Red Alert - Monetary Flood!

By: Puru Saxena | Wed, Dec 7, 2005
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INFLATION - Previously, I talked at length about the definitions of inflation and deflation so I won't go into this subject in great detail. All you need to remember is that inflation is an increase in the quantity of money whereas deflation is a decrease in the quantity of money. And, despite what you hear on your local T.V. or radio show, we are living in highly inflationary times. How do I know? Easy - simply take a look at the rates of money supply growth over the past year -

Australia

+ 9.8%

Britain

+ 11.2%

Canada

+ 9.8%

Denmark

+ 16.3%

US

+ 7.3%

Euro zone

+ 8.5%

Central banks around the world continue to print money like there is no tomorrow. And what option do they have? The "developed" world is now plagued with a ridiculous amount of debt. For example, the total American debt is roughly US$40 trillion whereas the size of its economy is around US$11 trillion. So, the debt to GDP ratio is over 350%! Similar imbalances can be seen in most advanced countries where households and governments are choking on debt. In the current scenario, the easiest way for nations to make this debt easier to handle is through inflation. You see, inflation makes debt less formidable as the money you owe today loses its value (purchasing power) over time. So, the hundred dollars you owe today don't "feel" like a hundred dollars when you repay your debt five or ten years later.

We can be rest assured that the central banks of this world will continue to inflate. After all, the same method has been tried (without success) several times before in history.

One of the earliest experiments with paper money was introduced in France by John Law in 1716. Back then, Law proposed the establishment of Banque Générale, a state-chartered bank with the power to issue unbacked paper currency (similar to modern-day central banking). Around the same time, he also established the Mississippi Company, an enterprise designed to develop the colony of Louisiana in North America.

The French instantly fell in love with the "brilliance" of Law and his paper money system. A paper money system backed by nothing, delivered an endless supply of money pushing asset-prices and the shares of Law's Mississippi Company to dizzy heights! Law was declared a national hero as the French celebrated their new found "wealth". Initially, Law's note-issuing bank was a spectacular success -- until it collapsed after a bank run in 1720, plunging France and Europe into a severe economic crisis! A loss of confidence in Law's paper money triggered the collapse as the public started swapping paper for tangibles such as gold.

More recently, Germany also adopted the inflationary route after the First World War. In a desperate attempt, Germany, decided to repay its war loans by printing money. This action had a catastrophic impact on the German economy as its currency eventually became worthless due to hyperinflation.

A similar approach was embraced by Latin America in the early 1980's. Once again, the end result was the same - economic chaos and plummeting currencies.

One thing is worth noting though - during these inflationary times in history, asset prices went through the roof when measured in the inflating country's local currency; even though the currency itself totally collapsed! For example, in Weimar's Germany, a loaf of bread cost 10 marks in 1921 and it rose to an unimaginable 200 billion marks just two years later!

So, if the modern-day central bankers continue with their inflationary efforts, it may well be that (despite record-high American deficits and debt) stocks continue to rise as long as the public remains confident about the paper money system. During inflationary times when money is abundant, valuations can be thrown out of the window (current situation). During such times, stocks don't necessarily rise due to any fundamental reason; the rising tidal wave of money lifts everything in its path! Looking around today - stocks are rising, bonds are soaring, oil is high, gold is shining and even real-estate remains suspended in the stratosphere! Obviously, the money printing efforts are paying off as all asset-classes continue to rise.

It is interesting to note, that whilst the central banks continue to inflate, they are doing whatever they can to hide the evidence. "How can that be?" you may ask. Well, for a start, the consumer price index (CPI) released by most nations is an absolute joke. In the majority of cases, the CPI does not include housing or energy costs and everything else, which is included, is seasonally adjusted to prevent the CPI from rising too quickly! Also, it is interesting to note that recently the Federal Reserve announced that starting March, M3 (the broad based money supply figure) will no longer be announced. And I ask myself, "Why has the Fed decided to stop releasing the money supply figure?" The answer is obvious - for people to accept inflation, it must remain concealed. Otherwise, the public might wake up and reject the confiscation of savings through inflation.

GOLD - For sure, you can hide inflation from the public by manipulating the official statistics but you can't fool the precious metals markets and you certainly can't fool gold. Sophisticated investors know that the yellow metal is real money with intrinsic value. It has been around longer than all the paper currencies put together! Gold is a store of value, which is free from debt. Physical bullion in your own possession cannot go bankrupt even though your cash deposits can vanish if your bank goes up in smoke.

As some of you know, I have been recommending gold as a long-term investment since 2001. Back then, most people thought I was crazy. Today, there are a lot more believers but they still jump in and out trying to trade the market. My advice - forget about the short-term movements, simply buy gold on the dips for the long haul.

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Puru Saxena

Author: Puru Saxena

Puru Saxena
www.purusaxena.com

Puru Saxena

Puru Saxena is the CEO of Puru Saxena Wealth Management, his Hong Kong based SFC regulated firm which offers discretionary portfolio management and research services to individual and corporate clients. The firm manages two trend-following strategies - Discretionary Equity Portfolio and Discretionary Fund portfolio. In addition, the firm also manages a Discretionary Blue-chip Portfolio which invests in high-dividend world leading companies. Performance data of these strategies is available from www.purusaxena.com

Puru Saxena also publishes Money Matters, a monthly economic report, which identifies trends and highlights investment opportunities in all major markets. In addition to the monthly report, subscribers of Money Matters also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription from www.purusaxena.com

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