In the old days, currencies were redeemable into gold or silver (usually). In order for currency issuers (e.g. central banks) to honor their agreements, they would have to own more than they owed. Occasionally, it would be revealed that currency issuers owned less than what they owed. In these cases, their currencies would fall to discounts to par.


It is my contention that irredeemable fiat currencies virtually always trade at discounts to par. The implications can seem paradoxical, hence they can be potentially profitable.


But, what do I really mean by ‘discount to par’?


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I’d like to present a rather eccentric comparison of two market environments; the emerging market boom of the 21st Century and the US boom of the 1830s.


The 1830s


During the 1830s, gold, silver and copper circulated as money throughout most of the world. In the US, both gold and silver were the legal tenders, but silver was practically the only one in use. This was the result of the misguided policies of bimetallism. Simply put, the US government decreed that silver should trade with gold at a rate of 15 to 1, whereas the world market rate stood at ~15.75 to 1. This put silver at an overvalued status and gold at an undervalued status; so the process described by Gresham’s law ensued. Silver rushed into circulation whereas gold disappeared into hoards and flowed abroad.


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Gresham’s law is the (formerly popular) insight that states: ‘Bad money drives out good’. It occurred (and still occurs in a way) when governments compulsorily overvalued one component of the money supply with respect to the other(s). A sound understanding of this has brought fortunes to alert speculators in the past; it is my contention that it may bring fortunes to them in the future.

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This is a pretty simple indicator for gauging the worries of the mass of market participants. Of course, one shouldn’t use it in isolation for anything, but nevertheless it seems to be of some value. In the two charts below I try to measure the search volumes for ‘inflation’ compared to ‘deflation’ using google insights. Basically, when the yellow line is going up, people are worrying about inflation, when the yellow line is going down, people are worrying about deflation. (Click to enlarge)

Inflation Vs Deflation (Google Searches)inflation vs deflation (rate of change google searches)

EDIT: Although the second chart says ‘ROC’ and ‘rate of change’, it is in fact a measure of ‘deflation’ and ‘inflation’ search volumes relative to the finance category search volume. The rudimentary principle still applies (yellow line up => inflation worries, yellow line down => deflation fears).


From a contrarian point of view, I want to be opposing dogmatic convictions about the future. When these indicators are high, I’m looking to underwrite the risk of inflation and insure against deflation. When these indicators are low, I’m looking to underwrite the risk of deflation and insure against inflation. Needless to say, both charts above point to underwriting the risk of inflation and insuring against deflation right now.


EDIT: I’ll be updating this indicator on a weekly basis. I should have it online by 4:00PM ET every Saturday.


Inflation Vs Deflation Free EBook


I monitor the daily treasury statements in order to get a feel for how much money is entering and leaving the coffers of the US Government. Below is a chart of the daily balance (blue) of the US Government against the S&P 500 inverted (red line). The individual accounts that make up the total operating balance are also shown. Simply put, when the blue line is going up, the US Government are – on a net basis – drawing money into their accounts. When the blue line is going down, the US government are – on a net basis – spending the money that is in their accounts. continue reading »

Content coming soon!

Feb 25, 2011