Since we at The Automatic Earth generally tell people to hold cash or cash equivalents, it makes sense to expand on that a little, and to point out some of the location-specific risks of doing so.

Eventually you should get into hard assets, even if asset prices still have further to fall. Liquidity can be as hard to hang on to as it sounds, and is therefore not a long term bet. A couple of years should be enough to ride out the worst of an asset price collapse while still being in a relatively low risk position regarding liquidity

But for now, we tell people to hold cash because that is what they will need access to in order to make debt payments and to purchase the essentials of life in a society with little or no remaining credit. The value of cash domestically – in terms of goods and services in your own local area – is what matters most.

Domestic currency value relative to other currencies internationally will be very much a secondary concern for most people, as the ability to exchange one currency for another is not likely to last far into the coming era of capital controls. Currency risk is likely to become very large, and almost everyone will be better off holding whatever passes for cash wherever they happen to be.

As the price of goods and services fall, thanks to the destruction of purchasing power brought about by collapsing money supply, what cash you still have will go a lot further in terms of, say, milk and bread. Capital preserved as liquidity will go a long way. However, there are NO no-risk scenarios. Apart from the obvious risks of fire, flood and theft, other risks to holding cash will grow over time. Liquidity can be as hard to hold on to as it sounds.

One particular risk is the reissuing of currency. Russia did this during the economic collapse of the Soviet Union, and made it so difficult for ordinary people to convert old currency into new that much of the middle class lost their life-savings. In Russia trust in relation to banks was not particularly high, hence there was a lot of money under the beds of the nation that the powers-that-be were attempting to flush out. That is not the case in present day industrialized countries, where people generally believe that banks are safe and deposits are publicly guaranteed in any case.

Requiring people to convert would require them to reveal what they had though, and this would probably result in windfall tax bills (i.e. extortion) for those who had been foresighted.

On top of that, few people have savings, having become dependent on access to cheap credit for their rainy-day funds. There is virtually nothing under the beds of the Western nation, and so essentially nothing to flush out.

Although that particular rationale for currency reissue does not really exist (the flushing out of hidden wealth), there may be other reasons for doing so, and these will be locational. The risk of currency reissue in the US is likely to be low for some time. The US is likely to benefit from capital flight from other places, on a knee-jerk flight to safety.

In addition, dollar-denominated debt deflation will increase demand for dollars, and hence increase their value. This should reduce pressure for any kind of radical currency reform for a while. If the US does eventually reissue its currency, I would imagine them doing so in order to deprive foreign holders of dollars of purchasing power. There are very large numbers of dollars held overseas, and these would not be able to be exchanged in a currency reissue. At some point this may serve the interests of the US, but not soon.

The pros and cons of short-term T-bills

Negative t-bill rates will make cash on hand look better than bonds, even of the shortest duration, as cash won’t have a built in depreciation.

T-bills will still be a good deal relative to most things, but cash on hand will be better.

That will increase the likelihood of cash withdrawals leading to bank runs.

Welcome to the perfect financial storm

What is coming, I think, is a nominal short term interest rate that is moderately negative – an official Fed rate rather than a market rate as at present (as the Fed follows the market). This means people will be paying to own t-bills, but this will still be one of the best options available for short term capital preservation. The capital will be far less likely to be lost there than in a bank, and the return OF capital is the important thing. Despite a negative nominal rate, the real rate (the nominal rate minus negative inflation) will still be high as deleveraging continues and accelerates.

It won’t be as high as it would have been at a nominal rate of zero, but there would still be a real return on top of greater capital security than most other options. I think a lot of investors will be happy to buy t-bills even where the nominal rate is negative. The US dollar appreciation relative to other currencies will be a significant bonus as well.

Of course cash on hand would be an even better option in terms of return, because that would have a higher nominal rate, zero percent, and therefore a higher real rate as well. The real rate will apply even outside a bank, reflecting the greater domestic purchasing power of liquidity.

But it isn’t practical to hold really large sums of money in cash

Hard goods

Everyone will need to make the transition from cash to hard goods at some point. Cash is what you need to navigate the great deleveraging, but over the time the risks to cash will rise and you will need to think of the next phase, which is addressing the risk of the kind of economic upheaval that breaks supply lines. That will come first, and inflation (ie actual currency printing) will come much later. Inflation is only a risk once the power of the bond market has been broken, and that is not today’s risk, nor tomorrow’s.

That is something to consider much further down the line. Deflation and depression are mutually reinforcing in a spiral of positive feedback. That is not a dynamic that will end quickly, but end it will some day. At that point, or well before depending on where you live, you will want to be fully invested in hard goods.