Thursday, March 26, 2009

How will $1 Trillion Dollars of Inflation Affect The Price of Gold?

Gold as hedge against inflation and collapsing dollarA little over a week ago we heard of plans for the US Federal Reserve to buy $300 billion in US Treasury Bonds as well as $750 billion in mortgage-backed securities. You do the math, this amounts to the printing of over a trillion new dollars to be pumped into the US economy. This is separate from Obama's stimulus plan which will spend $787 billon dollars into the economy this year and next, money for which will also need to be borrowed from the Federal Reserve.

The intention here is to stimulate markets and getting them moving upwards again. But remember that "stimulate" is a euphemism for "inflate", so even though we will see market prices going up, the value of everyday goods will also be going up as the dollar becomes devalued. It is impossible to pump 1 trillion dollars into the economy without prices inflating, unless people start saving all their money without spending. But that's the whole point - for people to spend and for this money to circulate. The government wants inflation. They want to avoid deflation at all costs, even at the cost of our buying power. Why? I suppose because deflation causes immediate problems that are politically unpopular, while inflation, if it can be controlled, wreaks its havoc slowly without the public really noticing. If it can be controlled.

I think the significance of this for gold and silver investors is pretty clear: while the US moves out of deflation and into inflation, the dollar will become devalued and lose much of its buying power, while the gold price will rise as its role as a safe haven and as real money will become solidified. With the inflation will come rising commodities prices in general, as economic activity creates demand. Oil prices will likely skyrocket once again, and since silver's function as an industrial precious metal makes its price somewhat follow the price of oil, silver will once again rise in price. This is not really new information, but the Federal Reserve's plans give a new indication that these conditions are just around the corner.

Gold & inflation of currency supplyHow much will a 1 trillion dollar injection inflate prices? To be honest, I don't know. The reason I don't know is because there used to be something called the M3, a wide measure used by the Federal Reserve to indicate how much currency is in circulation. In 2006 the Federal Reserve decided to stop publishing the M3. My guess is that they knew they would soon be pumping trillions into the economy, and seeking to hide the currency inflation they stopped publishing the M3. But in 2005 the M3 was around 10 trillion dollars. This doesn't account for all US money, since there are so many lines of credit and electronic dollars created through fractional reserve banking and other kinds of fancy "money", but the M3 was some kind of reliable measure. If the M3 was 10 trillion dollars and you added an extra 1 trillion dollars, you can see how big of an effect there could be. But what if this new money fails to stimulate the economy? People are scared, and may save all their dollars. Well, I predict the Federal Reserve will print more and more in desperate attempts to stimulate the economy. And eventually, all of those desperately printed dollars will make their way into the economy. And when they do, we'll see big inflation.

I think with all the economic news coverage we've become desensitized to just how big a number "trillion" is. Trillions do not even fit on the display of my calculator, the number is too big. With such a mindboggling number of new dollars being printed into existence, be weary of the gains you are going to see in the stock market. Those gains will be offset by highly inflated dollars. Gold will be your ultimate safe haven against this inflation. And as economic activity speeds up, commodity prices will skyrocket. I just shifted more of my money into the gold market, particularly the gold mining sector, into energy, and into agricultural commodities. And I'm continuing to stack gold and silver with the expectation that much of the value lost by the falling dollar will shift to precious metals.


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