Monetary Policy

Dollar Apocalo-watch


Gold back above $1,400. Silver above $29. (As of the time this entry is composed.)

This is not advice to buy, sell, go long, punt, panic, repatriate, or dig around for that "scrap gold." Past guarantees are no promise of future performance results. Save your confederate money. And remember, just stare at the TIPS yield and relaaaaax. (Or fret about deflation.)

NEXT: Rev. Al: Team Player on For-Profit College Regs

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  1. More Bail Outs TARP Stimulus Quantitative… Another fix for the Junkie Economy!!

    oh and

    1. Your source for gold and silver prices is Kitco? I prefer to view the Swiss America Trading Corporation’s up-to-the-minute chart whenever I wonder how these precious metals are doing.

  2. Gold back above $1,400. Silver above $29.

    And yet both are still undervalued, especially silver.

    Don’t sell, hold on to your Krugerrands and Silver Eagles, knapp a few more replacement flints, stock yourself with more powder and shot, and store more food in your root cellar, because this is going to be one hell of a ride!

    1. I don’t know why anyone thought it was a good idea to put Krugman on a currency.

      1. It’s actually Paul Krugrer, the last president of the free South African Republic, before the British raped it.

        1. That’s what they would like you to think. Open your eyes, OM.

          1. excellent work sugar substitute

            1. Why thank you, my little onomonopia.

    2. Gold used to be $35-ish an ounce, and a burger at mcdonalds was a quarter. Gold is now $14k an ounce, which is a 20 fold increase. However, the burger is not yet $5.00.

      gold is overvalued by approximately 2 fold.

        1. $1413/oz up $25.

          When the Federal Reserve was established in 1913, gold was about $20 per troy ounce. Now it is not uncommon for its price to increase by that amount in a single day.

          Nice job, Federal Reserve! WTG, USG!

      1. And candy bars used to cost a nickel. A nickel.

        1. How much were the onions on the belts?

        2. And candy bars used to cost a nickel. A nickel.

          Not only that, but they used to be larger – the actual bar, not the damned wrapper.

          1. Back when I was a boy, you could get a piece of Bazooka bubble gum a a penny, and we liked it!

            A penny … which is now an annoyance.

            1. Yeah. And the gum is too.

              Actually, if you got a stale one, that bazooka bubble gum shit was a lot more than annoying.

        3. Scientific calculators used to cost $10,000.

          1. Yeah, and they were twenty times the size and weight they are now. I remember the first one I ever used – it was as large as a typewriter. (For you kids a typewriter was a machine used for typing before the PC.)

      2. Actually gold used to be $20 an ounce, when FDR’s administration confiscated it in 1933. When Nixon was president, the government – before it devalued and then completely severed the dollar from gold – set up, or agreed to, a two tier pricing system. The US government’s official price would remain around $35 an ounce, but on the free and open world market the price would be allowed to fluctuate – which it did at around $75 to #85 an ounce. Naturally the US could not long continue to redeem dollars at such a low price – not with countries like France demanding to cash in their scads of Euro-Dollars for cheap gold to re-sell at the higher free market price; so the price was soon raised to $40 something an ounce. Eventually Nixon stopped all redemption and took us off the gold standard completely.

        There probably was no McDonalds back in 1933. When the McDonalds burger was 25 cents (in the late 60s?) and gold was government-priced at $35 an ounce, the government price was artificially low.

        1. (sorry, I hit submit instead of preview.)

          So because the government price was arificially low when the burger was only 25 cents, gold today is not over-valued. It is under-valued. By how much? Depends on what commodity you want to use as a benchmark.

  3. But it still is worth more that the Zimbabwean Dollar.

    For now.

  4. Silver? Over $29? I’m sorry, I can’t hear you…this Xerox is really, really loud.

  5. Uh, since when is gold a good measure of inflation expectations?

    Gold is globally traded and we care about U.S. inflation. Gold prices are determined by all sorts of other factors besides inflation expectations. Gold prices are driven by central bank purchases, increasing commodity demand in Asia, a hedge against various other world-economy wide risk, amateurs who don’t know how to invest etc. Gold prices are a very noisy signal – same goes for silver.

