Skip to comments.The Printing Press Is Running Hot, But Where Is Inflation And How Will It Affect Gold?
Posted on 09/06/2012 11:13:39 AM PDT by blam
The Printing Press Is Running Hot, But Where Is Inflation And How Will It Affect Gold?
Commodities / Gold and Silver 2012
Sep 06, 2012 - 02:48 AM
The key to understanding inflation lies in the implications of an increasing money supply. Here at Global Gold, we rely on the True Money Supply which is provided by the Mises Institute. The True Money Supply was originated by Murray Rothbard and represents the amount of money in the US economy that is available for immediate use in exchange. On the chart below you see that the True Money Supply has accelerated at a faster rate in the past couple of years; it is currently in an exponential growth phase. Even if one takes the official data published by the US Fed, the evolution looks similar: since 2000, the Fed balance sheet has increased fivefold.
What are the implications of the hugely increased money supply for inflation? The Austrian School of Economics defines inflation as the expansion of the money supply, whereas rising prices denotes the increase in the general price level. If the supply of a given good increases (in our case its money), one unit of the same good loses some of its value. That devaluation of money results in rising prices. Note that in spoken language inflation tends to be associated with consumer prices, which can lead to confusion.
Inflation is the root cause of the devaluation of money, whereas price increases are just the result of inflation. In the years leading up to the financial crisis, we had official inflation rates between 2 and 4%. At the same time however, the US was importing an increasing number of goods from low cost producer China. This should have lead to a decrease in the price level. But due to the increase in money supply, prices kept rising. This implies that the USD has lost much more than 2 to 4% of its value in real terms per year.
So why dont we see rising prices, although inflation is already here?
First, we should note that we believe inflation (as calculated by governmental entities) is manipulated in order to hide the currency devaluation. Shadowstats.com calculates inflation based on the traditional calculation methods. Based on those metrics, the inflation level in the US should be at least 5%. Even an inflation rate of 5% seems to be low for the amount of money that is being created.
Which reasons explain this phenomenon? We believe there are several reasons, the most important one being that the newly created money is not getting into circulation. Most of the fresh fiat-money has been used to bail-out the existing banking system. Even with these bailouts, the banking system is massively under-capitalized, so the huge amount of liquidity is not being lent out (to other banks, individuals or corporations). The liquidity is being horded and invested in safe assets. This is creating asset bubbles all over the world.
The biggest one of those asset bubbles are government bonds. Banks all over the world are investing in (read: inflating) treasury bills and government bonds. The perversion of the current bond prices becomes clear when you see people willing to lend out money to governments with a negative yield as a return. Thats unsustainable. I will not go into detail regarding the bubble in the stock market, but it should be noted that there has been a strong correlation between the quantitative easing measures of the US Fed and the strong equity price returns.
The channeling of liquidity into certain assets is keeping the velocity of money low. Velocity, which stands for the frequency with which a unit of money is spent in the economy, has collapsed since 2007. Back in 2001 every USD was turned over more than twice a year, today the number is down to only 1.5 times. Thats a decrease of almost 30%! Newly created money is not being circulated. You can be sure however that in the near future the velocity will go up again and that will finally lead to enormous price rises.
Are there any triggers already visible that could spur the velocity of money?
Well, history tells us that you cant control inflation over a long time. Somehow liquidity will inevitably come into the system, leading to sharp price increases. It will lead to a change in peoples perception as well. The shift on a large scale will come when people will finally lose their trust in paper money, which will only happen when they see its value declining and when they understand they beaome victim of it.
In my personal view, the next few years will be dominated especially in the western world by a declining real economy, higher unemployment rates, financial repression such as higher taxation, government restrictions when it comes to investment possibilities. Interest rates, which are kept artificially low, in combination with a moderate inflation rate, are leading to low or even negative real return on investments. Thats really destroying the existing wealth through the back-door, reducing the purchasing power of paper money / currencies.
It doesnt matter that the velocity has been decreasing for more than a decade now, as clearly visible on the above chart. The central point is that history shows that velocity increases when people expect prices to go up in the near future. When that happens, its impossible to stop the move.
