The economic landscape is puzzling, leaving many scratching their heads. Shouldn’t the substantial $4 trillion expansion of the Federal Reserve’s balance sheet over the past six years trigger price inflation? Connecting the dots seemingly leads to a simple conclusion: a surge in money supply accompanied by a limited supply of goods and services should logically drive prices higher. Consequently, it seems reasonable for individuals to consider selling dollars in favor of gold, guided by a solid rationale.
However, the world often defies logic. Unpredictable events can lead to outcomes that differ drastically from expectations. Taking a closer look, we see that gold’s price peaked at around $1,900 per ounce in 2011 but has since dropped to approximately $1,180, marking a decline of over 37 percent. What is driving this shift?
Currency Debasement
The U.S. dollar is currently gaining strength in international currency markets. The dollar index, which reflects its value against a basket of currencies, has reached a four-year high and may continue on this upward trajectory.
In recent years, the dollar prices of many commodities have seen significant declines. For instance, copper, which reached a peak of $4.40 per pound in 2011, has now fallen to around $3. Crude oil is also notably lower, priced at about $76 per barrel compared to its 2008 high of $146.
One reason for the dollar’s strength is the rapid debasement of currencies in other economies. In addition, the Federal Reserve has concluded its quantitative easing program and may begin increasing the federal funds rate as early as 2015.
“If all goes according to our forecast and the U.S. economy continues to make progress towards the Fed’s dual mandate goals of maximum sustainable employment and 2 percent inflation, the Federal Reserve is likely to raise its federal funds rate target off the zero lower bound sometime next year,” stated New York Fed President William Dudley during a recent gathering of central bankers in Paris. This stands in contrast to the monetary policies being adopted by Japan and the European Union.
For example, the Bank of Japan has significantly increased its quantitative easing efforts, pushing the yen to a seven-year low against the dollar. Similarly, the European Central Bank is expected to initiate its own quantitative easing measures in response to its struggling economy.
Hold On To Your Gold
A strong dollar, in its essence, tends to induce deflation. Contrarily, the Federal Reserve is aiming for an inflation rate of 2 percent or more. The Consumer Price Index (CPI), most recently reported through September 2014, showed an annual inflation rate of only 1.7 percent.
The upcoming CPI report for October will be published on Thursday, and it seems unlikely that the Fed will achieve its 2 percent goal. So, what actions will the Fed take in response? Will they risk allowing deflation to take hold?
It’s improbable that they would allow that to happen. The Fed is likely to employ every tool at its disposal to combat deflation. The stability of a credit-based financial system relies heavily on inflation to alleviate debt burdens and reduce the risk of widespread defaults.
Moreover, with all the artificial liquidity that has inflated stock prices over the past five years now being withdrawn from the system, a substantial decline in stock values could follow. Will the Fed allow the stock market to falter, or will they unleash a new wave of liquidity as they have whenever the market has faced challenges in the past eighteen years?
It’s our belief that the Fed will do whatever necessary to drive up stock prices, asset values, and consumer prices. In fact, this time they may consider even more unconventional measures. Instead of merely creating money to purchase debt, the Janet Yellen-led Fed might create liquidity to buy stocks outright, or even credit individuals’ bank accounts directly.
While this may seem far-fetched, we’ve seen bold moves before. Therefore, it’s wise to hold on to your gold.
Sincerely,
MN Gordon
for Economic Prism
