The Impossible Trinity

The Dollar’s Great Conundrum [The Daily Reckoning] December 27, 2022 [WEBSITE]( | [UNSUBSCRIBE]( The Impossible Trinity Portsmouth, New Hampshire December 27, 2022 [Brian Maher] BRIAN MAHER Dear Reader , We have two trinities to consider this Christmas season… The Father, Son and Holy Ghost was of course the first. An Open Capital Account, an independent monetary policy and a fixed exchange rate is the second. You may consider the first an unusual, even unlikely, trinity. But the second is the “impossible trinity.” Why is it the impossible trinity? And what does it mean for the fate of the dollar? Jim Rickards explains below. Read on… Regards, [Brian Maher] Brian Maher Managing Editor, The Daily Reckoning [feedback@dailyreckoning.com.](mailto:feedback@dailyreckoning.com) [Business Proposal for The Daily Reckoning Readers]( Want to see where Jim is putting his own capital ahead of 2023? It might surprise you. But Jim thinks it has more upside than anything else in the world... (And he's not the only one) And the best part it is... Jim can now actually bring you in on the deal with him. He'll explain everything. But you MUST act fast... As this opportunity will end on December 31st at midnight. [Go Here Now]( What is the Impossible Trinity? By Jim Rickards [Jim Rickards] JIM RICKARDS The Impossible Trinity is a simple rule with deep implications. It was first uncovered by Nobel Prize-winning economist Robert Mundell in the early 1960s. The rule is that a country cannot have an independent monetary policy, an open capital account and a fixed exchange rate at the same time. That’s it. You can have any two of those three conditions. You can even have only one or none if you like. But you can’t have all three at the same time. If you try, you will fail — markets will make sure of that. Those failures (which do happen) represent some of the best profit making opportunities of all. Understanding the Impossible Trinity is how George Soros broke the Bank of England on Sept. 16, 1992 (still referred to as “Black Wednesday” in British banking circles). Soros also made over $1 billion that day. Understanding and using the Impossible Trinity works wonders if you can spot the right conditions and set up your trades in advance of the inevitable policy failures of the central banks. Here’s how it works… The first part of the Impossible Trinity is an independent monetary policy. This simply means that your central bank can set rates where they want without regard for what other central banks are doing. If you want to ease to help your economy, and another central bank wants to tighten to prevent inflation, that’s fine. Each central bank does its own thing. The second part of the Impossible Trinity is the open capital account. This refers to the ability of investors to get their money in and out of a country quickly and easily. If you want to invest in China, you’ll have to take your dollars, convert these to the yuan, and make the yuan investment in whatever stocks, bonds or direct foreign investment you choose. Sometimes you don’t do this yourself; your broker does it for you. If you buy a Chinese based exchange traded fund (ETF), you may think you’re buying a dollar-denominated security on the New York Stock Exchange. But behind the curtain the ETF sponsor has to go out and buy the actual Chinese stocks to make the ETF work. Either directly or indirectly, your dollars end up in the hands of the People’s Bank of China, which issues yuan to complete the local stock purchase. Or, let’s say you’re a global corporation like IBM or General Electric and you want to invest $1 billion in a factory in Australia or Brazil. The same idea applies. The investor dollars end up in the target country central bank, and the investor gets local currency to complete the purchase. This is one way central banks build up their reserves of U.S. dollars and other hard currencies, (the other way they build reserves is from trade surpluses). So far, so good. Now let’s say you want to sell your investment and get your money out of the foreign country. [**Urgent Note From Jim Rickards – Response Is Requested By Midnight Tonight**]( [Click here for more...]( I’ve just made a massive change to Strategic Intelligence. This is one of the biggest changes to a newsletter in the history of our business… As far as I know, nothing like it has been done before. What’s going on? [Click Here To Find Out ASAP]( The process we just described works in reverse. The foreign central bank takes the local currency proceeds from your sale and gives you U.S. dollars from its reserves. This process of easily getting in and out of a foreign investment, and getting dollars when you want them is the essence of an open capital account. It’s like a revolving door — smooth, fast, and easy to get in and out. But sometimes the revolving door gets stuck with you in it. This happens when a central bank slaps on capital controls and doesn’t let your money out of the country. Then the revolving door is more like the Hotel California, (“You can check-out any time you like, but you can never leave.”) When this happens, we say the country has a closed capital account. The third part of the Impossible Trinity is a fixed exchange rate. This simply means that the value of your currency in relation to some other currency is pegged at a fixed rate. Of course, formally binding pegs were abandoned in the international monetary system in 1974. This was not long after U.S. President Richard Nixon ended the convertibility of dollars into gold at a fixed rate. Since 1974, all major currencies have technically been floating against others. But many countries do implement currency pegs informally using central bank intervention and other policy tools. For example, the Chinese yuan was informally pegged to the U.S. dollar at a rate of about 6.2-to-1 for most of 2014 and 2015. China unexpectedly broke the peg in August 2015 (causing a meltdown in U.S. equity markets) and devalued the yuan to 6.3-to-1. Since then the yuan has been devalued further, and now trades at about 6.54-to-1. Many countries pursue formal and informal pegs to other currencies, usually the U.S. dollar. The diagram below represents the Impossible Trinity. In this schematic, the open capital account is labeled “A”, the fixed exchange rate is labeled “B,” and the independent monetary policy is labeled “C.” The theory of the Impossible Trinity is that it is impossible for a country to achieve A+B+C at the same time. Any country that attempts this is doomed to fail: [IMAGE 1] That’s the theory. What about the practice? What’s so impossible about the Impossible Trinity? Consider the case of a country — call it Freedonia — that wants to cut its interest rate from 3% to 2% to stimulate growth. At the same time, Freedonia’s main trading partner, Sylvania, has an interest rate of 3%. Freedonia also keeps an open capital account (to encourage direct foreign investment). Finally, Freedonia pegs its exchange rate to Sylvania at a rate of 10-to-1. This is a “cheap” exchange rate designed to stimulate exports from Freedonia to Sylvania. In this example, Freedonia is trying the Impossible Trinity. It wants an open capital account, a fixed exchange rate and an independent monetary policy (it has an interest rate of 2% while Sylvania’s rate is 3%). What happens next? [Secret Gold Back currency RUINING Biden’s plans for a digital dollar?]