August 2012 …… Points to Ponder

02 Aug

What is happening in our economy ……… In financial markets ……. To interest rates …… And an interesting question – What is Money ………..

Dear Readers,

Thanks to all of you for accepting our invitation, for accessing our blog, and for your participation & feedback. I look forward to more of your active participation.

August is upon us and let us take a look at what is happening around us, and what to expect in the months ahead.

The Markets

Overall sentiment and activity is flat or weak ……..

There is talk of falling commodity prices (stuff that we mainly dig up & export) due to lesser demand from our major trading partners, and plenty of competition & capacity (all the investment in mining & agricultural infrastructure over the last 10-15 years, worldwide). What are you hearing ?

Property – As we observed in the June blog, we see a huge amount of conflicting data ………. Some are claiming a shortfall in housing stock, and others say there is a too much stock. What do you think ?
There are claims & predictions of a cooling of rental demand for up-market properties, due to ‘tightening’ of allowances/concessions to certain employees. What do you know ?
Property auction rates, some claim, are flat, or steady …….. We are seeing figures quoting 50-55% all over the press & media ……… While a few contrarians question the relevance & accuracy of data behind these figures. What is your observation ?
We hear the ‘Credit Crunch’ for builders is getting worse, and an increase in foreclosure & bankruptcies of building related companies. What are you hearing ?
Could we see this as a sign of ongoing weakness in the property & construction sector, or a healthy sign of the market correcting & sorting out distortions ….. What do you think ?

The Economy

Different Australian state governments have tweaked tax policies, over the last 12 months, to encourage, incentivise, and guide growth in activity within the property sector.
As discussed in the June 2012 blog, our local economy (NSW) is dependent on the performance of our national economy, and in turn on the global economy (our trading partners).
Our dollar, compared to US Dollar & other major currencies, is on a high and getting higher ….. Some are predicting even higher ….. Even parity with the euro, in a few years time …….. Good if you are going on a holiday ……. But what will the high AUD do to our manufacturers, producers & exporters ……. ?
Unemployment figures are stated to be around 5% ……… But how relevant is the data, criteria & measurement behind these general claims ……… There are contrarians who talk about much higher figures …….. What do you think ?
And the most important thing is ‘Sentiment’ – The way we hope, think, wish and guess things are going to be in the future …… This will play a major role in what we do, and how we spend ….. What are you thinking & feeling ?

This brings us to a subject which is fundamental to every economic activity & decision, whether you are buying a loaf of bread, or trying to understand the Ongoing Global Financial Situation ………… Money.

Subject of the Month – What is Money ?

Let us start with the standard definition – “A medium of exchange, in the form of Notes & Coins”.
It is so simple & obvious ……… but is it ?
I will concentrate more on the other function of Money …… As a store of Value ….. Which we do not hear much of, these days ……

Origin of Money – Barter system – Thousands of years ago we moved on to a stage where we settled down, in little families or communities, and started to produce a little bit more than our daily minimum needs.
We soon discovered that one person, or family, or community was better at producing some ‘things’ but not other ‘things’ ……….. Or we needed something which others had, and they probably needed things we had …… We created a system of exchange of goods & services …… We called it “Barter”.
The barter system was good, but not perfect ………….
“I have sheep, he has wheat, I need fish, and he needs salt” ……………….. or, “I have plenty of fish, need salt now, he needs grain now, but may have salt next year” ………….

The concept of Value – As more people & communities started interacting with each other, there grew a natural “Market” for goods & services. Concepts of “standard weights & measures”, of the “relationship between time, effort & output”, of “quality & quantity”, etc. started to be better understood and appreciated. Some ‘things’ were easier to barter or ‘Trade’ compared to others ………….
Things that were most generally needed by all, things that had longer shelf life (or even non-perishable), things that were easier to store & transport, etc. ………… In short, these ‘things’ were in higher demand, and so had more ‘Value’.

Storage of Value – Commodities, generally, emerged as higher Value items – To generate (produce), stock and trade. However, problems remained with direct barter of goods, whether between two parties or in common markets.
Over time, people came up with the concept of an ‘intermediary’, some ‘thing’ in common, that you could keep in store without losing value ………… and then could be exchanged again for whatever goods or services you would need in the future.

Gold as Storage of Value – Many commodities were tried and experimented, no doubt, including Grains, Livestock, Salt, Hides, Beads, Feathers, etc. in ancient times. But metals, especially rare metals, Gold and Silver in particular, were the natural choice in most communities, all over the world.
Gold is rare, divisible, non-perishable, cannot be replicated (counterfeited), and most importantly has high aesthetic value.

Gold as Currency – You could now produce anything, anywhere, trade it anywhere for a common store of value – a ‘Currency’ – Gold. You could then transport Gold easily to anywhere, store it for any period of time, trade it for any other goods or service, anywhere and anytime of your choice.

There were various experiments, mostly by force & diktat, by various leaders, rulers, invaders, etc. to use other forms of ‘Currency’ ……….. Peppercorns, Leather Coins, Tea leaves ……….. and Paper (ring a bell ????), but Gold remained the most popular free-market choice of Currency.

