Gold, money creation and debt monetization

By Jerry Bowyer

In the previous article in this series, I pointed out that even after recent massive sell-offs, gold prices are still higher than one would expect if viewed as purely motivated. through monetary creation. And this state of affairs has persisted for years, suggesting that it is not motivated by a panic reaction, as panics, by definition, tend to last for a short time.

Noticing that although gold fell to the high end of my expected value range using monetary metrics, I wondered why it had not fallen at least in the middle range.

Trying to solve the riddle, I thought that maybe gold is not only a function of national money creation, but also of international money creation. In other words, gold prices could rise in dollars even more than the creation of excess dollars alone would dictate. If other countries also depreciated their paper currencies, the citizens of those countries would also demand gold as a hedge against inflation. And since much of the world seemed at least partially to follow the United States’ lead in weakening its currencies, perhaps global demand for gold was pushing gold even higher than the devaluation of the dollar would suggest.

It’s an interesting theory, but there are some issues with this view.

First, there is an obvious theoretical problem with the view that global inflation determines domestic gold prices. Yes, global inflation would lead to global growth in demand for gold, but it would also lead to growth in global supply. Gold is a commodity with both a demand curve and a supply curve, and if it has both curves, it has an equilibrium price and the equilibrium price of gold and the dollar. is a function of the comparative demand and supply of each of these.

If among the three billion new capitalists in the world there is a certain proportion of buyers and consumers of gold, then among these three billion capitalists in the world there is also a certain proportion of producers and sellers of gold. ‘gold. As the price of gold increases, the incentives to find it increase proportionately. This is how the world economy maintained its monetary balance for millennia before the emergence of the global fiat money system.

Second, the biggest problem with global inflation driving the domestic gold price theory is that it doesn’t work. If we had used global inflation to try to predict gold prices in dollars, or used gold prices in dollars to try to predict inflation in dollars, we would have had very little success. . Global inflation doesn’t even seem to explain the times when gold prices break away from currency depreciating factors.

It seems gold investors aren’t just concerned about how much money the Fed creates, nor primarily how much money is created by Fed wannabes around the world; they are worried about something else, and maybe they have good reason to be. What worries them, and what seems to be driving current gold prices, is that public debt levels have risen to the point where the debt will be repaid in a heavily degraded currency. In other words, they are afraid of what is called “debt monetization”.

Debts are monetized when governments decide to use their monetary authorities (in the American context, it’s the Fed) to create new money which is then loaned to the government. This tends to happen when the government has borrowed up to its capacity and decides to continue borrowing above its credit capacity. When this happens, private lenders are no longer willing to take the risk of lending to an over-indebted government. At this point, governments often attempt to verbally intimidate private lenders, especially banks which are subject to very high levels of government oversight. Bond sellers are verbally assaulted as vigilantes and speculators and, in more extreme cases, attacked for their ethnicity or religion. Jews were frequent targets of this type of attack.

In some cases, regulators require financial institutions to lend to government anyway, often for reasons other than those stated. For example, recent regulatory changes associated with Dodd-Frank and the Basel Accords purport to act in the interest of financial stability by requiring banks to hold a greater proportion of “level 1 capital”, such as treasury bills, for risk reduction purposes. . But the problem is that this Tier 1 public capital is in many cases riskier than, for example, the corporate bonds it replaces. This is one of the reasons why the European sovereign debt crisis has been so devastating for the private banking system, as earlier versions of risk reduction forced extremely risky government bonds down the throat of the private system. What is even more infuriating is that after going through all of this, we have yet to witness a political lecture on market failures in the banking system.

So, once private lenders have been intimidated and then finally forced to buy as much public debt as they can bear, the greedy beast’s hunger for public spending remains unfulfilled. This is where monetization comes in. Huge piles of money are simply created and then shoveled into the mouth of the Leviathan.

Of course, public spending is not the reason given for money creation. Keynesian rationalizations are ceremoniously invoked as the beast is fed (by the Fed): “drop in the marginal propensity to consume”, intone the priests, “expansionist counter-cyclical fiscal policy”, answer the acolytes. The “grabbers” are punished according to their sins. Yet nothing changes except higher levels of inflation and lower levels of real growth, and the ritual repeats itself.

This ritual, it seems, is what worries gold investors, and although in the past they have sounded the alarm early on, for example during the gold price spike in the early 1980s, which probably underestimated the degree to which Volcker and Reagan would kill. the stagflation monster, that doesn’t mean we don’t have a better reason to worry now. Gold is both a store of value against the current devaluation and a hedge against the threat that debt will be monetized and devaluation will get even more out of control. With net debt of around 90% of GDP, this doesn’t seem like such a crazy scenario anymore.

About Ruben V. Albin

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