Posts Tagged ‘money supply’

Australia’s money supply growth in March 2008

Thursday, June 5th, 2008

Today, we will continue from Australia?s monetary growth update?February 2008 and report on the growth of Australia’s money supply for March 2008. In that month, Australia’s broad and M3 money supply has reach yet another record high of AU$1080.8 billion and AU$992.2 billion respectively (see What is money? on the explanations of the various measures of money). Between March 2007 and March 2008 (i.e. the year-to-date), Australia’s M3 money grew by 21.1%. The year-to-date growth for February 2008 and January 2008 was 21.6% and 23.2% respectively.

From the news media, you can read a lot of reports that Australia’s credit growth (and hence, has a relationship on the money supply growth) has slowed down due to the string of interest rates hikes and slowing economy. Well, the fact remains that credit growth is still growing, although growing at a slower pace. We can argue that it is still growing too rapidly.

Think about this: if real GDP growth is growing at 3% per year while the M3 money supply grows at 21.1%, guess what will happen to price inflation? Hint: take a read at Cause of inflation: Shanghai bubble case study.

Can “weak US dollar” be partially blamed for rising oil prices?

Thursday, May 8th, 2008

Yesterday, we questioned the validity of using fiat money as a unit of measure for the value of a commodity. Today, we will look at idea that the “weak US dollar” is one of the scapegoats for rising oil prices.

Frequently, we hear from the media explaining that one of the ’causes’ of rising oil prices (and by extension, inflation) is due to the “weak US dollar.” But notice one thing: oil prices had been rising in all currencies, not just in terms of US dollar. This leads us to one basic principle: everything else being equal, a falling US dollar has no effect on oil prices measured in non-US currencies. Of course, in the real world, everything else is not equal- oil prices rises to different degrees in terms of other currencies too, including the Australian dollar. In that case, can the rising in oil prices in terms of non-US currencies be attributed to supply/demand fundamentals?

But wait a minute! What is the meaning of “weak US dollar?” Can we interpret the meaning of “weak US dollar” to mean that the supply of US money and credit has been expanding at a faster rate than the supply of its non-US counterparts? Well, consider this fact: the supply of non-US money and credit has been expanding at an arguably greater rate than the supply of their US counterpart. For example, Australia’s money supply increased 21.6% (see Australia?s monetary growth update?February 2008) while the US money supply was estimated to be significantly below that figure (the US no longer publish figures on their M3 money supply). Putting aside the argument of which nation’s money supply has been increasing at a faster rate, this is the basic point: the supply of fiat money and credit of all nations have been increasing. In other words, high oil price is not just a problem of the “weak US dollar.” As we said before in What if the US fall into hyperinflation?,

Now, in this age of freely fluctuating currencies, the currency?s value is a relative concept. For example, a falling US dollar implies a rising Australian dollar. Therefore, one way to ?maintain? the value of the US dollar relative to the Australian dollar is to devalue the Australian dollar. Perhaps this is the route that central bankers will concertedly take to instil ?confidence? in the US dollar in order to create the illusion that the US dollar is still a reliable store of value? Well, they can try, but growing global inflation and skyrocketing gold price relative to all currencies will be tell-tale signs of such a dirty trick.

We can include oil prices in the last sentence of the above-quoted paragraph. Thus, we believe that global monetary inflation is one of the major contributing factors in accentuating the rise in oil prices, in addition to the fundamental supply/demand factors. It is an error to blame it on the “weak US dollar.”

In the next article, we will connect monetary inflation with oil price speculation.

Australia’s monetary growth update?February 2008

Monday, April 28th, 2008

Today, we will show you the latest chart of Australia’s money supply growth from July 1959 to February 2008. Our previous update was at Aussie money supply growth- December 2007 update. Click on the below chart’s thumbnail to see it in full-size:

Australia?s monetary growth (July 1959 to February 2008)

The terms used in this chart was explained in What is money?.

The left axis: The dark blue line represents the growth of the monetary base, while the light blue and red line shows the growth of M3 and broad money respectively.

