Hold On To Your Gold

Something befuddling’s going on.  It is quite the brain twister.  As night follows day and day follows night, should not price inflation follow the massive $4 trillion Fed balance sheet expansion that’s happened over the last 6-years?

Simply connecting the dots quickly leads one to a ‘yes’ conclusion.  More money chasing a static number of goods and services should result in price inflation.  For prices must rise to balance out all the new money.

This, of course, makes good practical sense.  In fact, it might even lead someone to sell dollars and buy gold.  Certainly they’d have a bullet proof rationale guiding their decision.

Yet the world isn’t always a practical place.  Often time things happen that don’t make sense.  Sometimes the exact opposite of what should logically occur ends up happening.

Gold’s price peaked around $1,900 an ounce in 2011.  Gold’s currently at about $1,180.  That’s over 37 percent off its high.  What is going on?

Currency Debasement

The U.S. dollar is now strengthening in world currency markets.  The dollar index, which measures its value versus a basket of world currencies, is now at a four year high.  Perhaps it’ll strengthen even more.

The dollar prices of most commodities have fallen substantially over the last several years.  Copper, which peaked at $4.40 a pound in 2011, is now at about $3.  Crude oil is about $76 a barrel, down from its 2008 high of $146.

Part of the reason the dollar is strengthening is because other economies are rapidly debasing their currencies.  At the same time the Federal Reserve has concluded its program of quantitative easing.  Moreover, the Fed may begin raising the federal funds rate in 2015.

“If all goes according to our forecast and the U.S. economy continues to make progress towards the Fed’s dual mandate goals of maximum sustainable employment and 2 percent inflation, the Federal Reserve will likely begin to raise its federal funds rate target off the zero lower bound sometime next year,” said New York Fed President William Dudley at the a meeting of central bankers in Paris earlier this month.  This is in contrast to the monetary policies of Japan and the European Union.

For example, the Bank of Japan recently ramped up its quantitative easing program.  This pushed the yen down to a seven year low against the dollar.  The European Central Bank will also likely follow with its own new quantitative easing program to counteract its flailing economy.

Hold On To Your Gold

A strong dollar, by definition, is deflationary.  Yet the Fed wants inflation of 2 percent, or more.  The Consumer Price Index, as most recently reported through September 2014, showed annual inflation at just 1.7 percent.

The October CPI report will be published on Thursday.  It is unlikely the Fed will achieve their 2 percent target.  What will the Fed do then?  Will they stand aside and risk deflation?

This isn’t likely.  The Fed will do practically anything and everything to prevent deflation.  For the credit based financial systems depends upon inflation to lighten the debt burden and minimize the risk of large scale defaults.

Plus, with all the funny money that floated up stocks over the last five years being withdrawn from the financial system, it shouldn’t take too long for stocks to fall in earnest.  Will the Fed then stand aside and let the stock market fall apart?  Or will they open the flood gates of liquidity like they’ve done whenever stocks have hit a rough patch over the last eighteen years?

We have a sinking inkling they’ll do whatever it takes to push stock, asset, and consumer prices up.  In fact, this time around they may even try something really absurd.  For example, rather than creating money from nothing and buying debt, the Janet Yellen Fed could create money from nothing and buy stocks.  They could also create money from nothing and credit people’s bank accounts.

This sounds crazy we know.  But we wouldn’t put it past the scoundrels.  Hold on to your gold.


MN Gordon
for Economic Prism

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