Political risk is the single biggest danger that stock market investors face today.  And although this chimera has been steadily growing for year after year, it receives curiously little attention in the financial press.

What is political risk in the context of investing?

Simply put, it is the possibility that politicians will institute new rules, taxes or regulations that significantly reduce the value of publicly traded securities.  And while it might be impossible to imagine the newly installed Biden administration taking any substantive steps toward disinheriting our current corporate overlords, I assure you that if the economy continues to fail the average person, a different, more economically populist administration will eventually be voted into office.

But why has political risk gotten so little recognition even as it looms gray and monstrous on the investment horizon?

I think we can all hazard a reasonable guess as to why financial media outlets such as CNBC, Bloomberg and the Wall Street Journal don’t want to have a serious discussion about political risk.

It spooks the muppets.

For those of you not up on the latest stock market lingo, muppet is a derisive term for a neophyte or unknowledgeable investor.  It seems to have originated in the halls of that deeply corrupt institution, Goldman Sachs, where executives would often use it to refer to oblivious clients the company was secretly trading against.

In any case, you don’t want to be a muppet.  Muppets involuntarily transfer their wealth to too-big-too-fail banks and other financial monopolists.  Muppets are cannon fodder for hedge funds, investment banks, professional day-traders and other sophisticated financial players.  Muppets perennially lose money.

Stock market participants, muppets included, are largely ignoring the gargantuan political risks that are steadily building in our economy.  And that’s exactly why I want to talk about it.

Before we get started, I want to clarify that there are ultimately only a handful of ways to recover your money after investing in a stock:

 

1) You can sell your shares to someone else for cash.

2) The company can pay out dividends from earnings.  Although it usually takes a considerable period of time, eventually you can recoup your initial investment.  Any dividends paid out after your breakeven point is reached become a gain.

3) The company can be acquired by another company, which will pay via cash, shares or a combination of the two.  If the acquiring company pays with cash, then you have crystallized your gains and truly gotten your money back.

But if the acquiring company pays either partially or fully via shares, then you really haven’t gotten all your money back yet.  Instead, you’re left holding at least some shares in the new, acquiring company.  In this case, refer back to items 1 through 3 to recover the rest of your money.

4) The company can be taken private.  This is a lot like an acquisition by another company, except that the buyout is usually conducted by either a private equity firm or management.  These are always paid in cash which is generally funded by debt.  As a result, these acquisitions often go by the term “leveraged buyout”.

A major limitation on taking a company private is size; it simply isn’t viable beyond a certain market cap.  The largest such privatization in history to date was the utility firm TXU energy, which was swallowed up by a leveraged buyout in 2007 for the sum of $32.1 billion.  This might seem like a huge amount of money, but many, many firms that are household names are far too large to benefit from leveraged buyouts.  For example, Walmart (market cap of $394 billion), PayPal ($283 billion), Nike ($214 billion), PepsiCo ($189 billion) and countless other well-known companies are much too large to be taken private.

In addition, market conditions must be just right (read: frothy) for most leveraged buyouts to occur.  It is no coincidence that 7 out of the 10 of the biggest leveraged buyouts happened during the 2006-2007 timeframe (right around the peak of the housing bubble).

5) The company can voluntarily decide to cease operations and liquidate its assets.  The proceeds must first be used to pay off any outstanding financial obligations (bonds, leases, salaries and pensions, etc.) before the remainder can be equally distributed to shareholders.  In reality, voluntary liquidations never happen.  As a rule, the management of a company will never willingly liquidate their firm as doing so would put them all out of a job.

Instead, almost all companies end their days with an involuntary bankruptcy filing once their financial condition deteriorates sufficiently.  In this case shares end up being worthless.

 

So it should be clear from our above list that there are only a precious few ways to recoup an investment in common stock once you make it.  And that finite number of possibilities shrinks even further when we strip out voluntary liquidations, which almost never happen.  I would also like to note that selling your shares to someone else is only really viable if the recipient either believes that 1) the company will pay a strong dividend stream in the future or 2) that they will be able to sell the shares to someone else for even more money later (aka the greater fool theory of investing).

This is important because much like humans, corporations have finite lifespans.  We all hope we invest in the next Coca-Cola or Ford – companies that have survived for more than a century.  But such superlative firms are few and far between.  Instead, we are far more likely to sink our money into pedestrian companies that will only survive a few decades at best.  And if we want to turn a profit, we have to make sure we recover our money (and a little more as well) before they go belly-up.

