Should people buy gold to get protection from inflation? The increasing use of Federal Reserve money printing because of the “Repo” crisis implies that the Fed will accidentally trigger a repeat of the terrible inflation of the 1970’s. During that era investors were able to protect themselves by holding short term bonds because the yields kept up with inflation (when a short term bond matured the proceeds could be reinvested at higher rates as inflation rose). But in the post-2008 post-GFC era rates have been artificially low and could be held down to zero by the Fed. Thus investors would not be able to replicate the benefits of short term bonds during a repeat of the 1970’s level of inflation.
Inflation is caused by an increase in the money supply. However, the Quantitative Easing increase in money supply didn’t cause inflation because the new money was simply stored in the accounts of very wealthy investors or institutions who sold their bonds to the Fed (indirectly through Primary Dealers) and these investors already had too much money to use for consumption. A repeat of the 1970’s inflation where unionized workers obtained lucrative pay rises and employers didn’t use offshore manufacturing is unlikely. Instead the new era of inflation (if it actually occurs) will be driven by deficit spending where the government issues too many bonds and then spends money on things consumed by the public such as infrastructure, health care, subsidies, etc. The book Monetary Regimes and Inflation by Peter Bernholz implies that government deficit spending is what leads to inflation.
For several decades the Developed world has been able to maintain growing government deficits where the bonds were eagerly bought by EM residents and governments of EM countries. These purchases avoided creating inflation because the savers, by giving up consumption, acted to offset the overconsumption of those who used too much debt. One wonders when will the saturation point be reached where these bond buyers simply say, “sorry we’re full and can’t buy any more”.
The phenomenon where growing U.S. Treasury debts didn’t matter may have been a temporary fluke which eventually in a few decades or maybe in one decade, will end, leading to inflation.
It’s not all doom and gloom: several solutions could be found: If the U.S. economy continues to grow faster than other countries with dramatic leaps in technology then that could create conditions where capital will be attracted into the U.S. economy and tax revenue will be generated by rising economic output. Also, the new tax law of December, 2017 started to tax U.S. multinationals’ foreign activities with a minimum tax of 12.5%. It’s possible Bernholz is wrong, as many famous hyperinflations were in the era before modern fiat currency fractional reserve central banking or were caused by an absurdly ruinous great war. The track record for modern fiat currency fractional reserve central banking starts roughly in 1913 when the Federal Reserve was founded.  Since then the only high inflation era was 1965-1981 and the Fed eventually fixed the problem. The German 1923 inflation was caused by absurd, unaffordable war debts and was thus a statistical outlier, compared to other Developed countries after the start of fiat money.
If U.S. blue collar workers are now and continue to be underemployed/underpaid due to globalization then increased deficit spending that triggers consumption may not be inflationary if the deflationary forces of job losses to EM countries are offset by consumption triggered by rising deficits. We do live in a new era of globalization that was unprecedented before 1980. Couple that with the bizarre counter-intuitive nature of fiat currency fractional reserve central banking and it may be possible the ancient history lessons (pre-1913) of what causes inflation are not applicable to this new era. (Yes, I know, the cliché is that a “new era” is bogus, that nothing changes, but that’s not true, some things can change.)
The key is if domestic consumption (from deficit spending) and Treasury deficits are merely an equal offset to the deflationary impact of globalization. By the word globalization, I mean a situation where a domestic job is lost to EM countries where the foreign worker’s pay is a tenth or a fifth of domestic pay levels. Surely that is a deflationary force that offsets the damage caused by U.S. deficit spending. If the EM oligarchs use their newly acquired savings to buy U.S. Treasuries then it could work out to be very different than ancient cycles of ruinous deficits that led to hyperinflation.
Ancient economies operated like a corporation or a “household” where it was necessary to have a balanced budget and avoid a rising deficit to avoid bankruptcy. The key difference between ancient versus modern times is that a modern G7 “print and pay” sovereign is (most likely, most of the time) immune from the constraints of a “household” accounting and finance system. This is because the Treasury and central bank may be able to make arrangements to have a very elastic money supply that can support big Treasury debts and make the interest expense affordable.
In ancient times when the sovereign decided to finance a deficit through money printing they had only gold coins and no fiat money, so to inflate they “clipped coins” and took out a piece of gold from them or they melted coins and recast them in a cheap alloy with less gold. This triggered fear of inflation amongst the public as they could see what was happening.
I’m amazed, despite the huge growth of federal deficits that disinflationist economists Gary Shilling and Lacy Hunt continue to feel inflation is not a threat and that gold is of no interest to them.
The answer to the inflation puzzle is to carefully assess the new overlapping eras of globalization (1980 to now) and fiat currency fractional reserve central banking (1913 to now) and see if these eras’ risks of inflation can be appropriately compared to the inflationary experience of a medieval king who clipped coins to handle a deficit while his government was stuck in a simple “household” economy. Before the era of industrialization, for example, in 1776, the sovereign only got about 3% to 7% of the economy in the form of taxes; governments were much smaller and weaker and thus had to operate like a small town that can’t issue Treasury bonds or fiat currency, etc.
Other reasons for owning gold are a fear of growing military or political conflict, etc. But these phenomena seem to eventually fade away, the big reason to own gold is simply inflation. During the 2008 GFC the markets panicked and assumed QE would create significant inflation, this made gold go from about $900 in 2008 to $1,900 in 2011 then the marketplace’s fear of inflation being caused by QE calmed down and gold dropped to $1,000 and slowly went up to $1,555. The total return of bonds from 2008 to now is roughly the same as gold. The risks of owning gold are demonstrated by the incorrect increase during 2008 to 2011.
Investors need independent financial advice about gold.