"Uncle Faruk," an uncle of a good friend of mine, made an interesting observation. What if a person you loan money to can't repay their debt? Does it make a difference if they are honorable or trustworthy? Despite your relationship and history with said person, their debt will go unpaid if they have no way to repay the loan, plain and simple. At first this observation and the implication that you shouldn't loan money to those who are unable to repay it, however close they may be, sounds cold. Surely you should take care of those in need of money that are close to you. What I believe he means, however, isn't that you shouldn't but merely that you should write off that debt as a gift when you make the loan and be pleasantly surprised should you see a return of what is essentially a risky investment.
What's interesting about modern financial markets is that they are a fairly new experiment. Markets of today look nothing like markets when the movie "Wall Street" was shot in 1987. The fundamentals of the financial system itself have only had a few decades to develop. The fiat monetary system began in the United States in 1971. This means that to make informed decisions about prudent investments, all of the historical data in the world is insufficient because there just isn't enough data. So as Uncle Faruk has pointed out, if there's no investment to be recouped, don't expect to get your money back.
So this brings us back to the eternal question (at least in finance circles) of "what is money anyway?" The word fiat is Latin for "let it be" or "let it be done." In the context of money, it means decreeing the value of a currency artificially. Relative to President Nixon's decision in the United States, moving to a fiat currency meant ending the U.S. dollar's convertibility into gold per the Bretton Woods system. One U.S. dollar was worth 0.81 grams of gold prior to Nixon's decision and was only worth more than the paper it was printed on the next day because the government said it was. Similarly all global currencies are only worth something because their governments say they are, with a few notable exceptions.
Some governments say their money is worth X amount of another currency and pass the buck on to another country. The Bulgarian lev is worth half a euro, for example. This is in preparation for Bulgaria to adopt the common currency. Or take the example of GCC countries. The Saudi riyal is worth $0.26 approximately and it will always be worth that until and unless the Saudi government says it no longer is. The former move is called "setting the peg" and the latter move is called "suspending the peg." Similar arrangements exist with other countries as well, some in which the peg "crawls" relatively predictably.
Why is this important? The foreign exchange volatility that takes place nowadays is many times the volatility in the same currencies in the 70s, 80s, and 90s. Any doubt as to the strength of a currency is enough to devalue said currency instantaneously. The current state of fixed-peg countries such as the oil exporting GCC countries or crawling-peg countries such as China therefore is critical to any decision to invest in such countries.
Countries with fixed pegs or crawling pegs (also known as variable pegs) will always pay their debts like the Lannisters. In this case their debts are the agreed upon amount of a "hard currency," such as the U.S. dollar. That is of course, until Uncle Faruk's rule comes into play. Turkey was unable to pay its debts, or protect its crawling-peg, 16 years ago and suspended the peg regime all together and reverted to floating its currency as it still does. Perhaps the wisest of investments, therefore, is betting on when the Lannisters will be unable to pay their debts? When will the conversions from the fixed peg currency to the hard currency become unsustainable and the peg be suspended?
Any model that successfully predicts such an event will yield incredible returns. Not only is "shorting" said currencies very cheap because they have no volatility but the devaluation that occurs when the peg is suspended is a major move. So if you want to make a good investment, be like Uncle Faruk and ask yourself, who will be unable to repay their debts?
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