On the Relationship Between the Size of the Monetary Base and the Price of Gold

The strong correlation between the gold price, and the size of the US monetary base that has existed during the era of quantitative easing appears to be in breakdown:

fredgraph

To emphasise that, look at the correlation over the last year:

inversecorrelation

Of course, in the past the two haven’t always been correlated. Here’s the relationship up to 2000:

2000

So there’s no hard and fast rule that the two should line up.

My belief is that the gold price has been driven by a lot of moderately interconnected factors related to distrust of government, central banks and the financial system — fear of inflation, fear of counterparty risk, fear of financial crashes and panics, fear of banker greed and regulatory incompetence, fear of fiat currency and central banking, belief that only gold (and silver) can be real money and that fiat currencies are destined to fail. The growth in the monetary base is intimately interconnected to some of these — the idea that the Fed is debasing the currency, and that high or hyperinflation or the failure of the global financial system are just around the corner. These are historically-founded fears — after all, financial systems and fiat currencies have failed in the past. Hyperinflation has been a real phenomenon in the past on multiple occasions.

But in this case, five years after 2008 these fears haven’t materialised. The high inflation that was expected hasn’t materialised (at least by the most accurate measure). And in my view this has sharpened the teeth of the anti-gold speculators, who have made increasingly large short sales, as well as the fears of some gold buyers who bought a hedge against something that hasn’t materialised. The global financial system still possesses a great deal of systemic corruption, banker greed and regulatory incompetence, and the potential for future financial crashes and blowups, so many gold bulls will remain undeterred. But with inflation low, and the trend arguably toward deflation (especially considering the shrinkage in M4 — all of that money the Fed printed is just a substitute for shrinkage in the money supply from the deflation of shadow finance!) gold is facing some strong headwinds.

And so a breakdown in the relationship between the monetary base has already occurred. Can it last? Well, that depends very much on individual and market psychology. If inflation stays low and inflation expectations stay low, then it is hard to see the market becoming significantly more bullish in the short or medium term, even in the context of high demand from China and India and BRIC central banks. The last time gold had a downturn like this, the market was depressed for twenty years. Of course, those years were marked by large-scale growth and great technological innovation. If new technologies — particularly in energy, for example if solar energy becomes cheaper than coal — enable a new period of spectacular growth like that which occurred during the last gold bear market, then gold is poised to fall dramatically relative to output.

But even if technology and innovation does not produce new organic growth, gold may not be poised for a return to gains. A new financial crisis would in the short term prove bearish for gold as funds and banks liquidate saleable assets like gold. Only high inflation and very negative real interest rates may prove capable of generating a significant upturn in gold. Some may say that individual, institutional and governmental debt loads are now so high that they can only be inflated away, but the possibility of restructuring also exists even in the absence of organic growth. A combination of strong organic growth and restructuring would likely prove deadly to gold.

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No! Currency Wars Are Not Good!

Matthew O’Brien claims that competitive debasement is good for the global economy:

Currency wars get a bad rap. The trouble starts with that second word. Wars, as we all know, are very bad. And a currency war — where countries compete to lower their exchange rate to boost their exports — reminds people of the kind of trade protectionism that killed some economies in the 1930s. But currency wars are the best kind of war. Nobody dies. Everybody can profit. In fact, currency wars didn’t contribute to the Great Depression. They ended it.

The downside of devaluation is that no country gains a real trade advantage, and weaker currencies means the prices of commodities like oil shoot. But — and here’s the really important part — devaluing means printing money. There isn’t enough money in the world. That’s the simple and true reason why the global economy fell into crisis and has been so slow to recover. It’s also the simple and true reason why the Great Depression was so devastating. We know from the 1930s that such competitive devaluation can turn things around.

The world needs more money. Currency wars create money. It’s time for policymakers to forget the wrong lessons from history, get competitive, and start pushing down their currencies.

Since the last recession every major central bank in the world has fluffed up its balance sheet with purchases, pushing out new money into the system, and driving down exchange rates. So we already have a currency war.

The most obvious point is that the last thing the global geopolitical system — already knotted and twisted — needs is more strain, or more abrasions, and to some degree a currency war could strain relations. The biggest players in the developing world — China, Brazil, Argentina, India — are already experiencing elevated inflation. China and Russia and Brazil have all recently expressed deep unease at America’s policy.

Under such conditions, is it not reasonable to foresee that greater competitive debasement might lead to a full-blown trade war? An easy means for developing nations to stanch the decline in dollar-denominated holdings (FOREX, Treasuries, etc) would be to constrain the flow of dollars coming into their nations. How might that be done? Export quotas, and capital controls. I have long been of the view that the hyper-productive Eurasian nations do not “need” American consumption when they already have a big enough dollar hoard to recycle in domestic and regional consumption. America’s real economy is not being sustained by The Fed (that is sustaining the financial system), but rather by the ongoing free flow of goods and resources and energy from the developing nations to America. That’s the main reason why America spends so much money policing the world, to keep global trade flowing, and goods flowing into America. America consumes far more than she produces in terms of energy, in terms of finished goods, and in terms of components.

Simply, America has enjoyed a humungous free lunch on the back of the dollar’s reserve currency status. Nations throughout the world were willing to trade out their productivity, their resources and their energy for dollars, the international medium of exchange. America could sit back and diversify out of domestic productivity and into unproductive but nominally-higher-yielding financial services, consultancy, communications and entertainment. But dollars are no longer in such short supply; America has traded trillions and billions of them away. So some nations appear to be asking: Why do we need dollars? Why should we subsidise the Americans, when our own people go without? And of course, the Eurasian ASEAN bloc — and all the various new bilateral currency agreements, where Eurasian nations have agreed to ditch the dollar, and instead trade in their respective national currencies — is growing precisely to further this end, to diminish the American economic hegemony, and end the American free lunch. A series of currency wars could very easily be the thing that pushes the system into chaos.

Can Bernanke Print Gold?

This week, I looked at America priced in gold — and noted that America is experiencing gold-denominated deflation. This means that when assets are priced in gold they have consistently fallen in price. Lets re-cap. Here’s the Dow Jones Industrial Average:

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