Today I want to talk about Ray Dalio’s article, “The Changing Value of Money,” which is linked at the end of this post!
The State of Currencies Today…
The dollar, euro, and yen are in the late stages of their long-term debt cycles. This could mean that in the near future our dollars could be potentially worthless. One of the reasons Ray Dalio says were are at the end of a long-term debt cycle is because debt is at an all-time high, and interest rates are at an all-time low. This makes holding our currency very risky. We have more and more debt piling up very little return on the dollar. Additionally large amounts of new debt are being created and monetized with COVID-19. Big devaluations and/or the loss of reserve currency status by the leading reserve currencies would result in the most disruptive economic event we could imagine.
Printing and devaluing money typically is the easiest way out of a debt crisis. While in a debt crisis, people have a tendency to hold cash, when in actuality the dollar is being devalued. Big devaluations and/or the loss of reserve currency status by the leading reserve currencies would result in the most disruptive economic event we could imagine.
The 4 Options to Bring Down Debt
Policy makers have four options to pull to bring debt and debt service levels down relative to income and cash flow levels.
Austerity means spending less money. Austerity is deflationary and doesn’t last long because it’s painful. It is also hard to implement or force people to spend less.
#2 Debt defaults and Restructurings
Debt defaults and restructurings is also painful and deflationary and typically happen over a short period of time. These occur when a debtor can no longer handle their obligation and the creditor had to default on this obligation. As a result, defaults and restructurings are painful for both the debtor and creditor. The debtor goes broke and loses their assets. The creditor loses the wealth arising from having to write down the debt.
#3 Transfers of Money and Credit
Transfers of money and credit means taking wealth from those who have plenty and transferring it to those in need. In order to do so the government must raise taxes on the wealthy to redistribute wealth. This is politically challenging but a more tolerable solution compared to the first two ways.
#4 Printing Money
In comparison to the others, printing money is the most expedient and common way of restructuring debt. However, it is the least well-understood. In fact, it is deceiving. On one hand it appears beneficial, because it helps to relieve debt squeezes. In most cases it appears that people are getting richer, but as a bi-product it causes inflation. Inflation goes hand-hand in with the devaluation of money.
Most people don’t pay attention to their currency risks. Most worry about whether their assets are going up or down in value. They rarely worry about whether their currency is going up or down in value…
Of the roughly 750 currencies that have existed since 1700, only about 20% remain. In 1850, the world’s major currencies wouldn’t look anything like the ones today. Many were completely wiped out. Others were merged into currencies that replaced them. Some remain in existence but were devalued, like the British pound and the US dollar.
What do currencies devalue against? Debt. The goal of printing money is to reduce debt burdens, but Ray Dalio says that in the late stage of a long-term debt cycle, printing money is not effective. During the late stages of a long-term debt cycle, the amount of debt and money is so large that it’s tough to tranfer it for the amounts of goods and services on those claims. This occurs in combination with low interest rates. When monetary policies like printing money don’t work anymore, there is a high likelihood that there is a breakdown in the currency and monetary system.
Let’s keep in mind that there are two types of currency devaluations.
The Two Types of Devaluations
1) Systemically beneficial. These are always costly to the holders of money and debt because money is worth less and the holders of debt assets get less.
2) Systemically Destructive. These ones damage the credit/capital allocation system, but are required to wipe out the existing debt in order to create a new monetary order.
Currencies devaluing and currencies losing their reserve currency position aren’t necessarily the same things, though they are caused by the same catalysts.
As previously explained, when central banks increase the supply of money and credit, they reduce the value of money and credit. This is bad for holders of money and credit, but it is a relief to debt burdens. When this debt relief allows money and credit to flow into productivity and profits for companies, real stock prices rise. However it can damage the actual and prospective returns of “cash” and debt assets. It can damage them enough to drive people out of assets and into inflation-hedge assets or other currencies. This leaves the central bank with the choice of either raising interest rates, to the detriment of the economy, or preventing rates from rising by printing money and buying cash and debt assets. The second path is the path that the U.S. economy has adopted.
Inevitably, they will follow the second path, which reinforces the bad returns of holding “cash” and those debt assets. It is plain to see that we are experiencing unprecedented times.
If you like my thoughts on Ray Dalio’s “The Changing Value of Money” please comment below! I would love to hear your thoughts or requests for more ideas of what I should post. Thanks.