This article is based on an interview with Claudio Grass from Global Gold in Switzerland. He gave his view on the question why inflation seems low although excessive amounts of money have been created over the past years. He describes as well what that means for the gold price.
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 it’s “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 don’t 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. That’s 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. That’s 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 can’t 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 people’s 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 become 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. That’s really destroying the existing wealth through the back-door, reducing the purchasing power of paper money / currencies.
It doesn’t 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, it’s 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.