Money is Worthless

Since I wrote my previous blog about money the news has been everywhere about two (by the time this is published, probably more) banks have imploded. The reasons for these crashes are in one sense rather absurd. They had lots of money.

Yes, the banks had lots of financial deposits. The question therefore arose: what to do with all this money?

Let me back up.

For years I have been saying quite simply that modern money isn’t worth anything. What on earth did I mean by that?

Let me back up even further.

When I first started my property business which was rather a long time ago, I needed money. I had to pay for it. In short, I borrowed money which came at a cost. That cost was 10% or sometimes even 11% p.a.

Let me put that slightly differently. The use of that money was considered in the open market place to be worth 10% a year.

Now let’s fast forward to today, or should I say last year. Throughout the world money could be borrowed at a basis rate of approximately zero per cent. A bit was added on to pay the bills of the company lending the money, but the actual money itself was said to be worth 0%.

Excuse me but isn’t that tantamount to saying the money isn’t worth anything?

So where are we now?

Well, actually we are not a lot further forward. In fact it could be argued that things are even worse. Today, around the world, money is worth less than nothing.

Let’s do the maths.

Let’s take the dollar as still the prime unit of money on the planet, and the 10 year Treasury Bond as the standard value marker. What is that currently paying? At the time of writing 4.5% or thereabouts.

What is the current rate of inflation?

That’s an awkward question. It depends on how you do the counting. The official figure is round about 7%, but is probably nearer twice that. But for the moment let’s not argue with the official figure.

To use someone else’s money for a year will cost you 4.5%. At the end of that year the money you pay back will be worth 7% less. In other words the lender is paying you 2.5% to take the money off his hands for a year. Does that make much sense to you? Doesn’t that tell you the money has become a wasting asset?

Let’s generalise from that.

Doesn’t that tell you there is something seriously wrong with the money? The money in your pocket is simply wasting away.

Let’s move forward a little further.

Doesn’t that mean we need new money? Money which doesn’t waste away?

Now let’s go back to the consequences of what I’ve just said.

Three US banks have recently failed. Those banks had plenty of money in their vaults. The trouble was, because of the above situation, money being not worth anything, or rather, money being a wasting asset, those banks had to try and do something productive with this wasting asset or they’d go broke.

Being banks they took what under normal circumstances would be considered a careful approach; they invested in reasonable secure securities.

The trouble is that short term securities dont pay much. In order to get any half-ways sensible return for their investments they invested in longer term bonds.

Over the past year interest rates have gone from effective 0.25% returns to effective 4.5% returns. As the return on the bond goes up, its value goes down. The idea is that at the end of the bond’s life you get back what you paid for it.

If anyone out there doesn’t get that, I do realise that they dont teach much that’s useful at school, so here is a quick update.

You invest £100 in a bond. The bond is advertised as paying out 5%. In other words, you would get £5 every year as the return on your investment.

Now suppose that same bond can be bought a year later for only £50. The coupon, or payout you get on the bond is still £5. That means you are being paid 10% on your money. As the price halves so the payout doubles, and vice versa.

Back to the bust banks.

In this case, the new bonds pay out 4.5% whereas the old ones paid out 0.25%. In other words the payout has substantially increased so the price of those bonds has dropped drastically.

In other words, the money paid out by the banks to get a return has crashed. Sell the bonds to get some liquidity and you immediately create a loss.

Didn’t I make the point last week that the current problem with investments in the international money markets is that every investment has a counter-party, and that all these investments are based upon borrowings. One debt is security for another debt, and so on all the way down the line.

It’s not difficult to work this out. And do remember the Federal Reserve Bank employs around 400 PhDs to manage all this stuff.

Not very good at it, are they?

And we have only just started. Expect a lot more unwinding in the weeks ahead. The real slide has only just started.