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Tuesday, March 29, 2011

Inflation, Deflation and Gold

The two charts above give as good a picture of the economy as you will find. The first is the money supply which is obviously exploding. For every dollar the Fed adds to the system, they create a dollar of debt.

How is that? Because the Fed adds money to the system by buying debt from the Treasury. The Treasury gives the debt to the banks (that own the Fed). The banks sell it to the Fed. The Fed puts electronic credits into a Treasury Account at the banks. The banks can then lend or gamble twelve times the amount in the account. Money floods the system.

According to the first chart this should be wildly inflationary. Austrian economics would predict that it must be. But it's not necessarily. Why?

Because in a productive economy the money will be lent to businesses that use it to expand, build, hire. This creates real economic activity. People are employed, earn money and spend it. This is how money multiplies through the system.

But look at chart 2. Money is not multiplying through the system. In fact, the opposite is occuring. As we explode the debt and flood the money supply, money is stagnating. This is highly deflationary.

Where then does all this money/debt go? It is gambled in the risk markets (including the stock market) by the banks. If they win their bets they award themselves huge bonuses. If not, the Fed takes the bet off their balance sheet and gives then banks more money to gamble:

This chart, of the S and P 500 has become an illustration of bank gambling. How do I know it's not a picture of a healthy economy? Return to chart 2. In a healthy economy money multiplies through the system. This is not rocket science. It is common sense.

What does all this mean for gold?

It means that inflationary push from the government and the deflationary pull from a stagnating economy loaded with debt will hold all assets in relative stasis until one force wins out over the other. If inflation wins, gold will rocket upward. If deflation wins, all assets will fall. The government will flood the system with new debt, and then gold will rocket upward.

Meanwhile, the only thing we know for sure is that the currency is being eroded by the ever increasing money/debt load. And gold trends steadily higher.

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