Myths about Gold & the Money Supply

Before we start, some definitions regarding the money supply are in order. M1, Money Supply; consists of cash plus checking accounts and travelers checks. M2, consists of M1 plus retail money market funds, savings and small time deposits. M3, consists of M2+ large time deposits, Eurodollars & large money market funds.

Myth 1 (Double counting)

A large portion of the M3 money supply is not really money and should not be included in any money supply discussions. Money is cash and spendable checking account balances. That's it. If you take $100,000 that you found in an old trunk and deposit it in a large time deposit, the bank will report it to the Fed as $100,000 in a new large time deposit. This will be counted as part of M3; this bank then lends this same $100,000 to someone who buys a $100,000 Mercedes: When this Dealer deposits this same $100,000 into a time deposit, that bank will then report to the Fed $100,000; which will then be include in M3. You, the first person, owns a certificate saying you have $100,000 in your bank. The Mercedes dealer also has a certificate saying he has a $100,000 in his bank. The Fed will now count $200,000 in M3. But only $100,000 is really in circulation. The truth is that money circulates and is counted many times because it is not labeled correctly. The real money supply in this example is the original $100,000. That's it. The second $100,000 that was counted should really be counted as a financial asset (since the Mercedes dealer bought a large time deposit certificate). It should not be counted as money.

In the same fashion, a portion of M2 is actually double counted also. So the question now is how much has the FED increased the "real" money supply. Real money is defined as cash or checking account money (the stuff that chases goods and services and that could create inflation). The answer is not precise but the amount is most likely quite a bit higher than reported. The best way to find out what the real inflationary effect of M1 really is, is by using ratios from the mid 1950's to mid 1970's; before money market accounts with check privileges came into being and distorted and confused the counting of "money supply" numbers. Back then, the average ratio between M1 and M2 was about 1 to 3 and M3 was usually only 10% higher than M2. Using these ratios, the portion of M2 that is actually spendable cash or cash equivalents might be as high as $3.6 billion. If this is true, then the real inflation inducing money supply (M1) in the last 10 years (1994 to 2004) has increased by $2.2 trillion, not by the $190 billion reported.. It appears that there is $1.971 trillion of money market mutual funds buried in M2 and these accounts have check writing privileges, so it is "real" money. In other words M1 should actually be $3.3 trillion. It is being reported as $1.3 trillion (June 2004). This portion of M2 which should be in M1, is the true money supply. These numbers imply that a severe and sustained inflation is more likely to occur than most people suspect which is very bullish for gold.

The confusion is that money (cash), Demand Deposits (checking account money) are different from Credit money (money lent to you by a bank) Stocks and Bonds They are financial assets and are totally different animals. That is why when the stock market (stocks are a financial asset, not money) loses $2 trillion because the tech stocks decline or we have a 1987 style crash, it really doesn't affect the price of cars, pizza or theater tickets. You would think a $2-3 trillion financial hit would create a huge "deflation", but it doesn't work that way. Stocks, bonds and buildings are assets that can be sold for cash, but are not cash. Remember that the cash you get from someone who buys your stocks or building means that person now doesn't have the money anymore to spend, since he has given it to you. The transaction does not affect the money supply. The easy maxim is that financial assets and real assets are not inflationary, and only excessive paper money increases that do not come out of real savings are what makes the prices of goods and services go up.

Myth 2 (Debt collapse)

A debt collapse is close at hand…and with it a massive deflation. FALSE. Someday this may actually happen, but to worry about this now is way too premature. Consider the following hypothetical scenario: There is a severe recession in the U.S. and there are massive bankruptcies and thousands of banks are about to go under. There is panic in the streets. The Fed would come to the rescue and sell everyone on the idea that it is necessary to do a one-time massive increase of the money supply to add liquidity to the system and ease the crunch, so as to eliminate panic and preserve jobs.. Let's say they propose a One Trillion Dollar increase in money and credit. Certainly a very large number that would raise a lot of eyebrows, but that is what would be necessary according to them to handle all the problems. $1 trillion would handle an awful lot of debt defaults and banking problems. Of course they would try to convince us that this might not be inflationary. They would come up with some clever, reasonably sounding explanation like "the extra $1 trillion will help productivity, create new jobs and help in capital investments which we create jobs and payu for itself. The thing to realize is that this is exactly what they will do and have already done so in the past. The Fed will create liquidity to bail out the establishment institutions, debtors, banks as well as depositors both large and small and just about everyone who votes. This is thought to be inflationary and it will make gold, silver and the mining stocks skyrocket.

