Poker Bluffing Central Bankers Means Gold Bullmarket Should Continue

Everytime gold prices goes into hibernation, devotees of the state yell “where is inflation?!”

The “No Inflation” Propaganda

As I have been repeatedly saying, the impact of monetary inflation has always been relative. Inflation affects different economic sectors at different degrees and at different times. Politically favored sectors are the primary beneficiaries followed by the sectors that commercially interact with them, thus the gradient multiplier effect to the economy as earlier explained.

In the stock market, this phenomenon is manifested through what I call as the rotational process.

Yet today’s seeming benign conditions of consumer price inflation (CPI), which account for as symptoms of monetary inflation, does not imply of the absence of CPI inflation nor has CPI inflation solely been manifested on gold prices alone.

Nonetheless anti-gold arguments based on reductio ad absurdum and the fallacy of reading history into the future represents no less than pretexts for further inflationism and government interventions: no inflation today, thus inflate more!

These people should be reminded that economic laws are always in operation and applies equally to everyone. And that the inflation disease operates through different stages which means that CPI inflation could explode at any given time.

In reality, gold has been up for the 11^th straight year despite the ephemeral bout of deflationary episode during the crisis of 2008.

Chart from Goldmoney.com

And gold’s 11 year phenomenal record rise came amidst the US Federal Reserve’s Bubble blowing policies.

The point is, prices of gold will continue to respond to policies and that there hardly are any market trends that moves in a straight line—unless the marketplace endures an episode of extreme pressure from embedded imbalances.

As I previously wrote,

If they do, then markets must be experiencing an episode of extreme stress, symptomatic of the ventilation of acute systemic imbalances on the marketplace. They appear in the form of a blowoff phase (climax) of a bubble cycle or of hyperinflation in motion.

These extreme episodes are the black swan moments.

And the seemingly harmless CPI inflation landscape has been prompting for what seems as the crisis-political response feedback loop mechanism: where policymakers intervene in response to the market reactions and vice versa.

Political agents and their followers will naturally ‘selectively focus’ on data that supports or fits on their views, for the simple reason any admission of the CPI inflation threat will force them to reverse on their policies that would discomfit the markets and work against their interests (more below).

Until we see CPI inflation surge and or a major political backlash on central bank actions, we should expect this cycle of political interventionism/inflationism to continue.

And such actions will come under the half-truth discourse of a “no” or “little” inflation risk environment.

Gold Outperforms Obama Crony Warren Buffett’s Berkshire Hathaway

And it is also important to point out that gold has beaten the portfolio of the Obama crony and statist, Warren Buffett in spite of his repeated ranting against gold.

Whether priced in the equivalent of gold grams...

Chart from Pricedingold.com

Or based on relative performance…

Chart from the Daily Reckoning

“Unproductive” gold has clearly outperformed Mr. Buffett’s flagship Berkshire Hathaway over the past few years.

While past performance may not guarantee future outcomes, the second point is that fundamental drivers underpinning gold’s bullrun remains firmly in place.

Inflationism (expansion of monetary base in the US—see lower window—as well as in other developed economies) and the policy of negative real rates worldwide should continue to drive gold higher in spite of the current consolidation phase (chart from US Global Investors)

So, aside from highly distorted markets through various forms of market interventionism, I think this phase can be construed as a normal profit taking consolidation phase following the recent record run.

And reading price signals over the short term in an environment of heavy interventions can mislead, as acts of market interferences may have short to medium term volatile effects on the market’s price channels.

And given these highly politically influenced conditions, gold should continue to defy any statist expectations and beat the returns of Berkshire Hathaway.

Poker Bluff, Redux

It can also be observed that many of the current attributions to weak gold prices have centered on the supposed reluctance by policymakers to continue with “further stimulus”.

Such blarneys over withholding stimulus have been the dominant narrative and may have partly influenced the recent violent downside swing of September of 2011 and in March 2012 (two arrows indicated). I don’t recall of what news was ascribed to the December decline, I was on vacation.

