A Flood of Money

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41

"Since October 1, 1877, all U.S. currency has been printed by the Bureau of Engraving and Printing, which started out as a six person operation using steam powered presses in the basement of the Department of Treasury. Now, 2,300 Bureau employees occupy twenty-five acres of floor space in two Washington, D.C. buildings. The Treasury also operates a satellite printing plant in Ft. Worth, Texas. Currency and stamps are designed, engraved, and printed twenty-four hours a day on thirty high speed presses. In 1990, at a cost of 2.6 cents each, over seven billion notes worth about $82 billion were produced for circulation by the Federal Reserve System. Ninety-five percent will replace unfit notes and five percent will support economic growth. At any one time, $200 million in notes may be in production. Notes produced in 2002 were the $1 note, 41% of production time; the $5 note, 19%; $10 notes, 16%; $20 note, 15%; and $100 note, 9%. No $2 or $50 notes were printed in 2002."

It would take a long time to print 2 Trillion dollars at this rate, remember a trillion dollars is over 67 miles high when stacked on top of each other in $1000 bills.

42

So, the burst credit bubble has caused many to default on their mortgage. They defaulted and the bank looses cash from their balance sheet in the process. The gov’t injects cash into the bank to keep them afloat. Some think that money doesn’t leave the bank because the gov’t essentially paid the bank for the defaulter’s shortcoming. It is incorrect to think the expansion of the money supply during this process does not create inflation. Why?

Think of it this way… money is a claim on labor. If I do work to make a product or perform a service I earn money. I first contribute to the economy to produce something that competes with other goods & services, thus keeping the price for that good or service low. Because I have now earned it, I can spend my earnings on something else. As Chris M. says, credit is a claim on future labor. Someone has the cash today to go buy goods in competion with those with earned money. More money chasing the same number of goods (because the guy with the loan didn’t contribute a product or service yet) raises the price of that good/service. This is when we notice what most of us call "inflation".

When you buy something on credit, your free money has won the competion to buy that good. It is now your obligation to produce a product or service to contribute to the economy. This produces something new that money can buy. If you default on the loan and the gov’t bails you out by injecting cash into the pocket of the lender, your contribution of a good or service goes unpaid to the economy. The bank’s balance sheet becomes whole again and able to lend out more money to compete with a fewer goods.

The asset price decline you see today is not deflation. It is a correction to the false economy that has grown beyond its means due to an inflated money supply. My savings are still in my bank account. I can go take out as much of my own savings as I want to go buy whatever I want. There is no restriction on my savings. The restriction of credit is causing less demand for goods that people haven’t yet earned the right to buy. It is this bursting of the credit bubble that is causing a correction in the economy and less demand for goods.

43

Debt and money creation can be returned by either an ever expanding economy OR a default of debt. The fact that bailouts are done at pennies on the dollar implies that a portion of the debt used to create all of this expansion is being defaulted on.

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to live by and how much gold you should buy, I’ve made a nice tidy sum on the rebound in markets and currencies. These same people will say that I am playing with fire, lucky… and a host of other accusatory things but in the end, I am just as bearish as the average person on this site but I also see an opportunity in making money in the meantime. I implore everyone to stay objective… recognize that attempts at long term trends is a useful exercise but that does not mean that there are not opportunities in the short run. The simple data point I was looking for was from the G7 meetings, and it was positive. The next data point that is just on the horizon is the price at which the TARP program will start buying assets at. A high price will make the markets rise but inflation more likely and a low price will likely make the markets fall but the risk of money supply increases will drop because there is a better chance that the gov’t will be able to make back its investment. In the background there is also the currency volatility to watch for as other key datapoints because that will represent a potential hiccup to overall confidence if a currency or futher bank failures come to fruition. It’s great to have Chris give us the tools to make good investment decisions and raise overall awareness but it’s only good if it is used in conjunction with all of the other ‘tools’ you have to make good, objective decisions. A great example is this debate on physical gold… no one sent me an email asking for more information and none of the people who claimed there was a big conspiracy over gold have made comments… do you think they are prepared to change their mindset with the new evidence being offered? I hope so… but me thinks not.

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If the Fed has expanded its balance sheet so much, what is the journal entry for the otherside? If they have prefunded TARP, then there is an offsetting liability that is now in TARP and awaiting deployment. If it isn’t and it has been to prop up short term ie. overnight credit markets, then because those assets cycle over such a short term, can’t it deflate just as quickly?

