The popular belief is that gold is a good hedge against inflation. Owning
gold will protect you from rising prices. Is that true?
Most people define inflation as rising prices. Economists will quibble and
say technically it’s the increase in the quantity of money, however Milton
Friedman expressed the popular belief well. He said, “Inflation is always and
everywhere a monetary phenomenon.”
There you have it. The Federal Reserve increases the money supply and
that, in turn, causes an increase in the price of everything, including gold.
It’s as simple as that, right?
Except, it doesn’t work that way. Just ask anyone who has been betting on
rising commodities prices since 2011. Certainly the money supply has
increased. M1 was $1.86T in January 2011, and in March it hit $3.15T. This is
a 69 percent increase. However, commodities have gone the opposite way. For
example, wheat peaked at $9.35 per bushel in July 2012, and so far it’s down
to $4.64 or about 50 percent. And the price of gold fell from $1900 in 2011,
to $1050 late last year, or 45 percent.
Would you say that inflation is +69%, or is it -45% or -50%?
Most people look at retail prices, not raw commodities or gold. Retail
prices have not followed into the abyss. Love it or hate it, the Consumer
Price Index registers a cumulative 8 percent gain from 2011 through 2015
inclusive.
Let’s consider an example to help understand why. Suppose you own a coffee
shop in a central business district. The city enacts a new regulation that
limits the hours for delivery trucks. This forces you to pay overtime wages
to your staff to unload the trucks, and of course, the carrier charges more
for delivery too.
Next, the city allows poor people to stop paying their water bill. So to
compensate, they raise the water rates on businesses. While they’re at it,
they raise the fees for sewer, garbage, gas line hookups, fire inspections,
and sign permits. The state passes a higher minimum wage law. The building
inspector requires that you increase the size of your bathroom to accommodate
wheelchairs, and you lose revenue-generating floor space. There are hundreds
of ways that government increases your costs.
Is this inflation?
Not yet, costs are up but not prices. Sooner or later, all of the affected
coffee shops try raising their prices. Consumers don’t necessarily want to
pay more for coffee, so a few shops fail. The survivors are now charging 15%
more for coffee. They have their higher prices, at the cost of lower sales
volume.
The burden of government bearing down on the coffee business only
increases. Every day, three constituencies conspire to drive up costs. We’ll
call them the “there oughtta be a law” crowd, the “government needs more
revenues” mob, and the “they served 10oz of coffee plus 4oz of ice so let’s
sue them” racket.
Regulation, taxation, and litigation drive up price. Friedman was wrong.
The rising price of lattes is not a monetary phenomenon (the monetary system
is pressuring prices lower right now, and in my theory
of interest and prices I discuss why). Rising retail prices are a fiscal,
regulatory, and judicial problem.
There is no reason for the price of gold to follow retail, because there
is no mechanism that connects gold to these non-monetary costs.
