Financial topics

[Oakwood]

OLD1953 wrote: Oakwood, I've got a question for you here. What do you regard as fiat money and what do you consider creation of money? As most here know, I'm a firm believer in getting definitions straight before getting into anything deeply.

From Investopedia :
Currency that a government has declared to be legal tender, despite the fact that it has no intrinsic value and is not backed by reserves. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on faith. Most of the world's paper money is fiat money. Because fiat money is not linked to physical reserves, it risks becoming worthless due to hyperinflation. If people lose faith in a nation's paper currency, the money will no longer hold any value.

[aedens]

OLD1953 wrote: Oakwood, I've got a question for you here. What do you regard as fiat money and what do you consider creation of money? As most here know, I'm a firm believer in getting definitions straight before getting into anything deeply.

From Investopedia :
Currency that a government has declared to be legal tender, despite the fact that it has no intrinsic value and is not backed by reserves. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on faith. Most of the world's paper money is fiat money. Because fiat money is not linked to physical reserves, it risks becoming worthless due to hyperinflation. If people lose faith in a nation's paper currency, the money will no longer hold any value.

http://www.chrismartenson.com/

[Oakwood]

Inflation or Deflation in our future?

From the National Inflation Association:

Don't Doubt Bernanke's Ability to Create Inflation

With the Dow Jones now down 11% nominally from its high last month, NIA has been getting hundreds of emails and phone calls asking if there is any way we could be wrong about the threat of hyperinflation in the U.S. and if indeed deflation is the real problem we need to be worried about. The names Nouriel Roubini, Robert Prechter, and Harry Dent get mentioned to us a lot, with many NIA members asking why these so-called "experts" believe deflation is in our future.

Roubini, Prechter and Dent have been wrong about the overwhelming majority of their economic forecasts over the past decade. When it comes to their latest predictions about deflation, they will actually be right to some extent. We will see deflation in some assets like stocks and Real Estate, but only when priced in terms of real money - gold and silver. In terms of dollars, prices for pretty much all goods and services are guaranteed to rise dramatically over the next few years. Creating inflation is the only thing in the world Federal Reserve Chairman Ben Bernanke knows how to do and is good at.

During the past week, the mainstream media has shifted from saying we are experiencing an "economy recovery" to now saying we are at risk of a "double dip recession". Nothing fundamentally has changed in our economy. The fact is, the U.S. economy has been in a recession since mid-2000. All government reported positive GDP growth since mid-2000 has been due to nothing but inflation. Our economy should have experienced a depression in 2001 and an even greater one in 2008, but the depression has been temporarily avoided at the expense of an inevitable Hyperinflationary Great Depression down the road.

NIA believes it is impossible for the U.S. to experience price deflation when the Federal Reserve has held interest rates at 0% for the past 17 months. Sure, there will probably be a second wave of mortgage defaults that could cause another round of forced liquidations on Wall Street, but during any future period of forced liquidations, we doubt the U.S. dollar will still be looked at as the "safe haven" it was in 2008/2009. Gold and silver will soon be looked at as the only real safe havens because they are the only assets that provide protection from both a deteriorating economy and massive inflation. Precious metals will decouple from the Dow Jones and we will begin to see gold and silver rise at the same time as the stock market falls.

Bernanke was questioned yesterday following a speech at the Bank of Japan about whether a 4% inflation target would be better than the Fed's current inflation target of 2%. Bernanke responded that "it would be a very risky transition" if the Fed changed their inflation target, claiming that U.S. inflation expectations are currently "very stable". (NIA estimates the real rate of U.S. price inflation is already north of 5%.)

Unfortunately, no policymaker in the world is smart enough to accurately control the rate of price inflation through the manipulation of interest rates, and certainly not Bernanke. It's mind-boggling to us how the mainstream media could believe anything Bernanke says about inflation after how wrong he has been about everything else. Maybe the press has already forgotten that it was Bernanke who in July of 2005 said, "it's a pretty unlikely possibility" that home prices will decline across the country, "house prices will slow, maybe stabilize but I don't think it's going to drive the economy too far from its full employment path". We are 100% sure that Bernanke will be proven wrong again when it comes to inflation.

