The Effects of Dollar Inflation

March 25, 2009

Since 2005 we have shared our thoughts regarding our expectations of how the markets might move in this current large cycle. In doing so, we have shown charts and discussed how we thought this large cycle would play out in this environment of Dollar Inflation which the Fed is applying to combat the massive deflationary backdrop of K-Winter. So far, the fractal relationships in the long-term $Gold chart have been practically perfect in the comparisons of the current moves of $Gold compared to the late 70's. The fractal nature of the Dollar price chart also closely mimics the late 70's Dollar moves, another environment of Dollar Inflation. The Dow chart is playing out much like we anticipated in the same form as the 70s. The driver of the markets is clearly the program of Dollar Inflation that the Fed has served up. In 2007 we cited our expectations of the Dow falling precipitously into a "Deflation Scare" bottom into the 4th quarter of 2008 at the same time as the anticipated bottom in Gold in the LT fractal chart. As an alternative we allowed for the Dow to see a momentum bottom into the 4th quarter of 2008, with a final bottom coming in 2009. We chose the term "deflation scare", not in terms of the asset deflation, but in terms of the panic we expected to ensue falling in the period between the two legs of Dollar Inflation "cure" that the Fed is creating. Still like the 70's market, our expectation of the Dow "price" falling to a lower low for the decade has evolved, in fact, the move might be close to ending for the cycle. With the Fed's recent move to the second leg of Dollar inflation by monetizing the bail-outs and by announcing they will monetize our Treasury debt- it is our opinion that the rest of our expectations for the cycle will likely be set in stone. There are only 2 events that could change things in our eyes. One would be if the Fed quit inflating the Dollar. The other would be if the Dollar was to suffer a sudden, sharp, and deep devaluation. In our opinion these two low probability events become less likely as time passes in the cycle since Global Competitive Currency Devaluations should be increasing from here on out. The GCCD will provide a certain amount of cover for the falling value of the Dollar since investors are used to looking at the Dollar only in terms of the smoke and mirrors pricing scheme, called the Dollar Index; whereby the Dollar is priced not in terms of it's "value" as determined by supply and demand, but in terms of the constantly changing values of other currencies. Below, we hope to clear some of the smoke of the markets caused by fiat currencies to see what is really going on behind the fog.

The Great Inflation Versus Deflation Debate has been occurring all over the place. The Deflationists cite the charts of the Dow in the last K-Winter, the period of 1929, as evidence of where the Dow is headed. Yet, they are comparing a chart of "Dow price" in the current period of Dollar Inflation with a chart of "Dow Price" in the 1929 period of Dollar Deflation. You cannot compare price charts in a period of currency inflation with price charts in a period of currency deflation due to the effect of the different currency environments on the charts. It just does not work because they "look" different. In a period of currency stability or lesser currency deflation, "price equals value." In a period of currency inflation, "price" and "value" diverge due to the effect of the currency inflation. The only way one can compare the two is to create charts where apples are compared to apples- by removing the effect of currency inflation from the price chart in the period of currency inflation. This concept was why we devoted a portion of an earlier editorial to showing why the Dow price chart would likely mimic the 70's Dow price chart in this Dollar inflation environment.

The differences between environments of currency inflation and currency deflation is extremely important to investors, in fact, it is probably the biggest factor investors must get right for the next 5 to 8 years. This one factor not only decides how an investor needs to invest, but it also decides what the "price charts" will look like. In our opinion the Fed has already firmly moved in the direction of the second leg of price inflation as we had anticipated. They really have no choice. Let's move on to look at the Dow with the help of a few charts. We are starting with the Dow so we can discuss certain aspects of Dollar inflation and Dollar deflation. Many of these concepts will be important when we get to discussing the PM sector, especially our liking of the PM stocks for many years to come.

