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Welcome to USAGOLD's "Gilded Opinion" pages. We invite you to browse our index of outstanding gold-based commentary. Each article or essay is selected on the basis of its long-term relevance for understanding the role gold plays in the individual's portfolio, the overall political economy, or both.
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Exploding Inflation
by Adam Hamilton
"When the inevitable consequences of inflation appear and prices soar, [people] think that commodities are becoming dearer and fail to see that money is getting cheaper. In the early stages of an inflation only a few people discern what is going on, manage their business affairs in accordance with this insight, and deliberately aim at reaping inflation gains. The overwhelming majority are too dull to grasp a correct interpretation of the situation. They go on in the routine they acquired in noninflationary periods. Filled with indignation, they attack those who are quicker to apprehend the real causes of the agitation of the market as "profiteers" and lay the blame for their own plight on them. This ignorance of the public is the indispensable basis of the inflationary policy." -- Dr. Ludwig von Mises, The Theory of Money and Credit, Chapter 21, 1912.
Ludwig
Heinrich Edler von Mises was born on September 29, 1881 in the
city of Lemberg, then part of the Austro-Hungarian Empire. The
son of a distinguished construction engineer working for the Austrian
railroads, Ludwig von Mises would grow into a living legend, becoming
arguably the most important and influential free-market economist
in world history. Ludwig von Mises was a tireless champion of
free markets and individual initiative, and an arch nemesis of
socialism and government interventionism. Although Mises passed
away in 1973 at the full age of 92, the wealth of economic work
he completed in his lifetime will be a priceless treasure for
all of humanity as long as free men engage in commerce.
Ronald Reagan, former President of the United States and another
outspoken champion of freedom and liberty and mortal enemy of
socialism, had these glowing words of praise for Mises, "Ludwig
von Mises was one of the greatest economic thinkers in the history
of Western Civilization. Through his seminal works, he rekindled
the flames of liberty. As a wise and kindly mentor, he encourages
all who sought to understand the meaning of freedom. We owe him
an incalculable debt."
Ludwig von Mises' phenomenally brilliant contributions to the
science of economics cannot be overstated. He was one of those
rare truly remarkable men who has left an indelible mark on history.
He is a hero to all those who crave freedom and liberty, and loathe
market manipulation and the rise of bloated, monolithic, and intrusive
governments.
Mises was studying at the University of Vienna during the height
of the great "Austrian School" of economics, and he
became its greatest proponent. Austrian economics was a triumph
over the rotten doctrines of classical economics, which centered
around the concept of class warfare, ideologically pitting the
employees against the providers of capital.
The virulent ideas of classical economics (which have now evolved
into Keynesian economics) inspired Karl Marx to write the Communist
Manifesto in 1848. The hate, misery, and destruction that sprung
from Socialism and Communism (a Communist is simply a Socialist
with a gun in a hurry) in the twentieth century is mind-boggling
and beyond comprehension. The classical economics of class warfare
bore some incredibly bitter and dangerous fruit.
The Austrian school of economics, in contrast to the dark and
sad deceptions of Classical and Keynesian economic theories that
lead to Communism and Socialism, extols the individual and his
or her individual decisions in the economy. Individuals, acting in their own self-interest,
make decisions of how and where they will spend their resources,
and these virtually infinite individual decisions collectively
become a free-market economy.
A free-market economy is the ultimate self-balancing machine.
Adam Smith's wonderful "invisible hand" concept demonstrates
that surpluses and shortages are quickly remedied in the free
markets by a change in the market price of an imbalanced good
or service to re-establish market clearing equilibrium.
Ludwig von Mises became the widely recognized godfather of the
Austrian economics philosophy. The first time one comes across
Austrian economic thoughts after wallowing in the usual pro-Keynesian
and pro-Socialist university curricula (read Leftist propaganda),
it is like a breath of fresh air or a brilliant crystal sunbeam
penetrating a dark room. Ludwig von Mises and the other great
Austrian economists exposed all the myriads of falsehoods of classical
economic thought and concentrated on the individual and the free
market.
One of the pillars of Austrian economics is the relation of the
money supply to the general price of goods and services. Money
is a medium of exchange, and everything is priced in terms of
money. An understanding of money is absolutely critical to truly
understand the concept of "inflation".
Today,
as we watch bubblevision and the mainstream media, it is readily
apparent that the popular definition of inflation is rising prices.
This definition is at best incomplete and at worse a dangerous
deception.