The right axis: The black line represents the ratio of the monetary base to broad money. As at February 2008, this ratio stands at a wafer thin margin of only 4.37%. As we said before in Australia?s monetary debasement & credit expansion, this means that approximately, every $4.37 of original cash

… in the economy gets lent and re-lent, over and over again until it becomes $100 of credit (broad money)

Please note that in that previous article, we used the currency/M3 ratio. Today’s graph uses the monetary base instead of currency in that ratio, which is more accurate representation.

Finally, the growth of M3 from February 2007 to February 2008 was still at a high level of 21.6%.

Aussie money supply growth- December 2007 update

Friday, February 29th, 2008

In Australia?s monetary debasement & credit expansion, we showed you a graph of Australia?s (1) money supply growth (base money, M3 and broad money) and (2) the relativity between standard and fiduciary money since July 1959 to October 2007 (see Are we heading for a deflationary type of recession? for the meaning of standard and fiduciary money). The November 2007 update can be found at An update on Australia?s money supply growth. Today, we have an update of the December 2007 figures from the Reserve Bank of Australia (RBA):

  1. Year on year growth of M3 to December 2007 was 22.7%
  2. The standard money to fiduciary money ratio remained unchanged at 3.7%

It looks that up till December 2007, Australia?s monetary policy is still loose, despite the interest rates rise in November 2007. (see What makes monetary policy ?loose? or ?tight??).

Where are we in the business cycle?

Friday, February 9th, 2007

Yesterday, in our article, The real story behind the phenomena of booms and busts, we asked this question. Today, we will look at the indications of where we may possibly be in the business cycle in Australia (which is applicable to the US as well).First we look at the November 2006 Statement of Monetary Policy from Reserve Bank of Australia (RBA):

What does seem clear, however, from several sources of information, is that the economy is operating with very limited spare capacity.

Clearly, as in the metaphor we gave in What cause booms and busts? Introduction to the Austrian Business Cycle Theory, the bus is running low on fuel i.e. the economy is reaching its limit of productive capacity. This is also the same situation that the United States is facing right now. Further down the statement:

Demand in some sectors has been especially strong over a number of years, reflecting the growth of the domestic and international economies. If firms cannot bring new factories or mines immediately on line when capacity constraints become binding, they may decide to hire more labour to work their existing production processes more intensively. This would lead to strong employment growth, but also a fall in the growth rate of average labour productivity because only relatively modest additional output can be produced by hiring more labour without additional capital.

To cope with the strong demand, businesses are forced to increase output. Unfortunately, the effectiveness of the existing capital stocks in the economy is reaching its limit and the only way to increase production further is to employ more labour and pressure the existing employed workers to produce more. As the statement says, without complementary capital, these extra labours are constrained in its effectiveness in increasing output.

Recently, we read in this news report, Consumer confidence ‘lowest since 2003’, ?dragging sentiment down in the half was a sharp 14 point fall in the quality of life rating to 25.5 points… But (they are) finding it more difficult to achieve due to the demand for longer working hours and more intense competition in the job market.? Anecdotally, many of us are feeling the increasing strain of work. Though Australia may be experiencing the lowest unemployment rate, it comes with a cost at our quality of life. Worse still, according to our personal experience, we can feel that price inflation is more pronounced lately.

With the economy struggling to increase output and the money supply still growing, we can expect price inflation to still remain a threat. But price inflation has been quite benign during the past few years. Why is it so? As in the United States, price inflation has been ?controlled? by importing of goods from China. As we said in The Bubble Economy, the rise of the Chinese economy?s productive capacity has a disinflationary effect on prices worldwide. But such low inflation can only be achieved at the cost of incurring a ballooning trade deficit?our imports exceeding our exports. But make no mistake about it: we cannot always rely on the Chinese to save us from price inflation by blowing out our current account deficit even further. So, the greatest danger to Australia?s economy right now is price inflation. As we said in The real story behind the phenomena of booms and busts, if interest rates persistently remain out of sync from the natural rate of interest for too long, we can run into the danger of hyperinflation.

How can we restore the economy back to equilibrium and ensure that it remains in a firm footing for the future?