Currency Effects on the Dow Price Chart
The 1929 Dow During Dollar Deflation

The first chart we will present is the chart of the Dow Crash in the 1929 period. In that time period the Dollar was "tied" to Gold. In fact, for most of that period the "Dollar was as good as Gold" because you could take your Dollars to the bank and redeem them for Gold. This convertibility of paper money for Gold made the Dollar very stable in price and in value during that time period. Theoretically the politicians could not simply print more money because they could only print as many Dollars as the quantity of Gold the nation owned would allow. The backdrop for the US economy was very similar in the 1929 period as it was entering the year 2000. We had very large debt levels as we entered into the K-Winter, a very large deflationary backdrop. The price of the Dow "broke" in late 1929, and a waterfall decline in the Dow commenced. Since the value of the Dollar was super-stable being tied to Gold, investors could simply flee the Dow stocks by selling them for Dollars. There was no risk to holding Dollars since they were convertible to the ultimate stable currency, Real Money Gold. Gold has proven intrinsic value as the ultimate money in times when confidence falls, over thousands of years. Thus in the 1929 period, investors who sold their Dow stocks simply held the Dollars they received when selling since they were convertible to Gold, creating a situation where the Dollars did not go back into the economy. The falling supply of Dollars created an environment of "Dollar Deflation." The Dow fall continued in the waterfall decline until the price of the Dow had fallen about 90%. Through history, most price bubbles retrace about 90%, once broken.

In the 1929 period the Dollar was tied to Gold so its price and value was stable. The Dollar was "priced" against Real Money Gold. The Dollar was not priced in a fiat scheme like the Dollar index of today where the Dollar is "priced" against a basket of other currencies that also are "variable in price"- ie., the price and value of the currencies the Dollar is priced against are constantly changing. In the 1929 period the price and value of the Dollar was pretty well a constant number- very different from a period of Dollar Inflation. In the 1929 era chart of the Dow crash, the stable value of the dollar created a situation where there was no real affect to the Dow chart by a currency fluctuating in price. For that reason in the 1929 Dow chart "price equaled value" because there was no "variable factor" affecting the chart except simple Dow stock supply and demand. Thus, it was much easier for an investor to understand what the value of his Dow investment was doing. In this environment for the Dow, you might say, "What you see is what you get."

Enter Pinball Dollar Pricing

By the early 70's the Dollar was no longer "backed by" or "tied to" Gold. Thus, the price and value of the Dollar was no longer stable so its price would move up and down. Since the Dollar was not tied to Gold as in the 1929 period, politicians could print as many Dollars as they wanted to. If they printed more Dollars the supply of Dollars would increase causing the value of the Dollar to fall due to basic supply and demand metrics. If politicians printed more dollars, the Dollar supply would increase, called Dollar Inflation, and the value of the Dollar would fall. With the loss of a stable Dollar and its constant price over time, suddenly investors had another factor that needed to be evaluated in terms of investments and investment "pricing." An investment now was a product of both its own supply and demand basics AND of the Dollar's supply and demand basics. Thus, the changing value of the Dollar now affected the "price" of everything you invested in, everything you bought, and the price charts of everything you might invest in.

Additionally, in March of 1973 the Dollar Index was created as a pricing scheme for the Dollar, where the Dollar was suddenly "priced" against other "variable priced" currencies that would change in price. I find this move wild as the "price" of the Dollar was now no longer a product of simple Dollar supply and demand. With this move, the "value" of a Dollar and the "price" of a Dollar could now be different. For instance, if the value of the other few currencies in the basket were all falling faster than the value of the Dollar, the Dollar Index would show the Dollar's "price" as rising!- Even though the value of the Dollar was falling due to increased supply versus demand. Down could now be down, or down could now be up. Don't forget that this pricing scheme for the Dollar is now affecting the price of everything you buy or sell. We now had a "variable priced Dollar" priced against a few "variably priced currencies", with those few variably priced currencies all priced against other variably priced currencies. Don't forget that you are basing your investments on all of this. You could make some semblance of this statement regarding the "price" of the Dollar at certain times; "It's up, it's down, it's up and down at the same time." The reason is because no longer is the Dollar's "price equal to its value" all due to the currency pricing scheme, The Dollar Index. The investing world has gotten used to accepting the Dollar Index as the price of the Dollar, but smart money understands that the Dollar's value is something different.

