Friday, 6 January 2012

Gold vs. Inflation


Those who work the hardest and are paid the least, suffer the most from the constant erosion of money's value. Since money has an ever declining value, a financially wise person must constantly seek ways to create and produce more and more value.

Under a Gold standard, the amount of credit that an economy can be support is determined by the economies tangible assets. Since every credit instrument is ultimately on some claim on some tangible asset but government bonds are not backed by tangible wealth only by the governments promise by payout by future tax revenues and cannot be easily absolved by the financial markets. A large volume of new government bonds can be sold to the public only progressively higher interest rates, thus governments deficit spending under a gold standard is severely limited. The abandonment of Gold standard made it possible for the welfare states to use the banking system as a means to unlimited credit. They are created papers in the form of government bonds which threw a complex series of steps the bank accept in place of tangible assets and treat as if they were actual deposits. This is just on a ledger in the federal reserve as the equivalent as formerly Gold. The holder of a government bond or a bank deposit created by paper believes he has a valid claim on a real asset. The Law of supply and demand says as the supply of money of claims increases relative to the supply of tangible assets in the economy the prices must eventually rise. Thus earning saved by the productive members of the society lose value in terms of goods, so if you are saving money you are losing money in the system. 

The example of monetary inflation (creating new money out of nothing). Monetary inflation is institutionalised counterfeiting, which means it is a form of theft. Although it is (or at least should be) intuitively obvious that the economy could never, under any circumstances whatsoever, benefit from an increase in the amount of theft, it is unlikely that someone without a grounding in Austrian economics would be capable of understanding or explaining, in practical terms, exactly why this is so. After all, during a financial crisis it can seem as if a shortage of money is a large part of the problem and that 'greasing the wheels' with more money is just what's needed to get us through the rough patch.

To fully appreciate why monetary inflation is always a practical problem rather than just an ethical problem, you have to understand the relationship between money-supply changes and the boom-bust cycle ("Austrian Business Cycle Theory"). More specifically, you have to understand that the most important adverse effect of monetary inflation is not the reduction in the purchasing power of money that it eventually leads to, but the distortion it causes in relative prices. These relative price distortions lead to widespread mal-investment and the large-scale destruction of wealth. Think of how much wealth was ultimately destroyed by the monetary-inflation-fuelled boom in US residential real estate. The reduction in the dollar's purchasing power is trivial in comparison.

There will eventually be a complete collapse of the global monetary system, but I don't have a strong opinion as to how we will get from here to there (other than generally via the rapid creation of money out of nothing) or when we will get there. Anyone who does have a strong opinion (i.e. an exact date) on the timing and the specific details is, I think, kidding themselves. Rather than trying to figure out how to figure, it is better to pay close attention to what's happening in real time and adjust your positioning accordingly. It's not like the collapse could happen next week. At least, the US$ is not going to collapse next week or even within the next 12 months (although the euro might). Some things are bound to happen well before the US$ collapses, chief among them being a huge rise in the T-Bond yield. We are not, for example, going to see the US$ collapse with the T-Bond yield at 3%, or even with the T-Bond yield at 8%. Before the US$ collapses we will see the T-Bond yield move well into double digits.

My only other piece of general advice is to not bet the ranch on a single extreme outcome. For example, don't bet everything on the idea that the US is going to experience hyperinflation in the near future. The US will eventually experience hyperinflation, but the probability of it doing so within the next two years is close to zero. As far as this year is concerned there's more chance that the US will experience genuine deflation (a decline in the supply of money) than hyperinflation, but both of these extreme outcomes have very low probabilities when taking a short or intermediate-term view.

Thursday, 5 January 2012

2012 GIH Message

Dear valued clients and well wishers of GIH,

It’s that time of the year when we reflect the past and greet the New Year with the anticipation of a prosperous year ahead.  

Whilst we need to take lessons with what has transpired behind us during the course of last year, we cannot or for that matter could not have changed the event and proceedings that have taken place. What we could only do now is to thank Allah (SWT) for helping and guiding us through the past year, a year which has endured a lot of violence and economic issues which have hit every corner of the earth.

A number of challenges and opportunities lie ahead when looking at the year ahead of us and we need to identify key trends and other signs to the future. The growing threat to the global economy which has been a thorn in our flesh since 2008, the political changes taking place within the Middle East and the shift of economic powerhouse from West to East.

Here are some of the key challenges we see could shape 2012 and beyond:

·        A new global financial crisis could be in the making and unleash its fury as early as 2012, a year when bond rollovers in the US, Asia and Europe worth a combined $7.6 trillion are due.

·        The Euro zone sovereign debt crisis has entered a critical new phase with France’s prized AAA rating nder threat of being downgraded by Fitch and the spectre of more sovereign downgrades looking imminent.

·         Although some green shoots of economic recovery has taken place in 2011 in the US, the same has yet to e transpired into sustainable trees. Should the Euro zone crisis keep dragging and a uniform solution to the Euro could not be put forth, it could impact the US and the global economy as a whole.

·      In the Middle East, apart from the Arab spring which is still continuing in parts of Syria, Bahrain, and Yemen could spread further into Saudi Arabia. Should the demand for oil slows down and we see a substantial impact to oil prices, then some of the reforms announced by the Saudi government could not materialize and could prove costly to the Saudi regime.

·      Prospects of China and India economies growing has been fading with growth estimates for 2012 been revised downwards. It would be interesting to see how China will try and spur growth inside its own country.

While the above challenges are pertinent and to be taken note of, we don’t see “all gloom and doom” for 2012. We believe with every challenge lies opportunities and we are hopeful that the 7 billion plus global citizens will continue to consume and proceed with their livelihoods.

GIH Focus in 2012:

As was the case in 2011, GIH would continue to focus on Sri Lanka and tap into the retail, construction, hospitality, logistics and consumable based opportunities which we feel are key growth areas expected in line with the projected GDP 8.0% for 2012. We at GIH are confident that there would be plenty of opportunities within the sectors outlines above to invest during the year.

We hope and pray that Allah (SWT) will bless the year ahead for all of us and give us good health, strengthen our belief and commitments towards the betterment of mankind.

With Warm Wishes,

Team GIH

DISCLAIMER - This document is issued by GIH - Sri Lanka, solely for the purpose of information to its staff and customers. All efforts have been taken to ensure facts and figures presented herein are as accurate and error free as possible. Data subject to change without notice. All Rights Reserved. GIH - Sri Lanka. 2012.