Saturday, April 17, 2010

Fiat Money and Market Crashes

In 1971 the world of modern finance and economics permanently changed, as the U.S. Dollar’s value was fully delinked from gold. Ever since then the world has operated under a fiat-based monetary regime that historically has never been successful. Indeed, there is an appearance of prosperity for a time, yet the very nature of a fiat monetary system is of an ever-increasing instability and potency of financial crises. The reasons are simple: rampant money creation provides the liquidity to fund investments that are not aligned with future demand. Keynesians and monetarists cannot distinguish that money creation (i.e. fiat) is not capital; they view them as one and the same. They also support that a central bank manage (i.e. manipulate) the price of money (i.e. interest rate). The primary beneficiary of our fiat-based monetary system is the U.S. Dollar, as it represents the world reserve currency. This means that the main side effects (i.e. price inflation) have been passed on to foreign nations, which over the last 40+ years have become more homogenized into the world economy. Invariably, the additional money creation from these foreign nations funds assets ever further. The inevitable result is an overvalued asset which at some point must implode. In order to stabilize an asset price implosion is a further liquidity boost (i.e. printing more money than before). And the pattern repeats itself until money printing gets to a point where the currency fails. This has happened to all fiat-monetary systems in history. Our present age is no different.

Let’s look back to some of the major financial crises since 1980.

1982: Emerging market debt crisis.
1987: U.S. stock market crash
1990: Japanese stock market crash
1994: Bond market crash
1998: Asia financial crisis/Long-Term Capital hedge fund insolvency
2000: Technology stock market crash
2006-2007: U.S. housing market crash & subsequent stock market crash (in 2008).

The most recent financial meltdown has been the one of greatest intensity and longevity since the institution of the fiat monetary system. As a result, it required an unprecedented amount of money printing to stabilize the system. The money printing represents future obligations (i.e. debt) which should be paid but never will. Our economic future doesn’t bode well, despite what U.S. elected leaders say. As can be noted, every 4 years or so we’ve had a major crisis. There is no evidence that this patter won’t be sustained. However, it is difficult to predict how much longer we have until the present market rally peters out.

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