The Math of Asset Pricing With Dollar Inflation

To continue, we need to review some basic 4th grade math. The reason we need to do this is because everything you buy or sell is "denominated" in the paper money, or currency, that your country uses for money. Thus, the term "denominated in Dollars" means that the Dollar is the "denominator" in a fraction which creates the "price" of anything that you buy or sell in the USA. That means that the price of everything you buy or sell is the product of the value of the item and the "price" of the Dollar as defined by the Dollar Index. So, the fraction is "item divided by Dollar" or "item/ Dollar." Thus, you are really buying and selling "Dow/ Dollar", "Bond/ Dollar", "Gold/ Dollar", etc. In the 1929 era the Dollar was a constant value since it was tied to Gold so it was the same as if the value of the Dollar for the whole period was "1." Back then, the constant value of the Dollar approaching "1" as the denominator of the fraction meant that only supply and demand characteristics affected the value or buying power of your investments since "anything" divided by 1= equals "anything." Once the Dollar was no longer stable in price by being tied to Gold, then the "value" of the Dollar started fluctuate due to supply and demand. Thus, the denominator of the fraction was constantly changing by the early 70s. From that time forward, the value of somebody's investments was no longer only determined by the supply and demand for the investment, but also by the "price" of the Dollar as determined by the Dollar Index scheme. Let's take a look at how the math fraction for investments works in a period of Dollar Inflation.

Here is a series of fractions with their "answers." Off to the right of the "answers" we show the percent increase in the "answer" with each drop of ten points in the denominator of the fraction. We have chosen to start with the number 120 since the Dollar Index was around 120 early in this decade before it started to fall.

Notice that as the denominator, the number on the bottom of the fraction falls, the answer gets bigger. Yet, the answers constantly rise at a higher percentage as the denominators of the fractions fall by the same amount.

During a period of Dollar Inflation, this is also true for the price of everything you buy and sell since you are dealing with the fraction of "item/ Dollar", or "book/ Dollar", or "Bond/ Dollar", or "Dow/ Dollar."

Thus, if the price of the Dollar Index is falling over any decent period of time, we have "price inflation" for everything denominated in Dollars as shown above simply due to the math of the fraction where the price of the Dollar is the denominator of the fraction. This effect is completely separate from any effect on price due to supply and demand metrics.

Now, let's "run the numbers" for the Dollar's fall from 120 down to 70.

This decade as the Dollar fell from around 122 on the Dollar Index down to around 70, the fraction itself created an increase of around 72% to the "price" of the Dow, just based on the fall in the Dollar Index due to Dollar Inflation……….an effect that was never present in the 1929 period when the Dollar was tied to stable Gold. This means that even if the Dow did not trade from the 2000 top, on, the effect of the Dollar in the fraction would have made the Dow rise about 72%, or to 20, 296. This effect is simply mechanical due to the math fraction, and is completely separate from any added increase due to "Dow supply and demand."

There is a major downside to the above, though. The bulk of the fall in the Dollar Index occurred from the late 2002 low in the Dow to the 2007 top in the Dow. (Dollar Inflation) During that time period the Dow rose from around 7,200 to around 14,200 or about 100%. Many Dow investors looked at their broker statements and were pretty happy with their investment results during that time period, but was the investment gain real? We'll get back to the answer when we look at the Dow chart in the current period.

The 1970's Dow

We showed the chart of the Dow in the 1929 period, above. During that period the Dollar was tied to Gold so the Dollar was stable. Thus, the price of the Dow was produced by the relative equivalent of the fraction "Dow/ 1" since there was no change in the value nor price of the Dollar (the denominator), in fact, in that time period "value = price" for the Dollar, and "value = price" for the Dow. During that period the "Dow price = the Dow value." We saw a 90% fall in the value and price of the Dow in a waterfall decline.

