Why Goldbugs were wrong about QE…………… for now

It is with interest that I saw some charts recently that I thought would be good to share and why I believe the current state of Inflation is not running away with itself as predicted by all the Goldbugs, and to be fair most of the mainstream investment community.

Back when QE started in the US most of us assumed the “printing” of money would rear its ugly head in terms of massive inflation. After all if you dramatically increase the supply of money then we should all go around spending with reckless abandon and drive up prices, and also suppliers would fear that the value of $1 is less than it was the previous day and therefore demand more $ for its goods and services.

Those that took it a little more seriously were the “goldbugs”, these are people who vociferously voice how important Gold is as a store of wealth and attack those who promote the use of FIAT (paper ) currency. Goldbugs loaded up on the shiny metal. Gold has always been viewed as a source of value when compared against FIAT currency or paper money. Why goldbugs seem to think that attaching value to paper money is madness but attaching it to a shiny metal is genius is beyond me, but this is what happened. Gold prices rallied hard and almost touched $2000 an ounce from about $600-$700 pre financial crisis.

However since 2011 (way before QE finished in the US at least) Gold has been in a downtrend and most recently broke a fairly important support level of $1200. Currently trading at approx $1095.

So what happened? Well we never got the “HYPERINFLATION ” that was prophesied. Those that made the observation early got out, those that were stubborn are now enduring a lot of pain (financially speaking).

A few charts might help explain this lack of inflation, or deflation, of stagflation or even dis-inflation if you feel so inclined.

First, A Saudi induced price war is afoot in the oil markets around the world. Saudi’s are in my view cognizant of the fact the oil demand is perhaps not once what it was, engines and machines are more efficient, we are not in what would be described as the industrial revolution anymore rather the technological one and various other factors have all contributed and more importantly will contribute in the future to slightly less demand around the world in oil markets.  Saudis are willing to accept lower prices for a barrel of oil in the future, they just want more of the market. Therefore the best play for them to make is to drive oil prices lower, and attempt to put the newer, highly levered shale oil players in the US at jeopardy and force some consolidation in the market. Long story short, this message has got to the market and Oil prices have collapsed this year especially to prices of around $43 currently form $100 this time last year.  This has contributed significantly to low inflation.

One more interesting note is that despite grand images of the FED printing money with abandon over the last few years and simply throwing it from a helicopter at the banks, this has not really materialized either. Its fair to say that the banks have been the recipient of the this newly created money in exchange for securities from their balance sheet. But this money has not fed its way out onto main street. If it did then yes, I would think inflation would be rampant but also growth would be ALOT stronger too.

The money on deposit with the FED has grown enormously since QE started, literally from almost nowhere to off the charts. So this money that has been printed never really found a home in the real economy. If I were being cynical I would say that banks are in the business of lending money, 0% interest rates are a real drag on their margins for doing so, therefore they haven’t pursued lending strategies with gusto. Its also hard for them to do “normal” business when they in the papers everyday being demonised for irresponsible and reckless lending practices. Therefore the impending rate rise may actually lead to more inflation in the medium to long term . (Appreciate most will say rising rates cools inflation not sponsors it, I know that is the theory but just go with my theory for a moment!!)

excess reserves

Second interesting chart is the Velocity of money. As can be seen from below chart the velocity of money has dropped to lows never seen before. Velocity of money is a fancy term for how quickly $1 gets recycled in the economy, I am not a good enough economist (in fact I am not an economist at all) to explain but see this link from someone who is, for a simple explanation. https://www.youtube.com/watch?v=stfSnPaaK04


We exist in a low growth economy right now as the velocity of money is far from ideal. At a micro level just think about your normal day to day life. Are you currently trying to deleverage previous debts i.e. pay them down, or are you actively seeking to borrow money and go out and create growth by spending in anticipation of a higher return. Personally all around I see a low growth low return environment currently which doesn’t lend well to risk taking or wild spirits.  So I would think that the average consumer is less bullish than they once were or busy paying for previous sins of the past to think about borrowing again and spending.

The banks are less aggressive in lending money or at least trying to lend money. While you may think they banking bailout was a gift from heaven for the banks (which it was) they also have been put under tremendous scrutiny, PR battles and a list of fines and regulatory burdens that have left a dent on their willingness to engage in lending and furthering business activity to all but the most credit worthy of borrowers.

I do feel that if rates should rise, and banks have all these reserves on their balance sheet they will engage in more actively seeking to lend as it gives them some wiggle room to raise their own margins. This could kick start the process of inflation, but as the saying goes, you can lead a horse to water but you cant make it drink. If consumers of credit are not interested, too scarred from the past or simply do not see enough viable investment products they will not borrow, all the while the technological revolution is driving down prices while increasing productivity around the world.

Predictions are useless and often you can be right and wrong in almost equal measure if you make them over a long enough time period, but I do feel inflation will start to pick up should rates rise in the US soon, but it will be a long drawn out process. Also oil will find a base level and begin to rise again, probably sometime next year, I wouldn’t be surprised to see a republican nominated president (ugh) start a war , or at least stoke tension with (>insert name of middle eastern country>) in an effort to drive prices back a little higher, most likely Iran given their current opposition to Obama lifting sanctions recently.

Either way, goldbugs were wrong, but it would be delicious irony if after they all got stopped out, inflation were to rise, “I told you so ” means very little in this industry unless you make $$ out of it.

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