Commendatori's Blog

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The Money Supply – 1/10/08

Posted by commendatori on January 12, 2009

“I do not think it is an exaggeration to say history is largely a history of inflation, usually inflations engineered by governments for the gain of governments.”

— Friederich August von Hayek, Nobel Prize Laureate, Economics, 1974

One of the most absurd arguments I’ve heard justifying the Fed’s current policy of printing record sums of money is that it won’t be printing nearly enough dollars to offset the massive losses created by the magnitude of asset sales around the globe — due to de-leveraging. More simply stated, the Fed is not printing enough money to match the losses incurred.

That notion is so preposterous it’s insulting.

Yes it’s true, the credit crisis has triggered massive de-leveraging. I’ve read and heard estimates ranging anywhere from $10 to $30 trillion in losses. But that isn’t a loss of currency! Asset prices are falling because debt and equity positions are being liquidated, but the supply of currency isn’t diminishing at all. In fact, the amount of currency being printed by just about every government on earth is staggering! Furthermore, the volume of assets in the world isn’t decreasing — only values are decreasing.

Printing currency doesn’t increase the true value of anything; printing currency is inflation, and the result of inflation will be rising prices, yields, and interest rates, across the board. It may feel like value is being created, but it’s not.

De-leveraging is a relatively short-term phenomenon; it’s going to end of its own accord — whether governments are printing currency and crushing yields or not. But the fact that governments are printing money, and that they are crushing yields only means one thing: when the de-leveraging stops, prices, interest rates, and yields are going higher. The purchasing power of the currency you’re using is going to diminish, and the only defense is to buy real assets that can withstand inflation — or even outpace it. What sort of safe-havens qualify? The usual suspects: commodities, durable goods, and precious metals — especially gold.

If printing vast sums of dollars isn’t enough, add to this already precarious situation the fact that the U.S. — already massively in debt — is planning to issue trillions of dollars in new debt this year, and trillions more in 2010. Now you begin to see how the potential conflagration only becomes more flammable, and you better believe the U.S. isn’t the only country printing currency and issuing debt. Japan, Germany, France, and England — to name but a few — are doing exactly the same thing.

And yet, as I’ve said so many times recently, governments like China and Japan, who have heretofore bought U.S. debt — thereby fueling the consumption-driven boom of the last two decades — are tapped out. They’re losing their appetite for U.S. and European debt. The cracks are starting to appear, and analysts all over the world are taking notice. Witness this passage from an article last week in the International Herald Tribune:

“…as fewer dollars flow into China, the government has fewer dollars to buy American bonds and help finance the U.S. trade and budget deficits.”

Everyone from Bloomberg, to Moneyweek, to Barrons is waving the red flag, and bond yields have begun to groan as the upward pressure increases.

I’m just shaking my head right now. I cringe at the thought of people draining the remains of their devastated stock portfolios, dumping the proceeds into Treasuries or cash. I know it’s trite, but this really is the perfect storm, and when the dollar and Treasuries fall apart, a lot of people are going to lose even more money — at a time when prices and interest rates are going to be skyrocketing in response to the reckless printing of an unprecedented amount of currency around the globe. I know I’m not the only person who sees what is about to happen; this is going to make the 1970s and 1980s look like a day at the fair.

I have always been an optimist, but I am, for the first time in my life, truly terrified of the future.

I hope I am wrong.



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