    TIPS spreads are far superior – how can this even be debated? Every plausible measure of inflation expectations with any reliability suggest inflation is to remain quite low – even with QE2 it will be below 2% per annum over the next 5 years. Not only does the indexed bond market suggest low inflation – but the inflation swaps market as well (and professional forecastors, but I don’t put much stock in that). Tell me what you think will be more accurate – an incredibly noisy signal like two commodities that rise for all sorts of global reasons – or two extremely liquid, notably informationally efficient markets that are directly tied to the variable we are looking at? Oh wait, we already know. TIPS spread and inflation swap inflation expectations have been correct thus far whereas gold has failed to be a predictor of inflation.

    Sorry, I take efficient markets seriously and both inflation-related markets tell me inflation is going to remain low. I’ll trust them over a noisy, inaccurate signals like gold and silver anyday.

    1. Re: Ted,

      Sorry, I take efficient markets seriously and both inflation-related markets tell me inflation is going to remain low. I’ll trust them over a noisy, inaccurate signals like gold and silver anyday.

      Yeah, you go ahead and do that.

      1. Perhaps you care to explain how gold measures inflation expectations … when it doesn’t. Whereas something that does measure inflation expectations … doesn’t?

        Either that or you don’t believe in efficient markets, in which case, you shouldn’t trust gold as an indicator either since the gold market consists of far more noise traders than the inflation swap market.

        The logic baffles the mind.

        1. Precious metals,especially gold, have always been an indication of expected inflation? Both in economics and finance? Markets are forward looking, always have been always will be.

          1. But gold prices aren’t measuring inflation expectations. They are measuring the price of gold – that’s it. A component of that is inflation expectations, but it’s impossible to tell how much of that is an inflation hedge. Whereas TIPS spreads and inflation swaps are actually measuring inflation expectations.

            Yes, markets are forward-looking and are approximately efficient. So, let’s look at the markets that actual measure predicted inflation.

            And, no, gold has actually been a fairly mediocre predictor of short-run inflation expectations (at least in fiat money regimes with floating exchange rates).

            1. But gold prices aren’t measuring inflation expectations. They are measuring the price of gold – that’s it. A component of that is inflation expectations…

              So they are measuring expectations, just not to the degree you want them to.

              It doesn’t really matter from an economic stand point. Expected inflation is priced in across everything. Unexpected inflation is what screws the pooch.

            2. I think what Ted is saying is that while gold makes a fine and dandy vehicle for protecting your wealth against inflation, but that doesn’t mean it’s a good indication of inflation, just a mediocre indicator, not necessarily a forward-indicator, and only truly accurate over long timescales.

                1. Fuck short timescales.

    2. Uh, since when was rent/price ratio a good measure of future housing prices and real values? I think I’ll stick with my conventional MarketWatch MSNBC wisdom thank you very much.

      1. This analogy says the opposite of what you mean it to say.

    3. Ummm, the U.S. dollar is globally traded also.

    4. you are funny. the bond market is not a free market. It is heavilly managed and manipulated by the Fed.

    5. The TIPS spread has worked fine, and will continue to work … until it doesn’t.

      As far as the efficient markets hypothesis goes, just how efficient was the market in CDS back in 2006?

      The gold price does reflect a multitude of market forces, including the reasonable fear throughout the world, especially China, that the American financial system is on the road to ruin.

      In the 1970s it was reasoned that the default risk of Latin American sovereign debt was negligible. Banks loaded up on Latin American debt, and received extraordinary returns, until they didn’t. USG bailed out the banks with Brady bonds.

      In the 1980s, it was believed that S&L bonds were essentially riskfree. Lincoln S&L bondholders received hefty interest checks and faithful repayment of principal at maturity, until they didn’t. USG bailed out depositors with the RTC.

      In the 1990’s, the indebtedness of the Asian Tigers was thought to be limited risk. The banks loaded up, and received extraordinary returns, until they didn’t. More bailouts by USG.

      In the 2000’s, home mortgages were thought to be of negligible risk. Record bailouts by USG.

