With Mario Draghi having launched a sovereing debt buy-back program and Ben Bernanke, the FED’s president, having just announced a new round of « quantitative easing », there has never been so much money in circulation. But that raises inflation and affects all consumers directly.

A few days only after a new round of quantitative easing (QE3) was announced by Ben Bernanke, the Fed’s president, which was preceded shortly by the European central bank’s Mario Draghi’s own plan, investors and savers alike are asking themselves, as they should, how to protect their assets in this inflationary context.

Those holding assets have to make decisions about portfolio asset allocations, while the rest of the people holding no assets will get poorer without really understanding why.

To answer the question of how to protect oneself, one has to go further than traditional financial analyses and try to understand the one thing that influences (up or down) all financial assets : the international monetary system.

How does the international monetary system work ?

Since August 15, 1971, when Richard Nixon took the dollar off the gold standard, the monetary system is based on trust- a fiat money system in which monies are created out of thin air.

Central banks issue what is called base money and, in turn, commercial banks issue, through loans, the rest of the monies in circulation (in theory, by a factor of ten times).

In other words, the central banks issue 10% of all monies in circulation and the commercial banks « create » the remaining 90% and make interest-bearing loans.

One has to understand what this implies :

The entirety of the monies in circulation is smaller than the total sum owed to the banks (principal + interests), because the banks only create the capital.

One could compare our monetary system to a giant game of musical chairs where the banks have to constantly issue more credit in order to help the different economic agents pay the accumulated interests.

And those economic agents are all competing to get enough money (or a chair) to re-imburse their loans (capital + interests).

In other words, it’s a system based on exponentiality. It requires perpetual growth in a world with finite resources.

When the music stops (unavailability of credit), debt defaulting by businesses and then by banks is automatic because there is mathematically not enough money in the system to allow the re-imbursement of all debt issued. To keep this system afloat, money has to be created permanently.

Not too many people really understand the actual monetary system and its inflationary nature. True, it is hard to grasp that our monetary system is based since 1971 on... trust. It is also mind boggling that there is no education on the workings of this system, even in universities and specialized schools (economy, finance).

All fiat money experiments have failed. It takes an average of 50 years to progressively devaluate and disappear entirely.

But, for the first time in History, all monies in circulation are based on this fiat system which cannot mathematically last without permanent money printing, on a planet with finite resources.

Our own experiment that started August 15, 1971, has been going on for 41 years...

The convertibility of monies into tangible assets (gold) was the only thing keeping banks and governments from devaluating, because one can simply not print gold.

It imposes a discipline that governments have never liked.

Gold keeps them from kicking the can down the road with more debts to finance the States’ engagements and obligations.

The actual economic situation

The problem we have today is that we are now at a peak with debt. The private economic agents are saturated with debt (the States are getting there as well), so monetary creation cannot come from the private sector, because it cannot take on more debt.

Monetary creation is diminishing, since it is created by credit, there is less money available, credit defaults happen with companies unable to pay their debts, which in turn brings about the failure of banks that depend on the economic agents to pay interests on their loans.

The only way to re-inject liquidities is through central banks money printing, or base money.

This money printing is actually more debt, but at a State level, and the interests are re-imbursed by tax increases.

How can we get out of this crisis ?

Today, there are two options : keep going with money creation or apply austerity measures that would lead to a deflationist crash akin to what happened in the ‘30s.

In both cases, solutions will hurt and will lead to a form of crash : hyperinflation (money printing) or ‘30s type deflationary crash.

And the choice between those two options is determined by the political class. Who are the voters ?

The choice between inflationary policies or austerity measures is... political.

The voters are, for the majority, private economic agents who need access to credit to re-imburse the interests on their debts. Those are the masses who could revolt.

There are also big corporations that need access to credit to finance their operations.

This dual pressure on the politicians will likely lead to inflation and « recovery », especially since deflation would increase the level of debt, which is not in the governments’ interests.

