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Prices Are Set to Soar
“Government,” observed the great Austrian economist Ludwig von Mises, “is the only institution that can take a valuable commodity like paper and make it worthless by applying ink.”
Mises was describing the curse of inflation, the process whereby government expands a nation’s money supply and thereby erodes the value of each monetary unit—dollar, peso, pound, franc, or whatever. It shows up in various ways, most visibly in the form of rising prices, which a lot of people confuse as the inflation itself. The distinction is important because, as economist Percy Greaves once explained so eloquently, “Changing the definition changes the responsibility.”
Define inflation as rising prices and you’ll think that oil sheiks or private businesses are the culprits, and price controls are the answer. Define inflation in the classic fashion as an increase in the supply of money, with rising prices as just one consequence, and you then have to ask the revealing question, “Who increases the money supply?” Only one outfit can do that legally; all others are called “counterfeiters” and go to jail.
So, it’s critically important to remember that inflation is not rising prices. Inflation is an increase in the money supply. Rising prices are just one of the effects of that.
Why do governments inflate? They all share one thing in common: an insatiable appetite for revenue. For both political and economic reasons, taxing and borrowing have limitations. But if you also have a monopoly over money creation, that becomes a third option for the monopolist. Anybody who thinks that politicians who possess such power will not abuse it is smoking some really bad weed.
Before paper money, governments inflated by reducing the precious-metal content of their coinage. The ancient prophet Isaiah reprimanded the Israelites with these words: “Thy silver has become dross, thy wine mixed with water.” Roman emperors repeatedly melted down the silver denarius and added junk metals until the denarius was less than 1 percent silver. The Saracens of Spain clipped the edges of their coins so they could mint more until the coins became too small to circulate.
Paper money originated in China in the 7th Century A.D. but for centuries wherever it was adopted, it tended to be a receipt for the real thing, namely, gold and/or silver. Then kings and queens realized they could print paper money, strip it of its redeemability into precious metal, and force it upon their people. The last 300 years of monetary history is riddled with paper hyperinflations that produced skyrocketing prices and economic disaster. Bolivia and Zimbabwe are among the countries that destroyed their own paper monies twice all within my own lifetime.
Rising prices are not the only consequence of ballooning the money supply. Inflation also erodes savings and encourages debt. It undermines confidence and deters investment. It destabilizes the economy by fostering booms and busts. If it’s bad enough, it can even wipe out the very government responsible for it in the first place. It can lead to even worse afflictions. Hitler and Napoleon both rose to power in part because of the chaos of runaway inflations.
In our age, inflation of the money supply has taken a different and more sophisticated form than coin clipping or simple paper printing. With precious metal “backing” removed to accommodate reckless spending, governments still print a lot of paper money and they mint a lot of junk-metal coinage. But today, inflation (properly defined) is primarily in the form of credit expansion orchestrated by central banks like the Federal Reserve. It lowers interest rates for a time, but the resulting increase in purchasing power eventually pushes up both prices and interest rates.
In the wake of the 9/11 terrorist attacks on New York and Washington, the Federal Reserve embarked upon years of monetary growth and dirt-cheap interest rates. Much of the new money and credit worked its way into real estate because of regulations aimed at boosting home ownership. That deadly combination of easy money and misallocation of resources into insanely cheap mortgages produced a bubble. When the Fed reversed itself and jacked up interest rates in 2007-08, the bubble burst and produced the stock market crash and Great Recession of 2008-09.
For more than a decade now, the Fed has been flooding the economy with liquidity. Many people have been puzzled that years of easy money and low interest rates have not produced soaring consumer prices, but that was explained recently by economists John Greenwood and Steve H. Hanke. In their February 22, 2021 op-ed in The Wall Street Journal, titled “The Money Boom is Already Here,” they wrote:
After that crisis [of 2008], the Fed began quantitative easing, which massively expanded its balance sheet. At the same time, commercial banks were busy shrinking their loan books from mortgage debt and securities, which meant the Fed’s injections did little more than offset the contraction of commercial bank balance sheets. As a result, money growth from 2010-19, as measured by the Fed’s broadest money measure, M2, averaged only 5.8% a year.
While money on the Fed’s books grew rapidly, money in the hands of the public grew more slowly. Spending and inflation were restrained, and the postcrisis recovery was anemic, with [price] inflation persistently below the Fed’s target.
The extended period of price tranquility may now be ending. Signs of a bubble in the stock, commodity, cryptocurrency and real estate markets are reappearing. Consumer prices are ticking up. And the reason why none of this should be surprising is to be found in this revealing paragraph in the same op-ed by Greenwood and Hanke:
Fast-forward to February 2020. Since then, the quantity of money in the U.S. economy, measured by M2, has increased by an astonishing $4 trillion. That’s a one-year increase of 26%–the largest annual percentage increase since 1943.
As COVID restrictions lift in coming weeks and months, demand for goods and services will rebound, at least for a while. Powered by all the funny money sloshing around in the system, pressure for producer and consumer prices to rise will come to a boil. I’m betting that well before the Biden administration completes a term, we’ll see annual rates of price increases in double digits, accompanied by rising interest rates, to be followed once again by another painful economic correction.