      Throughout, the sovereign debt of European nations was thought to be of negligible risk. Then Greece blew up. Bailouts by ECB. Then Ireland, Portugal, and Spain. More bailouts by ECB. Now the ECB is unravelling. Bailouts by USG.

      Now, the sovereign debt of the USG is thought to be riskfree. It doesn’t take a crystal ball to what the future holds. The only trick is to figure out when.

      1. including the reasonable fear throughout the world, especially China, that the American financial system is on the road to ruin.

        Maybe it is. But my crystal ball says it’s going to be one long, hellish road getting all the way there.

        There is another element to this game that must never be forgotten: in many walks of life you don’t have to be good by any hard standard. You just have to be a little better than everybody around you at the moment.

        Maybe the USG sucks, but it has one virtue (which at this stage is maybe not its own doing): everybody else sucks even more.

        Somehow, I don’t think the world is about to end. We may be on the road to hell, but there’s a lot of good intentions still to be paved in.

        1. No one said the path to the Star Trek economy was going to be painless.

          Earl Grey, hot please.

  6. I remember 5 years ago when silver was about 1/3rd of that and I passed on buying silver… Fuck.

    1. Oh screw that. You should have bought palladium two februaries ago. I did that. But i’ve already sold (at 600).

      1. Should have bought rhodium in 2002 and sold in 2008. The low in 2002 was $440/oz. The high in 2008 was $10k/oz. That’s 22x. 2,200%

        Don’t know where you go to buy and sell rhodium though.

        If I could go back in time and know the future, I’d take out a $50k line of credit, buy about 100 ounces of rhodium and make the monthly interest payments for a few years. Then sell in 2008 and make $1 million.

        Again, not sure who would buy $1 mil in rhodium, though.

  7. Uh, since when is gold a good measure of inflation expectations?

    To the extent nostrums about investments are self-fulfilling, I suppose.

    But really, gold doesn’t necessarily track inflation all that well. The gold price vis-a-vis any currency is more an indicator of confidence in that currency and the nation-state that issues it.

    I don’t think TIPS, which are inflation-protected bonds, are a good indicator of future inflation. Why would they be? They’re protected.

    Look instead at the spreads (which are widening) and the indexes (which are dropping like a stone). The bond market is sending out plenty of signals that inflation is becoming more and more of a concern.

    But where, you ask, will this inflation come from in an economy that is room temperature? I suggest you consult the commodity indexes, which are piling costs onto producers that they can’t absorb indefinitely. When retail prices for food, manufactured goods, and (although its lagging) energy start to pass through these increases, you’ll have your inflation on the cost side.

    Maybe not on the wage side, though, which is why “cost-push” inflation is so much worse for the economy than “demand-pull” inflation.

    1. The other thing to keep in mind when discussing recent increases in the price of gold is the liberalization of gold markets in India and China. There was a huge gold boom in India once the post office started selling it in 2008. China allowed private gold sales in 2002 and had its first bullion exchange in 2005. About 2.5 billion people in a suddenly flush economy with relatively newly liberalized gold markets equals a lot of upward pressure on gold that’s completely independent of the US economy. China and India are #1 and #2 in gold purchases.

      1. That’s actually really interesting. I love it when one liberalization in one country leads to immediate pro-liberalization effects in others. Makes me all tingly.

    2. Krugman talked about the spread. The article said the implied inflation of the TIPS spread is a reasonable sounding 1.98%.

    3. I said to look at TIPS spread. TIPS themselves obviously don’t tell you anything. TIPS spreads are also partially problematic because of the liquidity premium, which is why I actually prefer to look at inflation swap rates which are more accurate. Both measures are still indicating inflation below 2% per annum over the next five years.

      Even a gold-currency comparision doesn’t really indicate “confidence” in a currency either. That would work better if we were talking about open-market sales of gold on either a gold-standard or fixed exchange rate. A much better way to figure out confidence in a currency is to look at something like the ratio of broad money (like M2) to international reserves or equity prices.

