World markets are discounting that something big will happen

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For my latest musings - please visit www.scottreeve.com
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This is my take on the world economy - Preserve your wealth while you still can!

The current talk is that the US and Europe may go back into recession. The reality is that they never left recession that hit in 2008. Bogus diluted statistics, such as inflation, unemployment rates have falsely portrayed the economic reality being felt by individuals in towns and cities around the world. Arguably many cities have been in depression for the last decade (look at Detroit and parts of Europe). The world economy is now on a detox diet and it will take many years, if not decades, to clean it up.

The markets are currently discounting that something very, very big is soon to happen. The markets always do this long before the average man on the street and the media realise it.

It could be a combination of things:
*country default;
* Euro monetary changes (Greece is insolvent, and other countries are close behind);
* central bank quantitative easing (monetising debt);
* major bank failure (particularly in Europe); and
* a significant slowdown in China.

All of these things are very real and we are already seeing the effects of this on world markets.


European contagion

All the major Euro countries are so intertwined lending billions to each other. A contagion will quickly spread when more of the bad debts rise to the surface.

Most of the current Euro-cris discussion is centred around Greece. By many measures its economy looks quite sick. It's sharemarket is now at its lowest level in 18 years (This is debt implosion!).

On other measures it certainly doesn't look as bad as other countries. Greece doesn't have the largest amount of government or private debts in the world, or the highest debt-to-GDP. One big difference is that it owes a much higher per cent of its debt to foreign creditors (foreign banks and countries).

Many argue that its non-sovereign entities which are clamping down on Greece. ie. the Global banking cartel led by the IMF, the World Bank, the Federal Reserve etc working in tune with the credit rating agencies (Moodys, S&P, Fitch). All I ask is what is the interests of the global banking groups? All actions to date show that they put their interests and survival ahead of everyone else. They do not care about the sovereignty of nation states.

So which countries banks' have the most at stake with Greece?

The following interactive chart I put together uses Bank for International Settlements data demonstrating which countries banks are most exposed to sovereign Greek debt as of the first quarter ending March 31 2011.

The most exposured banks are (by country):
French banks US$56.9 bn;
German banks US$23.8 bn;
UK banks US$14.7 bn;

The most exposed individual banks are:
BNP Paribas with US$7.1 bn (France)
Dexia with US$4.8 (Belgium)
Société Généralewith US$3.8 (France)

This is just the banks. When you add Government's holding Greek debt the amount is another US$145 bn.

Chart : There has been a huge widening of bony yield spreads and risk insurance on credit default swaps. Greece has gone parabolic. Portugal and Ireland are where Greece was a year ago.

or as Alan Kohler puts it, when the financial crisis hit last time in 2008, it was about liquidity (banks wouldn't lend to one another). This time around its about insolvency. There is plenty of cash around, but the banks might be broke.

Chart:
source: Alan Kohler, ABC News, Sept 2011

The dominoes are lined up

The next graph shows why the banking system is trying to fix Greece before it sets a precedent. You may have heard that Spain and Italy are "too big to fail, too big to bail". Europe bank exposure to Spain and Italy's are 6 to 7 times worse than Greece.

Chart :

The harsh reality is that no industry should be bailed out, including the banks from country to country. The ongoing debt crisis has come about because banks have lended and taken billion dollar bets to keep this unsound monetary system going (which is based on nothing but paper money generated out of nothing).

Monetary systems do blow up - why is the Euro any different?

One article I came across discuses that country default is more common than we are led to believe. There were a number of large defaults in the 1980s and 1990s in emerging countries across the Americas and eastern Europe. Economist Carmen Reinhart states that the list of deadbeat countries included

"current investor favorites like Brazil, which defaulted in 1983, went through a bout of hyperinflation in 1990 and effectively defaulted again, for the same reason, in 2000"

Reinhart and Professor Rogoff show that, on average, nations add 86% to their debt loads within three years of a credit crisis. At the same time, government revenue falls an average of 2% in the second year after the onset of the troubles. The way things are heading Greece and other Euro countries are heading down this path. Debts need to be rolled over...just like...a few snow flakes can lead to an avalanche.