Due to this faulty understanding of inflation today, as well as
cooked CPI numbers watered down with arcane statistical smoke
and mirrors called hedonics (see our earlier essay Lies, Damn Lies, and CPI for an explanation
of this farce), there is a general consensus that we live in a
virtually inflation free era. In this essay, we build on the timeless
truths Mises presented in "The Theory of Money and Credit"
and look at current data from the United States Federal Reserve
to attempt to refute the common fantasy that inflation is largely
dead.
Like anything, the only way to study inflation is to understand
what it truly is. Inflation, as the Austrian economists including
Ludwig von Mises have recognized all along, is really a product
purely of money supply, nothing else.
Inflation, in the true sense of the word, is an increase in general
price levels that comes into existence when relatively more money
is injected into an economy than new goods and services injected
into that same economy. The supply of money defines inflation,
per Mises and the Austrian school of economics. Although one would
not realize this by following the mainstream media drivel, this
Austrian definition of inflation is correct and true, and is not
a radical idea. Webster's massive current unabridged dictionary
defines inflation as "a persistent, substantial rise in the
general level of prices related to an increase in the volume of
money and resulting in the loss of value of currency."
The key to understanding inflation is it is a MONETARY phenomenon,
not a supply/demand imbalance in a commodity. The energy markets
of the last two years, for instance, are widely thought to be
inflation. This thought is incorrect. Oil and natural gas demand
has simply been higher than supply, so prices rose in order to
re-establish a market-clearing equilibrium price and eliminate
the supply and demand imbalance. Monetary inflation no doubt contributed
slightly to these energy price increases, but the primary reason
energy prices have been rising is growing demand outstripping
dwindling supply.
In a relatively closed system, it is easy to understand how true
inflation, monetary inflation, occurs. One excellent example centers
around the North Slope of Alaska when the oil boom occurred a
few decades ago. Before the oil, prices in towns such as Point
Barrow were fairly normal, although a bit higher than prices in
the US due to the logistical difficulties of transporting food
and supplies through the Arctic Ocean that is frozen the majority
of the year. As soon as the oil money began pouring into the North
Slope area, prices of goods and services began to skyrocket.
All of a sudden a relatively closed community had a massive influx
of new money paid to oil workers. When more currency chases the
same amount of goods, prices rise. Money becomes less dear and
folks are willing to offer more money for a given good or service.
A hamburger that cost a dollar before the oil boom in Point Barrow
probably cost 25 times as much after the oil money hit the community.
Prices of other goods and services rose by a similar amount, as
the deluge of fresh money sloshed through the Alaskan economy.
Relatively more money chasing a finite supply of goods and services
virtually ALWAYS produces inflation!
If we zoom out to a macro level and view a nation state, the same
fundamental basics apply. When the money supply grows rapidly
and goods and services offered do not keep up, inflation is the
result.
There are many fabulous examples of this phenomenon throughout
history, including Germany after the First World War. One of the
most entertaining ones surrounds the British rogue John Law in
the early 1700s. John Law was forced to flee England in order
to avoid prosecution for some alleged crimes. He traveled around
Europe and eventually settled in France, where his powerful personality,
incredible mind, and command presence ultimately brought him to
the attention of the King of France.
Law convinced the King and the French monetary authorities that
in order to have a perpetual business boom, all they needed to
do was print enough fiat currency so that business was assured
of having access to the capital it needed. Law stated that a stable
gold-backed currency, which by its very nature stops meddlesome
government bureaucrats from living beyond their means, was too
archaic and far inferior to his new fiat currency theme. He assured
the French ruling class that because the government would print
money when more was needed and buy it back when there was a surplus
of money, that there would not be inflation and business would
have the optimum amount of capital to thrive. Unfortunately, the
French powers that be bought into Law's inflationist plan and
executed the necessary monetary policy to make it happen.
Initially, Law's plan seemed to be working brilliantly. In the
1720s, France experienced an incredible boom as vast amounts of
new fiat capital flowed into the existing markets. Prosperity
seemed to be everywhere, and the French stock market was exploding.
Soon, ordinary folks were quitting their jobs to hang out on the
street where securities were traded and they became day traders.
Charles Mackay reports in his 1841 magnum opus "Extraordinary
Popular Delusions and the Madness of Crowds" that one
deformed hunch-backed man made large amounts of money renting
out his slumped back as a mobile writing table for the frenzied
stock jobbers buying and selling French equities on the street!
The wild stories that came out of this particular mania are endlessly
fascinating!
John Law became the most famous and loved man in France, accruing
enormous wealth for himself.
He then convinced the French government to join him in forming
a company to develop the fabled wealth of the Mississippi River,
of which the French controlled the gateway with their colony of
New Orleans. The Mississippi company was floated and everyone
in France wanted to own shares of this hot new IPO. They were
convinced that they would be able to retire in a year or two because
of the legendary wealth that the Mississippi company would generate.