Yet it has been a predilection, if not a habit, of the mainstream to associate current events to the market’s price actions (available bias).

We have seen this happen before through the gibberish of so called “exit strategy” in 2010. Then, I called this nonsensical propaganda as poker bluffing central bankers.

In reality in 2011, the US Federal Reserve monetized about 61% of US treasury issuance or a “whopping 8.6% of gross domestic product (GDP) on average per annum” according to Lawrence Goodman of Center for Financial Stability.

The US Federal Reserve financed most of the expenditures of the US government to compensate for the insufficiency of funding sources from private sector savings and the decline of foreign demand for US government papers. As US government expenditures continue to swell, the buyer and financier of last resort will be the US Federal Reserve.

The third point is that any constrains towards further “stimulus” would extrapolate to an outright default by the US government. Such event would ripple across the political spectrum that would adversely impact the favored banking industry and to welfare-warfare state. And US politicians and bureaucrats won’t likely resort to this option as this would put in jeopardy the survival of current political institutions or the cartelized central banking-welfare warfare state-banking system.

So policymakers will find ways and means to conduct more inflationism through overt or through stealth and possibly will come in different names.

Alternatively, this means another round of poker bluffing chatters.

Gold’s Correlation with Various Asset Classes

Lastly gold’s correlations with asset markets have been vacillating.

For most of the past years, the inflation tide has been manifested with gold’s leading the way relative to the equities as represented by the US S&P 500.

But this relationship appears on the rocks. During parts of 2011 (red ellipses), prices of gold and US equity markets parted ways. This came coincident to the end of QE 2.0 and the policy dithering by the US Federal Reserve. Then, gold prices rose as US stocks fell. This divergence was finally resolved when central bankers abroad reintroduced their versions of QE.

However, such divergence—but on an opposite path where gold has been in consolidation gold while the US S&P continues to ascend—seems to have remerged anew today.

My guess is that gold will close this anomalous divergence by heading higher.

My impression is that the gold appears to partly mirror the actions of the euro.

While the gold-Euro correlations has been loose over the past 3 years, where the upward streak of gold’s trend came amidst the sharp gyrations of the euro, recently gold seems to be moving in sympathy along with the euro’s decline.

Correlation should not be read as causation though. It would be mistake to think of gold as plainly anti-US dollar trade.

In reality, gold is the nemesis of fiat or political money, whether the US dollar, European euro, China’s yuan, Japanese yen, British pound or the Philippine Peso.

The bottom line is inflationism will continue to breath life into gold’s bullmarket, current volatility notwithstanding.

Betting against gold, says Professor Gary North, is the same as betting on governments. He who bets on governments and government money bets against 6,000 years of recorded human history.

The Suddenness of Inflation

Bloomberg columnist, author and Council on Foreign Relations (CFR) analyst Amity Shlaes warns about the complacency of political authorities over inflation. (hat tip Professor Antony Mueller)

“Sudden” is more like it. The thing about inflation is that it comes out of nowhere and hits you. Monetary policy is like sailing. You’re gliding along, passing the peninsula, and you come about. Nothing. Then the wind fills the sail so fast it knocks you into the sea. Right now, the U.S. is a sailboat that has just made open water, and has already come about. That wind is coming. The sailor just doesn’t know it.

“Sudden” has happened to us before. In World War I, an early version of what we would call the CPI-U, the consumer price index for urban areas, went from 1 percent for 1915 to 7 percent in 1916 to 17 percent in 1917. To returning vets, that felt awful sudden.

The popular mainstream ‘begging the question’ argument on consumer price inflation goes something like this: inflation risk is minimal, because there has been little signs of inflation today.

Present and past actions have been construed as extending to the future, with little regards to the cause-and-effect relationship from implemented policies such as money printing or zero bound rates. In reality, these arguments have been pushed to justify more inflationist-interventionist policies: No inflation? Have more inflation.

