Select Articles - Something Wicked This Way Comes

Something Wicked 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 years − gold − 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 Reserve − 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 data.

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 − they 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 value − 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