An interview with Paul van Eeden, founder of Cranberry Capital
Yesterday, we published part one of an interview from our US sister publication, The Daily Reckoning America, with Paul van Eeden. He explained to you how he discovers gold’s intrinsic value; the key, according to him, is using his ‘Actual Money Supply’ measure, which he described yesterday. (If you missed Part One of the interview, you can read it on our website, right here.) Below, the conversation continues…
The Daily Reckoning: Today, we’re here again with Mr. van Eeden.
Paul, thanks for joining us.
Paul van Eeden: Thank you for having me again…
The Daily Reckoning: Since the Fed’s started inflating its balance sheet by trillions, there have been many calls, especially here in the DR, that, eventually, gold will have to shoot into the stratosphere. Why, in your opinion, has this ‘gold to the moon’ scenario not played out?
Paul van Eeden: That’s a very complicated question. One of the reasons is that the people who were expecting the gold price to go up dramatically were looking almost exclusively at the Federal Reserve balance sheet. They looked at the tremendous expansion of the Federal Reserve balance sheet and they said, ‘Well, if the Federal Reserve balance sheet goes from $500 billion to $3 trillion, what’s that – a sixfold increase? – then that should imply a sixfold increase in the value of gold.’
Well, no, it doesn’t. Because you have to look at how that money flows into the economy and into the ‘Actual Money Supply’ that’s available to the economy.
See, the Federal Reserve balance sheet counts deposits that commercial banks have at the Federal Reserve Bank. When the Federal Reserve creates money, they typically do so by buying US government Treasuries in the open market. So let’s say the Fed goes and buys $1 billion worth of US government Treasuries. The counterparty to the Fed is a bank. There’s a select group of banks that can be counterparties to the Fed.
So the bank is selling a government Treasury to the Fed, and the Fed pays the bank. But the money that the Fed pays doesn’t actually go into the bank’s general bank account, where it can spend it; it goes into that bank’s account at the Federal Reserve Bank. That money the bank has on deposit with the Federal Reserve is unavailable to the bank. The bank cannot draw on that money. It cannot spend that money. The only thing the bank can do is use that money as a reserve asset when it does its reserve asset calculations. That’s it. It cannot withdraw it ever.
The only way that money gets out of the Federal Reserve account is if the Fed sells any Treasury or debt instrument back to the bank. The bank can now use that money in its deposit account at the Fed to pay for that Treasury; that’s how the money comes out of the money supply.
So the creation and destruction of money, the mechanism by which the Fed is creating and destroying this money, is intimately tied to the commercial bank accounts at the Federal Reserve, called reserve accounts. But because that money cannot be spent by the bank or by you or by me or by anybody, that money isn’t functionally in the money supply.
Let’s say that an investment company has $1 billion worth of government Treasuries, and they want to sell these Treasuries. So the Federal Reserve buys $1 billion worth of Treasuries from the bank, that money gets into the reserve account; the bank buys a Treasury from an entity, from the investment company and pays the investment company. That money that was created by the Fed wasn’t created and went straight to into the economy; it got stuck there in the reserve accounts. So you cannot look at the increase in the reserve account balances and make an extrapolation or make a deduction as to what that means to the money supply. You have to actually count the money supply to see what impact it has, and that data is on my website. I update it every week.
So what went wrong for these guys is they looked at the Federal Reserve Bank balance sheet and they said, ‘My God, look at the money printing. This is massive, this is hyperinflation, this is Armageddon.’ But it wasn’t, because it wasn’t in the money supply. What the Fed was doing was actually changing the structure of Federal Reserve Bank balance sheets, and they were creating the ability for banks to create money in the economy.
The Daily Reckoning: So just to reiterate, the potential is there for the money supply to increase, but going off of your Actual Money Supply measure, which you explained yesterday, you just don’t buy the hyperinflation story.
Paul van Eeden: Right. But the banks cannot create the money if the demand for the money isn’t there or if the match between credit demand and creditworthiness isn’t there. So the other part you have to understand and think about is when the Federal Reserve prints money, as I said, it goes into the reserve bank account.
The entity that actually creates the money supply is not the Federal Reserve Bank. It’s the normal commercial banks. It’s when you take out a car loan, that creation of the loan is the creation of money. When you pay back a car loan, that’s deflation, that’s destruction of money. That’s how the money supply increases and decreases. So all the Federal Reserve Bank did was enable the banks to create a whole bunch of money. But the rate at which the banks actually created the money depended on the economic demand for that money. And we can measure what the increase in the money supply is very accurately. So while everybody was talking about this massive hyperinflation and the gold price going to $2,000, $3,000, $5,000 an ounce, I was looking at the money supply and saying there’s no basis for that.