At that point in time, people everywhere are going to understand that paper money is worthless. They will rush into assets which have real value. That will be an incredible driver for real assets! History has shown that in hyperinflation scenarios people rush into precious metals. The coming collapse of our fiat currency system will be no different in my view, sooner or later gold and other precious metal prices are going to skyrocket. Again, history shows us that especially gold has outperformed any other asset classes in those kind of environments
because gold is money for more than 5000 years now.
I got inflation right here....
Where is inflation.
Try the grocery store..
Dry beans that I bought a year ago at 1 buck a pound is 1.50
I used to stock up on Sirloin roasts at .99/lb and haven’t seen it under 4. Can’t buy hamburger for under 3 a pound.
Gasoline is twice what it was 4 yrs ago.
The real inflation is in the stuff they don’t include in the measurements.
OK, where’s the guy that swears up and down that food and energy are NOT EXCLUDED from the reported rate of inflation?
Beer Nuts are 99 cents and Deer Nuts are just under a buck!
And the bastids are going ahead with a “stealth QE3”.
It’s the collapse in velocity that is “keeping the presses running”. Knowing Bernanke’s background tells you he will do whatever is necessary to avoid the monetary mistake of the Great Depression when tightening occurred triggering a double dip sever recession. The author indicates the key issue: when velocity improves, how quickly can the Fed drain the liquidity out of the market to avoid runaway inflation. Timing will be everything.
There is package deflation to hide the costs.
The price of dog food hasn’t changed much. A 20 pound bag of Beniful kibbles was 15 bucks..Then the 17 pound bag was 15 bucks.. Now the 14 pound bag is 15 bucks.
I used to buy Kroger frozen vegetables for a buck a pound.. Still a buck on sale but it’s now 12 ounces.
I don’t have a reference point for them.
Food, energy, education, the usual. Clinton told us last night that housing prices are finally rising, as if it were a good thing. Aren’t there stories about subprime car loans running wild? Such phenomena we never seem to tie to an increase in the money stock.
We’re fundamentally handicapped as regards monetary policy. All these indicators, all these induces. But we can’t ever tell until it’s right on top of us. The booming housing market was a badge of honor for decades before it blew up. Assuming we could tell, and knew what was happening, and furthermore impossibly knew whether it was good or bad, we couldn’t make the right move. Because by the ti.e complementary or counter actions take effect conditions have changed.
I have yet to mention our biggest handicap, in that we never know how things would look without our meddling. Inflation may not be punching us in the face, but what if prices are higher than nature would have them? Who knows?
Ten trillion in wealth destroyed. About one trillion in “printing” added back in. We’ve got quite ways to go to create structural inflation.
The inflation in food is mainly due to drought, the use of corn for fuel instead of food and animal feed, and the high price of oil/gas. In other words, not structural inflation but temporary due to weather, and temporary as to oil and stupid policy. (although high oil price will hang around if Obama wins, since that’s his policy goal.)
Here’s what’s deflated:
The value of your labor. Real estate (80% of our wealth). The value of most retirement accounts. The cost of many retail items like TVs and computers.
So, we have massive asset deflation (net worth and wages of Americans both down) and weather and policy related inflation of certain items, most noticable being food. Small inflation in truck-delivered goods due to gas prices.
The food inflation can be partially solved through policy, and the rest of it will fade when the drought fades, as droughts always do.
of course gold will increase in price, as it’s measured in US dollars
and as you dilute the value of the dollar... which they are doing to keep the markets ‘up’... those commodities that do not dilute, such as gold... will spike in price
The “amount printed” above should be 2 trillion, not 1, sorry.
Indeed. One trip to the grocery store.
“when tightening occurred triggering a double dip sever recession.”
That didn’t happen. But ideas have consequences and since everyone in power think depressions are caused by deflation we will get endless helicopter dumplings. Or maybe ideas don’t matter and government control of monetary systems will only ever produce one answer, Keynes and Friedman or no.
