Fed Drops the Inflation Bomb & the Return of Gold

by Michael Nystrom
September 26, 2007

Have you noticed? Chairman Ben (not to be confused with that all-powerful chairman from another time and place, Chairman Mao) has recently acquired a new nickname. No longer is he referred to merely as "Printing Press" or "Helicopter" Ben, those playful nicknames of yore which poked fun at his threats to stave off deflation via massive inflation. Those silly nicknames no longer accurately depict the amount of inflation he is prepared to produce, nor the destruction that such inflation will inevitably cause. Ben won't merely be tossing money from helicopters, content to let it flutter to the ground. His new nickname signals that he's deadly serious about his mission and he's pulling out the heavy artillery to prove it. The new nickname references the destruction the Fed's policies will inflict. Say hello to B52 Ben, who stands on the ready to carpet-bomb the world with the catastrophic effects of the inflation bomb.

If you haven't done so already, say goodbye to the American Dream. If the Fed has its way, inflation will destroy it to the point that most of us won't be able to afford nor recognize it. As Ron Paul makes clear, even though it appears that the money comes from thin air, it has to come from somewhere. Printing money has its own costs which are borne by the American people.

In spite of official government pronouncements, the cost of the things that matter most, the things that contribute to a higher quality of life - food, housing, energy, medical care and education - have been and will continue to spiral out of reach for many Americans. Just look at the price of oil and gold: Oil recently hit an all-time high of $84 per barrel. Gold is now trading over $700 per ounce, and many think it will surpass its all time high of $850 by year's end.

Do you believe the government when it says inflation is only 2%?

Commodities are clearly signaling the inflation that the Fed is creating. And yet, some still maintain that this is just a bubble. After the experiences of the past few years, this is understandable: We've seen bubbles come and go in Japan, SE Asia, the Nasdaq, and most recently, housing. Surely, many people think, the best gains in the commodities bubble have already been had. It is too late in the cycle to get in, because the "commodities bubble" will soon burst like the rest of them.

In Commodities for Every Portfolio, Emmanuel Balarie does an excellent job dispelling this myth. This is not a bubble, but a long-term boom, and we are still in its early stages. Fundamental factors favor its continued growth. We are in a global market, and the world's population is not only growing, it is getting wealthier, leading to increased commodity demand. There will be more mouths to feed, more houses to construct, more transportation systems to create, and more useless crap to buy - worldwide. All of this growth will put an increasing demand on a finite amount of commodities.

As advanced as mankind's manufacturing apparatus has become, we still cannot make oil, copper, zinc, iron, lead, platinum, silver or gold. We rely on nature to provide them for us, but once they are extracted, they cannot be replenished. Without a radical breakthrough in science, monetary technology, or in human nature, these finite resources will be depleted over time. As a result, they can only increase in value -- when measured in dollars that have a potentially infinite supply. As Richard Russell puts it, the US government must 'inflate or die.' Federal debts are too big to ever be repaid, and since the government has no intention of dying, inflate it must. And that money must go somewhere. In addition to the fundamental factors that Balarie cites, monetary factors point to a continued commodity bull run.

This being the case, how does one protect one's wealth from confiscation through inflation? Commodities markets remains a mystery to most people. Do commodities mean trading live hogs and pork bellies, learning new trading symbols and taking on excessive risk? Not necessarily.

While Balerie has a chapter on trading futures, I wouldn't recommend it to the average investor. The leverage in futures trading creates risk levels that are simply too high for a novice to fully understand and manage. Fortunately, you can capitalize on the commodities boom through investments that are more familiar - stocks, mutual funds and exchange traded funds. Balerie has a chapter on each that can help you clarify your priorities and how to think about structuring your investments. And because of the towering importance of gold, he has devoted an entire chapter to the merits of gold and the different ways of investing in it.

Part II: An Irrelevant Fed and the Return of Gold

For an excellent, comprehensive treatment of gold itself, see Nathan Lewis's excellent new book: Gold, The Once and Future Money. This is a 421 page book devoted exclusively to gold. Surprisingly, it is down right fascinating. It is among the best financial books that I have read this year. As Mr. Lewis states in his preface, "I have never seen a correct and complete description of how today's central banks work, nor have I seen a lot of evidence that others understand their workings, even central bankers themselves."

Amen! Thank you Nathan Lewis for the reassurance that it is not me who is crazy. Nearly every book on the subject of the Fed, Money and Gold (Save Griffin's Creature from Jekyll Island) has given me conflicting ideas and reasoning, and left me slightly more confused than before.

Lewis further states in his preface that:

[My book] is intended to stand alone. It could be picked up by an auto mechanic, a homemaker, a high school student, a real estate agent, or even a politician, journalist or central banker who would find everything they need to solve the major economic problems of the day, and create a functioning world monetary system from scratch. It is my expectation that enough auto mechanics, homemakers, high school students, and real estate agents will read it that politicians and central bankers will have to clean up their act out of sheer embarrassment.

Recent events indicate this may actually be happening. Ironically, a widespread rekindling of interest in gold and the gold standard may be sparked by Alan Greenspan's new memoir and his nonsensical ramblings on the subject of the gold standard in his many recent media appearances. Anyone who has read Lewis's book should have a powerful hogwash detector when it comes to listening to the words of the prior (and current) Fed chairman.