Someday, when they finally print too much money and no one wants it, a total collapse could occur but this may be a long time from now. They will do everything in their power so as to not let the system collapse, even if they knew it would only be temporary. At some point in the future they may not be able to do anything, but I think we are many trillions of paper dollars away from that point.


Libertarians along with most other DOOM & GLOOMERS talk about the end of paper money as the point when everyone knows everything they buy will be selling at a higher price (within days or weeks), therefore everyone spends the cash as soon as possible to beat the price increases.

This is when a hyperinflation becomes a runaway inflation and paper money is exposed on the grandest of scales as a fraudulent economic concept. A deflationary collapse would then soon occur but it would have to be on the order of many trillions of dollars of defaults and bankruptcies all at once - an economic accident of huge proportions. Therefore I wouldn't bet on a deflationary nightmare just yet… but you can still take some precautions without damaging your potential investment returns by owning some Gold Bullion and Gold Coins such as Double Eagles, Maple Leafs or Krugerrands just in case. As long as they can print money and get away with it, a massive deflation will not take place.

To a gold investor, the argument is non-consequential because during an inflationary period, gold is your best bet anyway, as it is certain to retain its purchasing power. Should there be a massive deflation, gold is also your best bet as it will be the only money still standing. Either way you are protected.

Myth 3 (Gold is related to Oil)

The gold price is NOT related to the price of oil. Oil like Onions, wheat and beef all have their own Demand/Supply dynamics. Gold does too. But gold unlike every thing else is also money and until that idea changes, pegging gold to the production of anything (except paper money) can lead to a false conclusion.

Yes, if oil is going up because of "inflation" and corn flakes and everything else are going up then gold will also be going up But you could very easily see $25 oil and $50/lb beef someday because of price mechanisms that are based on supply and demand that are manifesting themselves independently of currency depreciation and have nothing to do with gold or the money supply. There are over 1000 commodities and I am sure that we could all produce a few graphs that trend to or diverse from gold and then we would go off into the world of false Causation. As a commodity, oil does deserve to be included in any inflation discussion, but if oil goes down to $25 a barrel but 200 other commodities go up in price, I wouldn't bet on gold going down because it was linked to oil, it's not - and the opposite is true as well.

In the final analysis, I think gold mining shares should be on the top of anyone's investment list. The summer time is usually quiet for gold mining shares. Canadians, who dominate the global mining circles, freeze so much in winter, that they take plenty of vacations in the summer. So does the brokerage and investment industry. Europeans, traditional large gold investors, are also gone for the summer. The summer is usually a good time to accumulate gold mining shares on sell-offs.

A recent extensive survey of Global Fund Managers had 10% reporting that they thought inflation would be "a lot higher" next year. There are tens of thousands of fund managers globally. If only 10% of this group decides to start buying gold mining stocks, as a hedge against this expected "lot higher" inflation rate, then a huge demand will develop.

Since the realization that the inflation cycle is just beginning, I am sure the number of managers who start seeing the trend will swell in the months and years to come. This will mean a great deal of buying power coming into a relatively very thinly traded market Remember, the total capitalizations 0f all the world's gold mining companies put together would total no more than the capitalization of maybe an IBM alone.

