Melamine in my Money

“Melamine is sometimes illegally added to food products in order to increase the apparent protein content. Standard tests such as the Kjeldahl and Dumas tests estimate protein levels by measuring the nitrogen content, so they can be misled by adding nitrogen-rich compounds such as melamine.” - Wikipedia on Melamine

Unscrupulous operators added Melamine to pet food and the result was the death of thousands of loved pets all over the world. It should have been a dire warning but no, not long after, other unscrupulous operators added Melamine to milk products and human babies started dying. This irresistible temptation lies in the fact that Melamine fools the protein test, which in turn allows the operator to degrade the product for greater profit. The doctored foods pretend to have great nutritional value but ironically will kill you.

The horrible truth is that Melamine, a deadly toxic compound, is added to foods to cover up another criminal act. First a food is diluted to increase mass and therefore allows the operator a greater profit. Then Melamine is added to fix the protein content so the product will pass the protein tests. It is a stealth poison. It accumulates mostly in the kidneys and acute kidney failure occurs only after the body has absorbed a relatively high dose over time.

In a world of monetary management we find a similar process. The first step is for Central Banks to dilute the wealth of all holders of money by creating fictitious money. The fictitious money is fed into the economy via the debt channel. Banks are given access to Central Bank Melamine Money on repurchase agreements of Government Bonds (or any other qualifying financial assets – all forms of debt). You may immediately ask, what can possibly be wrong with that?

The repurchase arrangement between banks and the Central Banks is fatally flawed as a fictitious money creation mechanism. It is not technically difficult to understand. The bank will sell Government Securities to the Central Bank and will undertake to buy the Government Securities back after a specified elapse of time. The repurchase price would be calculated as an amount equal to the selling price plus interest calculated for the period. It is simply a loan against security but for the fact that the Central Bank becomes the legal owner of the Government Security until the Bank repurchase that Government Security. Being a legal owner allows the Central Bank to simply keep the Government Security should the bank fail to repurchase the Government Security and the Central Bank would not need to engage in complex legal procedures to gain ownership of the collateral which would be the case of a loan against security. The unintended consequence of this practice is outright fictitious money creation.

A simple but absolute truth is that Central Banks do not have the money to buy the Government Bonds (or any other asset) from banks. The Central Bank must borrow that money. The fantastic part about Central Bank borrowings is that they never pay interest because they do not have to negotiate the loan with the providers of the loan. They simply take it at will. Be amazed at the simplicity and duplicity of the process.

The Central Bank will simply create a money credit for the bank in exchange for the Government Stock. It is a “loan” against the inherent wealth in the economy. Even better the Central Bank gets to earn interest from the bank on the money that it granted itself on an interest free basis. Ever wondered how Central Banks “earns income” to finance their own activities, this is how it’s done – earning interest by diluting our wealth. Accounting rules based on “substance over form” allows banks to show “assets under repurchase agreements” still as their own assets and requires a contra “loans from the Central Bank” to be shown on the liabilities side. Here is where my teenage daughter would comment, “How cool is that!”

It all happens because Central Banks do not need to ask anybody for a loan. The Central Bank can simply borrow purchasing power from the economy without anybody’s permission. That is macroeconomic talk for the Central Bank can borrow money form each and every economic participant through money creation. It is what happens every time that the Central Bank enters into a repurchase agreement with a bank (it’s called it providing liquidity to banks).

Interesting how the Melamine Money can fool the economy into believing that purchasing power has not been compromised. The objective has been achieved, successful dilution without detection.

Melamine is described as a compound with low toxicity. That makes it no less deadly. The initial dose will not cause kidney failure, nor the next but eventually it will be achieved. The characteristic which gets you is the fact that it is accumulating. Acute kidney failure occurs after acute exposure to melamine. It is the same with the economy and money creation. It never leaves the system and it can never be digested, so it accumulates in bubble formation and excessive speculative activities. Then the bubble markets fail and the market experience systemic failure. Banks start dying because they suckle on too much Melamine Money.