And all this assumes that we live in a financially stable world, which we do not at the present.  Instead, we are all swimming in a metaphorical ocean of political risk.

For example, it isn’t too hard to see a future where politicians looking to mitigate anthropogenic climate change levy a series of onerous carbon taxes.  This would immediately endanger the viability of numerous companies in the oil and gas sector.

In fact, the coal mining sector has more or less experienced a similar outcome already.  While the fundamentals had been moving against coal extraction for some time, implicit government hostility toward that most polluting of fossil fuels was the final nail in the industry’s coffin.

I would also like to point out that political risk for the energy sector is completely disconnected from the actual sensitivity of the climate to changes in atmospheric levels of carbon-dioxide.  For investors, whether 450 ppm of CO₂ signals imminent environmental apocalypse or not is ultimately immaterial.  All that matters is that a future political administration perceives relatively high atmospheric CO₂ levels as being an existential threat to civilization and acts accordingly.

Much-needed financial sector reform is another event that could suddenly and violently re-orient the capital markets to the great detriment of shareholders.  Although it might seem fantastical today, I have no difficultly envisioning a situation where a future populist government resolves to nationalize the corrupt too-big-too-too-fail banks: Citigroup, J.P. Morgan, Wells Fargo, Bank of America, et al.

We can’t say exactly how it would happen, but it could be as straightforward as an outright seizure of bank shares without compensation by the government.  And while I believe that depositors and CD holders would certainly be made whole, bondholders might find themselves dispossessed just like equity holders.

Make no mistake, if our venal mega-banks were nationalized, most working-class Americans would cheer the action on.  In fact, it has been my longstanding supposition that the first American Presidential candidate who credibly promises to liquidate Goldman Sachs by any means necessary will easily win the highest office in the land.

Of course we don’t need an outright seizure of banking shares in order to create massive losses for equity investors.  If the U.S. Federal Reserve should ever institute a fully-digital dollar, it would have the side effect of disintermediating nearly the entire banking sector in an instant.  That would mean banks would enjoy dramatically lower levels of deposits, loans and, subsequently, profits.

Shareholders would be massacred.

Another area ripe for the bitter harvest of political risk is the technology sector.  Google, Facebook, Twitter and Amazon have all proven themselves to be incorrigible monopolists.  They apply suffocating control over key areas of the information economy, snuffing out lesser competitors on a whim.

It isn’t very difficult to imagine a future where a hostile political administration decides to vigorously apply heretofore neglected anti-trust regulations to these technology behemoths.  In a best case scenario for investors, these companies would simply be broken up.  But it is just as easy to see a future where the firms are nationalized or even turned into non-profits!  In either case, shareholders would surely suffer great financial loss.

The healthcare sector is also horribly exposed to political risk.  The price of both medical services and health insurance in the United States has been rising far above the rate of inflation for decades.  At this point healthcare has become utterly unaffordable to the average U.S. citizen, making it a leading cause of personal bankruptcy.  And although the Affordable Care Act (otherwise known as Obamacare) mandated health insurance coverage for nearly every citizen, the legislation did absolutely nothing to curtail skyrocketing costs.

If major healthcare reform were to pass congress and be signed into law, it could be devastating for investors in healthcare firms.  For example, the popular idea of “Medicare for All” would more or less put the entire health insurance sector out of business overnight.  Even if that doesn’t happen, it is easy to see a future where prices or profit margins for medical procedures are capped across the board.

I wouldn’t be surprised if a future administration, spurred on by an outraged populous, simply voided patent protections on all existing pharmaceutical products.  If these political risks weren’t enough to frighten you, outright nationalization also remains a distinct possibility.

In light of the myriad political risks in today’s market environment, investors would be wise to demand a quick return of their principal.  In short, it is vital to get paid back on your investments before political risk intervenes and flips the financial game board over.

Unfortunately, one simply has to casually examine the U.S. stock market to see that many people haven’t put much thought into how they are going to recover their money.

Despite being obscenely successful, tech giants Alphabet (Google’s parent company), Amazon, Netflix and Facebook don’t pay any dividends currently and have no plans to do so in the immediate future.  Other corporate behemoths such as Microsoft, Apple, Johnson & Johnson and Visa do pay dividends, but do so at such a low rate that it will take many decades for an investor to recover his principal.

For example, as of February 2021 Apple has a dividend yield of 0.60%.  If the dividend doesn’t change from its current level, it would take an investor 166 years to break even on an investment made today.  Even if we assume that Apple grows its dividend at an unrealistically robust 10% annual rate from now until eternity, it will still take you over 30 years to get your principal back.  And you will have to wait even longer (and assume perfect financial conditions persist for the entire time) if you hope to make a profit on your investment!