Like hungry sharks boiling around a wounded whale, the people
of France started a bidding war that propelled the Mississippi
company stock and other French equities to dazzling heights.
Of course, since France was printing inherently worthless fiat
money with both hands, the prices of everything in France were
rising dramatically. Gresham's Law, the timeless axiom that bad
money drives good money out of circulation, came into full effect.
Gold coins were hoarded and smuggled out of France, and paper
fiat currency was spent as rapidly as it was received. Eventually
the gold hemorrhage became so bad that the French government,
on John Law's advice, outlawed gold.
In the meantime, like all exponential parabolic manias, the French
bubble soon collapsed. The aftermath of the disastrous inflationary
policy of creating money out of nothing was brutal, and the Mississippi
Scheme is one of the most widely studied speculative manias and
bubbles in all of history. The country of France and the French
people bore the consequences of this monetary inflationary nightmare
for decades, and some would argue France has never regained the
prominence it had before the greatest inflationist of all time,
John Law, took the reigns.
The man whom kings used to wait to consult was widely known as
the "eldest son of Satan" in France after the bitter
fruit of rampant fiat monetary expansion became apparent. Provocatively,
reading accounts of the Mississippi Mania in France and its sister
South Sea Bubble in England, which arose at the same time, is
eerie in that the parallels with the US NASDAQ tech bubble of
early last year are startling and profound. The lessons of history
are never learned by governments and they continually repeat these
same mistakes.
With Mises and the Austrian economists' true definition of inflation
in mind -- a disproportionate increase in the money supply --
let's review the US money supply to determine if the popular pundits
are right that there is no inflation in America at the moment.
The following graphs focus on the broad US M3 money supply. The
first graph is from 2000 to the present. The red columns represent
the 4 week rate of change in the money supply, annualized so the
percentages are meaningful. Weekly M3 data direct from the US
Federal Reserve was used to populate all the graphs in this essay.
The dashed green line is the linear trend of each graph, and the
solid blue line is a 25 week moving average of the 4 week rate
of change.
With all the propaganda of no inflation in the States, one would
expect money supply growth that was only slightly higher than
the growth rate of GDP, say a few percent, right?
Ominously,
the AVERAGE growth rate in the M3 money supply since early 2000
has been an astounding 6.7%! This is quite amazing because the
GDP grew by a fraction of that, and was rapidly slowing down to
around 2.4% in the last quarter of 2000. Both Alan Greenspan and
Bush's new SecTreas Paul O'Neill have alluded to ZERO growth in
the US economy so far in 2001, so there is no doubt the economy
is still slowing and is possibly recessionary already.
Even more incredible, however, the piece de resistance of the
graph is the MASSIVE spike in M3 growth that was unleashed like
a tidal wave on an unsuspecting beachside resort in late December
and early 2000. This Mt. Everest of US monetary growth is marked
by the yellow arrow and question mark, as if it doesn't already
stand out like a central banker at a Ralph Nader rally!
A 20% annual growth rate in the money supply is NOT what one would
expect from the world's primary economy. Growth like that is more
in line with third world banana republics. Since the two 20%+
growth rate weeks in late December, M3 is still growing at a dizzying
11% to 13%. The really important question becomes WHY? Have Greenspan
and the Fed gone mad? What are the implications for near-future
inflation in America?
Before we muse a bit on those important questions, it is helpful
to obtain a broader more strategic perspective. How often do 20%+
spikes in M3 growth rates occur in modern history? First, we will
take a look at the same dataset from 1995 to the present. The
same conventions used in the previous graph apply
One
other similar spike is immediately evident in late 1999. The second
to the last week of that year witnessed a 19.9% M3 growth rate,
and the final week saw 22.1%. This, of course, was liquidity which
Greenspan and crew injected into the economy due to Y2k concerns.
Notice the Y2k spike was nowhere near as wide and sustained as
the present M3 orgy. From the graph alone, it is readily apparent
that the reasons for the current Fed goosing of M3 must be more
compelling than Y2k. Take a second to think about that!
Regardless of your thoughts on Y2k then or now, you have to admit
that there was a LOT of fear and uncertainty surrounding the date
changeover. The current M3 spike makes the Y2k capital injection
look as skinny as if it was living through a famine!
Note that the average growth rate of the M3 money supply for that
six year period was above 6%, FAR exceeding the growth of the
US economy as measured by GDP in the same period of time.