The answer from monetary and treasury authorities is to increase the dosage of Melamine Money and distribute it as bailouts to all and sundry. Distribution by the Central Bank happens through liquidity provision; and buying more Central Government Securities with money created from nothing will allow Treasury to engage in bailout activities. Consider for instance that the bailouts have now been extended even to the suppliers of goods and services to the auto industry. The source of all bailouts is Melamine Money.

So the patient has been placed on life support and given a melamine drip. No recovery is immanent. The economy goes into a slow death, just look at the Japanese economy. Their melamine money was initially introduced in too large quantities to sustain an export orientated, undervalued currency economy. The Melamine Money caused systemic failure. Melamine Money solutions kept a deteriorating economy in a downward spiral of life support and slow death for 19 years from that fateful December 1989 when the Nikkei started its own downward spiral.

The toxic flow from melamine money accumulates and eventually causes systemic failure. Ultimately Central Government Debt is used to settle all debt but debt just circulates and accumulates in Central Government debt which never seems to be in need of settlement. It sounds like a snake eating itself up from its own tail and grows bigger as a result of the sustenance, because it follows a similar bizarre logic.

Schematically the process can be shown as follows:

The process begins with the issue of Government Bonds.





The Central Bank purchases Government Bonds with Melamine Money (steps 1 & 2). In the normal cause, the Central Bank would again sell the Government Bonds and would sterilise the Melamine Money when it receives payment (steps 3 & 4). The only Melamine Money remaining would then be that for which the Central Bank carries Government Bonds on its own balance sheet.

The Melamine Money is reintroduced when the Central Banks enters into any repurchase agreement(s) with any bank. The introduction of Melamine Money to the economy is accelerated when the Central Bank accepts financial assets other than Government Bonds for repurchase agreements and accelerated again when the Central Banks make outright purchases of financial assets from the banking or non-banking sectors such as purchases of commercial paper.


It is a growth spiral of exchanging debt for debt. Now imagine a process which requires banks to offer a physical good such as gold as collateral asset for a Central Bank repurchase agreement. The act of being forced to purchase gold would sterilise the money creation. The money is “frozen” in gold form. The compounding nature of Melamine Money creation is stopped in its tracks. It should come as no surprise that gold in this context can be called an antidote for Melamine Money poisoning.

I have never understood how thinking such as hereunder could prevail in a sophisticated and enlightened global society such as the one we are living in.

1. “A Central Bank which actually has no money can lend money to Central Government and lately to almost anybody without simply creating “money” from nothing.
2. The “money from nothing” loans can be used to buy real goods and services in the economy without any consequences other than inflation.”

The sci-fi economies usually functions this way, but it is fiction nevertheless. Since this kindergarten variety of economic theory postulates that Central Bank money represents economic value, I would propose that we all stop working and simply demand access to Central Bank money for our purchasing needs. Sadly we will all run around with wagonloads of money but find nothing to purchase since nobody will be producing anything. The economic truth is that Central Bank money has no value other than to temporarily fool the tests for money. Fool the tests for long enough and the economic patient goes into systemic failure and will stay there until the toxic compound is removed from the system.

Inflation is the first symptom of Melamine Money poisoning. Acute Melamine Money poisoning expresses itself as a deflationary depression in the economy. Economic death by Melamine Money poisoning is the final stage in a Hyperinflationary Depression (lots of Melamine Money but no products to buy). Care should be taken with predictions of economic death by monetary poisoning. Japan has shown that the acute monetary poisoning stage can last a long time without the economy slipping into the Zimbabwe example.

No matter how you want to look at it, Melamine Money has no economic nutritional value.

Sarel Oberholster
BCom (Cum Laude) CAIB(SA)
3 January 2009

© Sarel Oberholster

Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .

Note: I will soon publish “War on Savings” which contains a detailed economic theory of the progression of monetary invention through the various inflation stages. I also deal with the consequences of monetary excesses beyond inflation. Please send me an e-mail to ccpt@iafrica.com with “War on Savings – request” and I will provide you with link to a pre-publication copy which I will make available on my blog from 14 January 2009.

