I have updated the US money supply chart on my website (link) up to the end of May. Because the monthly, year-over-year data depicted in the chart is so volatile I added a rolling 12-month average of the Actual Inflation Rate to the chart. The rolling 12-month average inflation rate is itself still quite volatile, but much less so than the actual monthly data.

It is interesting to note that the average rolling 12-month inflation rate averages 8.25% for the past 15 months. To put that in context, the average inflation rate from 1970 to 1979 was 8.32%. We are, absolutely, in a highly inflationary environment. Deflation is not only unlikely given the structure of the US banking system, but nowhere to be seen in the data either.

Demand destruction has had a severe impact on the prices of many goods and services, but that should not be confused with deflation. Inflation and deflation are monetary phenomena and the recent decline in prices has only lead to confusion and further obfuscation of what is really going on.

Monetary inflation is currently mitigating the price declines we are witnessing, meaning those prices that are declining would have declined much more were it not for the inflation, and will eventually cause prices to start rising again. Our greatest concern should not be with the current falling prices of goods and services, but with the rate at which they will rise in the future vis-à-vis our capital and income. I suspect there are very few people out there whose income and investments are keeping up with the inflation rate, which means their wealth is eroding in real terms.

I have also been aggregating and calculating similar money supply and inflation data for Canada and found that the Canadian dollar's inflation rates for 2007 and 2008 were much higher than the inflation rates of US dollar. However, the average inflation rates for 2009 thus far are exactly the opposite. Canada's inflation rate is falling while that of the US is remaining steady above 8%.

Year US CAD
2007 7.93% 9.55%
2008 8.31% 10.23%
2009 8.48% 6.89%

For those interested in gold, my fair value of gold for 2008 was $763 an ounce. Using the average of 2008 and 2009's inflation rates for the US dollar, and gold's inflation rate for 2008, I come up with an approximate average value for gold of $815 for 2009. Please note that this is an estimate of the average value for the year, and not a year-end estimate.

Clearly the gold price is well above $815 an ounce, and has been so for quite some time. The macro economic environment has probably never been so obviously in favor of gold and it is my belief that the market has already priced much of this into the gold price. While I fully recognize gold's lure at these times, and the probability that the gold price could still increase quite substantially, I remain cautious about gold. Recall that investors who bought gold when it was grossly over-priced during 1979 and 1980 and then forgot to sell, suffered severe losses.

I would personally prefer gold to sell down to around $800 an ounce, where I know it represents good value, than buy gold at over-valued prices and hope that it keeps going up.

Paul van Eeden
www.paulvaneeden.com

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