The Building Storm: Gold, The Dollar And Inflation

By David Galland, Managing Editor – The Casey Report
21 Aug 2008 at 04:48 PM GMT-04:00

One could hardly fail to notice that gold investors have suffered a little more than a “bit of pain” over the past month. More like a good kicking as gold moved down by about 20% from its recent high of $986 on July 15.

PARIS (ResourceInvestor.com) -- Making assumptions is often a bad idea, but I am going to go out on a limb here and make the assumption that those of you with an interest in gold are concerned over the latest setback, the depth of which has surprised even us.

Don’t be.

The evidence to support that statement would fill a telephone book at this point. Starting with the latest U.S. inflation numbers which, even using the government’s own crooked calculations, rang in the last reporting period at 5.6%. Quoting John Williams of ShadowStats.com from a recent email I received from that organization…

Reported consumer inflation continued to surge on both a monthly and annual basis, once again topping consensus expectations. The July CPI-U jumped to a 17-year high of 5.6% in July, while annual inflation for the narrower CPI-W — targeted at the wage-earners category where gasoline takes a bigger proportionate bite out of spending — annual inflation jumped to 6.2%. The CPI-W is used for making the annual cost of living adjustments to Social Security payments. The 2009 adjustment — based on the July to September 2008 period — remains a good bet to top 5%, more than double last year’s 2.3% adjustment for 2008. Such is not good news for federal budget deficit projections.

Based on William’s calculations, which use the same CPI formula used by the Fed prior to the jiggering of the Clinton years, the actual inflation rate is now running at 13.64%.

And on August 19, we learned that the U.S. Producer Price Index rang in at a month-over-month increase of 1.2%, the third month in a row where that leading indicator has topped the 1% mark. Meanwhile, in Europe, the latest numbers put inflation at a 16 year high. And these are not anomalies, but the norm as the inflation tide continues to rise literally around the world.

Dark Clouds

A good analogy to the global currency devaluation is a slow-moving hurricane that, once over warm water, gains energy.

Right now the global inflation is a huge storm, slowly circling off the proverbial coast where it is gathering strength from the hundreds of billions of dollars being fed into it by governments desperate to avoid economic collapse… and from pricing decisions being made by everyone from manufacturers to local shopkeepers looking to cover rising costs.

At this point the skies are dark, the wind is rising, and the torrential rains are beginning to sweep in. The radio is broadcasting warnings to move to higher ground, but the hurricane has yet to hit the shore.

But when it does, it will be a Category 5 and maybe worse.

That’s because, in addition to the straight-up consequences of the government monetary prolificacy and businesses raising prices to try and stay afloat, there is something else feeding power to the storm… something we have been warning about for years now: the rising odds that the global fiat currency system will fail.

Let me add some nuance to that remark.

In recent years, the global financial community, reflexively looking for an alternative to the obviously damaged U.S. dollar, has settled on the euro. But the euro is equally flawed, and maybe even more so, than the U.S. dollar. Now that the trading herd has also come to that conclusion, they are rushing back toward the dollar.

They are doing so not because the U.S. dollar is healthy, but rather because that is all that they know… a heads-or-tails continuum running something along the lines of “If the ‘it’s-not-the-dollar’ play is over, then it must be time to go back into the dollar.”

The euro sinks, the dollar goes up.

And so gold, viewed by these same traders only in terms of its inverse relationship to the dollar, gets hammered.

What they are missing, but not for much longer, is that rushing back into the dollar is akin to heading for the vulnerable coast, and not to the higher ground now proscribed. They are also missing the point that gold’s monetary value is not limited to protecting only against a failure in the U.S. dollar, but against any faltering fiat currency… a moniker that the euro deserves in spades. Not only is it backed by nothing, but it is also backed by no one.

I hope that the above point is clear, because it is an important one. One way to think about it is to think about Zimbabwe. If you lived in that blighted country and a year ago you could have had an ounce of gold or a wallet full of that country’s failing currency, which would have been the better bet?

The answer, while obvious, is illustrative… because the wealth preservation role that the ounce of gold would have played for a citizen of Mugabe’s paradise had zero connection with how well gold did, or didn’t do, against the U.S. dollar over the period.

A Return to Sound Money

Gold is viewed as tangible money right around the world, and has been for millennia. When the trading herd wakes up to the fact that neither the U.S. dollar nor the euro, nor any other fiat currency, will protect them against the monetary storm that will soon begin tearing the roofs off their cozy offices, they’ll fall all over themselves in the rush for something that will: gold and other tangibles.

Those of you who have been Casey Research subscribers for some time know that the scenario just described is one that we have forecasted for some time. If you think the thing through, precedent to the global monetary crisis, the euro first had to stumble. Well, it now has. The next stage -- and given the volatility of the situation, I don’t think we’ll have to wait long for it – will be the realization that there is no safe fiat currency. It is at that point that the massive hurricane, a crisis of confidence in the entire fiat system, will begin ravaging the global economy in earnest.

The price action of gold and, especially, gold-related investments over the last year, have been frustrating… to say the least. But the scenario now unfolding remains step-by-step in sync with our base case. As such, the best way to view this latest correction in the price of gold is as a temporary setback of no real consequence from an investment perspective (unless you use it as a buying opportunity).

The failure of the euro, on the other hand, is not just important… it is as monumental as it was inevitable.

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David Galland is Managing Editor of The Casey Report, the flagship publication of Casey Research.