Are Two-Tier Monetary Systems a Possible Tool?

QUESTION: Mr. Armstrong; It seems few people even understand that there have been two-tier monetary systems. Do you think this can be a possible tool in the currency crisis you are forecasting for 2021?

Thank you;

Looking forward to Rome and meeting Mr, Farage as well


ANSWER: Various countries used to mint trade dollars in silver with different weights for external trade with China. That was a two-tier monetary system for trade during the 19th century. But there have been instances where there were two separate currencies that were also used as capital controls to isolate the domestic economy from the external international capital flows. This was the case with South Africa.

An important example of an official deliberate two-tier monetary system is the modern monetary history of South Africa. Until the late 1960s, South Africa had a fixed exchange rate for its currency. The rand was pegged to major foreign currencies, as was the case under the Bretton Woods system.

It was during 1979 when the South African government switched to a system that formally expressed parity against the dollar. The value of the rand followed changes in the balance of payments and moved roughly with sterling and other weaker currencies until 1985 when the dollar soared and the birth of the Plaza Accord took place.

The foreign debt crisis of 1985 caused the rand to depreciate at a spectacular rate and the dollar rose in value. The rand fell to an all-time low of less than 40 cents to the US$. The rand recovered somewhat in 1987, reaching 43 cents, but it declined steadily thereafter into 1998. The rand collapsed to about 26 cents against the US$ in late 1995. Between February 1, 1996 and May 1, 1996, the rand lost roughly 16% of its exchange value, falling from R3.7 to R4.33 = US$1, or a value of about 23 cents to the US$.

The government realized that its domestic policy objectives were incompatible with international investment. They then created a parallel currency to act as a two-tier currency unit they named the “Financial Rand.” This hybrid currency was used exclusively for the movement of nonresident capital during the 1980s and early 1990s. The Financial Rand developed out of currency-exchange controls instituted in the early 1960s, known as the “blocked rand.” The Financial Rand was available only to foreigners for investment in South Africa and was created by the sale of nonresidents’ assets in the country.

Therefore, South Africa created a formal two-tiered currency system, which insulated the country’s foreign reserves from politically motivated capital flight. Since any divestment by nonresidents was automatically met by new investment, and the price of the Financial Rand varied independently of the commercial rand, a stability was achieved.

The Financial Rand invariably stood at a discount to the commercial rand, but the size of the discount depended on South Africa’s relative attraction as an investment destination. The discount stood at almost 40% during most of 1992 during the political crisis. The Convention for a Democratic South Africa (CODESA) began in December 1991 at the Johannesburg World Trade Center, attended by 228 delegates from 19 political parties. Mandela remained a key figure and after de Klerk used the closing speech to condemn the ANC’s violence, he took to the stage to denounce de Klerk as the “head of an illegitimate, discredited minority regime”.

This confrontation caused the rand to collapse. CODESA 2 was held in May 1992, at which de Klerk insisted that post-apartheid South Africa must use a federal system with a rotating presidency to ensure the protection of ethnic minorities. Mandela opposed this idea and demanded a unitary system governed by majority rule. Following the Boipatong massacre of ANC activists, Mandela called off all negotiations, and called for a special session of the UN Security Council and proposed that a UN peacekeeping force be stationed in South Africa to prevent “state terrorism.” Calling for domestic mass action, in August the ANC organized the largest-ever strike in South African history, and supporters marched on Pretoria. The rand declined to about 20% by late 1993.

Reserve Bank governor Chris Stals, under pressure from the banking and business communities, said that the government would phase out the Financial Rand in 1994 or 1995, assuming that South Africa’s foreign currency reserves reached at least R20 billion and that the discount between the financial and the commercial rends narrowed to about 10%. Foreign currency reserves were low in early 1994 but thanks to a dramatic reversal of the capital outflow in 1993, foreign currency reserves increased throughout 1994 and into early 1995.

Finally, by March 1995, with foreign reserves of only about R12 billion, the government abolished the financial rand. The newly unified currency began to trade on international currency markets, marking a vote of confidence in South Africa’s business potential.

Only a two-tier currency system can possibly weather the economic storm on the horizon from the collapse of the European Union at the hand of this lethal combination of policies. The next banking crisis will most likely begin in the Eurozone due to a continued failure to resolve the systemic weaknesses of its construction. The failure to have consolidated the debts means that the failure on the state level will ripple through the entire European economy. In the United States, state debt is not used for reserves. The failure of California will only send bond seekers into the federal debt who are fleeing state and municipal debt. We see that in Europe as capital fled from most members concentrating in Germany, which is the US Treasury equivalent within the Eurozone. With the first bail-in under the BRRD agreement, the contagion will be devastating as was the case when Michigan closed its banks in 1933 in the USA.