The first thing that has to happen is to increase our national savings. As we said in The myth of financial asset ?investments? as savings, we need to restore and rebuild our stock of capital goods to ensure our future prosperity. Already, the quality of our education, health, telecommunication and transport infrastructures are in decline and they are in need of repair and upgrade. This means that the only way we are going to achieve that is to reduce our current consumptions and cut down our debt. When that happens, the economy will slow down and many businesses and investments will fail as a result. Since most of the Australian (and the US as well) is made up of consumer spending, in which much of it is funded by debt, we can see that this remedy will be painful. If the consumers do not slow down and get their act together, we can expect the RBA to impose a restraint by raising interest rates.

Thus, we believe that Australia (and the US as well) is at the top of the business cycle. For investors, we have to bear in mind that we are now probably at the cyclical top. If we assume that the current trend of companies? profit growth will extend indefinitely into the future, we will be in for a nasty surprise.

The myth of financial asset ?investments? as savings

Friday, February 2nd, 2007

Today, the savings rate of the United States has never been lower since the Great Depression. This is a very serious concern that should never be underestimated. However, there are some who argued that if we include financial asset ?investments? such as home equity, pension and managed investment funds, stocks and so on, the savings rate is actually positive.

Here, we wish to dispel this myth.

First, we would need to understand what the true nature of savings is. In Chapter 15, Section 2 (Capital Goods and Capital) of Ludwig von Mises?s book, Human Action: A Treatise on Economics:

At the outset of every step forward on the road to a more plentiful existence is saving?the provisionment of products that makes it possible to prolong the average period of time elapsing between the beginning of the production process and its turning out of a product ready for use and consumption. The products accumulated for this purpose are either intermediary stages in the technological process, i.e. tools and half-finished products, or goods ready for consumption that make it possible for man to substitute, without suffering want during the waiting period, a more time-absorbing process for another absorbing a shorter time. These goods are called capital goods. Thus, saving and the resulting accumulation of capital goods are at the beginning of every attempt to improve the material conditions of man; they are the foundation of human civilization.

Goods that directly relieve a need or want are called consumer goods. Capital goods, on the other hand, are goods that help in the production of consumer goods?they increase the future productive capacity of the economy. As we all know, the economy has a finite quantity of resources. It has to choose between producing consumer goods for current consumption or capital goods which will help in producing future consumer goods. Furthermore, capital goods depreciate over time?resources are required to maintain them. The extent in which the people in the economy choose to produce (and maintain) capital goods over consumer goods constitutes the savings rate of the economy.

For example, let?s say we save $100 in the bank. The bank then lends out $90 to an entrepreneur who uses it to set up a business enterprise that will produce goods that consumers want down the track. In this case, the $100 that we save is a sacrifice on our current consumption. Part of that $100 of ours is then put in good use to add value to the economy in the future. In return for my sacrifice, we are paid interest.

In another example, let?s say a company decides to raise money in the stock market to fund its expansion plans. We invested $100 in that company?s IPO. That company then uses our $100 to build a new manufacturing plant that will produce consumer goods in the future. In this case, that $100 that we invest is considered savings since it involves us sacrificing current consumption worth $100. In return for our sacrifice, we are paid dividends from the company?s future earnings.

Now, based on this understanding on savings, can our home equity be considered savings? We have ‘equity’ in our homes if its current value exceeds the amount we owed. But the problem with such ‘equity’ is that it depends on the home’s current value, which is merely a paper value based on the principle of imputed valuation (see Spectre of deflation for the concept of imputed valuation). As we said before in The Bubble Economy, since the phenomena of inflating home values is mainly due to the increase in money supply (colloquially known as ?printing money?), they cannot be considered as savings as they do not have any resulting influence in the increase of capital goods in the economy. In the same way, if we buy and sell existing stocks (as opposed to newly issued ones in an IPO) in the stock market, are we in any way contributing to the accumulation of capital goods in the economy?

As the financial side of the economy (see Analysing recent falls in oil prices?real vs investment demand on the concept of the real and financial side of the economy) becomes increasingly influential in the economy, we wonder how much this side contributes to the amassing of capital goods, which is the foundation of building the future wealth of the nation? Can the printing of money, which spawns the growth of an industry to shuffle it, cause a nation to be richer in the long run?