The Stumble Cycle

Sovereign defaults--when a country stops paying its bills--go in waves, often following global financial crises, wars or the boom-bust cycles of commodities. Some countries, like Spain and Austria, mend their ways; others, like Argentina, are repeat offenders.

Chart :

The combination can be fatal for investors holding bonds issued by financially shaky countries like Argentina or Greece, which sell a lot of their debt outside their own borders (as does the U.S.--45% of all publicly held debt). As a nation's finances deteriorate, foreign investors sell their bonds, putting upward pressure on interest rates. That usually sets off a spiral including a deteriorating currency, which, if the bonds are denominated in foreign currencies, makes it impossible for the country to pay its debt. Greece doesn't have to worry about this last syndrome, because it uses the euro. But that might make things worse since it can't print its way out of its financial difficulties. "It's like entering a prize fight with one hand tied behind your back," Bass says. Argentina takes a different tack. Still struggling in the wake of its 2002 default on foreign-held debt, its president recently tried, and failed, to seize central-bank dollar deposits (and cashier her central banker) in order to repay overseas debt.

France

Following from earlier discussion, the big questions are which of the big European banks will go under first. The largest French banks, Credit Agricole and Societe Generale have billions in exposure to Greece and other Euro countries.

Chart : The share prices of the 3 largest French banks have fallen 73%, 87% and 87% since start the debt crisis started in 2008.



Italy

Until recently UniCredit was the largest bank in Italy by market capitalisation and a major euro-zone bank. It owns other large banks in Germany, Austria, and Poland with around 40 million customers all up. As the following charts shows, the market is dumping the two largest Italian banks. UniCredit is one of the "too big to fail and bail" euro banks and many of its depositors lie outside Italy, making and bail out practically impossible.

An ironic twist to this is that, UniCredit's predecessor was a bank called
Credit-Anstalt. This bank collapsed in 1931 which lead to a contagion which took Europe off the gold standard and pro-longed the Great Depression. Few people remain from the last depression era. Perhaps the money lessons need to be relearn?

Chart :



Australian dollar

The Australian dollar is a proxy for commodity prices and ultimately China. The Australian dollar has recently fallen sharply to 97 cents and has hit a major support level. If this fails there is another major support level at 94 cents.

Chart: The Australian dollar managed to bounce off the firs support level at US$0.97



Commodities

Overall commodity prices are not showing that China is in immediate trouble. Base metals: copper, zinc, nickel, lead etc are not in a major bear market yet. This may mean that the current correction will be short lived. If base metals start free falling and other negative signs come from China (popping of housing bubble?), than the Australian dollar and commodity prices will fall a lot (a huge amount) further.

Gold

Meanwhile, gold and silver have recently experienced a significant correction. Chart wise (USD/gold), gold's correction is not unhealthy. Gold was sitting at 11 year bull-market resistance line and its trending support line is about US$1550.

Chart:


As I posted recently, I believe the gold demand is getting stronger, and will remain strong, despite the recent price volatility. Since that post it has been reported that Mexico, Russia, South Korea and Thailand have all made large purchases in 2011 and globally, central banks are set to buy more gold this year than at any time since the collapse of the Bretton Woods system 40 years ago. The IMF even reported that European Central banks have started accumulating small quantities of gold after selling on average 400 tonnes of gold a year since 1999.

Silver

Silver plummeted last week by 34 per cent within trading days. It went straight through two key support levels and bounced back above them. After hitting a low of US$26.03, silver rebounded 28 per cent in 28 hours.

Chart: Silver fell 34 percent within 4 trading days, then bounced 28 percent within 28 hours


Is this volatility unusual? Silver is a very small market and historically has been prone to major corrections. My research shows that the major corrections in the last few years has lead to an increase in demand for physical silver (from mints and bullion dealers). I believe this will happen again.

Australia

Take away mining and Australia is in recession, and as I stated early, the key to the Australian economy is whether China can keep its economy upright. If it shows signs of weakness, commodity prices will collapse (along with oil, gold and silver) and the Australian Dollar will fall 10 or 20 cents against the USD.