Silver Smoke & Golden Mirrors

"Whenever in the judgment of the Secretary of the Treasury such action is necessary to protect the currency system of the United States, the Secretary of the Treasury, in his discretion, may require any or all individuals, partnerships, associations and corporations to pay and deliver to the Treasurer of the United States any or all gold coin, gold bullion, and gold certificates owned by such individuals, partnerships, associations and corporations. Upon receipt of such gold coin, gold bullion or gold certificates, the Secretary of the Treasury shall pay therefor an equivalent amount of any other form of coin or currency coined or issued under the laws of the United States."

Emergency Banking Relief Act of 1933, U.S. Statutes at Large (73rd Congress, 1933 p. 1-7) – Amendment (n) to Section 11 of the Federal Reserve Act. Approved, March 9, 1933, 8.30 p.m.



Many reasons are offered to explain Central Bank sales of gold. The one most often offered is a lack of return. Holding another Government’s bonds earns interest but gold has a storage cost. Holding sovereign risk is the reason for the difference in return and presently buying sovereign risk is still in a bull trend. Gold on the other hand is free of credit risk and should gain when sovereign risk becomes unpalatable. The current race to zero interest rates, a race for 2nd place as Japan has already won, pose an intervention risk for gold price formation.

The much valued return on government bonds is now more than counterbalanced by a risk of capital loss should interest rates start to rise. Then again why would interest rates rise? Japan has been at near zero interest rates since September 1995 when it first plunged below the 1% level. Thirteen years below 1% and the clock is still ticking. The USA seems to be playing follow-my-leader.



Exhibit 1

Data Source: Japan Basic Discount Rate – Bank of Japan series: Policy Interest Rates and Money Market Rates in Major Economies. USA Target Rate - Board of Governors of the Federal Reserve System series: DFEDTAR month end data.



There is only one way to get to an interest rate below 1% and that is the route of money creation. Use expansive monetary policy to flood the market for debt with money created from nothing and rates can be forced to below 1%.


Exhibit 2



A consequence of such an expansive policy is a lower return on Central Government Bonds. The rational expectation would be that Gold would under these circumstances be well placed to compete with Government Bonds.


Exhibit 3




It is exactly at the point where Gold becomes a competitive threat to money when the first part of the above quote becomes important: “Whenever in the judgment of the Secretary of the Treasury such action is necessary to protect the currency system of the United States”. It is not in the interest of the Central Government to allow Gold a competitive advantage over currency.

The expansive monetary policy is inflationary for the price of Gold and will make Gold increasingly attractive as an alternative store of value. The inflationary effect on Gold should in theory protect the holder against a constant devaluation of the currency.

Both the fiscal and monetary authorities cannot allow Gold to become an effective competitor for the currency. Steps would therefore be taken to manage the competitiveness of Gold relative to the currency

This is not a conspiracy theory. These are rational and logical steps which must be taken to protect the currency. A high interest rate will automatically afford a currency protection against Gold. A policy of near zero interest rates or even zero interest rates will make a currency vulnerable to any stores of value. Gold as the most traditional store of value will then be targeted for management. It is not significantly different form targeting an artificial interest rate. One intervention necessitates another.


Exhibit 4





Exhibit 4 shows a 1 year return and a 3 year return on an investment in gold at a monthly average price for entry and exit. The theory of inflation would have one expect that Gold would outperform Government Bonds under an expansionary monetary policy regime. Gold should therefore under monetary conditions of extreme liquidity accelerate equally in price. Yet, every attempt to outperform collapsed. Lately the Gold price has been under pressure.

It is clear from Exhibit 4 that monetary policy will fail should Gold be allowed to raise consistently as a result of easy monetary conditions. Gold would absorb newly created money and short-circuit the monetary stimulation. Contemplate the dilemma of a FED creating debt against a Gold liability. It would become a de facto return to a Gold Standard. Proactive management strategies will be undertaken to avoid such an outcome.

The second part of the quote above contains the alternative strategy in the event that the steps taken to negate the competitiveness of Gold fail. The holders of Gold will be forced to exchange the Gold for currency on such terms as the Central Government will dictate.

Central Banks across the globe cooperate on monetary policy. They will all cooperate to prevent outcomes which will reduce the efficiency of their policies.