Gold, Banking & Notes – One problem remained – Safety – Theft & seizure by force if you stored it in your house …… Theft & seizure in transit (traveling to various distant places), etc. ….. And ‘Security’ came at a cost ……. In short, carrying physical gold all the time was not ideal …………. And the ‘Market’ came up with a solution.
“I will build a vault with adequate security, you store (Bank) your gold in my vault, I will issue you with a “Note” or receipt stating your claim to a fixed amount of gold ……….. You use these ‘Notes’ to trade, anywhere, anytime ……… You can redeem (get back) your physical gold anytime, on demand, by returning notes issued to you…….. I will charge a small fee for this service”.
A win-win solution. You could bank you gold in safety and trade easily, exchanging notes as currency, then get back your gold from the bank anytime, minus a small fee.

Fractional Reserve Banking & Credit – You were now assured that your gold was always held in ‘Reserve’ …….. 100% Reserve (If there were 100 units of gold in the bank, there were only 100 notes in circulation).
You could now use your notes – “Money” – to produce, trade and multiply your wealth, based on your ability and market conditions. The Bankers income, however, was limited to the amount of gold held in the bank, and the frequency of exchange (deposit and withdrawal of gold & notes).
You, the banker, and many others realised, soon, that there was a lot of trade & business to be done …….. But you needed ‘Money’ (Gold, and, or, Notes) to profit from this potential.
The banker realised that he could make more money by creating & issuing (credit) a few extra notes, even though it was not backed by any physical gold ……..
“Surely there is not much harm” ….. “No one need ever know” …… “And it is unlikely everyone holding notes will come into the bank and claim all of their gold back, at the same time” …………. “And there is a genuine demand for this extra money, or “Credit”, in the Market” ………..
This meant only a fraction (or part) of the notes (money) circulating in the market was backed by physical gold ………. Not 100% anymore ………. Fractional Reserve Banking had arrived.

Money was created by individuals, in a free market, by mutual consent, trade & commerce, without intervention of any external parties or use of force.

Yes, there was a risk of some bankers overextending notes (creating excess of notes and lending it out to the market, to earn extra fees/profit) ….. And many indeed did so, probably with negative consequences for themselves and their depositors (owners of Gold) ….. But this was limited in scope, only affected locally (not the whole kingdom / nation / globally), and most importantly would not be repeated & perpetuated (Loss of banker’s reputation, fear of punishment & retaliation by depositors, etc.).

Central Banking & Fiat Money – Families & communities had now grown towards kingdoms, nations, rulers, kings, emperors …….. And governments …………
And rulers needed vast amounts of money to rule ………… Palaces, Institutions, Lifestyles, Armies, etc……..
Rulers and Governments do not “Produce” anything, like you & me ……….. They collect wealth (revenue) from the “Ruled”, the citizens, by force, called taxation. But there is a limit to how much you can tax citizens. This limits the activity & ambition of Governments.
They can borrow money, from their own citizens, from other nations, etc……. But there is a cost to pay (interest), the debt has to be repaid eventually, and there is always a limit to how much they can borrow (Trust – Creditworthiness).
The third option is to “Create” more money ……… But money, over time, has been based on a sound commodity ……… Gold ………. And there is a limited amount of available gold.

But what if governments declare, by force (by Fiat) that “Money” is now pieces of paper …….. And this is the only “Currency” permitted to be used by citizens, by law. Government & related institutions control the Supply of Money & Terms of Credit. Elaborate structures of Central Banks, Legislation, Rules & Regulations, etc. have, over time, delinked gold from money & currency.
Welcome to Fiat money and paper currency. And what is backing these pieces of paper (what is redeemable – what do you get back – if you are not happy with the management of this paper money system) ? How do you measure its value, against what, based on what standard ?

You could probably buy an ounce of Gold by paying approx. $35 US Dollars in the late 1960’s …… and approx. $20 Australian Dollars …………. Today you pay approx. $1600 USD or $1550 AUD.

It is the late 1960’s in Sydney ….. Let us say Grandpa Jim put 4 ounces of Gold & a $100 note in two separate tins, sealed them, hid it in his garden, and instructed his grandchildren Jack & Jill to open it in 2012 ………. Jack got the note and Jill got the Gold coins ….

Now we are in 2012 …. Pretend Jack & Jill open their tins today in great anticipation ….. Jill sells the gold and gets approx. $6100 AUD, but Jack is left with $100 …… ‘It’s not fair’ says Jack ….. What do you think ?

Recently I was chatting with  clients …… Seems one of their parents bought a quarter acre block around Strathfield, NSW, in the late 1960’s, for approx. $40,000 ……… Today you would pay close to a Million ……..

Conclusion – I have a series of questions …… for you to consider, think about and comment on ….. What is our paper based money system based on ?
Is it being managed well ?
What is the relationship between money, prices, value & inflation ?
What is inflation ?
What is Money Supply ?
Who determines terms of credit (interest rates) ?

Let me throw open the discussion to you. I look forward to your opinion, counter argument, response, constructive criticism, feedback, etc.

Looking forward to hearing from you …………


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Posted by on August 2, 2012 in Uncategorized


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