China kept the world economy somewhat afloat during the global financial crisis, and is the sole reason why Australia didn't go and stay into a technical recession. One of the key barometers on the health of China is commodity prices.

Tourism has been in recession for many years now, in part to the high Australian dollar and a tightening of consumer belts.

Manufacturing has largely been in recession for a number of years except for businesses with astute management and niche business models.

Manufacturing insolvencies growing

Despite insolvencies around the world dropping to their lowest levels in nearly four years, Australia is headed in the opposite direction. This year is shaping up to be a record one for business failures on a par with troubled Eurozone countries. The most recent D&B Global Insolvency Index, ranking business failures in more than 30 key economies, found Australia's insolvency rate was on a par with indebted countries such as Italy, Spain and Hungary. Australia recorded a 12.1 per cent increase in business failures in the June quarter compared with falls elsewhere in the world of 5.7 per cent. D&B said its findings tied in with Australian Securities and Investments Commission data which pegged 2011 as a record year for insolvencies.

Business failures in manufacturing have soared 60 per cent in three years. Almost 300 manufacturing firms went broke in the first six months of this year, the business analyst Dun & Bradstreet says, and just 14 new manufacturers started up. By contrast, in 2008, 974 new manufacturers got off the ground, and only 392 folded.

Retail

Retail is finally entering recession. This has long been coming, even though the likes of Westfield (and other groups) have been creating mega-shopping centres around Australia. The whole retail industry relies on ever increasing amounts of debt (more credit cards and increasing consumption). This model is dead, and there is currently too much competition in Australia alone (before you look at internet shopping of overseas products on eBay and the like). Take electronics, there are so many major stores competing on price, and margins are getting thinner. Many of the private equity firms which bought up a lot of the retailers in recent years have failed, as over-inflated sales targets have missed the mark. In the last 12 months several major groups have entered administration: REDGroup (Borders/Angus and Robertson bookstores); Colorado Group (Jag, and shoe shops), Allied Brands (Baskin Robbins, Cookie Man), Krispy Kreme doughnuts, and Starbucks Australia. Most recently sharper falls in consumer spending has forced Harvey Normany to scrap its Clive Peeters and Rick Hart brands (7 stores to close) and David Jones announcing a 10.3% drop in fourth quarter sales and now expects a small profit for the new financial year.

Sizeable retrenchments are coming.


Housing

Chart:


Lastly, this is a very good presentation by Mike Maloney


Cheers
~ Scott

The Inflation vs. Deflation Debate

There are a lot of articles going around about whether the world economy is facing Inflation or Deflation. Here is my take on the situation.

It’s asset-deflation

Deleveraging of financial assets worldwide has been driving short-term deflationary pressures on world money supply. I label this as asset-deflation or debt-deflation. Deflation has a snowballing effect. It comprises of:

a) Illiquidity. When buyers hit the sidelines on expectations that prices will fall lower in the future.

b) Spreads Widen. With buyers drying up, the difference between what the nearest buyer is willing to pay and what the seller expects to get paid widens. For example, someone may believe their house is worth $500K, but the nearest buyer is now at $400K, causing a spread of $100K. In other words, the house is only worth what the nearest buyer is willing to pay!

c) Many sellers exit the market at almost any cost. In a rising market, buyers out bid each other to acquire an asset. In a deflation environment, many sellers are forced into a position to sell to the nearest buyer (even though it may be vastly under what they believe their asset is worth). There doesn’t need to be many sellers in an illiquid market to make prices fall sharply (just like a lack of buyers). For example, if someone forecloses on their mortgage, the bank will offload the property back onto the market and get what ever it can. As unemployment rises, mortgage default rises, the quantity of surplus properties in bank hands rises. This causes more asset-deflation.

Baby Boomers

More so in the future, demographics will be a major influence on asset-deflation. The Baby Boomer generations is the largest living generation in the United States, Australia and many Western economies. As they move into retirement at the end of their working life, many will sell down their properties, businesses, and shares (held in the Superannuation accounts). However the following generations will be unable to match this selling pressure as they are starting our/half way into their working life. This factor alone will ensure the next 20 years will be vastly different to the last 20 years for financial (DEBT) driven assets.