"…in an unprecedented joint action with five other major central banks and in response to the adverse implications of the crisis for the economic outlook, the Federal Reserve, again, eased the stance of monetary policy. We will continue to use all the tools at our disposal to improve market functioning and liquidity, to reduce pressures in key credit and funding markets and to complement the steps that treasury and foreign governments will be taking to strengthen the financial system."

Ben S. Bernanke, The Economic Club of New York –– October 15, 2008, pp 4


The now very obvious global monetary choice is a choice for Stasis. Containment of the financial crisis. All economies get stuck in a downward spiral similar to the example of Japan. Monetary authorities provide unlimited liquidity to sustain Stasis. A rising Gold price will not be tolerated under these conditions.

The market risks are not that easily overcome. Every step taken to sustain Stasis on a global scale holds the risk of weaker countries failing. Sovereign risk will cause funding limitations and currency depreciations. Gold will become attractive given such an outcome.

The ultimate risk is currency failures. Monetary policy taken to the zero bound invites currency failure. Japan’s economy was structured to encourage a weak yen for an economy positioned strategically to export to the rest of the world. How many other economies can say the same? How long can the structural imbalances and stresses be held in Stasis with unlimited liquidity?

The monetary policies of Stasis will include the management of the Gold price. Gold will become prohibitively expensive should control over the global structural distortions be lost in spreading hyperinflations. Understand the smoke and mirrors of monetary policy. Understand the risks of facing off against the FED. Be extremely aware of entry and exit points when trading in Gold. Comprehend the signals when the first Hyperinflationary episodes appear. Only those who have physical gold stored outside the jurisdiction of their governments will be protected when their currencies collapse.

I leave you with a final quote form Paul Volker’s 1990 Per Jacobsson Lecture (p17, published by the graphics section of the IMF)



Sarel Oberholster
BCom (Cum Laude) CAIB(SA)
6 December 2008

© Sarel Oberholster

Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .

The reality of fiscal irresponsibility




A genuine Zim note, given to me at Joburg airport as a novelty. It is worth a couple of dollars US.

Kind regards

PETER DAWE

News Flash

Dear Visitors.

First I want to wish you all the very best holiday season. May you and your families share in a season of personal generosity.

I have been working on a substantial and significant assessment of the global crisis and the document is in the final stage of editing for publication. I had hoped to have a result form the publishers by now but the assessment is taking longer than expected. It is groundbreaking new work so perhaps some patience is appropriate. Please click a reminder or come and visit again.

"War on Savings" will be posted immediately upon publication.

Kind regards,
Sarel Oberholster

Beware December 29th

“Suppose the Bank of Japan prints yen and uses them to acquire foreign assets. If the yen did not depreciate as a result, and if there were no reciprocal demand for Japanese goods or assets (which would drive up domestic prices), what in principle would prevent the BOJ from acquiring infinite quantities of foreign assets, leaving foreigners nothing to hold but idle yen balances?” [p20]

“By a fiscal component I mean some implicit subsidy, such as would arise if the BOJ purchased nonperforming bank loans at face value, for example (this is of course equivalent to a fiscal bailout of the banks, financed by the central bank). This sort of money-financed “gift” to the private sector would expand aggregate demand for the same reasons that any money-financed transfer does. Although such operations are perfectly sensible from the standpoint of economic theory, I doubt very much that we will see anything like this in Japan…” [p23-p24]

Japanese Monetary Policy: A Case of Self-Induced Paralysis?* Ben S. Bernanke, Princeton University, December 1999
* For presentation at the ASSA meetings, Boston MA, January 9, 2000.


You can call it a “lack of confidence” when you cheat on your wife or girlfriend and get caught out. You can sweet talk your way back into “confidence” but should not believe that you can continue to cheat. Do not complain to others that the problem with your relationship is a lack of “confidence” then continue cheating. The excruciatingly simple answer is that your cheating is the problem. The “lack of confidence” is only a symptom of your cheating.

