Hola! Today I am writing you from my swanky hotel room at the W Hotel in Santiago, Chile (thank you Simon Black for having excellent taste in accommodations!). Santiago is a beautiful city—modern, charming, and bustling with energy and excitement.
La gente (the people) of Santiago are warm and welcoming and definitely don’t seem to be suffering from any sort of economic malaise whatsoever—Kung Fu Guy and I had dinner in an awesome open-air venue last night (off Constitucion near the Patio Bellavista) and every restaurant and bar was thriving and filled with happy customers on a Thursday night.
We even found an outstanding funky/jazzy house music DJ downstairs and can vouch for the fact that it was “happening” until at least midnight—people here are happy about life, determined to enjoy it, and seem to have lots of money to spend on fun evenings out with friends!
Tonight begins the actual Sovereign Man program so I will have more to report on Monday…
On to this week’s questions!
First, Melissa forwarded me an article on China and asks,
Hi KFG, I’m a lame finance person. What does this exactly mean and how does this affect us? I know it does… Just trying to connect the dots. Thanks!
Here is an excerpt from the article she sent:
China Cuts Bank Reserve Ratio to Spur Growth
By THE ASSOCIATED PRESS
Published: February 18, 2012 at 9:38 AM ET
BEIJING (AP) — China’s central bank will lower the ratio of funds that banks must hold as reserves in a move that frees tens of billions of dollars for lending and aims to help spur slowing economic growth.
The reserve requirement ratio for major commercial banks will be decreased Friday to 20.5 percent from 21 percent, the People’s Bank of China said Saturday in a one-sentence notice on its website.
The cut frees money for lending at a time when the growth rate is expected to drop from last quarter’s 8.9 percent to closer to 8 percent.
The cut is the second in two months. The bank had pushed the rate to a record 21.5 percent in June after consumer prices rose by a three-year high of 5.5 percent the previous month.
Consumer prices rose by an unexpectedly strong 4.5 percent over a year earlier, up from December’s 4.1 percent. Food prices shot up 10.5 percent, accelerating from the previous month’s 9.1 percent.
The spike in inflation could complicate efforts by Chinese leaders to gradually ease controls to boost growth and create jobs. Regulators are moving cautiously, however, avoiding interest rate cuts and retaining lending controls imposed to cool an overheated housing market.
China rebounded quickly from the 2008 global crisis with a flood of stimulus spending and bank lending that ignited a speculative boom pushing up stock and housing prices. New policies are being put in place to help the working poor and exporters hit by a fall in global demand.
Hi Melissa! You are not lame. The fractional reserve banking paradigm is crazy, for lack of a better word, and difficult to understand. However, it is also very important and you are smart to question what is happening and why.
Basically, this is exactly what I have been writing about lately, except in China instead of the U.S.
China has reduced the amount of currency that banks need to keep on hand as “reserves” from 21% down to 20.5%….this means that before this change they could lend out (“create”) 79% of whatever currency they had in their reserves, and now they can lend out a little more, 79.5%. That probably doesn’t sound like a big change, but to a massive economy like China’s that is huge…Chinese banks will now literally be able to create billions more of their currency and release it into their economy, which they hope will help to spur growth.
Actually, many people don’t know that banks don’t ever have enough money on hand to pay all of their depositors back. If you and I were the only two people banking at a local bank and we each deposited $100 to the bank, that bank would instantly loan out 90% of what we deposited ($180) to someone else. If you and I then both decided we wanted our money back, we would be out of luck…the bank wouldn’t have it—it would only have $20 so we would get $10 each.
That’s an oversimplification, but pretty accurate…that is one big reason why the “FDIC” was created to “insure” our deposits. Banks are not required to keep all of our deposits on hand at the bank, but they are required to keep “some”, and this “some” is what they call “reserves”. So in the U.S., it’s usually only 10% that they have to keep on hand in most instances, and in China it used to be 21% of deposits but now the government just reduced it to 20.5%.
Hopefully this makes sense…
It’s easier when you think of it in old-school terms like with gold coins—if you deposited 100 gold coins in your Chinese bank, the bank used to be able to just keep 21 of your coins on-hand in case you wanted them back, and then lend out 79 coins to someone else. (Actually they didn’t lend out the coins themselves, but they issued you a receipt for 100 coins and then they could also issue a receipt to someone else for 79 coins, even though they only had 100 actual coins in the bank…they “created” 79 “new” currency units or “receipts” out of thin air). If this doesn’t make sense (and it is weird, believe me!), read the article I wrote on John and Steve and Sarah…I went into much more detail.
Basically, when banks create these receipts against the “reserves” they have in the bank, they are creating new money out of debt. This increases the money supply—the number of currency units in the economy, and causes inflation, because there is now more money chasing the same goods and services. You can think of it like Bay Area housing….it is much more expensive here in Palo Alto where I live than it is in Tennessee, for example, because salaries are much higher—there are many “Internet millionaires” and tech millionaires and super-educated and highly paid professors and doctors (Stanford), etc., and all that money is competing for the same limited number of houses, so the prices get bid up. That is inflation…an increased money supply causing prices to rise.
From the article you sent me, it looks like China had at first raised the reserve requirements (to try to “tighten” their money supply or shrink it) in order to curb their inflation, because consumer prices had risen by a three-year high of 5.5% (so things were getting much more expensive…inflation), but now they are lowering the reserve requirements to try to expand/inflate their money supply and spur their economy.
They are in a difficult place however, because every country right now is “printing more money” (e.g. creating more money by debt) so there is inflation everywhere (and the value of each of these currencies is declining, just as it did in our John-Steve-Sarah example). China is trying to balance their inflation and crazy price increases—it looks like food prices “shot up 10.5%” in a month according to the article, with their slowing growth…e.g. their economic growth has dropped almost a percent, from 8.9% down to 8%.
That’s kind of like if you imagine your household and your food prices are going up 10.5% in one month, and other things are rising 5.5% or more each month (electricity, housing, etc.—the things you need to survive), but you don’t “mind” too much (actually that is big inflation—our Fed tries to keep inflation at 3% or so) as long as your household revenue (your salary) is also going up by that much or more.
But if your salary raises start to decline, suddenly you are *very* worried about the rising prices…. economies are the same. China is trying to balance their need and desire to grow their economy (by reducing the amount of reserves banks need to keep on-hand and expanding their money supply) with their need to control inflation.
Great question Melissa, and I hope this helped!
Next, Thomas asks,
Hey Kung Fu girl, I hope that you are doing well, actually I really like your blog and your posts. You mention in your bio that you managed to find real financial advisors or gurus.
Who do you think is entitled for a trustworthy investor / advisor from whom I can learn as well.
You mentioned that you want to help to 1000 people to become financially free. Do you have a plan for that :)))? Do you offer any coaching course or training?
Hi Thomas! Thank you so much for your nice email and questions! Yes, I recommend everyone on my “sites worth visiting” sidebar on the right hand side of my website, and I will try to update that soon (there are more that I want to add to that list).
And yes, I do have a plan for helping 1000 people become financially independent this year 🙂 and am planning to “launch” it on June 1st….stay tuned, and thank you for asking!
OK, I am off to grab some lunch before our “official” Sovereign Man program starts this afternoon, but I’ll be back on Monday…have a great weekend!
To your financial success,
— Kung Fu Girl