The bottom line is that you can’t expect to make your money back in a reasonable length of time on many stock investments made today.  But don’t worry!  Most investors implicitly believe they will just be able to flip their shares to someone else when the time comes – a classic hallmark of bubble psychology.

In fact, our current stock market mania is undoubtedly the most extreme in financial history.  It exceeds the Japanese equity bubble of the late 1980s, the British South Seas Bubble of the 1720s and the infamous late 1920s DJIA bubble that preceded the Great Depression of the 1930s.  Indeed, today’s speculative excesses in stocks, crypto-currencies and bonds are so extraordinary that they even make the hopelessly irrational Dutch tulip-mania of the 1630s seem downright sober by comparison.

Insanity doesn’t even begin to describe our dysfunctional capital markets these days.

And don’t think for a moment that you’ll be able to sell before things fall apart either.  The suggestion that the average investor will somehow figure out the game is unraveling and head for the exits just before political risk manifests itself in portfolio-destroying nationalizations, patent cancellations or windfall profit taxes is just hubris.  This is especially so when corporate insiders and connected political players will undoubtedly be tipped off about what is going to transpire long before you or I will get the memo.

In the end analysis, political risk isn’t simply one of the biggest dangers of a dysfunctional stock market – it is the defining risk of a global economic system that is rapidly spinning out of control.  This is why I advocate for intelligent investors to carefully accumulate high quality tangible assets such as precious metals, antiques, gemstones and fine art.  Hard assets will act as a hedge against the massive economic dislocations that are sure to rock the financial world in coming years.

Smart investors will own some tangible assets and avoid financial heartache; muppets won’t.  Don’t be a muppet.

 

Read more thought-provoking Antique Sage investing articles here.

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A 2019 Australian Perth Mint Year of the Pig 1/2 troy ounce gold bullion coin and a 2016 Royal Canadian Mint 1/10 troy ounce gold bar sit atop a 125 gram polished slab of jewelry-grade, off-white Siberian nephrite jade.

Let’s face it.  2020 had been a rough year for a lot of people.  And while I would like to be able to tell you that 2021 will be better, I can’t do that with any degree of certainty.

As 2020 ended, it became apparent that central bankers and governments around the world will resort to further money printing in an attempt to (temporarily) solve their problems.  This is in addition to the printing press largess that has already flowed forth.  As a reminder, the Federal Reserve’s balance sheet expanded by almost $3.2 trillion during 2020.  Meanwhile, the U.S. Treasury mailed out checks totaling $1,800 to every adult citizen ($1,200 in the spring and another $600 at the end of the year, with more possibly coming in 2021).

And the U.S. Government hasn’t been especially profligate compared to foreign governments either.  Other central banks around the world have been printing money just as quickly in relation to the size of their economies.

It is a situation that cannot persist without eventually triggering negative financial consequences.

So smart investors are beginning to look for inflation hedges – ways to protect their hard earned money from rampant monetary dilution driven by foolhardy central bank policies.  So without further delay, I present to you the Antique Sage’s best inflation hedges for 2021 and beyond (in no particular order)!

 

Inflation Hedge #1 – Nephrite & Jadeite Jade

Jade is the Rodney Dangerfield of gemstones – it can’t get no respect!  At least it can’t get any respect outside of China, where the Stone of Heaven has been coveted for millennia.  But Westerners really should take a good look at jade as a tangible investment.  The gemstone possesses superlative physical properties that place it among the very best of inflation hedges.

Jade is actually a blanket term for two gemologically distinct minerals: nephrite jade and jadeite jade.  Both varieties of true jade are harder than either glass or steel.  They vary between 6 and 7 on the Mohs hardness scale of minerals, rivaling the hardness of quartz.

Jade is also the toughest natural material known to man.  Toughness, otherwise known as tenacity, is a material’s ability to absorb physical shock without being damaged.  Laboratory tests performed on jadeite jade have determined that it has at least double the compressive strength of granite.  Nephrite jade is even tougher than jadeite jade, sporting a compressive strength that can be quadruple that of granite!

Jade is also immensely beautiful.  Its micro-crystalline structure scatters and diffuses light, giving it an ethereal or dreamy appearance.  This means that jade is unique among gemstones; its luster can mimic soft butter, delicate porcelain or highly-reflective glass, depending on the exact structure of the material.

