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Money
serves as a medium of exchange and store of value. Price provides an
important clearing mechanism in a society. Here we are going to explore the
interesting dynamics between money and price.
In a free market, when the quantity of
money is fixed, the fact that the price of an apple is $1 and that of a
Parker pen is $2 has tremendous implications. It takes knowledge, ingredients
and time to grow an apple while it involves branding, material, and
capital to produce a Parker pen. What the market says here is that the total
efforts put into producing the pen are worth twice as much as the efforts of
growing the apple. There are thousands of valuations communicated through the
market by this simple exchange. Over time, with advances in technology, it
takes fewer efforts to produce more goods. The same farm that used to grow
10,000 apples can now grow 20,000 in half the time. While the ratio of
exchange between apples and pens might still be 2 to 1, since it also takes
less to produce a pen, in a world where the quantity of money is fixed the
price of both apples and pens should decrease (i.e. 80 cents for an apple,
and $1.60 for a pen).
The decrease in the price level of goods
represents an economic advance and an increase in the value of money. As the
human race progresses and wealth is being accumulated, shouldn’t people
be able to buy more with less money? Shouldn’t people be rewarded for
their savings over time with increased purchasing power of their money? Obviously, the exact opposite is taking place in
this world. What’s going on?
A picture is worth a thousand words and
the chart above is no different. There is 1,500% more
paper money today than there was in 1970.
 
Oil Price Since
1960
Hey, where did all this money come
from? Doesn’t more money mean more economic
progress?
The huge increase in the paper money
supply is from borrowing at all levels from consumers, corporations, and
government. Every dollar borrowed is a dollar created out of thin air by the
banks. The process is legitimized by “the fractional reserve
system”, as the bank literally prints dollars in its computer and
writes a check to you upon your loan approval.
To answer the second part of the
question - there is no positive correlation between the money
supply growth and real economic growth. As we explained, the world can
function and advance
with a fixed money stock.
What’s wrong with more
money? It stimulates consumer spending, creates more interest-income for
savings and promotes higher housing and stock prices. More of everything is a
good thing!
To that argument, I say: What if the Fed
through its ingenuity and generosity, doubles everyone’s savings
account balance? Does that create progress? By the same token, to combat
price increases, did Venezuela
fix anything fundamentally by issuing a new currency, “Strong
Bolivar”, that essentially chops a zero off the old Bolivar? Here are 4
more points to consider:
1. Fairness – Arbitrarily, some
are allowed to borrow more than others. Does it make sense for a government
to have unlimited borrowing power while it hardly produces anything? And what
is so special about a banker in that he can lend to whomever, for however
much he wants, with the money that’s not even his?
2. Price Distortion – Since new
money is not distributed evenly, the prices of various goods and services
increase in a cascading fashion, depending on who gets the money first (like
a ripple effect). Think of a lottery winner. He is likely to outbid others
for the things he wants, thus causing prices of his desired items to go up
first. Let us be clear: The random introduction of new money impairs the role
of price as a proper clearing mechanism.
3. Bad store of value – With
online banking and credit cards, today’s money is a great medium of
exchange. However, the ever-increasing quantity of paper money makes it a
terrible store of
value. Remember: Every time someone borrows, new money is brought into
existence, diluting the money you and I have meticulously accumulated. Should
a retiree rely on the risky stock market to retain his wealth?
4. Moral Hazards – How is it fair
that bankers can borrow billions of dollars to spend and invest? And when
banks and companies become too indebted but are too big to fail, they are
bailed out. How does that serve as an incentive for those who make cars, sew
clothes, and plant trees to save?
When unfairness, price distortion,
corruption, and loss of true wealth reach the extreme, the result is a loss
of confidence in the paper-money system.
I quote John Keynes from 1919:
"There is no subtler, no surer
means of overturning the existing basis of society than to debauch the
currency. The process engages all the hidden forces of economic law on the
side of destruction, and does it in a manner which not one man in a million
is able to diagnose. "
Paul Volker was right when he said in
2000:
"Inflation is related to
monetary policy. It's related to the issue of money. The issue of money is a
governmental responsibility predominantly, and to use that authority in a way
that leads to inflation is a system that fools a lot of people, and to keep
fooling them you have to do it more and more; [that] is a moral issue. I put
myself in that camp. "
And Bill Gates said at Davos world
economic forum in January 2005:
"I'm short the dollar. The
ol' dollar, it's gonna go down.
We're in uncharted territory when the
world's reserve currency has so much outstanding debt. It is a bit
scary."
How do you short the dollar? With ECB printing Euros no slower than the Fed
printing dollars, it’s clear that gold is the only refuge of savings. Gold
has raced from $428 to $850 today since Bill spoke in 2005. Is it too late to
join gold? The right price for gold today is a long topic that’s best
be left for another day. However, judging by how oil rocketed from $10 to
$100 within the past decade, gold has not nearly reached its potential. We
manage a gold fund and have written much about gold and currencies at www.goldmau.com I
invite you to read up.
By :
John Lee, CFA
Goldmau.com
John Lee is a portfolio manager at
Mau Capital Management. He is a
CFA charter holder and has degrees in Economics and Engineering from Rice University.
He previously studied under Mr. James Turk, a renowned authority
on the gold market, and is specialized in investing in junior gold and
resource companies. Mr. Lee's articles are frequently cited at major resource
websites and a esteemed speaker at several major resource conferences.
Please visit www.GoldMau
for instant market alerts and stock updates.
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