Sunday, July 8, 2012

Fiat Money

Ray Dalio has said something to the effect of: On 15th August, 1971, the US got rid of the Bretton Woods system which is hailed as the end of the gold-backed currency system and the beginning of the fiat regime; but in fact, the US had defaulted on its debts but nobody was eager to point this out. In turn this caused the crazy commodity shocks of 1972-73.

Fiat money is an interesting concept which of course has had practical utility for the last 40 years or so. Financial deficits are financed by printing money. In addition to that, foreign exchange rate pegging / adjusting can influence the strength of the currency in the domestic economy and so forth. 

Inflation is usually measured as a price increase of a basket of goods. Inflation usually means an erosion in the purchasing power of money. Now, what happens when one's ability to earn income of saved money is suppressed? This too, erodes purchasing power. Oddly, this does not show up in inflation numbers just because of how inflation is measured. 
Welcome again to China.
M Pettis has a wonderful post yet again. He says: 

"... And these subsidies are substantial.  A mainland think tank, Unirule, estimated in 2011 that monopoly pricing and direct subsidies may have accounted for as much as 150 percent or more of total profitability in the state owned sector over the past decade.  I calculate that repressed interest rates may have accounted for another 400 to 500 percent of total profitability over this period.  Monopoly pricing, direct subsidies, and repressed interest rates all represent transfers from the household sector."

When state owned enterprises earn most of the economy's profits, it can really distort an economy's purchasing power, especially if outsized profits make their way into outlandish investments. 

M Pettis has been arguing this for a long time now and Jim Chanos says something similar - that with the lack of investment avenues for earned money which the populace is reluctant to spend because of the 4-2-1 demography (4 grandparents, 2 parents and 1 child) they will invest in property - hence the idle properties.

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