Friday, November 21, 2008

Gold predicts inflation

I've been a devoted fan of gold for a long time. Over the years (actually over the centuries), gold has been a sort of canary in the coalmine, warning of us whenever there are imbalances between the supply of and the demand for money. As this chart shows, gold has tended to forecast where inflation is headed about one year in advance. What it's saying right now is that all the talk about deflation is way off base. Sure, we know that the recent huge decline in energy prices will knock at least several points off the CPI, but that doesn't mean all prices are going to fall. Lower energy prices could make it easier for other prices to rise, for example. And there has been no tightening of monetary policy and no shrinkage in the demand for money at all, and those are the things that are generally sure-fire signs of declining inflation to come. Besides, we've already seen that non-energy producer prices continue to rise at an above-average rate.

I can't guarantee that what this chart is predicting will come true, but it's hard to see how we are going to get years of deflation (as the bond market is now predicting) when gold prices are hovering around $800, about double its long-term average inflation-adjusted price. Real deflation only threatened after gold prices fell below $300 in the late 1990s.


SpeakToMe said...

Great post -- makes the idea of deflation followed by very rapid inflation seem almost inevitable.

Barbarous Relic said...

Don't you think we're at least going to have short run deflation? What do you think will be the catalyst for inflation?

Scott Grannis said...

We're likely to see some short-run deflation, but only because of the drop in energy prices. This is not going to be a generalized deflation. For that, monetary policy would have to be a driver: gold would have to be much lower, the dollar much stronger.