The Engines of Inflation

The Daily Reckoning PRESENTS: If inflation is such a menace for society, why do the central banks continue with their inflationary program? And why do they claim that they are fighting inflation? Puru Saxena explores…


Central banks are the engines of inflation. Whether it is the Federal Reserve or the Bank of England, the sole purpose of these institutions is to inflate. At the same time, they understate the ongoing inflation problem and manage the public’s fears. Therefore, in order to protect your wealth in this era of constant inflation, it is absolutely essential that you properly define and understand inflation. In other words, you need to distinguish between “cause” and “effect”.

Today, most people have been conditioned to believe that inflation is an increase in prices as captured by the official “Consumer Price Index”. However, the truth is that inflation is an increase in the quantity of money and credit. As the supply of money and credit are inflated (the cause), prices of goods, services and assets rise within an economy (the effect). Allow me to explain:

An over-supply of an item causes its value to diminish due to abundance. For example, a bumper crop of wheat will cause its market value to decline. On the other hand, a shortage of an item causes its value to appreciate due to scarcity. For example, a poor harvest of wheat will cause its market value to rise. Similarly, when you have a constantly increasing quantity of money and credit available within an economy, its value will continue to diminish. In other words, the purchasing power of each unit of money will dilute, requiring more and more quantities of money to purchase the same amount of goods, services and assets within an economy. This “confiscation” of purchasing power is the biggest consequence of inflation.

Monetary inflation has another dire consequence; it does not affect everybody in a uniform manner and causes a great wealth-divide. Those who get access to this newly available money first, and most importantly BEFORE the remaining population, gain the most, as their incomes rise prior to any increases in the prices of items they buy. In contrast, impoverished people in the remote areas of the economy who have not yet received the new money get robbed as they find that the prices have already risen before the new money has had a positive impact on their incomes. Furthermore, inflation also causes grave distortions within an economy. As this ever-expanding supply of money spreads through the economy, it causes gigantic “asset-bubbles” and the inevitable busts resulting in much hardship and wealth destruction for the majority of people. The most recent example being the sharp 10% intra-day decline in Chinese stocks.

So, if inflation is such a menace for society, why do the central banks continue with their inflationary program? And why do they claim that they are fighting inflation?

Banks are in the business of lending money in exchange for interest. The more credit they create, the greater their income through the collection of interest. Under “normal” circumstances and as long as the public is not worried about inflation, banks continue to inflate. However, for this immoral system to work and be accepted, the public must remain oblivious; hence the constant official propaganda of fighting inflation.

Occasionally, a situation arises whereby the public panics about the loss of the purchasing power of their savings. This causes people to start exchanging their paper money for tangible assets. Under these circumstances, banks momentarily stop their inflationary program and raise interest-rates to show they are indeed “fighting” inflation; a monster which they themselves created in the first place! This scenario occurred in the late 1970’s, when Americans started dumping their US Dollars in exchange for gold and the Federal Reserve had to intervene by substantially raising interest-rates.

If you still have any doubts about the constant inflation agenda, you may want to note that despite the highly advertised recent monetary “tightening”, US bank credit has continued to surge and currently stands at a record US$8.4 trillion. In fact, US bank credit rose 9.4% over the past year which is close to the record-high annual growth rate of 11.2% recorded in December 2005.

Furthermore, our planet is still awash in a sea of inflated “paper money”. Non-gold international reserves held by non-US central banks are also at a record-high (US$4.92 trillion). Emerging nations hold a record-high US$3.52 trillion and the industrial nations hold US$1.4 trillion. It is interesting to note that China’s reserves alone have soared to over US$1 trillion, whereas Japan’s reserves are now around US$880 billion with no signs of a slowdown in sight. Finally, Asian central banks (excluding China and Japan) own another mind-boggling US$1.17 trillion of paper money.

This ever-expanding quantity of money and credit may eventually contract. However, in the meantime, central banks have plenty of methods they could use (if required) to flood the world with additional supplies of Dollars, Euros, Pounds or Yen.

In a world of inflated asset-prices, precious metals, energy and agricultural commodities are still inexpensive in real-terms and (especially) relative to financial assets.

Furthermore, given the massive Chinese demand for natural resources and tight supplies, I believe that this sector will continue to be the biggest beneficiary of monetary inflation over the coming years.


Puru Saxena
for The Daily Reckoning
April 4, 2007

P.S. With further inflation and loss of purchasing power almost a certainty, as investors, we must try and identify those assets that are likely to benefit from this monetary malaise. Luckily for you, esteemed economist Dr. Kurt Richebächer has done the legwork for you.