One way to gain a sense of jade’s potential value is through its geology.  Alluvial or placer deposits of jade accumulate via weathering into streams and rivers over millions of years.  It is important to note that only a handful of different materials can survive the punishing hydraulic action of constantly flowing water over such long periods of time.  This short list consists of gold, platinum, diamonds, rubies, sapphires and jade.

Think about that for a moment.  Gold, platinum, diamonds, rubies, sapphires and jade.  It is excellent company for a precious stone to find itself in.

Even though prices for both nephrite and jadeite jade have risen considerably over the past 20 years, the gemstone is still dramatically undervalued in my opinion.

For instance, I recently purchased a rectangular gem-quality Siberian jade slab online.  A slab is simply a piece of rough stone that has been sliced (relatively) thin for collectors or as an intermediary step on the way to a fully carved piece.  This slab had the rind and any fractures or other bad parts cut away, leaving only higher quality material.  It was a tight-grained, highly translucent, off-white to celadon nephrite jade tinged with light green (see the hero photo at the top of this article).

 

Rough Jade for Sale on eBay

(This is an affiliate link for which I may be compensated)

 

Siberian jades are among the best in the world – so much so that most Russian production gets exported directly to China without ever seeing the West.  My slab weighs about 125 grams and cost nearly $150.  That translates into a value approaching $1,200 per kilo.

And I was happy to pay it too!

Why?  Because at the time I bought my jade, it was worth about the same as 1/12 of a troy ounce of gold.  It is easy for me to see a world in 10 to 15 years where gold is $4,000 an ounce.  That catapults gold into the upper echelons of inflation hedges.

But I believe that in that same scenario my jade slab could trade for close to 1/5 of an ounce of gold.  That would mean a quintupling of its dollar value from $150 to $750 – an annualized return of better than 11% over a full decade and a half!  An outcome like that would make jade an even better inflation hedge than gold!

If you are interested in finding out what to look for when buying jade, please read my jade investor’s buying guide.

 

 

Inflation Hedge #2 – Precious Metals – Gold, Silver & Platinum

Precious metals are, with good reason, the most widely recognized of inflation hedges.  In addition to being highly portable and liquid, gold, silver and platinum are the very embodiment of the term “intrinsic value”.  This is of unparalleled importance in our digital age.  Too many investments these days are simply 1s and 0s in some far off server farm, which offer investors no real safety whatsoever.

But as simple as the concept is – buy precious metals as an inflation hedge – the execution can be surprisingly complex.  First there is the most obvious question, which precious metal do you choose?  They all have their own individual weaknesses and strengths.

Gold is the old-standby of the tangible asset investor.  It has been used as money for at least 5,000 years and there is absolutely no indication that it will ever stop being used as money.  But everyone from housewives to hedge fund managers knows about gold’s inflation-hedging abilities.  So although I feel that gold is still a reasonably good value at almost $2,000 an ounce, there is no great bargain to be had there.

Silver is almost as venerated as gold.  But the last 150 years of monetary history have been particularly unkind to the lunar-themed metal.  As a result, it takes more than 70 ounces of silver to equal the price of 1 ounce of gold today.  Throughout most of human history that ratio was well under 20 to 1.

The plus side of this predicament is that silver is tremendously undervalued versus gold today.  And if silver is undervalued versus gold, then it must be egregiously undervalued compared to hopelessly inflated paper assets like stocks and bonds.

Platinum, the dark horse of the precious metal family, has also fallen on hard times lately.  For most of the 20th century, an ounce of platinum was more valuable than an ounce of gold.  However over the past decade the price of platinum has fallen until it takes almost 2 ounces to equal a single ounce of gold.

This means platinum is a screaming buy, in my opinion.  But platinum investors must be wary too.  A significant amount of platinum demand is industrial in nature.  Automobile catalysts, scientific equipment and the chemical/glass-making industry all use substantial amounts of the precious gray-white metal.  Consequently, platinum demand is vulnerable to swings in the broad economy in a way that gold demand isn’t.

Another conundrum investors looking for inflation hedges face is choosing what form of the metal to buy.  Do you go with modern bars and coins?  What about older coins that used to circulate?  And what size bars or coins do you buy?

Honesty, I don’t think it matters whether you choose newly fabricated bars and coins or older circulated coins.  Feel free to buy whatever strikes your fancy, provided the premiums over spot aren’t too high.

 

Fractional Gold Bullion Coins for Sale on eBay

(This is an affiliate link for which I may be compensated)

 

I find the question of size to be much more interesting, though.  Premiums are lowest on larger bars and coins, and lower premiums are always good.  But you lose flexibility when it comes time to sell because you must sell at least one full bar/coin at a time.

