Chinese Inflation Hits 6.4%, Government Tells People Not to Buy Silver.

In Commentary, Inflation on July 11, 2011 by CQCA

China Daily reported that the Chinese CPI has reached 6.4%, the highest in three years.

If you had put money in the bank in June 2010 for one year, your interest rate would have been 2.25%. Since CPI is now at 6.4%, Chinese savers have actually lost wealth. Put in another way, real interest rates in China are about -4.15%.

Not surprisingly, yesterday CCTV had a special report on why silver is a bad investment.

Here is my favorite quote, courtesy of Google Translate: “Chun-Li Wang told reporters, silver in the first half of the test roller coaster price fluctuations, the company has gone through half of the ocean, half of the flame of the abyss. Chun-Li Wang analysis, investment in silver and gold investment are very different, because the value of silver is relatively low, ordinary working-class can afford, so people buy and invest more than an ordinary consumer, and this ability to judge people without investment , the public mental trend is very strong, difficult to resist collapse of the sense of risk. Because silver bullion this one, it touches the surface, this is the most popular working-class, the most common investors, some retired, he’s took a pension, he can, he can buy one, that working in Beijing, he can buy one, so we feel very much a danger that.

The original Chinese text is from iFeng Finance, and the television report can be seen on Diyi Shijian (starts at about 26:00 and ends when they start talking about sofas).


If Gold Reaches $3,264 Per Ounce, It Will Surpass the Dollar as the World’s Reserve Currency.

In Currency on July 10, 2011 by CQCA

The U.S. Dollar is currently the world’s reserve currency, meaning most foreign countries rely on the Dollar as a hedge against domestic instability. Any discussion about replacing the U.S. Dollar always ends with the same uncertainty about which currency should replace it. The Japanese economy has too much debt, the Chinese Yuan is too restricted (and has a picture of Chairman Mao on it), and the Euro is trash.

Gold, on the other hand, is not issued by any government, and cannot be controlled by one. It is the only true denationalized money, to borrow a term from Hayek.

According to the IMF’s data, governments of the world disclosed that they held $3.2 trillion worth of U.S. Dollars as apart of their total foreign exchange reserves. There was a total of (U.S.) $9.6 trillion worth of foreign exchange in the world. (That means some governments were too embarrassed to admit which currencies they hold as reserves.)

At about the same time, governments of the world held about 30,684 tones (986 million ounces) of gold. (World Gold Council data, free membership required to access the data.) If we divide $3.2 trillion by 986 million ounces, we get:
3,219,964,000,000 / 986,521,284 = $3,263.96

Meaning: If the price of gold reaches $3,264 per ounce, the value of national gold reserves would surpass the value of allocated U.S. Dollar reserves. The current value of one ounce of gold (July 8th, 2011 Monex closing price) is $1,544 per ounce. That means the value of national gold reserves is $1.5 trillion. This is more than the value of allocated Euro reserves, which stood at US$1.4 trillion at the end of 2010.

Gold has already surpassed the Euro, which is the Dollar’s most likely alternative as a reserve currency.

The problem with these calculations is that we only know the allocated reserves of the world. There are still $4.4 trillion worth of reserves that we do not know which currency they are held in. Even if we assume this total amount is held in U.S. Dollars, which is not likely, the price of gold would only have to reach $7,713 per ounce to surpass the U.S. Dollar as the world’s reserve currency.

Anyone who believes the U.S. Dollar will remain the world’s reserve currency should ask why gold has already surpassed all of its most likely competitors, yet no one seems to be talking about it.

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Marc Faber is Right About the Price of Gold in 2011.

In Investment Returns, Money Supply on July 5, 2011 by CQCA

In a recent interview, Marc Faber, a well known investor and author of the Gloom, Boom, and Doom Report, stated:

“My view is, yes, I have been positive for gold for the past 10 or 12 years and I could make a case that gold today is cheaper than it was in 1999 when it was at $252. Cheaper in the sense that if I compare gold to international reserves or to the increase in the credit markets in the world, I don’t think it’s expensive.”

I did the math on the monetary base and the price of gold. The results are shown below.

The blue line shows how many billions of ounces of gold it takes to equal the U.S. monetary base. The monetary base is made up of currency in circulation and bank reserves. One Dollar placed in the monetary base will usually multiply into more Dollars as it moves higher up in the money supply, so it is a better indicator of future inflation than the overall money supply.

The lower the line on this graph goes, the more expensive gold is; and the higher the line on this graph goes, the less expensive it is. In 1980, the price of gold averaged $612.56, and the monetary base stood at $144 billion, so the monetary base was worth 235 million ounces. In 2001, the price of gold averaged $271.04, and the monetary base stood at $639 billion, so the monetary base was worth 2.36 billion ounces.

Below is the bi-weekly ratio of the monetary base to the price of gold in 2011.

On June 29, 2011, the U.S. monetary base was worth 1.75 billion ounces. This is only slightly lower than the 1998 ratio of 1.76 billion ounces. Even though the Dollar price of gold has increased over 400% between 2000 and 2010, in terms of credit expansion, gold is essentially as cheap today as it was when the average Dollar price was $294.24. Marc Faber is correct.

