By Sean Hyman

You may have heard John Paulson’s name before.

Paulson is the now legendary hedge fund manager who shorted the subprime markets, when he correctly predicted the decline of the U.S. housing market.

His personal cut from his hedge fund at the time was $2.8 billion! Now hedge fund mangers only make 2% upfront and 20% of their profits, so you can imagine how well his hedge fund performed if his personal cut was that large.

In fact, Paulson was one of the few guys on the right side of the trade during the entire credit crunch. While many investors were long stocks and real estate, he was shorting the right assets to cash in as the market tanked.

So what’s he up to these days? He’s been watching the economic indicators again like a hawk to see what his next billion dollar play will be.

Over the past few months, he’s found his next billion-dollar indicator in the markets. How did he find it? He took note of the one indicator that has had a parabolic climb…

It’s the money supply.

You see, back when Lehman Brothers collapsed and the Dow was hitting the 6,000s again…the Fed and Treasury had to do something.

So they increased the money supply by a whopping 120%. In other words, they pumped more than double the money into the economy than there was before.

3 Reasons Why the Money Went to the Banks and Not to You and I!

Now where did all that money go? We all know it’s not in our pockets!

Actually the Fed and Treasury put this money on deposit with the banks. They did this for several reasons…

1. To avoid an outright depression
2. To recapitalize the banks that were practically bust after everything fell apart
3. To make money available for lending so that consumers could spend again and stimulate economic growth

Now they made have avoided a depression and pumped cash into the banks, but the third, the “lending and spending” part has NOT happened yet!

Banks simply aren’t lending. So consumers can’t make big purchases.

Now frankly, I can’t blame them for this. I wouldn’t be inclined to lend out money either with over 10% unemployment in the U.S. and a likely stock market correction coming.

That’s why banks have been hoarding cash. Also, banks want to ensure they can continually pass the government’s stress tests so they have to keep plenty of cash around.

If they failed to have enough in reserves when one of these tests comes, it would turn into Obama Bank and Trust. Why? The government would have the right to go in and take over the bank if it failed the test.

These CEOs first want to keep their jobs and control their banks. Everything else is secondary – including lending to us. 

Now, so here we sit. We have banks full of cash that refuse to lend. The worldwide economy is improving while we improve at a creeping, crawling pace…

Eventually, the banks will start to ease into lending mode once again. When that happens, all that money sloshing around in the system will come back to haunt us.

We’ll see the true velocity of money, and that’s when inflation really starts to kick in.

What is the velocity of money? An example of this would be a bank lending to a business. That business does well and makes profits from the loan because they were able to expand their business and buy the needed goods/services to charge ahead.

Part of the company’s profits are spent in the economy. Part of the profits go to pay the workers which will in turn spend money in the economy.

As those workers buy up goods in the retail sector, the retailers make money and so do their employees. These companies and their employees spend more in the economy because their paychecks have increased, etc. All of this happened because one company originally got a loan from a bank.

In other words, there’s a multiplier effect.

History is Paulson’s Teacher!

Back in the 1970s, there was a rise in the money supply by 13% for two years. But there was a delay in its effect upon the economy.

Of course those of you who lived through this period know that it was a very rough time to live in since interest rates reached 18-20% and the cost of goods went through the roof.

It became hard to buy a house because it was like trying to buy one on a credit card type of interest rate.

Well, Paulson sees history repeating itself in a major way. Except this time, we’ve increased the money supply by 120% and not 13%. Then we had a two year delay before inflation kicked in…and Paulson is expecting that we could see some serious inflation hit very, very soon since we’re close to the two-year mark since the money supply increased by 120%.

Therefore, Paulson’s bet is that within the next six to 24 months, regular lending will resume and that over the next 2-3 years, we could see inflation in the double digits.

I’m thinking that he must be betting that all of this happens sooner rather than later since he’s recently put ALL of his personal assets into gold in some form recently.

He knows that all this money in the system will eventually cause gold to rise further and the dollar to fall. Coincidentally, when this happens, we’ll also see key foreign currencies rise especially the com-dollars.

Why China, India and Paulson Continue to Snap Up Gold Even at Over $1,000 an Ounce!

While many people call the “gold play” overdone…India just bought over 200 tons of gold when gold pushed over $1,000 an ounce. And as you read yesterday, they’re talking about buying another 200 tons.

China has also been a big buyer of gold lately and they’ve encouraged their citizens to do the same.

Then you have Paulson putting ALL of his personal investible money into gold with gold exceeding $1,000 an ounce too.

So what do India, China and Paulson know that everyone else doesn’t? In addition to the substantial increase in the money supply, they know that of the $200 trillion in investible assets in the world that only about $800 billion of that is in gold.

Therefore, if all of this “smart money” is placing such huge bets on gold…I’d say it’s still a smart reason to still own some.

I still own some through an ETF where I’m long gold (and also short the Russell 2000 at the same time). I plan on holding these positions for quite some time to come BUT I’ve got much of my money in other things that will benefit from the rise of gold and the fall off of the dollar. What is it? Commodity based countries and in particular their currencies.

That includes the shining star among them all that benefits the most from the rise of gold, the Australian dollar.

Therefore, make sure you’re ready, like Paulson is, for the double digit inflation that is to come. If you think the dollar has fallen so far…you’ve not seen anything yet.

Better consider getting some gold and Aussie dollars before all of this hits and wipes out the buying power of your dollars!

Happy Trading!
Sean Hyman, aka Professor FX

A 17-year veteran in the financial markets, Sean Hyman has been a senior writer for FX University Daily since 2007, and a currency trader since 2001. To get the full story on how Sean got started in the industry, and hear key trading tips that can boost your currency profits as inflation sets in, read our latest special report: http://www.sovereignsociety.com/Portals/0/landing/FullPromo_WMTRKB03.html.