This post is a bit long – but I just had to pull out the soapbox get this off my chest

We live in a curious age. If something becomes a problem, our society has come up with a new way of dealing with it – change the name we use to describe it. I have often referred to my country boy background. It should come as no surprise that I find our new way of dealing with problems to be, well, a problem.

Take QE (quantitative easing) for example. I will admit that the term sounds more sophisticated than “print more money”. But, reverting back to my country upbringing, I am thinking “if it looks like a duck, walks like a duck and quacks like a duck – then it must be a duck”.

The FED has been “printing much more money” for going on three years now. Their “balance sheet” is full of about three trillion dollars of paper – all of which was paid for with newly created money. Maybe they didn’t actually print it – but in the cyberspace world of today there is scant difference between printing money and creating it electronically.

But why does an insignificant little nobody like me really care? I am so far removed from the picture that it couldn’t affect me – or can it?

Remember I like to look at things simply – like a country boy. So I ask myself, “What is money – what does a dollar represent”?

I think of a dollar as a share of stock in a company named “USA”. The USA is in the business of providing goods and services for people and the sum total of all those goods and services make up what we refer to as “the economy”. So the economy is the business the USA is involved in. And, of course, that means that a dollar must represent a small share of that economy.

If the business of the USA economy grows the value of its stock (the dollar) should also grows – unless there are more dollars created to adjust the value of the dollar to the larger economy.

That is the job of the FED. Maintain the proper balance of available dollars to the size of the economy – thereby maintaining the value of the dollar and providing price stability for the economy of the USA.

The FED (the Federal Reserve System) was created by Congress in 1913 and its task was essentially to manage the monetary well being of the US Dollar. That was 100 years ago this year.

Let’s take a look at the purchasing power of the US Dollar in the past 100 years, shown in Figure 1.

Figure 1

If you owned a stock with a value chart like the one shown in Figure 1, wouldn’t you be asking yourself whether or not your investment was being handled well – or not.

Actually, a company whose stock had suffered a value curve like the one in Figure 1 would likely e looking for new management, new ownership or even liquidation.

Now let’s take a look at the amount of “stock outstanding” in USA.

Figure 2 shows the supply of dollars – but the chart ends at the beginning of 2010.

Keep that date in mind.

Figure 2

I do not claim to be an economist – nor a mathematician – but the above chart is disturbing to me.

The amount of dollars – that is shares of stock outstanding in company USA – has increased more than FIVEFOLD – in the ten years leading up to Jan. 1, 2010.

Now just visually add the THREE TRILLION DOLLARS the Fed has created in the last three years to the chart in Figure 2 and the graphs not only go off the chart – they almost go off the page!

And what has the business of the USA done in that same time span?

Examine the chart shown in Figure 3. Note that the growth in GDP (which is the total economic output of the USA) from about 2000 to 2005 – the last data on the chart.

The growth was not impressive – from about 10 trillion to only bit more than 11.5 trillion.

Let us be generous and say growth over those five years was 1.175 trillion. That is about 11.75% – and we will be even more generous and round that up to 12%.

A growth rate of 12% over five years is not going to merit bonuses for the management, but it is growth nevertheless – about 2.5% per year average.

Figure 3

What about the growth in the number of shares outstanding (dollars) for that same five years?

Our chart shown in Figure 2 is not really detailed enough to be really accurate, but one can readily see that it was pretty close to a doubling of the number dollars available.

Now 100% increase in the number of dollars and only 12% increase in the economy seems a little out of whack to me.

But it gets worse – our GDP chart does not go beyond 2005 – but most of us were around for those years and we know that our economy simply crept along at a very slow growth rate – but money supply again more than doubled!

Those percentage variances cannot be sustained for long. By any reasonable accounting standard, the US government is bankrupt. But the party still goes on – and it will continue – until it doesn’t.

Okay, we are just an itsy bitsy little nobody, one lonely short term trader in the crowd. But that short term trading is often in the US Bond markets because – other than FOREX – they are among the largest and most liquid markets available.

What The FED is doing is leading to a bubble in the US Bond market. The popping of that bubble will result in a financial meltdown of biblical proportions. The man on the street is about to learn the true meaning of a TRILLION dollars.

I do not know exactly when the bubble will pop – but the bubble is being fed by more and more dollar creation – and the new FED head to be is an avowed believer that more is better.

Apparently, the FED thinks that the reason that injecting more dollars into the economy has not worked as expected so far is that they have not injected enough. I am not even going to attempt to explain that thought process.

So what does all this economic mumbo jumbo mean to us little people?

If there could possibly be a case to justify short term trading that is better than this, I do not know what it could be.

I may not know when it is going to happen – but at least I can start being prepared for it to happen – and hopefully, reduce the damage it does to my financial and mental well being when it finally does happen.

Historically, without exception, excessive money creation has led to financial collapse. It scares the hell out of me when I hear our politicians say, “this time it is different”!

I do not give financial advice, but I will say that it is worth noting that the dollar was supported by gold when the FED was created. It is now a completely fiat currency – backed by nothing more than its proportionate share of the USA economy. And I will concede that the USA economy is still the largest in the world, I would like to point out that the dollar – in terms of gold – is now worth a small fraction of that when the FED took over in 1913.

Take a look at the chart in Figure 4. A picture is worth a thousand words.

Figure 4

Damn, I wish FDR (that’s Franklin D. Roosevelt, President of the USA) had not confiscated by Granddaddy’s gold coins in 1933 – he reportedly had quite a stash.

For those that don’t remember that event, I copied the following quote from Wikipedia:

Executive Order 6102 is an executive order signed on April 5, 1933, by U.S. President Franklin D. Roosevelt "forbidding the Hoarding of gold coin, gold bullion, and gold certificates within the continental United States". The order criminalized the possession of monetary gold by any individual, partnership, association or corporation.

To paraphrase another USA President, Ronald Reagan, “The most fearful words I can imagine hearing is, ‘I am from the government, and I am here to help you’”.

On the potentially bright side, one can be optimistic about the fact that in the past, financial disasters have produced great wealth building opportunities for a few – those few that had the foresight to be prepared.

I hope to be one of those few.

Phil Elrod

Author & Trader


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