Asset-deflation should be embraced

Prices have been lifted artificially high for too long, and now the market forces are accounting for misallocation of capital.

Governments, central banks, commercial banks and individuals fear asset-deflation. This is why the Australian Government is guaranteeing deposits, the States debt, forming a Rudd-bank (commercial property fund). The aim of the Federal Reserve (and central banks worldwide) is to ensure property has soft landing so people feel wealthy again. They now want to prevent massive asset bubbles from bursting as it will destroy the artificial wealth effect.

artificial wealth effect - the general population get angry when food prices, rent prices continually inflate (because of an expanding money supply), but also dislike when the sharemarket and property values fall in price (again, due to an expanding money supply). We can’t have it both ways.

Historically property prices are said to double every seven years. What is never mentioned is how much the money supply has grown every seven years, or how our purchasing power has decreased every seven years. For example, if you buy a property for $100K in 1988 and sell it for another house in the surrounding suburb, you would have to pay around $100k for a similar house. Come forward to 1998, that same house is now worth $200K, but if it were sold, you would still have to buy a similar house in that area for around $200K. House prices have doubled in this 10 year example, but overall purchasing power decreased as the M3 money supply more than doubled. This is an artificial wealth effect.

A couple more points. The 1970s and 1980s were ideal times to acquire and invest in property and the sharemarket. The market was in a Debt-cycle. From 1982 to 1999, commodities were largely lousy investment and lost purchasing power. The two cycles have an inverse relationship. We currently remain halfway through an average commodity cycle. The purchasing power gains will continue to occur for gold, silver and most commodities, while the purchasing power of investing in the sharemarket and property will continue to decrease.


By design the system must inflate

The monetary system is designed to inflate over time and reduce our purchasing power. The system is mathematically designed on an exponential growth curve.
These factors include: fractional reserve banking, mandatory savings scheme, government monetary/fiscal power.


i) fractional reserve banking.
Every time someone signs a new mortgage or a new bank loan, new money is created right there and then. Fractional reserve banking is at the heart of the flaws in today’s monetary system. By design, all debts can never be repaid. Exponential credit (debt) is guaranteed. Therefore many nations, businesses, individuals will remain in spirally debts and bankruptcies.

“The most powerful force in the universe is compound interest” - Albert Einstein

ii) mandatory savings scheme (Superannuation)
Superannuation, Government Funds (such as the Future Fund) artificially inflate asset prices over time as they provide excess liquidity to the market and a guaranteed source of continual investment. By design, these schemes also need asset prices to inflate in price.

iii) Government monetary and fiscal power
The reason we have such extreme volatility in the economy is that Governments central banks, commercial banks try to re-inflate bubbles whenever market forces try to account for bad debts through asset-deflation. Central banks (through monetary policy) around the world are currently lowering interest rates in a desperate attempt to manipulate investor decisions, to draw more financially able investors into the asset-deflation black hole. Central banks/Governments aren’t lowering interest rates so people buy more food or enter the rent market. The monetary framework today is all about saving the PRICE of financial assets (debt).

Through fiscal policy, Governments are giving financial incentives (free handouts - free as in using taxpayer money…), such as the first home owner grant to artificially keep house prices high. In the future (its already happening…), these insentives will be funded by Government-debt.

These actions ensure the longer-term money supply will inflate over time and that debts will become increasingly unsustainable.

iii) a) the US Government is insolvent

The US Government currently has a national debt of US$11.2 trillion. Right now the US Government is spending almost. In 2008, the interest repayments on the national debt is US$431 billion (around 14 percent of the annual budget). When you add future liabilities (of an aging 80 million US baby boomers) such as Medicare, Medicaid and social security – debt liabilities total over US$65 trillion.

The US Government cannot escape its debt situation without borrowing more debt. The Government will never consider reducing Medicare or pension liabilities. The result – more money has to be created, and purchasing power must continue to decrease.


