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Can You Really Call A Currency Dilution A STIMULUS Package? If You Dilute Wine Massively With Water And Still Label It As 13% Alcohol, Is That Ok?

Well folks, the whole YEN overseas-bond rumour this morning shows one very important things: currency traders pay attention to a fact that equities traders don`t, but should: debt & inflation caused by currency dilution.

If a government with a sovereign currency announces a STIMULUS package, its means a government plans to act as investor to actively put money into the pockets of businesses and hopefully in the end in the pockets of its tax paying citizens.

The original idea of the stimulus concept stems from modern economics. The original idea is because a government collects tax from its citizens and businesses, in economically challenging times the government should distribute the available amount of tax collections in a way that instead of dumping large amounts of that tax collections in areas where it does only benefit specialized businesses (i.e. businesses that benefit from military spending, government employee benefits, Government Projects) in areas where a large amount of businesses in general and citizens in general benefit from the amounts to be spent.

Did you get the caveat? Keyword here is available amount of taxes. It is clear that if a government is required to stimulate its economy there is no household surplus available - why else would you need to stimulate an economy that is down?

How would a sensible group of investor stimulate a large scale corporation that has problems with its business, one that suffers from the same problem as a government, namely having borrowed too much debt from investors financing dead end projects that have created no or bad revenue streams?

Easy: step one terminate all dead end projects, sell any available assets from these dead end projects, negotiate repayment for existing debt and restructure your business operations, streamline all other projects, fire inefficient employees and managers and most importantly monitor your pension commitments (which were a major contributing factor in the business deaths of many 100 year multi-billion companies like Bethlehem Steel and Kodak). Step two, modernize your business and focus on growth areas, identify and expand moats. Step three, use your new revenue streams to pay off debt to become more profitable.

How do governments solve the same problem? keep dead end projects, don`t fire anyone, don`t talk about your pension commitments, do not identify and expand moats, do not payoff existing debt but just roll it and issue new debt, or even better: just turn on the printing machine.

Governments can do what businesses can`t: a governments finance department (it`s central bank) can simply push the enter key of a keyboard and voila, there is another couple of hundred billion or trillions of its currency issued.

This leads to a mind-boggling problem: any government`s balance sheet in today's time like pretty much the same, it has almost always negative Shareholder`s Equity, best achievements are in some decades a slight surplus. For every 1 billion in assets a government balance sheet has on average 2.95 billion in debt, every 1 billion in debt is only backed by about 0.15 billion in cash, but for every 2 billion net debt there is also the same 0.15 billion in cash, leaving most currencies with roughly only 7.5% of actual cash in circulation. Now you understand why governments prefer the digital accounting of a currency opposed to cash accounting of a currency, yes?

Now, coming back to the topic of a STIMULUS package: because governments do not execute any economic or financial theory as they should, it is preposterous to simply issue new debt and call this a stimulus, or let`s call it a revitalization package.

If a company with negative shareholder`s equity and a staggering amount of debt would announce to revitalize and stimulate its business by just having secured more debt financing with no change in revenues, would you invest in that company and buy shares after that announcement? Stupid question, right?

But how come governments get away with it? Well, here is the thing: they only do with its citizens and with equity traders. They never get away with it in regards to currency traders. Currency traders immediately punish a government or reward a government for bad or good policies.

If you simply issue more currency and distribute this via digital accounting, it is more or less not obvious to either citizen or currency trader what the economic impact of that issued amount is. The only measurement is key statistical numbers that are going to be reported over the next 12 months, and the going theory is that if those numbers, i.e. GDP, Unemployment, Consumer Confidence and Purchase Manager Spending improve, the Finance Department of the Government is taking credit for it.

Well, is that really true? Of course not. Here correlation is mixed with causality. If you dilute wine heavily with water, does the wine get better? Does this improve the taste so that those who drink it are thanking the one responsible for dilution? Probably not.

On the other hand, if you issue debt, especially overseas debt that has also foreign investors and foreign nations looking very, very closely at how your debt situation devlelops, you invite too many witnesses and watchers/bystanders to the crime you are about to commit so to say.

Effectively a debt stimulus package only works if it is not obvious to see as debt and it works its magic only if the government makes it difficult to verify for non-centralbank employees (meaning for everyone else) the actual status of its digital debt accounts and accounting procedures. The best is to publish just a couple of key numbers, as few as possible like M1, M2, M3 and say 3 more breakdowns and that`s it. And that is precisely what most central banks do. No big telephone-book thick like appendices with real accounting data. Ingenious, isn`t it?

No, it is rather corporate effectiveness and corporate survival, even citizen effectiveness and citizen survival that is the reason why things change from bad to better. Both corporates and citizens restructure their lives, and those that reduce debt and increase efficiency in their lives not only survive but thrive.

Isn`t it ridiculous that governments actually are the ones taking credit when the survival instinct kicks in for both citizens and corporates and betters those circumstances by restructuring?

Yes it is, and that is why if you really want to measure a government`s effectiveness, look at its currency value during the government`s administration period against its major trading partner currencies and then you can really know whether a government was economically effective or not - even if a stimulus package was just a psychological placebo effect, even if a much needed one. Off you go now, and look at short- and long term reactions of currencies over 4-6 year periods with financial decisions by their governments layed over/marked on the chart.

What do you see? Random results or a pattern?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.