Gold prices jumped after Federal Reserve Chairman Ben Bernanke’s press conference on Wednesday because he confirmed that he doesn’t understand monetary inflation.
Here is what transpired towards the end of the press conference:
Reporter: Irrespective of inflationary expectations or psychology, isn’t it possible that the Fed’s policies could be providing the monetary tender for inflation, the longer they continue?
Bernanke: We anticipate that we will tighten it at the right time and that we will thereby allow the recovery to continue and allow the economy to return to a more normal configuration, at the same time keeping [consumer] inflation low and stable.
Never mind that loose monetary policy does indeed provide the tender for consumer price inflation, as history has shown time and time again, or that loose monetary policy has already caused price inflation for consumers and businesses.
How all of this relates to gold is a matter of basic arithmetic, which is that if Bernanke pumps the supply of US dollars while the supply of gold remains relatively stable, the price of gold would naturally become more expensive relative to the dollar.
Imagine a hypothetical marketplace where there exist 5 dollar bills and 5 bars of gold, and 1 dollar bill buys 1 bar of gold. If the supply of dollar bills suddenly doubles to 10, wouldn’t gold now be twice as expensive relative to the dollar?
During the financial crisis, Bernanke printed trillions of dollars through TARP, QE1, and other bailout programs. After financial conditions stabilized, he is in the process of printing $600 billion more through QE2.
Meanwhile, he has left interest rates at 0.25 percent, paving the way for the creation of more money through the fractional-reserve banking system.
In the press conference, Bernanke essentially said he’ll disregard the increase in the money supply and focus exclusively on consumer price inflation and the economy (as measured by the CPI, which may not even accurately reflect the real cost of living for average Americans).
This means in all likelihood, Bernanke will not shrink the supply of the US dollar (and may even increase it) for the foreseeable future because it may take a while for the CPI to rise meaningfully.
Gold, therefore, will continue to appreciate against the ever-increasing supply of the US dollar.
In the grand scheme of things, the price of gold isn’t the big issue. Rather, it’s the cost of living for average Americans.
Americans are already feeling the pinch of higher oil prices, which appreciated against the dollar partially for the same reason gold appreciated against the dollar.
Eventually, they’ll see inflation accelerate across the board. It’s only a matter of time before it happens, unless Bernanke contracts the money supply.
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