Yet like natural disasters, inflation wreaks havoc at the least expected moments.

The volatile episodes of US CPI inflation coincided with wars (World War I, World War II and the Vietnam War). (chart from tradingeconomics.com)

In a relative sense, today’s US CPI inflation environment has been ‘calmer’ than the current periods. Even if the US has been engaged in numerous imperialist wars, along with the huge welfare state that substantially contributes to the ballooning record fiscal or budget deficits. (chart from the Heritage Foundation)

chart from Cleveland Federal Reserve

And this comes amidst the exploding balance sheet of the US Federal Reserve. The US Federal Reserve has topped China as the largest owner of US treasuries, which means that the US central bank has become the key source of financing for the US government.

And these banking based financing of public expenditures are inflationary. The great Murray N. Rothbard explained

Deficits mean that the federal government is spending more than it is taking in in taxes. Those deficits can be financed in two ways. If they are financed by selling Treasury bonds to the public, then the deficits are not inflationary. No new money is created; people and institutions simply draw down their bank deposits to pay for the bonds, and the Treasury spends that money. Money has simply been transferred from the public to the Treasury, and then the money is spent on other members of the public.

On the other hand, the deficit may be financed by selling bonds to the banking system. If that occurs, the banks create new money by creating new bank deposits and using them to buy the bonds. The new money, in the form of bank deposits, is then spent by the Treasury, and thereby enters permanently into the spending stream of the economy, raising prices and causing inflation. By a complex process, the Federal Reserve enables the banks to create the new money by generating bank reserves of one-tenth that amount. Thus, if banks are to buy $100 billion of new bonds to finance the deficit, the Fed buys approximately $10 billion of old Treasury bonds. This purchase increases bank reserves by $10 billion, allowing the banks to pyramid the creation of new bank deposits or money by ten times that amount. In short, the government and the banking system it controls in effect "print" new money to pay for the federal deficit.

Thus, deficits are inflationary to the extent that they are financed by the banking system; they are not inflationary to the extent they are underwritten by the public.

While we cannot exactly predict exactly when CPI inflation is bound to hit the US economy, given the recent actions by the US Federal Reserve and US Federal government, we understand though that inflation will eventually rear its ugly head.

The question is a WHEN rather than an If. And to what degree of inflation.

And worst, since the world has operated on a monetary standard based on the US dollar, the effects of US inflation will be worldwide.

The basis for such prediction is our theoretical understanding of the 3 stages of inflation

As the great Ludwig von Mises pointed out, (bold highlights mine)

In the early stages of an inflation only a few people discern what is going on, manage their business affairs in accordance with this insight, and deliberately aim at reaping inflation gains. The overwhelming majority are too dull to grasp a correct interpretation of the situation. They go on in the routine they acquired in non-inflationary periods. Filled with indignation, they attack those who are quicker to apprehend the real causes of the agitation of the market as "profiteers" and lay the blame for their own plight on them. This ignorance of the public is the indispensable basis of the inflationary policy. Inflation works as long as the housewife thinks: "I need a new frying pan badly. But prices are too high today; I shall wait until they drop again." It comes to an abrupt end when people discover that the inflation will continue, that it causes the rise in prices, and that therefore prices will skyrocket infinitely. The critical stage begins when the housewife thinks: "I don't need a new frying pan today; I may need one in a year or two. But I'll buy it today because it will be much more expensive later." Then the catastrophic end of the inflation is close. In its last stage the housewife thinks: "I don't need another table; I shall never need one. But it's wiser to buy a table than keep these scraps of paper that the government calls money, one minute longer."

A fundamental example has been the most recent bout of hyperinflation which buffeted Zimbabwe’s economy during the last decade, which I posted three years back.

When inflation strikes, it slams like a tidal wave. Zimbabwe’s hyperinflation produced a hockey stick like effect, similar to Weimar Germany’s experience.

While the risk of hyperinflation is not yet imminent, if the current path of inflationist policies is sustained, then this would enhance the probability of such a risk.