Money in a Diverging World

This is Part 3.

In Part 1 – The Truth About Money – We discuss the properties of Money and explore why Money should be considered debt.

In Part 2 – The Death of Capitalism and the Rebirth of Religion – We discuss how society is rejecting the long-established rules around Money (and Capitalism) and why that will usher in a new era of Religion.

In Part 3 – Money in a Diverging World – We examine how the current geopolitical conflicts in Europe and Asia are interesting case studies to explore the ideas we have discussed around Money, Capitalism, and Religion.

In Part 4 – The Issues With Capitalism – We discuss the issues that Capitalism is already facing before the coming challenges in an era of Religious ascendence.

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One of the key arguments I put forward in Part 2 is that Capitalism is dying:

Our world is financializing more than ever.

But make no mistake – Capitalism is dying.

Capitalism is dying because we work for pieces of paper that are increasingly hard to redeem.

In a functioning Capitalist system, I can do Work for you in exchange for promises, and I can redeem these promises to get you to do something for me.

This kind of system used to exist, but it’s dying.

Source: The Death of Capitalism and the Rebirth of Religion

Part of the reason why Capitalism is dying is because the world is rapidly shifting towards Religion and Ideology.

In a Capitalist world, people do Work in exchange for Money only because they expect to be able to eventually use these magical pieces of paper to get something they want in return, no questions asked. I don’t need to care about who you are or what you believe in. In a Capitalist world, as long as you do something for me, I will do something for you.

However, our world is becoming more dangerously Religious (I use this to refer to the concept of religion rather than any specific religion) and more dangerously Ideological.

As this process continues, more and more wants are becoming off limits because the things that can satisfy the rapidly multiplying Religions and Ideologies are shrinking. The rise of Religion and Ideology is interfering with society’s ability to make good on its Capitalist promises. And if this is allowed to continue, Capitalism will eventually die.

When I wrote Part 1 and Part 2 a month ago, I already knew that we live in a Chaotic era, an era of Change. I already thought we were on a long-term journey to a very different world, but still I did not expect the world to change so quickly. But change it has! Especially with Russia’s invasion of Ukraine.

Although I am still trying to digest the news of the past few weeks, Russia’s invasion of Ukraine does offer us a very interesting opportunity to explore many of the ideas we have previously discussed.

One good place to start is the concept of Money.

As you know, many countries around the world including the US, UK, EU, Canada, Japan, South Korea, Singapore, and many more have now announced sanctions on various Russian entities. The most aggressive sanctions so far have been around freezing Russia’s Central Bank assets and reserves. Russia’s reserves are basically like money in a vault that they own, yet with a few announcements, more than 50% of Russia’s reserves are now frozen (the remaining 40% that is accessible is primarily in RMB and gold).

Many people are now questioning what Money is if another nation can just cancel your Money!

For example:

“What is money?” is a question that economists have pondered for centuries, but the blocking of Russia’s central-bank reserves has revived its relevance for the world’s biggest nations—particularly China. In a world in which accumulating foreign assets is seen as risky, military and economic blocs are set to drift farther apart.

After Moscow attacked Ukraine last week, the U.S. and its allies shut off the Russian central bank’s access to most of its $630 billion of foreign reserves. Weaponizing the monetary system against a Group-of-20 country will have lasting repercussions.

…

Many economists have long equated this money to savings in a piggy bank, which in turn correspond to investments made abroad in the real economy.

Recent events highlight the error in this thinking: Barring gold, these assets are someone else’s liability—someone who can just decide they are worth nothing.

Source: WSJ

Most people believe Money is an equity-like asset. Most people believe Money is a thing that has value in and of itself.

But as we discussed in Part 1, this is not true.

The truth is Money is debt.

Money is a promise.

Money is an agreement between two parties…the moment one party decides to not honor its side of the bargain, the existence and viability of that Money starts to come into question.

In terms of the asset freezes, there is a technical element related to the custody of money. A lot of Russia’s reserves are simply NOT in Russia. I have written about this before since most central bank reserves around the world are kept in either the US or EU for efficiency reasons. It should be obvious that Russia’s reserves held in the US and EU would be inaccessible because there is no way the US or EU would allow Russia to touch the Money on their shores even if it belongs to Russia.