Editor’s Note: Puru Saxena is the editor and publisher of Money Matters, an economic and financial publication available at

An investment adviser based in Hong Kong, he is a regular guest on CNN, BBC World, CNBC, Bloomberg TV & Radio, NDTV, RTHK Radio 3 and writes for several newspapers and financial journals.

The above is an excerpt from Money Matters, a monthly economic publication, which highlights extraordinary’ investment opportunities in all major markets. In addition to the monthly reports, subscribers also benefit from timely and concise “Email Updates”, which are sent out when an important development in the capital markets warrants immediate attention. Subscribe Today!

A Dear Reader from London sends this reminder – a ditty from the 1930s – when Goldman Sachs Investment Trust nearly wiped out its investors:

I didn’t have no income

I didn’t pay no tax

Thanks to Mr. Goldman

And thanks to Mr. Sachs

Mr. Goldman and Mr. Sachs were pretty smart. But not even the Alpha Dogs can outrun a market trend whose time has come. Misters Goldman and Sachs couldn’t do it in the Great Depression; and their heirs and assigns can’t do it today.

Yesterday brought news that Goldman’s flagship Alpha Fund took a loss of 5.7% in the month of February.

We have no idea of the specific bets that went bad. But the fact that any bets made by the masters of the masters of the universe went bad, signals to us that money shuffling is not as sure a business as it was a year ago.

From the Peach State comes word that another mortgage lender has closed up shop.

The Journal Constitution:

“Atlanta mortgage lender SouthStar Funding has shut down, citing the industry’s subprime lending woes.

“SouthStar’s Web site posted a brief note saying the company ‘regrets that it was necessary to cease its mortgage lending operations. The recent unprecedented downturn and policy changes in the mortgage industry necessitated this action. SouthStar appreciates its employees’ and customers’ loyalty to the company throughout the years.’

“The company, which employed about 500 in Georgia and another 100 in California, was founded in 1998…it generated $6.3 billion in mortgage loans last year, [and] shut down operations in Denver and Orlando about a month ago.”

Meanwhile, the New York Post reports that M&T, a mortgage company in Buffalo, got whacked. Investors marked down the stock 8% on Monday, after the company reported trouble with its Alt-A mortgages (one step up from subprime).

How fast and how far up the problems in the credit structure will go we can’t tell you. The National Association of REALTORS admits to only a 2% decline in housing prices nationwide. The former Goldman-man, now U.S. Treasury Secretary, Hank Paulson, says the trouble in subprime won’t affect many people – only minorities and trailer trash.

(Here, an aside…we only know one person who lives in a trailer, and he’s one of the least trashy people we’ve ever met. He’s also one of the last few people in America who doesn’t believe in credit. He’s saving his money to buy a house – with cash!)

“It generally takes a crisis to get people to act,” a recent TIME magazine article quoted our own Addison Wiggin in saying. And when the subprime disaster finally reaches fruition, we’ll be seeing a lot of people scrambling to get their acts together.

But have we seen the worst of the trouble in subprime? We doubt it. Over the last two years, we have illustrated the connection between property prices and economic activity so often that our dear readers are probably getting sick of it. No house price increases, no increase in mortgage debt, no increase in consumer spending, no GDP growth…at least, that’s what we kept saying. Maybe now we’ll find out if we were right.

More news:


Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis…

“The European Central Bank (ECB) is still waging a war of words to engage the markets in the thought that they will be raising interest rates again soon…and they have to do this because the markets have ADD.”

For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig

And more random and inconsequential thoughts:

*** So far, the lenders have proved remarkably robust. Once they can do no more damage to one group of borrowers…they move on to the next! Techs, telecoms, dotcoms, subprime…now they are falling all over each other to lend money to private equity deals.

Investors’ “appetite for risk rises,” reports Bloomberg – focusing on the growing appeal of futures contracts over boring old bonds. With all the trillions of dollars worth of derivatives already passing through the world’s financial digestion, a trade war with China getting underway…and perhaps a real war with Iran (Russian intelligence sources say it’s brewing in a matter of days)…you’d think it would be time to push away from the table and light a cigar. But no…they’re still chowing down. “Deals…deals…deals – give me more deals!”

Sam Zell just scored a big one – buying the Tribune company. It took $8 billion to swing the deal, according to the press reports. But Zell put in only $315 of his own money. The rest was ‘leveraged’ – debt, in other words. How? It’s not clear but there is speculation that Zell is using a leveraged Employee Stock Ownership Plan (ESOP). That is, he will borrow a huge amount of money through the plan and have employees vest into the stock over time as a pay back. A big attraction to the new owners would be the significant tax benefits, but what happens if the value of the company declines in the future, as it might, with all the new debt added?