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deflation first… then inflation…

Can’t see this happening. By definition (at least my understanding)

AMS - actual money supply (notes, coins, deposits etc…)

Deflation - decrease in the AMS. In a deflation period the value of money goes up.

Inflation - increase in AMS. In an inflation period the value of money goes down.

Depression - referes to a slow down of economic growth

We are headed (or are in) an inflationary depression.

Can’t see deflation getting into the mix when the US is printing all this cash and dumping it into the system.

m.z.

47

Xflies

If you can prosper by trading, more power to you. Most people lose badly at it - including me. I started accumulating silver on the dips about five years ago and doing nicely, thank you. I have no issue with government suppressing the prices of gold and silver. These prices are so cheap, I kept on buying until I can’t buy anymore. Now I have a year to pay off that 2% APR loan. The banks are practically giving money away.

48

I hear you… I shouldn’t have been so rash with my comments. I also didn’t mean to sound like a Day Trader (nothing wrong with that either). My portfolio probably turns around 6x a year on average. What I really wanted to emphasize was the whole issue of objectivity and the application of the Scientific Method… make a hypothesis, maybe make an experiment or two, or do some due diligence, make observations… if the hypothesis doesn’t match the conclusion, wash rinse and repeat.

Great trade on silver, I am long silver, short gold. I am also long the markets in a different type of way. I isolated liquidity by buying commodity related stocks which have been sold beyond fundamental moves in the underlying commodity and shorted the commodity. Over the medium term I do not have much price risk since I am hedged and I am long more market liquidity. For example, I am going to go long YRI (TSE) and short GLD (US gold etf) and I am long ECA and short OIL (US Oil etf).

49

More power to you for being able to make money in the current environment - just remember that a strategy works until it doesn’t. You may also want to take a step back and consider the evidence that Chris presents here through a broader lens than you posts imply is your usual one. (I have not read the postings/debate over physical gold. I am speaking about the general flavor of many of the posts of yours that I have read.) I have not read anything that Chris has written that has said that there is no money to be made, just that the risks are especially high right now and that the first priority should be to get yourself various forms of insurance. After that, if you have the stomach and resources for making money in the market, go for it.

There is also nothing wrong with sticking to long term trends. I know of one man who gave newsletter readers his "trade of the decade" back around 2000, which was "buy gold on the dips, sell stocks on the rallies." The first part of his trade has gone pretty well, up 3-4 times since then. The second part has not gone so well in nominal terms until the last year, but, adjusted for inflation, he has been spot on with both sides.

Best of luck to you.

50

My memory of Chris’s definition of inflation and deflation is not just the AMS. I remember it as being basically measured by the old M3 statistic, which is all forms of money and credit. The current deflation is being caused by huge amounts of credit disappering through de-leveraging. Inflation will take over when the amount of liquidity (cash/credit) being pumped in by the monetary authorities overcomes that process.

51

With all these countries throwing money at the banking system. I assume at some point there will be inflation. What I am trying to wrap my head around is when other countries inflate with the USA at the same time. Will this give a false appearance of the dollar staying the same in value or will different countries bailout there banks at different times creating a roller coaster between currencies?

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I’ve actually read through Chris’ posts and many if not all the posts on this board. I’ve done this a long time Reuben and the key to my success is to NOT have a strategy. I have long term forecasts that are similar to CM but I choose to remain in the present and wait for certain key data points to confirm a change. We are definitely at a crossroads, whether it is the crossroads that plunge us into a 10 year depression, I’m just not sure yet but at least I am willing to say that I’m not sure. My posts have been nothing but a call on objectivity and raising questions that seek more detail. I still haven’t got an answer to my questions on the relativity of currencies explaining the enduring strenght of the US$ or my question about the other side of the journal entry of the increase in the Federal Reserve budget but I’ll wait patiently for an answer. I never received anything on my point about physical gold either… so if you were to objectively look at this board, would you say that it is filled with open minded people looking for self awareness or would you say they are better described as a group of similar thinking people looking for affirmation? I sincerely hope it’s not the latter but given what you’ve seen, what would you say? I am challenging people to think outside the box, just like what Chris has done by doing all of this work… it’s fantastic! I’m always in the search for new answers. Consider one more thing… you say that there’s nothing wrong with sticking to long term trends… let me just say that the longer term you go, the less accuracy in anyone’s guess as to what will happen. What is wrong with sticking to a certain trend or strategy is that there is opportunity cost to not only if you are wrong but in the time it takes you to realize that it won’t happen for much longer than expected. You can’t take one person’s success as it is just anectodal evidence.

