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Hypothesis: Increasing The Money Supply Fosters Currency Devaluation

April 13, 2009


Increasing the money supply fosters currency devaluation; AND currency devaluation is a discreet, subtle method for WEALTH DISTRIBUTION.

I will attempt to prove this Hypothesis via thoughts posted to this august forum by others (Sources given), but which support the idea that President Obama (covertly) seeks to fulfill one of his principal campaign promises, namely:

A Greater Distribution of the Nation's Wealth.


Part I: Quantitative Easing (QE) Policy in the US
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The US has cut interest rates from 1% to between 0 and 0.25%. This is the lowest rate (ever) for interest rates in the US. However, there was greater concern about the Fed's plan of quantitative easing (QE) - i.e. buying assets such as Treasury bonds and mortgage backed securities to effectively increase the money supply.

Many feel that the interest rate cut will do little to boost spending, borrowing and investment. (rates on short term Treasury Bills are 0% already) However, the willingness to increase the money supply through quantitative easing has been heralded by some as a bold move to deal with the threat of deflation. To be sure the best weapon against DEFLATION IS INFLATION.

The US has already been increasing the monetary base this year. With the velocity of circulation falling, this has not increased inflation. In fact consumer prices fell last two months.

Quantitative Easing (QE) and the Risk of Hyperinflation.

Quantitative easing is modern day version of printing money. What the Fed will do is buy Treasury Bonds and mortgage backed securities, this effectively increases the money supply and keeps interest rates on bonds low.

Some economists, argue that a dramatic increase in the money supply that the Fed is fomenting could easily lead to inflation and possibly hyperinflation.

At the moment, the increased money supply is not causing inflation because the velocity of circulation is falling. However, if there were a sudden rise in the velocity of circulation, then combined with an increase in monetary base, we would see rapid inflation - rapidly leading to hyperinflation.

Could this happen? Bond Bubble?

At the moment, there is great appetite for buying US Treasury Bonds - even though interest rates are close to 0%. However, if investors felt that bonds were not as secure as they hoped, then people would rush to sell their bonds and buy other assets such as commodities - and this would cause a rise in the money supply, resulting in devaluation in the dollar. The risk comes from the rising level of US government debt. If the US loses its credit worthiness, people would no longer want to hold US securities at 0% interest rates. They would sell these debt instruments, thus causing depreciation in dollar and increased money supply.

At the moment, the risk of deflation is greater than inflation. Increasing the money supply, is less painful than further government borrowing. But, the Fed will be walking a tightrope - print too little money, the US could be sucked into a deflationary trap; print too much and it could cause inflation.

Part II: The Fed Monetizing the Debt
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We have to admit that Fed actions announced at the last FOMC meeting very much took us by surprise. Point being, we did not expect the Fed to begin monetization so soon. But surprised we should not have been. Not by a long shot. To be honest, Fed monetization of Treasury debt was inevitable in the current cycle. The recent global capital flow and realized/expected Treasury issuance numbers over the last half-year really tell the whole story quite emphatically. So although there has been plenty of ranting and raving about Fed monetization, ourselves included, we think it's much more important to our forward investment decision making to simply address this fact objectively and unemotionally. The Fed really had no other choice. Moreover, as we'll discuss, this is the beginning of monetization actions by the Fed. They're just getting warmed up.

… as of right now, the OMB (Office of Management and Budget) has projected at worst an annualized $1.8 trillion deficit for the US later in the current year.


We all know that at the margin China has been the key foreign country buyer of US Treasuries over the current decade. From 2000 through January of this year, China accounted for 37.4% of all Treasuries purchased by foreign entities. As of now, they are the largest holder of US Treasuries on Earth, holding 24% of all Treasuries owned by the foreign sector. Bottom line? China's global capital flows at the margin are extremely important. Let's face it, it's China who could change the dynamics of what we talked about above for the better or for a whole lot worse as we move forward. They carry the largest stick and their forward actions will be the key factor influencing just how much monetization of Treasuries the Fed will necessarily need to undertake. Again, not want to undertake, but forced to undertake.

The top clip of the next chart looks at actual year-by-year purchases of US Treasuries by China. From our standpoint, there is simply no way China can keep up the level of Treasury purchases we saw last year, especially when trade flows are falling like a rock and China needs to commit stimulus funds domestically.

