The original article shows just how unsound currency
has become since the banking crisis, with FMQ appearing to be hyper-inflating
from that time. This article explores the implications for the price of gold.
Firstly lets look at
Chart 1, the chart of FMQ.
It differs slightly from
the chart in my original article, in that I have recalculated the exponential
growth curve at 5.859%, which was the average annual growth rate for FMQ
between 1960 and 2008 before the banking crisis. This throws up a larger gap
of $4.5 trillion between that long-term trend and FMQ today. Therefore, FMQ
is now 62% over trend.
This is a massive and
potentially currency-destructive development going unrecognised. But since
July 2008, the month before Lehman Brothers collapsed, gold has risen from
$918 to about $1270 today, which is a 38% increase. Does this illustrate that
gold is broadly discounting monetary developments?
The answer is no, because
the question ignores the accumulating quantity of above-ground gold and more
importantly the expansion of FMQ. And while both have increased over the last
five years, FMQ has expanded much more rapidly than the stock of gold. The
net effect is illustrated in Chart 2, where gold at $918 has been indexed to
a base of 100 as at July 2008.
This chart shows that at
Friday’s nominal price at $1270, gold adjusted for increased gold stocks and
FMQ has actually fallen to 68, 32% down from its pre-Lehman crisis level.
Of course, any value we
place on gold is entirely subjective; but in coming to that view we naturally
assume that the quantities involved do not change. The more sensible thing to
do in forming a judgement is to take changing quantities into account,
particularly when the expansion of the currency is unprecedented and appears
to be out of control.
Before Lehman collapsed,
there was a general lack of awareness of the risk that the whole financial
system was in danger. In this context, a gold price of less than $918 was
perhaps justifiable. After the event, while the Fed struggled to stabilise
the banking system, the gold price initially fell to $656, or to 71 on our
index, reflecting fears of a deflationary collapse. As the Fed showed signs
of succeeding with monetary expansion, gold began to rise and in January 2009
regained the pre-Lehman crisis level in nominal terms for the first time. It
wasn’t until September 2010 that gold recovered to pre-Lehman levels in real
terms deflated by both FMQ and the increased stock of gold.
The conclusion is simple:
gold should logically be priced at a premium to pre-crisis levels to reflect
the increasing inevitability of future monetary hyperinflation. That figure
today would be somewhere above $1860, which is the equivalent of the price in
July 2008. Instead it stands at a discount of 32% to its pre-Lehman level,
and therefore appears to be grossly under-priced.