Also, if we wanted to calculate how high the price of gold would have to go before it reached a 1980 style bubble, we could set the ratio’s equal to each other. Or, in equation form:
(1980 high point)/(1980 monetary base) = (equivalent high point)/(current monetary base)
($850)/$133,436,000,000) = (X)/($2,645,989,000,000)
X = $16,855

Meaning, the current price of gold would have to reach $16,855 before it is anywhere near the bubble territory it reached in 1980. The closing price yesterday was $1,511.

Update July 14, 2011: Gold is not money.


Currency and Population Growth.

In Money Supply on July 3, 2011 by CQCA

Supporters of a fiat currency system believe a gold standard is too rigid, but always seem to point to some other indicator, such as productivity or population growth, as a metric for expanding the money supply.

The supply of gold in the world is limited. It does not change much in quantity from year to year. One ounce of gold will always be worth one ounce of gold. The only way to increase the money supply in a gold standard is to extract more from the earth or find alternatives to what is already consumed.

Increases or decreases in productivity cannot be objectively measured. It can be observed, such as the fact that it now takes hours to travel around the world, instead of years. But, there is no way to objectively measure it. Whether the money supply should be increased by 4.3% or 4.4% after the development of the iPad 2 would be up to the opinions of the central planners. The productivity argument also overlooks the fact that increased productivity in any industry would most likely find its way into the mining and metal processing sectors, which would increase the quantity of money in a gold standard. So in essence, a gold standard would accomplish the same goal, but without a central bank.

Population growth is more objective, considering population is much more easy to measure. The question, though, is how much money we should allocate per person. I used data from the top 20 economies by GDP and divided their most recent M2 money supply data by their total population. The results were then converted into U.S. Dollars using December 31, 2010 exchange rates.

Each country has a vastly different amount. If there were some objective, natural amount of money that should circulate per person, there would probably be more consistency in the numbers.

The other problem for both systems is distributing the money. Under a gold standard, mined gold would be used to buy other goods required for mining (such as food, water, clothing, housing, etc.) This would allow wealth to flow directly to the wealth creators (be they directly involved with mining or not). If a central bank increases the money supply to reflect their opinion of productivity, that money would be unevenly distributed to whomever borrowed the money first. If population were used as a metric, the only logical way would be to give inflated dollars to newborns and confiscate money from dead people and destroy it. This would create a society I do not want to live in.

Most central bankers claim to rely on some form of productivity to increase the money supply. This has never succeeded. All fiat currencies have ended in hyper inflation, all the way back to the first real fiat currency, issued by the Mongolian empire. Population measures, to my knowledge, have never been used. Gold has been currency for thousands of years. It still is.

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Objectively Valuing Currencies.

In Investment Returns on June 24, 2011 by CQCA

I’ve always thought that foreign currency exchange has to be the worst business to be in. There seems to be no rhyme or reason for why some currencies move up and why some move down. The whole market is a matter of throwing bad money after bad.

Now that I live in China, I have to think about whether or not I want to keep my money in U.S. Dollars or Renminbi. If I were to just base my decision on the money supply, I would rather keep my money in U.S. Dollars. Today I thought of another way to value currencies, and it is similar to how the P/E Ratio is used to value companies. (I am certain I am not the first person to think of this.)

The price of any currency is 1.00, but its earnings for the year is the interest rate that can be earned on an account in that currency.

According to, MetLife Bank is offering a one year CD at a rate of 1.30%. In that case, the equation for valuing the U.S. Dollar is:
1.00 / .0130 = 76.92

The Bank of China (a commercial bank, not the central bank) is offering CDs at a rate of 3.25%. The equation for valuing the Renminbi is:
1.00 / .0325 = 30.77

Using just this method, the U.S. Dollar is way over valued compared to the Renminbi. But the problem with this method is that the inflation rate has to be taken into account. The CPI rate in both the U.S. and China are above the bank rate, so savers are actually losing wealth. Zimbabwe Dollar, which can earn 800% in the bank, would be valued at:
1.00 / 8.00 = 0.125

This shows the weakness of using this method for valuing currencies, because obviously the Zimbabwe Dollar is not the best option in terms of value investing. (Or is now the time to be a contrarian?) Also, gold and silver currently do not have interest rates, but are still the best currency available. This is why I do not trade forex.

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Chinese M2 Rose 15% Between May, 2010 and May 2011.

In Investment Returns, Money Supply on June 15, 2011 by CQCA

Chinese M2 increased from RMB 66.3 trillion in May, 2010 to RMB 76.3 trillion in May, 2011, or 15% annually.

I got back to China four days ago, and from a few observations, I can see that this new money is flowing mostly into housing. I went down to the convenience store yesterday, and the price of a large bottle of water and a cup of yogurt are the same as they were two years ago, when I first came to China. Meaning that the increase in the money supply is not being reflected in basic consumer goods.

