Currencies, contracts, and viruses...

Note: The below strategy was originally taken up with clients in 2014. Since then the term "fiat" money has gone from being something tossed around by fringe elements to a part of the everyday lexicon. While Bitcoin was on the scene and I had written a strategy paper on it, I didn't take-up so-called "cryptos" in any meaningful way in this piece. Now 10 years on from the "global financial crisis", the triage that has held things together for a decade is wearing thin. Venezuela is putting stress on the system. Brexit (whether hard or soft) will undoubtedly have some unintended consequences. The moribund state of the broader EU economy and the US/China trade war all figure prominently in this discussion. Oh, and don't forget that although US shale and the return to coal fired power plants are all great for the US economy, they also have the perverse impact of undermining the petro-dollar system. Lots, and lots to think about. So here is the strategy from 2014, does it still have legs?

Money, money, money…What does the CONTRACT say about that?

Early last year [2013], some colleagues and I were brainstorming new ways to look at the now 6-year old "global financial crisis". For the sake of full disclosure, we were all lawyers, so our command of economic matters ranged from "very little" to "even less".

And like any panel of “good economists,” we couldn’t agree on whether the global economy had lapsed back into recession, whether it had actually ever left recession, or whether the “next leg down” was years away or perhaps just around the corner.

Once we’d exhausted our collective anecdotes in support of one argument or another, the conversation turned to the heart of the matter… if there’s risk out there (which none of us denied), then there had to be a commensurate amount of reward – somewhere. But where?

How could we identify where that risk was? And perhaps more importantly, how would we fashion that identification/recognition into a solution for which we could justifiably charge a fee?  

About that time, gold ATM machines were beginning to pop up in places like Dubai, and bitcoin was starting to enter the popular lexicon. Bloomberg and the other financial rags were (and still are) awash with stories of “global currency wars”, “competitive devaluations” and the like.

That was the backdrop that framed our discussion then, and the one that continues to drive how I look to position my clients now to benefit (or at least suffer no harm) from this “crisis”.

As a lawyer/strategist, one thing I avoid like the plague is even the suggestion that I’m giving investment advice (for that you need to consult an investment professional). So from my vantage point the concept of risks/rewards is manifested in the contracts that are the basis of my client’s corporate, commercial, and financial transactions.

What does the contract say about that?

Contracts are based on “consideration” – i.e., the thing that requires the parties to perform (that’s simplistic, but sufficient for this discussion).

Consideration can be many different things, but usually, that thing is money – and not just “money” in the general economic sense, but “money” referenced or denominated in a specific currency…ding, ding. That's when the bell went off in our collective consciousness!

There are lots of recent and historical examples of currency failures, Zimbabwe and Weimar Germany, just to cite a couple. But those examples are of only limited use. In the Weimar situation the world had yet to be globalized to the extent it is today – so the degree of interconnectivity amongst peoples, countries – and most importantly, contracts, was not there. In the case of Zimbabwe, its currency was national and therefore its failure was limited in its ability to spread contagion beyond its borders.

But what happens when the currency that fails is a major point of reference in vast numbers of contracts around the globe? What do you do then?

The so-called “global financial crisis” has been nothing if not demonstrative, and what it has demonstrated with an absolute certainty is that ANYTHING IS POSSIBLE. So its no longer unthinkable that one or more of the major reserve currencies could fail or suffer a significant valuation crisis in the medium to longer term (or perhaps next week)…

 So what else does the contract say about that?

Against this backdrop, there are two things that we know to be true with 100% absolute certainty.

• Firstly, we know that printing money diminishes the value of the unbacked currency already in circulation. Although such a simplistic view obviously doesn’t take into account the destruction or creation of credit alongside such printing, the general premise is sound.
• Secondly, and this point requires absolutely no nuance whatsoever, is the fact that every single (unbacked) paper (fiat) currency in the history of mankind has always reverted to its intrinsic value…ZERO!

As a strategists/lawyer, assuming that a reserve currency crises is even a remote possibility, I have to ask myself – what should I be telling my clients? As always, discerning a correct answer starts with asking the right questions. As alluded to above, in this case, the questions revolve around the notion of consideration, for example:

• In the commercial context, what happens when a reference currency fails or is no longer available (e.g., Euros for Drachmas)?
• What claim would one party have against another to require payment in an alternative currency (special drawing rights (SDRs) for example)? Could such claims be “specifically” enforced? 
• Does the applicable law stipulate an outcome?
• Should companies right now be considering strategies that hedge their downside risks against suppliers/contractors/counterparties generally?
• What would such strategies entail?
• Would having reference points to one or more precious metals (e.g., gold and/or silver) mitigate this risk? How could such reference points be structured into new and existing contractual arrangements? What would the reference points actually mean -- i.e., a claim to actual metal / derivative (e.g., mere certificate)?
• Are there adverse/advantageous accounting consequences?
• Do traditional legal concepts of force majeure/impossibility or frustration of purpose come into play?
• Are there any potential windfalls to be had via a contract having gold (again, just to take one example) as an alternative reference point?
• What are the potential implications of a force majeure clause within the context of a currency crisis?
• Can/must a contract still be performed if the reference currency no longer exists or is hyper-inflating (e.g., can a severability clause be used to reform/fix it)?

 Ultimately what this all boils down to is money, money, money…what does the contract say about that…and do I have a strategy to deal with it?