We don’t know. But there is debt everywhere. If it ever gets marked down…there will be a lot of unhappy investors around. Reports also say that Tribune might invest a part of employees’ pensions in the new firm…without even seeking the beneficiaries’ permission.

Maybe lending billions to a real estate tycoon so he can buy into a newspaper business, whose sales must be under threat from the Internet, is a good financial move. Maybe it is not. We have not looked, but there is bound to be Mr. Goldman and Mr. Sachs in the deal somewhere.

*** We tried owning a cell phone a few years ago. But we could never think of anyone to call or what to say if we did. And since no one called us, we gave it up.

But now, we have a new one on its way – an Iridium phone.

“Ya, ve vill buy ze phone for you,” said Hans on Friday of last week.

Hans and Dag are two very nice German fellows, who came to see us in Paris. They work for Land Rover near Köln and are planning a long road trip through the Andes Mountains, in order to show off their new model Defenders. They invested a lot of time and money planning the trip – which involves shipping 10 cars across the Atlantic, a whole crew of automobiles, staff, travel writers, mobile doctors, hotels, flights, etc., etc. They carefully mapped out the route by satellite images and old military maps…across deserts, over mountains, fording rivers, bouncing along on abandoned mining tracks.

Then, just a few weeks before the trip was scheduled to depart, they discovered that they had neglected an important detail. Their caravan needed to cross private property in order to get from the main road to the Atacama Desert – and part of that property is owned by your editor. Because of the configuration of the ground in that area, there is practically no other way of getting where they are going – unless they reorganize the whole trip.

Speaking on the phone a few weeks ago, we had refused permission. Not that we had anything against them or the Land Rover caravan, but we had asked Francisco, the farm manager, and he was worried that since we didn’t know exactly when they would cross a remote section of the farm, they would leave the gates open and the cows would get out.

So, Hans and Dag came by to pay us a visit. We explained that we had no phone on the property, and thus, no way of staying in touch with the caravan. As a result, they kindly offered to buy us one, in return for permission to cross the ranch. We happily consented.

And since we have no car or truck down there either, we had an idea.

“What are you going to do with all those Defenders after you’ve made your press trip?” we asked.

“Ve’re not sure,” Hans responded. “It’s so expensive to ship zem back to Germany; ve’ll probably sell zem into ze local market.”

“Well…if you could give us a good deal on one of them…we’d like to buy it.”

“A good deal…ya…zey are not ours, of course. Zey actually belong to ze English company. But ve vill get a good deal for you. Ya…ve’ll bargain on your behalf…”

“Ya,” Dag added, “ve’ll really take dere pants off! Dat’s a German expression. It means to get a very, very goot deal.”

“Great, then…take their pants off!”

*** We went to Palm Sunday mass at Notre Dame of Paris.

As you might imagine, dear reader, the place was packed. Churchgoers crowded into the seats in the middle…while an unusual crush of tourists worked their way around the periphery, taking photos, gawking…but maintaining a respectful silence.

The tourists made up a homogenous mass – all clad alike in jeans, sneakers, and sports jackets. “Where did they get the idea for such get ups?” we wondered. They reminded us of Edward’s theatrical boom-boom on Saturday night. Same outfits. Same dull expressions. Same ratty styles, inspired by U.S. music videos. What do they think about? What gods do they worship? After three thousand years of Judeo-Christian culture…what does modern man have to show for it? Star Academy…piercings…and leveraged mortgage debt?

Above us…around us…in our eyes…in our ears…maybe even in us…were some of the most remarkable sounds and scenes ever to have reached our senses. Statues…stained glass…soaring buttresses, perfectly sculpted and laid up before the invention of the internal combustion engine, chiseled out of hard stone by soft flesh, and pulled up by ropes and pulleys by tough human arms, elegantly curved, reaching up above the galleries with their stone columns and arches, up to their nooks and crannies, where a Quasimodo might have sulked…

…and the magnificent organ…with its polished wood, its gleaming towers of copper and brass…swelling, echoing, rolling and pitching with the musical genius of Mozart and Thomas Byrd…

…and the Palm Sunday mass itself…carefully worked and reworked…considered and reconsidered…practiced and rehearsed over 2000 years…exquisitely performed.

Three times came the knocking on the great doors at the west end of the Cathedral. And then, the ports were opened – slowly, grandly. And we, sitting near the front of the church, saw the blaze of light just as we were meant to see it; and the Bishop of Paris entered with his curved staff of gold, and palm frond in his hand, and his entourage of priests…and the whole lot of them made their way down the aisle, reenacting Christ’s triumphal entry into Jerusalem. What a show!

But what did the gawking tourists think of all this, we wondered? Did they envy the faithful…or despise them?