Ignore Government-Issued Stats, Gold Is Still An Inflation Hedge

The government uses "core inflation" numbers to measure inflation. These ignore the price of food and energy because they are too volatile. Some experts say that gold has gone out of whack with its traditional relationship to inflation, but that is because inflation is based on the government's statistics, not actual inflation rates.

Jack Adamo
8/08/2013 @ 9:30AM
Forbes

In part three of this series, Elemental Forces On The Price Of Gold, I began my discussion on the forces moving the price of gold. I discussed supply and demand factors, as well as the function of gold as a hedge against outlier economic dislocations, such as war.

Today I will discuss the role of gold in the current economic/fiscal/monetary environment, as a hedge against inflation.

We’re hearing from some quarters that gold has gone out of whack with its traditional relationship to inflation. At first glance, the statistics cited have some merit. However, the major failing in that line of thought is it uses government-issued inflation statistics, which are clearly understated.

The government uses “core inflation” numbers. These ignore the price of food and energy because they are too volatile. Economists have known for centuries how to deal with volatile data series. They use rolling averages. The fact that prices are volatile doesn’t mean the goods don’t cost anything.

The Bureau of Labor Statistics pulls this nonsense with two of the three biggest living expenses, food and energy. The other big expense, housing, is calculated by a system so arcane as to approach necromancy. I think part of the methodology involves goat entrails.

Here’s what the well-respected publication John William’s Shadow Government Statistics has to say:

* The Consumer Price Index has been reconfigured many times since the early 1980s, so as to understate inflation versus common experience.

* CPI no longer measures the cost of maintaining a constant standard of living.

* CPI no longer measures full inflation for out-of-pocket expenditures.

Williams meticulously compares the original “Cost of Living Index” used by economists for hundreds of years to the new “Consumer Price Index.” His conclusion? Simply using the old index methodology, inflation has been understated by 5.1% per year since 1980.

The government number for current inflation is 2% for the 12 months ending February 2013. Using the government methodology from 1990, inflation today is a little under 6%. Employing the methodology used in 1980, the number is even worse, 9.6%. The government has to keep changing the lie to stay ahead of the cruel facts.

Incidentally, think of what this says about real GDP, which subtracts inflation from headline GDP. With real inflation data factored, we may still be in recession. The stock market doesn’t show that, but employment and disposable income statistics do.

So who do you believe, the government or Shadow Statistics? Personally, I believe myself. My experience is much closer to Shadow’s than to the government’s.

The other problem I find with the inflation-to-gold ratio analysis is this: We are truly in unknown territory with the U.S. and world money supply. In 2008, when the Fed geared up its printing press, the entire balance sheet of the Federal Reserve, accumulated in its 95 year existence, was $1 trillion. For the last several years, it has been growing its balance sheet $1 trillion per year.

The only reason we don’t see rampant inflation is that the velocity of money is so low. If the economy ever picks up for real, watch out. Fortunately, or unfortunately, depending on how you look at it, there seems to be no immediate threat of that.

As if the Fed’s actions were not enough, now the rest of the world’s Central Banks are following suit. The current situation is unparalleled in the history of modern economics.

What will the eventual effect of all this Quantitative Easing be? Do you think the answer to that is over your head? Too complex?

It’s not. You are smart enough to figure out this answer in 10 seconds. Just ask yourself this simple question: If just printing money could make countries richer, wouldn’t the whole world be wealthy by now?

History gives us the answer in recent disasters like the Weimar Republic and Zimbabwe, as well as examples going back at least as far as ancient Rome.

So, we have a simple progression here.

1. Experience and objective third party data tell us that U.S. inflation statistics are a lie.
2. History tells us that all fiat currencies eventually fail.
3. Today’s rate of exotic monetary adventurism is unprecedented.

These obvious truths lead to one inescapable conclusion: Gold may be somewhat overpriced at the moment (or not), but with all financial assets inflated by Fed policies, the price divergence between hard assets and financial assets with no toehold in the real world must eventually be closed.

Commodity guru and self-made billionaire Jim Rogers agrees. He warned of an overbought condition in gold in October 2011, but said in late June of this year that he was buying again, averring that it might not be “the bottom” for gold, but looked like it was near one. He also said “Europe, Japan, America and the U.K., are all frantically trying to debase their currencies…I’m afraid that in the end, we’re all going to suffer, perhaps worse then we ever have, with inflation, currency turmoil, and higher interest rates.”

In my view, the only x-factor is whether these Central Bank policies lead the world to high inflation, wherein the gold price will explode, or a decades-long period of low-to-negative economic growth, accompanied by deflating financial assets. I’m not sure which it will be, or whether it will be some mutant variant of the two, but gold is an inflation hedge and cash is a deflation hedge; I want to have a good helping of each on hand. Only in that way will I be safe whichever way things break when the lights go out on this drunken monetary orgy.

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