The Mortgage Bankers Association in the US reported that sub-prime adjustable rate mortgage delinquencies reached 14.4% during the fourth quarter of 2006. Including all one-to-four family homes, delinquencies reached 4.95%. Lenders clearly did not consider the consequences of their exotic lending practices, and neither did the investors who financed them.

While it is clear that greed overwhelmed both banks and investors, the real culprit here is excess liquidity. The world is awash in fiat money and whenever governments debase the legal tender the result is symptomatic gambling: money is easy to get and is spent rapidly without regard to risk. Investors, banks and home buyers all tried to “take advantage” of rising real estate prices while in reality they were merely gambling with easy money.

Investment companies, awash in cash from expansionary monetary policies and the yen carry trade, needed to do something with all this money and among other things gobbled up mortgage backed assets as fast as they were created. Banks and specialty mortgage firms noticed this demand for packaged mortgages and obliged by creating more and more of them. The investment firms seemed not to care too much about the quality of the mortgages since they were trying to spend cheap money as fast as possible, and so the lending institutions lowered their lending standards so that they could generate more fees and remain competitive. Home buyers were overjoyed since many who could not afford to buy a house could now get in on the game with no money down, ultra low “teaser” interest rates and loans for up to 125% of the value of their homes. All this speculation in real estate, stocks, bonds, antiques, rare coins, art, etc. can be traced back to “easy money”.

Easy money is possible because all the money we have (other than gold) is fiat money and central banks are not shy to create more and more of it. It seems that there is very little comprehension of the nature of money and the consequences of changes in money supply: even Alan Greenspan admitted he does not know what money is or how to measure how much of it is around.

The US Federal Reserve is managing US money supply by focusing on inflation expectations and stopped publishing M3 so that nobody would know what it is. This is so preposterous that had I not seen the quote by Ben Bernanke myself I would have never believed it. Apparently the Fed believes that it can create as much money as it wants with positive ramifications as long as people don’t expect prices to rise.

The US Treasury used to have a website dedicated to publishing the US Public Debt. Now if you go to that website you are re-directed instead to the website where you can buy US Treasury debt. Like M3, it is being taken out of the public eye. It seems that the game plan is to talk people into believing that prices will not rise and then, the theory goes, prices won’t rise and the Fed can create all the money it likes. The strangest thing of all is that Americans are falling for these shenanigans.

While fiat money across the globe is being created at a blistering pace the production of gold is slowing down. Last year total mine production of gold amounted to 2,467 tonnes. It is estimated that the total amount of gold ever mined is about 155,000 tonnes and essentially all this gold is still available in some form or another. This “above ground” gold is the gold equivalent of money supply and annual mine production is therefore inflation of the gold supply. Last year’s gold inflation rate was 1.6%. US monetary inflation is above 10%, Britain’s inflation rate is about 12%, Europe’s inflation rate is roughly 10% and Japan’s is about 4.5%. It is interesting that all of the fiat currencies that are actively managed by reserve banks have higher inflation rates than gold, which is not managed at all.

The price of gold over the medium to long term is determined by its inflation rate relative to that of the currency you want to measure it with. With most fiat currency inflation rates running substantially higher than gold’s inflation rate it’s easy to see why the gold price will continue to increase over time, and why it has consistently increased over time. This is not about to change regardless of short term volatility.

Paul van Eeden

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