The U.S. Dollar Index has rallied from 75 to 87 since December and is approaching its high from March of 2009 of 89. This has given Bernanke the cover to keep interest rates at a record low 0%, but NIA believes Bernanke is misreading these economic signals. When the U.S. Dollar Index reached its high last year of 89, gold was only $900 per ounce. Today, gold is approximately $1,200 per ounce. The fact that gold has held up so strong despite a rapidly rising U.S. Dollar Index, proves that our financial system is getting ready to overdose on excess liquidity. The U.S. Dollar Index has rallied only because it is heavily weighted against the Euro. The Euro is now overdue for a huge bounce, which we believe will send the U.S. dollar crashing while sending gold to new record highs.

It's not good for us to pay too much attention to short-term volatility in the financial markets. Short-term "noise" often causes investors to second guess what they know is true. In our new documentary 'Meltup' (which has now surpassed 441,000 views in 10 days) we said, "If stocks were to see a nominal decline one last time, we will likely see Bernanke shoot up his largest ever dose of quantitative easing, which could turn the current Meltup into hyperinflation."

We are seeing signs of this coming true already. Washington is now calling for another stimulus. Larry Summers, senior economic adviser to President Obama, has asked Congress to begin drafting a new stimulus bill in an attempt to prevent a "double dip recession". The proposed size of this new stimulus is so far only $200 billion, much smaller than the last $787 billion stimulus bill. However, we are sure Congress will increase the size of it, especially if stocks continue their nominal decline. The new stimulus bill will likely coincide with trillions of dollars in additional quantitative easing by the Federal Reserve.

[John]

The National Inflation Association??????

What does the National Deflation Association have to say?

John

[richard5za]

Explanation requested by John

Dear John,

Do you have any explanation, in either generational or
non-generational terms, why the market fell from 1966 to 1981?

Yes, here is an explanation which has a generational theory component, at least in part. Much of what follows I have extracted from work done by Crestmont Research.

Firstly, consider the following ‘decade’ table of the correlation between economic growth and DJIA (Dow) growth:

AVERAGE ANNUAL CHANGE (COMPOUNDED)
(All figures in nominal value)

DJIA versus GDP.jpg (29.65 KiB) Viewed 7884 times

The first conclusion is that economic growth is not driving stock market prices. Something else is at play here.
The idea that the economy will recover so stocks will go up in price is an erroneous conclusion.

So what is it? Before we answer that lets look at the BULL and BEAR cycles of the DJIA from 1901 to 1999:

Bull bear Cycles.jpg (54.77 KiB) Viewed 7884 times

From this we see that the “valuation instrument” of the stocks is the PE ratio

Let me explain: Lets take the Bear cycle of 1966 to 1981.

During this period company earnings within the DJIA grew at 6.4% per annum compound, only a little slower than GDP economic growth of 8.8% per annum compound.

The PE ratio at the beginning of the period was 21. So on a share with a price of say 100, if it were to grow at the same rate as company earnings of 6.4% per annum, in 1981 the price should have been 269.8 but in fact this didn’t happen. The price had gone down by 10% !!! Not up by a large amount which you would have expected from the earnings growth.

Why? Because the PE ratio had dropped from 21 to 7 over the 16 years.

The PE ratio is the mechanism that investors use to value shares in the longer term. (Short and medium term can be bedevilled by insane investor sentiment)

How does the PE ratio work?

Well here is a scatter plot chart done by Crestmont Research. The X axis is the inflation %, both positive and negative, and the Y the PE ratio. There are 109 plots for the period 1900 to 1909.

Scatter plot.jpg (35.64 KiB) Viewed 7884 times

With your math you will clearly see the Y curve, which gives the message that when inflation is low and positive there tends to be high PE ratios, and when inflation is high or negative the PE ratio tends to be low.

