Saving and Banking in a World of Monetary Chaos

What is money? Every finance student is taught that money can be defined as any of the following:

  1. A store of value
  2. A medium of exchange
  3. A unit of account
  4. A common measure of value
  5. A means of payment
  6. A standard for deferred payments

As a multitude of items can satisfy the above requirements, we see that money is basically a social convention.  Consequently, money can take on a variety of forms.  Most modern day societies use a form of paper and digital bank balances (bank entries).

Convertibility

One can imagine a time when different societies first began to interact.  At that time, people would trade various goods on a bartering basis.  As the number of interacting societies and the level of trade grew, however, it became necessary to develop an easier system of exchange, one that was more efficient than direct barter.  Money was therefore developed as a convention to facilitate trade.  Money is not a direct good, but it has value simply because society accepts, or is forced to accept by legal tender laws, its “convertibility” into other goods and services.  Money therefore is a derivative.  Money derives its value either from the basic nature of the item into which it is convertible or because of the effort that was expended in obtaining it.

Why use Precious Metals, Commodities or Bitcoin as Money?

Commodities (hard money) and bitcoin (global internet currency) lend themselves as candidates because each has intrinsic value apart from their use as money.  Gold and silver, for example, if not in coin form can be used in jewelry or industrial applications.  Consequently, the convertibility feature of hard money currencies has been less prone to breakdown because hard money is a real asset.  The absolute convertibility feature of hard money was important in a world where governments, societies, and kings were frequently overthrown.   Moreover, certain commodities like precious metals have the added features of being convenient, easily stored, uniform in appearance, and portable.  Enter the bitcoin.

What is Bitcoin?

First, bitcoin is convenient, easily stored, uniform, and a perfectly portable global digital currency.  Its value is derived not for what it is, like gold and silver, but rather from what it is not, a centrally controlled, and therefore, taxable and confiscatable, form of money.

The Wikipedia description of bitcoin seems adequate for our purposes:

Bitcoin (sign: BTC) is a decentralized digital currency based on an open-source, peer-to-peer internet protocol. It was introduced by a pseudonymous developer named Satoshi Nakamoto in 2009.

Internationally, bitcoins can be exchanged by personal computer directly through a wallet file or a website without an intermediate financial institution. In trade, one bitcoin is subdivided into 100 million smaller units called satoshis, defined by eight decimal places.

Bitcoin does not operate like typical currencies: it has no central bank and it solely relies on an internet-based peer-to-peer network. The money supply is automated, limited, divided and scheduled, and given to servers or “bitcoin miners” that verify bitcoin transactions and add them to an archived transaction log every 10 minutes.

Is Bitcoin the only internet currency?

No.  In fact, Amazon intends to roll out Amazon Coins in May for Kindle Fire owners.  These internet coins, however, are more limited in their convertibility than bitcoin.

Enter Cyprus?

Even Wikipedia and governments cannot keep up. The value of the bitcoin market at March 22, 2013 is above $800 million in value largely because of the wealth tax being placed on depositors around the globe.  A bitcoin in the U.S. is now worth over $74 as of March 25, 2013 (source: bitcoincharts.com) up from less than $40 a year ago.  In the U.S., Japan, and Europe the war on savers takes the form of zero interest rates and the regular issuance of increasing amounts of worthless government debt.  In fact, the U.S. Senate just passed a budget bill that won’t balance in the next 10 years.  In places like Cyprus, the hit is more direct.  Depositors in the Cyprus woke up last week to find their money frozen, their banks closed, credit cards frozen, and deposits subject to some level of “tax” or confiscation yet to be decided by the politicians.  The debated ranges for the tax have been between 3% and 15% depending on the size of one’s account.  If companies exist to provide utility to their customers, then what is the value in this action?  What is the incentive to keep a deposit in an account that pays no interest and can be frozen and confiscated?  The natural question for global investors becomes, what interest rate would be necessary to compensate a saver for subjecting their wealth to such potential taxes.

How serious is this trend?

The Wall Street Journal in its article “Web Money Gets Laundering Rule” shows that the authorities are now taking notice of bitcoin.  This is always done under legal tender laws, which are designed to go after “illicit” activities, but when have those engaged in illicit activities been concerned about the laws?  There is a reason the Secret Service is the agency tasked with counterfeit crimes and defending the President. Make no mistake, legal tender laws are about limitations on freedoms and taxation on both the criminals and law abiding citizens alike.  Big brother is watching both.

U.S. Policy

While U.S. investors may look at Cyprus as a side show, the reality is that the taxation on wealth rather than the taxation on income is the formal policy of the United States.  The chief executive of the country, openly stated that he wanted to “spread the wealth around” and Bernanke’s negative interest rate policy raises the prices of financial market goods directly and other goods indirectly.  All this is accomplished through the use of newly created digital entries ($85 billion a month currently, and over $3 Trillion in the last 4 years).  This inflation is accomplished by the Central Banks purchasing of bonds, which thereby pushes interest rates ever lower, and other financial asset prices higher because of the lower discounting rate.

What is Money?

The growth in bitcoin is a clear example that apart from legal tender laws, global currencies and the global banking systems, are quickly losing their value because they are failing in the number one function that defines money:  acting as a store of value.  In fact, U.S. dollar bitcoin prices are up over 65% in the last month.  Gold and silver have increased in value for 12 straight years.  We live in a world of monetary chaos because central banks do not believe that currency should act as a store of value.

How does an investor protect themselves against wealth taxes and global monetary chaos?

  1. Diversify currency
  2. Invest in productive assets
  3. Take physical delivery and title on some portion of assets

Many items and strategies can satisfy the above criteria: gold, silver, yuan, and yes even bitcoin.  Stocks, private equity, and commodities all certainly satisfy number two.  One could also consider investments in those subsidized industries like banking, which is currently benefiting from the financial repression as well as consolidation.  Item number 3 returns an investor to a world as it used to exist where it may make sense to take physical delivery of some currency, coins, and certificates of ownership of securities.

As a firm, we are set up to facilitate any of the above.   We can transact in over 23 currencies, gold and silver, sorry no bitcoin here (yet), and we advise on stocks and bonds. In addition, we provide financial planning services where we examine issues like the titling on accounts, risk mitigation, and tax considerations that are separate from the underlying securities themselves.

Allen R. Gillespie, CFA is a partner with FinTrust Investment Advisors, in its Greenville, SC office.  For more information, call 864-288-2849 or e-mail agillespie@fintrustadvisors.com.

 

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