      Trying to guess where inflation will “show up” is really a pointless excercise I think. The Federal Reserve can push up the price level, but it’s basically impossible to know what the effects of relative prices will be. Those are determined by demand-supply components, not inflation itself.

      1. Liquidity premium? I meant “flight to safety.” I don’t know why I wrote liquidity premium.

  8. Silver is highly manipulated, not sure I’d wade into that mess unless you think the people manipulating it are going to lose control. (puts tin foil hat on) Gold could be manipulated by governments and kept low, but proof of that is a little harder to come by.

  9. The TIPS spread is all well and good, Ted, but why would the bond markets take a dump right after Bernanke announced he was going to buy hundreds of billions of bonds?

    Ordinarily, that would push up the price of bonds. But it didn’t. Something is exerting downward pressure on the bond market. I think its inflation expectations. What do you think it is?

    Trying to guess where inflation will “show up” is really a pointless excercise I think.

    I don’t think so at all. Inflation comes in different flavors, as expanded money supply hits the economy in different ways. “Demand-pull” inflation means the money supply is showing up on the demand side, in higher wages. “Cost-push” means it is showing up on the supply side, in higher costs. They have very different impacts on the economy.

    The Federal Reserve can push up the price level, but it’s basically impossible to know what the effects of relative prices will be.

    The Fed is indeed pushing up the price level, on the supply side, as cheaper/more abundant dollars compete for commodities on a global market. Its not that hard to figure out what the effects of this will be, at least in the short/medium term – margin compression (which is Not Good for the equities market) and higher prices, with hiring and wages likely to remain stagnant (see, margin compression, above).

    Why aren’t the TIPs spreads (and the stock market) reflecting this scenario? Could be I’m wrong. Could be that there are still lots of market players worried about deflation in a room-temperature economy.

    Could be that all the liquidity that Bernanke is injecting is flowing into equities, bubbling that market (still), and the QE purchase program is distorting the yield side of the bond market.

    1. I’ll address each of your comments in turn.

      i) Bond prices may or may not rise on an open market operation. More often than not it will, but it’s not guaranteed. Your logic would imply simply because people are buying more wine, the price must rise which isn’t nessecarily true. It will more likely be true, but it’s not guaranteed. What this more likely means is the market anticipated the Fed’s actions before the Fed’s action (this is actually pretty common) and so the bond prices didn’t rise. I doubt it’s inflation expectations because the spreads don’t signal it, nor do inflation swaps. The spreads should signal inflation expectations and they aren’t especially high.

      ii) Yes, where the inflation “shows up” can be important since relative price changes can act as supply-shocks and disturb productivity. But, I was merely pointing out it’s impossible to predict where. My guess is because we expericed a nominal shock induced by the Federal Reserve it’s going to show up in both price and wage inflation and be roughly evenly distributed.

      iii) Any increase in NGDP will likely show up in both wages and prices. If nominal wages are sticky, then an increase in nominal income / inflation expectations will eliminate the wedge distortion and encourage hiring and increase output. This will push up equities. Your scenario is true if the inflation is expected so wages and prices rapidly adjust.

      The issue isn’t deflation, that’s a red herring. It doesn’t matter if we are expericing deflation, inflation or whatever. What matters is expectations of what the price level was suppose to be. If expectations are set on a certain nominal wage or price level (or nominal debt level which is important in a mortgage crisis), deviations from that can generate recessions if they don’t adjust rapidly enough. I s

      1. Got cut off somehow …

        TIPS spreads likely yield low inflation expectations because a lot of the money supply is expected to be temporarily. Most observers expect that once inflation rises above 2%, the Fed would start contracting the money supply and so inflation expectations are tamed. Just look at Japan. The monetary base increased dramatically, but every time inflation ticked up the BOJ contracted the money supply so nominal income hardily moved at all despite the large increase in the money base.

        It’s hard for monetary policy to generate an equity bubble.It can, but it requires incorrect productivity expectations by investors and very strict inflation targeting. Monetary policy can generate bubbles in unsophisticated markets much more easily, but I don’t think equities are unsophisticated.