This is further substantiated by sophisticated financial models showing returns versus inflation and interest rates. I haven’t covered this here.

Clearly the bull and bear cycles are substantially influenced by various factors from the economic cycle (but not GDP growth as demonstrated above) but also and in particular to investor sentiment related to the generational cycle.

For instance:

The compound growth from in the Dow from 1921 to 1928 was 15.5% per annum. This is a typical bubble situation of investors losing restraint and behaving irrationally. i.e. creating a serious bubble. In my view bubbles and generational theory have a high correlation, for the all reasons that you have put forward over time.

Now have a look at 1933 to 1936, a compound annual growth of 18.9%, even higher. These guys hadn’t learned their lesson; there was an insatiable desire for more bubble! The party must go on. Sound familiar?

The next strong growth period for the Dow was 1942 to 1965. Much more restrained at a compound growth of 8.9% and in the context of a strongly growing economy, but nevertheless a mini bubble. I lost every cent I owned, plus borrowed money as well in that 60’s mini crash. It’s made me a wiser investor.

In fact, the 60’s mini crash hurt a lot of people but not nearly as badly as the 30’s. It wasn’t uncommon to attend a dinner party in the 70’s to be told by one of the guests that never again would they put money into a stock market. A retired and widowed aunt of mine lost 94% of her savings in that mini crash.

Now comes the bull market of 1982 to 1999. Here we are back to a compound annual growth for the period of 14.9% with a PE ratio of 42 at the end of the period. The bubble characteristics are very similar to 1929. (The bubble formed in 1995) Investor insanity is surely the correct interpretation? But like the aftermath of the 1929 crash, with a 200% growth shortly afterwards, these bubble investors of the 21st millennium, had another go and pushed the Dow up to a 2007 peak. Same insane pattern of the 30’s?

I do hope that this provides the explanation you were looking for, John.
Regards
Richard

[OLD1953]

OLD1953 wrote: Oakwood, I've got a question for you here. What do you regard as fiat money and what do you consider creation of money? As most here know, I'm a firm believer in getting definitions straight before getting into anything deeply.

From Investopedia :
Currency that a government has declared to be legal tender, despite the fact that it has no intrinsic value and is not backed by reserves. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on faith. Most of the world's paper money is fiat money. Because fiat money is not linked to physical reserves, it risks becoming worthless due to hyperinflation. If people lose faith in a nation's paper currency, the money will no longer hold any value.

The problem I see is that you are limiting money or dollars to that created by the government. The currency declared to be legal tender by the US govt is a minute fraction of the quantity of money in circulation. Most of the money in circulation is created by banks in the form of fractional reserve lending. Given the huge reductions in lending over the last couple of years, dollars are deflating. Remember that debits and credits don't match in terms of credits vs reserves in our banking system, thus the banks do in fact create credits that are equivalent to dollars in any real sense. They are fungible with respect to paper dollars, up to the point where you run out of paper, just as gold backed paper bills were fungible with physical gold, up to the point where the bank ran out of gold.

As these credits are fungible with dollars, an increase or decrease in their supply is inflationary or deflationary just as an increase in actual coin would be inflationary or deflationary.

Tracking the total credits show they are dropping, and that's why we generally agree here that the dollar is in a deflationary period.

It's important to keep in mind though, that with nothing backing the dollar but the promises of the US govt to pay its debt, the dollar becomes a commodity as our debt is essentially a commodity. And it therefore undergoes surges and declines in demand that aren't related to quantity of dollars/credits, but are more related to international conditions. And our politics relating to money react to these conditions. If the US bond rating was under serious threat to be downgraded, as Spain's was today by Fitch, you'd see the US moving to austerity measures, as such a downgrade would mean an interest rate increase that would seriously affect the country in a number of ways.

