When any Governmental system rests on a monetary system which uses a paper derivative of the wealth created by that system - also known as a "fiat" monetary system - that paper derivative is only as valuable as the promise that stands behind the paper which is used to represent systemic wealth creation. At the end of the day, a fiat monetary system depends on the degree to which you trust the person or entity making the promise. - Dave in DenverMost people have no clue what the word "fiat" means in reference to the U.S. dollar or any other paper currency. The word "fiat" is a Latin word which meant "let it be done." For the purposes of Modern English, the word "fiat" means "a command or act of will that creates something without or as if without further effort; an authoritative determination or 'dicatate;' or an authoritative or arbitrary order, a 'decree.' Thus, as it is used in reference to a currency system, "fiat" means a command or decree that creates something without further effort and is an authoritative mandate.
In other words, the U.S. dollar (euro, British pound, yuan, etc) is nothing more than a piece of paper that must be used by all citizens as currency by order and dictate of the U.S. Government (supra). This currency is thereby mandated for all economic transactions. Because the value of the currency is based on the decree of its value by the Government, everyone who accepts its use is exposed to the risk that some day the Government will not be able to uphold its decreed value.
I hope that helps explain why it is said that the U.S. dollar exposes the user to counterparty risk. There is counterparty risk embedded in the U.S. dollar because to the extent the U.S. Government allows the value of the U.S. dollar to erode, there is an event of default. The value of the U.S. dollar as measured against gold has eroded over 95% since the creation of the Federal Reserve in 1913. Why? Because the amount of dollars printed and outstanding has increased since then by a like amount in excess of the net wealth created by the U.S. system.
How is this possible? Because the net wealth of the U.S. system is the economic value of the entire system LESS the amount of debt and other outstanding liabilities racked up over the years. In fact, since Obama assumed the White House, the amount of Treasury debt issued is almost as much as the total amount of Treasury debt issued by all previous Presidents before Obama. And with each additional Treasury auction, which occurs now every two weeks in three maturity tranches, not including the weekly T-Bill "rollover" auctions, the risk increases that the U.S. Government will never be able to uphold the value of the U.S. dollar as a fiat currency. Is that a risk you are willing to bear?
Facebook is the classic example of the "derivative" risk embedded in a fiat system. The value of Facebook stock is supposed to represent the inherent economic wealth of Facebook as a business. But what happens when the "counterparty" making representations of the amount of this wealth makes differing representations of the amount of Facebook's value to different segments of investors participating in the Facebook IPO? What happens when promises from management get conveyed on different levels to different investors?
This is exactly what happened in the Facebook IPO. And what was supposed to be the crown jewel embodiment of the U.S. system of "capitalism" turned out to be a complete cesspool of fraud and corruption. Let's cut to the tape:
Capital Research & Management wanted to buy into the Facebook Inc. FB +0.38% initial public offering. But days before the IPO, an underwriting bank on the deal warned the big investment firm about Facebook's dimming revenue prospects...The Los Angeles firm, armed with information from a May 11 "roadshow" meeting with underwriters and Facebook, along with similar estimates of its own, slashed the number of shares it intended to buy. The night before trading began, a Capital Research manager told a banker at Morgan Stanley, MS +0.37% the lead underwriter, that the deal's pricing was "ridiculous," according to a person familiar with the situation. Some Capital Research fund managers didn't buy into the IPO at all...You can read the play-by-play in this reprint of the Wall Street Journal article: LINK
Jennifer Kohne received no such warning. The 52-year-old retired medical-device salesperson in St. Louis bought 3,000 Facebook shares Friday at $42 through an online brokerage and now sits on losses of $30,000 based on Wednesday's closing price of $32
I had suggested the other day that Morgan Stanley had seriously violated SEC and FINRA regulations in their underwriting of the Facebook IPO. The above article confirms it. And based on my extensive involvement during the 1990's on Wall Street in underwriting, selling and trading new issue securities, I could probably write a detailed article on what happened behind the scenes in the last few weeks leading up to the Facebook IPO.
For instance, I suggested the other day that not only did Morgan Stanley warn its best institutional investors that the numbers being used represent Facebook's wealth (revenue and income projections) were too high, but that the retail brokers and investment advisers failed to make the same representations to their retail investors when they phoned them up to tell them the "good" news that they could buy a lot more than 500 shares. I know this happened because I participated in this charade on bad deals from the institutional side and I know what we told our retail outlets in order to move paper that we couldn't move to the big boys. This is all fact.
To tie this in to my diatribe on "fiat" currency, stocks and bonds are risky because they are "derivatives" of currency. Not only are stocks and bonds "promises" based on a represented underlying representation of wealth, but their promise is "derived" from the promised value of the currency used to satisfy the claim represented by stocks and bonds. And that currency is in turn based on the promise of the Governmental body to uphold its value. So when you buy a stock or a bond, you are relying on the promise of the issuer to pay back the value of that stock or bond (obviously there are differences between an "equity promise" and "debt promise," but that is beyond the scope of this blog post). In turn, you are ALSO relying on the promise by the Government that the currency you are getting also has its representational value intact.
Thus, when you buy a stock or bond, there are two counterparty promises standing between you and the value of your investment. And it all boils down to this: to what degree do you trust Morgan Stanley - or any Wall Street firm - and to what degree do you trust the U.S. Government?
Re-read my blog post from the other day explaining why Facebook is a bigger Ponzi than Madoff. Then read that Wall Street Journal article and tell me if you trust Morgan Stanley or any other Wall Street firm? If you do you are an idiot. If you don't, it means our system of trust - of currency and investment by "fiat" - is collapsing.
Based on some recent Rasmussen polls released, I would say that trust in our Government is also in serious decline. We know less than 10% of the public trusts Congress. You can google it, but it looks like based on the latest Rasmussen polls, less than 40% of the public trusts Obama. If this is the case, it also means that trust in the ability of the Government to uphold the value of the U.S. dollar should also be in serious decline.
If you don't trust Congress and you don't trust the current Presidential administration, or the one before it and likely the next one, then why in the hell would you trust the U.S. dollar? Or any fiat currency for that matter? From Zerohedge.com: