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Money Slow Down

As a general rule, the most successful man in life is the man who has the best information

Many have called for very high levels of inflation possibly leading to hyperinflation. Their reasoning is that over printing of the US dollar will cause the dollar to weaken and inflation to set in - more money chasing the same amount, or less, of goods causes prices to rise. A rise in gold and silver (and commodities prices), would be the result.

Gold and commodities have gone up, substantially - prices reacted to the increase in the monetary base and the corresponding increase in the velocity of money caused by financial innovations such as mortgage-backed securities (MBS), collateralized debt obligations (CDO), derivatives and credit default swaps etc.

But the called for massive inflation hasn't yet happened, yes there's been more than a modest rise in the real price of goods (much more then the government measured Consumer Price Index), but treasury yields and home prices are at record lows, jobs have languished and credit has stalled. These are not the conditions one would expect to see in a highly inflationary environment.

This brings up two questions:

  • We've not had the much higher inflation called for - why not?
  • Are there further gains to be made in the prices of gold and silver (and commodities in general)?

Monetary Base

Between August 11, 2008 and the end of 2011, the monetary base, which only the Fed can produce, almost tripled with a Bernanke Fed injection of $1.7 trillion dollars.

Most of the money issued by the Bernanke Fed is parked in banks as excess reserves that the banks are not required to hold.

On October 6, 2008 the Fed announced it would begin paying interest on the reserve balances of the nation's banks. The Fed's records show they were paid $2.18 billion interest on these reserves just in 2009.

These interest payments are an incentive to hold the cash. At the end of 2011 U.S. banks were holding 88 percent of the monetary base ($1.5 trillion of the $1.7 trillion increase) issued by the Fed since August 2008 as excess reserves they are not required to hold.

As long as this money stays parked at the Fed it has no velocity, it's not loaned out, it's not changing hands, it's not being spent, its velocity is zero.

Velocity of M2 Money Stock

When we talk about the velocity of money, we are speaking of the average frequency a dollar is spent. If nobody is spending money the velocity is zero.
Velocity, as shown by the above chart, is currently at a record low.

Most of the dollars created in the stimulus programs (ie QE's 1 & 2), after the bubbles burst, have never made it into circulation to be spent by small businesses (the largest job creators) or consumers (the driver of the US and world economies), there either parked at the Fed or the world's central banks as foreign reserves (many countries hold US dollars in their foreign reserve accounts, China has trillions of US dollars, most of these dollars will never make it into circulation).

Let's take a look at four charts; the US monetary base, gold's price, money velocity and the US dollar index. You can see that gold has not, and is not, responding to the dollar's strength or weakness as much as it responds to the increase in the US monetary base and money's velocity.

Monetary Base

Gold - London PM Fix 2000 - present

Velocity of M2 Money

US Dollar Index

Now we know why precious metals, and commodity prices, were so strong - the monetary base was expanding and there was an orgy of money spending fueling expectations of inflation. Currently the monetary base is not expanding, money is not circulating, this is fueling deflationary fears. Add in the multiple fears of a China slowdown, the EU imploding and the US slipping back into recession and we can see why prices are falling.

The questions we need to find answers for are:

  • Are the Fed, and the world's central banks, done with increasing the global monetary base?
  • Have they given up in their attempts to revive credit and fuel another economic "spend your way to riches" prosperity bubble?
  • Is austerity here to stay?


Governing parties are suffering major losses in election after election as anti-austerity parties make gains.

Unless continuously fed with new credit the global financial system will implode, when confronted with this possibility governments always respond in the same way - by printing more money.

The world's governments have unlimited printing presses.

France has elected a socialist leader who will demand an end to austerity.

The European Central Bank has accepted that growth should take precedence over balanced budgets.

German Chancellor Angela Merkel's CDU party won only 31% of the vote in Scheleswig-Holstein, the party's worst showing in 50 years. Merkel's hard line austerity programs, so unpopular in the rest of Europe, are increasingly being viewed with skepticism at home in Germany.

Greek voters just delivered a resounding anti-austerity election verdict - more than 50 per cent of them cast votes for parties opposing public spending cuts. If there's another election in Greece this summer there is a high probability of Greece defaulting and exiting the Euro.

Fed chairman Bernanke has made it clear he'll step in with more easing if necessary.


The resource boom isn't over, someone hit the pause button on the printing presses to take stock, do a review of their attempted fix methods and success achieved to date.

Single minded money printing has to be the next stage. Politicians, governments and central banks will abandon the restraints they have been operating under and do whatever they think it will take to pacify voters, save their re-election chances, "right" their economies and salvage the fiat monetary system. Tax cuts, more and bigger deficits, continued low interest rates into the forseeable future and aggressive asset purchase programs, steroidal quantitative easing, are all going to achieve previously unimaginable levels.

The monetary base will explode, and if the money velocity chart reverses - if small businesses and consumers actually get their hands on some of this money - precious metals and commodities prices will soar.

The greatest leverage to soaring precious metal and commodity prices has historically been junior resource companies. It is this authors opinion that we are presently being given the greatest buying opportunity of our lifetimes.

The whole world is the stage and the drama is set to continue. The greatest show on earth, a couple of charts (monetary base/money velocity), and a handful of carefully selected junior resource companies, should be on all our radar screens.

Is the drama, two charts and a couple of juniors on your radar screen?

If not, maybe they should be.


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