Would you like to lend money to someone you don’t know, who you don’t know if they’re going to pay you, who doesn’t have any backing or guarantee and who also changes their mind every five minutes? Probably not. Well, the same thing happens with money. Trust is the basis of its value and its functioning. Trust in the issuer, who is the one who creates and puts money into circulation.
Who is the sender? It can be a central bank, a government, a company, a person, or even a computer network. How reliable is it? It depends on whether you have the ability and the will to meet your commitments, if you have your house in order, if you offer me stability, certainty and predictability. If we begin to doubt the reliability of the issuer, trust may be one step away from being lost.
What is the most important thing a currency must have to serve as a medium of exchange? No, it is not the color, nor the size, nor the design. It is stability. Stability means that the currency keeps its promise to be able to buy things with it. For example, if you have a 10 euro note, you expect to be able to go to the supermarket and buy bread, milk and eggs. Or pay electricity, water and internet. Or even taxes (although that’s not much fun). But if the currency loses value rapidly (inflation), or no one wants to accept it (illiquidity), or the government that issues it is bankrupt (bond market), then your 10-euro bill may be worth less than the paper it’s on. printed. And that’s not funny.
Developing countries are largely used to having bad governments that spend more than they take in. Instead of exporting products with added value, such as technology or industry, they are dedicated to selling raw materials and agricultural products, which do not give them much benefit. And on top of that, since they want to live like in the first world, they import everything they can, from cars to clothes, which generates a large trade deficit. And how do they finance all this? Well, by borrowing money from international organizations, which then charge them very high interest rates and impose very harsh conditions on them.
Inflation is the general increase in the prices of the goods and services we consume. If there is a lot of inflation, money loses value and you cannot buy the same as before with the same amount. This is very common in developing countries, especially in Latin America, where there are extreme cases such as Venezuela and Argentina, which have such high inflation that it seems like a joke. But Latin Americans do not give up and manage to have savings and be creative. Because they know they can’t really trust the currency issued by their government, that it is an unreliable issuer.. Do we have the guarantee that the Venezuelan or Argentine government will fulfill its promises? Can we trust his word?
Due to this distrust, what is normally done is to take that money out of the country and place it in the United States or Europe. The poor financing the rich! Because? Because these “rich” have proven to be more reliable because they offer greater stability than the poor who, due to indiscipline and waste, what they do is devalue their currencies. In addition, due to political instability, a charismatic leader could arrive at any moment and destroy the institutions with the support of the people. And, in the heat of a speech, he can say that he is not going to pay his debts to the “Empire” while he is applauded by a euphoric audience. Due to this political and economic instability, many developing countries are not very attractive to the world’s big capital. Because whoever lends money or invests, he wants his money back. And, logically, it does not like to lend money to delinquent or low-credibility actors.
Have you ever wondered why the dollar is still the strongest currency in the world despite inflation in the United States? Well, it turns out that inflation is not just a problem for gringos, but a global phenomenon that has to do in large part with the effects of the pandemic on production and distribution chains. And also with all the distortions it has caused in the labor market. So, of the bad, the United States is still considered the least bad. And the evidence is the great rise of the dollar during the last two years. International investors realized that everything is wrong, and that all currencies are falling. The dollar is bad, but not as bad as the others. Thus, by default, it remains a (relative) refuge.
Now, then came the banking crisis. But international investors very soon discovered that we were not in a banking crisis as such. In reality, it was a crisis limited to regional banks. But the big banks were, in fact, better off than before. So the solution was simply to move the money from the smaller banks to the larger ones. Ready.
But then came the crisis around the debt ceiling. And here things do become quite worrisome. We all knew that sooner or later a solution would be found to avoid default, which would have epic consequences. Finally, an agreement was reached. Thanks to the one above! But that crisis revealed to us the enormous political polarization in the United States. The division is extremely large. Extremism is growing at quite alarming levels. Where are the moderates? Where is the center? What we have now, it seems, are right-wing extremists and left-wing extremists. In other words, at any time, one can build a Latin American one: populist leaders, street confrontations, debt defaults, and things like that.
Imagine an international fund manager thinking about buying 30-year Treasuries after seeing the debt ceiling debate. The radicalism is such that I assure you that there are politicians who are willing to default just to see the Biden government plunged into chaos. We saved ourselves this time, but this mess doesn’t inspire much confidence. Because this can get worse.
Is it time to buy 30-year T-bills? Frankly, because of this tendency toward extremism, it’s scary. This doubt, sooner or later, will have an effect on the reliability of the dollar.
Disclaimer: The information and/or opinions expressed in this article do not necessarily represent the views or editorial line of Cointelegraph. The information presented here should not be taken as financial advice or investment recommendation. All investment and commercial movement involve risks and it is the responsibility of each person to do their due research before making an investment decision.
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