The Strange Case of the Economic Fall

Just as autumn follows summer, it seems that human behavior patterns follow some kind of seasonal rhythm when it comes to the economy, because it has more to do with human needs than anything else and these change over time. 

In this analogy, in the economic summer things are going well, banks grant loans with good rates, there is liquidity, there is an abundance of products and services, with prices to bargain, people have the chance to meet their basic needs, to experience new sensations, to plan, to project into the future with confidence and tranquility.

When an economic summer situation occurs, society as a whole is relatively happier.

On the contrary, when unmistakable signs of economic fall appear, of high interest rates, inflation and scarcity, human behavior takes a turn towards contraction, with greater restrictions when starting new projects, with a lesser tendency to experiment, and in general uncertainty makes appear more pessimism in the environment.

According to my analysis and that of many others, we find ourselves today at a pivotal moment in world economic history.

There are several events that have been unfolding behind the scenes that signal a change of seasons in the economy.

Many will not see this change coming and are going to be hit hard.

This essay raises some milestones that would indicate this change and also raises some possibilities to take shelter, in the event that we must prepare for a seasonal change, such as when autumn arrives and the afternoons get colder.

A little history

The US dollar has been the world's reserve currency since the Bretton Woods agreement in July 1944, almost at the end of World War II (1), when most of the allied countries met to define the post-war financial system.

In this agreement it was defined that the American dollar would be the strong currency (the standard for international transactions) due to the industrial strength of the United States, due to the large amount of gold that the country had managed to store and due to its great war capacity, which gave enough confidence to achieve and maintain the long-awaited peace.

According to this agreement, the dollar could be exchanged for an exact amount of grams of gold, which was kept in the Fort Knox reserve, and which gave physical support to the currency.

This Agreement generated the high demand for US dollars worldwide since then.

In August 1971, a serious breach of the Bretton Woods agreement occurred when US President Richard Nixon detached the dollar from gold, that is, from that date there would no longer be a direct relationship between the amount of dollars and the amount of gold stored.

Despite the seriousness of the fact, the economies of the world accepted the new conditions without complaint, under Nixon's promise that the detachment of gold and the dollar would be transitory.

Since then, the dollar and all the currencies in the world have become fiduciary, that is, based on a promise of value delivered by the central banks of each country.

After Nixon's decision, the dollar could begin to be printed in unlimited quantities since it was not tied to the availability of gold. From there the monetary base (amount of money) skyrocketed.

51 years later, the US dollar remains detached from gold and most likely will remain so.

This fact would be, according to our example, the beginning of summer for the world economy, since the central banks and consequently all the banks in the world were able to expand credit to companies and individuals with almost no restrictions, generating an increase in consumption, spending and wealth.

But every action has a reaction, so the gold-detached dollar standard, massive monetary expansion and excess credit have already begun to show signs of failure.

Four signs of seasonal change

First Sign: The Subprime Crisis

Fast forward to 2008, with the collapse of the giant US investment bank Lehman Brothers, the biggest global bankruptcy to date.

The excess credit (leverage) of many banks, companies and individuals meant that a small variation in liquidity quickly left entire institutions without money, infecting the global financial system.

The Federal Reserve of the United States (Fed) had to come out to rescue the entire financial system by printing trillions (millions of millions of dollars) for several years, also reducing interest rates to zero or even negative, to make credit cheaper.

It seems that without this constant injection of capital the world financial system could not stand.

When the Fed wanted to end the aids, another signal occurred.

Second sign: The Repo Market

In mid-September 2019, the North American interbank short-term credit market (Repo) had a failure.

The Repo market is about daily credits that international banks make among themselves to maintain the necessary liquidity to operate with large transactions, therefore, this is an invisible market for common people.

This market is based on the confidence that banks will return the money from each of these transactions in a short period of time.

On the indicated date, it seems, confidence ran out and once again the Fed had to go out and generate emergency loans to banks to prevent them from going bankrupt and generating another crisis like the one in 2008.

These Fed loans to financial institutions around the world have continued ever since, indicating that there is not enough confidence among banks.

