Follow The Bottom Violation
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Jan
19
The Disconnect Between Gold and Inflation
As a follow-up to my article yesterday, I want to talk a little more about the relationship between gold, the dollar, and inflation. In response to my post, one reader wrote:
“Holding physical gold [that has no intrinsic usefulness to most people], may not be effective. In a true financial crisis who will be able to buy it from you and why would they want it?”
Several other readers suggested that gold is not a good “hedge” against inflation.
I have referenced a chart from the St. Louis Fed in several articles this week that shows just how much currency is being printed right now. Every time I look at it, I chuckle and shake my head. The line in 2008 is nearly vertical!
Look, if you try to make things complicated, you’ll succeed. But there’s no reason to do that. Here are a few key things to remember:
1. If you increase the supply of dollars, you had better increase demand for those dollars at the same rate — or an even greater rate — or those dollars are going to lose value. Period. Granted, there has been some increased demand for dollars in recent months, but can you honestly tell me that demand is sufficient to outpace the number of dollars being printed? Furthermore, do you honestly see sustained or increasing demand for those dollars? If so, why? We’re a debtor nation that manufactures almost nothing. We’re a colossal pack of spoiled brats who think we deserve to work 30 hours a week for $85,000 a year.
I’ll try this again: if you see sustained or increased demand for dollars, I’d like to know why.
2. If you are unable to increase the the supply of gold in any sort of meaningful way (which you can’t), and you are making an argument that the price if gold is going to fall, you had better also make a strong argument that demand for gold is going to fall. I say this, because you cannot predicate any argument for the price-destruction of gold using supply as a premise. In other words, supply of gold can’t be increased, so if the price is about to fall, you better convince me it’s going to result from reduced demand — because it sure as hell isn’t going to come from an oversupply.
If you can’t meaningfully create gold, it cannot be inflationary. I know you’re all getting very tired of hearing me say this, but the only definition of inflation is an increase in the money supply.
Didn’t I say something about avoiding complication earlier in this article? I think I did. Okay. Here’s the simple part. Are you ready?
The supply of dollars is increasing. Prices and rates are going to rise unless the Fed can miraculously find a way to bring all those dollars back in, very quickly. But how could they possibly achieve that? Are they going to borrow more? Are they going to print more money? The problem is so obviously and viciously unsolvable that I’m not quite sure how anyone thinks the dollar can survive.
Meanwhile, the supply of gold in the economy is not increasing. If anything, it’s being hoarded, which translates to increased scarcity. Does somebody want to tell me how the government (or anyone else) plans to print more gold? How do you do that? Do you look up “alchemist” in the yellow pages?
Okay, I’m getting to the good part now. The supply of dollars is increasing. So the dollar is losing value. The supply of gold is, at best, stable, but probably shrinking.
And here’s all you have to think about: would you bet that demand for dollars is going to outpace its production? And would you bet that demand for gold is going to fall in the face of a stable or declining supply? Don’t think about it too long…
Now if I could just get the whole “timing” thing figured out.
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Disclosures: Paco is long TBT, UCO, and gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.
You can buy his novel Discipline wherever books are sold.
2 Comments so far
Partners
Hey, great blog, interesting stuff.
I think something that supports your points about inflation is that fact that it jives with what Obama’s stated intentions are – to sort of “spread the wealth around”. Inflation would tend to make a large number of people pretty poor rather than letting wealth be concentrated. He also warns us that things will be a struggle for a long period – you could think of that as opposed to a horrific crash that then starts improving right away.
Although, I have a couple of questions. I know that you’re using the basic laws of supply and demand to say that the dollar’s decline will be due to the increase in money supply, but you’re saying that the decline of asset values and bank money through lending won’t counteract that. I don’t think that you’ve explained that enough. If M2 shrinks, I fail to see how an increase in M0 will cause inflation, unless lending all of a sudden starts again at full force. If it begins again but slowly,then shouldn’t inflation be contained for some significant amount of time?
Also, on a related idea, couldn’t gold fail to increase in value if a gold equivalent were used, thereby lessening the demand? I don’t know what- like other metals, or other commodities, that sort of thing? I guess what I’m saying is that I understand what you’ve put forth so far, but we should try to find flaws in it in order to have better faith that you’ve covered all the angles.
Cody, Paco is right. Gold has been in demand since stone age man first saw gold gleaming in a rushing stream. Gold is now and has always been a measure of worth and value. The dollar is just a piece of paper which has buying power only because we have accepted “the full worth and credit” of the United States government’s monetary system. Just try to spend a 1863 confederate dollar! The buying power of the dollar has been falling for decades. I just don’t see how this nation can grow wealth with Americans selling services to each other. Eventually this house of cards may take a tumble.