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The One Word That Holds the Global Financial System Together

Plus, where are the CRE losses?

An independent finance researcher I follow on X (formerly Twitter) recently travelled to Argentina. As you know, Argentina is one of the countries that have inflation at a very bad level. The currency has been decimated through years of extremely high inflation.

I have experienced the same in Nigeria, another country that I am very familiar with. That is where you put all the inflation assumptions to test and see what works. But let's focus on Argentina first.

This finance researcher noticed that people didn't want bitcoin. They prefer US dollars. The local currency was less preferred too. In fact, he said they preferred the hundred dollar notes and not the smaller denominations. Instead of US dollars in the smaller denominations, they prefer their local currency - pesos.

Do you see what is happening? They want the 100-dollar bills to save it. And the pesos, they can keep spending from day to day. Why do they not want bitcoin? They don't because bitcoin is volatile.

What about gold and silver coins? Most people don't know what to do with that. You can get a good deal for those in certain places, but for regular trade, it is not in demand.

What about trade by barter? That is not working either. People just want money instead. The optionality of money makes it very attractive.

This reminds me of something I read in the book Hedgehogging by Barton Biggs. He told the story of a wealthy family that got trapped in a country during a war and couldn't do business anymore. The only thing that saved them from poverty was jewellery. They sold their jewellery to afford food. But that was because the people who occupied their territory were interested in jewellery.

I have seen scenarios like Argentina play out in Nigeria too. People save money in US dollars. As the US hiked interest rates, the dollar became more expensive in international trade. And countries that overly depend on dollar imports and dollar debt service got creamed.

That brings me to today's question - what is the most important word in global finance? Why is money money? In other words, what makes money to be money?

The answer is TRUST.

Everyone trusts the math. That is why money is money. The US dollar is the unit of money in today's world. Now, I think that is grossly misguided. But it is the reality we have to deal with. And it often takes at least a generation to change what people know as money.

I have thought about the problem many times. And I have written about a proposed solution. But even that will be a long-term solution. Today's problems will remain for a while.

The US dollar is money today because people trust the strength and stability of its value. It is important to know this. Generally speaking, the currency of the current world power is usually the global reserve (through history).

The CRE Losses

Now that you have this background of money, you will appreciate what comes next. This is where we are in the game of the Federal Reserve - the only game in finance that matters.

Now, everyone is starting to agree with me that inflation is not coming down after the March CPI report. The only thing that will force the hand of the Fed to reduce interest rates is something really bad happening in the economy.

In particular, I think the banks are to watch here. There are two main potential sources of stress for the banks. There is the commercial real estate loans which everybody already knows about. And there is private equity. I already did a deep dive into the private equity stress.

So, let's talk more about CRE.

First, CRE stands for Commercial Real Estate. These are mainly skyscrapers built as office buildings. With the new "work from home" trend, the demand for offices fell through the roof.

Now, many of these buildings have as high as 20% vacancy rate. This can be detrimental because the cost of debt service is going to go higher once they refinance the loans on those buildings. The current interest rates will make many of those buildings a bankrupt asset.

Many owners of such assets are already selling. I saw a building in St. Louis that sold in 2006 for 205 million, sell for 3.6 million in 2024.

Now, the question is who takes the L? The 200+ million hole, in whose balance sheet is it? I know it will be disguised somewhere. And I have a guess - the bank.

Why the bank? Well, it is because the Fed can take it from there. And the Fed can make it disappear if they so wish. But Fed intervention will not come until the banks are under attack. So, maybe we will see a few more banks go under.

The Bullish Bias

Now more than ever, Yellen has an incentive to pump the stock market. The reelection campaign of the incumbent president depends on it. That tells you how bad things are.

The current US president is also now commenting on when the Fed will cut rates. Which is not supposed to be. Everyone believes the Fed is independent. Turns out they are not so independent right now.

Also, remember that a fresh 1.2 trillion was just passed by the US Congress. And Nvidia is back over 900 dollars per share. It's the bubble of all bubbles. But that is not to say that you should not enjoy the ride.

One way or the other, this will pop. But that time is yet to come. When it is time to short, I'll sure hint it. But right now, this is a top. The incentives line up on the side of keeping the stock market like this till November. A significant run-up is not so likely.

However, to start the downward run, something major has to happen. And it hasn't happened yet. The options are currently - recession, stagflation, or currency crisis. Recession is the best-case scenario of the three. That is why I keep looking out for it.

Conclusion

The one word keeping the global finance world together is TRUST. Once there is a loss of trust, everything begins to fall apart. The world is losing trust in the US dollar. But there is no viable alternative yet.

We continue to hear of steep discounts in commercial real estate (CRE). In whose books are those losses going into? Some are estimating the losses to be a potential 1 trillion usd. Well, given that I have seen a 200+ million loss on one property (that is not even in New York), the potential losses are definitely going to be way more.

There is no reason to short yet. But there are reasons to take profit, rebalance, and be cautious. Play smart.

Stay rich.

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