Enter Quantitative Easing (QE)

As we're sure you already know, Japan was very late in the game in its own post equity and real estate bubble reconciliation cycle when it decided to pull the QE monetary policy trigger. When interest rates are already practically zero, a government must engage in more 'creative' actions to stimulate its economy. Consequently, not long ago Japan too began printing money to buy its own debt, which is called by the by innocuous term "Quantitative Easing (QE)." But clearly it is monetizing the debt…literally PRINTING MONEY.

Clearly, the Fed is obliged today to engage in Quantitative Easing (QE), which vis-à-vis President Obama's 10-year Trillion Dollar Annual Rescue Program will necessitate astronomical amounts to be monetized - subsequently causing the money supply to orbit.

The US now begins QE after not having been able to internally fund its own borrowing for many moons, being already heavily indebted and in a burgeonous deficit position. And so now deficit spending in the US is to move into high gear, supported in large part by Fed sponsored QE…which will inevitably lead to a draconian dollar devaluation.

In our opinion massive QE by the Fed will probably save the US economy from another Great Depression, but the cost will be a dramatically lower dollar value, which is evitable.

This brings me back to the original hypothesis:
Increasing the money supply fosters currency devaluation.

Indubitably, relentless QE via debt monetization will massively increase the money supply, which will translate into a draconian dollar devaluation. And history is testament that currency devaluation is a most effective (albeit subtle) method of WEALTH DISTRIBUTION…President Obama please take a bow for your looming success.

Part III: Ramifications of Increasing the money supply causing massive currency Devaluation

Without one iota of doubt the U.S. is between a rock and a hard spot. Increasing money supply via QE will indeed keep interest rates low. Consequently, this will help alleviate the real estate debacle (i.e. failing banks and tidal waves of foreclosures throughout the land). On the other hand near zero interest rates, coupled with massive monetization of the ballooning national debt to finance President Obama's overtly ambitious Rescue (bailouts) and Stimulus Programs, will inadvertently cause a draconian devaluation of the U.S. greenback. It is as sure as rain is wet.

How To Protect Your Accumulated Wealth?

We all know what is coming down the pike: Continued exploding money supply; Massive debt monetization, and; Eventual hyper-inflation. This begs the question: What can an investor do to mitigate the government's efforts to effect WEALTH DISTRIBUTION?

Lamentably, all uninformed investors are destined to suffer material loss of the purchasing power of their savings (accumulated wealth)- as QE relentlessly evolves in the coming years of Obama's planned annual Trillion Dollar Budget Deficits. However well-informed smart investors will recognize that as the value of the dollar declines, the value of gold and silver will inexorably appreciate (as will most other commodities). Moreover, highly sophisticated investors will take advantage of the LEVERAGE EFFECT that gold and silver mining shares have traditionally enjoyed in past precious metals bull markets. On-balance the HUI Index boasts an historic 2.5:1 to 4.0:1 PERFORMANCE LEVEL over bullion in past bull markets. AND SO IT SHALL BE AGAIN.


Our nation faces its greatest challenge since the 1930s Great Depression. Banks are literally at the precipice, as tidal waves of real estate foreclosures flood the land. Further, unemployment has reached an alarming 26-year high of 8.5% with dire echoes of topping 10% by yearend with little respite in sight.

In an effort to avert another Great Depression, the Obama Administration has reduced interest rates to practically zero. But unfortunately this drastic measure has not stemmed the tide of devastating deflation. Consequently, the Fed has begun to implement Quantitative Easing (QE) via monetization of the burgeoning debt issured by the US Treasury, because China et al have sharply reduced their heretofore insatiable appetite for Uncle Sam's paper IOUs. This has caused an unprecedented acceleration in the growth of money in circulation.

The above confluence of the effects of draconian measures by President Obama to save the U.S. economy will severely undermine the value of the currency, which will inevitably lead to a deep devaluation of the greenback.

The only sure road for prudent investors wishing to preserve the purchasing power of their accumulated wealth is through traditional safe haven precious metals and/or shares of select gold and silver mining companies.

The chart below emphatically demonstrates how precious metals investments have far out-performed all alternatives…especially vis-à-vis the US Dollar Index. The chart covers the entire period of the evolving precious metals secular bull market that began in 2001.

Total Performance for each during the 8-year period:

HUI………………………………………UP +617%

Gold……………………………………UP +223%

Silver…………………………………UP +166%

Dow…………………………………Down - 25%

US$…………………………………Down - 22%$HUI&p=W&st=2001-01-01&id=p50636593590

Count on the comparative performance to favor precious metals going forward….perhaps even more so as the US dollar loses value for reasons stated above.

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