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Will this give a false appearance of the dollar staying the same in value or will different countries bailout there banks at different times creating a roller coaster between currencies?
The answer is yes and no. They can inflate within close range, but they can't inflate commodities. That's were we'll see inflation get ugly.
54

Sorry for my ignorance, however, several posts mention or question the position of owning hard gold and silver. I have acquired several lumps of both and would sure hate to be in the wrong direction holding these for "safety". Would sure appreciate feedback on this issue.

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GDon,

Thanks for the insights. I can feel your anger in the words you wrote and we should be outraged for the reasons you state.

Let’s back up for a minute. Did the Founding Fathers prohibit fiat money? We’ve seen a great post recently full of great quotes about the concern over money (and I went back and found the post - which you wrote!! - on Fri. 10/10/2008 at 20:01 linked to a post at Fri. 10/10/2008 at 13:50 by Jeff B linked to Chris’ post "Berlusconi Say Leaders…" although I see joe2baba’s response questioning one of the quotes.)

(perhaps a set of FAQs with applicable quotes would be good so that we have a central place to refer to them)

I’ve read about the first sixth of Adam Smith’s Wealth of Nations and he painstakingly documents the problems with using gold and silver as currencies simply from a supply and demand point of view. For instance Adam Smith writes (in 1776) that economies would be flooded with "money" when gold came back from the Americas but at other times economies become physically constained when there wasn’t enough money to conduct the trade that the economy wants to do. I’d highly suggest reading what Adam Smith wrote - he’s very witty and you can see how much fun he had writing it. (The only reason I stopped reading is because I have limited time and I could see how Adam Smith was torn between what we would call "left wing" and "right wing" and our economic solutions are going to come from somewhere else).

Let’s conduct a quick thought experiment following a "hard reset" to see how your gold standard is going to work. The government says: "Ok, gold is the only currency - since we are going to conduct trade electronically we will offer to have everyone deposit their gold in a vault and they will be issued electronic credits equal to the gold". OK - day one everyone with gold does this and now has their wealth stored electronically. Everyone else has wealth stored in the labour that they are ready to perform, their real estate, oil fields, machinery, cars, ships, raw materials, mines, livestock and crops, plus pending increases in the rate of wealth creation from entrepreneurs and inventors (which together we call technology).

"Go!"

The sun beats down, the crops continue to grow, the livestock eat the available feed, but no one other than the farmers are working. Why not? Where is the money to conduct the trade? It is sitting in the electronic accounts but until those with the electronic gold conduct trade no one else can. The government can’t pay its employees, businesses can’t trade with one another because they don’t have a means of settlement, people can’t conduct real estate transactions, and on and on. OK, slowly the electronic currency begins to move within the economy but trade is limited to the electronic gold that is transacted - the rest that sits in the electronic accounts is unavailable to allow the economy to function. In time - yes - more and more electronic gold becomes available but always the economy is throttled by the amount of money that is circulating because there isn’t a link between the amount of gold in circulation and the amount needed in circulation for the economy to function.

The brilliance of fiat money, and yes I would say brilliance because it is an example of a social technology that allows our economies to flourish, is that it can be created to facilitate trade and it can be used by government to conduct its activities. However, it is ABSOLUTELY IMPERATIVE that the amount of money that is created by the government be watched carefully by its citizens. I agree wholeheartedly that its overuse is a hidden tax. And I’m not saying that this is easy - it most assuredly is not!!

At this point I’m going to close by directing you back to srarbour’s response to your post which I have valued above. Please consider his arguments because I am fully in agreement with his response and I see that you haven’t posted a reply to him. You are clearly a passionate person and if we are going to make progress as a group we need you to reflect on his perspective. For starters please look up Gresham’s Law as I’ve done today and you’ll see that the thousands of years of using gold simply isn’t true.

We aren’t very far apart in our thinking because we share the same source of concern - central banking. And everyone should be concerned - we just haven’t been aware how concerned we should be. However, one day once this all settles out, a great number of us will be watching fiat money creation very closely and assuming our responsibility as citizens - a responsibility that we’ve abdicated. Through Chris we are now beginning to take this responsibility back.