If unrestrained money growth causes inflation, the question should
be asked why didn't we see dramatic inflation since 1995? Actually,
the US DID witness massive inflation since 1995. Instead of inflation
of goods and services, however, all this excess capital deluged
into the US equity markets. Take a look at a ten year S&P
500 or DJIA chart and it is crystal clear that the US equity markets
have gone ballistic since 1995. The Y2k spike in the M3 growth
rate noted in the graph above was directly responsible for the
parabolic blow-off of the NASDAQ in early 2000. Much of that excess
fiat money created by the Fed for Y2k bid up the already stratospheric
NASDAQ to nosebleed valuations, immediately before it crashed.
As John Law and the French government created the excess fiat
currency that bid up the Mississippi scheme in France in the 1720s
until it exploded, Alan Greenspan and the US Fed created the massive
fiat capital excess, apparently for Y2k reasons, that forced the
NASDAQ into its terminal trajectory.
Zooming out even further, let's look at the M3 growth rate since
1990
Wow!
The fiat money excesses of 1995 to present and especially the
current M3 mega-spike REALLY stand out with an eleven year longview!
Interestingly, from 1990 to late 1994-early 1995, the 25 week
moving average of the M3 growth rate (blue line) was relatively
flat, hovering slightly above zero. At the midpoint in the graph,
however, M3 growth literally exploded, slamming through 5% like
an armor piercing bullet through plywood and rapidly approaching
10%. The Y2k spike and the current rampant fiat expansion look
far more suspicious and anomalous with this longer-term perspective.
The Y2k
spike is understandable at least, in light of the information
available at the time, but why the heck is the Fed inflating at
banana republic rates RIGHT NOW?
A final extended look at the same data series is in order, from
1981 to the present
One
other mega-spike in M3 is apparent in 1984. Although it only lasted
two weeks, M3 growth rates shot up to 28.5% and 26% in March 1984,
off the scale of this graph. We do not know why this M3 spurt
happened in 1984, and do not recall any extremely noteworthy events
surrounding that month. Nevertheless, with only three episodes
of 20%+ M3 growth rates in 20 years, it is quite obvious that
they are NOT common and should be carefully investigated when
they occur.
Looking at the blue 25 week moving average line, notice the parallels
in the average level of M3 growth between the early 1980s and
the late 1990s. In the early 1980s, everyone KNEW we were in an
inflationary environment virtually no one disputed the fact. During
those times, the excess money was flowing into commodities and
goods and services instead of financial assets. TODAY, the M3
growth rates are trending up and rapidly approaching 1980s benchmarks,
yet most people and professionals today live in a Utopian fantasyland
where inflation does not exist -- what a joke!
If Ludwig von Mises was around to look at these graphs, we are
positive he would say that they are a harbinger of much higher
inflation in the near future. The gobs of fiat money created out
of nothing by the wizards at the Fed have to go somewhere, and
when it sloshes into its new home, prices will rise as more money
chases relatively fewer goods and services. This law of economics
is as immutable as gravity in physics, and it cannot be defied.
Now, back to the million-dollar question WHY?
The latest M3 spike surrounds the unprecedented (in Greenspan's
"gradualist" career) 100 basis point interest rate slash
and burn of January 2001. Greenspan and the Fed were obviously
terrified that something appalling would happen if they did not
goose the money supply and annihilate short-term lending rates
to re-liquefy the economy. Whether the unseen specter is the California
energy regulatory scheme blowing-up in the socialist regulators'
faces, some yet unknown derivatives disaster ala LTCM, or a systemic
problem with the ultra-fragile US fractional reserve banking system,
something IS definitely up.
The exploding money supply coupled with the emergency rate cuts
are a very persuasive sign that the Federal Reserve is well into
panic mode, and it probably has little to do with the imploding
NASDAQ bubble.
All the mountains of new fiat capital being created by the Fed
have to find their way somewhere, and no doubt Greenspan stays
up at night sweating and praying that the new money seeks out
the US equity markets instead of goods and services. Odds are, however, since
the US equity markets are listing badly and foreign capital is
fleeing the falling dollar, that the new money the Fed is pumping
out at fantastic rates will soon become highly inflationary in
the important goods and services of the general economy, and financial
assets will continue to crumble.
M3 is exploding. Inflation will be exploding. The legendary Mises
would no doubt shake his head in disgust at the inflationary policies
the US Fed is knowingly undertaking in a desperate attempt to
slow the rapidly unwinding excesses of the Kondratieff bubble.
Greenspan and the US Fed have apparently embarked on an inflationist
course that John Law would be proud of Position your assets accordingly!
by Adam Hamilton, CPA, MCSE
February 9, 2001
Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing delivered from an explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for more information.
Copyright 2001 Zeal Research. All Rights Reserved.
Reprinted by USAGOLD with permission of Adam Hamilton. No further reproduction without permission.
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