Wednesday, January 13, 2010

The Origin Is Gold

How can inflation and deflation occur simultaneously? It all comes down to how you define your terms, like saying down is up and putting up to down, then you can easily go up a down staircase and never see the inflation you are drowning in.

One definition of inflation is an increase in the money supply. The more dollars in circulation less each dollar is worth. There is no guarantee that prices will go up, but a natural consequence of more money in circulation is that the purchasing power of each dollar is diminished, holding all other variables fixed. So, let's use the consequence as our definition of inflation. Inflation will be a decrease in the purchasing power of the dollar.

Now prices may go up at or down regardless of an increase or decrease of the money supply, but what's missing in the current inflation deflation debate is that inflation is so defined has been raging for at least the past decade. You need only take a look at the chart of gold going from roughly $400 an ounce to over $1100 an ounce in that time. This marks a serious debasement of the currency regardless of which way prices move. Why?

Gold is the fixed origin against which all other currencies move. It is not that is gold is not a getting more expensive in US dollars, but the dollar is becoming worthless in absolute terms, i.e. in the gold standard. That is the purchasing power of each dollar is diminished. The result would be exactly the same as if more money were put into circulation. So, regardless of which way the cross currents blow prices each dollar is worth less, much less than it was a decade ago.

Now don't let Mish's academic definitions of inflation tied to the credit markets and complex derivatives mislead you. Take a good long hard look at the dollar in your pocket and know that that dollar has been debased from the dollar a decade ago and dollar debasement is inflation, inflation is what we are in and judging by the trend in gold what will be be in for years and years, to come.

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