It is true that people are sitting on money, and that it is not changing hands at rates satisfactory to our overlords. But once in a blue moon businessmen forecast correctly, and maybe skittishness is justified. For one thing, why expand if you don’t Knowles whether the federal government will up and confiscate your profit tomorrow?
In 1937, the economy was getting on its feet after the calamity of the Depression. Did the policy makers move too quickly in 1937 as they may have done in 2011 to withdraw government support for the US economy? In the long run, the budget deficits were and are still, clearly not sustainable. However, as FDRs closest aide Harry Hopkins famously said, People dont eat in the long run; they eat every day! And todays approach, if 1937 is a guide, could create not only more suffering but also less prosperity. In order to grow, the economy needs people who eat, people who work, people who produce and people, as well as businesses, that contribute to the Treasury by paying taxes.
The Federal Reserve did its part to throw the US economy back into recession by tightening credit. Wholesale prices were rising in 1936, setting off inflation fears. There was concern that the Feds easy monetary policies of the 1920s had led to asset speculation that precipitated the 1929 crash and ensuing Great Depression. The Fed responded by doubling banks' reserve requirements between August 1936 and May 1937, in several stages, leading to a sharp contraction in the money supply.
Read more: Is It 1937 All Over Again?
"Federal Reserve Chairman Ben Bernanke, an expert on the Great Depression, once promised that the central bank would never repeat its 1937 mistake of rushing to tighten monetary policy too soon and prolonging an economic slump."
The Perfect Storm
In the decades following Friedman and Schwartzs work economists started examining other government-policy failures in the aftermath of the crash. They have found an abundant supply of them. Here are several key examples of these bad policies: 1) In response to a sharp decrease in tax revenues in 1930 and 1931 (caused by a slowdown of economic activities), the federal government passed the largest peacetime tax increase in the history of the United States, which clearly applied the brakes on any recovery that could have taken place; 2) the federal government also passed the Smoot-Hawley Tariff Act in 1930, substantially increasing tariffs and leading to retaliatory restrictions by trading partners, which resulted in a considerable decrease in demand for U.S. exports and a further slowdown in production (not to mention a loss of mutually advantageous division of labor); 3) the federal government also instituted all sorts of public works programs, beginning under Herbert Hoover and increasing dramatically under FDR; the programs removed hundreds of thousands of people from the labor market and engaged them in economically wasteful activities, such as carving faces of dead presidents into the sides of a mountain, preventing or delaying necessary labor-market adjustments; 4) another federal policy that prevented (labor and other) market adjustments was the price and wage controls enacted under the National Recovery Administration and in effect from 1933 until 1935 (when ruled unconstitutional); this policy massively distorted relative market prices, impairing their ability to function as guides to entrepreneurs; 5) the Fed was not blameless after 1933 either. It increased bank-reserve requirements in three steps in 1936 and 1937, leading to another significant decrease in the money supply. The result was the 193738 recession within the Depression, adding insult to injury.
“The liquidity is being horded and invested in safe assets. This is creating asset bubbles all over the world.
The biggest one of those asset bubbles are government bonds.”
It should be pointed out though that money doesn’t just sit in government bonds, the government takes those funds and spends it on entitlements, etc and it ends up circulating throughout the economy and adding inflation pressure. The bigger issue right now is that we’re still the worlds reserve currency, so much of that fiat money is spread around globally. If the dollar is ever rejected as a reserve currency and dollars are dumped then inflation will go through the roof.
Your post highlights for me one of the huge problems with thinking in aggragates. All this loss, and the printing presses have been humming but can’t match that so everything should balance out, thinks Bernanke. Well, we only pretend it’s aokay until velocity gets away from us, or the structure of the entire money supply isn’t out of control. But is that so? Was 08 about “structural inflation”? Yes and no.
It was inflation in a few related industties: banking (as always), securities, housing construction, insurance, debt holding, etc. Our precious aggregates didn’t see it coming, only those with rather elaborate theories or horse sense about when the other side of the cycle’s coming did. But here’s the thing: inflation caused the meltdown. That is, not higher prices or higher velocity across the entire economy, but asset bubbles sparked by the malinvestment of extra money sitting around waiting for an outlet. The important thing is not how much money there is or how fast it’s changing hands or how high are prices, but whether the prices are market prices (whether they actually tell us the truth) and whether the money’s being spent correctly.