The Financial Rand fell below the domestic commercial rand when the 1992 political crisis unfolded, and capital fled South Africa unwilling to invest in a nation that might move into civil war. The two-tier currency system can and does help to distinguish between domestic and international capital flows.

There is the potential to create a two-tier monetary system with a new type of international currency that is separate and distinct from that of the domestic currency. This would allow the US dollar to end its reserve status and end the clash between domestic and foreign policy objectives.


The Fate of Europe

QUESTION: Marty; Your capital flow models have been remarkable. Do you see Europe as ever getting its act together? We need support to get decisions approved as you know. Will you provide that for us to present to the men above?


Nice to see you in Europe. Rome should be great at this time of year.


ANSWER: I have covered that is a special report for attendees. It took me a month to write this one. I have tried to cover every aspect so we can deal with the forecasting at the conference rather than all the supportive history. I understand that institutions need the support to justify their decisions. This is the report everyone needs for their files to CYA as the say for decisions.

Things look very dicey for Europe and this will be a very interesting WEC. Here is the Index of the Report. I believe this will answer all questions and provide the backup you need to present to any board of directors.


The Consequence of War that Led to the German Hyperinflation

QUESTION: Everyone has a chart of the German DAX postwar. I have never seen a chart of the German stock market before the war. Do you have any?


ANSWER: Yes. However, you must understand that because the world was on a gold standard, the arbitrage volatility was reflected in the bond and share markets when the currency was fixed. This is why the German share market closed in August 1914, along with just about everyone else. Here is a chart that show the performance of the German share market during the hyperinflation period. We have the DAX also extended back in time. But don’t forget, the DAX is a total return index. If we plot just price, you will see that the German share market looks very much like France.

The primary stock exchange in Germany was in Berlin. However, there were 21 exchanges in total. The origins of the Frankfurt Stock Exchange date back to medieval trade fairs during the 11th century. By the 16th century, Frankfurt developed into a wealthy and busy city with an economy based on trade and financial services. Annuities in particular were the hot items back then. It was in 1585 when the bourse was established to trade in fixed currency exchange rates. Currencies actually led to exchanges rather than shares. Eventually, Frankfurt developed into an early share market, competing with London and Paris. Mayer Amschel Rothschild and Max Warburg became very influential in the financial trade of Frankfurt.

The Frankfurt Stock Exchange had been a major international center. It was completely wiped out by World War I and its consequences. Back then, foreign shares and bonds traded on cross exchanges since money was fixed. German investors at the start of World War I dumped foreign bonds and shares, fearing that their capital would be restricted or confiscated. This is also why all the exchanges simply closed in Europe. Any capital they managed to free up from the sale of foreign investments was reinvested mostly in German government bonds. They were patriotic and believed in their government. However, by the end of the war, the Frankfurt Stock Exchange lost all foreign securities listings for bonds or shares. Frankfurt lost its standing as an international stock exchange entirely, and that would only begin to resurface in 1949.

In Europe, the fear of catastrophic declines in stock prices was met with controls at first. Overall, stocks and bonds were not allowed to trade below the price they had been trading at on July 31, 1914. Restrictions were also placed on capital. Money movement was highly restricted to preventing any large outflows of capital, forcing many into black markets. One means was to buy collector stamps and coins. They would then export especially rare stamps and then sell them in America. After two world wars, most of the rare stamps happened to be in America and gradually returned to Europe during the late 1960s.

With these restrictions in place, markets reopened in Europe. The London Times began printing stock prices for London and Bordeaux on September 19th and for Paris on December 8, 1914. In January 1915, all shares were allowed to trade on the London Stock Exchange, though with price restrictions. The St. Petersburg exchange reopened in 1917, only to close two months later due to the Russian Revolution. The Berlin Stock Exchange did not reopen until December 1917.

The loss of the war meant those who had invested in German bonds suffered the same fate as those Americans who invested in Confederate bonds. Indeed, to fund World War I, Germany relied more on raising money by selling bonds than imposing taxes. This had the net effect of wiping out the savings of the middle class and upper class. During the hyperinflation going into 1923, the losses in bonds were devastating, but in contrast, equities became a prized object among speculative investors. The Frankfurt stock exchange saw unprecedented losses in the bond markets and shares became the speculation objects that rose sharply going into 1923.