So for example, a 1 troy ounce gold coin will cost you nearly $2,000 today.  That is a substantial chunk of change for anyone to put down for a single purchase.  And if the price of gold were to double to $4,000, you couldn’t sell just half an ounce.  No, you would have to sell the entire 1 ounce coin.

This is why I favor fractional platinum and gold bullion these days, provided the premiums are reasonable.  Anything from 1/10 to 1/2 troy ounce bars and coins look great in the current environment.  I also like gram-sized gold and platinum bars ranging from 2 to 20 grams.  These bite-sized precious metal pieces can be found starting at around $150 to $200 for the smaller sizes, making them attainable for ordinary people.

Factional bars and coins give investors maximum flexibility in both buying and selling, so they are great inflation hedges.  As an added bonus, if precious metal prices really run skyward then retail demand for small bars and coins would drive premiums up.  This would allow you to recapture some of those elevated premiums when the time comes to sell.

 

 

Inflation Hedge #3 – Numismatics (Rare Coins)

Rare coins are uniquely positioned among inflation hedges, offering investors a safe haven in a world of ever-devaluing fiat currencies.  They combine the best attributes of two different asset classes – antiques and precious metals – rolled into one.  But strangely, returns for rare coins have been pretty horrid over the last 30 years.  You just have to look at this chart of the PCGS 3000 (a broad index representing the collectible U.S. coin market) to see how abysmally coins have performed as an asset class since 1990.

But it is important to keep in mind that long term returns in all asset markets – including tangible asset markets – are driven by valuations.  So asset classes that underperform for long periods of time (like rare coins have after their late 1980s bubble burst) almost always outperform in the future.  From its peak in 1989 through the end of 2020, the U.S. rare coin market has returned a cumulative (nominal) loss of nearly -70%!  And although this historical market underperformance has undoubtedly been painful for past coin collectors, it means that numismatics is like a coiled spring right now from an investment perspective.

 

 

Let’s take a look at a specific example to get a better idea of the bargains that can be found.  Not too long ago I bought a Japanese 2 shu gold coin (known as a nishu-kin) in XF condition from eBay for less than $60.  This Tokugawa Shogunate coin was hand-struck at the Edo (modern day Tokyo) mint between 1832 and 1858 – a time when samurai warriors still roamed the streets of Japan.  The cash-strapped Tokugawa government struck nishu-kin coins from electrum, a debased alloy of gold mixed with silver.  In this case, the coins are 29.8% gold and 70.2% silver.

Despite its obvious beauty and historical significance, this particular coin has performed abysmally from an investment perspective over the past 50 odd years.  In 1972 you could buy an example for $7.50.  In 2020 I paid $52 + $4.90 shipping for a grand total of $56.90.  This represents a return of only 4.31% per annum from 1972 to 2020 – a rate that barely beat inflation as measured by the U.S. Government CPI (consumer price index) over the same period.

Another way to look at it is that my Japanese coin has increased in value by a factor of 7.6x over that 48 year period.  At same time silver has increased by 12.3x, gold by 29.0x and the S&P 500 (price only; no dividends) by 30.7x.

 

Edo Era Japanese Gold Coins for Sale on eBay

(This is an affiliate link for which I may be compensated)

 

Now you might look at this result and wonder how Japanese coins (or any other coins for that matter) could possibly be a good investment.

It all comes down to the coiled spring effect I mentioned earlier.  Low returns for long periods of time in an asset class invariably lead to future outperformance.  We just don’t know when.  But we can indirectly measure this decline in valuations by looking at the premium above melt value that Japanese nishu-kin gold coins sold for in 1972 versus today.

 

	Intrinsic Value
	of a Nishu-kin in
	1972	2020
Gold:	$0.99	$28.75
Silver:	$0.07	$   0.89
Total:	$1.06	$29.64
Price:	$7.50	$56.90
Premium:	606%	92%

 

As you can see, the poor returns for nishu-kin coins mean that the premium over melt value – the collector’s premium – has plummeted from 600% in 1972 to less than 100% in 2020.  A nishu-kin sold for more than 7 times its precious metal content in 1972 versus less than double today.  These low premiums over scrap value wring the risk out of the equation for today’s buyers.  And when you purchase an asset with very little risk, it means that the only thing remaining is reward.

The best part is that Edo era Japanese gold coins are absolutely typical of the performance put up by ancient, foreign and U.S. rare coins over the past several decades.  This means you can buy almost any type of coins you like, safe in the knowledge that numismatics is among the best inflation hedges out there.