You can worry about timing, but let’s just assume that by some miracle Bernanke cuts off the spout before we exceed the limit of what was lost in 08. Does that mean we made up whet was lost? Not at all. It doesn’t even mean we won’t have runaway inflation. But nevermind. The point is, the money must not only be pumped in without overfilling the tub. It must also be spent correctly. If it is funneled disproportionately into losing prospects like the housing bubble or the dotcom bubble, the economy as a whole loses. And that’s something aggregates can’t see until after it has led to recession.
So I trust not in everything being okay while “structural inflation” is absent. I don’t even worry about limited price inflation as such. Sometimes it’s a drought, as you say. Sometimes it’s a bubble caused by easy money as in higher education, which won’t sink the economy. But something will, or some things will; they always do. And in the meantime they will be ignored in tabor of chasing down general price inflation and too much velocity.
Yep, I’ve noticed the package size reduction myself.
Especially with ice cream.
Costco still sells the full half-gallon ice cream containers, though.
Inflation is one way to pay off the massive debt. You can pay it off pennies on the dollar, just keep printing
The real inflation is in the stuff they dont include in the measurements.
Yeah, funny how they decided to leave food and energy out of the consumer price index
OK, wheres the guy that swears up and down that food and energy are NOT EXCLUDED from the reported rate of inflation?
They might be included in some reported rate, but they’re not in the CPI. That’s the official one
Depressions are not caused by not pumping money into a faltering economy. The bad part if the cycle is not the slump; it is the boom. That’s when things get out if joint. The following slump, which was caused by inflation, is what corrects maladjustment. Reinflating only perpetuates problems. Bad markets need to be liquidated to figure out where everyone stands so production can start growing again. Bernanke confuses symptom for cause.
I realize the federal reserve wad created to bail Bug Business out of its mistakes purportedly for the general good, and I shouldn’t expect its chairman to k ow any better. But how many times does reinflation have to fail and inflation bubbles cause recessions for us to notice? How much government spending, unprecidented federal regulation of markets, going for the first time off the good standard, inrernational trade wars and regime uncertainty did there have to be 33 to 36 not to blame the second dip on the bogey of tight money?
I love Friedman, but between income tax withholding, the earned income tax credit, and the deflation theory of great depression he has helped big giverment more than any libetariam who ever lived.
There’s some FReeper that always comes into these inflation threads and derides anyone that says that food and energy costs are excluded from the reported rate of inflation. He usually posts a “face palm” picture or something.
I’d really like to see him site his source that says these data points are included.
A lot of the Control-P activity has been “sterilized”. This is like when the Federal Reserve Corporation prints up a billion dollars of paper money, wraps it in plastic, loads it on pallets and puts it in the back of a truck. At that moment, the billion dollars is added to the various M’s and appears in the money supply figures. That billion CANNOT cause any “inflation” until it is in the hands of someone who will use it to bid for workers and things in the market.
Suppose for example, the Fed drove the truck to a troubled bank and had the officers come out to the curb and climb in the truck, and put their hands on the plastic wrapped money, they could say to them, we will swap this money for that box of bad loan notes, but because of a rule we just made, you cannot take physical possession of the money you just touched, we will take the truckload of YOUR money back to our vault for safekeeping. Please sign here and thanks. Then the bank officials were dismissed and the truck driven to a secure undisclosed location. The bank could now use the “asset” to issue more loans, and THAT money would bid up wages and prices.
The above example is that of asset laundering, where a non-performing loan (which is an asset that cannot be used for fractional-reserve lending) is upgraded through the Fed into an asset that can be used for fractional reserve lending. This has the effect of restoring the lending capacity to the bank that it has before the crash in loan valuations.
Some of this “sterilized” (sequestered) money has the economic effect of only increasing the bank’s leverage of its good Tier 1 assets. The bad paper is now on the balance sheet of the Fed instead of that of the bank.
Maybe they are included but are ‘hedonically obfuscated’.
