Why These Gold Standardites Are Wrong, 13 October

Let’s look at the graph of the price and basis (i.e. abundance) action.

For the first part of the day, the action is from speculators, for the most part.

Then around the time that the US west coast comes online, we see a continued rise in price but a drop in basis back to where we started.

Folks, this is what buying of physical metal looks like: prices rises by about 30 cents accompanied by a drop in basis from about 2.9% to just over 1.9%.

If this continues, there will be a much higher silver price, relatively soon. Let’s keep an eye on the basis action!

This is a good segue into a topic we see discussed over and over again.

Gold & Silver…and Inflation

Let’s look at three slightly different premises:

• • Gold (and silver) are good predictors of inflation expectations
  • They’re good predictors of inflation itself
  • And/or they’re good hedges against inflation.

It’s widely believed that rising quantity of dollars causes rising consumer prices.

And a rising gold price too.

This premise is accepted by Fed apologists and Fed critics, Wall Street analysts and Wall Street critics, liberals and conservatives, etc.

There is even a movement for a gold standard of sorts based on it. This movement accepts the central planning of the Fed, but not the monetary rules of maximizing employment and stable purchasing power of the dollar (George Orwell would be proud/dismayed that this is defined as relentless 2% inflation forever). These gold standardites want the Fed to centrally plan the dollar based on the gold price.

In his Forbes article, The 10 Minute Gold Standard, Nathan Lewis writes:

“…when the value of the currency is too high compared to the standard i.e. the price of gold determined by the central planners, you increase the supply. When the value of the currency is too low compared to the standard, you decrease the supply. It really is that simple.”

No, it’s not that simple.

The price of gold is not a function of the quantity of dollars. It just isn’t. Not to mention the very practical problem of what Lewis blithely refers to as “you decrease the supply.” Dollars are notoriously tricky to un-borrow once they’re borrowed into existence.

Silver Basis and Co-basis and the Dollar Price

- Click to enlarge

When Will Prices Rise?

Every speculator in the world would love to be able to predict when prices will rise durably, and begin rising faster and faster. To know this, is to know when it will be safe to load up on copper, oil, and soy futures with maximum leverage (and short real estate and stocks and anything else that depends on falling interest rates).

Even the Fed talks a great deal about inflation expectations. In the Keynesian view, one should not look to reality for reasons why prices change. It’s due to animal spirits. So these monetary witch doctors try to communicate with the spirits to understand when the herd of animals will stampede. In their belief, the change in expectations will cause people to cause inflation.

In their theory, people will buy more stuff if they think it will be more expensive in the future. And when prices are falling, people will defer a purchase. If we were inclined to be sarcastic, we would say yeah, just like they deferred all purchases of flat screens, computers, mobile phones, and Levi’s 501 jeans (which fell from $50 in 1983 to $35 now).

Incidentally, this is one of the reasons cited for the gold price suppression conspiracy theory. If the gold price rises then, the thinking goes, people will expect more inflation. And so to head this off at the pass, the government supposedly wants to keep gold down. And thereby avert the disaster of rising consumer prices. This strikes us like pushing sideways on the front tire of a car, in order to turn the steering wheel. And by car, we mean a mining ore truck.

So to recap, rising quantity of dollars does not cause prices to rise, does not cause people to begin hoarding consumer goods, does not give speculators a risk-free trade, and does not cause gold to go up.

However, we came across an article that illustrates what does cause prices to rise. In fact, there is only one force that causes prices to generally rise in a falling interest rate environment.