 

 

Inflation Hedge #4 – Antique Sterling Silver Flatware

Sterling silver flatware and hollowware is the asset class that time forgot.  From the 3rd millennium BC right up until the 1970s every wealthy household aspired to own a chest filled with solid silver tableware.  And no wonder!  Silverware is a store of value (due to its precious metal content) and a useful luxury good wrought into elegant sculpture.

So what in the world happened to one of the world’s premier inflation hedges to bring it low?

First, middle class families began coming under increasing financial stress starting in the 1970s and 1980s.  As discretionary income began to dwindle, some traditional luxury goods like silverware saw stagnating demand.

Second, a dramatically rising silver price during the 1970s commodities bull market priced many newer households out of the sterling silverware market.  At the same time, dining and entertaining was becoming less and less formal.  As a result, even after silver prices dropped again in the 1980s and 1990s many consumers had already moved onto buying different luxury goods.

The final coup de grâce for sterling silver flatware arrived with the Great Recession of 2008-2009.  Up until that point, there was still a fairly healthy market for antique pieces from respected makers like Gorham, Tiffany & Co. and Asprey & Co.  But as the middle class financially bled out in the torturous aftermath of the recession, antique and collectibles markets of all types collapsed in value.

Antique silver was one of those unfortunate victims.  Whereas before it was not uncommon for a good antique silver piece from the late 19th or early 20th century to sell for 4 to 5 times its scrap value, it is now normal for such items to trade for less than double melt.  Sometimes more common patterns from less venerated manufacturers will hardly sell for any premium over melt at all.

Although it hasn’t been pretty to watch, it is great news for anyone looking to invest in inflation hedges today.  At this point in time, there isn’t much downside left.  The value of most antique silverware is well supported by its underlying bullion value, which acts as a floor under the current price.

 

Antique Sterling Silver Flatware Sets on Sale on eBay

(This is an affiliate link for which I may be compensated)

 

And the upside is quite considerable indeed!  If fine antique silverware was to trade back up to 4 or 5 times melt, it would imply a doubling or tripling in value with no corresponding move in the underlying price of silver whatsoever.

As an added bonus, huge amounts of antique and vintage sterling silver flatware have been melted over the past 50 years, making the surviving pieces increasingly rare.  Every time the price of silver spiked higher, barrelfuls of silver services disappeared into the refiner’s crucible.  In spite of this fact, the depressed antique silver market has been so beaten up for so long that it is possible to pick up some really magnificent pieces for shockingly low prices.

So what types of antique silver do I like right now?

Continental European (especially French) silver is a great buy right now.  Vintage silver services from classic American manufacturers like Towle, Reed & Barton, Alvin, Wallace and Gorham are all solid choices that rarely sell for much over bullion.  To be honest, it is tough to go wrong in antique silver right now regardless of what you buy.

I also find great value in sterling silver “short” sets, which I define as 6 to 12 of a matching set of either spoons, forks or knives.  Because they are smaller than a full service, sterling short sets are among the most affordable of inflation hedges.  Sometimes you can find them in their original custom-fitted cases, too.

As little as $100 will get you started building your very own chest of antique silverware.  And due to it being a buyer’s market, you have the ability to pick and choose whatever pattern or style you like.

 

Read more thought-provoking Antique Sage investing articles here.

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We’ve all heard about Bitcoin and other crypto-currencies, which are all the rage right now.  But did you know that central banks around the world have been looking to create their own versions of crypto-currencies called central bank digital currencies?

This entire process kicked off in mid 2019 when social media giant Facebook announced ambitious plans to create a blockchain-based digital stable-coin called Libra.  This new crypto-currency was going to be backed by vast pools of safe, short-term debt instruments denominated in U.S. dollars, euros, British pounds, Japanese yen and Singapore dollars – much like a money-market fund.  The resulting digital currency would be relatively low-volatility – hence the name “stable-coin” – and could easily be traded across international borders via Facebook’s digital Calibra wallet.

However as 2020 dawned, it quickly became apparent that Facebook’s Libra digital currency would be stillborn.  Politicians and central bankers across the political spectrum strenuously objected to the bold plan.  Although the official skepticism towards Libra was ostensibly because of concerns over money laundering, in reality the idea was scuttled because it had the potential to permanently disempower existing national fiat currencies and their political beneficiaries.

But this idea did make it apparent to central bankers all over the world that digital currencies were here to stay and that if they wanted to remain relevant, they needed to adapt.  Facebook’s failed Libra initiative became the motivation behind the idea of replacing existing national fiat currencies with central bank digital currencies.

