The Gold Meme Is Spreading...

The lastest person to pick up on it, although skeptically, is President and Chief Investment Officer at Pacifica Partners - Capital Management, A.J. Sull. Sull says that the goldbug argument claiming that recent high deficits and quantitative easing will guarantee high inflation has its merits, but seems too early and doesn't factor in the obvious (and needed) benefit of a low inflation rate: relatively low interest payments on most developed nations' sovereign debts. [Even Greece is benefitting; recent rates have been 'shockingly high' at about 6 1/2%. Twenty years ago, 6 1/2% on U.S. Treasury bonds would have been seen as near-miraculous.]

...[I]t could be that the inflation fears are a little ahead of themselves at this time. The global economy is still quite weak as unemployment reaches a 26 year high, banks are still reluctant to lend and consumers around the world seem to be gripped by fear once again. Recent consumer confidence data from the US shows this clearly as it dropped to a ten month low – leaving many on Wall Street scrambling for possible explanations.

At this point in time, it seems that the Fed and other central banks are doing what they have to do. As some [goldbugs] call for gold to reach levels of $2000 per ounce or more – it would be best to step back and take an inventory of the facts. This is not to dismiss the arguments of the gold bulls. They are not altogether invalid. But for the kind of inflation to take hold that would result in an upwards explosion of gold prices from current levels, the Federal Reserve and other central banks would have to throw in the towel and abandon the fruits of the hard won victory against inflation almost thirty years ago. At this point, it would seem that a policy error is a more likely reason for inflation getting out of control rather than outright indifference.

It may seem twisted of me to note this, but the budgetary benefits to keeping inflation low shine two different lights on some of the goldbugs' favorite arguments. On the one hand, it dampens the case for '70s-style inflating which took advantage of negative real interest rates. That benefit ended as the '80s opened, and governments paid for it over the next 10+ years. The "bond vigilantes" remembered, many painfully, the climax plummet of the bond market which ended in '81. Given what 10% long rates can do to government budgets, not to mention 10% short rates, there is a lot of reluctance to push inflation up to the near-double-digit range even if a net inflation premium can be scooped. Although foreigners are easy to beggar from a domestic-voter standpoint, they don't pay taxes like domestic bondholders do. Particularly, foreign governments don't. The fisc could tolerate double-digit interest rates 'way back when for reason other than the much lower size of the overall funded debt back then. A large majority of the bondholders had to fork over part of their inflation-boosted interest payments back to the government in the form of income taxes. Back in the late '70s, this was known as "taxflation" and it did add to governmental gains from inflation.

A lot has changed since bell bottoms were last fashionable. Tax-deferred retirement savings plans were little heard of in the 1970s, and shielded little when compared with today. Treasury bonds held in a tax-deferred plan avoid the tax part of taxflation until the deferral ends. So do sovereign-held Tresurry securities, if memory serves me correctly. The withholding tax is imposed on private holders but not governments. There's also the newfound existence of inflation-protected government bonds, which will be more sought after more should inflation accelerate. In addition, marginal tax rate are lower now; that lowers the gain from taxflation too.

These points back up the claim that developed-economy governments today have a lot less to gain from inflation than they did back in the '70s, even if real rates are negative again. Also, we know what the long-term costs of inflating are thanks to the '80s experience. That experiecne was lacking in the '70s. For all these reasons, the decision to deliberately inflate is far more problematic now than then.

On the other hand...the same constraint on ramping up the inflation machine - interest payments crowding out everything else on the government budget when rates rise - makes the hyperinflation scenario less implausible. A burst of inflation, whether deliberate or accidental, could snowball into real hyperinflation in order to meet crushing deficits engendered by rate jumps. The margin of safety in government debt is lesser than it has ever been.

However, it's likely that any hyperinflation-inducing response will be only one part of a policy cocktail. There's a greater chance of retirement-savings-plan funds being commandeered during a debt crisis than of hyperinflation bursting forth.

Not to mention other nasty measures...