Still Think That a Money Market Fund is “Cash”?

When investors decide to close out their riskier positions and move into “cash,” most simply sell their stocks and let their broker sweep the proceeds into a money market fund which, they assume, is the same thing as cash because it holds high-quality short-term commercial paper that almost never defaults.

That assumption breaks down when you look at a typical money market fund’s holdings and see that it owns, among other disturbing things, a lot of European bank debt. But at least you can get your money out with a mouse click, right? Well, maybe not. Apparently the Fed, cognizant of the potential weakness of the money fund system, is considering withdrawal limits.

In a healthy society many things can be legitimately seen as risk free, starting with a sound currency and moving through the financial instruments based on that currency and administered by well capitalized and sensibly regulated banks.

In an unhealthy society fewer and fewer things are risk free. The banks can no longer be trusted to survive, governments run out of money, and even the currency stops functioning as a store of value.

Currency risk and market instability go hand-in-hand, with each amplifying the volatility of the other. So along with inflation-induced booms and busts comes an increase in the incidence of capital controls, where panicked governments limit citizens’ and foreign investors’ ability to move wealth around. The Fed’s proposed money market fund rules are both a perfect example of this and a sign of things to come. Once the crisis really gets going, expect controls to be imposed on bank accounts and international funds transfers initially; from there, who knows.

If history is any guide, by the end of this process gold will be the only remaining risk-free asset, and its value in debased fiat currency terms will be astronomical.

To read John Rubino article: Still Think That a Money Market Fund  is “Cash”?

Tagged as: Capital control, Commercial paper, Currency, Fed, Federal Reserve System, Money, Money market fund