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Steve Saville: Thoughts on Monetary Inflation



January 12, 2010 – Comments (0)

My intro in the post: Puru Saxena: The Debt Bomb - is very applicable to this post has well.

We are in the midst of a massive recession bordering on a meltdown. Demand is slowing and the natural market forces desire deflation to purge all of the excess leverage and massive mal-investment.

But as long as there is a Federal Reserve, it won't happen.

I own gold because it is a combination inflation hedge and hedge against bad economic policies / finanical shenanigans / loss of confidence. I don't own it because I like shiny yellow rocks. In fact, in an ideal world I would much rather own Dollars because they **should** keep their value. Fiat currency is basically a tax credit, if you want to distill it down to its essence. That means that it is a representation of the combined productive energy of the American public. And there is a mechanism by which this productive energy is funnelled into productive endeavors. It's called the Free Market.

Our currency should not be diluted by distributing it to non-productive endeavors, it should not be diluted by politicans wanting to curry favor, it should not be under the control of one body that does not have the US public's best interest at heart (the Fed has the US Government's best interest at heart, and many people will say they are the same. I argure that they definitely are not).

But I don't trade and invest in the world I wish we had, I trade and invest in the one we have. Which means I am forced to seek some sort of protection against inflation. As long as there is a Federal Reserve, the preferred expedient political solution will be inflation, and in the current environment, primarily through debt monetization.


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Thoughts on Monetary Inflation
by Steve Saville


Inflation: A deliberate policy, not the natural way

The US Federal Reserve ("the Fed") was created in 1913. All the shares of the Fed are owned by private banks (every bank operating within the Federal Reserve system must have equity in the Fed), so it can be said that the Fed is privately owned. However, the shares held by the private banks confer almost none of the normal ownership privileges, and control of the Fed is almost completely within the hands of the US Government. It is therefore more accurate to consider the Fed a government agency -- an agency that operates for the benefit of the government and the banks.


Money Supply Variations

Rarely in the past has the choice of monetary aggregate (TMS, M2, M3, etc.) been so important, because rarely have there been such large differences between the rates of change of the different money supply measures. For example, the following chart reveals a dramatic divergence over the past 12 months between the year-over-year (YOY) growth rates of M2 and TMS, such that we now have M2's YOY growth rate at a 10-year low at the same time as TMS's YOY growth rate is near a 10-year high. Moreover, some measures of US money supply -- most notably, the M3 calculation at and Frank Shostak's AMS calculation -- currently show outright monetary deflation!

When TMS diverges markedly from M2 and M3 we can be confident that TMS reflects the true situation. The reason is that M2 and M3 have components that are not money, and when divergences occur they are caused by changes in the non-monetary components (Money-Market Mutual Funds and Time Deposits, primarily). The current situation contains an additional complication, though, because TMS has also diverged markedly from the Austrian Money Supply (AMS) calculation done by Frank Shostak. As discussed in the 21st December 2009 Weekly Update, this particular divergence is mostly due to the treatment of the US Treasury's Supplementary Financing Program (SFP). Specifically, Dr. Shostak's decision to treat the SFP account at the Fed as "money" distorted the year-over-year numbers in his AMS calculation by creating a huge upward spike in money-supply growth during September-November of 2008 and then a plunge in money-supply growth as the program was unwound during 2009.

The reason we are harping on this subject is that over the next few months you will very likely read articles in which money-supply charts are used to 'prove' that DEFLATION is occurring and other articles in which money-supply charts are used to highlight an INFLATION problem. It is important to understand how such contradictory conclusions could be drawn about something that should be straightforward.

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