This is the famous recurring phrase that most of us have heard throughout all the seasons of the hit series «Game of Thrones».
It is always pronounced as a reminder of the hard times the protagonists are going to face, but also as an irrefutable argument for taking measures, which are no less drastic than necessary, in the face of the darkness, severe cold and shortages that are already looming.
Well, we would say that winter is also coming for the financial system.
All that is missing is a catalyst to unleash the tremendous consequences of the distortions to which central banks have subjected their balance sheets and markets.
Trust—that essential treasure that prevents chaos from taking hold of a system based on the printing of paper money and electronic transactions anchored in nothing—is as fragile as it is difficult to rebuild.
And to this day, the only argument for maintaining that confidence in the fiat money was the ability of states to reliably back their respective fiat currencies.
That solvency, recognised by the currency’s other users, must be based on a number of factors: These include the amount of gold held in the state’s vaults, political stability, the credibility of monetary policy makers (central banks), the health and soundness of the national and international banking system, and, of course, the solvency of each country’s economy. Such economic solvency must be determined by stable and sustainable debt levels, that is, with a downward trend. And these declining trends must be based on: budget surpluses (or, at worst, the absence of deficits); economic growth (GDP); and expansionary fiscal policy, amongst others.
If we therefore take a look at the foundations underpinning the monetary trust on which the entire financial system is based, we will see that today Most developed countries do not meet any of these requirements fundamental. So what is it that currently sustains confidence in fiat money? That is the million-dollar question, the answer to which is as uncertain as it is frightening. Could it be mere globalisation, which bestows upon us an interconnected sense of confidence and thus one that is somewhat harder to shatter? If that is the reason, it is a double-edged sword, since if mistrust is triggered in any one hotspot (and there are so many… Greece, Brexit, China, Syria…), that interconnection would spread it like petrol on a fire. Could it be that today’s generations have never experienced monetary crises (not caused by wars) such as the Great Depression or the Gold Rush? Could it be that the «corralitos’ we have seen so far have been few and far between, highly localised and therefore suffered only by a minority? Is it merely a matter of time? Or does it simply take a butterfly flapping its wings in Shanghai to trigger this overloaded financial chaos? As they said in the film based on events that were more than real, ‘The Big Short«…the financial authorities haven’t a clue, and they don’t care either.’.
Furthermore, zero and negative interest rates are setting an expiry date on this impossible equilibrium, as they are distorting one of the universal laws of the market: If money is not worth anything, penalising those who hold it and rewarding those who owe it, there is no incentive whatsoever for a productive economy or for competitiveness. Furthermore, these zero or negative rates undermine the survival of institutional economic agents such as banks, insurers, pension funds (private or public), etc., which are vital to the functioning of the system (you can read more about this at «Negative interest rates and Darwin»). Therefore, either interest rates must be brought back down to healthier levels soon, or the systemic damage will be irreversible. But squaring the circle is not so easy, because on the other hand, developed economies are not yet prepared to return to positive rates without extremely painful defaults, which are inevitable given their astronomical levels of debt. And such defaults or non-payments will spread massively through the global interconnection that also exists in the debt market, despite imaginative attempts to separate the eggs for the omelette and again put them back in their shells.
To the cry of «Winter is coming…!», all investors must now pause for thought as we stand on the threshold of a winter unlike any we have ever seen. Colder, darker, more unknown and longer than the worst we have ever experienced. A winter in which it will be very, very difficult to maintain purchasing power, as Value will be the most coveted hidden treasure. And only those who are most adept at reading the map will avoid such a loss of purchasing power. Furthermore, the loss of value in assets can occur in various and cumulative ways, such as currency devaluation (with or without a break-up of the euro), a fall in asset prices (widespread capital losses in fixed income, equities, etc.), extraordinary tax confiscation, capital controls, etc. Given this situation, we cannot be too careful, but they will determine which assets will be wiped out by this Armageddon and which will survive it.
For the time being, the orchestra is still playing on the deck of the Titanic, but the date already set for the official start of the Brexit countdown has added a steep incline to a deck where the wind is growing ever colder. Whilst most people continue to wonder when the crisis will end, the right question should be how much longer the system’s seams will hold.