One potential trouble-maker to watch out for in 2007

Wednesday, January 3rd, 2007

As 2006 closed with stock markets around the world in record high with an eerie calm in terms of volatility, it is very tempting to assume that 2007 will bring more of the same. From the news report, many fund managers have such optimistic view. With the supply of money and credit still expanding, it is indeed very much possible for the good times to continue in 2007. But this does not mean there are no dangers. Hence, today, we will look at a possible danger scenario: the sustained downtrend of the US dollar. As we said in Will the US dollar collapse?, it is only a matter of time before this scenario will happen. The question is, will it happen in 2007?

At this point in time, both the US bond and stock market (especially the bond market) are expecting interest rates to decline in 2007. We said before in Are you prepared for the coming storm?, the ?market seems to be spell-bound by some kind perfect wonderland myth?it ?thinks? that the economy is so weak that the Federal Reserve will cut interest rates next year (which is good for stock prices) and so strong that a recession will be avoided.? If events turn out to contradict the markets? expectation, we can be sure that the results will be very unfavourable.

As we elaborated in What can we expect in a US dollar decline?, a sustained decline in the US dollar will show up as inflation in the US domestic front, which will force the Federal Reserve to raise interest rates. With the US economy already faltering, this will lead to a recession. When that happens, the bull run of 2006 will turn into a bear, as it happened before in May 2006 when talk of raising interest rates spooked the stock and commodity markets. Thus, we will be faced with a hard-landing scenario of declining US dollar and rising interest rates. At this point in time, it will be much harder to foresee what will happen next. As such, what follow will be merely our gloomy guesses.

It is possible for a sustained decline of the US dollar to descend into a nightmare rout in the US dollar through a circuitous route of cause and effects (though it is unclear how likely it would be). If that happens, the results will be unpredictably ugly. Though Asian and Middle-Eastern central bankers certainly have the means to set off a disorderly collapse of the US dollar (see Awash with cash?what to do with it?), it is unlikely that they will have the motivation to do so unless some unpredictably drastic developments took place in their domestic front. It is more likely that they will not sell their US dollar reserves out of their own accord?that is, if they should do so, it would likely be because the US dollar is already falling. But whatever the initial cause, if should we see foreign central bankers dumping their US dollars, it will be the sign of the beginning of great global upheaval as there will be great implications on the Middle East and oil (we will talk about that in the future). Since much of the world?s financial assets are denominated in US dollars, there will be a rush to shift from those assets into safe havens?that can only mean old trusty gold, which is humanity?s choice since ancient history.

So, for 2007, watch out for the US dollar!

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Why is China printing so much money?

Thursday, December 7th, 2006

In our previous article, Cause of inflation: Shanghai bubble case study, we explained that the root cause of price inflation is monetary inflation. The Chinese economy is awash with growing liquidity (that is, the economy is soaked with ever-growing supply of money). The next question to ask is: why is money supply growing in China?

One of the culprits for this problem is the inflexible exchange rate of the Chinese currency (RMB). The RMB is not a freely floating currency?its exchange rate is still controlled by the Chinese central bank albeit having some semblance of flexibility. At the current rate of exchange, the RMB is undervalued. Since it is undervalued, foreign capital will want to enter China in the form of foreigners buying up the RMB. If the RMB is a freely floating currency, the demand for it by foreigners will bid up its price, which will reduce its demand as it becomes more expensive. Conversely, as its price rose, domestic sellers of RMB will sell down its price. Finally, a market equilibrium price will be reached where the quantity supplied will meet its quantity demanded. Since the RMB?s undervalued exchange rate is still barred by the Chinese central bank from rising, foreign demand will exceed its domestic supply. So, the question is: where is the RMB going to come from? In the absence of capital controls freedom, the only choice the Chinese central bank has is to print RMB to maintain the undervalued exchange rate. Now, with foreigners armed with freshly printed RMB, they bided up the prices of Chinese assets, including stocks and properties. In the case of Shanghai, real estate prices had reached dangerously bubbled prices. As those newly printed money permeate its way into the rest of the Chinese economy, the result is price inflation. We are hearing reports from the grassroots level that prices of many things (including everyday goods and foodstuffs) in Shanghai are increasing.

