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What has happened to our money?

*Dow Theory Letters, Richard Russell, September 25, 2006

“It started in 1971 when Nixon shut the gold window.  When that happened, suddenly the whole world was dealing with fiat paper.  That meant that the central banks could grind out all the “money” in the form of paper that they wanted — and world liquidity increased exponentially.  In 1980 the US passed the Monetary Control Act of 1980.  This effectively eliminated Regulation Q — that was the regulation that placed a ceiling on how much interest a bank could pay.  With Regulation Q gone, the banks could pay any rate of interest and therefore compete for money.  The lending power of the banks surged.

Today the world is flush with liquidity.  There’s so much liquidity that one reason for the current abnormally low interest rates is said to be “too much savings.”  That’s the Fed’s story.  What they really mean is not that there’s too much “saving” the story is that there’s too much liquidity.  The world is literally floating in liquidity and credit.  Thus, we read in this week’s Barron’s (page 24), “Leveraged buyout activity is running at a feverish pitch.  LBO funds that led these acquisitions are expected to raise more than $100 billion in 2006, a record . . . That so much money is in the hands of so many eager deal makers competing for the same basic opportunities is also cause for worry. ”

The cover story in this week’s Economist magazine is “The Dark Side of Debt.”  A paragraph from the article, “The world is once again in the grip of a spree of lending, but this time to companies rather than countries.  What is striking is that much of this lending is occurring not through public share and bond markets.  The issuance of syndicated loans vaulted to $3.5 trillion last year from $ 2.3 trillion in 2000.”

The net result of the removal of gold behind paper money has been a virtual explosion in credit creation and liquidity.  The sheer amount of liquidity that is floating around the globe is incalculable.  Fifty trillion, one hundred trillion?  Nobody knows.  The only thing we do know is that the total amount of unbacked paper is utterly enormous.  The result is that it’s floated up the price of everything from stocks to bonds to real estate to commodities.

In the face of this enormous inflation of paper money and credit, the Fed pretends that it’s holding back inflation.  The Fed does it with phony inflation statistics.  The current reasonably accurate inflation number is 7 percent.  The current estimation of the M-3 money supply is 9 percent.     The only thing holding back massive price inflation today is the massive over-supply of goods.”


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