For example, it is well known that former Fed Chief Alan Greenspan was a disciple of Ayn Rand, who believed in (among other things) unregulated capitalism. When interviewed recently on NPR's Fresh Air, Greenspan was asked if he didn't see some irony that, despite his own self-proclaimed libertarian beliefs, he spent much of his time as one of the world's most powerful regulators.

Greenspan's response: Regulator? Moi?

Here is a transcript of the actual exchange. (This comes in the last seven minutes of the interview):

Greenspan: Well actually, we were not fundamentally regulators [at the Fed]. The vast portion of our efforts were not involved in bank regulation.

NPR: No, but you were regulating interest rates, which have a profound effect on world economies.

Greenspan: You're raising really a very interesting question. I have always argued that the gold standard of the 19th century was a very effective stabilizer. It kept inflation essentially at zero, and I felt it was critical for the tremendous growth that occurred for the American economy in the latter part of the 19th century. When we went off the gold standard essentially in 1933, we then had to have what we call "fiat money" which is essentially money that is - it's printed paper money. Which unless we restrict the volume of, can be highly inflationary.

The type of interest rate regulation that I and indeed most central banks in the last 20 years have been involved in...has been to try to replicate the laws and rules that were governing the gold standard. And so it is an odd situation where all the central bankers -- while none of them are advocating a return to the gold standard -- nonetheless try to replicate the various types of interest rate policies that the gold standard would have created. And it is an interesting question whether you call that regulation, or basically functioning of a central bank in stabilizing the economy."

In listening to his smooth, soothing voice, the meaning of his words can easily get lost. The man nearly puts you to sleep with what sounds like soothing wisdom. But in reading the above transcript, clarity returns with a vengeance. Allow me to clarify. What he said was: The gold standard was responsible for the tremendous growth during one of America's most innovative and productive periods, but unfortunately we "had to have" fiat money. (Really? We had to have it? Who made that decision for us?) Greenspan then goes on to admit that fiat money can be very inflationary, so it has to be regulated. However, in spite of the fact that he is the Chairman of the institution charged with regulating it, he is not the regulator.

How can this be possible!? Because, he soothingly reassures us, he was simply emulating the gold standard! He would have us believe (if we did not have brains) that he was simply an automaton - doing what the gold standard would have been doing automatically anyway. Which begs the question: If this is the case - if the gold standard worked so well - why do we need the Fed to attempt to emulate it?? Why not just bring the gold standard back?

Continuing along with this line of thinking, here is a short (7 minutes) but sweet clip of Mr. Greenspan on the Daily Show with John Stewart, talking more absolute nonsense.

Once again I've transcribed the key exchange:

Jon Stewart: Many people are free-market capitalists, and they always talk about free-market capitalism, and that is our economic theory. So why do we have a Fed? Isn't the free market - wouldn't the market take care of interest rates and all that? Why do we have someone adjusting the rates if we are a free-market society?

Alan Greenspan: You're raising a very fundamental question.

Stewart: I am? Should I leave? (Laughter)

Greenspan: You didn't need central bank when we were on the gold standard, which was back in the nineteenth century. And all of the automatic things occurred because people would buy and sell gold, and the market would do what the Fed does now. But! Most everybody in the world by the 1930s decided that the gold standard was strangling the economy. And universally this gold standard was abandoned. But! You need somebody to determine - or some mechanism - how much money is out there, because remember, the amount of money relates to the amount of inflation in an economy.

Stewart: You think I'd forget that? What are you? Sure I know that. (More laughter) (Sadly, most people don't understand how money works.)

Greenspan: In any event the more money you have, relative to the amount of goods, the more inflation you have, and that's not good. So...

Stewart: So we're not a free market then.

Greenspan: No. No.

Stewart: There's a visible - there's a benevolent hand that touches us.

Greenspan: Absolutely. You're quite correct. To the extent that there is a central bank governing the amount of money in the system, that is not a free market. Most people call it regulation. (Emphasis mine)

"Most people call it regulation," he says. But apparently Greenspan doesn't. However, the key point is that Greenspan flat out admits that, in his own words: "to the extent that there is a central bank governing the amount of money in the system, that is not a free market."

The next logical question, which Stewart unfortunately did not ask (so I will ask): Can we have a free market in housing, automobiles, oil or anything at all if we do not have a free market in money? The answer, clearly, is no. Money is the common denominator of all of these otherwise non-related markets. If the money market is not free, then none of these markets are free. By Greenspan's own admission, the much-vaunted free market is a fraud.

Which brings us back to commodities. Should we manage to maintain the economic status quo over the next decades - Emanuel Balarie will no doubt look like a genius. Commodities will continue to increase in prices measured in fiat dollars. But should the people manage to overthrow the current fiat money system - a system that Nathan Lewis helps to expose and clarify, and that Greenspan himself declares is not free - then look out below! The inflated prices of the global economy will be forced to deflate.

In either event, gold is most certain to shine both in the short term and the long term.

References:

Commodities for Every Portfolio
Gold, The Once and Future Money
Creature from Jekyll Island
The Age of Turbulence
Greenspan NPR Interview
Mr. Greenspan on the Daily Show

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