Lately (as we mentioned before in Are you being ripped off by fund managers?), we are not keen in handing our hard-earned wealth into the managed fund that is sinking more money into the massive pool of raging liquidity in the Chinese economy. There are better alternatives to take part in the growth of China than to join in the bubble.

Cause of inflation: Shanghai bubble case study

Tuesday, December 5th, 2006

A few days ago, we learnt about the mad speculative fervour over real estates in Shanghai. From what we hear, the annual salary of an average middle-class worker in Shanghai is somewhere in the order of 50,000 to 100,000 RMB. However, apartments over there can cost up to prices to the order of 1 million RMB. We were simply astounded at the relativity of these two anecdotal figures, which we obtained from people we know who live in Shanghai. How is it possible for people to afford such exorbitantly priced housing? More amazingly, even at such sky high prices, many people over there feel that apartments are still ?cheap? and consider them good ?bargains!? We learnt further that the prevailing attitude over there was that real estate prices can never fall and that if you do not buy today, you will lose out because they will be more expensive tomorrow. Therefore, people piled themselves with debt to buy real estates that they cannot afford. With their assumption that prices will be going up indefinitely, they reckon that if the worst should ever happen, all they need to do is to liquidate their property at higher prices to the next buyer.This is a gigantic bubble that defies all rudiments of proportion, common sense and prudence. We suspect that with the Olympics in 2008, there will be a need for the authorities to at least keep up the spectacle and illusion of prosperity till then. Meanwhile, as we expected, inflation is experienced everywhere in Shanghai. We heard that this scenario is working out in other Chinese cities as well.

Now, it comes to the topic for today: inflation.

The mainstream economists? definition of inflation is rise in the general level of prices. However, according to the Austrian School of economic thought, the definition of inflation is the increase in the supply of money, in which the effect is the rise in the general level of prices. For the sake of discussion, let us call the mainstream definition as ?price inflation? and the Austrian School?s definition as ?monetary inflation.? We see that the Austrian School?s definition is far more accurate and correct because it goes right down to the root of the problem.

If the economy?s money supply increases relative to the increase in production of goods and services, then prices in nominal terms will have to increase because there will be more money chasing after the same amount of things in demand. As this article, Defining Inflation, said:

Consider the case of a fixed money supply. Whenever people increase their demand for some goods and services, money will be allocated toward other goods. Thus, the prices of some goods will increase?i.e., more money will be spent on them?while the prices of other goods will fall?i.e., less money will be spent on them.

As Ludwig von Mises said in his essay, Inflation: An Unworkable Fiscal Policy:

Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term `inflation’ to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation. . . . As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation.

Therefore, because the approach that mainstream economists take to define inflation is deficient, the benchmark that they use to measure it (an index of the price levels e.g. CPI) is also deficient. Does the CPI (or whatever the alternative price index that central bankers prefer to use) measure the price levels of assets? The answer is no! As a result, the conventional yardstick that mainstream economists use does not fully disclose the full extent of the economy?s inflation problems.

The mainstream economists do not see monetary inflation as an evil?as long as price inflation is not a problem, they do not see the need to care about monetary inflation. But Austrian School economists see that the inevitable consequence of monetary inflation is price inflation because the former is the root cause of the problem and the latter is the effect. That is the reason why Austrian School economists are strong advocates of gold-backed monetary systems because such systems will have automatic built-in checks to prevent undisciplined monetary inflation (aka printing of money).

In the case of Shanghai, we are not the least surprise to see price inflation happening. In fact, if the Chinese central bank does not control monetary inflation (that fuelled the property speculation in the first place), price inflation will get worse before it gets better. When that happens, the common people, especially the poor will suffer. On the other hand, if the Chinese central bank decides to raise interest rates to rein in price inflation, they run the risk of bursting the property bubble, which will have a destabilising deflationary effect. In that case, the speculators (of which many of the middle-class common people are) will suffer first, followed by the rests. It looks to us that the Chinese central bankers may have trapped themselves into a box.