The German war costs covered by taxation, including state and federal combined, was only 13.9% which was lower than 18.2% taxation imposed in Great Britain for the war effort. German debt exploded after 1916. That is when the federal government’s short-term floating debt grew relentlessly, and by the end of the war it accounted for nearly one-third of the German national debt. The seriousness of the German debt crisis, which led to the postwar hyperinflation, was the fact that after 1916 German banks began to purchase more of the government’s floating debt. Government debt dominated the market and banks took on more public debt than private. When the public debt was marginalized by hyperinflation, it also wiped out the banking system.

By the end of the war, the international contacts of the Frankfurt Stock Exchange had been lost. Inflation set in and reached its first peak in 1923. In October 1929, the Germany stock exchange prices crashed dramatically on the 25th. The world economic crisis ruled the following years. The economy only began to stabilize in 1932. The following year, the Nazis took over and centralized the nation’s economic policy. The Frankfurt Stock Exchange was merged with the Mannheim Stock Exchange and the number of exchanges nationwide was reduced from 21 to nine. Under the stringent Nazi economic regime, free trade was suffocated as Hitler defaulted on external debt. The majority of capital assets was directed to benefit the war economy. He even issued conversion fund certificates that were exchanged one for one with German marks if you sought to leave the country. This was part of the currency controls but they were worthless once you left the country.


Book on Economics, Written in 1994

From The introduction to my book …

I first had the idea of writing a book such as this about ten years ago. It seemed to me that each of us learns something of value as we go through life, but most of us do not succeed in passing along our knowledge to others before we die. This, then, is my attempt to pass on to others what I, over my fifty-odd years, have come to believe are the truths of life and what I believe may be a path into a better future. Much of what I write about involves economic issues, since I am an economist by training. Economics, however, is a social science, and my excursions into other areas of the social sciences are therefore not totally out of line.

I have had a great deal of “life” experience (both educational and professional) and this book thus covers many subject areas. While analyzing these subjects, I have tried to be logical and objective (as I have tried to be all my life), and hopefully this proclivity is reflected herein. You, the reader, will probably disagree with some or much of what I have written. That’s fine if your disagreement is based on fact; it’s unacceptable, however, if your disagreement is the result of prejudice and preconceived ideas.
Throughout this book, I have included editorial writings, which I felt were astute, and which help to illuminate my ideas. In each case, I have credited the author and distinguished his/her writing from my own.

Much of what I write about could be construed as anti-religious; it is not. It has not been my intention to support or deny the existence of God or a Supreme Being.
A thought that should be kept in mind when reading this book is that virtually nothing we do today is done as it was in the past. By this I mean the “near past”–remember that radio was invented only ninety-nine years ago, and it has been only ninety-one years since the first powered flight. Most of the technology that we now take for granted has been developed in the past fifty years. The corollary to this is that our ideas and attitudes must also be different from those of the past. Try to imagine how people will regard the “absurdly primitive” last decade of the twentieth century in the year 2045 (when all that we know today will have been gone for fifty years). The point is to keep an open mind, don’t pre-judge, and don’t be too certain about anything.

We live in a world of fantastic ideas if only we can keep an open mind!

The link below will allow you to download the book, if you want, and at no cost.

Power Economics

Turkey & the Real Risk of a Debt Crisis

The Treasury and Finance Ministry of Turkey announced that the country’s net external debt stock totaled $286.2 billion going into the end of the 3rd quarter of 2018. The country’s net external debt stock to its gross domestic product (GDP) ratio was 34.4% at the end of the third quarter of 2018. However, Turkey’s gross external debt stock amounted to $448.4 billion at the end of the 3rd quarter, bringing the debt/GDP ratio to 53.8% according to the official figures.

Interestingly, because of the fear of the Turkish lira, Turkish corporations have been often compelled to borrow in dollars. Therefore, the private sector’s share in the country’s gross external debt stock was 68.2% ($305.9 billion), while some $215.9 billion of this amount consisted of long-term debts with a maturity of more than one year. The Turkish public sector’s share of this debt was 30.6% in the country’s total foreign debt, which is about $21.4 billion in short-term (under one year) with $115.7 billion in the long-term (over one year). The banking sector’s (lenders and the central bank) external debt stock was $176.99 billion at the end of the 3rd quarter.