Cause and Effect

Economics is all about cause and effect. Unfortunately many (including our current PM) do not understand both elements.

Fractional reserve banking, mandatory savings scheme and Government monetary and fiscal power are all causes. The consequence is Inflation (loss of purchasing power).

Likewise, many journalists continue to ignore the root causes of deflation, but are fixated on reporting the effects of (asset) deflation. For instance, many are now writing up articles about how wages are falling across many Western economies. Wages just don't fall on their own. Wages are falling as a consequence of something else happening. That is, businesses are collapsing due to DEBT, the drying up of liquidity in markets (including debt markets) and as a result, demand is collapsing. Consequently, as the number of unemployed rise, wages come under pressure as they should.


The CP”lie” – is money supply deflating?

Another mechanism now entrenched in today’s monetary system is the constant dilution (manipulation) of Government statistics. Unfortunately Governments and media are now fixed on the Consumer Price Index (CPI or CP-“lie”). It’s the intention of Governments (and thus the media) that it is possible to sell the idea of deflation through manipulated statistics (particularly CPI).

Currently in Australia, the official CPI rate is 2.5 per cent.


Australia’s money supply is still inflating

In the year to March 2009, Australia's money supply:

Broadmoney 12.4 per cent;
M3 increased by 15.1 per cent;
M1 increased by 8.1 per cent.

There is no deflation in the money supply numbers. It's all on the RBA website. It's the media's fixation on CPI that a drastically diluted scenario is continued to be created. We will never hear what real inflation is doing through the mainstream media.

Chart 1: Exponential curves keep expanding
source: Wikipedia

Chart 2: A chart from my second post last year.
The above chart shows the annual grow rates of Australia's M3 money supply. It's not a conincidence that both the sharemarket and property market continued to bubble in the last couple of years (as M3 grew at a faster rate). Expect M3 volatility like the 1970s over the next couple of years (at least).


Japan’s decade of deflation?

Money supply has consistently increased in Japan during the last couple of decades whilst it has experienced deflationary pressures. Asset prices (property, sharemarket remain well below the bubble levels of the 1980s). As the following chart shows, the inflator mechanisms of fractional reserve banking, monetary and fiscal policy etc have meant that Japan's money supply has continued to grow even those asset prices are still subdued.

Chart 3: But the money supply is still growing?
source: Wikipedia

Japan has already been through much of what the Western World is now facing: significant asset-deflation. (Obviously there were other issues going on such as the zombie banks, several stimulus measures etc which I will go into more depth another time).

Summary:

Assets worldwide are being deleveraged and revalued by the market. Asset-delfation is healthy and should be embraced by Governments, banks and individuals worldwide. The market is accounting for excess money and debt in the system.

In Australia the current CPI is 2.5 per cent p.a., banks are offering around 4 per cent interest for savings. Official M3 data shows overall money supply inflation is 15 per cent p.a.
- Aren’t our savings going dramatically backwards in the bank?
- The RBA shouldn’t be reducing interest rates!

Ultimately when it comes down to the inflation/deflation debate, ask yourself this:

* Will the Australian Dollar (or other fiat currency) increase or decrease its purchasing power in the next couple of years? (in this "deflationary" environment). How much stuff will it buy in the future compared to today. This is the crux of the issue.

Remember there is a huge difference between price and value.

- Scott

Money Supply, Debt, Inflation and Purchasing Power!

Today I detail over money supply and what this means for inflation, purchasing power and the world economy.

What is Money Supply?

- is the total amount of money available in an economy at a particular point in time.
(http://en.wikipedia.org/wiki/Money_supply#cite_note-18)

Money supply used to be backed by a gold standard. However all this changed in 1971 when the Bretton Woods system fell apart. Today money represents debt. The total supply of money is infinite so long as there is debt in the economy. No debt = no money being created.

Money supply and Inflation

To leverage our potential buying power we borrow money (debt) to be able to buy more goods then what we could have done otherwise. However, the first rule in economics is that we have unlimited wants, yet limited resources. So at its most basic level, the more money supply in existence (created from loans), the more money there is competing for food, land, labour etc. This leads to price inflation and increased volatility and uncertainty in the economy. Booms and busts become more extreme.

