Monday, January 25, 2010

John Tamny Suggests Gold As Proxy For Inflation

John Tamny, the editor of, has suggested using gold as a proxy for inflation after debunking two conventional definitions of the phenomenon. Both monetarist measures and the overheating hypothesis have been found wanting, and both are easy to discredit nowadays. On the other hand, gold - because of its apparent uselessness - makes for a good proxy of inflation. Rather than use a metrical definition, Tamny describes inflation as a period when capital moves into hard assets and out of business uses.
[R]ather than a measure of prices that change for various reasons that have nothing to do with currency policy, inflation is at its core the painful process by which capital flows to the hard assets of the earth and away from innovative, wage-creating industries. As individuals we don't so much hate inflation for the rising prices as much as we balk at it because our chances to capture good jobs and good wages are compromised for capital essentially hiding.

As the rising price of gold has revealed throughout the decade we've been inflating, no matter what the more quiescent government measures of consumer prices have been telling us. A weak dollar explains our economic unhappiness because a weak dollar is what has made capital disappear....

In short, inflation is about capital going on strike...

His definition won't please monetary economists, but he does have a point because money is fungible. There's no iron law saying that an increase in the money supply must push up consumer goods exclusively; other goods can be pushed up too.

A sharp economist will note that he leaves out a particularly insidious kind of inflation, one that's quite evident in the PRC right now. Jacking up the money supply, under certain economic conditions, induces a bubble in the capital-goods arena. As a result, too much capital is diverted into "innovative, wage-creating industries." This kind of bubble is the most insidious because it appears the most sustainable and benign. Who doesn't like growth?

In reality, it's the closest bubble to the mythical one-hoss shay...and the one most likely to induce depression when it finally pops. We've seen what happened to the U.S. housing market after the residential real estate bubble came and went. Imagine that same fate exerting its grip on the producers' end of things.

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