Housing prices are another story. A friend of mine told me that when she went to meet the new people that had moved in above her, she found out they had paid double what she had paid two years ago. (And this was on the fifth floor of a building with no elevator.)

Another friend’s house has increased four times over the 2005 purchase price. That is much higher than that the 160% increase in China’s currency over that time. I believe China will most likely experience what the U.S. is going through in that housing prices crash while the price of every day goods continue to rise.

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Is the U.S. Resorting to Old Fashion Inflation?

In Money Supply on June 5, 2011 by CQCA

Since the start of the 2007 financial crisis, the Federal Reserve has reacted by printing money on a scale that has never been seen before. Most of that, though, has been digital inflation. The bailouts, TARP, the deficits, and quantitative easing have all just been numbers on a screen, mostly flowing into bank reserves held at the Federal Reserve, which are not calculated in the money supply. That is a sign of our digital age, but it seems like the Federal Reserve is also taking us back to the kind of inflation in a horse and buggy era.

M2, the broadest money supply indicator that the Federal Reserve publishes, increased 27% between January, 2007 and April, 2011. The monetary base, which represents digital inflation, has increased 213.8% over the same period. M0, which represents bills and coins in circulation and is an indicator of printing-press inflation, increased 26.5% over the same period. (It is a coincidence that they expanded at about the same rate, and an increase in M0 does not directly lead to a proportional increase in M2. M0 is only 10% of M2, so a 26.5% increase in M0 should have been a 2.65% increase in M2, all other things being equal.)

A quick look at the U.S. Bureau of Engraving and Printing’s annual production figures shows that more $100 bills were produced in 2010 than ever before.

In 2002, Ben Bernanke gave a speech titled “Deflation – Making Sure ‘It’ Doesn’t Happen Here.” He stated: “Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

It looks like the Federal Reserve has been using both its printing press and its electronic equivalent.

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2001-2011 Greek Financial Leverage Ratios.

In Debt on May 31, 2011 by CQCA

The chart above shows the leverage ratio of Greece’s central bank and its aggregate figure for all monetary financial institutions. In January, 2001, both the Bank of Greece and Greek MFIs had a leverage ratio between 10 and 15, meaning for every €1 they held in equity or capital, they had €10 to €15 in assets (or €9 to €14 in liabilities).

Monetary financial institutions increased their leverage exposure steadily until a high point of 17.86 in December, 2008. Since that time, they have de-leveraged considerably. The Bank of Greece, by contrast, has leveraged itself higher since that time. The Bank of Greece, by comparison, leveraged itself a high point of 50.03 in December, 2010.

Much of the Bank of Greece’s growth in assets has come from claims on MFIs, which are most likely of dubious market values. If the Bank of Greece’s €130.4 billion in assets go down by 2.46%, it will completely eliminate its capital reserves of €3.2 billion. This will cause Greece’s “lender of last resort” to become insolvent, if it is not already.

Hopefully Germany will throw more of its citizens’ money at Greek banks.

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Belarusian Ruble Devalued Overnight.

In Inflation on May 23, 2011 by CQCA

When Belarusians woke up on Monday, May 23rd, one U.S. Dollar bought 3,145.00 Rubles. The next morning, one U.S. Dollar bought 4,930.00 rubles. Within one day, the National Bank of the Republic of Belarus devalued its currency by 56.76%.

According to Telegraf, in February, 2011:

Belarusian banking system is working smoothly, and it is not planned to make any changes to its operation, including the ruble devaluation, in the near future. This was reported by Chairman of the National Bank of Belarus Petr Prokopovich to President of Belarus Alexander Lukashenko on February 22.

The IMF was involved with a monetary disaster? Who knew?

Other “experts” are cheering a central bank turning its entire citizenry destitute in one day:

  1. BBC: “What they’ve done today is a positive step,” says economist Alex Pivovarsky of the European Bank for Reconstruction and Development.

    He explains that Belarus has lost international competitiveness over recent years, not least because its government raised wages significantly last year in the run-up to elections.”

  2. WSJ: “A cheaper Belarussian ruble may make the country’s potash fertilizer exports more competitive, said Charlie Robertson, chief economist at Renaissance Capital.”

A sign of things to come?

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Historical CPI Rates Modeled Over Time.

In Inflation on May 22, 2011 by CQCA

The Federal Reserve has decided to keep an inflation target of 2.00% each year. Historically, according to the CPI, inflation has been 3.26% each year.

The green line shows the annualized rate of increase in the CPI since 1913. (The actual yearly CPI rate varied, but the green line shows the average and calculates it as though it were the yearly rate.) The red line represents what would have happened to the U.S. Dollar’s purchasing power if the Federal Reserve had targeted, and achieved, a 2.00% inflation figure. The Dollar would buy more than three times what it does today.

The blue line represents the purchasing power trend between 1870 and 1913, the year the Federal Reserve was created. At that time, the U.S. Dollar on average was actually increasing in value by .69% every year. If that trend had continued, the U.S. Dollar would buy 42 times what it does today. Imagine that.