Bob Mestjian, one of our advisors and a fellow resident of Melrose, Massachusetts, wrote in with a very good question, to wit: “At the National Conference, you mentioned margin debit balances skyrocketing. However, I'm trying to reconcile skyrocketing margin debt with what I keep hearing about record levels of cash on the sidelines. Is there cash on the sidelines? Are there select investors who want to take risk ‘all in,’ using margin, while others are in cash and want nothing to do with stocks?”

Good question. First, let’s look at the concept of “cash on the sidelines.” This is a commonly used phrase, but unless the cash is actually stuffed in a mattress, it has to be somewhere in the financial system, where its removal—or relocation, really—would have effects. The phrase is usually a misnomer, as it reflects an investor preference for other asset classes over stocks.

I’ve been doing a number of interviews recently, and the one thing everyone wants to talk about is the new records being set by the market. With the S&P 500 touching 1,800 and the Dow touching 16,000, the question is whether this is the start of another upward run or whether it marks the peak.

There’s something about round numbers that gets people going. The end of the world in 2000, the hype over Dow 10,000 (both ways), and the repeated questions at every 1,000 mark suggest that somehow this number is different.

The photo below comes from an old B movie called Independence Day that I’ve always enjoyed. The plot is pretty simple: A race of space aliens shows up in orbit around the Earth and utterly destroys Washington, DC. Later on, though, it turns out the aliens are actually hostile.

Watch Brad’s interview on Reuters TV, where he discusses the Dow hitting a historic high of 16,000 and what this means for the markets going forward.

In the previous four posts in this series, we focused on the role of the dollar in the U.S. economy. We found that the money supply has actually been growing more slowly than the economy as a whole, and that, for most sectors, credit isn’t a problem either. In fact, scarcity—one of the two key properties of money—is being maintained at reasonable levels. We also looked at how that might change in the future, and what to watch for.

Now, let’s move on to the role of the dollar in the international system—specifically, the question of whether the dollar will collapse or at least lose its role as the world’s reserve currency. In this discussion, our conclusions about scarcity remain, but an added dimension must be considered: how scarcity has been maintained for the dollar, not just in absolute terms but also in relative terms, compared with other currencies. Next, we have to reintroduce the concept of exchangeability, which, besides being a fundamental characteristic of money, is also key in analyzing the future of the dollar.

We talked yesterday about how consumer price inflation has been pretty moderate, and why that is. To recap: The speed at which money circulates has declined, even as the Fed forces bank reserves into the financial system, meaning that when the economy recovers, when the banking system gets its mojo back, and when lending starts to take off again, we can expect inflation to accelerate—potentially very much so.

A point worth mentioning here is that the Fed does have tools it can deploy to help limit inflation. And although the Fed has said it will wait to do so, inflation is actually a problem we know how to solve. This is something to watch, therefore, but shouldn’t become a long-term systemic problem.

Yesterday, we talked about how the money supply has not expanded unduly, given the level of economic growth. We also looked at credit growth and found that it too was running at or below the levels expected, considering the level of economic growth. There appears to be no sign of the Federal Reserve’s stimulus in these measures.

Does that mean we’re off the hook on inflation? The short answer is no, and the reason is interesting. First, though, a bit of background.

I have to apologize to Micah Crabdree, who posted a question on Halloween. Since then, I’ve either been preparing for our National Conference or attending it, and I meant to respond earlier. Sorry, Micah, but here you go . . .

The question concerned when the Fed was going to start the taper process—specifically, wouldn’t it be better to do so in a strong market environment, when the possible negative market effect would be limited, as opposed to a weaker environment, when the Fed’s action might serve to weaken it further?

Yesterday, we talked about the two fundamental requirements of money: scarcity and exchangeability. Today, we’ll focus on how those elements work in the current monetary system.

Money today is almost exclusively fiat currency, with no underlying assets behind it. Dollars, euros, pounds, and the yuan/renminbi all have value because their governments say so. “Money” that has no governmental backing, such as gold or bitcoins, is a fringe player right now.

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” — Mark Twain

What is money?

At first blush, the question either sounds pretty obvious or like a Zen koan. I think it’s worth asking, though, for the same reasons it was worth asking “What is a house worth?” in 2007. Although everyone thought they knew all about the real estate market, it turned out we didn’t. In the same vein, I think there’s a real benefit to taking a deeper look at exactly what money is, and has to be, to determine if what we think we know about it (and about current economic conditions) actually makes sense.