Try explaining this simple concept to a Central Banker. They cheat on the market with unlimited liquidity and artificially low interest rates. A “lack of confidence” they say, is the problem when the market catches them at it. Then they want to sweet talk the market but go right back to cheating. On 29 December 1989 the Nikkei kicked out the sweet talking Japanese Central Bankers. Nineteen years later she still refuses to listen to their sweet talking. Nineteen years they keep trying to talk their way back in without giving up their cheating ways.

Central Bankers in the West treated the Japanese market behaviour like that of a wilful child. Telling the Japanese you should cheat more and sweet talk with more purpose. It did not work and sometime in 2007 the sweet talking Romeo’s in the rest of the world also got kicked out. No amount of sweet talking would restore confidence when they chose to go on a cheating binge.

Stop cheating or stay outside in the cold. Nobody is listening. Take a good look at what to expect for the next 20 years should Central Bankers fail to stop their cheating ways.


Banking Stagnation.




Systemic banking failure with the Bank of Japan providing unlimited liquidity and zero or near zero interest rates. This Central Bank policy prevents debt clearing and ensures stagnation. It is no surprise that Bank of Japan officials have designated the NPL (Non Performing Loan) as enemy number one for Central Bank policy.


Long term Bear Market in Stocks with high volatility.




Let’s record the pivotal points again. 29 December 1989 intraday high of 38,957; 19 August 1992 intraday low of 14,194; 28 April 2003 intraday low of 7604; and 28 October 2008 new intraday low at 6995. A nineteen year Bear market in the Nikkei and still making new lows. Any stock market trader would look upon this chart and identify the trend but know that one wrong point of entry could end his career. This market is for long term professionals and not for speculating taxi drivers.


Exploding Government Debt without pressure on long term interest rates.




The Nikkei high of 29 December 1989 haunts this chart. Japan’s Government liabilities exploded upwards and tapered off only at the height of the boom in the rest of the world. How near is Japan to the precipice of a Hyperinflationary episode?

The world in 2008 stand before three choices, none of them pleasant.

1. Liquidation of Debt. This choice is the least palatable for politicians and Central Bankers alike. It will bring about a market driven realignment of the economy. The rebalancing of the economy will remove the malinvestment and structural imbalances from the economy and produce fast recovery thereafter. An undertaking to follow prudent and responsible Monetary and Fiscal policies will restore that elusive “confidence”. The political will for this option does not exist and it is therefore an unlikely scenario.
2. Japanese style incremental liquidation of debt. All my research indicates that this process will take from fourteen years to longer. The fourteen year benchmark is the extent to which monetary policy had stimulated 20 year mortgage absorption below the 8% crossover where capital repayment become more important than interest repayment, which need to be rebalanced. The reality of the Japanese scenario is as above, nineteen years and still counting. This is the explicitly stated choice of the Politicians and Central Bankers as of November 2008. I can detect no change in the intent or rhetoric indicating a change of heart. It is therefore very likely that we will get to experience this scenario. The likelihood is high that the experience will prove worse than Japan. Japan had savings, reserves and a huge Current Account surplus and a rest of the world in an extraordinary boom to keep it from slipping further into the abyss. Let’s not forget the Yen Carry Trade so eloquently suggested by Bernanke to the BOJ in the quotation above. (Beware anyone who does not comprehend that the FED could choose to engage in exactly the same tactic). The 2007 Depressionary Bubble is now world wide in decline with everybody trapped in its grip.
3. Hyperinflationary Bubble. It requires one final co-operation between Monetary and Fiscal Policy. The creation of money for direct spending by Central Government without using the formation of debt as the distribution channel. The risk if Monetary and particularly Fiscal interventions getting out of hand is high but not likely for now (my sincere hope). I have no personal desire to experience this scenario firsthand.

It is good to look at the 1929 experience. So too the 1970-1976 experiences. History gives us prior warning and we need to revisit the lessons of yesterday but the Japan experience is the prior warning for the 2007 systemic collapse. The cause was the same type of Monetary Policy, the collapse was the same type of systemic banking failure and the remedy so far is the same. Why would the result not be the same?

Sarel Oberholster
BCom (Cum Laude) CAIB(SA)
14 November 2008


© Sarel Oberholster

Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .

