The dollar is always losing value. To measure the decline, people turn to the Consumer Price Index (CPI), or various alternative measures such as Shadow Stats or Billion Prices Project. They measure a basket of goods, and we can see how it changes every year.
However, companies are constantly cutting costs. If we see nominal—i.e. dollar—prices rising, it’s despite this relentless increase in efficiency. This graphic illustrates the disparity (I credit Tom Selgas for a brilliant visualization, which I recreated from memory).
CPI measures only the orange zone, the tip of the iceberg. Most people don’t see the gray zone, and that’s a result of the greatest sleight of hand ever.
We need an accurate way to measure monetary debasement. For example, in retirement planning it’s tempting to divide your net worth by the cost of consumer goods. This seems to show your purchasing power. For example, if you have $200,000 and the cost of groceries for a year is $20,000 then you can eat for ten years.
However, this approach is flawed. To see why, let’s briefly consider primitive times when there was no lending or banking. People had to set aside some of their income, to buy a durable good like salt or silver—hoarding. When they could no longer work, they sold a little bit every week to buy food—dishoarding. People accumulated wealth while working, and dissipated it in retirement.
Life got a lot better with the advent of lending, because interest enables people to live on the income generated by their savings. People no longer consumed their principal, worrying about outliving their savings.
Don’t think of capital assets as something to sell in order to eat. An old expression says, if you give a man a fish then he eats for a day, but if you teach a man to fish then he eats for a lifetime. Think of a productive asset like a fishery. It should produce for a lifetime. It should not be consumed as a mere fish.
Capital assets should be valued in terms of how many groceries they can buy, not by liquidation, but by production. Unfortunately, monetary policy is making this increasingly difficult. Interest rates have been falling for over three decades, and now there’s scant yield to be had anywhere. We are regressing to the dark ages of paying for retirement by dishoarding.
CPI understates monetary debasement, because companies are constantly becoming more efficient. Dividing wealth by CPI compounds the error, because asset prices are rising.
We need a different way of looking at monetary debasement. I propose Yield Purchasing Power (YPP). YPP is the yield on assets divided by the Consumer Price Index (or other index). The idea is to look at the productivity of assets to see what you can really afford.
Let me explain YPP with a simple example. If hamburgers sell for $5 and interest is 10%, then $50 of capital lets you eat one burger per year. Suppose the price of the burger doesn’t change, but the interest rate falls to 0.1%. You now need $5,000 in capital to earn that burger. Unfortunately, if you still only have $50, then you only get one burger every 100 years.
CPI doesn’t show this collapse in purchasing power, but YPP does.
Let’s take a look at YPP since 1962. The graph is inverted, to make the trend easier to see.
It’s interesting that the drop in purchasing power (rising in this inverted graph) begins around 1984, when the conventional view said inflation was tamed. CPI may have slowed down, but interest was falling too.
YPP shows us a staggering monetary devaluation—a classic parabola. The problem isn’t skyrocketing prices, but collapsing yields.
You need more and more assets to afford the same lifestyle. If your assets don’t keep up, then you have to liquidate your capital.
Ben Bernanke presided over the Federal Reserve for two terms, from 2006 through 2014. A year and half into his first term, he began driving the Federal Funds Rate down. By the end of his frantic interest episode, this key overnight lending benchmark had been crushed. It hit bottom, and it hasn’t sprung back in over 6 years since.
Everyone is harmed by zero interest policy. Who suffers the most is open to debate, but one obvious candidate is the retiree who lives on a fixed income. These are people who worked and saved their whole lives, and now they depend on interest to buy groceries and heat their homes. For them, zero interest is like breathing air without oxygen. They suffer a slow death by suffocation.
In writing about this class of people, economist John Maynard Keynes used a term he intended to be pejorative—the rentier. In Keynes’ view, those who invest capital to earn a yield are parasites. In The General Theory of Employment, Interest, and Money, he asserted that the rentier is a “functionless investor” (i.e. gets paid for doing nothing). Keynes called for “the euthanasia of the rentier” by government suppression of the interest rate.
Recently, former Federal Reserve Chairman Ben Bernanke has begun blogging at the Brookings Institution. He wrote that legislators said he was “throwing seniors under the bus.” He reassures us that he “was concerned about those seniors as well.”
That is a neat little example of context-switching. These unnamed legislators did not ask Chairman Bernanke how he felt as he was throwing senior citizens under the bus. His feelings are not the issue. The issue is whether zero interest does, in fact, throw seniors and other rentiers under the bus. Bernanke can’t deny that, and he doesn’t try.
