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Gadfly, long-term horizon, macro, gold
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Summary

  • In spite of the Fed's almost humorous self-confidence, price inflation seems to be on its way even without significant GDP or employment progress.
  • Unless our money managers change identity or miraculously find wisdom, this Keynesian experiment with fiat money will eventually come to a bitter end.
  • Historically, financial claims on current goods production and services, gold, and contracts related directly to these items are the only monies that have not eventually led economies into self-destruction.

I have become impatient over the last few years with the incredible slowness of the dénouement, i.e. the final act of this Great Keynesian Experiment directed by the Federal Reserve Board that began shortly after the Board's inception in 1913.

Following the prescription of the Keynesian school of economics, the Fed has now pumped up the money supply to record proportions in an attempt to drive up GDP and labor-force figures. Yet their method isn't working. The money so urgently created isn't even getting into the economy. Rather, it is sitting on a park bench in bank reserves at the Fed. (See this Cato paper for an analysis of why; adjusted M2 is at $11.280 trillion, according to the latest Fed figures, and bank reserves are at $2.658 trillion.)

Over the last few years, and given my lack of faith in Keynesian tinkering with the money supply based on my study of monetary history, I have foretold an approaching conundrum wherein the Fed governors will observe an unexpected combination of stagnating GDP/work force figures and foreboding signs of rising prices. (See my previous Seeking Alpha articles as well as some of my blog posts here.)

If this were to happen the way it has happened every other time in history when governments have debased the currency and if the tools at the Fed's disposal (which have never been tried) don't work as expected, the overconfident maestros might soon be asking themselves, "How can this be? Why isn't the economy progressing as we told it to? How can we raise interest rates now with things moving so slowly? Would this not endanger growth? Where have we gone wrong?" (Okay, forget that last one; it's way too out-of-character.)

I now see signs that a conundrum is indeed approaching. Already a couple of blogs ago I gave readers the results of my personal M&M inflation index according to which prices are going up, seemingly in spite of the official CPI numbers. And another gadfly ear-to-the-ground piece of data: last February my plumber told me that he and his ilk were very happy to note (I'm not sure how) that they were going to be able to raise their prices during 2014. I was dubious at the time, and yet my own M&M index seemed to confirm his prognostication.

Well, lo and behold, the moment appears finally to be arriving, according to this article. Food prices, the canary in the coal mine as far as the CPI is concerned, are soon going up, and drastically. Of course the powers that be will blame it on the California drought or the Texas and Oklahoma droughts or some other "unusual" phenomena, as though these situations have never happened before. But they have happened before. In fact they happen all the time in the normal cycle of business.

So we seem to be heading towards a rise in the CPI, which is an index that the Fed observes closely. Will our confident Board governors be able to control the movement of our money supply (including what the economists call its "velocity") once the price moves start to occur and prove to be more than temporary? Will the stock market correct at the first sign of serious trouble? Will US treasury bonds retain their luster no matter what the Fed decides to do? Will gold--the true barometer of all world currencies' "moneyness"--move up or down relative to the dollar?

The American stock market and treasury bonds are probably going to be pretty resilient at first, given the US's current status as the Momma to whom one runs when things get tough outside. But the other two questions are the more interesting.

Gold, at various periods of history until the early 1970s, was popularly and officially considered to be money, or at least a monetary anchor. It was used as a reserve in what was a very sound commercial banking system for over a hundred years until the early 20th century, and it has circulated as currency for long and relatively stable periods. Now that gold has been removed from any official link to any modern currency, it has nonetheless become the barometer sine qua non of the extent of government tinkering with the purchasing power of our money.

At first gold may move down relative to the dollar when some players in that market bet the Fed will make a money-tightening move. But the next question is, will the Fed succeed? Or more importantly, will it appear to succeed (since actual success is less important in this fiat world than its appearance)?

The Fed most likely will not dare to raise interest rates now that their representatives have pretty much promised not to. This lack of courage in itself will be counterproductive, but the Fed doesn't seem to be aware of this. So at some point their actions, whatever they will be, will seem ineffective.

At that moment, will the world perceive the Fed's startled but well masked incredulity as things get out of control? Or will investors decide that most people are too dumb to see the precarious reality under the mirage of security the Fed will try to exude? Or again, will the market assume (perhaps correctly, albeit until proven otherwise) that the US remains the only game in town no matter what happens to the CPI, GDP, unemployment, Fed decisions, or its interest rates?

What is certain is that the outcome of this particular episode of the Great Keynesian Experiment just may be the dénouement of the long-standing argument between two camps: the Keynesians such as Paul Krugman; and the anti-Keynesians such as Steve Forbes, Edward C. Harwood, and myself who tend to believe that gold is money and that fiddling with fiat replacements are doomed to failure--sometimes even catastrophic ones--in the long run.

And if, much to my exasperation, this time around is just another episode in this interminable play, the final act will simply be put off for another turmultuous day.

Source: Let The Party Begin (And Watch The Mounting Fear In The Fed Chairman's Eyes As The CPI Rises)