This, by itself, is a very bad sign.

Third Sign: The Financial Response to the Pandemic

In 2020 and 2021, millions of workers through the world lost their jobs due to the confinement generated by the pandemic.

Countries responded by generating various financial aid to help overcome these hard times. Something unprecedented in human history.

The world's central banks printed trillions of dollars, euros, yen, yuan and pesos to finance aid.

In the case of the United States, more dollars were printed in two years than in the first 200 years of that country's history. There are sources that indicate that 80% of the dollars printed in the history of the United States were created since the beginning of 2020.

If we go to the definition of inflation this is it; "An increase in the monetary base", that is, after the pandemic, the highest monetary inflation of the last two centuries has been generated.

Fourth Sign: The Beginning of the End of the Petrodollar

When Nixon ended the gold-dollar attachment in 1971, there was only one technical reason left for countries to need to hoard US dollars; the Petrodollar accord.

This agreement signed between the United States and Saudi Arabia forced all oil purchases to be made in US currency, in exchange for aid and military protection for the Saudi kingdom. Until today, this situation obliges all countries to hoard dollar reserves to finance their oil purchases.

While the petrodollar accord still stands, there are signs that both China and Russia are trying to oust the dollar from this deal and Saudi Arabia seems to be interested in that.

When this happens, the US dollar will lose its only anchor as a reserve currency and an economic paradigm shift will take place that can be deadly. What I mean is that the United States will not let this situation happen without fighting where it knows best, on the battlefield.

One of the reasons for the West's support for Ukraine in the war with Russia is based on the financial dominance of the dollar.

Recession or change of model

The resultant of the signals mentioned above can take years or be triggered in the next few months. That is our current fragile financial situation. Only time will tell us how this process unfolds, which I have graphed as the change from one season to another, where we would be moving from summer to an economic autumn.

There are more threats to the financial system than those already mentioned. This article is only intended to shed some light on events that go on for much longer than expected.

The price inflation we are experiencing today may be partly due to recent or local actions by each country, but the inflation we see today is only a symptom of what central banks (especially the Fed) have been doing for more than five decades.

Factors to put in the US dollar blender:

• Fiat currency without physical backing
• Highest monetary inflation in 200 years
• Beginning of the end of the Petrodollar system
• Fragility and distrust of the financial system

Some additional factors but not covered in this essay:

• End of cheap credit
• Uncontrollable financial derivatives
• The dollar market as a weapon
• Blockchain technology (digital currencies)
• High interest rates
• debt growth
• deindustrialization of the west
• The rise of the BRICS countries (Brazil, Russia, India, China and South Africa)

We must keep an eye on the United States and the dollar, because if it sees its predominance as a reserve currency threatened, the world financial system could freeze for a while. Faced with this possibility we are in unknown territory and it would be good to take some considerations.

Resistance and adaptation

We must remember that whatever the impact of economic cycles on our lives, our role is to adapt and grow in new ways if necessary. After a certain point of contraction, the natural strength of the human being is triggered and inventiveness is present to break the stagnation.

Many enterprises have been born to respond to difficult times, to the new prevailing needs. Adaptation is part of our way of being and with each squeeze comes a creative reaction that tries to get out of a bad streak, to resist bad omens and survive bad weather.

Therefore, if something that has been raised here resonates with you, and as a suggestion:

I) Start a venture, or expand the one you already have, because it is still time to take action and generate a second income, thinking from now on action strategies in extreme cases, improving, changing or leaving what you are doing, depending on the new conditions that may arise.

II) Have liquidity on hand (cash), because there is nothing more disastrous than having immobilized resources when what you want is to move them from there.

III) Structure a food pantry, as food insurance and even if you feel calm about it today. This means having a pantry that you can depend on for a few months if necessary. Remember that an insurance must be secured before it is needed.

Having time to analyze the signs and react in a timely manner can be key to growing and successfully adapting to the changing economic environment of the coming years.

Blessings.

LUIS LEIGHTON

(1) https://saludfinancierachile.blogspot.com/2013/12/el-fin-de-la-convertibilidad-dolar-oro.html