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Decimal Digest
13 Feb 2012

Wither Paper Money?

This week we revisit Decimal Point Global Liquidity Index. This measurement of global liquidity, based on central bank balance sheets of key nations, has continued to show relentless rise throughout 2011.

In the last one decade, global liquidity has increased fourfold as various central banks, most notably the PBOC (2002-2009), the Fed (2008-2011), the ECB (2002-2011), the SNB (2008-2011) and the BOJ (2002-2011) continued to use the blunt and savage instrument of balance sheet expansion to achieve their respective short-term goals, be it currency manipulation or targeting credit expansion.

The year 2011 did not prove an exception to this decade long trend, with the index rising by 20% in the year – far above increase in nominal GDP for the globe during the same year.

As the monetary instrument of surgical precision - interest rate – starts losing its relevance in more and more economies of the world, investors looking for real protection of their wealth should start getting more and more concerned on the asset allocation that they need to follow.

In the short-run, this cornucopia of liquidity has the ability to generate an illusion of paper wealth creation, as is being seen in last few weeks. However, since the fulcrum of price mechanism of the global economy, namely the price of money, is now broken, how this would feed through various assets, labour, and commodity markets over the medium to long term is a matter of uncharted territory.

Also, another implication of this trend - of plentiful of paper money - is the relative merit that general population will see in continuing with the existing economic & political order. The only good news for the status quo is that there is no other less discredited alternative available for any eventual or opportunistic revolutionaries.

The death of OWS and the birth of ECB’s LTRO (and other sundry QEs by BOE / BOJ in last few days) needs to be analyzed in this perspective of breaking down of existing price signal based economic system and a lack of alternative to the current broken system.

We continue to live in the interesting times.


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