By Rudy Fritsch…
The pundits are constantly harping on inflation, hyperinflation, ‘money’ (actually currency) printing etc… With the underlying assumption that Gold price responds to inflation… and that inflation responds to excessive printing.
Now the connotation of this mindset is simple; belief in the quantity of money theory. That is, the belief that inflation is the result of ‘more money chasing fewer goods’. Mind you, at least this is a better belief system that the more commonly held belief that inflation simply is… and that Central Banks ‘fight’ inflation.
Indeed, those who hold the ‘printing > inflation’ meme are at least one step closer to the truth. But the reality of inflation is beyond the simple quantity theory; the theory only considers half the real cause of inflation. The first half is the quantity of money; the second half, the other factor leading to inflation and the proximate cause of hyperinflation, is the velocity of money.
Not often talked about, as TPTB do not want to admit that the ‘all powerful’ CB does not control inflation; that the CB can indeed control money supply, but has no power over velocity. A simple but fundamental way to see this is to consider GDP; the sum total of all financial transactions in one year in one state.
GDP is simply money supply multiplied by money velocity. Money supply is the actual stock of currency in the economy, more formally called M2. It can be compared to the stock of Gold, vs flow (mine output that adds to the stock). Growth of the money supply means new money borrowed into existence to increase the stock…
If the money supply of a state is for example one trillion Dollars, and the GDP is ten trillion, then by definition all the money must change hands ten times in one year. One trillion times ten equals ten trillion…just as surely as one plus one equals two.
But notice that if money supply doubles to two trillion, and velocity falls by half, the GDP will still be ten trillion; two trillion times five equals ten trillion. Clearly any claim that quantity of money rules GDP and thus controls inflation is false. The combination of quantity and velocity rule GDP, not quantity by itself.
Since inflation is not dependent on quantity, the price of Gold is not either; nevertheless, Gold price does respond to inflation. As the Purchasing Power of Fiat currency falls, the Fiat price of Gold rises. This is well proven by the historical record; inflation correlates with rising Gold price.
Now it seems logical to assume that if inflation leads to rising Gold prices, then deflation will lead to falling Gold prices. Unfortunately, it seems like this bit of logic is a frail reed; the historical record also shows that the PP of Gold does NOT fall in deflationary times. Do you wonder why not?
Recall that deflation is seen as a rise in the PP of currency; again, falsely attributed to a drop in the quantity of ‘money’ in circulation; but actually, velocity is just as important as in case of inflation. The reality is that if monetary velocity drops for any reason, deflation is the result.
In deflationary times, ‘Cash is King’… but then what is cash? Real money (Gold) is cash, Fiat notes are but promises. This fact drives reality; cash Gold, the fizz, the coin, is King; and its PP does not fall, but rather tends to rise… even faster than the PP of Fiat rises.
Now inflation is destructive even in the smallest measure, no matter that CB’s aim for ‘moderate’ inflation; this is like the ‘moderate’ Takfiris in Syria. The ‘moderates’ don’t chop heads; they slice heads off slowly, moderately.
The destruction of monetary value is like head chopping in the economic sphere. Holders of hard earned currency lose; the only question is how quickly. Even CB’s admit that rapid inflation is not desirable… but they are terrified of deflation, for good reason. Just like inflation is subject to positive feedback… potentially leading to hyperinflation and collapse… so is deflation subject to positive feedback.
CB’s are rightfully afraid of deflation, especially under Fiat regimes; look at the endless drag of deflation and the concomitant efforts of the Japanese authorities to fight deflation in the Japanese economy. Decades of lost time, constant currency printing, and still no desired inflation; Proof that quantity does not control inflation… or deflation.
As the PP of currency falls with inflation, if the fall is too fast then people start to notice that their currency is losing value; they start to spend it, get rid of it, trade it for something real that does not lose value… like Gold… before they lose even more value. This naturally increases money velocity, leading to even more inflation; a vicious circle that can quickly turn inflation into hyperinflation.
The very same feedback effect can occur with deflation; if the PP of currency is seen to be increasing rapidly, people will hang on to it as much as possible, waiting for even more value (even lower prices). The velocity of money falls, and the positive feedback kicks in.
A rapid deflation is called a crash or depression. There should be a word ‘hyperdeflation’ to describe this state of affairs. Runaway inflation is the mirror image of runaway deflation. Both are crises with similarly destructive effects.
On the other hand, a slow, steady ‘deflation’ is actually desirable, and natural under an unadulterated Gold standard. The cost of goods decreases as technology improves, thus the same quantity of money buys ever more goods. The rising PP of real money is (falsely) attributed to deflation… by the same PTB that praise ‘moderate’ inflation.
Notice that we are starting to approach the real price driver of Gold; the perceived risk of monetary crisis. Gold is a noble metal, not subject to corrosion either by the ravages of time… or the ravages of failed monetary policy. Gold simply is… and the price or perceived value of Gold rises as risk to the Fiat system rises.
Which fact leads us to an understanding of Gold valuation; Gold is seen as more valuable in times of rising economic risk. Gold is suddenly in the spotlight as the ultimate risk-free asset, the only monetary asset (except for Silver) with no counterparty risk.
Gold is the epitome of quality; not an IOU but real wealth, with thousands of years of historical evidence of its timeless value. By comparison, all other forms of money are inferior; the only question being how much inferior. When paper money is seen as being relatively stable, when the economy appears to be steady and growing, the premium accorded to Gold is reduced.
When paper is seen to be threatened, the economy appears to falter, suddenly Gold is back in favor; and the paper price of Gold grows. This is easy to see in times of inflation, the PP of paper is dropping visibly, and holding Gold is a no brainer. In deflationary times, the problem is lack of paper in circulation; this gives Gold a greater immediate monetary role.
Gold will move to help ease the cash shortage; this in turn increases the perceived value of Gold, even as the value of paper also increases. Gold is win win. Gold gains in inflationary times and in deflationary times.
The question is, are we now living in peaceful, low risk times… or not? If you are not sure, I suggest a quick read of internet news preferably not mainstream. De-dollarization is going on big time, the wars and war threats in the Middle East, in the Balkans, in the Ukraine, in Korea are festering. There is even an ongoing war on ‘cash’… on paper bank notes held by ordinary people.
The ‘price’ of Gold is climbing in recognition of the risks the world faces… climbing in spite of all efforts of G’men and banksters to counter the rise. No agency has the power to stop this rise, although interruptions and setbacks to the rising trend abound. Gold is on its way to assuming its real value, just as Fiat currencies are on their way to assuming their real value of zero.
Rudy J. Fritsch