Our financial system, based as it is on high and rising leverage, low and falling rates, borrowing short to lend long, and financial engineering, has become very brittle.
Inflation, understood in this light, can pump up asset prices for a
while, and then cause a violent crash. Inflation directly undermines the
stability of the system. It has nothing to do with consumer prices. Though, at times, consumer prices can rise as a result of inflation.
There is a much more important dynamic than consumer inflation that we should consider for its role in the
formation of the gold price.
Let’s use Cyprus as a microcosm. Prior to
March 15, the average Cypriot thought of gold as an inflation hedge. He
may have felt that since prices weren’t rising that much, despite
unconventional monetary policy, it was not worth holding. Today, he is
regretting not having bought gold. Why? Because Cypriot banks defaulted,
and gold is as good as ever.
Again: I emphasize that the reason to own gold has nothing to do with
consumer prices. The problem with the system is that every financial
asset, except gold, is the liability of another party. Every one of them
is leveraging up in a desperate attempt to chase yield and keep
mismatching the duration of their funding to their assets, and their
assets consist increasingly of counterfeit credit. The probability of
default is rising. Gold is the only way to avoid risking default and
So who is pushing down the price of gold?
Everyone who thinks of his wealth in dollars, whose balance sheet
uses the dollar as numeraire, and especially, everyone who borrows
dollars to fund gold purchases is contributing to the unsustainable
spikes up and vicious crashes down that characterize the current market
for gold. And I have one other unpleasant thing to tell you:
Volatility will rise, as the financial system gets closer to the terminal phase!
If you think that $250 down in a week is painful, you can look
forward to $250 up or down in a day. Not necessarily this year, but it’s
Once most of the speculators are flushed, then other buyers can begin
to push up the price with their more steady—and
unleveraged—accumulation. Patient, and relentless, these people think of
their wealth in terms of gold. (THINK CHINA, INDIA, SOUTHEAST ASIA) They are the driver towards permanent
backwardation, as they are not motivated to sell by higher prices.