How do you measure Money Supply?

In Australia the RBA define Money supply as:

M0: currency

M1: currency + bank current deposits of the private non-bank sector

M3: M1 + all other bank deposits of the private non-bank sector

Broadmoney: M3 + borrowings from the private sector by NBFIs, less the latter's holdings of currency and bank deposits

M3 is generally used by economists to estimate the total amount of money available in the economy.

What increases money supply?

Every time someone borrows money from the bank, the money supply expands. If you get a new mortgage for your house, or a margin loan to buy shares, you are helping increase the money supply and you are leveraging credit. Through fractional reserve banking, banks have the ability to make money out of thin air. If the fractional reserve is 9 to 1, you deposit $1,111.12 dollars into a bank, the end result is that the original $1,111.12 can ultimately create almost $100,000 of new money!

Movie: See Money as Debt to understand how our Monetary System works today (part 1 of 5 below)



Governments can increase money supply by spending more than they tax (one of the big reasons for money supply growth in the US). US money supply has expanded significantly in recent years due to a double whammy of tax cuts and increased expenditure.

Central banks try to manipulate money supply through interest rates. Central banks do this by buying and selling government securities (and other financial instruments). Ultimately, central banks can only do so much to influence money supply. As we saw in the US earlier this year when the Federal Reserve cut interest rates quickly and threw a $168 billion stimulus package, there was short-term elation, but has ultimately did little to prevent the stockmarket and property prices from falling much lower.

Only a very small portion of money supply (M0) is in the form of currency (notes and coins) generated by a central bank to meet physical withdrawals. This is usually less than 5% of the money supply.

What decreases money supply?

When someone pays back their mortgage (or other debts), money supply decreases. Money supply also decreases when someone defaults on their mortgage or closes a margin loan account, or the Government reduces expenditure and runs surplus budgets.

Central banks try to decrease the rate of money supply growth by increasing interest rates and providing disincentives for people to take out mortgages, margin loans etc.

Ultimately today's monetary system needs money supply (and consequently debt) to keep increasing for the economy to function.

Australia's Money Supply

Putting some numbers on money supply growth and using Australia as a case study, we can see that historical through-the-year growth in M3 has been very strong.
Cumulative:

- In the year from July-2007 to endJune 2008 M3 increased 23%
- In the last 5 years (to end of 2007) M3 increased 82%
- In the last 10 years (to end of 2007) M3 increased 174%
- In the last 20 years (to end of 2007) M3 increased 563%
- In the last 30 years (to end of 2007) M3 increased 1847%

As at June 2008, M3 totalled over A$1 trillion Australian Dollars.

Chart 1: Australia's historical through-the-year growth in M3.

Betweem 1971 and 1990, Money Supply growth was very volitile and tended to grow over 10% per annum. The 1990s till 2006 growth was between 5 and 10% per annum. It now appears we are heading for volitile times again.A spike in money supply will trickle into increased inflation.

Chart 2: Cumulative growth in M3 (A$ billions). An exponential curve. As MS increases, debts owed increases.



Chart 3: Log scale of Australia's M3 money growth.

Note the elasticity has been quite constant over time.

The US Money Supply

Since 1944 the US Dollar has been the world currency and until 1971 the $US dollar (and consequently currencies around the world) was linked to gold. Removing the link to gold essentially gave central banks around the world a blank check to print as much money as they want, as the amount of gold under vault no longer constrained how much money supply could exist in the economy. Money is now backed by our confidence in Government (whom guarantee coins and notes are legal tender). The paper used in a $50 dollar note is no more valuable then the paper used in a $100 dollar note – the only difference is that the Government assures us that one is more valuable than the other.

Is US Govt trying to hide something?

In March 2006 (see chart 4), the US Government ceased publishing its M3 money supply data. The reason? To save money!?


Chart 4: United States money supply

M3 was well over US$10 trillion dollars in early 2007.