        What I think the Fed should do is commit to a nominal income or price-level path, level target based on where both should have been had they not screwed up in 2008 and let the market work the restructuring process out. I actually prefer a lower inflation target, but I don’t support generating a disinflation during a recession (though a clear stated annouced one would have very little real effects since wages and prices would adjust rapidly).

        By the way, I am actually skeptical how much the Fed can do to improve the economy. They could have done a lot in 2008 / 2009, but now a lot of real effects from the nominal shock have taken hold (skill-loss related to long-term unemployment; consumer bankruptcies, etc etc.)

    2. Thanks, Ted. Given me a lot to think about.

      I found this particularly interesting:

      TIPS spreads likely yield low inflation expectations because a lot of the money supply is expected to be temporarily.

      This seems to assume that Bernanke can withdraw significant liquidity from the economy.

      However, I don’t think he can, not without setting off a credit lockup. I haven’t heard a convincing explanation of how he can, either.

      Now, of the two markets (equities and bonds), I tend to think the bond market is the more reliable, so maybe people know something I don’t.

      1. I’m more concerned about the unconventional side of their balance sheet affecting their capital in an exit strategy rather than their inability to contract the money supply.

        The reason is they are now paying interest on reserves. Once the Fed starts paying interest on reserves the quantity theory of money breaks down. The Fed can encourage banks to hoard whatever amount of money they want at the Federal Reserve by doing so. They can easily keep the money out of circulation and contract it to keep the price level stable. This of course also makes one wonder why the interest-on-reserves is being done since it encourages hoarding of the money supply. Why the Fed thought it was smart to institute a contractionary policy like IOR in Fall of 2008 is just staggering, but that’s for a different discussion. Dropping the interest-on-reserves to 0 (or even imposing a penalty) would do far more than QE2 to increase the money supply, actually.

        My concern is that the unsual asset purchases may create a capital problem in the future which could require a tax-payer financed bailout of the Fed by the Treasury.

    3. I think this is the best indicator of inflation.

      M2 is a function of M0, but I dont know if that M0 is going to be bled into the system 2% annually and prevent a recovery or if the economy will actually recover and with the increased velocity of money, it all gets in rapidly with a few years of big inflation.

      Either way, that chart tells me the value of the dollar is going to halve.

      1. And, as Ted says above, the Fed could also pull some of that money supply out. But thats bullshit, we know they arent going to do it in any significant way.

      2. This of course also makes one wonder why the interest-on-reserves is being done since it encourages hoarding of the money supply.

        Replying out of place here. I think the M0 graph explains it all, they absolutely dont want the higher level money supplies to go up that sharply, so keeping the money hoarded prevents inflation. Basically they created enough new money to prevent deflation but dont want 10% inflation either so they cant let the economy recover quickly, so they have to restrict capital from flowing out of the banks too fast.

        This isnt at all my area, but that seems like best guess to me.

        1. I’ll reply to all three posts:

          i) You are forgetting that the quantity theory of money doesn’t hold once the Fed starts paying interest on reserves. The monetary base cannot be a reliable indicator when the Fed is paying IOR.

          The monetary base is generally a poor indicator of inflation expectations at low inflation rates also. This is why Milton Friedman actually abandoned monetarism in the 1990s and said the Fed should target the TIPS spread.

          For example, the monetary base in Japan rose by more than 75% – yet nominal income barely moved. There had been virtually no inflation during their QE period. The monetary base is not an appropriate measure of future inflation. In fact, a rising monetary base coupled with little inflation likely implies the market anticipates the money supply increase is temporary – or the bank is paying interest on reserves.