When we break this down further, 58.5% of the total gross external debt is denominated in U.S. dollars with only 32.3% denominated in euros. The amount denominated in Turkish lira among the external debt stock was a trifling 5.9%. This illustrates the crisis that will emerge with a change in the currency values.


Roman Coins Wash up on Beach in Florida


There have been discoveries of Roman coins in Japan as well as in North America. There has even been the discovery of a Roman sword in Newfoundland. Now, a treasure hunter with a metal detector uncovered seven Roman coins that washed up on a beach here in the Tampa region. This is strong evidence that there must have been a Roman shipwreck off the coast of Tampa or in nearby proximity.

These coins are of the 4th century from the era of Constantine. They are bronze and of no particular rarity. In such a condition, they are really worthless. Nevertheless, there certainly seems to have been Roman ships that crossed the Atlantic long before even the Vikings, no less Columbus.

There are accounts that the Roman Emperor Marcus Aurelius sent diplomats to China around 180 AD. There are no written records from Rome, but there are written records from China confirming that meeting and even a recording of the name of the Roman emperor.

There are no documents that confirm Romans traveling across the Atlantic, yet there is evidence that they were indeed here in North America. This raises the possibility that these were one-way trips, perhaps from a ship caught in a storm and set on its path to America.

The left coin in this photograph is clearly one of Saint Helena who was the mother of Constantine I the Great. She was a devout Christian who set out to discover the major places in the Holy Land. She built the church in Jerusalem over Calvary and near the tomb of Jesus Christ

Preferred v Ordinary Shares

QUESTION: Hi Martin,

What are your thoughts on preferred shares? Especially the ones with good quality DBRS ratings. Will they survive the downturn or will they fail?

ANSWER: Ordinary and preference shares are a claim on corporate earnings and assets. Dividends for ordinary shares may be irregular and indefinite, whereas preference shareholders will receive a fixed dividend which will accrue usually if the payments are not made in one term. Ordinary shareholders are in a riskier position than preference shareholders since they are the last to receive their share in the event of liquidation. That may not be a concern in a blue chip company. Nevertheless, they also are open to the possibility of a higher dividend during times when the firm is doing well in contrast to preferred shared with fixed income.

Preferred shares can be looked upon as a hybrid debt where you have a claim on the assets, but like a loan, it has a fixed rate. Ownership of preference shares offers advantages and disadvantages. On one hand, it provides a higher claim on earnings, assets, and fixed dividends. On the other, it limits voting rights and the possibility for growth in dividends in times when the company is financially sound.

The good companies will generally survive. This is a collapse in government – not the private sector

Fear of Inflation & Sterilization

QUESTION: Mr. Armstrong; you were friends with Milton Friedman. Do you agree with his view that the Great Depression was caused in part by the Fed refusing to expand the money supply? Isn’t Quantitative Easing expanding the money supply yet it too has failed to create inflation. Would you comment on this paradox?

Thank you for your thoughtful insight.


ANSWER: Yes, this certainly appears to be a paradox. This results from the outdated theory of economics which completely fails to grasp the full scope of the economy and how it functions. This same mistake is leading many down the path of MMT (Modern Monetary Theory) which assumes we can just print without end and Quantitative Easing proves there will be no inflation. They are ignoring the clash between fiscal policy carried out by the government and monetary policy in the hand of the central banks. This is a major confrontation where central banks have expanded the money supply to “stimulate” inflation. Governments are obsessed with enforcing laws against tax evasion and it is destroying the world economy and creating massive deflation.

In 1920, Britain legislated a return to the gold standard at the prewar parity to take effect at the end of a five-year period. That took place in 1925. Britain based its decision in part on the assumption that gold flows to the United States would raise price levels in Britain and limit the domestic deflation needed to reestablish the pre-war parity. In fact, the United States sterilized gold inflows to prevent a rise in domestic prices. In the 1920s, the Federal Reserve held almost twice the amount of gold required to back its note issue. Britain then had to deflate to return to gold at the pre-war parity. Milton saw that the Fed failed to monetize the gold inflows, fearing it would lead to inflation. So what we had back then was the opposite roles. This predates income tax being applied to everyone so there was no hunt for taxes on the part of the government. The scale was tipped because the Fed was imposing deflation by sterilizing the gold inflows.

Conversely, following World War I, France had counted unrealistically on German reparations to balance its budget. When they did not materialize, it used inflation as a tax to finance expenditures. In 1926, France pulled back from the brink of hyperinflation. Unlike Britain, France’s inflation had put the old parity hopelessly out of reach. Consequently, France returned to gold but at a parity which undervalued the franc. Fearing inflation, France sterilized its gold inflows to prevent a rise in prices declining to monetize the gold.

