by James G. Rickards
01-Oct (DailyReckoning) — One of the conundrums of monetary policy over the past eight years is the Federal Reserve’s failure to cause inflation. This sounds strange to most. People associate inflation with misguided monetary policy by central banks, especially the Fed.
So-called “money printing” is seen as a certain path to inflation. The Fed has printed almost $4 trillion since 2008. Yet inflation (at least as measured by official statistics) is barely noticeable. With so much money around, where’s the inflation?
This conundrum has several answers. The first is that the Fed has been printing money, but few are lending it or spending it. The banks don’t want to make loans, and consumers don’t want to borrow.
In fact, the private sector on the whole has been deleveraging — selling off assets and paying off debt — even as public debt expands. The speed at which consumers spend money (technically called velocity) has been sinking like a stone.
…These deflationary tendencies create a major policy problem for the Fed. Governments need to cause inflation in order to reduce the real value of government debt. Inflation also increases nominal (if not real) incomes. These nominal increases can be taxed.
Persistent deflation will increase the value of debt and decrease tax revenues in ways that can cause governments to go bankrupt. Governments are therefore champions of inflation and rely on central banks to cause it.
…A central bank’s worst nightmare is when they want inflation and can’t get it. The Fed’s tricks have all failed. Is there another rabbit in the hat?
Actually, yes. The Fed can cause massive inflation in 15 minutes. They can call a board meeting, vote on a new policy, walk outside and announce to the world that effective immediately, the price of gold is $5,000 per ounce.
…Of course, the point of $5,000 gold is not to reward gold investors. The point is to cause a generalized increase in the price level. A rise in the price of gold from $1,000 per ounce to $5,000 per ounce is really an 80% devaluation of the dollar when measured in the quantity of gold that one dollar can buy.
This 80% devaluation of the dollar against gold will cause all other dollar prices to rise also. Oil would be $400 per barrel, gas would be $10.00 per gallon at the pump and so on. There it is — massive inflation in 15 minutes: the time it takes to vote on the new policy.
Don’t think this is possible? It has happened in the U.S. twice in the past 80 years. You may even know some people who lived through both episodes.
…This makes gold the ultimate “all weather” asset class. Gold goes up in extreme inflation and extreme deflation. Very few asset classes work well in both states of the world. Since both inflation and deflation are possibilities today, gold belongs in every portfolio as protection against these extremes.
PG View: I agree with Jim, the Fed will eventually get the inflation they so desperately desire. To what extent they will go to achieve that end remains to be seen. However, when it happens, you’re going to want to be prepared. The best way to preserve the wealth you’ve already accumulated is to dedicate at least a portion of your savings to physical gold.