          What Woodford taught us most importantly was it doesn’t matter what the monetary base or interest rates are at the moment. It only matters what people expect the path of interest rates to be in the future.

          ii) I think the Fed will pull some of the base out later (unless we get into a Japan situation where everyone thinks with a slight uptick they will pull the base and so inflation doesn’t rise). They aren’t going to allow inflation to go significantly above 2%. If the Fed explicitly announced their target, as the should, this would actually stabilize the markets expectations about this problem as well.

          iii) Your are forgetting the endogeneity here. Part of the reason the monetary base grew so much is BECAUSE the Fed started paying interest on reserves. If they hadn’t, I suspect the money supply would have actually fallen – not risen – as the demand for dollars wouldn’t have risen as much. IOR is a contractionary policy since it encourages money hoarding. To offset it, they had to not only satiate the current demand for dollars set off by the financial shock and the nominal shock they initiated but they had to cover the contraction of IOR.If the Fed was level targeting nominal income and didn’t implement IOR, we likely would have seen the monetary base pretty much stay the same or slightly fall. Also, I agree IOR is an important policy tool. But, what matters is the future. The risk of inflation from a bloated monetary base isn’t now, it’s in the future. The IOR should be zero now and when inflation expectations start to rise, simply re-implement the positive rate to control the base. IOR is an important tool and we should have been using it a long time ago, but the question is what should the rate be? Right now, the rate should be zero – but positive later. Knowing how to use the tool is just as important as having the tool.

          1. Or, we could end the Fed and allow the market to decide. Deflation/inflation, whatever. End the Fed.

            1. I’m actually in favor of both government and private circulating liabilities. Solely private money can lead to excess volatility from congestion and news / expectational effects whereas government money has it’s own obvious problem.

              Why I like a system is that it both has a lot of choice and greater efficiency. Fiat government money can solve the excess volatility problem and due to the competition posed by private currency competitors the government will not have an incentive to use inflation to generate seignorage income since consumers then have alternative currencies we can turn too.

              It’s the best of all worlds. Choice, competition, efficiency, reduced volatility, and it limits the government’s ability to use inflation for seignorange and nominal debt reduction.

              If I can’t have that, I’d prefer a private money regime and just have an automatic tax rule that controls the excess volatility / business cycle problem (most people don’t realize you can exactly mimic the monetary allocations by adjusting tax rates by simple rules).

              Interestingly though, there is no legal barriers to something like electronic money anymore – so why haven’t we seen it yet? Either there is something about private fiat money that is inefficient (some have argued private fiat money can’t work, only private capital or commodity backed money) or nobody dares to start their only cash in fear of regulatory back lash and a loss of sunk investment costs.

              1. When did “excess” volatility become a problem?

                nobody dares to start their only cash in fear of regulatory back lash and a loss of sunk investment costs.

                Liberty Dollars?

                1. I’d heard of liberty dollars, but I didn’t know much about them. Wikipedia seems to say that they were charge criminally because their currency was supposedly “too similar” to U.S. currency, which is in violation of Federal law. But the actual act of printing currency itself is not illegal, I know that for a fact (wikipedia cites the Treasury department who ruled that Liberty Dollars were legal). Money is merely just a note that symbolizes some liability – it would be very difficult to actual ban this in practice anyway.

                  Now, on the merits of the case, looking at the Liberty Dollar notes

                  (see picture here:…..ollar.jpeg )

                  I think you would have to be totally retarded to confuse these will Federal Reserve notes – but either our justice department (and the grand jury that indicted them) are retarded or this is just a back-around way to prevent new currency.

                  Electronic money doesn’t suffer from this problem, obviously, since the Feds couldn’t claim you confused electronic money with “real” money.

                2. Volatility in the sense of varying different discounts and premia that fluctuating wildly outside the region of origin. It harms people because of the volatility in the rates of return on real balances. This was a pretty big problem in almost all private money regimes. This mostly depicts differing default risks across firms.

                  No system is perfect and excess volatility is private money’s problem, but I’d prefer private money systems to a federal reserve system since the Fed regularly screws up. If the Fed somehow followed perfect optimal monetary policy we’d have a real debate, but given one or the other private systems are probably better.

  10. I heard this rumor that no one has been able to control the velocity of money once it unfreezes???

  11. I don’t trust any economist who isn’t a multimillionaire.

    1. Well, I don’t trust the wisdom of any economist who isn’t a multimillionaire. But I don’t trust the motives of one who is.

  12. A decent discussion in H&R comments. marking calendar.

    1. H&R: Come for the bestiality, stay for the investment advice.

  13. patriate, or dig around for that “scrap gold.” Past guarantees are no promise of future

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