagine if we were to impose term limits on all government servants. The ripple effect of this one act alone as it spread thru out all of society would be immense. Our founding fathers got this one right.]

So What Is It That Gives A Nation’s Money It’s Value?
There is enough truth and insight to be found in Mr. Amer’s quote that we could simply stop right here, point to it all, and then call it a day. But to single out just one important truth we must pause to recognize that in saying these words:

“The exchange rate should reflect market and economic forces”
In this he captured the essence of the business cycle in an open and public acknowledgement!

Economies across the developed world have been contracting (called deflation) for several years and we should not be surprised that nations are devaluing their currency to simply reflect this new level. A currency is therefore first and foremost a reflection of a nation’s economic output despite what any leading economist might wish you to believe.

To go a level deeper here? In the past decade the relationship between a nation’s economic output and the declared value of its money, as well as the supply of money, has been stretched like a rubber band ready to set sail. The proper balance of these things is open to some debate but make no mistake, there is a relationship that exists here and as we see the value of any given currency suddenly shift we are simply watching the rubber band taking flight as the business cycle, the unseen force, is telling us that “yes, an imbalance was present”.

Economic discussions can appear quite complex and deep but surprisingly the deeper I go the more I appreciate that this stuff is not rocket science. The ability to understand how things truly function is right there for us to discover if we will but roll up our sleeves and observe it.

Opposing Forces At Work
Ok, so now let’s look at a fictional country “nation A” and observe that they have a currency pegged to the USD which is rising relative to their own. We also see that nation A has been bleeding foreign currency reserves (USD) attempting to maintain their fiat value internally. In the example that follows here we are going to now see that the exact same “fixed” relationship between these two currencies also creates an opposing force when we look at it from the lens of nation A’s debts.

Since 2007 emerging markets have borrowed heavily into the USD to the tune of about $9T dollars. This is a big deal and is a story still being written. With historic low rates of interest being offered to borrowers let’s assume that nation A has partaken in this bonanza of liquidity that has been offered so freely at such attractive terms.

As long as an equilibrium exists among currencies then life is good and the party goes on however we know that ALL things move in cycles so where does the downside of this equation kick in? Is there even a downside here to discuss? The money that they have borrowed, when denominated in USD, has great implications to them if the USD rises in value without a corresponding increase within nation A’s own economy. If we recognize deflation as being present then we also expect nation A’s GDP to contract, the opposite of what would be needed to support the USD denominated debt. Even tho the face amount of what is owed has not changed, the debt has effectively grown by simple virtue of a change in the relative values in the currencies! This can be expressed as the debt rises in “real terms” vs. “nominal”. To view this as a form of hidden tax would not be incorrect here with the added “tax” flowing FROM nation A’s economy.

Remember The Swiss Franc?
This then becomes a discussion of “currency risk”. We never want to be the debtor who has borrowed funds into an appreciating currency. Why is that? Well to attempt and make it plain we must place ourselves in the shoes of nation A. We must view this from THEIR perspective. They earn a wage within their own economy and are paid in their own currency and then pay their debts FROM that same currency right? But what if the debt is owed “externally” and is denominated in a rising USD? The debt has now suddenly grown.

Their hard earned money is worth less than the day before when expressed in relation to the rising USD such that they must input more of their money to equal the same value as it had when the debt was originated.

[note: This was the precise failure of many businesses and private parties who had CONFIDENCE in the peg and borrowed heavily into the Swiss Franc only to be ruined in early 2015. Again, when we reach extremes all nations become introverted and return to domestic policy. Switzerland’s big currency move was actually EXPECTED and PREDICTED…..but only by a select few.]

A quick story here about the Swiss Franc may also help illuminate this concept. For several years most of Switzerland’s neighbors borrowed funds in the Swiss currency and it made good sense on paper to do so. Or at least it “seemed” to be a no brainer. For example, Polish banks lent out vast sums of money in personal mortgage debt all across their nation and all tied to the Swiss Franc. These bankers sold their citizens this debt, denominated in another nation’s money and made no effort to explain the concept of currency risk to them. And why should they have?! Assuming the bankers even grasped the nature of this risk, who among the common people would have cared or even understood?! The party was good…until it wasn’t.

You can imagine the fallout here when the Swiss Central Bank de-pegged from the Euro and saw their currency shoot up 30% overnight! Many thousands of young Polish couples just starting out in life, having babies and trying to make ends meet, were slapped with an overnight 30% increase in their mortgage debt! Multiply this story by hundreds and you’ll have some understanding of what currency risk “feels like” still today to many people across Europe.

So we have competing forces at work here. Does nation A maintain a lower relative currency and reap the near term economic benefits; taking their losses effectively on the back end? Or does it compete against the rising USD and service it’s debt at the most favorable exchange possible while allowing things internally to wax worse. This event is far from over and will be something to watch for sure.

I have resisted the urge to expand this discussion into the new financial system that will employ a new supra-national currency ABOVE the central banking level. This has been covered separately in great detail so please just appreciate that there is much that could be said here that is not.

This Too Shall Pass
Pulling this together, the world is not about to end tomorrow or anytime soon from my vantage point. Nothing is forever in this world and it’s economic engine will regain new life and the trend will slowly reverse. But in the near term as economic forces continue to cause capital to concentrate there will be further effects from the combined one-two punch of a rising USD and deflation that is yielding deflating GDP’s, less tax revenue and thus less capital to repay sovereign debts.

Far from the often heard narrative that the dollar is about to crash and burn, capital flows (medium and likely even long term) are going to continue INTO the USD as it is the only what? The only game in town wherein big money can go. China is not yet ready for prime time and money cannot just go into a hole. Even the American economy CANNOT hold all of the capital that is headed our way which again brings us full circle back to the SDR.

ADDITIONAL READING: https://www.armstrongeconomics.com released a blog that not only fully supports my thoughts illuminating the worldwide destruction being wrought by a strong USD but he touched on the exact same global concerns as well. It is a short read packed with a punch. I offer it to any serious student as support to this topic:

The Euro and Why the Dollar Will Not Be Dethroned
*** http://www.gulf-times.com/story/501670/Targeting-exchange-rate-was-a-grave-mistake-says-E







  • Good day My Ladies
    How do you “measure a nations true economic out put ” ? In the business cycle model there are un- foreseen
    variables such as wars and natural disasters. Alliances among nations change and the balance of economic
    and military power shifts when they do. The US economic out put since the end of world war two has been
    to a large measure fueled by the arms race has it not ? The IMF, UN, WSB etc. all came into being after WW2
    did they not ? Is it just a rumor or conspiracy theory that the World Court declared the US to be bankrupt ?
    What now really backs up the value of the US dollar if not the confidence that other nations have in it ? The
    laws of economics may not change but the balance of military supremacy has a profound effect on these. For example both the Russians and the Chinese continue to build up their military might while the US’ appears to be in decline.



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