I.e. The price of steak is through the roof, but it’s assumed that everyone who can’t afford steak just eats hotdogs instead. And hotdogs are much cheaper than steak so - hey! - the price of food isn’t going up much.
Crazy I know. But I bet the Government massage their statistics with such evil fictions.
Yeah, I’ve seen that done as well.
Since people cannot afford to pay more for food, they make different choices, so, magically, their food budget stays the same (maxed out, but with lower quality food) and thus no inflation in food prices.
Though it might seem sensible, the math doesn't really run quite that way. Wealth was destroyed but not MONEY. A very important distinction.
As an example, say I buy an uninsured house for $100,000 and it burns down. Yes I lost my "wealth" of 100 grand but the $100,000 I paid the contractor is still in circulation, as is the $100,000 with the would have been buyer of my home. IOW, the same amount of money exists as did before I lost my house, but not the same amount of wealth.
Central banks creating money out of thin air won't in any way ameliorate my burnt $100,000 of wealth. In fact, it won't help anyone else get wealthier or restore lost wealth anywhere. All that happens through central bank intervention is the currency - at some future point - will be devalued and the unsustainability "can" gets kicked down the road.
Oh, the other thing that happens is the central bankers get interest on everything they print and hence get filthy rich by ripping us off through inflation.
They are making a fundamental error, based on old logic:
> “At that point in time, people everywhere are going to
> understand that paper money is worthless. They will rush
> into assets which have real value.”
This would have been the case many years ago, but things have changed in a very odd way. While there is an overabundance of “virtual” money, grotesquely inflated if not liquid; at the same time there is tremendous *deflation* in paper money.
In circulation there is only enough paper money to support 5% of US daily retail trade. Were there no virtual money, paper money and coins would instantly be worth 20 times (or more) their face value. It is massively deflated.
But can’t the government just print more paper money, or higher denomination bills? In a nutshell, no. The US Bureau of Engraving and Printing has only two currency printing offices in the country, working around the clock to print a tiny amount of mostly $1 bills. Proportionately fewer higher denomination bills.
And most $100 bills are shipped out of the US to meet foreign demand for physical US currency. So they can’t make more money, and if they printed higher denomination bills, nobody could make change for them.
And this is exceptionally important to people who are using gold as a hedge, as it might preserve the value of their assets.
As gold-holders hope, the price of gold skyrockets, but this presents its own problem: priceless is almost the same as worthless, unless it can be converted to something else.
So how does this come about? First of all, an economic “judgment day” comes to the virtual money supply. Broad inflation, bank holidays, credit collapse, bond and equities failures, who knows what all.
But paper money has something that virtual money does not. The magic words “legal tender for all debts, public and private”.
Though there are all sorts of possibilities, a side effect of economic crises will likely be a specialized type of bank run, called a paper run. People will have so lost confidence in the banks and other virtual investments that they panic and want cash in hand, that cannot be taken away easily by the government or bankers.
There is a parallel to this that gold investors know well, the holding of gold futures vs. physical gold. But in this case, the public goes to the banks to try to withdraw their savings in cash.
And there is so little cash that every bank in the US will be stripped of cash within an hour, with none in reserve.
At that point the light will dawn that virtual money is worthless, because everyone will demand cash for everything.
In economics, it is called Gresham’s law, but in this case with virtual money horribly inflated, and physical cash very deflated, the end result is a “currency split”.
While the government might insist that virtual money is the same as paper money, this is not the case if the public rejects the idea. $10 billion in the bank might be worthless compared to $10 cash in your pocket.
But say the value of gold is officially $20,000/oz. The government might say that it is worth $200,000 in worthless virtual money that can’t buy anything; but a retailer could value it at $2,000/oz compared to deflated paper money, and you can buy a LOT in their store with $2,000 in paper money.
Probably as much as you could have purchased with $40,000 or $60,000 before the crisis.
So paper money will have preserved the value of your gold.
Prices should be decreasing along with money wage rates in a recession or depression. The inflation is in the fact that money prices have not been able to fall due to the increase in the money supply this time.
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