This Way Comes:
Oil, DOW, Gold, & Inflation
Many often argue against
the gold standard by saying something like, "Can't they just inflate the
currency, irrespective of whether or not it is linked to gold?" This
argument is naive because it misses the main point. With a gold or other
hard money standard, there is very little time lag between when
irresponsible monetary policy translates into the rising cost of goods.
Alternatively, with a fiat standard, irresponsible monetary policy can
be hidden for years, even decades. Still, the discerning eye can see
this inflation, though often only in hindsight
the search for this hidden inflation is the subject of this paper.
Dr. Paul Malone, the protagonist in
my first novel, Eye of the Pyramid, presents the above argument in more
simplistic terms. Speaking about this subject matter, he says, "Then,
there was the more recent comment the Chairman made while giving a
speech to an audience in New York. He had started by talking about gold
in a positive way, citing the stability and lack of inflation under a
gold standard. It was hard to inflate the currency when people could
immediately see the loss of their purchasing power. If the cost of goods
ranging from eggs to automobiles
went up twenty percent overnight,
most people would not readily accept the cliché that the Federal Reserve
was simply adding liquidity. Nor would they accept the explanation that
their Congress had severely overspent their budget."
So where should we look for this
hidden inflation data? Even the most conservative analysts have finally
come to the conclusion, which has been known to the contrarian community
for years. The CPI and other reported inflation data is a bad joke,
having very little to do with real inflation - we'll come back to what
the CPI might be later. Aside: One of the many reasons why CPI data is
badly flawed is that it uses hedonic adjustments
− one more way to
transform a quantitative argument into a subjective one (you might
notice this trend elsewhere in our society). I always smile at the way
the word hedonic is similar to the word hedonistic
according to Paul Malone in my sequel, Power of the Scepter, "Bit of
a stretch, but sounds like someone wants to keep the party going."
All right, we continue our search for
this "hidden confiscation of wealth." [A. Greenspan.] If we can't
find it in the reported numbers, how about looking for true inflation
data in the oil price? Oil represents a huge market, and as such, is
difficult to manipulate ad infinitum. But where should we start? How
about in 1971 when Nixon took America off of the gold standard? ...in
the sense of settling international debts. This brings us to the first
plot shown below. As you can see, a compounded 8% curve started in 1971
fits the data well - granting that a multitude of other fundamental
factors will cause oscillations about the inflation value.
The plot above speaks for
itself. You, the reader, can decide if the compounded 8% interest curve
resonates with the oil price data. Now let's turn to the DOW.
Some might argue −
"What does the value of the DOW have to do with inflation?
Doesn't this represent companies growing their business?"
I've often thought something quite different. That is...
investment in the DOW or a similar basket of stocks simply
represents one way to avoid the hidden tax. Let's see how
the DOW looks against an 8% compounding as shown below.
Call the DOW performance above whatever you like: capital
gains or stock appreciation. The fact is, it looks a lot like inflation
to me. Now let's turn to what has been deemed money for thousands of
− and look at the price since the world decided the sage
advice from George Bernard Shaw and a plethora of others was no longer
needed. "You have to choose [as a voter] between trusting to the
natural stability of gold and the natural stability and intelligence of
the members of the government. And with due respect to these gentlemen,
I advise you, as long as the capitalist system lasts, to vote for gold."
Above, the 8% inflation curve starting in 1971 (purple) didn't match
quite as well as the others, so a curve starting in 1961 (yellow) was
added. It tends to better fit some of the price models for gold's
true value today, which is not surprising. The price of gold was
held artificially fixed against the dollar for many years preceding
1971. In fact, if we start the curve in 1949, more than halfway between
1971 and 1913
the beginning of the not so Federal
then today's implied value of gold is $3255/oz.
All right, we've presented
an argument for inflation
the increase in money supply
as being well represented by 8%. So who cares? Aren't salaries
increasing accordingly? If so, everything is relative. Unfortunately, we
come to the devil in the details. The plot below shows the rise in the
annual salaries of unskilled laborers since 1972. Seen also in the
plot is a growth model of only 5%, which almost inarguably fits the
Thus, if the previous
arguments are to be believed
you are the ultimate judge
then the common man has been losing 3% to inflation for decades. Now,
though the data was for unskilled laborers, we expect similar historical
performance for the growth of middle-class salaries
and invite comments about same. The final plot below presents the loss
of purchasing power as a result of this 3% decline (5%-8%).
Also shown on the plot above are two
significant declines in the stock market (1987 and 2001).
Coincidentally, they occur at round numbers for the depreciated value of
your dollar (40% and 60% respectively). Perhaps not so coincidentally,
the astute reader can identify the point in the plot above where the
majority of families required both husband and wife to work
had a bigger family to feed, but nobody told them.
In closing, I promised to provide a
different slant on the CPI
− and I admit a priori that this is a
stretch. But I find it puzzling that the loss of purchasing power of 3%
seems to resonate with the reported CPI. So is this CPI measure
simply a convoluted way of reporting this loss? It's a number that
should certainly be of major concern. Why? Because every fiat system in
the history of mankind has seen this fiat "money" converge to its true
zero. Only one questions remains. What is the value in percentage terms
when the system implodes? If it is 67% loss, then it is this year. If it
is 75% loss, then we have nine years left... and so on.
Bottom line: Wouldn't hurt to look
for some protection
Something Wicked This Way Comes.
Terry L. Krohn
March 30, 2007
2007 by Terry L. Krohn