Sunday, May 14, 2006

Danger of Inflation

Have you noticed that gold is selling for $700? Something has happened. And the US dollar is down against most currencies. Our daughter went to college in Canada starting four years ago when the Canadian dollar was worth about 70 cents US. We were in Langley, BC two weeks ago for graduation and the C$ was worth 90.5 cents. That's a increase of 30%. Steve Forbes says inflation is not things getting more expensive, but the currency losing value. That sure seems to be what we are seeing. Forbes writes in Forbes Magazine:
"There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."--John Maynard Keynes, The Economic Consequences of the Peace (1919) Inflation is back again, an incredible development considering the hard experiences we and the rest of the world had with this debilitating disease from the late 1960s through the early 1980s. Inflationary symptoms are already rampant in the commodities market. Gold, oil, copper and other items are approaching or exceeding rates of price increase not seen for a quarter of a century. In the months ahead inflation will spread through the rest of the economy here and overseas. Keynes was right. ... For 4,000 years gold has been the best barometer of inflation, the Polaris of stable money. In the late 1960s it jumped after decades of stability, and inflation soon followed. The same phenomenon repeated itself in the early 1970s, when gold soared, and again when it roared ahead in the late 1970s. Each rise was followed by a disastrous round of generally rising prices and ever higher interest rates--and each ended in a recession. Today the price of what Keynes called the barbarous relic is the highest it's been since 1980, up 150% from its 2001 lows. During bubbles and preinflationary run-ups in gold prices, policymakers always assure us that things are "different" this time. Federal Reserve officials today tell us that there is far less of a link between commodities and inflation. Gold is going up because the emerging middle classes in India and China love to buy jewelry. Oil is high because of uncertainty over Iran, disrupted supplies from Nigeria and Venezuela, crazy U.S. regulations prohibiting exploration and production in most of the Outer Continental Shelf and parts of Alaska, and expanding energy appetites in fast-growing India and China. All of this is true. But make no mistake: At least $20 of the price of a barrel of oil today is pure inflation and inflation-induced speculation.
But something can be done. US policy by the Federal Reserve Bank can stop this.
The Federal Reserve is debasing the dollar, and, in lockstep, the European Central Bank (other-otc: CHPA.PK - news - people ) and the Bank of Japan are doing the same to the euro and the yen, respectively. The Fed could break this fever easily by soaking up excess liquidity until the gold price falls below $400 an ounce. (The ten-year average is around $350.) Sadly, the Fed's new boss, Ben Bernanke, fully disdains gold as a useful monetary tool, sharing John Maynard Keynes' prejudice against the yellow metal. Like most of his economist peers Bernanke thinks that the traditional gold standard, which governed monetary policy in Great Britain and eventually elsewhere from the early 1700s to the 1930s, caused or at least deepened the Great Depression
Those of us who suffered through Jimmy Carter's run-away inflation know how it destroys confidence in our economy to see the value of our work shrinking. And it leads to strange decision making, such as making a purchase before you need to because if you wait the price will go up. People even bought early when they weren't sure what they needed, because the price was going up. One of Ronald Reagan's great legacies was chasing inflation away with President Jimmy. Let's not bring it back. Read Forbes' whole commentary.

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