Be Careful What You Wish For
(Part II)
Dr Heinrich Leopold
Ten years ago I wrote an article with the same title for GOLD-EAGLE.com. The essence of this article was that Central Banks - regarding inflation as their prime enemy - will some time discover that inflation may be their best friend. This time has now arrived.
Until 2000 there has been a clear inverse correlation between inflation and economic growth. When inflation picked up, economic growth started to slow and Central Banks had to bring down inflation. Volcker was the most radical in this respect, yet Greenspan followed his legacy.
Low inflation was self-evident to Central Banks. For each percentage point lower inflation, the economy grew by 0.6 % on average.
However in the 2001 when inflation declined, the US economy did against all odds not recover swiftly. There was a brief recovery in 2002 when inflation went up, yet when inflation came down again in 2003, the US economy weakened again. This came very much as a surprise -- and Bernanke then made his famous helicopter speech to reassure investors and politicians.
Nevertheless, it became clear that something had fundamentally changed: The inverse relationship between economic growth and inflation no longer existed. To the contrary: inflation was necessary to spur economic activity.
Principally for this reason I invested in commodities in 2000. If the US Fed had not been forced toward an inflationary policy (ie lower dollar, Quantitative Easing…etc), commodities would still be at record lows. REMEMBER mega-bear Robert Prechter (ridiculously) predicted at that time a gold price below US$100/oz.
The explanation for this secular change is in my view the overly inundated credit market in the US (and also Europe), which slows down monetary velocity. In other words: money alone is not enough to create economic activity, MONEY VELOCITY must accelerate.
Over the last decade, the US debt level has reached four times GDP. This is very much also the limit for individuals and companies (debt four times revenue or income). At this point a recovery is very unlikely as new debt has to be used for paying old debt and any new activity is put on hold.
Young people without jobs and burdened by student loans are very UNLIKELY to enter the housing market. People with existing loans are unlikely to take on more debt. Companies facing slower revenues will NOT be hiring and investing for expansion.
As the policy growth through debt does not work anymore, Central Banks in the Western World have no choice other than to move the existing money by inflation. Albeit they have to do so slowly to allow for only moderate inflation. Should they stick to the low inflation policy, there is significant risk for an economic implosion, which would lead to an even higher money supply which could go completely out of control when inflation is ignited by an outside event (oil price spike ..). This is very much a realistic scenario for Europe -- as Germany has a propensity to do 'the right thing' even when the world has another view.
The secular bull market in gold began IN 2001. Even if inflation did not rise substantially over the last ten years, the increase in the price of gold is valid testament that the money supply grew substantially during the past 11 years,
Subsequent to the short inflationary boom of last year, inflation should fall over the next few months…a will economic activity in the US and Europe. In this event further inflationary stimulus will be necessary. In this regard Japan FINALLY has realised that inflationary stimulus is necessary. However, as developing countries benefit from lower inflation due to their credit markets in an early stages, we should see a worldwide economic boom this year. The current monetary situation is a fantastic environment for commodities --- and certainly gold will be the leader.
Dr Heinrich Leopold
I welcome all comments at hgleopold@yahoo.com
22 January 2012
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