By the early 70's the Dollar was no longer stable by being tied to Gold so changes in the "price" of the Dollar started to affect the price of the Dow as the denominator in the fraction, the price of the Dollar, started to fluctuate. An investor could now see gains or losses reflected in either the value of the Dow as the numerator in the fraction, or see gains or losses in the Dollar denominator in the fraction- or both at the same time. Thus, an investor now needed to view the "value of his investments" or his "buying power" as the product of two variables. SUDDENLY THE CHANGING DENOMINATOR CHANGED THE ANSWER TO THE FRACTION, THE DOW PRICE, AND IT ALSO CHANGED HOW THE CHART OF THE DOW LOOKED. Now, politicians could print Dollars and increase the supply- Dollar inflation. A higher supply of Dollars equated to a lower value of the Dollar. In the 70's the Dollar fell from around 120 down to around 80 as seen in the chart, below.

The effect of the falling Dollar on the price chart of the Dow in the 70s due to the math fraction was significant. The falling Dollar supported the price of the Dow due to the "fraction", resulting in what appears to be a sideways move in the Dow. In reality, if the falling Dollar is factored out, the Dow fell about 86% in the 70's. The fall in the Dow in the 70's if the effect of the inflated Dollar is factored out, would have looked much more like the chart of the Dow Crash in the 1929 period. Again, the fall in value in the Dow in the 1929 period was almost exactly the same as the fall in the value in the Dow in the 70's, about 90% versus about 86%, but the price charts look completely different in the two time periods. This is because part of the loss of value for the Dow in the 70's was due to the loss of value in the Dollar that was no longer tied to Gold. Below, is what the price chart looks like showing the very different views with approximately equal losses in Dow value for both the 1929 era and the 1970s. On the price chart the fall of about 90% for the Dow in the 1929 period looks like a "crash", but for the 86% drop in Dow value of the 70's the price chart looks like a mild sideways consolidation. Such is the smoke and mirrors of fiat pricing. You cannot compare price charts of periods of currency deflation with price charts of currency inflation, without removing the "effect" of the currency inflation.

One might not easily understand how two approximate 90% corrections can look so different on the same chart, unless he understands how Dollar Inflation affected the Dow price chart differently in the 70's. Considering the current period with the massive Dollar Inflation we long ago decided that today's Dow chart would likely trace out much like the 70's Dow chart due to the effect of currency inflation.


The "driver of the markets", today, is not the massive deflationary backdrop but the Dollar Inflation cure being applied to that backdrop. Dollar inflation when applied through the usual source of credit expansion, the fractional reserve banking system, acts like the rains of Spring to the vegetation. In that form it affects everything across the financial landscape by increasing the number of Dollars chasing all things financial, commodity, and stock-related; due to supply and demand metrics. It also directly affects the price of everything denominated in Dollars due to the math fraction involved as we have shown. This was the story of the first leg of Dollar Inflation applied to the massive K-Winter backdrop.

Let's take a look at a more focused chart of the Dow in the 70's, then a chart of the Dow, today. After that we will look at today's Dow from a different perspective to try to better understand what is going on. First a closer look at the Dow price chart of the 70's…..

Similar current Dow movements…………

Here is what I find curious about the "false rise" in the price chart of the Dow from around 7,200 in late 2002 to the top around 14,000 in 2007. We have shown above how the "math fraction" causes a rise in the "price" of the Dow when the "price" of the Dollar as determined by the Dollar Index scheme is rising. We also have shown that as the Dollar fell from about 122 down into the low 70's, the pure math would have caused about a 72% rise in the price of the Dow. Since the rise was about 100% for the Dow from the 2002 bottom- a 72% rising effect from the Dollar inflation on the fraction only leaves about 28% of the rise due to supply and demand metrics. Such a 28% move seems very low for a Dow rising sharply since we'd expect the Dow supply and confidence of investors to rise in some sort of parabola. My guess is that a great volume of supply from insider selling suppressed the rise from gaining more steam, along with an influx of supply from "naked shorting."