Ben Bernanke, the president of the American central bank (FED), was a student of the crisis of the ‘30s. According to him, that crisis happened because not enough money was created, and he vowed very clearly that he wouldn’t let a deflationary crisis, like in the ‘30s, happen again.

Ben Bernanke’s decision to launch QE3 is the choice of inflation. And Mario Draghi, from the ECB, has done the same thing a few days ago, by monetizing sovereign debts.

This common approach will prevent a deflationis crash and social upheaval but it will lead to a destruction of purchasing power of the currencies and to a risk of a hyperinflationist crisis.

So who will be the victims of this new inflationary chapter and how will they protect themselves ?

Investors and savers are the loosers

Inflation brings about the destruction of the monies’ purchasing power. With billions of new dollars and euros flooding the system, their value is being diluted. One needs more money to buy the same amount of tangible assets.

All savers, big and small, who leave their money in a bank account are exposed in reality to a loss of purchasing power equal to the real rate of inflation.

(Leaving 100,000 euros in a bank account for one year when real inflation rate is 8% reduces your purchasing power by 8,000 euros a year.)


And investing one’s money in financial products that yield only 2% or 3% is not enough to protect one’s assets, because the real inflation rate is higher, which gives you a negative return.

(If the real inflation rate is 6% and the return on investment is 3%, the investor actually loses 3% of his purchasing power every year.)

And to see if the real inflation rate is higher than the official rate, one has but to do a bit of shopping every day.
One of the hardest things today, due to the speed at which billions of euros and dollars are printed, is to find something with a higher return than the real rate of inflation.

So both savers and investors are likely to be highly exposed to these inflationary policies.

The big losers

Unfortunately, in this inflationary context, most populations are directly impacted, because prices of food increase faster than salaries. Said salaries are not adjusted to the real inflation rate.

As a reminder, the higher prices of base materials are primarily due to the loss of purchasing power of the currencies; they are the symptom of the exponential growth of the monetary mass.

Some numbers for the future

A real rate of inflation of 7% for seven years destroys half of the people’s purchasing power if salaries are not hiked. Even though this figure brings a chill down one’s spine, it may well be below reality, given the permanent « quantitative easing » programs our elected officials have embarked on.

At the speed at which billions are printed (creating new bubbles, like on base materials) and with the almost certainty that salaries won’t keep up in the coming years, the impoverishment of the « masses » is virtually guaranteed.

Almost half of the world population lives with less than 2,5$ a day. There are over 7 billion people on Earth. Around 3,5 billion people will be affected by the loss of purchasing power of the monies... « saving » the actual monetary system is done on the back of those people.

Retirees are affected as well, because their pensions are indexed to the official inflation rate, which does not reflect the real inflation rate.

Poverty will become endemic, the middle class will be destroyed, stucked between an increase of the cost of living (due to the loss of purchasing power) and increasing taxes to finance the exponential governments’ debts.

How can one protect oneself ?

To protect oneself against these inflationary (I’d say hyperinflationary) policies, one has two choices : try to get returns on investment higher than the real inflation rate, which is merely impossible, or invest in tangible assets (precious metals, farmland) that have not been influenced by the credit bubble that has been going on since 1971, when the dollar was no more convertible in gold.

The savers and investors who will come out on top of this crisis are those who will have taken the time to understand the workings of the monetary system and its consequences on the destruction of the purchasing power of the currencies.

Conclusion

As long as the issue of monetary reform is not tackled by the political class, the money printing will continue exponentially, due to the very nature of the actual international monetary system.

Unfortunately, most people in the world have no way of protecting themselves from this inflationist deluge that, contrary to what most people believe, does not originate from recent decisions by central bankers, but rather dates back to 1971, when the convertibility of the world reserve currency to gold, a tangible asset, was abandoned.

The 2008 crisis is the end-result of a monetary system that needs to be replaced.