There are a lot of very rational reasons for the adoption of central bank digital currencies.  Probably the biggest benefit is that it can simplify and expedite global payment systems.

Most people aren’t aware of this fact, but the world’s financial system is laboring under a disorganized patchwork of different payment systems that have haphazardly accumulated over the last several centuries.

We have cash, consisting of paper money and coins which originated in the 17th century or earlier.  There are checks, which are a late 18th century invention.  The first credit card was the Diners Club card, which was first issued in 1950.  The ACH (Automated Clearing House) system was deployed in Great Britain in 1968 and the U.S. in 1972.  Finally, we have the SWIFT (Society for Worldwide Interbank Financial Telecommunication) system which came into being in the mid 1970s.

Unfortunately, these payment systems are slow by modern standards and often don’t communicate well with each other.  Enter central bank digital currencies.  Under this new system the dollar (or euro or pound or yen) would utilize blockchain technology to allow for near-instantaneous transfers of money from person to person, institution to institution, or any combination thereof.  So for example, a digital U.S. dollar would be nearly identical to the existing dollar other than its purely digital nature and built-in payment system.

The coming advent of central bank digital currencies isn’t just idle speculation either.  The Swedish Riksbank began testing its digital e-Krona in February 2020.  The United Kingdom’s Bank of England is actively researching its own digital currency.  And the Reserve Bank of Australia announced in November 2020 that it will explore the concept of a sovereign digital currency.

But the Bahamas has beaten them all by launching its very own (domestic use only) digital currency called the Sand Dollar in October 2020!

The United States Federal Reserve has signaled that it will not be left behind in the rush for central bank digital currencies by preparing its own FedNow Service.  FedNow is slated for release in 2023 or 2024 and will include core functionality necessary to any successful digital currency including fast clearing and settlement capabilities and balance inquiry/reconciliation features.  Although FedNow isn’t a digital currency in its own right, it could very easily be used as the foundation for a future U.S. digital dollar once it has been perfected.

Now this is all well and good, but what I’m really interested in is the future implications of fully functional central bank digital currencies.  And due to the U.S. dollar’s importance in global trade and finance, I’m going to focus my analysis on the effects of a possible Federal Reserve digital dollar.

My thinking was really sharpened on this matter by a YouTube video I recently watched featuring Raoul Pal, the CEO and co-founder of Real Vision Finance.  It is an incredibly thought-provoking video that I highly recommend you watch.  I would even go so far as to say that Raoul Pal is almost prophetic in his musings.  I’ve embedded the video below for you convenience.

 

 

Let’s see if we can intelligently speculate about the future ramifications of a fully-digital, Federal Reserve dollar (which we will nickname “FedCoin”).

First it is apparent that upon the launch of FedCoin every citizen will receive a free online account (or digital wallet) capable of storing, sending and receiving the Fed’s new digital currency.  This will almost certainly be coupled with enticements for individuals to use the new system.  These could include higher interest rates on balances held in FedCoin (versus dollars held in the traditional banking system), faster receipt of government mandated stimulus payments, lower prices for goods and services (because there would be no credit card vendor fees for retailers to pay) and the possibility of bonus stimulus payments not sent out to people who don’t use FedCoin.

The savvy observer will immediately note that a Federal Reserve digital currency would permanently disintermediate a large segment of the financial services sector almost immediately.  The importance of this development cannot be overstated.  If FedCoin is rolled out successfully, the demand for credit cards, bank deposit accounts or other transactional, retail-facing banking services (think PayPal or Venmo) would decline dramatically nearly overnight.  FedCoin would simply do what these companies’ services already do, except faster, cheaper and better.

However once successfully established, the financial authorities would have unprecedented control over the financial system.  They could almost instantaneously credit or debit any FedCoin digital wallet for any amount with little oversight.  It would be difficult – bordering on impossible – for any central bank to resist the raw power that this scenario would bestow on them.

And while it could be used relatively responsibly – for the fast payment of stimulus funds or UBI (Universal Basic Income) to citizens in need – it is more likely that our central bank overlords will ultimately abuse their newfound financial power.

I imagine this would be a gradual, creeping process.

For example, if the economy were to take another nosedive (a distinct possibility in a world of rolling lockdowns due to COVID) the Fed might feel compelled to step in to provide fiscal stimulus if the legislative branches of government were unable to come to a speedy agreement among themselves.