Ps. I count the 17 years for the Deflationary Bubble from 1991 when the property bubble joined the collapse. For a good chart see Fig 8 on page 25 of "Effects of the Quantitative Easing Policy: A Survey of Empirical Analyses by Hiroshi Ugai, published by the BOJ.

ARE WE NOT CIVILISED MEN?

“… “Not to go on all-fours; that is the Law. Are we not Men?
“Not to suck up Drink; that is the Law. Are we not Men?
“Not to eat [raw] Fish or Flesh; that is the Law. Are we not Men?
“Not to claw the Bark of Trees; that is the Law. Are we not Men?
“Not to chase other Men; that is the Law. Are we not Men?”…
“His is the House of Pain.
“His is the Hand that makes.
“His is the Hand that wounds.
“His is the Hand that heals.”…
“His is the lightning flash,” we sang. “His is the deep, salt sea.”…
“His are the stars in the sky.”…
“He is a five-man, a five-man, a five-man—like me,” said the Ape-man.”…”

“The Law” - The Island of Doctor Moreau
Author: H. G. Wells - 1896

(http://www.gutenberg.org/etext/159 Download the ebook for free from this site)


Dr Moreau plays god over life in this classic tale of HG Wells. Over and over the question is asked “Are we not Men?”, for the descend into barbaric animalistic behaviour is a constant almost irresistible temptation. Perhaps the question should be asked, when does Economic Man become a Beast?

The first Law of Economic Man is respect for private property. Oh the temptation of the Beast to show disrespect. Take from the “Rich” (“Are they not Men?”) and give to the “Poor”. Take for the individual (“Are we not Men?”) and give to the Banks, the Insurance giants, the motor Manufacturers, the Government Supported Entities. The joy of the gift with other people’s money has not the loss of giving from your own.

The second Law of Economic Man is to save. How the Beast hunger for Debt? Why does He (Government and Central Banks) encourage debt with low interest rates and unlimited liquidity provision? Do not encourage the Beast, encourage Economic Man. Economic Man pays for his consumption from the fruits of his labour. The enslavement of Economic Man starts when he succumbs to the temptation to pay for his consumption with Debt.

The third Law of Economic Man is ownership of his body and the fruits of his labour. Increasingly He dispossesses Economic Man of the fruits of his labour and disrespects Economic Man’s ownership of his body to gift other men (“Are we not Men?”) with the fruits of Economic Man’s labour.

The fourth law of Economic Man is to resist the cravings for easy monetary solutions. Recognition of the inflationary spiral is essential. Stimulatory monetary policy by His hand is a process with known consequences. It’s a drug addiction to the Beast. Rehab from this drug addiction is inflation and a recession. Refuse rehab and accelerate monetary consumption and the next stop is endemic inflation and a deep recession (in its final phase called stagflation). Still not prepared to go to rehab? Binge on debt and asset bubbles in a hallucinatory boom followed by a depressionary systemic collapse. Absolutely refuse rehab with exponentially growing money and liquidity creation backed by unfunded fiscal stimulations to destroy the monetary system in a hyperinflationary death. Death by overdose.

The fifth law of Economic Man is preventing Him from indebting Economic Man and his children, and his children’s children. He will indebt Economic Man fiscally when Economic Man resists the temptation of debt enslavement. He will seduce with promises of prosperity in the interest of all. The Beast will succumb to the siren songs of endless debt. This is the refrain of the Beast.

Not to disrespect private property; that is the Law. Are we not Men?
Not to suck up Debt; that is the Law. Are we not Men?
Not to eat the Labour of fellow Men. That is the Law. Are we not Men?
Not to claw the Bark of the Money Tree. That is the Law. Are we not Men?
Not to debt burden other Men. That is the Law. Are we not Men?
His is the House of Debt.
His is the Printing Press.
His is the Hand that makes Exuberance.
His is the Hand that Gifts.
His is the Hand that Controls.
His is the deep, dark Depression.
His are the dizzy heights of Hyperinflation.
His is the slave master of our children.

The Beast has five fingers on each hand and five toes on each foot just like you. Are you not Economic Man?

Sarel Oberholster
BCom (Cum Laude) CAIB(SA)
10 November 2008

© Sarel Oberholster

Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .