Endless Credit-Creation!
Puru Saxena
23 October 2006
MONETARY TIGHTENING - Over the past few months, there has
been a lot of talk pertaining to the ongoing monetary tightening.
In fact, central banks are being widely applauded in the mainstream
media for raising short-term interest-rates and "fighting"
inflation. Moreover, the "tight" liquidity conditions
prevalent today are being held responsible for the recent sharp
declines in commodities and the emerging-markets. The current
sentiment seems to be leaning more towards deflation, which is
a major shift away from the runaway-inflationary fears present
not so long ago.
In my view, not much has really
changed and we are still living in a highly inflationary environment.
Although, I concede that the rate of inflation (money-supply
growth) in the US has been in decline since 2002 (Figure 1);
bank credit continues to grow at a record-pace - $4.4 trillion
annualised in 2006 compared to $3.3 trillion last year. So, there
is no scarcity of money and credit today. In the past, whenever
the central banks were serious about monetary tightening, credit
contracted in a meaningful way compared to the previous year.
After all, monetary tightening has one prime objective: to curtail
credit in order to prevent excesses in the economy and capital
markets. On this account, the central banks have done a poor
job of tightening as credit growth (not captured in the money-supply
figures) is still in the stratosphere.
Figure 1: US inflation
(monetary-growth) in decline
Source: www.yardeni.com
In summary, money-supply growth
has contracted somewhat due to rising short-term interest-rates,
but this has been largely offset by a surge in bank credit, thereby
making the monetary tightening ineffective.
It is critical to understand that monetary inflation is now a
global phenomenon and over the long-term, the purchasing power
of your savings will be confiscated regardless of the "paper"
currency you select. Take a look at the latest money-supply growth-rates
around the world:-
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So you can see that despite
the monetary "tightening" being advertised by the media,
over the past year, the supply of money has continued to grow
rapidly.
It is interesting to note that
the rate of inflation or money-supply growth in the US peaked
in 2002 (Figure 1) however, the public only started to get worried
about this problem earlier this year when inflation was significantly
lower than the previous 4 years. On the contrary, in 2002, when
the inflation-rate was extremely high, most people were concerned
about deflation! This may seem totally absurd but it begins to
make sense when you realise that most people equate rising prices
to inflation and falling prices to deflation. The majority fail
to understand that rising prices are an effect of inflation (money-supply
growth) and falling prices are an effect of deflation (money-supply
contraction). So, when asset-prices collapsed in 2002 following
the NASDAQ-bust, a "deflation scare" emerged, thus
giving the Federal Reserve the perfect excuse to inflate. Figure
1 shows that the US inflation-rate in 2002 rose to a shocking
22%! Back then, as the supply of money (or inflation) soared,
its effects (rising asset and commodity prices) only started
becoming more visible to the public 4 years later. This is due
to the fact that there is a time-lag between inflation (the cause)
and rising prices (the effect).
Today, the rate of inflation
(money-supply growth) in the US is relatively subdued, commodity
prices have taken a beating, real-estate is cooling-off and a
"deflation scare" is emerging yet again. If history
is any guide, you can be sure that the response of the central
banks will be to accelerate the supply of money and credit to
unprecedented levels. I suspect that the next bout of inflation
is not far away and when it occurs, the current trough in asset-prices
will end, setting the stage for the next advance in asset-prices.
As investors living amidst
an endless supply of paper "money", we must not underestimate
the inflationary powers of the central banks. Back in March 2000
when the tech-bubble burst, I bet against the US stock-market,
which after 2003 was a painful experience as asset-prices rebounded
sharply due to monetary inflation. So, in the current inflationary
environment, I would not advise you to try and profit from falling
asset-prices. A better strategy is to utilise the current weakness
in asset-prices and take positions in precious metals, commodities
and the emerging stock-markets where a sound case can be made
for a sustainable boom.
Since the early 1970's when
gold was removed from the monetary system, we have seen constant
inflation around the world. Figure 2 captures this development
and confirms that the total non-gold international reserves worldwide
have grown to US$4.6 trillion today; a 46-fold increase from
the 1974 level of US$100 billion!
Figure 2: Non-gold
reserves at a record high!
Source: www.yardeni.com
In the 1970's, this liquidity
found a home in tangible assets (commodities) and in the 1980's
and 1990's, it rushed into financial assets pushing stocks and
bonds in the developed world to record-highs. Since the start
of the millennium, capital has been flowing out of financial
assets and rushing (yet again) towards tangibles. Over the coming
decade or so, I expect this trend to accelerate, which will cause
the prices of precious metals and commodities to rise immensely.
The above is an excerpt
from Money Matters, a monthly economic publication, which highlights
extraordinary investment opportunities in all major markets.
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Puru Saxena
Saxena Archives email: puru@purusaxena.com website: www.purusaxena.com Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription from www.purusaxena.com. Puru Saxena is the founder of Puru Saxena Wealth Management, his Hong Kong based firm which manages investment portfolios for individuals and corporate clients. He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs. Copyright ©2005-2015 Puru Saxena Limited. All rights reserved.
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