Guest Post: On Gold, A Cracked Dam, And The Fed’s Small Thumb

Sunday, April 1, 2012
By Paul Martin

Submitted by Brian Rogers

Real growth vs. the illusion of growth
Understand the short video below and you will understand what I mean when I say that the United States of America (and the rest of the world for that matter) has not fundamentally grown much at all over the last 40 years.

We have instead replaced fundamental growth with the illusion of growth brought on by constantly increasing the monetary supply, aka, inflation.

Usually, when a good or service is dramatically increased, it’s price will fall. Too many cars manufactured? Prices will fall. Too many new houses? Prices will fall. You get the idea. Good ol’ laws of supply and demand.

But laws, especially economic ones, can be broken or at least bent for extended periods of time. Too many dollars produced? Rates should rise. But that didn’t happen. Quite the opposite.

Despite the dramatic increase in the amount of dollars circulating since 1971, interest rates in the US have fallen. Exactly the opposite of what the laws of supply and demand tell us should have happened. How was this possible?

It’s good to be king
The dollar is the world’s reserve currency. This means that the rest of the world buys and pays for things in dollars rather than their own local currencies. This situation, brought to us by the winning of World War II and dominating the Bretton Woods Conference, created a convenient and almost constant demand for dollars.

This constant demand for dollars has somewhat offset the constant creation of new ones. Not entirely, of course, we have experienced periods of great inflation like 1973-1980, for example. But the point is, our inflation has generally been much lower than anyone would have expected because the rest of the world has continually lined up to buy more dollars.

This has led to one of the greatest periods of sustained asset price appreciation in human history. The period of time from 1980 to today is often-times referred to as the 30-year bull market for bonds which is another way of saying that rates have been falling for about 30 years now.

With rates falling for 30 years, every asset which is priced off of interest rates, which is basically everything, has gone up in price. Bond math 101 says that as rates fall, asset prices rise. Rates rise, asset prices fall. Easy peezy.

But like any good Ponzi scheme, even this one has a limit and investors briefly approached it in 2008. When it looked like our global banking system was going to collapse, investors started dumping everything in site, essentially a de facto rejection of dollar based assets.

Houston, we have a problem.

The dam has cracked and the Fed has a small thumb

The Rest…HERE

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