How Inflation Could Be Caused in 15 Minutes
My expectation is that the Fed will soon reverse course and return to some form of easing — probably more forward guidance and a cheaper dollar. If I’m wrong and the Fed actually does raise rates, deflation will get worse and a global recession will emerge.
A central bank’s worst nightmare is when they want inflation and can’t get it. The Fed’s tricks have all failed. Is there another rabbit in the hat?
Actually, yes. The Fed can cause massive inflation in 15 minutes. They can call a board meeting, vote on a new policy, walk outside and announce to the world that effective immediately, the price of gold is $5,000 per ounce.
The Fed can make that new price stick by using the Treasury’s gold in Fort Knox and the major U.S. bank gold dealers to conduct “open market operations” in gold. They will be a buyer if the price hits $4,950 per ounce or less and a seller if the price hits $5,050 per ounce or higher.
They will print money when they buy and reduce the money supply when they sell via the banks. This is exactly what the Fed does today in the bond market when they pursue QE. The Fed would simply substitute gold for bonds in their dealings. The Fed would target the gold price rather than interest rates.
Of course, the point of $5,000 gold is not to reward gold investors. The point is to cause a generalized increase in the price level. A rise in the price of gold from $1,000 per ounce to $5,000 per ounce is really an 80% devaluation of the dollar when measured in the quantity of gold that one dollar can buy.
This 80% devaluation of the dollar against gold will cause all other dollar prices to rise also. Oil would be $400 per barrel, gas would be $10.00 per gallon at the pump and so on. There it is — massive inflation in 15 minutes: the time it takes to vote on the new policy.
Don’t think this is possible? It has happened in the U.S. twice in the past 80 years. You may even know some people who lived through both episodes.
The first time was in 1933 when President Franklin Roosevelt ordered an increase in the gold price from $20.67 per ounce to $35.00 per ounce, nearly a 75% rise in the dollar price of gold. He did this to break the deflation of the Great Depression, and it worked. The economy grew strongly from 1934-36.
The second time was in the 1970s when President Richard Nixon ended the conversion of dollars into gold by U.S. trading partners. Nixon did not want inflation, but he got it.
Gold went from $35 per ounce to $800 per ounce in less than nine years, a 2,200% increase. U.S. dollar inflation was over 50% from 1977-1981. The value of the dollar was cut in half in those five years.
History shows that raising the dollar price of gold is the quickest way to cause general inflation. If the markets don’t do it, the government can. It works every time.
History also shows that gold not only goes up in inflation (the 1970s), but it also goes up in deflation (the 1930s). When deflation runs out of control, as it did in the 1930s and may again, the government will raise the price of gold to break the back of deflation. They have to — otherwise, deflation will bankrupt the country.
Do I expect deflation to run out of control soon? Actually, no. Deflation is a strong force now, but I expect that eventually the Fed will get the inflation they want — probably through forward guidance, currency wars and negative interest rates.
When that happens, gold will go up.
Still, if deflation does get the upper hand, gold will also go up if the Fed raises the price of gold to devalue the dollar when all else fails.
This makes gold the ultimate “all weather” asset class. Gold goes up in extreme inflation and extreme deflation. Very few asset classes work well in both states of the world. Since both inflation and deflation are possibilities today, gold belongs in every portfolio as protection against these extremes.
Regards,
Jim Rickards
for The Daily Reckoning
dailyreckoning.com
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