Understanding the global financial depression
What is the GFD?
No, it's not a typo. The Global Financial Depression, or GFD has been operating in the shadows like a tax since the U.S. Congress bailed out the banking system in 2009 in an attempt to halt the Global Financial Crisis (GFC).
To understand the true picture of how that affected the value of ’money’ (which we use to measure value) we can look to the USD as a proxy and see how much of it has found its way onto the U.S. Federal Reserve (Fed) balance sheet.
Why? Because the level of purchased treasuries and mortgage-backed securities on the Fed’s balance sheet roughly approximates the reserves (or money) the Fed deems necessary to have in or out of the market to create stable prices and economic conditions. Think of it as unproductive reserves/money/debt.
But why look at the growth of the Fed’s balance sheet, instead of the growth in the money supply (M3)? It’s because I’m interested in net incremental debasement, i.e., the net excess/surplus of reserves (i.e., money/debt) that’s injected into/withdrawn from the banking system by the Fed by way of quantitative easing (QE) and quantitative tightening (QT).
QE and QT are achieved through the Fed buying and selling (or running off from its balance sheet) treasuries and mortgage-backed securities in order to effect liquidity and influence interest rates, borrowing, and spending - all with the aim of achieving macroeconomic objectives such as stable prices and maximum employment.
Since the GFC, a massive amount of net buying of treasuries and MBS has remained on the Fed’s balance sheet in order to maintain price stability and the Fed’s other pursuits. Such pursuits include monetising Treasury’s debts and government deficits.
Buying started at a level of just $900 billion before the GFC and peaked at just under $9 trillion in April 2022. And as the balance sheet grew bigger from excess reserves, this effectively debased the currency - which is to say that the expansion of central bank balance sheets through QE can be likened to the dilution of a currency's value, much like the gradual debasement of coins in history.
And the rate of this debasement since the GFC reached ~15.4% at the peak of the Fed’s balance sheet, in 2022.
Similar analyses, albeit from different perspectives, have been conducted by others on the balance sheets of the five major central banks, revealing a growth rate of around 15%.
Thus, when considering these five major currencies alongside the U.S. dollar, we can observe a fiat debasement of around 15% since the GFC.
It’s like a silent and invisible annual tax of 15%, and a form of currency disinflation where the value of the currency diminishes over time.
And the punchline is that if you have not been able to generate returns exceeding the cost of capital plus this debasement rate (in your business, wage or investment portfolio) you’ve effectively experienced financial repression and have been trapped in a depression for roughly 15 years.
While some investors have seen significant gains, largely due to VC, private equity, crypto or tech stock appreciation outpacing currency debasement, the majority have felt the pinch of stagnant wages, rising prices, and higher taxes.
Considering the negative wealth effect of this ~15% annual debasement, it's evident that we're not merely experiencing a recession but a genuine depression.
And yet, the lack of discussion on this topic by media, commentators and others says to me that there’s very little understanding of what underlying currency devaluation is, how long it’s been happening and how it differs from consumer price inflation and keeps most people financially poor.
Hmmm……….
Now what?
As interest rates remain high and currency debasement outpaces the benefits of inflation for governments (i.e., inflation affords the opportunity to service and repay fixed rate debt with newly inflated dollars) the cycle of financial repression continues. And yet, central banks stick to their scripts by rolling out new acronyms designed to deliver a simple message: ‘nothing to see here’.
The most likely scenario going forward? Governments and central banks will probably continue to collaboratively kick the QE can down the road, perpetuating the monetisation of government debt, servicing costs, deficits, and the fractional banking system.
If correct, this probably means that Armageddon scenarios are unlikely to happen. Central banks are not incentivised to destroy the world’s collateral base that underpins a $300 trillion plus debt stack. They are incentivised to kick the heavier can down the shorter road. It’s what we call a ‘Put’, or a get out of jail card.
However, once we acknowledge that we’re in a GFD, it underscores the need to align our businesses and personal investing, with this new normal.
Moreover, we need to pursue business and investment strategies that can outperform the cost of capital and a ~15% debasement rate. And for finance geeks, that means calculating your cost of capital using traditional means, e.g., CAPM, and adding on an additional 15 percentage points of debasement. If your business, project or investment does not show a positive result after that level of discounting, then it is not a GFD resilient asset.
Certain high growth assets offer a way to mitigate this annual tax/loss, caused by global currency debasement. That’s why we see start-ups (once they can monetise), private equity, bitcoin, uranium, tech stocks, collectibles, NFTs and a small handful of assets and projects producing outsized returns.
While the balance sheet growth rate has slowed a little since April 2022, it’s hard to see how central banks can further reduce their balance sheets in a big way. Similarly, it’s not clear how governments can materially wind back their deficits and repay their debts. Central bankers and treasurers need each other to collaboratively kick the can further down the road.
And as more citizens realise that they are being silently taxed through fiat debasement (something that the crypto industry is very good at pointing out) their only alternative will be to chase outsized return assets harder.
Do you see what’s going on, right here, right now?
And some will eventually see that bitcoin is neither rat poison nor a fraud. Rather, it’s the world’s first and only decentralised virtual programmatic system of trust with a built-in deflationary system of value exchange that is finite; and unlike fiat, the Satoshi means of exchange utilised by the bitcoin system can never be printed or debased by central banks and governments. For these reasons, It’s the ultimate anti-debasement asset.
In conclusion, navigating the realities of fiat currencies and the ongoing Global Financial Depression requires a nuanced approach that acknowledges the ongoing printing/debasement of fiat currencies and seeks avenues to preserve and grow corporate, personal, and social wealth in this challenging environment.
Unfortunately, the GFD is further compounded by still high (and visible) inflation, making it even worse for certain sections of the community that are unable to benefit from QE. And this also makes it harder to see the currency debasement (or monetary inflation) that sits under consumer price inflation!
But by understanding the role of assets on the Fed's balance sheet and the broader context of monetary policy and government debt/deficit monetisation, we can be better positioned to catch the anti-debasement tailwinds.
See you on the other side of debasement.
Mike
Next Level Corporate Advisory is a leading Australian corporate development advisor specialising in M&A, investment, financing and exit solutions. With a dealmaking track record spanning three decades, we help family, private and publicly owned entities develop and realise value in their businesses and investments.
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