Money, the Discredited Credit

Reporting season kicks into gear this week, with big hitters Commonwealth Bank and Rio Tinto, among others, reporting. It will be interesting to see whether the market takes any notice of what’s actually happening on the ground, or whether it will continue responding to the enormous flows of capital produced by the escalating currency wars.

Dan Denning pointed out last week how the rally in the Aussie share market was a product of a weak yen. That is, as the Bank of Japan threatened to weaken the value of the yen (because the Government of Japan threatened it), everyone got the message and started selling yen and buying anything in its place.

And Aussie equities have been a favoured destination for the yen sellers. Especially the Australian banks. They have absorbed a huge amount of the incoming capital flows despite a slowing local economy. The banks remain the defensive and offensive asset class of choice. They sit at the heart of Australia’s financialised economy, inhaling interest repayments and fees from the debt soaked household sector and exhaling dividends to the investor class. They are Australia’s largest and most liquid companies…just what currency traders need for quick speculations.

Of course the banks aren’t the only beneficiaries. Most Aussie large caps are enjoying a bit of the action. So the Australian share market is having a very good currency war. Fundamentals play second fiddle to capital flows…at least for the moment.

Although that may change this week as reporting season heats up. Rallies built on speculative currency flows are inherently fragile. In this late stage of the modern money system, capital doesn’t know whether it’s coming or going. So it comes and goes. It is fleeting.

The old adage is that, ‘Capital goes to where it is treated best.’ In this age of currency wars, no one is particularly interested in treating capital well. If too much of it shows up on our doorstep, we turn it away. We’re not interested in housing and nurturing it. If only we’d get to know it better…let it stay and grow of its own accord, it could do us so much good.

Instead, we shun it. We think capital is the problem. It’s makes currencies too strong and weakens nations’ ability to export, create jobs and earn foreign income.

But the world is confusing capital with money.

Money is the problem, not capital. Too much money makes capital less productive. It can’t settle down and get to work. It takes flight and constantly looks for shelter instead of generating wealth.

But where does money come from? Who makes it?

This was the rather lengthy subject of our latest issue of Sound Money. Sound Investments. We traced the history of ‘money’ – as in the concept of it, not the bland history of coinage – to get an idea of where we stand today.

And history shows that people create money through building and earning credit. Banks grant credit, which is ‘money’, to creditworthy individuals and businesses. These individuals and businesses spend this ‘money’ (by consuming or investing it) and it flows throughout the economy generating income, sales, taxes and profits.

The money though, is really just an abstract concept. It’s a unit of measurement and exchange, with its value limited to this utility. The wealth…the capital…is in the ‘stuff’ that the money obtains. Human ingenuity and innovation then combine with this stuff to grow wealth and capital.

Money is just the vehicle for this wealth to pass through in a standardized ‘unit of account’. Throughout history money has been many things…seashells, rocks, cigarettes, paper, gold and silver, copper, bronze etc. But it’s not wealth and never has been. Wealth is something that takes sweat, brains, perseverance and failure. Money is none of these things.

In the era of the ‘modern monetary system’ we utilise paper as our money. More precisely, we use government produced paper, which uses the collective credit and credibility of nations’ resources and people to in turn give the paper money ‘credibility’. Nothing tangible backs our modern money, only intangible qualities like the goodwill of men (yes, mostly men) and nations.

It’s probably the most efficient form of money society has ever used. But unfortunately, the management of it is in the hands of humans, which makes it inherently unstable.

Ever since this modern system arose, breaking free from the ‘shackles’ of gold in 1971 (we’d call it cutting the golden safety net), the managers of the system have attempted to create more and more ‘money’ by creating more and more creditworthy borrowers.

Lowering interest rates, cutting banks‘ reserve requirements and myriad other regulatory changes have all bestowed credit upon people who in a more disciplined system would have been denied it. As a result, credit, and therefore money, is easy to get.

But just as credit creates money, discredit takes it away. And so the great US housing bubble created trillions in money when it had ‘credibility’. But by 2008, with the credibility of the bubble destroyed, trillions in ‘money’ went along with it.

That’s why the Fed stepped in. It didn’t ‘print’ money. It monetised previously created money that was rapidly turning bad and disappearing from sight. It did this by buying bad mortgage debt for a price well above what the private market was prepared to pay. In effect, it swapped Fed produced ‘money’ for market produced money that was rapidly falling in value. Money and credit are intangible concepts, here one day and gone the next…

The Fed’s job is to make sure it is never gone. It stands ready to monetise all the debt ever created. It has to. The system cannot handle the disappearance of money…the discrediting of previously credited accounts. If it did it would collapse.

The market knows this. And it’s just not the Fed, it’s all the central banks. By monetising discredited credit, central banks give the green light to rampant speculation, the most discredited form of ‘wealth creation’ in history!

That it’s getting out of hand is obvious to most people. You’re seeing it in asset markets all over the world. But there’s now rumblings at the Fed that all is not well in the bowels of the world’s monetary system. They’re very faint rumblings, to be honest, but all stampedes start that way, don’t they?

More on stampedes and the Fed’s uneasiness tomorrow…


Greg Canavan
for Markets and Money

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From the Archives…

Money in the Time of Financial Cholera
8-02-13 – Satyajit Das

Dishonest Leaders and Delusional Voters
7-02-13 – Bill Bonner

Uranium: The Commodity Like Gold Ten Years Ago
6-02-13 – Byron King

How Australia-China Relations Are Caught in the Monetary Battle Space
5-02-13 – Dan Denning

The Great Rotation Into Stocks
4-02-13 – Dan Denning

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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