Gold And "A Mug's Game"
The Gold / US Currency in Circulation Ratio
31 December 2005
For the better part of the past 86 years, holding gold has been what Humphrey Bogart in a 1938 gangster movie would have called "a mug's game". A mug's game being an occupation best left to losers. In this article I will discuss an oscillator that for 86 years has correctly called the turns when gold was the smart play and when gold was best left to the mugs. I call it, "The Gold / US Currency in Circulation Ratio" (The Gold / CinC Ratio or just The Ratio). Right now, The Ratio is telling us that gold is a mugs game - no more.
The logic behind The Ratio would not be dismissed by any serious economist. Broadly speaking, when an economy's money supply expands at a rate slower than the goods and services produced, aggregate prices fall. When an economy's money supply expands at the same rate as the goods as services being produced, aggregate prices are stable. When an economy's money supply expands at a rate faster than the goods as services produced, aggregate prices rise. The Gold / CinC Ratio displays the relationship between the price of gold and US Currency in Circulation from January 1920 to the present.
The Gold / CinC Ratio is very simple. To construct it, one only uses as variables the price of gold and US Currency in Circulation (CinC) both indexed to 1.00 on 05-January-1920.
Gold Indexed / CinC Indexed = Gold / CinC Ratio
Note: Unless specified, all dates listed are the publishing date for the issue of Barron's where the weekly closing data I used can be found. As the first issue of Barron's was published on 09-May-1921 and Barron's did not weekly publish CinC until its 23-February-1931 issue, the author used other sources he found reliable as required.
The above chart shows The Ratio oscillating between the upper and the lower dashed lines. At the high end of the range, the markets are satisfied, if not happy with the stability of US Federal Reserve Note (dollar). The high end in the range corresponds to a period of sever international economic instability which results in a large dollar increase of the price of gold, a price not thought possible just a few years before. After the peak, The Ratio trends downward as CinC increases at a rate faster than the price of gold and holding gold becomes a mug's game. As The Ratio trends down towards its lower end point in the cycle, the markets reach a point of revulsion to Federal Reserve Notes (dollars). Confidence in "the full faith and credit" behind those controlling the issue of US currency is shaken, serious money sell their dollar assets to buy hard assets including gold, and gold is no longer a mug's game.
The above chart's green arrows indicate when trading your paper dollars for gold was the smart thing to do. The red arrows indicate when gold and gold based investments became wasting assets over periods that lasted decades. From 1920 to present, paper money, financial assets and the financial institutions that profited from them had their way with gold except for the times noted above.
It is important to know that during the entire 86 year period The Ratio covers, there have always been voices warning of coming problems resulting from of CinC inflation. Standing on a soapbox decrying the evils of paper money is an occupation with a long and honorable tradition. Clarence Barron, founder of Barron's Financial Weekly, was not shy of warning his readers in the 1920's of coming problems if the Federal Reserve maintained an inflationary monetary policy. Barron's magazine in the 1920's had the below slogan on the top of its front page:
"Finance: The Application of Money to Practical Ends"
- Barron's Cover Slogan from its 1920's issues
Mr. Barron made it clear that inflationary financing that resulted in the Great 1920's Florida real estate boom and bust via the Federal Reserve CinC inflation was not what he had in mind when he thought of money or practical ends. As today's warnings of problems to come by Bill Murphy and Chris Powell of www.GATA.org, Mr. Barron's warnings made no difference upon the management of the US monetary system by the Federal Reserve. CinC inflation continued to push The Ratio downwards until the international money markets reach a point of exhaustion in the confidence supporting the US Federal Reserve Note (dollar). Gold became revalued in US Federal Reserves Note (dollar) terms in 1934 from $20.67 to $35.00 not because The Federal Reserve and Treasury wanted this to happen but because they had no choice. I cover this topic in detail with my article: What Happened To The American $20 Double Eagle.
Below are three charts showing the two variables that make up The Ratio: the indexed values of the price of gold and CinC. The extent of CinC inflation since 1920 makes it impossible to graphically display what happened from 1920 to the present with one continuous chart. As I indexed my values to 1.00 = 05-Jan-1920, the left Y axis displays how many time the price of gold or the numbers of dollars in circulation has increased since 1920. I chose the end point of the first two charts, 1941 and 1986, as they best display the reaction of gold to CinC during significant points on The Ratio, the third chart ends in the present time.
As a reminder, the data points for The Gold / CinC Ratio charts above is simply Indexed Gold divided by indexed CinC or:
Red Line / Blue Line = The Gold / US Currency in Circulation Ratio
The below charts show the raw data that The Ratio is constructed from.
