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Can the Fed use Gold as the Vacuum to Higher Inflation?

09 Jul 2018 - Archive

Friday was a fairly strong day for gold. The precious metal jumped 2% on reports that the American labor market was weaker than expected.

Overall, since bottoming on September 11 at $1,100 per troy ounce, gold is up about 4% to about $1,140 per ounce.

Interestingly, gold is strengthening even though inflation – typically thought of as the driver of gold prices – has been trending downward, perhaps even moving towards actual deflation in Europe, the U.S., and China (China probably not, although it is possible).

The disinflation or movement towards deflation presents a conundrum for (mainly) European and American central bankers. Mr. Draghi, Ms. Yellen, and their likeminded advisors have long been attempting to manufacture inflation, but to no avail. They have tried printing money, buying bonds, avoiding raising rates, and sending messages that they have no intention of raising rates anytime soon. None of these actions have worked.

The answer as to why massive government printing has not led to significant inflation lies in a complex web of deleveraging, demographic forces, weak business loan demand, and globalization.

So, What Could They Do To Manufacture Inflation?

With the aforementioned as the background, what could American and European central bankers do to manufacture inflation quickly?

The answer: buy gold above market rates.

Essentially, the American and European central banks could announce that they are going to buy gold at say $4,000 per troy ounce. 

That would be a massive depreciation of the Euro and Dollar relative to gold. And, all other prices would need to follow suit.

In order to keep price parity, the price of oil would rise to $350 per barrel, and other prices would summarily follow suit (at least theoretically).

Seem preposterous?

Well, the American Federal Reserve has done it twice before to boost inflation.

The first time was in 1933. President Roosevelt announced that the American federal government would buy gold at $35 per ounce, a 75% jump from the $20.67 per ounce it was paying up to that point.

The action contributed to a break in deflation.

The second time was in the 1970s, when President Nixon and the Americans moved the other way. Nixon announced that the U.S. would no longer convert dollars into gold with major trading partners.

Gold went on a tear, gaining over $2,200% over the next nine years. Inflation followed suit, with price inflation in the U.S. reaching double digits in the early 1980s.

So, central bankers, most notably the Americans, can make moves to quickly turn deflation into inflation.

When governments around the world decide to do this, one can certainly expect gold to appreciate materially, as it did before.

Conclusion

Overall, could central bankers attempt to quickly turn prices from deflation into inflation?

The answer is certainly yes, as they have done before.

One way for central bankers to turn the price trends around is to announce they will buy gold at rates well above market rates. As before, such a step would quickly cause all prices to appreciate materially.

Although gold investors would not be intentionally be targeted, they would be massive beneficiaries of central bank policy. It has happened before; it can happen again.

 

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