But it goes beyond that. Russia has USD reserves in other countries that haven’t sanctioned it. THIS money is also effectively now off limits, too. In fact, all USD reserves no matter where it is held is essentially effectively cancelled.

Russia can use the USD reserves it still has access to, but the question is who will accept those reserves if it can no longer be used in any country that has sanctioned Russia (which is a huge portion of the world). No one accepts Money for the sake of accepting Money. You only accept Money because you want to eventually exchange it for something else. And the US has effectively declared that a large portion of the world will never accept those dollars for anything. And if anyone tries to violate these sanctions, the US could come after them with secondary sanctions, too.

This strikes at the heart of what I argued in Part 1. Money is a promise. The moment one party decides to not honor its side of the bargain, the Money no longer exists. You may still have a pile of green bills in a vault, but if the other party no longer accepts those bills as valid, do you really have any Money? Realistically, what you have is toilet paper.

Money is a promise. And now the promise is being broken.

This brings me to one of the key ideas we discussed in Part 2 – What happens when other people’s promises to you are not honored? You would probably never deal with them, again!

Russia has a lot of promises from the US (gained through selling oil). Over the years, Russia has already done their part and held up their end of the bargain by Working diligently to extract oil from the ground and selling to the US and EU. These promises have been sitting in a vault waiting to be redeemed one day.

And now all of these promises have been cancelled.

One of the most interesting details during the initial round of sanctions two weeks ago was the carveout for Russian oil and gas:

The Biden administration won’t sanction Russian crude oil because that would harm U.S. consumers and not Vladimir Putin, a U.S. State Department official said Friday.

“The sanctions will not target the oil flows as we go forward,” Amos Hochstein, the State Department’s senior energy security adviser, said in an interview on Bloomberg Television.

Source: Bloomberg

The thinking was that the West still wants Russian oil and gas…so let’s not sanction that and continue buying it.

But if people truly understood the nature of Money, you would immediately recognize how fanciful that view is.

Since Putin can no longer use USD, why would he sell more oil to get more USD?

Although Russian oil and gas is not yet sanctioned, it is effectively sanctioned because the pieces of promises Putin is getting is no longer redeemable.

Money is not a thing. Having the physical thing doesn’t mean you have Money.

This brings me to the 3rd thing – If Money is a promise, this system of Capitalism cannot work unless we are either agnostic to what our debtors want in return…or we only dole out promises to parties that we know have desires that are not antagonistic to us.

The challenge is that the world is becoming more and more Religious and Ideological. Some of these Religions (like crypto) and Ideologies (like autocracy) are antagonistic to what the West views as sacred (e.g. Democracy and Capitalism).

The problem is that the West has given away a lot of promises without ever asking what it is that these counterparts might want in return.

Increasingly, we are discovering that some of the people that we owe want things that are bad for us.

We can either make good on those promises, or break them and potentially see our debtors never performing Work for us again (in this case, producing oil and gas).

Russia is an interesting and important case study, but the real hairy question that the US needs to reflect deeply on is China.

China is the US’ largest creditor. China has promises that are worth, on paper, $3 trillion.

Increasingly, China is going down its own path that many Americans believe to be antagonistic to the US’ desires.

What happens when China eventually calls in those debts?

Do we honor them? Or do we break those promises?

Unlike Russia, the US gets an enormous amount of things from China.

Breaking promises to China will carry a very high price.

We have already been denying some of China’s wants.

China wants to buy American technology, but many of the most appealing goods are now under export controls.

China wants to buy American companies for technological capabilities, but many of the most appealing companies are now off limits.

Increasingly, we are already telling China you cannot redeem our promises for the things you want.

Let’s hope there are still things that China wants that are not caught up in the rising Ideological battle of systems…otherwise, prepare for a world where Chinese goods are no longer available to us.

At the end of the day, Chinese people are not so different from us. They only do Work and make things for us because they still believe they can eventually get what they want in return.

The point of Money is to eventually use it to get what you want.

The point isn’t to stack up the bills (unused) until we die.

While some people might find Benjamin Franklin attractive enough to just stack them up for enjoyment, I’m pretty sure the leaders of China are not stacking up Benjamins for that reason.

Source: US Currency