( [Click here for more...]( What I’m holding in my hand is a completely new form of money… As we speak, it's being used as an alternative currency across the U.S. minting in places like Utah, New Hampshire and Nevada… And since it’s made out of a thinly printed sheet of REAL gold... It may be the single best way to protect your wealth from Biden’s plan for a government controlled digital dollar. That’s why, I want to offer to send one to you today. But since I have a limited number I need you to respond to this message by Tuesday at midnight. I’ve recorded a short 2 minute message that explains everything here. [Watch My Video Now]( The arbitrageurs get to work. They borrow money in Freedonia at 2% in order to invest in Sylvania at 3%. This causes the Freedonia central bank to sell its foreign exchange reserves and print local currency to meet the demand for local currency loans and outbound investment. Printing the local currency puts downward pressure on the fixed exchange rate and causes inflation in local prices. Eventually something breaks. Country Freedonia may run out of foreign exchange forcing it to close the capital account or break the peg (this is what happened to the UK in 1992 when George Soros broke the Bank of England). Or Country Freedonia will print so much money that inflation will get out of control forcing it to raise interest rates again. The exact policy response can vary, but the end result is that Country Freedonia cannot maintain the Impossible Trinity. It will have to raise interest rates, close the capital account, break the peg, or all three in order to avoid losing all of its foreign exchange and going broke. This shows you how powerful the Impossible Trinity is as an analytic tool. Once you see a country trying to achieve the Impossible Trinity, you can be sure their system will break down one way or another. You can begin to make investment decisions in anticipation of the breakdown. Conversely, when you see a country avoiding the Impossible Trinity (by not targeting either A, B, or C in the diagram above), you can have more confidence in their economic management. That way you can make investment decisions based on that level of confidence. The Impossible Trinity is a tool to separate countries with good policies from those with bad policies. It is also a tool used to make accurate forecasts based on the sustainability of those policies. By the way, there is one big exception to the Impossible Trinity. That’s the United States. The U.S. sets interest rates independently and has an open capital account. The U.S. does not officially peg the dollar to any other currency (thus technically not breaking the Impossible Trinity). But it does work with other countries to allow them to informally peg to the dollar. Why does the U.S. not suffer adverse consequences? Because the U.S. does not need foreign exchange. The dollar is the leading reserve currency in the world (about 60% of global reserves and about 80% of global payments), so the U.S. can never run out of foreign exchange to pay for things, it can just print more dollars! This is what the French called the dollar’s “Exorbitant Privilege” in the 1960s. Now you see why so many trading partners are trying to escape from a dollar-denominated global system. The game is rigged against other countries, and in favor of the U.S. This is why the game won’t last. King Dollar’s days are numbered. Using the Impossible Trinity to spot trends and make investment decisions requires a lot of analysis. There are three policies that can go wrong (A, B and C above), and three ways to fix them (again, A, B, and C). That gives nine basic scenarios (3 x 3 = 9), and many more when you consider hybrid or combined policies, (a country could devalue its currency and slap on capital controls at the same time). You don’t need to sweat the details or get a Ph.D. in economics to use the Impossible Trinity. That’s what I do for my readers. I’m always on the lookout for nonsustainable policies that are bound to break. Regards, Jim Rickards for The Daily Reckoning [feedback@dailyreckoning.com.](mailto:feedback@dailyreckoning.com) P.S. In my 2011 book Currency Wars, I warned that the U.S. was engaged in a special type of economic war. I said that these wars would: Degenerate into sequential bouts of inflation, recession, retaliation and actual violence as the scramble for resources leads to invasion and war. The historical precedents are sobering… Some version of the worst-case scenario is almost inevitable. Now with Putin invading Ukraine, rising tensions with China, inflation, recession, supply chain issues and the potential for greater violence breaking out all over the world… I’m afraid my worst fears are coming true, or at least some of them. [That’s why I recorded this short video message.]( I want to help you prepare for what I fear is coming next. Because if history is any indicator, there could be real trouble ahead. [Click here to view my urgent video message.]( Thank you for reading The Daily Reckoning! We greatly value your questions and comments. Please send all feedback to [feedback@dailyreckoning.com.](mailto:feedback@dailyreckoning.com) [Jim Rickards] [James G. Rickards]( is the editor of Strategic Intelligence. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He is the author of The New York Times bestsellers Currency Wars and The Death of Money. [Paradigm]( ☰ ⊗ [ARCHIVE]( [ABOUT]( [Contact Us]( © 2022 Paradigm Press, LLC. 808 Saint Paul Street, Baltimore MD 21202. By submitting your email address, you consent to Paradigm Press, LLC. delivering daily email issues and advertisements. 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