Resource investors, gold bugs and doomers warning of an inflation crisis are all licking their wounds this week after a deflationary broadside took down commodities in an epic smack down. It’s the task of today’s Money Weekend to see if US Federal Reserve chairman Ben Bernanke might be spitting chips along with them – and why the case for hard assets stays strong.
That might sound strange. It’s tempting to think a week like this is a ‘win’ for the US Federal Reserve as gold loses lustre in the eyes of investors and the US dollar strengthens.
Remember, one of the main arguments of having a strong exposure to hard assets in your portfolio is because of the inflationary policies of the world’s major central banks, especially the US Fed. When the Fed inflates, it means the US dollar loses value. And because commodities are priced in USD, that makes them the first place to take a look.
When you see oil and gold rising, effectively that’s the US dollar going down. But as you saw this week, the US dollar went up…
Uncle Ben Bernanke Has a Problem
But Ben Bernanke doesn’t want the US dollar to go up. He wants it to go down. Many people take the line that this policy is to increase American exports. You devalue the currency and your products become more competitive in the global market. But there is another view, which your editor prefers.
Bernanke wants to import inflation. He wants the US dollar to go down so the cost of imports rises. The export benefit is a side effect. This is consistent with the fact that America imports more than it exports and with Bernanke’s working neo-classical mindset.
But why this policy? Like his counterpart Haruhiko Kuroda in Japan, Bernanke wants to generate inflation. The theory being that as inflation expectations increase, you generate spending as people move to buy before prices rise. By stimulating spending, you get the economy moving. ‘Aggregate demand’ goes up. You get nominal GDP growth. Companies will start to invest in response to economic activity.
Like we said, that’s the theory. But Ben Bernanke has a problem (or one of a few!) which doesn’t get a lot of airtime. Uncle Ben can control the supply of money. That’s a given. And gold bugs point it out often. But supply always has to meet demand. And Bernanke cannot control the demand for money.
And, by the looks of this chart, he’s losing the war in the US.
The Mystery of Velocity
This is a chart measuring velocity of the base money supply in the US. Velocity is notoriously hard to measure. But even giving this chart a wide margin for error, the trend is obvious.
Velocity is falling within the United States. In simple terms, velocity is a measure of the speed of money changing hands in an economy. Or as Wikipedia puts it, ‘Velocity has to do with the amount of economic activity associated with a given money supply.’
This relates to the ‘demand’ for money. When people aren’t spending, the demand for money is high. As in, they’re hanging on to their dollars. When they are spending, the demand for money is low (in other words, people prefer the goods they buy rather than keeping hold of money). As people spend faster this has an impact on prices. So rising velocity can have the same effect as increasing the money supply. Prices rise.
But the converse is also true. If people aren’t spending, velocity falls. This has the same effect as withdrawing the money supply. This goes some way to explaining how Uncle Ben can print so much money without generating headline inflation rates in the USA.
This also matters for Australian investors because the US dollar has a velocity outside the US and inside the US, because it is both a domestic and international currency.
Anyway, velocity is down and the US dollar is up. To generate inflation, Bernanke wants that chart to rise, not fall. Instead, Bernanke’s getting deflation. His whole career is based on the idea of preventing deflation. What a great excuse to keep printing money!
Oh! What’s this?
Bloomberg (Thursday):
‘The slump in gold may hand activist central bankers more reasons to pursue the easy monetary policy that helped drive up the metal’s price in the first place…The combination of growth jitters and reduced inflation anxiety boosts the case of Federal Reserve Chairman Ben S. Bernanke and counterparts elsewhere to keep pump-priming their economies in the hope they will finally secure traction.’
So that’s what he’ll do. But at some point, velocity will rise again. An increase in the money supply and rising velocity will take prices up with it. The question is, can Bernanke engineer it without losing control? Hard assets are your bet that he can’t.
Callum Newman
Editor, Money Weekend
PS. Don’t forget if you want to keep track of the latest things we’re reading and brief commentary on events that happen through the day, check out our Google+ page and Kris Sayce’s as well.
From the Port Phillip Publishing Library
Special Report: TORRENT SIGNAL 3
Daily Reckoning: The Brains of Barbarians
Money Morning: A Trader’s Eye View of Gold’s Frightening Collapse
Pursuit of Happiness: Reports of Gold’s Death are Greatly Exaggerated