We finally get to what I wanted to talk about. Charts are really just graphic (or picture) representations of numbers. There are many ways to look at charts to get different comparisons of what is really going on with the numbers involved. In fact, we have shown above that after the Dollar was no longer tied to Gold a whole new set of numbers had to be interpreted when talking about the "price of the Dow", the "price of the Dollar." This new variable injected into everything denominated in Dollars precludes the usefulness of comparing the chart of the 1929 era to the Dow chart after the early 70's, though I will note that the "time relationships" are not affected. This is important because suggests that "time cycles" for today are still applicable even if price metrics have changed. So, if we cannot compare the price chart of the 1929 era to the present Dow chart due to the change in the Dollar becoming a "variable denominator in the fraction", just what do we do? Well, all we have to do to be able to compare charts equally in the two eras, is to factor out the variable Dollar price from the denominator of the fraction by setting up a "ratio" chart where "Dollar/ Dollar" is reduced to the number "1."

Below, we will show a chart of the $Dow price chart divided by $Gold chart. This in effect strips the variable number of the Dollar price out of the chart, thus, it removes the effect of the Dollar Inflation from the "price chart" of the Dow to give us what I call the "value chart of the Dow." I use that term because with the Dollar variable removed, we are basically left with only one variable- the Dow. In reality it gives us a ratio chart of Dow:Gold, but Gold is pretty much a constant when the effect of Dollar inflation is removed. One might cite differences due to the supply/ demand metrics for Gold, but to a large extent those effects are stripped out due to the increased supply of paper gold. (In fact, we have only seen a divergence in the "price" of Real Gold versus paper gold in the recent fall in late 2008 where physical Gold holders demanded a large premium versus paper gold.)

Below, in the $Dow:$Gold chart we see a very different story of the Dow "value" with the effect of Dollar Inflation stripped out. Remember the added boost upward that the "fraction" gave for the 100% rise into 2007? Where did it go? This Dow "value chart" looks very different when the effect of Dollar Inflation is stripped out. This same effect is seen in all charts. The difference is why we say that in a period of Dollar Inflation "price and value diverge." In this chart we see that the Dow has fallen in a waterfall decline the whole decade. This chart with the effect of Dollar inflation stripped out is the approximate correct comparison to the 1929 Dow Crash, IMO. In this chart the Dow has already fallen about 86%~ an almost exact equal percentage fall as the 70's Dow chart if also adjusted for Dollar Inflation.

This chart shows the correct chart to compare to the 1929 Dow where there was no effect of Dollar inflation. If one uses this chart to compare to the 1929 Dow, I think you will find that the "time cycle" matches up very closely for a bottom to occur in the current three month window of time. Since I was using monthly charts, the window may be more like 6 months. Still, the relationship is "our favorite apple dessert." We think that those using the 2007 high for the Dow are being tricked by Dollar Inflation smoke and mirrors.

What we see in this chart is how the "value" of the Dow deteriorated greatly before the "mark-down phase" in "price" came in late 2007 into 2008. We saw the same phenomenon in the Real Estate value before the mark-down phase occurred, and we are seeing the same occur in the "value chart" of the USB. The USB is currently down approximately 75% in value and has been falling almost the whole decade while its "price chart" has been rising. We certainly expect the second leg of Dollar inflation via monetization to accentuate that, and to cause the "mark-down phase" for the US Bond to commence soon.

Gold and Silver will not only perform, but will start to aggressively move to the throne of Real Money- a parabolic ride. As long as the Dollar Inflation is applied, the Gold and Silver stocks will be treated as the owners of deep storage Real Money that they are as reserve valuations go wild.


I had intended to include charts and comments about how the Dollar Index pricing scheme as priced against variable currencies also demanded a deeper look, but my time is running out so I'll just make a few comments. Many who see deflation in the future have been pointing to the recent rise in the Dollar as a sign of the coming Dollar deflation. Personally, I expect the current Dollar Index rise to eventually look like a little blip on the LT Dollar chart. The Dollar Index has risen about 27% off the 70 bottom. At the same time the largest currency in the basket the Dollar is priced against, the Euro, has fallen about 22%. Thus, it may well be that somewhere around 75% of the Dollar Index price rise is due to the fall of the currencies it is "priced against." The true barometer for all currencies during times of loss of trust in paper currencies is Gold. Gold started to fall as the Dollar rose, but since early in the 4th quarter of 2008 Gold has risen back to around the old highs. This has come at the time when we have just started to move into the period of Global Competitive Currency Devaluations- a time period when currencies are being devalued all over the world. As time goes on any "Dollar strength" might only be the Dollar falling "less fast" than the other currencies. I'd still expect the Dollar Index to continue South from this point to lower lows, before that happens, though. The Dollar chart shows the usual non-confirmations of the TA indicators. Sometime soon after the next fall to new lows in the Dollar Index, the Index will become completely useless as a pricing gauge for the Dollar- exactly like the same point in the cycle in the late 70's.


