Double-Digit Inflation and the Rise of Gold

Double-digit inflation is a non-linear development. What I mean by that is, inflation doesn’t go simply from 2%, 3%, 4%…five…six and so on. What happens is that it’s really hard to get it from two to three, which is ultimately what the US Federal Reserve wants.

It’s proving extremely difficult just to get up to 2%. The US personal consumption expenditure (PCE) is the core price deflator, which is what the Fed looks at. Currently, it is at about 1.6–1.7%, but it’s stuck there. It’s not going anywhere.

The Fed continues to try everything possible to get it to two with hopes to hit three. Where the problem arises is once you get to three, the next stop isn’t four, it’s eight, and then it goes to 10. In other words, there is a big jump.

The reason is that it’s not purely a function of monetary policy; it’s a partial function of monetary policy.

It’s also a partial function of behavioural psychology. It’s very difficult to get people to change their expectations but, if you do, it’s hard to get them to change back again.

Inflation can really spin out of control very quickly. So is double-digit inflation rate within the next five years in the future? It’s possible. Though I am not forecasting it. If it happens, it would happen very quickly.

We would see a struggle from two to three, and then jump to six, and then jump to nine or 10. This is another reason why having a gold allocation in advance is of value. Because if and when these types of development begin happening, gold will be inaccessible.

To this point, I am often approached on, ‘How can you say gold prices will rise to US$10,000 without knowing developments in the world economy, or even what actions will be taken by the Federal Reserve?’

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Here is where the US$10,000 per ounce number comes from

It’s not made up. I don’t throw it out there to get headlines. It’s the implied non-deflationary price of gold. Everyone says you can’t have a gold standard, because there’s not enough gold. There’s always enough gold, you just have to get the price right.

That was the mistake made by Churchill in 1925. The world is not going to repeat that mistake. I’m not saying that we will have a gold standard. I’m saying if you have anything like a gold standard, it will be critical to get the price right. To this regard, Paul Volcker said the same thing.

The analytical question is, you can have a gold standard if you get the price right; what is the non-deflationary price? What price would gold have to be in order to support global trade and commerce, and bank balance sheets, without reducing the money supply?

The answer is: US$10,000 an ounce.

The math is where I use M1 (which is all physical notes and coins, plus money held in a standard banking accounts) is what I base my judgment on. You can pick another measure if you choose — there are different measures of money supply. I use 40% backing. A lot of people don’t agree with that. The Austrians say it’s got to be 100%.

Historically, it’s been as low as 20%, so 40% is my number. If you take the global M1 of the major economies, times 40%, and divide that by the amount of official gold in the world, the answer is approximately US$10,000 an ounce.

Now, if you go to 100%, using M1, you’re going to get US$25,000 an ounce. If you use M2 (all of M1 plus short term deposits and 24 hours money market funds) at 100%, you’re going to get US$50,000 an ounce.

If you use 20% backing with M1, you’re going to get US$5,000 an ounce. All those numbers are going to be different based on the inputs, but just to state my inputs, I’m using global major economy M1, 40% backing, and official gold supply of about 35,000 tonnes.

Change the input, you’ll change the output, but there’s no mystery. It’s not a made-up number. The maths is eighth grade maths — it’s not calculus.

That’s where I get the US$10,000 figure. It is also worth noting that you don’t have to have a gold standard but, if you do, this will be the price.

The now impending question is: Are we going to have a gold standard? That’s a function of collapse of confidence in central bank money, which is already being seen. It’s happened three times before, in 1914, 1939 and 1971.

Let us not forget that, in 1977, the US issued treasury bonds denominated in Swiss francs because no other country wanted US dollars. The US treasury then borrowed in Swiss francs, because people didn’t want dollars — at least not at an interest rate that the treasury was willing to pay.

That’s how bad things were, and this type of crisis happens every 30 or 40 years. Again, we can look to history and see what happened in 1998. Wall Street bailed out a hedge fund to save the world.

What happened in 2008? The central banks bailed out Wall Street to save the world. What’s going to happen in 2018?

Each bailout gets bigger than the one before.

The central banks are out of bullets

The Governor of the Bank of England, Mark Carney, cut rates at the start of August. He spent two years teasing the markets about raising rates, and now he’s cut them. That shows you that there’s something bigger than a pill. There’s something bigger than the central banks going on here that you have to analyse.

If the next crisis is bigger than the last one, which I expect, and the central banks are tapped out, where is the money coming from? How will you re-liquefy the world? The answer is that the IMF is going to print a massive amount in dollars of SDRs. Is that inflationary? Of course it is.

If you flood the market in dollars of SDRs, one of two things is going to happen. Either that’s going to work, and will be highly inflationary, which is going to take gold to US$10,000 an ounce, or it’s not going to work, in which case you’re going to have to go back to a gold standard — and gold will jump to US$10,000 an ounce.

You can have multiple paths, and timing has to be watched, but this number is very well grounded analytically.

All the best,

Jim Rickards,
Strategist, Strategic Intelligence

Editor’s note: Jim touched an interesting subject here: SDRs.

Very few people are familiar with SDRs, or Special Drawing Rights. What are they?

Well, they are ‘money’ issued by the International Monetary Fund. They were created by the IMF way back in 1969. Think of them as emergency money. Except SDRs aren’t money at all.

Basically, SDRs are bits of paper that entitles you to exchange an SDR for a ‘useable’ currency from one of the IMF member countries.  The currencies that ‘back’ the value of the SDR are currently US dollar 41.90%, euro 37.4%, Pound sterling 11.3% and yen 9.4%.

Perhaps most importantly though, SDRs are backed by nothing. They are an international reserve asset which has been created to back a country’s ‘official’ reserve asset.

As of March this year, 204.1 billion (AU$376 billion) SDRs have been created and allocated to members since their creation. I’m not making this up either; it can all be found on the landing page of the IMF’s factsheet.

Come 1 October this year, a historic change is taking place.

The Chinese yuan is being added to the SDR basket of currencies. China will now be the fifth currency to be accepted as international emergency money.

The new weighting has seen some of the world’s most dominant currencies lose their top spot. As of the first day of October, SDRs will now look like this: US dollar 41.73%, euro 30.93%, Chinese renminbi 10.92%, yen 8.33% and Pound sterling 8.09%.

The yuan is the newest country to join the SDR basket. Yet it somehow managed to push its weighting percentage to third, bumping the yen and sterling to the bottom.

The US dollar keeping its SDR dominance is mostly political pandering. But the yuan moving straight up to the third spot tells you the growing importance of the yuan as an international currency.

Investors aren’t able to access SDRs. However, there are local and international investments that you can use to benefit from these changes. To read more about Jim Rickard’s strategy for doing so, click here.

PS: This article was originally published in Money Morning.

Jim Rickards
James G. Rickards is the editor of Strategic Intelligence, the newest newsletter from Port Phillip Publishing. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He is the author of The New York Times bestsellers Currency Wars and The Death of Money. Jim also serves as Chief Economist for West Shore Group.

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