Therefore, all the theories behind MMT are once again wrong for they are only looking at one side of the equation. Today, simply stashing money in a safe deposit box is illegal and considered to be money laundering. The government can justify itself in confiscating your assets even after you paid your taxes.

Therefore, in the ’30s, Milton’s criticism of the Fed was justified because there was no massive hunt for taxes from the fiscal side. Today, we have the fiscal policies hunting capital resulting in a contraction economically (declining in investment) while you have QE just funding the government – not the private sector. It is a different set of circumstances today v 1930s.


Basel III – IMF – Liquidity Crisis

QUESTION: As of today, Basel III comes in effect. Rumour goes that in a couple of months, there will be a lot of turmoil on the market and it would be the start of the implementation of an SDR like thing where people would lose 20-30% of their value and get stuck with this new currency. You have mentioned before this was in the pipeline but no timing was given. Is it really this close or is it for 2020-2022?


ANSWER: The IMF has been pitching Washington to let their SDR become the new reserve currency. They claim this would eliminate the problem of the Fed having to worry about external influence v domestic. Let me say that this will NEVER eliminate the issues of international capital flows. The fixed exchange rate of Bretton Woods never prevented that problem and it was that very issue that brought it crashing down. Until we are ready to begin teaching the meaning of a floating exchange rate system and abandon Keynesian economics, I do not see this problem ever being eliminated.

Basel III is separate from the IMF and its purpose is capitalization of banks — not the reserve currency of a dollar v SDR. Basel III was agreed upon by the members of the Basel Committee on Banking Supervision in November 2010, and was scheduled to be introduced from 2013 until 2015. However, implementation was extended repeatedly to March 31, 2019, and then again until January 1, 2022. The Committee replaced the existing Basel II floor with a floor based on the revised Basel III standardized approaches. This revised output floor is to be phased in between January 1, 2022, and year-end 2026, thereby becoming fully effective on January 1, 2027, if the banking system can survive that long to begin with.

The Basel III leverage ratio framework and disclosure requirements (“the Basel III leverage ratio framework”) was supposed to be raised to protect banks from failures. Many were required to raise more capital. The Net Stable Funding Ratio (“Basel III NSFR standards”) was to be applied to participating banks. Moreover, the committee is monitoring the overall impact of Total Loss Absorbing Capacity (TLAC) and banks’ holdings of TLAC instruments. Capital requirements for market risk as well as the committee’s finalization of post-crisis reforms were all supposed to be back-tested. Additionally, profit and loss (P&L) accounts related to the revised internal models-based approach (IMA) for calculating minimum capital requirements for market risk more specifically.

All of that said, the crisis we have is a LIQUIDITY Crisis. This time it has been created especially by the European Central Bank (ECB). By keeping interest rates negative and punishing banks for having cash, they have (1) lent into real estate to get higher yields but this type of asset cannot be sold easily, (2) buying emerging market debt to get a high-yield like Turkey. Turkey was the favorite of Spanish Banks and the capital controls that Turkey did before the election sent shivers down the spine of institutional investors. The ECB has driven banks into these markets that are notoriously illiquid. This means that under Basel III, banks will not have the liquid assets to support their capitalization requirements. It becomes more likely that the Basel III requirements will be suspended or else there will be a wholesale collapse of the banking system.

Liquidity Crisis

QUESTION: I have attended the last 2 conferences and you have said the “liquidity” in the stock market will become tighter coming into 2020 and that there will be less stocks available to buy. Does that have something to do with this inflow of capital from Europe as people become more aware? I read your article about the Emerging Market crisis with great interest and remembered what you said. Is there more information you can share with us on this topic?


ANSWER: Since Quantitative Easing has failed, capital was driven into non-traditional investments to simply try to earn income. There were institutions buying farmland just to lease it out to get 5% annual income. Others ran off into Emerging Markets. Spanish banks are heavily invested in Turkey. The problem is that this trend has caused a liquidity crisis insofar as capital has been invested in assets that are not liquid. Add to this corporate buybacks that are reducing the supply of stocks available.

All I can say is thank God for Socrates. There are so many global trends emerging that by themselves are confusing and would be impossible for a standard domestic analysts to forecast from a personal interpretation perspective. The combination of investment shifts into real estate, Emerging Markets, and corporate buybacks have created an interesting risk factor for liquidity during a financial panic.