This would not be a consideration in the case of 22kt gold "in the pocket" money, but that system has its own problems. One does wonder what the reason would be for starting a bank, in the case of a gold backed system devoted to maintaining 100% reserves and no fractional lending. I suppose you could charge citizens for keeping their deposits safe, but you could not make loans, as you'd have nothing to lend. There would be little profit in starting a bank in such circumstances, and the fear of the poor banker grabbing the deposits and fleeing the country would become very real.

The perfect system for managing money in circulation has yet to be devised.

[vincecate]

One does wonder what the reason would be for starting a bank, in the case of a gold backed system devoted to maintaining 100% reserves and no fractional lending. I suppose you could charge citizens for keeping their deposits safe, but you could not make loans, as you'd have nothing to lend.

A bank could reasonably loan money without fractional lending if all deposits were for some length of time and not demand deposits. So if you got deposits for 5 years and made loans for 5 years then all could be ok. You can have many different lengths as long as each time period (say month) the bank total loan payments coming in and deposits coming due matched. See:

http://pair.offshore.ai/38yearcycle/#banks

I think banking would be better if done like this. If nobody was willing to deposit money for 30 years at less than 4% then banks could not make loans for 30 years at 4%.

[Oakwood]

OLD1953 wrote: One does wonder what the reason would be for starting a bank, in the case of a gold backed system devoted to maintaining 100% reserves and no fractional lending. I suppose you could charge citizens for keeping their deposits safe, but you could not make loans, as you'd have nothing to lend.

Banks have been in existence far longer than the fractional reserve system. As long as they borrow cheaply and lend dearly they make money. The fractional reserve system simply allowed them to leverage their profits to outlandish levels.

OLD1953 wrote: If the US bond rating was under serious threat to be downgraded, as Spain's was today by Fitch, you'd see the US moving to austerity measures, as such a downgrade would mean an interest rate increase that would seriously affect the country in a number of ways.

I'm afraid we disagree there. What evidence is there that Americans are going to accept any austerity measures any more than the Greeks are? (The only reasons the Greeks did--and are trying to recant, by the way--is because they were threatened by outside forces and were also bribed by a rather large amount of money. But not even enough money to stave off the inevitable default. Volcker was able to institute austerity measures previously when the US had far less debt and we had a different generation in charge. Good luck now. Besides, it doesn't matter how much austerity you institute, we're doomed. When the debt to GDP level exceeds 90% as it has now, there has never been a society that has recovered. Their fiat money has always destroyed itself. So it's not even a question of inflation/deflation, but a question of faith in the currency/government. Democrats, Republicans, Independents, Tea-baggers, no one can save us now. Anybody who tried to institute the type of austerity that would be necessary would cause a revolution.

[OLD1953]

Looks more to me like the revolt is happening in favor of austerity measures. Or so the tea party would have me believe.

Other factors control that 90% measure vs instability, most countries in the past have approached that level because of war, and nobody wants to bet on a country that might lose. Japan currently has double that level in national debt, but the Yen is appreciating against the dollar.

It's hardly mentioned that if the US returned to the taxation system of the 50's, we'd have surpluses in the Treasury. We undoubtedly will, though probably after the start of WWIII.

Fractional reserve lending is much older than you seem to think it is, going all the way back to goldsmiths who lent more than they had via letters of credit and promissory notes. I'll cheerfully admit they've recently gone overboard on leverage, and that's the generational aspect of this matter in a nutshell, the irresponsible generations are willing to take monsterous risks, as they are certain Mommy and Daddy will bail them out in the end.

I suspect most of the people who post on this forum have some financial disaster in their past, and this personal disaster has taught them caution the hard way. Until the mass of the people are taught this same lesson, the hard way, we won't see financial responsibility unless it is forced on us from outside. Downgrading US debt is one way that could happen. IMHO, responsibility is a learned thing that cannot be taught without a horrible object lesson.

[JLak]

FIne art, gemstones and gold as intrinsic value? Ha!

The only intrinsic value right now is in oil. USD has problems but OPEC pricing in USD is the modern equivalent of Bretton Woods.