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The US Monetary Base and Gold

February 7, 2013

Last week COTW noted that the US monetary base had broken out of an 18 to 20 month sideways pattern. The US monetary base first hit $2.7 trillion back in June 2011 and since then it has ranged between $2.7 trillion and $2.6 trillion. That is until January 2012 when the monetary base hit just under $2.71 trillion. The sharp rise in the US monetary base since 2008 has coincided with the quantitative easing (QE) programs of first QE1 then QE2.

QE2 ended in June 2011. QE3 was announced in September 2012. Under QE3, the Federal Reserve is to purchase monthly $85 billion of mortgage backed securities (MBS) and US Treasuries until such time as the unemployment rate falls to 6.5% while keeping inflation under 2%. At $85 billion a month that is just over $1 trillion annually. QE is an unconventional monetary policy used by central banks to stimulate their economy. Not only is the US using QE as a monetary tool but Japan is pursuing QE quite aggressively. Japan recently increased its QE program from 10 trillion Yen per month to 80 trillion Yen per month. The Euro zone is using QE in order to stimulate the moribund European economy as ECB head Mario Draghi declared they would buy unlimited quantities of European Sovereign debt. China and Britain are also carrying out QE.

There are many different ways to look at the monetary base. The above chart shows the ratio of the US monetary base to the US population. Despite growth in the US population, the monetary base has been rising at an even faster rate. Since October 2008, the US monetary base has gone up 194% from roughly $949 billion to $2,796 billion. Gold has gone up only 102% rising from $828 to $1,672. This suggests that the US monetary base can now buy more ounces of gold at current prices then it could in October 2008. Alternatively, put another way it would take a higher gold price to match the ratio that was seen in October 2008. Gold today would have to be $2,400 to match the ratio seen in October 2008.

That the price of gold has gone up as the monetary base has increased should not be a surprise. A study correlating gold prices to the US monetary base found that the correlation coefficient was 0.94. The chart below shows that correlation.


Gold is also closely correlated to the US debt. In October 2008, the US public debt stood at $10.7 trillion. Today it is at $16.3 trillion a 65% increase. As noted above the price of gold has gone up faster. As the debt limit is increased, the price of gold should rise accordingly. The US is adding roughly $1 trillion annually to the deficit.

That is just the reported deficit. The US government GAAP based budget deficit hit $6.6 trillion in 2012. The 5-year average annual shortfall based on GAAP has been $5.2 trillion. That is sharply above the $1.1 trillion officially reported budget deficit. $6.6 trillion is 42% of the US GDP. GAAP accounting is what is typically used by US corporations. The additional deficit includes unfunded liabilities in social programs such as Social Security and Medicare. The unfunded liabilities are reported in terms of net present value (NPV). What all of this suggests is that the US debt situation is even worse than what is being reported.

The US has supposedly 8,133.5 metric tonnes of gold in their reserves (World Gold Council – World Official Gold Holdings). If the US were to use the gold to back the US monetary base, the gold price would have to be $9,745 per ounce. Even backing 40% of the US monetary base the price of gold would need to be $3,898 per ounce. (This assumes that the US gold reserves are still there. Some have suggested they are not. The US has not allowed any independent audit of the gold reserves. Many have called for an audit of US gold reserves. The calls have been rebuffed.)

It has been suggested in some circles that in order for the US to get its monetary house in order it should back its money with gold. What all of these suggests whether looking at the US monetary base per capita compared with gold or using the US gold reserves to back the US monetary base the conclusion is the price of gold is too low. That suggests that while gold has been trading in a range for the past 15 months that could soon end. As the US monetary base rises and as well as the US debt rises gold should go up with it.


copyright 2013 All Rights Reserved David Chapman

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