Glossary of terms
Fiat means something that is done by force of authority.
A fiat currency is a means of payment that is intrinsically worthless as it is no longer backed by anything of value, such as precious metals. It is a forced method of payment by control of government under the legal tender laws. It’s purchasing power is determined by the government and central banks rather than free market economics.
Hedonics in economic inflationary terms is basically, the revaluing of items based on the improvements and usefulness over time from the item, and accounting for those in inflationary terms.
For example: A computer costing £500 one year, may have improved the next year by being twice as fast with twice the memory and twice as good a screen but costing twice the price £1000, a 100% increase, but hedonic adjustment would take into account the doubling of usefulness of the computer so reflect the effects of inflation as 0%.
However, hedonic adjustment doesn’t work the other way, many items we purchase these days don’t have the same standard of quality or last as long as they did, so something that may have lasted 10 years now only lasts 2 years before it needs replacing, this costs us more over time but isn’t taken in to account.
Substitution is when items used to measure the effects of inflation increase in price too much, they are substituted for cheaper alternatives to artificially lower the official inflation rate.
For example: As the price of quality steak increases and becomes too expensive for families to buy, this is taken out of the basket of items used to reflect the rise in the cost of living and is replaced with the cheapest cut of steak, artificially lowering the cost of everyday shopping in terms of the government’s inflation figures. A basket of items used to reflect everyday purchases is slowly replaced with different and cheaper alternatives to manipulate the total lower. Using the cost of the original items that have increased, would show an accurate but higher rate of price increase and affect of inflation.
Weighting is a gauge of how people spend a percentage of their income based on the importance of each and how their priorities change due to price increases.
For example: A typical family household might spend more on certain items where prices have remained stable compared to a student who sees a higher rate of inflation due to an increase in rental accommodation and books.
The rise in prices caused by inflation can affect people in different ways, and affects households in different ways compared to industry. You may be more or less affected by the rise in prices of certain items compared to other sections of the economy.
This is a method used by manufacturers to increase profits, whereby they shrink the products (usually food items), change the ingredients to cheaper ones or simply put less in a package but they still charge the same amount or even increase it slightly. Over time the prices still increase but you receive less for your currency.
The interesting thing about this is, how long do they have left before the products are so small and the price so high, that no one actually buys them anymore?
Moral Hazard is the position banks are in, thanks to government, where they are isolated from the negative affects of their risky behaviour by not being held responsible for their actions. They are free to do anything they want and to take risks in order to profit in vast quantities knowing that, if the risks they take go bad causing them to effectively go bankrupt, they will be rescued by the taxpayer or the creditors and shareholders of the bank. As they have been before, and no doubt will be again.
In the past, when gold and silver was still used as money in the form of coins, those in charge of the money started to reduce the amount of gold and silver in the coins and replace it with a cheaper alternative, such as copper. The act of lowering the amount of precious metal in the coins debased the value and the coins became worth less, as people started to realise they were getting less gold or silver in the transactions, the obvious result was that people would demand more of the coins because each one had lost some of its value. The same is true today, as banks print new currency notes, it debases the value of all notes in circulation, so people and business demand more of them, raising prices.
The principal amount is the original amount borrowed before any interest is added.
The nominal figure is the the balance you will see on your bank statement. It is the figure that is quoted without taking into account the effects of inflation.
For example: If you deposited £1000 in to your bank account and decided to leave it there for 5 years to grow at an interest rate of 1% each year, at the end of the 5 years your balance would show a nominal amount of £1051.01. But if inflation was 2.5% a year over the same 5 year period, your £1051.01 would only have the purchasing power of £926.04 due to the rise in the cost of living due to the effects of inflation.
Compounding is the process of receiving interest on interest, If your original deposit is increased by say 5% a year, so £1000 after 1 year would be £1050, but in year 2 the 5% is added to the total of the previous year, so instead of being £1100 it increases to £1102.50 / year 3 = £1157.62 and so on. The interest is applied to the total of the new balance not just the original deposit amount, over long periods this compounding effect increases exponentially.
Compound interest is widely praised by just about every financial article you will read relating to savings and interest, but what many of them fail to explain is the effect of inflation which is also compounded on your fiat savings. If the inflation rate is higher than the interest rate you are receiving, then your savings are losing purchasing power even though your (nominal) account balance appears to be increasing.
Allocated & Unallocated
Generally speaking, if you are buying a gold product from a financial institution it will be unallocated. It is like making a deposit into a bank account where by, you are lending your ‘money’ to the financial institution so you can have a claim on the gold, you do not own the gold, the financial instutution owns the gold, therefore it is possible for you to lose your claim to the gold. Although they would probably still refund you the fiat currency amount that the gold is valued at, at the time. Unallocated gold can have numerous counterparty risks and the same gold is sold to numerous different people who all have a claim to the same piece of gold (Rehypothecation). Counterparty risk is having numerous individuals or companies between you and your gold, any one of them could fail or lay first claim to your Gold, it is the riskiest way to have exposure to Gold as your investments are still held in the financial system.
This is a direct claim to an amount of gold you have purchased, it is vaulted under your name and you own it, many allocated gold providers will allow you to take delivery of your gold (subject to minimum quantities and a fee for delivery).
Even if the company you hold the gold with fails, you will still be able to collect or have the gold/silver delivered to you, or the trustee of the gold/silver will ensure you receive compensation to the full amount of your gold (less an admin fee) If you want to own gold but do not want to take physical delivery, allocated gold is the best, and least risky way.
Buying and taking delivery of physical gold has the least counterparty risk. You own it and it is out of the system and in your hands. The risk is now on you, to ensure you keep it safe and secure. When buying physical gold, only buy from reputable companies and do your research in to the companies before you make a purchase. There are many reputable companies, but as with anything, there are also people who will try to scam you. Always be aware!
KYC & AML
Know Your Customer
Anti Money Laundering
Basic due diligence taken by financial institutions to identify customers and checks they are who they say they are. In practice this means obtaining a customer’s:
Photograph on an official document which confirms their identity
Residential address and date of birth
All checks are required to ensure customers are who they say they are and to prevent money laundering through the financial system. Which is quite ironic, when we learn the biggest money launderers and financial criminals, are the banks themselves!