When all this happens, we’ll look back and note that nothing really ever changed. Only the numbers and the magnitudes got bigger. It took a while for easy money to blow prices up, longer than most economists expected. But ultimately, the laws of economics cannot be repealed by any mortal, not even presumptuous politicians and planners in government.
I think that’s a lesson we should never have forgotten. We are about to learn it all over again, and it’s not going to be pretty.
Welcome to this week’s Market Wrap Podcast, I’m Mike Gleason.
Gold and silver markets gyrated up and down following the Federal Reserve’s policy meeting on Wednesday.
Fed chairman Jay Powell recommitted to keeping the central bank’s benchmark funds rate near zero. This, even as surging bond yields seem to be sending a market signal that rates need to move higher across the board.
Fed policymakers are insisting they won’t hike rates at all this year and most likely not in 2022, either. Powell vowed that accommodative monetary policy will remain in force until the Fed sees official inflation rates persist above 2% over an unspecified period of time – likely well into 2023.
Jerome Powell: With regard to interest rates, we continue to expect it will be appropriate to maintain the current 0 to 0.25% target range for the Federal funds rate until labor market conditions have reached levels consistent with the committee’s assessment of maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time. I would note that a transitory rise in inflation above 2%, as seems likely to occur this year, would not meet this standard. The median inflation projection of FOMC participants is 2.4% this year and declines to 2% next year before moving back up by the end of 2023.
Investors received Powell’s comments as dovish. But he offered up no specific program to tame the bond market. Bond yields continued to rise on Thursday, triggering something of a breaking point for some stocks and commodities.
The Nasdaq sold off hard yesterday, as did crude oil and other raw materials. Precious metals markets, meanwhile, held up relatively better.
As of this Friday morning recording, the gold market is posting a weekly gain of 0.5% to bring spot prices to $1,743 an ounce. Silver is up 0.7% since last Friday’s close to trade at $26.29 per ounce. Platinum checks in at $1,200 and is down by 1.5% so far this week. And finally, palladium is powering up with an 11.1% surge for the week to command $2,674 per ounce.
The impressive move in palladium represents a breakout from a trading range that had been in force for several months. A new all-time high is likely just ahead.
Will gold and silver markets follow palladium’s lead? Or will they succumb to pressure from rising rates and a breakdown in crude oil and other commodities?
Technically, gold remains oversold and has plenty of room to rally if a flight from equities triggers safe-haven buying. The other trigger which may coincide with a gold rally is a relief rally in the bond market.
Treasury bonds have suffered their worst drawdown in years. And while Treasuries may continue to be a poor investment long term, there is too much at stake for too many powerful invertors to let yields continue spiking.
After all, the government’s debt management strategy depends on being able to issue trillions of dollars in bonds at negative real rates – a strategy that also happens to be a primary driver of higher gold prices.
As for silver, it has the potential to soon break out above its 50-day moving average. It ran into resistance there multiple times this week. Once that line is broken, silver could “do a palladium” and quickly race up to the $30 level and beyond.
Yes, a silver squeeze could still play out. The idea of forcing the large institutional short sellers in the silver futures market to capitulate remains a hot topic on some corners of the internet.
But silver and hard assets in general continue to be overshadowed by internet-fueled crazes in stocks such as GameStop and cryptocurrencies such as Bitcoin.
The latest speculative buying frenzy is occurring via a new blockchain vehicle for trading digital assets. They’re called non-fungible tokens, or NFTs.
NFTs are essentially digital collectibles – art, video clips, tweets, and the like. The strange thing is that some are selling for millions of dollars despite conferring no actual intellectual property rights. They are literally just tokens linked to various digital creations.
The NFT craze is certainly a sign of the times. So much newly created cash is sloshing around that assets are being invented out of nothing for it to buy. And so many people live so much of their lives online that they seem to have lost the ability to distinguish a real asset from a virtual asset.
But perhaps some are learning or re-learning basic lessons in economics – such as what a fungible asset is.
Fungibility refers to being interchangeable and divisible in any amount. For example, gold is said to be fungible since any troy ounce of the precious metal carries the same value as any other troy ounce.
Generally, any gold bullion bar regardless of its mint mark will be worth the same as any other bullion bar of the same size.
Coins such as American Eagles can be worth a bit more than other coins or rounds of the same size. But the gold content itself is fungible and still determines the bulk of any bullion coin’s value.
Coins with historic or collectible properties that can be valued more highly than the actual metal content are non-fungible. Their value is individually unique depending upon subjective numismatic criteria such as condition.
Non-fungible numismatic coins tend to carry large bid/ask spreads. And it can be difficult to know whether you’re getting a fair price when buying or selling. These specialty products often attract scam artists who aim to profit from deception.
Owning fungible gold and silver bullion gives you liquidity similar to cash since precious metals are widely recognized and traded everywhere in the world. And their value will endure long after any online fads have fizzled.
Well, that will do it for this week. Be sure to check back next Friday for our next Weekly Market Wrap Podcast. Until then this has been Mike Gleason with Money Metals Exchange, thanks for listening and have a great weekend everybody.