Instead, he offers this, “But if the goal was for retirees to enjoy sustainably higher real returns, then the Fed’s raising interest rates prematurely would have been exactly the wrong thing to do.” Got that? We have to keep interest low, so seniors can earn more interest.
Bernanke then unwittingly makes a good point. “Contrary to what sometimes seems to be alleged, the Fed cannot somehow withdraw and leave interest rates to be determined by ‘the markets.’ The Fed’s actions determine the money supply and thus short-term interest rates; it has no choice but to set the short-term interest rate somewhere.”
This is indeed the whole point of irredeemable paper money and central banking. The decision to extend credit, and at what interest rate, has been taken away from the people. The saver is totally disenfranchised. The power to set rates has been concentrated, and placed into the hands of the committee who runs the central bank. It’s just how irredeemable paper money works.
We free marketers should always keep something in mind. The regime of the dollar centrally planned. Although then planners deserve criticism, we should not focus on them. We should take care not to imply that any other planner would do better.
There is no such thing as a good central planner. There are only central planners that destroy capital less quickly and those who destroy more quickly. Sometimes, people may think that a Fed chairman is not so harmful during his tenure, only to realize the full extent of the destruction later (for example, Alan Greenspan).
Bernanke thinks he is defending himself, when he makes his most damning statement. “A premature increase in interest rates engineered by the Fed would therefore have likely led after a short time to an economic slowdown and, consequently, lower returns on capital investments. The slowing economy in turn would have forced the Fed to capitulate and reduce market interest rates again. This is hardly a hypothetical scenario: In recent years, several major central banks have prematurely raised interest rates, only to be forced by a worsening economy to backpedal and retract the increases.”
So interest rates have to go down when the economy is weakening. Consider the interest rate trend since 1981.
(Courtesy of the Federal Reserve Bank of St. Louis)
Why has the rate been falling for over three decades? Why has the economy been weakening for 34 years? It’s even worse in Japan and Germany, and even worse than that in Switzerland (which sports a negative rate on the 10-year bond).
Bernanke and his colleagues did not see the crisis of 2008 coming, even as they centrally plowed the world into it. Despite his crocodile tears, savers all have bus tire tracks on their backs. When I was in grade school, kids could work a paper route, and with compounded interest, pay for a college degree. No longer. Workers can set aside 10% of their salaries, if they wish, yet they have no hope that it will ever support retirement. Seniors are forced to spend their capital, fearing to outlive their money.
This is the central banking endgame. Have you ever seen one of those humorous signs that says “The beatings will continue until morale improves?” Similarly, the interest rate will keep falling until the economy improves. The Bernanke’s of the world will never find an opportunity to raise rates.
If we don’t change the regime, rates will continue to fall into the black hole of zero—and negative, as in Switzerland and Germany.
Instead of giving us an apologia, Ben Bernanke has a unique opportunity to show the world that central banking has weakened the global economy. Central banking cannot plan us out of the quagmire it has planned us into. Bernanke could give a clear statement, and explain that for all of his intelligence and education, it availed him not. The irredeemable dollar cannot be fixed.
What he should say is that it is now time for the world to consider a four-letter word that has been all but banished for decades. Gold.
It’s the start of a new year. The question on everyone’s mind is whither the prices of gold and silver? This Brief presents our answer (and the full Monetary Metals Outlook 2015 report gives our reasoning).
One approach to the question of price is to draw a line, extrapolating the past trend into the future. Here is the graph for gold.
This line would give us a gold price around $1000 at the end of 2015. If we did it for silver (not shown), we would get around $10.
We don’t think that most traders would do something this simple (though some mainstream anti-gold commentators might). Our point is that technical analysis is about looking at the trend. We do not believe that the past trend in the gold price is likely to be a good predictor of the price in the future, because the past drivers of the price won’t be operative in the future.
Another approach is to plot gold against M1 money supply. Here’s what that looks like.
This implies that the price already ought to be well over $2,000 and unless central banks put down their keyboards and back away, it will be hundreds of dollars higher by the end of 2015.
We don’t believe this approach, or any approach based on the quantity of money, is valid. At best, one can find correlation without causality. For example, some people thought that there was a correlation between the winning conference of the Super Bowl and the presidential election (an NFC win was supposed to forecast a Democratic president). We think this chart proves there is no causal link between money supply and the gold price.
