Fed boss: More securities buys could help economy [and our take on it]
"Bernanke and other Fed officials have suggested that the Fed's next likely step to help the economy is buying more government debt. The goal: get Americans to boost their spending, which would strengthen the economy and make businesses more inclined to increase hiring."
Read the full article at: Fed boss: More securities buys could help economy
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Why these news are so relevant for Silver [Our Comments]
As a rule of thumb the currency supply in the US is composed of:
- Base Currency issued by the government . This is created by selling bonds to the public or foreign governments but often the fed "buys" the debt by creating new currency out of thin air.
- The loan Multiplicator which represents the additional currency created when loans are issued by financial institutions. When a loan is made the issuer only needs a small portion of the currency as reserve. As the loan currency is used by the borrower and deposited in other banks these banks can again issue new loans using only a small portion of the currency as reserve. In practice this means that the base currency is multiplied over and over (typically up to factor of 10) depending on the amount of loaned.
- Velocity of Currency which represent how quickly consumers spend the currency. The higher the savings rate the lower the velocity of currency.
Thus:
Currency in circulation = Base Currency x Loan Multiplicator x Velocity
As the USA has so much personal and public debt it is only natural that some consumers start to pay back their loans or go bankrupt (reducing the Loan Multiplicator) and spend less frequently (reduces velocity).
Thus currency in circulation is reduced. When there is less currency the currency becomes more valuable and the price of goods start to decrease. We call this "Deflation".
The FED does not want deflation as it is bad for deeply indebted entities such as the US Government or the US Consumer. The reason is simple, if the value of a currency appreciates then the "real" (measured by purchasing power instead of nominal value) debt liability of debtor will become higher and higher. This is good for the debt holder (e.g. China) but bad for the debt issuer (e.g. USA).
On the other hand by inflating a currency the value of each dollar decreases, making the "real" (instead of nominal) debt smaller. This is bad for a debt holder (e.g. China) but good for the debt issuer (e.g. USA) .
Ben Bernake, the Chairman of the Federal reserve, is intent not to allow deflation and is infamous for stating that he will go as far as having helicopters drop currency on the streets to stop deflation from occurring. So far he is not using helicopters but "Quantitative Easing" which consists of creating debt (Fed Balance Sheet) to purchase more debt (US Government Debt) with the aim to reduce long term interest rates which cannot be controlled directly by the FED. The aim is to keep currency cheap and keep consumers and companies spending in spite of their high debts.
Thus, as Jim Rogers elegantly summed it up, the Fed is trying to solve the problem of too much debt by creating more debts.
Yet the public is not cooperating. The net current result is that currently:
- Base Currency is going through the roof as the FED QE program is expanded and the US government takes on more and more debt (~1,500,000,000,000 USD per year) in the name of fighting deflation and “stimulating the economy”
- yet the loan multiplicator has been decreasing as companies and individuals take fewer new loans, pay back loans or go bankrupt
- And the Velocity of currency decreases as consumers they spend less / save more currency given an uncertain future.
To avoid deflation Ben, “Helicopter”, Bernhake will continue to expand Base Currency to new records to try and make up for reduced spending, savings and bankruptcies in the economy.
This raises a few questions:
- With base currency being increased enormously to make up for the falling “loan Multiplicator” and “Velocity” what will happen when these two factors start increasing again ? or in other words what will happen when companies and individuals try to take loans out again in large numbers and consume as they did in the past ?
- Remember that the currency supply is given by “Base Currency” x “Loan Multiplicator” x “Velocity”. Thus the currency supply, given the large base currency factor, is set to expand very quickly and uncontrollably. This means that we might quickly go from “deflation fears” to “high inflation” or “Stagflation” as occurred in the late 1970s.
- And secondly , What the intrinsic value of the USD ?
- The answer is that it is nothing but debt. With US Dollars being created in unprecedented amounts, QE policies and deficit spending the US FED is intent on insuring that the USD’s value keeps decreasing even while publicly stating that “the FED believes in a strong dollar’.
If the masses or major US bondholders (e.g. China) lose confidence in the US Currency then this loss of confidence might spread and the treat of “high inflation” has the potential to become hyperinflation as occurred in Germany in 1923.
Even if hyperinflation does not happen it is now a mathematical certainty that the USA will never be able to pay back its debts without massive devaluations in the US Dollar.
Investors who understand the long term implications of the changing role of the USD in the world can profit handsomely from these fundamental changes and shifts of power.
With the Euro and Yen also having fundamental problems it is a natural choice to revert to the universal stores of value of Silver and Gold which have been accepted in virtually all countries throughout history. Physical Gold and Silver also has the great advantage that it is a finite resource that cannot be created at will at the stroke of a button.
Please note that this later factor is not true for Gold & Silver Derivatives (Paper Silver) which are IOUs created when a position is opened and typically have no physical backing or are backed only by a tiny fraction of physical Gold / Silver.
if you are seeking a long term protection against inflation and a currency crisis that will be precipitated by too much debt then get real thing rather than more IOUs. As we say in the industry… If you cannot touch it you probably don’t own it.
Article by: Gregor Gregersen
(Co-Founder of Silver Bullion Pte Ltd and Silver Bullion Owner)