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The Abyss | CFO Lounge

The Abyss

Mon, Sep 22, 2008

Down to Business

Before 1971, U.S. currency was backed to some extent by the price of gold…known as the Gold Standard. The U.S. government (I guess the Fed Reserve) began the task of separating gold from U.S. currency after 1933 but the final decoupling didn’t take place until 1971.

So now enters the concept of fiat money or fiat currency. The principle of fiat money is that the U.S. government declares that a $1 bill must be accepted as legal tender and is worth $1. Pretty simple. The only problem is that depending on market conditions and macroeconomic factors affecting money supply, $1 may not be worth the same as it was yesterday.

Whether you agree or not with Paulson’s plan to bailout the financial sector to the tune of $700B, increasing the supply of money (some have estimated well in excess of $1 trillion after all is said and done), will undoubtedly do two things over the next few years: 1) Hammer our taxes to pay for the bailout (sorry McCain, there is no way out of this one) and 2) Drive inflation up into the stratosphere. Scary $hit considering already that the U.S. currency is worth less than economies a tenth of our size and oil is back to an all time high.

As Nietzsche said, “when you stare into the abyss, the abyss stares back at you”. I guess Paulson stared into the abyss and when it stared back, it was too much to handle.

David Walker, the Ex-Comptroller General of the U.S. thinks things will go from already bad to worse. But he’s just an accountant, what does he know?

This post was written by:

Chad Cohen - who has written 51 posts on CFO Lounge.

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13 Comments For This Post

  1. Garry Z Says:

    First. David Walker should have concentrated on his job of auditing government agencies. A few TRILLION dollars missplaced at Pentagon is his responsibility. And he should stick to that. Fiat money and concept of inflation is clearly above his paygrade.
    Second. Agree. Inflation raises its ugly head when money supply is raising faster than production of goods and services available for sale. But how can you even suggest an inflationary outlook during a credit cruch? With bad debt on the books, banks have to keep their capitalization ratios up and unable to provide new credit. Hence, less money. If anything it is deflation that is a real threat here. Paulson is right to take bad loans off private balance sheet and let bank continue lending. And sooner Congress will approve it, better for everyone.

  2. Chad Cohen Says:

    David’s job wasn’t as a regulator, Garry. That’s an impt distinction to be made.

    Secondly, if the gov’t is going to pump $700 billion plus into the financial sector over the next few years to clean up dirty balance sheets how can you not see that as a dilutive factor affecting money supply. Banks still need to borrow money in order to invest and earn money on those borrowed assets. They may not be as leveraged as they were this time last year but they will still be highly leveraged. I don’t see anyone sharing your viewpoint about deflation…if you find something, send it my way.

  3. Garry Z Says:

    falling asset prices is deflationary sign - bursting asset bubble in equities and real estate. Look at housing. Look at the stock market. Shrinking consumer spending coupled with the same level of output and high productivity growth is deflationary sign. Low interest rates is deflationary sign. Your dilutive factor of $700 billion could be offset with half a point increase in interest rate by the Fed, but they won’t dream of doing it. What more evidence you need? I’ll send you what I can find.

  4. Chad Cohen Says:

    There are obviously forces acting in both directions. I don’t think half a point increase would do a damn thing, money is still so damn cheap right now that it would take a couple point increase to make any impact.

  5. Garry Z Says:

    Why is money cheap? Because Fed says so? Wait a few months, when people will start loosing their jobs, savings and houses to foreclosures. We’ll see how cheap money will be then. And why would you want to wait for that to happen? For the sake of fiscal discipline? That is anti-American! Throw money at the problem. Give out as much as you can. Do another stimulus. Another $600 per head. What does it cost to the goverment? Let’s say 250 mil working force, that’s $150 billion. Peanuts compared to Iraq war. Change terms of mortgage agreements. Yes, it is unfair to those who didn’t dig themselves into the hole. But fairness has nothing to do with economic growth. We are very lucky to have people like Paulson and Bernanke at the helm.

  6. Jason Says:

    Here’s the head of the Government Accounting Office saying that our government’s accounting is off. Kinda scary, I think.

    We can quibble about whether deflation or inflation is likely. My take is that deflation will be the near term result of the current credit crisis, as banks, hedge funds, and weaker credits seek to improve liquidity by selling assets, pushing prices down.

    Walker, however, is talking about a longer term problem. He’s talking about fiscal irresponsibility. Ultimately, I think the government will have no choice when faced with mounting debts to China and Japan than to inflate the currency and water down the debt.

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