See Important Disclosures at the end of this report.
and deposits are conjured simultaneously at banks and become unreserved electronic currencythat floats through the economy as credits and debits, used for wages, consumption, capitalspending, and even savings. Simply, banks create unreserved credit (i.e., a short in basemoney), which is generally and erroneously perceived as base money. The base money shortmust eventually be covered by central banks. This “fractionally-reserved” global monetarysystem is analogous to the Treasury bond market in that “when-issued money” (i.e., M1, M2,and M3) trades in the economy before it is ultimately issued (as M0). In this case long before.So, should we count our bank deposits as wealth? Presently,there are nowhere near enough bank reserves to cover bankdeposits (deposits are unreserved by over 7:1). There is noneed to fear bank runs, however. Were every depositor inthe world to suddenly demand his or her money, centralbanks would easily create it with a few keystrokes.As for banks, credit-currency creation levers their balancesheets while injections of central bank base money, in theform of QE bank reserve creation, de-levers them. It is an easy leverage/de-leverage model.
Foreveryone else, this process raises natural conflicts – especially in an already over-levered globaleconomy in which producers, consumers and trade partners must constantly sort the value of resources, goods, services and assets. The only logical metric to value anything has becomethrough contemporaneous agreements among bilateral counterparties that this is worth that.Thus, m
odern money is satisfying the requirements as units of account and media of exchange,but not the requirement as a store of future purchasing power. So, it is foolhardy to save money.
Second Chukker: The Pricing Matrix
Investors must consider a more nuanced decision making metric than savers.
The true driver of broad asset prices reduces to: a) the size of the total money stock and, b) its composition (i.e. itsmix of base money and credit currency).
(This Chukker is dense but we think insightful.)There are two planes in the pricing matrix: inflation/deflation and leverage. The growth orcontraction in the nominal quantity of money, in concert with an increasing or decreasing flowof that money stock (velocity), determines the rate of inflation or deflation, which in turndetermines absolute pricing (i.e., the General Price Level or “GPL”). However, leverage levelsand trends generally determine the
of assets vis-à-vis goods and services. Wethink understanding this relationship is the Holy Grail of secular asset pricing.The mechanics and consequences are quite clear and logical. For goods and service pricing, anitem has a universal price, say $1.00, €1.32 or ¥88.15, which reflects consensus value. The itemis exchanged in the world and its supply and demand shift along with preferences for it. Thissuggests ongoing price equilibrium for the item, higher or lower, based on population growth,innovation and reflexive availability and preferences. Keeping these variables equal, significantsecular price changes of all goods and services (i.e., the GPL) – what is commonly referred to asinflation or deflation – must be derived from an exogenous input. That input is the growth rateof money.