Monday, April 28, 2008

Cash Model Synopsis

In prior posts I have constructed a model that accounts for the strength of cash in light of the upcoming recession. Here is synopsis of the “Cash Value Model” with references:

1. The value (V) of the dollar is determined by the value of all the goods dollars can buy (I), divided by the number of dollars in circulation (or money supply). The money supply is the sum of printed money (P) plus outstanding credit (C). Or: V = I/(P+C). Cash is a good investment if the value of the dollar rises (ref. a).

2. In the housing bubble, enormous credit was extended, thus increasing the money supply (ref. b). Now that credit is no longer extended at the same rate, money supply will contract through repayments that exceed lending, and through defaults (ref. c). Through all this, the amount of printed currency has not grown much (ref. d).

3. I anticipate the value of cash will rise as money supply dwindles due to the contraction of credit, while the amount of cash and the inventory value of purchasable goods remains about the same. So, in the above equation, as C declines, V increases.

4. The primary risk of a cash investment is a hyperinflationary event, where financial regulators try to bail out the incipient recession by printing enough currency to make up for the contraction of credit. Though they will almost certainly print some money, it will not be enough to stave off a deflationary recession. So they will have to choose between allowing a deflationary recession or hyperinflation (ref. e). Since many people have much of their wealth stored as debt, or bonds, payable in U.S. dollars, which would become worthless after a hyperinflationary event, the chances of that happening is unlikely—but not to the degree it can be totally dismissed (ref. f).

a. The Value of Money
b. Austrian Economics, Recessions, and the Dollar
c. Monetary Expansion and Fractional Reserves
d. Printing, Cash, and Credit
e. Why not “Muddle Through”?
f. Power, Inflation, and the “Reset Button”

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