Other analysts attempt to calculate a gold price based on inflation—by which they mean rising consumer prices. They say gold should do well in inflation. And, they say that it should be coming any day now because look at how fast the money supply is growing. We don’t think that the money supply drives consumer prices any more than it drives the gold price. The crashing commodity markets over the past few years—notably oil in the second half of 2014—should once and for all debunk this idea.
Gold is not purchased for consumption. So even if consumer prices were rising, that does not mean that the gold price must rise. Or, vice versa. Consumer prices are influenced by numerous variables such as efficiency of production that have nothing to do with gold.
Many fall back on the fundamental argument for gold and silver. Paper currencies are now being debased recklessly. Every central bank in the world has openly declared its intent to beat down its currency. This is true, paper currencies have been falling for decades. We believe they will all go to their intrinsic value—zero. There’s just one catch, it doesn’t necessarily have to happen tomorrow morning.
So the past gold price doesn’t predict the gold price of the future. Any correlation between the gold price and macroeconomic indicators is temporary. And, we can’t trade gold based on the premise that paper currencies will meet their final fates. So where does this leave us?
We first need a method of measuring current supply and demand fundamentals in the monetary metals. They are quite different from all other commodities, as humanity has been accumulating them for millennia. We discuss our methodology and show our data and reasoning in the full report. In this brief, we will just skip to the bottom line and give our year-end Fundamental Prices for gold and silver.
They are $1,319 for gold and, brace for it, $15.10 for silver. Both of these numbers have come up a little in the first weeks of the year, but not enough to change our view of the market as it stands now.
That’s the key phrase: as it stands now. The supply and demand fundamentals emerge from a dynamic interplay between several kinds of market participants (we describe this in more detail in the full report). At the moment, it’s not showing any signs of major breakouts. There simply is no reason today to back up the truck and load up on gold—much less silver. (If you don’t own any, then our advice is to go buy a little—not for trading but for holding—and don’t worry about the price).
That said, a sea change is coming.
To have any chance of predicting it, we have to understand what drives people to buy gold. We don’t mean what news stories make people hit the buy button on their futures workstation, or buy GLD calls on E-Trade. Speculators, especially those who buy with leverage, cannot create a durable and long-term move higher in price. They are just trying to front-run what they believe will happen, and often end up front-running only each other.
What makes people buy gold coins and bars, and stick them under the mattress for years or decades?
The answer is simple, but a paradigm shift from everything we’ve all been taught in government schools, watched on TV, read in the financial news, and learned in Econ 101. Gold is the only financial asset that is not someone else’s liability. There are plenty of other financial assets; the world is overflowing in paper derived from paper, stacked on top of paper. And every one of them depends on a counterparty servicing the debt and making payments. There are also many tangible assets such as antique cars, real estate, and art work. Every one of them is illiquid in good times, and may be impossible to sell in a crisis.
Gold is unique for these reasons.
Ignoring the speculators, who only buy gold to sell it for a quick gain when the price rises, or to cut losses when the price falls, who buys gold to hold for the long term? What are their motivations?
Anyone in the world buys gold when they don’t like the interest rate offered on paper, and especially when they don’t like the rising risks.
Based on the price and supply and demand moves so far, it is likely that the price of gold will end the year higher than it ended 2014. However, silver will fall if the speculators currently holding it up give up.
In this annual report, we’re not just trying to look at whether the metals are over- or under-priced. We are trying to predict a change in attitudes. It is not a matter of if, but of when.
We think the sea change is more likely than not to begin in 2015. We don’t use the term “sea change” lightly. The crisis of 2008 was the beginning of a credit collapse. Most market observers believe that the central banks fixed the problem, and have been talking of the “green shoots” and “nascent recovery” and “GDP growth” for years.
It is noteworthy that even the skeptics have accepted that the system will hold together. Most of them have given little thought beyond how to make more dollars. Even gold is just a vehicle to speculate to make dollars. In other words, few have been worrying about default risk. They have focused on inflation, and trading to get a higher rate of return than that.
This means they have not focused on counterparty risk or credit quality. We think this will change in a big way.
At the moment, we see little reason to put a lot of capital in harm’s way betting on a rise in the gold price, much less on silver. But that’s why we reassess the supply and demand fundamentals every week in our Supply and Demand Report. We will report on changes as they occur.
This Monetary Metals Brief 2015 is based on the full Monetary Metals Outlook 2015 report. The full report contains graphs of the monetary metals’ Fundamental Prices for 2014, a fuller discussion of gold, our macroeconomic views including the resent crisis in Switzerland, and our supply and demand theory.
© 2015 Monetary Metals LLC. All Rights Reserved.