In fact, the Federal Reserve has already floated a trial balloon for this idea via what it calls “insurance recession bonds“.  These would be contingent, zero-coupon bonds that would only be “activated” when GDP declines below a certain threshold.  Once activated, the Fed would automatically issue checks to every American household using the bonds as collateral.  It is important to note that the bonds would simply be a book-balancing accounting exercise – in reality it would be naked money-printing.

Insurance recession bonds are important because they would allow the Fed to usurp congress’ traditional role of allocating government spending.  Suddenly, the Fed would be the real fiscal power behind the throne.  I expect this outcome, if for no other reason than because the U.S. Republican and Democrat parties are unable to collaborate in any meaningful way anymore.

And if a Fed issued central bank digital currency already exists, then this entire process would become even more irresistible.  After all, it would be convenient for both U.S. political parties if they were to grandstand for the cameras, each refusing to give an inch to the other side, while the central bank did the real heavy lifting of making sure tens of millions of people got the necessary funds to put food on the table or avoid eviction.

One dark side to this system is that there will be tremendous political pressure to make FedCoin the only game in town.  Right now the Federal Reserve (along with most other central banks) is bumping up against the limits of monetary policy due to the zero-bound problem.  When interest rates are at 0%, it is almost impossible to stimulate the economy via traditional monetary policy.  It is also very difficult to institute negative interest rates because people can always flee to physical cash (which is exempt from such a policy).

But once FedCoin has been properly rolled out and scaled-up, there isn’t any reason why the U.S. Treasury couldn’t phase out the use of cash (and non-FedCoin bank accounts).  The justifications for such a move could be numerous: cash is dirty and unsanitary in an age of pandemics; cash is antiquated and unnecessary; only criminals and tax-cheats use cash, etc.

The point is that once Fedcoin has been firmly established as a universal, convenient and low-cost alternative, the financial authorities might well move to ban cash.  This could be done via a carrot and stick approach, with small bonuses for those who use the new FedCoin (extra one-time payments or higher interest rates) and punishments for those who fail to adopt the new digital currency (slower stimulus payments or additional financial scrutiny from the authorities).  It is even possible that citizens may eventually be forced into using FedCoin or face the prospect of not receiving their stimulus or UBI payments at all!

Once the Fed has transitioned everybody to FedCoin and phased out cash, it will find a wonderland of new monetary policy tools at its fingertips.

For instance, the central bank could easily implement negative interest rates without having to worry about people hoarding cash.  It could (electronically) print and instantly distribute massive sums of money to systematically-important financial institutions or favored industries.  It could engage in targeted interest rates where some groups (like college students) would receive high interest rates on their FedCoin (to encourage them to save) while other groups (like retirees) might receive negative interest rates on their savings (to encourage them to spend).

It is even conceivable that the Fed could deposit stimulus funds into peoples’ digital wallets, but then declare that if the money is not spent within a certain time frame it will disappear!  And all of this could be done with little to no oversight from elected officials.

There are other downsides to central bank digital currencies for the average citizen besides delightfully cruel new monetary policies.  Once FedCoin is the exclusive money of the realm, the government would be able to track every single purchase or financial transaction that you make.  The central bank would even have the ability to block transactions that they feel are suspicious or that they don’t like.

So when might we realistically see FedCoin come into existence?  That isn’t exactly clear.  The Federal Reserve states that their FedNow Service won’t be ready until 2023 at the earliest.  This technology could serve as the backbone of a FedCoin rollout.  But in my opinion, it would still take a minimum of 18 to 24 months after the introduction of the FedNow Service for an official U.S. dollar-based digital currency to be ready.

That would put the first realistic date for the release of FedCoin at 2025 or 2026 at the earliest.  In all probability it would take substantially longer than this given the technical hurdles inherent in such an ambitious project.  In other words, the late 2020s or early 2030s seem like a far more viable date for the release of FedCoin.

But let’s not lose sight of what is important here.

Although central bank digital currencies may be the future of fiat money, they’ll only serve as a trap for the average person.  This is why I advocate buying portable tangible assets as a way to protect yourself from the possibility (maybe even inevitability) of FedCoin and other central bank digital currencies.  This could be as simple as purchasing a $1,000 face value bag of U.S. 90% junk silver coins or as complex as assembling a fine collection of vintage Patek Philippe wristwatches.  Bullion, fine art, gemstones and antiques are all feasible alternatives to a locked-down, FedCoin-dominated financial ecosystem.

Central bank digital currencies are coming, maybe not this year and maybe not next year, but they are coming.  Invest accordingly.

 

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