The Dilemma that Chairman Greenspan and the Government are now faced with is: How can they continue to print money when inflation has clearly reappeared? But how can they not print money in the face of Katrina, Rita and Iraq. There is also the dual reason for the FED's existence besides keeping our money stable and that is maintaining full employment. It appears that their only solution is the one that they are following; gradual rate hikes and plenty of new money at the same time - all long term bullish for gold and gold mining shares.


A long time ago, the store-of-value aspect of money was taken seriously by world governments and economists. That era coincided with a gold standard that began in 1717 by the British. In 1785, the Americans adopted a bi-metallic standard of silver and gold. In 1900, the US switched entirely to a gold standard. The US maintained full convertibility of the dollar into gold until 1933 when FDR not only banned US citizens from owning gold, but confiscated the gold that they already owned, but continued to honor convertibility by foreign central banks. This lasted until Nixon closed the gold window in August 1971, ending the Bretton Woods era, leaving the US dollar as the world's only reserve currency. The dollar from that point on has been no more than an "IOU Nothing" just another piece of paper. As long as the dollar was tied to gold, there was practically no inflation from 1785 until the formation of the Federal Reserve System in 1913. In 1967, 20 years before he was appointed Governor Alan Greenspan released a very profound statement summing up the reality of a sound money/credit system tied to gold: "As the supply of money increases relative to the supply of tangible assets in the economy, prices must eventually rise. In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no store of value". In light of Greenspan's almost total disregard for the dollar's integrity over the past 18 or so years, it is hard to believe he would still stand by his statement of 1967. However, reports of conversations with the Fed Chairman indicate he recognizes gold as money and privately still embraces the gold standard. Another one in the Proofs of the desirability of Term Limits.

Debasement of the dollar during the 90+ years of Federal Reserve management is shown by the fact that goods and services obtained in 1913 for $100 would cost more than $1900 today, and the loss of the dollar's purchasing power goes on unabated. Since the 1930's, the application of Keynesian economics, later joined by monetarism and the NeoCon's, has centered on maximizing economic growth via the expansion of credit and paper money created by fiat.

Central bankers have intellectually demonetized gold, and the 34,000 tons of Gold our central bank claim to have left in their vaults is probably 50% less as the result of the forward-selling schemes of the last twenty-five years. Most modern economists express optimism that the world's evolved money/credit system, without gold. is sound and that central bank managed economies are here to stay. The problem is that the normal cycles of economic contraction are being dealt with by unprecedented fiscal and monetary stimulus, pushing debt to unprecedented levels. At present, it takes $5 of debt stimulus to get only $1 of GDP growth. With total credit market debt (government, corporations, and individuals) at over $36 trillion, debt is now over 300% of GDP and still growing. Total credit market debt had reached 260% of GDP in 1929, on the eve of the Great Depression. US total credit market debt has more than doubled over the past five years, alone.


The steady rise in the gold price, that started four years ago, is forecasting that the paper money economy and world debt pyramid is essentially out of control and eventually will come face to face with reality. It will then come as no surprise in the years ahead to witness gold, with its 5000 year history as money, to once again resume its rightful role in enforcing monetary discipline and as a store of value against a background of severe economic upheaval. In the meantime, prudent investors are encouraged to look beyond the soothing reassurances of Wall Street's conventional wisdom to the early-stage investment opportunities in a primary gold bull market.

MYTH 4 (We are not running out of oil & there is no Real energy crisis)

In a free market economy the only way to create a crisis is by Government regulation.. 85% of all the land in America as well as its continental shelf is not available to exploration. Refineries & Nuclear Power plants cannot be built because of Government regulation and the Courts. We could be 75 to 85% self sufficient in oil if government just got out of the way. Instead we are looking to set up commissions to look for price gouging. There is no such thing as price gouging in a free market economy. Remember the 70's Price fixing only causes shortages and long lines but it does not lower prices. Allowing the Free Market to work is the only way to solve any and all problems, from High Oil prices to Poor Schools and every thing else in between.


Aubie Baltin CFA, CTA, CFP, Phd. (retired)

Palm Beach Gardens, FL



2 October 2005

Gold is using for heat dissipation in some cars.

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