Money Heaven

A lot of money is about to go to heaven.

Almost everyone in the precious metals space knows the Exeter pyramid. Most investors have heard the term hard money. A "strong" pyramid would be one where all money is a derivative of the money below it (higher order) on the pyramid. Similar to the idea of fractional reserve lending. Bubbles collapse, credit is destroyed as wealth tries to escape into more secure, stable, higher order money.

A "weak" interpretation of the pyramid says lower forms of money can be created ex nihilo, like cryptocurrency. There are higher and lower forms of money, but they aren't linked and its not necessarily clear which money in higher or lower based on its form alone. Example, fiat currency. Look at the list of existential hyperinflations and there is a recurring theme: the country or government issuing the fiat is facing or faced an existential threat such as war, foreign occupation after a war, lost a war, engaged in civil war and so on. Or the government engages in mass destruction and expropriation of wealth, such as communist governments (Venezuela the most recent example) or for other reasons (Zimbabwe's genocidal war on white farmers). Other fiat is more secure because the government still exists. All the currencies are fiat, but they have wildly different valuations. Some fiat may be superior to other assets. Would you prefer to hold a gold certificate from the Zimbabwe government or a Canadian government bond?

When Greece faced its sovereign debt crisis about a decade ago, the long-term government bonds didn't drop nearly as much as short-term bonds. It was believed Greece could not pay back its creditors today, but nobody thought Greece wouldn't exist in 10 or 20 years. Extreme hyperinflation is existential: the existence of the fiat issuing entity is called into down. Extreme hyperinflation is the nation-state version of the Bear Stearns and Lehman bankruptcies.

Now consider the stock market. What is the value of a company? In the marketplace, it is the last transaction multiplied across all the shares. What is that valuation though? It is a shared delusion once it exits from a cheap fundamental valuation. At some low price, someone could buy the whole company, finance the debt with cash flow and never have to re-IPO the company. Beyond a certain price, the valuation becomes ephemeral. It is based on the current risk appetite. Did Netflix and Facebook lose billions upon billions of dollars this year? No. The shared delusion that is their valuation collapsed towards fundamental value.

Bonds have a clear valuation because there is a known cash flow. However, the rate of interest and the value of capital itself can exist outside of this calculation. If suddenly people fear lending or refuse to lend at current rates of interest, all existing bonds are devalued. Holding a bond until maturity may produce no paper loss, but inflation could destroy the value of the money by the time it is return.

Which brings me to money heaven. Consider this example. Someone owns Netflix at $300 per share. They've owned it for a long-time and their risk tolerance is declining. Bonds are falling in price and a 5-percent yield on mortgage bonds looks good. They sell their Netflix and buy a mortgage bond. Money flows out of stocks and into bonds.

A quick look at the chart tells us both stocks and bonds are falling in 2022. Paper wealth can escape from stocks into bonds at the same time both keep falling in price. Only when the market rate of interest balances all the factors of inflation, risk appetite and so on, will bond prices stabilize. 

Where is Czechoslovakia? Where is Yugoslavia? They still exist as a concept, but not one with any currency (pun intended).

1 comment:

  1. https://www.youtube.com/watch?v=9LD-rBi8cdc