Business fundamentals post-Covid – how Sir Thomas Gresham got it right

21 April 2021 - Elizabeth O'Hanlon

Until the mid-20th century, some coins were still made of silver or gold: precious, soft metals which over time became lighter as the metals wore away. And this, in turn, meant that coins which lost only a small amount of bullion would go largely unnoticed. Coin debasement – the act of decreasing the amount of metal in a coin whilst it continued to circulate at face value – was the literal work of the “coin clippers”, who shaved off a small portion of the coin, then smelted the shavings into new coins.
This illustrates some rather fundamental economic and behavioural principles. Those of “sound money”, and “Gresham's Law”. Sound money is money that is not prone to sudden appreciation or depreciation in purchasing power over the long term. It is aided by self-correcting mechanisms inherent in a genuinely free market system.
When I was a student in the nineties, I spent some time in Geneva at CERN. Much fondue and vin des glaciers was consumed. A comment of my supervisor from one of those evenings has stayed with me: “the price of this meal has been pretty much the same in the 20 years I have been coming to this restaurant…”. So, I looked it up. Indeed, the 25 year CPI index in Switzerland has increased by about 10%. This means a loaf of bread that cost 2 Francs in 1996 costs 2.2 Francs in 2021.
Contrast that with Venezuela where the 25-year CPI index has increased by approximately 60,000,000,000,000%. So our loaf of bread, which costs approximately 460,000 Venezuelan Bolivars today, would have been 0.0000008 Bolivars back in 1996. The currency unit has been redominated twice since then to make the literal number of notes required a little more practical, otherwise you would need a wheelbarrow for your visit to the bakery. But there you are: sound money vs. unsound money.
The resulting behaviour is described by Gresham’s Law: hundreds of years ago you spent the clipped coins and kept the good coins. Today, you spend Venezuelan Bolivars and you keep Swiss Francs.

Time has moved on but these principles remain. All currency is now fiat, meaning it has no inherent value. Fiat money – government backed money – is by definition only as good as the credibility of its supporting government. If it is printed willy-nilly, like in Venezuela, then that is not coin clipping. That is coin obliteration.
Since all money is now basically fiat and digital, and since global capital flow is competitive, and transactions happen at speed, international bond markets do a fair job of telling us which countries are “clipped” and which are “sound”.

Why am I banging on about this? In the last 12 months the debt bubble in the UK has been expanded by a further £400bn-ish. 20% or so of the total. I believe the impact of this has yet to really filter through.
UK businesses use pound sterling in their accounts as a means of keeping score of accumulated assets and liabilities. So, should you be hedging to effectively keep score of some of those items in other currencies? Or should you be looking at what you are in fact keeping score of – that is to say, what are your underlying assets and liabilities? What is it that your business is actually doing?

To put it another way: given such a shock to the economic fundamentals in the past twelve months, now is the time to take a close look at your business’ fundamentals. Sir Thomas Gresham would have been.

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