The above three charts clearly illustrates that twice in the past 86 years, the over issuance of Federal Reserve Notes (dollars) has resulted in a corresponding rise in the price of gold. Bluntly stated, if bankers and politicians in the last 86 years had acted responsibly by not allowing this inflation in the Currency in Circulation to have occurred, the price of gold would still be trading at $20.67 an ounce as it had for the 97 years before 1934.
Yes, I know about Lincoln's "green back" inflation and Jay Gould's gold machinations in the 1870's. The fact is that after all that, the US Government in the 19th Century recognized the moral hazards of paper money inflation and returned the value of the US dollar back to its pre Civil War value of $20.67 for an ounce of gold. The hazards of CinC inflation is an issue that the US Government of the 20th and now the 21st Century have been willfully ignorant of. In the years to come, Senator John McCain will rue the day he called Alan Greenspan "a national treasure."
To the nay-sayers of the current bull market in gold, your anti-gold arguments are going to become more difficult to make in the months and years to come. Gold will do what it has always done; respond to Federal Reserve created CinC inflation with an appropriate price rise in Federal Reserve Note (dollar) terms.
I want to make a note before I continue: my CinC data is incomplete. The price of US gold was $20.67 from 1837 to 05-Feb-1934; some 97 years, I have that. However a complete data set for CinC would have to include data to the last year the US did not have a central bank controlling the currency of the United States, say 1912. With data going back to 1912, before World War One, I would really have a complete picture of what has happened here. The omission of the first eight years of CinC data is a significant omission that must have affected my charting of The Ratio.
The Ratio's minimum value in Spring of 1933 was .52 on a down spike and not a gentle sloping trend to .10 as the ratio reached in 1972-3 and the current era. If I had access to the CinC data during WW1, (1914-18) an inflationary period in the US monetary history, I suspect that the 1933 bottom in The Ratio would prove to be very similar to the later bottoms by its trending down to the 0.1 at the bottom dashed line.
The real question in my mind is how firm is my top dashed line? If I am correct in believing that the missing data would bring the .53 bottom in 1933 to a similar 0.10 level we see in the later bottoms, I can see the 1934 peak only reaching up to only the 1.0 graph line instead of the 1.4 dash line as my current incomplete data places it. This too is very significant as the top dashed line would no longer be parallel to the bottom dashed line as each upswing oscillates higher than the last. If this is true, gold could go much higher than most gold bulls expect if The Ratio's next reaction to CinC inflation exceeds the 1.4 line.
To demonstrate the potential move in gold The Ratio is suggesting, consider the following. Using the current CinC figure for the 19-Dec-2005 issue of Barron's, to make The Ratio jump from the lower (0.1) to the upper dashed line (1.4) would require the price of gold to rise up to $5,200 an ounce in the next few days. We know that is not going to happen, gold going to $5,200 an ounce in the next week, or even more improbable - CinC remaining constant for years to come. The logic behind The Ratio is compelling - if the Federal Reserve continues to create money and credit in unlimited quantities, gold's ability to revalue itself upwards in US dollar terms is also unlimited, given sufficient time.
That monetary authorities will fight any gold price appreciation goes with out saying. They always have in the past why would they not now? What isn't being said and what most people will never understand is that the actual struggle the "monetary policy makers" find themselves in is not with gold bugs, oil sheiks or international terrorist but rather with themselves. It is their obsession to divorce their past actions of reckless CinC inflation from their present perilous circumstances that has caused them to act in such a reckless and self destructive manner in the gold and derivatives markets. To have an unregulated 200 trillion dollar notional value OTC derivative market littered with non-standard and illiquid contracts is not a sign of international financial well being. Rather, that such a market is allowed to exist at all is a telling sign that the "monetary policy makers" and elite international corporations following the advise of their New York investment bankers have been very busy losing other people's money. No doubt they intend to make all well again by doubling up their bad bets, hoping that all will become well with a single roll of the dice. It won't.
If these self styled "monetary policy makers" cannot control themselves, their printing presses or their modern electronic equivalent, then ultimately they will not be able to contain the price of gold on a permanent basis. The price of gold is only a reflection of what the people in control of the US Banking system and the US Treasury have done with their ever increasing volumes of US Dollars they have placed in circulation - it is nothing more, or less.
Above, I have plotted The Ratio along with the un-indexed Handy & Harman spot gold price. I direct your attention to the substantial move in the price of gold while The Ratio stayed fairly level. This is simple enough to explain. The rate of increase in both the price in gold and CinC are almost identical, so they cancel themselves out. Remember, The Ratio is only the ratio of indexed gold / indexed CinC. What we see here is the Federal Reserve creating currency at an accelerated rate during a major move up in the price of gold. This is what I call "a Mug's Game."
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