The simple fact is there is so many $US dollars out there today! (remember a very small amount is actually printed notes and coins ie. M0). As the $US Dollar is the world currency, today about 50% of the world's currencies is in $US Dollars, and about 50% of the $US Dollars reside outside the US! So non-Americans have also contributed significantly to the growth of US money supply.

The US Govt is trying to hide the true rate of inflation. As money supply increases, the new money has to find a home. More money becomes available to compete for finite resources such as food and property. This is why there is always bubbles in property markets, the sharemarket etc. as more money is created through larger mortgages, larger margin loan portfolios etc. All this leads to inflation and ultimately hyperinflation. At the top of booms there is often deflation. This is when buyers hold off from buying in the expectation that prices will be cheaper in the future. Those struggling with their finances are are pushed to sell (to clear debts) are forced to sell to the nearest buyer. People may think their home is currently worth A$1 million dollars today, based on recent prices. However it is only worth $1 million if you have a buyer willing to sign on the dotted line. Your $1 million house might be only worth $800,000 if that’s where the first buyer is. This is deflation.

The $US Dollar = smoke and mirrors

We are constantly reminded by the daily news reports that over the last several years the $US dollar continues to depreciate against other world currencies (namely the Euro). However, in the last few weeks all we have heard is about the rising $US Dollar. I'm expecting this move to be a short-term pull-back, with the long-term downward trend to continue on its way.

As the $US Dollar is the world currency, it has been used as a base reference to provide a measure of value. For example, we hear the price of oil in $US per barrel or copper in $US per pound. Exchange rates are always first compared to the $US Dollar before other currencies. This continues to disguise the true value of assets. The world knows the $US Dollar is becoming more and more worthless over time. Many OPEC member countries are pushing for the $US Dollar to be dropped as the reference currency in favour of the Euro or a basket of currencies. OPEC knows the $US dollar is disguising the true value of their oil!

Is it a coincidence most basic food prices such as rice, wheat and corn have spiked dramatically in the last year? Rice has trebled in the last 12 months, yet the number of people eating rice hasn't gone up dramatically compared to say 24 months ago.

Ponder this. As more people in developing countries go from the poor class to the middle class, deposable incomes increase, and consequently the money supply. There is now more money (supply) chasing a finite resource. Add on top of this, there are hedge funds and large institutions in the futures (derivatives) markets, which help push prices higher (fuelling expectations). This all causes a bubbling of price inflation. As people soon realise they are spending more of their income on food, fuel, rent etc, wage demands increase, which economists argue is the main cause of inflation.

It's all about price expectations! If people expect higher prices, they will factor this into their spending habits. People gradually expect that fuel will cost more. Rice will cost more. Steel will cost more etc. If people expect higher inflation, they will ultimately receive higher inflation (and more money supply).

The US dollar has lost about 97% of its original purchasing power (of 1913) to inflation! The Australian Dollar has lost about the same amount of value, as have most other fiat currencies.

The Euro

A quick word on the Euro.

Chart 5: The Euro M3 money supply is fast approaching the size of US dollrs and is now about 9 trillion Euros.



Conclusions and predictions for the long-term:

- Money Supply growth tells us about the future. The faster it grows, the greater price inflation will be - "the new money has to find a home" - in food prices, in rent prices, in commodity prices etc. There is a time lag for this new money to go through the system and find a home.

Australia:
- Australia's money supply is going to expand rapidly between 10 to 25% plus, and should be volatile like in the 1970s due to uncertainties and expectations in the economy.

The World:
- The $US Dollar will continue to depreciate against most world currencies, however compare any world (fiat) currency to gold/silver/oil and they are all falling.
- The true rate of inflation in the $US is much worse then the US Government is publishing.
- Measuring goods in $US Dollars is disguising the losses in purchasing power.
- The Euro is fast becoming the new world currency; however the Euro’s money supply is increasing at an alarming rate.

In the near future I intend to cover off on some key value indicators. Namely: gold/silver ratio, gold/oil ratio, gold/Dow ratio and go into more detail on purchasing power.

Until then,
Scott