Financial advisor gives a quick lesson.
Grand Rapids, MI -- (SBWIRE) -- 03/01/2013 -- Financial advisor Dennis Tubbergen spent a few days recently on his blog explaining inflation and deflation and how they relate to our current world economies.
Tubbergen, who is an author, radio show host, and CEO of PLP Advisors, LLC, spends a lot of time giving his opinions on the economy in his weekly newsletter at http://www.moving-markets.com and in his online financial blog. On February 21, 2013 his blog continued a discussion on today's economy and was titled Inflation - Deflation and History, Part Two.
"Throughout history, a money pattern that I call the money cycle has existed," began Tubbergen.
He shows a chart beginning with Hard Money, flowing to Paper Money with a Link to Hard Money, going on to a Fiat Currency (No Link to Hard Money), and flowing on to Fiat Currency Failure.
"Historically speaking, money has always been something of value," explained Tubbergen. "The first systems of commerce were based on the barter system, which is the trading of goods and services. These systems were cumbersome and awkward. As time passed certain items became recognized as widely exchangeable for goods and services."
Tubbergen went on to say that early settlers in the United States used beaver pelts as money. As recently as the 1800s in the Far East, tea leaves compressed into bricks were used as money. For centuries gold and silver have been used as money. Something as tangible as money is the first stage in the money cycle.
"The next stage in the money cycle is paper money with a link to something tangible like gold or silver," continued Tubbergen. "An example of this type of money is evident as far back as the 17th century. Gold was being used as currency at this time in Europe and the business of being a goldsmith developed. For a fee, the goldsmith would store your gold for you in a secure vault and give you a receipt to present to claim your gold whenever you wanted to reappear at the vault."
Tubbergen notes that after a time these receipts were used as money since they could be redeemed by the holder for a specific quantity of gold. Instead of passing around gold to pay for goods and services, an individual could pass around these receipts redeemable for gold since they were more convenient and could be redeemed for gold at any time.
"This was the system of money in the United States during much of the 1800s," stated Tubbergen. "One ounce of gold was redeemable for $20.67 and $20.67 was redeemable for one ounce of gold. As we'll soon discuss, this system of money has been used in every century since the 1600s."
Tubbergen said as time passes, this direct link between paper money and a tangible asset like gold or silver is weakened by policymakers. Instead of backing paper money with gold at a rate of 100%, money rules are changed to have the paper money backed by gold at some lesser ratio. A great example of this weakened link between paper money and gold occurred shortly after the Federal Reserve was established in 1913.
"The Federal Reserve is the central bank of the United States," explained Tubbergen. "It is controlled by bankers who determine monetary policy. There have been three central banks in the history of the United States. The first two were abandoned after their initial 20-year charter expired. A central bank can elect to weaken the link between paper money and a tangible asset like gold or silver, or even decide to eliminate the link."
Tubbergen notes that is what occurred shortly after the Federal Reserve was established. Instead of having the U.S. Dollar backed 100% by gold, the backing was reduced to 40%. This resulted in a massive increase in the money supply and the illusion of prosperity for a time; the Roaring 20s are a textbook example of this prosperity illusion. An increase in the money supply leads to easy credit, which in turn leads to increasing debt levels as consumers borrow to consume. This is the autumn economic season which turns to winter once the system reaches its capacity for debt. The autumn season of the Roaring 20s turned into the winter economic season of the 1930s.
"Finally, the last stage of the money cycle has the weakened link between paper money and something tangible completely eliminated resulting in the creation of a fiat currency," said Tubbergen. "This happened in the United States in 1971 when then President Richard Nixon suspended the redemption of U.S. Dollars for gold. At that point, the U.S. Dollar became a fiat currency. Historically speaking, fiat currencies survive for a period but there has never been a fiat currency in the history of the world that has survived."
Tubbergen states he believes there is a significant link between the money cycle and economic seasons. He describes inflation and deflation as follows.
Technically defined, inflation is an increase in the money supply. A symptom of inflation is rising prices. If there is more money in the system chasing the same quantity of goods and services, prices rise. One of the stated goals of central banks is modest inflation. The central bank attempts to produce inflation by reducing interest rates to encourage borrowing to fuel consumption and through money printing.
Historically speaking, inflation is spurred when the money supply is expanded as a result of money printing to cover debt levels that are not sustainable or when the link between paper money and something tangible is loosened.
If inflation is defined as an increase in the money supply, deflation is the exact opposite; a decrease in the money supply. When the money supply decreases, prices fall. Massive levels of debt are deflationary since defaults by borrowers pull money from the financial system. This process is known as deleveraging by economists.
"Central bankers and politicians hate deflation," explained Tubbergen. "During deflationary periods, wages fall and workers that have accumulated debt find it harder to make ends meet as debt repayments remain constant while wages fall."
Tubbergen goes on to say that consequently, central bankers try to combat deflation by creating inflation through loose money cycles. Initially, they reduce interest rates and bank reserve requirements. If that doesn't produce the desired result, they may resort to money printing in an attempt to create inflation.
"At the present time all around the world, many central banks are printing money in an attempt to combat deflation," concluded Tubbergen. "Collectively, world central bankers have printed the equivalent of $10 trillion in an attempt to stave off deflation and its painful consequences. However, the debt that causes deflation still exists."
To read the blog in its entirety go to http://www.dennistubbergen.com and select his February 21, 2013 entry.
Tubbergen’s syndicated radio show can be heard on metro Michigan stations WTKG 1230 AM and WOOD Newsradio1300 AM and 106.9 FM. To hear his shows as a recorded podcast go to http://www.everythingfinancialradio.com.
About Dennis Tubbergen
Dennis Tubbergen has been in the financial industry for over 25 years and has his corporate offices in Grand Rapids, Michigan. Tubbergen is CEO of PLP Advisors, LLC and has an online blog that can be read at http://www.dennistubbergen.com. To view Tubbergen’s latest Moving Markets? newsletter, go to www.moving-markets.com.
The opinions expressed herein are those of the writer and not necessarily those of USA Wealth Management, LLC. This update may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Therefore, no forecast should be construed as a guarantee. Prior to making any investment decision, individuals should consult a professional to determine the risks, costs, benefits and fees associated with a particular investment. Information obtained from third party resources is believed to be reliable but the accuracy cannot be guaranteed.