Those looking for deflation seem to focus on two things. The first is the fractional reserve banking system as the major cause of Dollar Inflation. The second is the recent "Dollar strength" as shown in the invalid Dollar Index- invalid during times when everybody is devaluing their currency.

At this juncture the Dollar Index is on its way to obscurity after the next fall in the Dollar if the 70's cycle continues to repeat. It will simply become an "oscillator" of different currency devaluations with no respect to "Dollar value" as determined by investors due to supply and demand.

The first leg of Dollar Inflation was based on the use of the bank's fractional reserve system. In our opinion that phase ended when the derivative scheme that was also applied to increase leverage and to keep rates lower was forced to mark-to-market, or to zero.

That event occurred at the same time that the Fed "ran out of balance sheet." This was the "gap" between legs of Dollar Inflation where the Dow fell sharply into late 2008. Strangely enough, and quite by accident I am sure, that event was what precipitated the ability of the second leg of Dollar Inflation to be manufactured. The "Deflation Scare" allowed the Fed to convince Congress to start the monetization of Debt in the form of the bail-outs, then last week the Fed announced further debt monetization.

The second leg of Dollar Inflation is not fractional reserve based. It is based on the crack cocaine of Dollar Inflation- "Monetization of Debt." In fact, the start of the second leg of Dollar Inflation was to monetize the bad debts of the banks. Somehow that seems to me a bit like taxpayer money revolving back to the Fed. This second leg of Dollar inflation goes straight to the issue of debt monetization which no matter what fancy names they apply is actually a default on debt. We appear close to the point of the "price mark-down phase" for the US bonds as we reach the similar point where the Dow tanked after severe internal "value" deterioration. We'll show that chart in the future.


All of the above relates to why we believe the Precious Metals and the Precious Metals stocks are going to go absolutely parabolic over the coming years. The above explains how many factors will come together to create the Precious Metals Parabola. Part of it is the mechanical support of the math fraction of Dollar inflation. Part of it is the relationship of time cycles and their further relationship to price movements. Part of it is related to a further deterioration of trust in paper currencies as soon to be seen in US Bonds. The whole scenario is very 3-dimensional in nature, it fits a regular cycle, and we hope to return soon to offer our views of other parts.

Though it is true that Dollar Inflation creates a rise in the supply of Dollars chasing good that can cause price inflation, the simple math fraction also works to create an immediate rise in prices as the value of the Dollar falls in price due to increased supply. This might be particularly true if the Bond market sees a price mark-down as investors flee the Fed monetizing debt. Such an event might well create a sharp rise in money velocity as Dollars look for a safe haven.

With some work and responsibilities out of the way, we expect to be moving to a subscription newsletter or investment site. It looks like I will have a friend as a partner. Anyone interested in receiving information when our site is up, feel free to send a note to the e-mail contact, below. Anybody who contacted us last year will have an e-mail notification sent to them.

[email protected]

For the moment…………..Goldrunner.

Again, I'd like to thank all of the posters at the Gold-Eagle Forum for their daily input. Special thanks go to Dr. Vronsky and Westerman for creating the Gold-Eagle site and for editing my work. A very special "Congratulations" go out to Dr. Vronsky and Westerman after Gold-Eagle saw its hit counter ring up to 378 million this last week.

Here is the link to a site I use to research the warrants of Precious Metals stocks. I will be discussing some aspects of the leveraged use of warrants later in this editorial series.

Another very good site that is dedicated to investments in Silver belongs to David Morgan, and his site can be found here…………….

China has only 2% of its Total Foreign Reserves in gold.

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