All the best,

James

56

Bearing01,

This is a great post that I found insightful. I would make a distinction between the timing of the events. First comes the credit creation leading to inflation as it competes against earned money. The period that we are in now is deflation because money is being destroyed as it is being (slowly) written off by the banks.

Now that earned money is no longer in competition with credit money the overheated economy begins to move in reverse. There is now just the earned money chasing goods since credit money is hard to come by. Businesses try to cope in a new environment by "right sizing" leading to a downward spiral of layoffs which leads to less earned money chasing goods. This could lead to price declines of goods as businesses try to encourage more sales.

Putting money into the banks equivalent to defaults puts further liabilities on the balance sheet of government and transfers wealth to the banks. The hope is that if the banks are capitalized then they can start lending again and the economy will grow again. The banks can’t be forced to lend and why would they? Even with the recently announced government capitalization and a guarantee against losses they still face impending losses as the credit bubble unwinds. Go to Chris’ Essential Books area on this website and click on the link to Amazon and then pick up a copy of "The Trillion Dollar Meltdown" by Charles R. Morris where the extent of the problems are outlined. The Trillion Dollars was just his first approximation of the losses - the author has lots of question marks beside large amounts that he couldn’t quantify but that will emerge in the fullness of time.

For instance, the subprime mortgages written in 2005 and 2006 had their rate resets in 2007 and 2008 so they won’t finish ending up in foreclosure until early 2009 so this hasn’t run its course yet. Plus the Pay Option ARMs (Adjustable Rate Mortgages) (of equivalent size to subprime) with five year terms that were written in 2005 and 2006 would start coming up for renewal in 2010 and 2011 except that the work done by Mr. Mortgage on the California housing industry shows that this will be brought forward into 2009 and 2010. (http://mrmortgage.ml-implode.com/)

Then there are the credit default swaps issued by hedge funds for which the premiums were gladly pocketed but is there enough equity to make good on the promises? What losses will accrue to the investment banks that loaned huge sums to the hedge funds to leverage them up?

How about the foreclosures that will result from the real economy slowing down? Layoffs have occurred in financial services and the construction industry but this will feed back into the general economy such as layoffs in the automotive sector. Meanwhile the banks will hold on to their capital for fear that they will be caught by their own insolvency which has not yet unveiled itself.

Meanwhile the ticking time bomb that Chris has pointed out is hyperinflation. How can this occur if, left to its own devices, we are experiencing deflation? That’s because if confidence in the US dollar leads to a "cut and run" and US Treasuries are sold in exchange for cash (printed by the US government as it monitizes the debt) then there will be cash running through the system buying up assets at a huge pace. What would they buy? Oil and gas stocks? Corporate real estate? Agricultural land? Wind farms? Physical metals? Physical oil? Grain? And those that sell would be left with a mountain of cash that they in turn would dispose of for other assets or consumption - hyperinflation being the result and a collapsing US dollar.

Rather than recapitalize the banks if the government wants to spend money to fight deflation they need to capitalize the sectors of the economy that are needed to allow people to earn money. Where are the best places? Let’s consider the major issues that Chris has identified: demographics, peak oil, and natural resource limitations. How about funding pure research into "green" technologies like cellulosic ethanol, building biodiesel plants, electric cars (there are emerging independent car companies). How about programs to make homes and business more energy efficient? Solar panels for homes? Wind farms? Infrastructure programs? I’m not suggesting exactly how this should be structured - just pointing out the direction government spending should go. All of this would generate value in the economy that would help support the debt.

Or we can just wait for deflation to run its course to the bottom in a few years without trying to soften the blow and hope that no one notices the ever increasing mountain of debt as mistakes are compounded…

All the best,

James

57

Where ever the new money is, there is an offsetting liability for the fed, and the report does show both assets and liabilties expanding at about the same rate in nominal terms. If the overnight markets are being proped, then yes, the balance sheet could theoretically be shrunk just as quickly. For other facilities, it could probably be shrunk back to previous levels over time. This does assume, however, that the assets used to collateralize the loans are soundly valued. If they are, then your theory is actionable and we are likly to see that deflation of the balance sheet once the crisis passes. If they are not, then we are likely to see the loans rolled over indefinitely as the banks who used the assets for collateral wanted those assets off their balance sheets in the first place because of the trouble they were causing. Tading their assets back would also mean that the money would have to be paid off - rather hard to do if the cash was used to settle other liabilities.

