Another Gold-Bull Rationale

Gold bulls tend to be cynics, so it's not surprising that there's another rationale for a rising gold price now that a ballooning of excess reserves has not turned into an exploding money supply. The central banks of at least two developed countries, including the Fed, have launched quantitative easing programs in order to prevent deflation. On the fiscal side, deficits have exploded. Those deficits signal more quantitative easing in the future in order to keep interest rates down, so goverments' interest-servicing burden doesn't become onerous.

That's the case, and the managing director of Salida Capital shares it:

With rampant consumer borrowing having been replaced by rampant government borrowing, Greece and other European Union countries are making the headlines right now. But the problem is not limited to them. In fact, this is a global issue that most OECD nations face, says Brian Trenholm, managing director at Salida Capital.

He expects the result will be trillions of dollars of new bonds will need to be sold. But who will do the buying?

"I think the answer will ultimately be central banks," Trenholm says. "While the Fed's quantitative easing program is set to expire in March, I'd be shocked if we didn't see a follow-up program. I think quantitative easing will be with us around the world for a long, long time."

This is the dream scenario for gold in particular and scarce commodities in general, the portfolio manager notes....

That's the game plan for gold bugs who don't groove to the hyperinflation scenario. Deflationary tendencies in the economy will be fought by governments, and expansionary monetary policy will be added upon expansionary fiscal policy to do so. The two forces will result in a temporary standstill, during which future inflation will be baked in the cake. As has usually been the case ever since the still-warned-about 1930s, both the Treasury departments and central banks will overshoot in retrospect. That overcompensation is what will bake the inflation in the cake. Once the economy gets rolling again, and the deflationary liquidation tendency either disappears or becomes dormant, then the counter-deflationary stimulus will again have the effect of overstimulus...and will be seen as such in retrospect.

To be fair, there's a systemic bias towards overstimulus because normal inflation takes a long time to get out of hand. Except in cases of genuine hyperinflation, which also take some time to get rolling, there isn't any One-Hoss Shay element to inflation. It's believed by almost everyone that deflation does make the economy a One Hoss Shay, which will collapse of its own accord quickly.

Central banks, therefore, act on this political calculus: Inflation is a problem, but one that takes some time to appear; it can be scaled back without major disaster should the necessity arise. Deflation is a disaster, which strikes out like a cobra when quickened. Thus, quick action is needed to prevent deflation at all costs. In contradistinction, inflation need not be treated as a national emergency because pulling back from the brink can be done in a relatively orderly matter. Hence, erring on the side of inflation when deflation makes its appearance is rational given those two differences.

With the exception of Germany, no developed economy has suffered hyperinflation over the past century. France and Italy did have serious inflation problems, but their inflations didn't gut their economies. On the other hand, all developed countries' economies have been gutted by deflation. Hence the skewing of priorities in central banks' responses to each.

The above may sound cynical, but it's merely a sketch-out of well-known political realities. The '70s are not remembered fondly, but that decade lacks the panic-inducing qualities that the '30s still has. At least from the political-optics angle, the inflationist case has sense: there is a bias towards inflation in the system.