Welcome to our Friday mailbag edition!
Every week, we receive great questions from readers. And every Friday, I answer as many as I can.
Our first question today touches on something I wrote about on Monday. In that essay, I showed you that digital payment systems are on the rise.
Regular readers know I’ve been following this story here at Inside Wall Street and our premium services.
We have written that it’s only a matter of time, perhaps a few years, before digital platforms and central bank digital currencies (CBDCs) become the norm for payments in the U.S. and worldwide.
The number of countries developing digital payment systems and CBDCs is growing.
There are now 134 countries, representing 98% of global GDP, in some phase of CBDC development. In May 2020, that number was only 35.
Plus, 68 countries are in the advanced exploration phase – development, pilot, or launch.
Of these, 19 of the G20 countries are in advanced stages of CBDC development. Three countries – the Bahamas, Jamaica, and Nigeria – have fully launched CBDCs.
In addition, there are 36 CBDC pilot programs. That includes one for the digital euro.
Other nations in the pilot stage include Brazil, Japan, India, Australia, South Korea, South Africa, Russia, and Turkey.
So you can see it’s a global trend. And that brings me to this practical question from reader Gene R…
I travel abroad. Will a cup of coffee be the same price in CBDCs around the world?
– Gene R.
Hi, Gene. Thank you so much for that question.
I’m an avid traveler myself. There’s no better way to understand the world than to get out there and explore it.
To answer your question, let’s talk about the Big Mac Index.
The Economist developed it back in 1986 to show the cost of a Big Mac burger in different countries. In economics wonk speak, that’s called “purchasing power parity.”
I remember it from my days living in London as a senior managing director at Bear Stearns. I ran the analytics group there, and we traveled to meet with central banks, pension funds, and banks around the world.
During one year in the mid-1990s, I traveled to 12 countries in Europe, eight in Asia, and a couple in the Middle East. Talk about air miles!
I didn’t buy Big Macs in any of them (I’m a vegetarian). But the index was a topic of conversation at the office for my team.
You can still find it today. Take a look…
A Big Mac in the U.S. costs $5.69. In dollar terms, it’s most expensive in Switzerland, where it costs $8.17. And it’s cheapest in Taiwan, where it costs $2.39.
In other words, the price for a Big Mac in dollar terms is different around the world, even though it’s the same item.
That’s because of domestic economic differences. Like what your original currency of exchange was… And the cost of getting or producing that item in each country.
In theory, if the dollar is strong relative to other currencies, you can buy more Big Macs in another country for the same price than you can in the U.S.
But there are other costs to consider. Like transportation costs for getting raw materials and commodities from one country to another.
Some countries are net exporters, and some are net importers of certain materials. Some are developed, and some are developing.
In short, all of these economic factors contribute to how much any currency can buy at home or abroad.
And all of this backdrop will apply to CBDCs, like it applies to non-digital currencies today.
That means your cup of coffee will cost a different amount in other countries, just as it does today, once we convert to a CBDC-based world.
As we’ve written, most of the world is in different degrees of analyzing or reaching the ability to launch a digital currency in their nation.
And we discussed how these would eventually replace current “cash” or non-digital versions of their currencies. This process will likely unfold over several years. It will happen more quickly in some countries than others.
But overall, your money in the form of a U.S.-based CBDC will have a roughly similar purchasing power relative to other countries’ CBDCs as it has now.
Next up, reader Steven K. wants to know more about the cozy relationship between Washington, the Federal Reserve, and Wall Street…
I read that the banks with Congressional support have forced the Fed to back off proposed increases in capital requirements for banks.
Why does the overnight lending market exist? We have unintentionally built a house of cards.
– Steven K.
Hi, Steven. Thank you for your thoughtful question.
Banks have many ways to game the system, including access to overnight and one-month loans and inadequate capital requirements.
Plus, the more debt we have as a country and society, the greater the financial burden on the banking system.
The high level of debt in the U.S. concerns me, for reasons I wrote about here. Excessive debt has severe consequences, including financial instability and slowing economic growth.
Escalating debt creates a vicious cycle, where high debt levels eventually reduce consumer spending and business investment, further stifling economic expansion.
The next financial crisis – one caused by problems in the commercial real estate market – would be amplified by high debt levels.
As we saw with the Silicon Valley and other banks crisis last March, it could force the Federal Reserve to step in and print money. And that would intensify the distortion between markets and the real economy.
That makes the Fed more subservient to Wall Street and less to taxpayers. I wrote more about how that situation impacts your money here.
The Fed’s traditional tools, such as lowering interest rates or quantitative easing (QE), might not be effective enough at stimulating the economy if it first has to deal with supporting bank bailouts.
That could result in an economic downturn, increasing hardship for individuals and businesses. And yet, as you note, the Fed backed away from proposed capital requirements increases.
Fed Chairman Jerome Powell said he is aware of Congressional concerns that U.S. banks might have to set aside more capital to absorb losses under a new set of proposed global bank capital regulations called Basel III.
Powell intimated he would fight to reduce those requirements.
This concerns me. It shows that for all the Fed’s talk about wanting to preserve stability and fight price inflation, it’s less worried about maintaining financial stability if that upsets the big Wall Street banks.
Inadequate bank capital requirements could lead to higher bank failures and financial instability. With less capital set aside to absorb potential losses, banks are more vulnerable to credit problems.
This can harm the overall economy, resulting in a credit crunch, reduced lending, and a slowdown in economic growth.
Higher bank failure and financial instability risk can have far-reaching economic consequences. It can lead to confidence loss in the banking system.
Then, as we saw last March, depositors could withdraw their funds, exacerbating a crisis. This can trigger a domino effect. As banks fail or become more cautious about lending, they reduce credit access for businesses and individuals.
Contraction can further exacerbate the financial crisis. Reduced spending and investment can result in job losses, decreased income, and a downward spiral in the overall economy.
And there’s another problem aside from long-term debt.
The Fed’s overnight lending or repo market has created a house of cards, as you point out.
Short-term Fed funding encourages banks to take risks.
Wall Street’s reliance on this short-term funding – during a liquidity crisis or just because it can access it – makes the system more fragile.
On the other hand, implementing stricter bank capital requirements would foster greater financial stability. This would make it less necessary for the Fed to save banks, preventing the next financial crisis from spiraling out of control.
Meanwhile, it’s critical to remain wary of the banking system and the Fed’s support of it.
To all my readers, I can’t stress enough how crucial it is for you to divide funds in the banking system between banks to reduce your own bank concentration risk. In other words, don’t put all your money in one bank basket.
I also encourage my readers to own a little Bitcoin and tangible assets that hold value even if the financial system crumbles.
Growing your wealth by buying gold is essential. It already hit my first target of $2,400 this year. Based on past cycles, it’s likely to settle for a while, and then be in a bull cycle that could reach $3,000 next year or so.
I hope that helps. And thanks to everyone who wrote in! If you have any other questions, write me at [email protected].
I’ll do my best to address them in a future Friday mailbag edition. Just remember, I can’t give personal investment advice.
In the meantime, happy investing… and have a fantastic weekend!
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins
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