All the best

58

that go against the grain of most of the viewers of this board. So if the increase in H.4.1 was made in short term securities and used to shore up short term liquidity, then a reversal to this increase is quite possible. Again, I don’t know, just trying to raise the point and then look deeper into where that increase came from. My first thought would be that there’s no way it would have been spent on settling liabilities because #1 TARP hasn’t even begun yet and #2, we haven’t heard of the gov’t using their cash to settle liabilities. Possibly it has something to do with some of the earlier transactions like FNM but I"m not sure.

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Xfiles,

I think you have the right attitude. You clearly have the perspective that we don’t always control our overall situation, but we can do our best to utilize whatever it is in our best interests. Bravo. You clearly have prepared yourself for the long-term and seem to have the ability to "have fun" and play with this situation at hand. Good for you…I mean this. Remember, however, that some may be in a different stage of dealing with the situation and/or different financial situation and are still unsure about where to put any available money they might have as to protect themselves and their families; your comments then may come off as pompous. I am an individual who has limited means (financial assets) and am trying to plow through information as to prioritize in order to ensure my family is safe; I wish I had the ability to be a bit more cavalier about the immediate situation. I appreciate your dissent on some issues because this makes us be more diligent with our decisions…it just feels like we don’t have the time to be as deliberative as we would like to be. In essence, many are looking for streamlined choices especially if new to financial markets because much of society was sold on the status quo of inactive, almost unconscious second hand investment. In any event, these forums and discussions are cathadic and extremely important since some personal communities are still drinking some of that "it will work itself out" koolaid of denial. (*This commentator in no way condones, supports, or has financial interests in koolaid brand beverages.)

60

I don’t mean to imply that you are new to the game - that you are able to be flexible in your strategy (you do have one, it is just not the kind that can be laid out in a book and replicated by others. Nothing wrong with that.) and react to the data as it comes out says that you are not.

I agree with us being at a crossroads, and I also can’t say for certain that we are headed for a major depression. I can say that I have a hard time agreeing with viewpoints that paint a rosy picture and a continuation of what we have experienced for the last 20+ years (basically 2/3 of my life). I do not mean to say that it will be a sudden change. There are sure to be events that are seen as positive by those who want to continue the party. As the saying goes, markets can remain irrational longer than most people can stay solvent. Change is inevitable, and the main question in my mind is whether we do it by choice (sooner) or it is forced on us (later).

From what I have read on the forum, which is not as much as you, I would say that there is a mix of people. Some are seeking affirmation and support for their views and others are seeking to understand what they see in the world around them in new and different ways.

You speak of opportunity cost as though it is only present when a long term view is taken. I have to disagree. There is opportunity cost involved in every decision we make. For instance, if you put money into stocks now, you are (potentially) missing an opportunity to buy gold or other investments at the current price. If something snaps tomorrow, and price of gold quickly breaks through $1000/oz. and never looks back, you will have lost the opportunity to buy gold at these prices. While this particular scenario is may not be the most likely one, the opportunity cost is there no matter what you do with your money.

One of the things that I seem to have noticed is that you tend to view everything from a dollar-based point of view. I point this out not to say that it is right or wrong, just that it is something that might be coloring your perspective. A question to ask yourself that would not be dollar based is how has your portfolio done relative to gold or oil over the last 8 years? Would it buy as much of either now as it would have in 2000?I know that as of this summer, the general markets have never regained their 2001 peaks when priced in the Euro or gold. Why doI think this matters? To me it shows that the decline in purchasing power of the dollar in real terms has been sinking faster than the market was rising. This means that anyone in the market for the last 7 years, unless they were consistantly beating the overall market, was loosing purchasing power. For me in my overall, big picture thinking, there is a distinct difference between loosing dollars and loosing purchasing power. In general, rising prices do not reflect an increase in the value of the item being priced. They are a reflection of the loss of value of the dollar in real terms. Said another way, price inflation is not about value going up. It is about the absolute value of the dollar going down.

 

I hope that this does not feel like an attack, for I certainly don’t intend it to be. I am trying to use this as a way to clarify my own views by putting them down on the screen and reading them back to myself. I hope that doing so will also help others in their own thinking, and that they will respectfully challenge any inconsistancies that they find in my writing.

All the best