Money Supply vs The Price of Gold

February 27, 2013

There is strong empirical evidence of a direct relationship between long-term price inflation and money-supply growth. An outstanding example is Zimbabwe, which saw rapid increases in its money supply fueled by rapid increases in prices (hyperinflation). This is one reason for the reliance on monetary policy as a means of controlling inflation.

GRAPH OF MONEY SUPPLY vs THE Price of Gold (1992-2012)

Quantitative Easing and Money Growth:  A viable Potential for Higher Inflation !

After Lehman Brothers announced on September 15, 2008, that it was seeking bankruptcy protection, the Federal Reserve massively increased the size of its balance sheet through a wide range of new lending facilities. As reliance on these facilities waned, the Federal Open Market Committee (FOMC) undertook a large-scale asset purchase program, commonly referred to as “quantitative easing” (QE), whereby it purchased $1.75 trillion in longer-term debt; this first program is commonly called QE1. In November 2010, the FOMC announced it would purchase an additional $600 billion in longer-term Treasury securities (QE2). These actions and the FOMC’s decision to reinvest principal payments from maturing securities more than tripled the Fed’s balance sheet: from about $900 billion before Lehman’s announcement to about $2.8 trillion currently. This essay discusses the potential of these actions for growth of the money supply and inflation.

M1 Money Supply and Inflation

Who's Afraid Of The Big, Bad QE? M2 Growth, Inflation And P/E Ratios

QE and Money Supply Growth: The first two rounds of QE meaningfully increased the money supply, with 1-year growth in M1 - or the Monetary Base plus Travelers Checks, Demand Deposits and other Checkable Deposits - peaking at record levels in both June 2009 and July 2011. However, while growth in M2, which augments M1 with retail money-market funds and savings deposits, has risen to multi-decade highs as well, it has lagged the growth of M1 significantly, one sign that money supply increases are not being transmitted effectively to the real economy. This is in stark contrast to the 1960s-70s, the mid 1990s, and the mid-2000s, when M2 growth was above M1 growth, stoking inflation (see chart below).

In short the quantitative easing monetary policy of printing money is used to counteract the deflationary forces of the banking system as a whole and keep the total supply of money at a constant as there is a move back to financial sanity nationwide.

Gleaned from all the above, one is forced to conclude Quantitative Easing (whether QE1, QE2, QE3,  QE4 or QE-whatever) increases M1 Money Supply. Via this mechanism inflationary conditions slowly ramp up leading to the gradual increase of prices of everything…but especially commodities – GOLD AND SILVER IN PARTICULAR.

MOREVER,  studies prove that increased inflation fosters JOBS CREATION.

Obviously there are many economic problems facing the USA.  However, our country’s main problems today are (in order of urgent importance):

-    Too high unemployment

-    Falling real estate values

-    Banks severely by Falling real estate values

-    Stagnant economic growth

Historically, these same problems have plagued other countries – and even the USA in the past. Most notably was the 1930s Great Depression (under President Franklin D Roosevelt) and the late 1970s (under President Jimmy Carter).  Both Presidents help quicken economic recovery by increasing the Money Supply and devaluating the US dollar.

The US M1 money supply to gold price ratio, from 1970 till 2012:

Today Democrat President Obama faces the same FOUR challenges. However, he has the obedient attention of the US Federal Reserve Bank, which has methodically been increasing the Money Supply via Quantitative Easing (since March 2009). Moreover, Fed Chief Dr Bernanke has publicly stated that QE3 and QE4 are unlimited with regard to duration and magnitude…with the primary praiseworthy goal of bringing down the UNACCEPTABLY HIGH UNEMPLOYMENT RATE (whether it be 7.9% or 15% or 25% depending on how you measure it).

Consequently, we may count on the US Fed to tirelessly implement QE to ratchet down UNEMPLOYMENT.  The upshot will be an inexorably growing Money Supply, which will eventually be reflected in higher inflation…INDEED MUCH HIGHER INFLATION.

Within the increasing environment of higher M1 Money Supply and growing inflation, the price of gold and silver will move inexorably the value of the US dollar inevitably slides to much lower levels.

The Central Banks of the world know this, which is the reason why they have become net buyers of gold in recent years – vis-à-vis net sellers in years past. Additionally, Germany’s Central Bank believes timing is so crucial that it has ordered the repatriation of all its gold outside its borders (especially all its gold deposited in New York). 

Central Banks Are Still Gold Buyers

On November 15, 2012, the World Gold Council published its report, Gold Demand Trends Q3 2012, where it was clearly expressed that this trend is continuing. According to the report:

Diversification of reserve assets remains the driving force behind gold demand by central banks and purchases of a similar order of magnitude are expected for the fourth quarter. Official sector demand is likely to act as a fairly solid pillar of demand going forward.

More Graphs showing Central Banks Gold buying:

Current Central Bank Gold Reserves by country:

Central Bank gold buying is steadily increasing

Based upon several fundamental bullish factors, but especially increasing Central Bank gold purchases, the price of gold might top US$2,200 in 2013 --- and eventually reach US$5,000/oz before President Obama leaves office…thanks to QE exponentially increasing the Money Supply. In concert with U.S. inflationary policy are a hoist of countries pumping up their Money Supply. Here is the entire list of Money Supply (M3) increases by all major world nations:

BANK ON GOLD AND SILVER VALUES TO REACH RECORD LEVELS IN THE NOT TOO DISTANT FUTURE…year after year – as global Central Banks try to inflate away their burgeoning debt and reduce unacceptably high UNEMPLOYMENT by vastly expanding Money Supply.


Dr. Doolittle

18 karat gold is 75% pure gold.

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