Thursday, 13 May 2010

The $1-trillion misunderstanding

John Mangun
Outside the Box
Business Mirror

In the early 1960s, a rather bold book was published titled The $100 Misunderstanding. It tells the story of a college student who meets and spends an extended weekend with a teenage, barely literate prostitute. During the course of their time together, and between the sexual encounters that they both enjoy, he takes her to museums that she has never seen, puts her on the path to finding the father who abandoned her, and builds her confidence by showing her how she can learn to read.

The young man does all that he thinks he can and should, to change the relationship to something different. Yet when the next week comes, it is all about the $100 he owes her for her sexual favors. And he catches an STD.

Even as we have been focusing on the elections, the most amazing events have been unfolding on the global financial scene. After weeks of talk and negotiation, the European Union (EU)—with the International Monetary Fund (IMF), which is funded in large part by the US—agreed to put up $1 trillion to support the euro currency.

While the talk is all about a bailout of Greece and other bankrupt national governments in Europe, it is really about the currency.

To give you an idea of how much money $1 trillion is, the annual gross domestic product of the Philippines is about $170 billion. $1 trillion is equal to almost six years worth of the total economic activity of more than 90 million Filipinos. If that $1 trillion was distributed to everyone in the country, no one would have to work, all businesses could close, and we could all go on vacation for six years.

Currency only works as a medium of exchange and store of wealth if people believe that the currency will have value to someone else in the future. If a particular currency loses its credibility, people will change from that currency to another that they believe will continue to hold future value. Perhaps the most important factor of credibility is that the government will not print too much of a particular currency because an oversupply of “money” reduces its value in relation to goods and services.

A friend once told a worker who was on strike for higher wages that he would be glad to triple basic salaries. But then again, he would have to triple the price of the goods that he sold. The worker thought about it for a moment and decided that was not a good deal since he, too, purchased the company’s products. There was not any net gain if there was too much money for wages.

It works the same way in an economy.

One local economist is suggesting that the Philippines peg the peso at 55 to $1 to help exports, those who use remittances, and foreign investors. Yet would there be any net gain if that overseas Filipino worker’s family gained more pesos and then had to pay 20 percent more for gasoline, imported milk products, and electricity? Of course not!

The purpose of the $1-trillion European “loan package” was to support and strengthen the euro. The idea was that confidence and credibility would be gained if the financial markets knew that the EU was ready to buy the euro in exchange for other currencies, primarily the dollar, thereby strengthening the value of the euro against other currencies. But the financial markets are not foolish. More euros in circulation mean less future euro value. The euro fell from 1.30 to the dollar, before the $1 trillion was allocated, to 1.26 to the dollar afterward.

Because there is no intrinsic value to any modern currency, printing more paper money actually weakens, not strengthens, its future value.

A silly analogy might be that the poor man reaches down to pick up a P1 coin while the rich man, who has many pesos, ignores the coin, although they can both buy the same amount of goods with that coin.

The EU leaders, the IMF and the US all acted like the young man in the story I mentioned above, trying to convince the “wolf pack” of the financial markets that good intentions and a good heart could change the relationship. But like the young prostitute, the wolf pack is only interested in money, the profits. They sold the euro and bought dollars. And knowing that the dollar is losing future value, they also bought yen and the British pound. But the currency that they know is not going to lose value is gold. Gold broke through to historic highs against both the euro and the US dollar.

The pound may be next, and soon the yen and eventually the dollar will be eaten by the wolf pack. The last two currencies that will fall will be the Canadian dollar and the Swiss franc, but they will all fall as people turn to gold and currencies like the Philippine peso in countries that are more financially stable and where there is confidence in the long-term value of the currency.

Major stock markets will fall also as stock prices will not be able to keep up with currency depreciation. China has already entered a bear market as inflation hits another 18-month high and their property/stock-market bubble begins to burst.

Major governments are running a massive pyramid scheme trying to convince the markets, to pretend, that if 5 kilos of carabao manure has little value, maybe 20 kilos will have more value.

Also, do not listen to any nonsense about a bad Philippine economy or the nation’s financial stability. Unless the Aquino administration makes some very foolish monetary- and fiscal-policy mistakes, foreign capital inflows will rise dramatically in the next 12 months as foreign money leaves its own burning financial houses.

The major countries’ financial systems are so incredibly weak that countries like the Philippines are financial giants in comparison. Buy the peso. Buy the PSE. Buy Philippine government debt. You will not lose.

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