by Simon Black: A
Look Back, and Some 2011Predictions
Without a doubt, the existing global financial system depends on
the widespread use of fiat currencies issued by insolvent governments.
The wealth of the world’s large financial institutions requires
that there be currencies with sufficient size and circulation to
absorb massive capital flows.
The current system is based primarily on the dollar; with a $14
trillion economy, the United States was for years the only country
in the world with a sufficient money supply and financial infrastructure
to take in the preponderance of the world’s wealth.
It is for this reason commercial loans, commodities contracts,
international reserves, and cross border settlements have traditionally
been denominated in US dollars.
Competing reserve currencies arose with the advent of the euro
and Japan’s post-war rise; while the dollar has continued to
remain dominant, these three are the only currencies which have
the necessary supply and credit rating.
With trillions of dollars floating around the global financial
system, managers are constantly making capital allocation decisions,
moving funds in and out of various instruments. The reserve currencies
play a big role in this because unallocated capital is frequently
parked in their bond markets.
For example, large corporations or banks that are sitting on billions
of dollars in cash typically purchase short-term US or European
government bonds because the low default risk.
The dollar, euro, and yen have bond markets of such size that getting
liquid is never a problem, even for billions of dollars. There is
always a market for treasury securities, hence they are considered
You couldn’t do the same thing in the Kingdom of Bhutan with
its tiny $3.5 billion economy. If you tried to move $100 million
into Bhutan, its currency (the ngultrum) would spike. In the US,
Europe, and Japan, $100 million barely registers a blip.
Over the last few years, though, the confidence has begun to fade
quickly, and the reserve currency issuing governments are starting
to be viewed with increasing skepticism.
The thing that’s missing right now is an acceptable alternative.
There’s really nothing out there in large enough scale to withstand
massive capital flows, and as I have written before, the game is
now one of judging the “least worst” of these three major
In what seems to be a 6-month cycle, the dollar and euro have been
jockeying for the u201Cworst of the worst” title; markets focus
on Greek woes for a few months, then turn their attention back to
California and Obamanomics.
With Bernanke’s “100% certainty” and nonsensical
economic numbers coming out of the America’s Ministry of Truth
(Newspeak: USMiniTruth), we seem to be back in a period where the
markets are more concerned with Europe. I think that Japan will
be called to the carpet before too long as well.
As such, in an almost ritualistic cycle, financial markets are
shifting funds around these currencies… the analogy I like
to think of is like a series of buckets.
Imagine three buckets and an increasing volume of water. Capital
allocators are essentially dumping the contents of one pail into
another – from the dollar bucket into the euro and yen bucket,
and from the euro bucket back into the dollar bucket.