Gold vs. the Money Supply

August 25th, 2016 by

One important dynamic that investors would do well to pay attention to is the ratio of the money supply to gold. Although it doesn’t seem incredibly important on its face, this can be one of the most important measures for evaluating the health of the economy.

Call It a Recovery

recession3Unless you are a member of society’s upper crust, you have probably noticed that the economic recovery from the financial crisis has been anything but swift. It’s been more like a gradual crawl back toward mediocrity.

Nonetheless, the media consistently follows a pattern of casting the health of economy with undue optimism.

They point to several economic measures—such as home sales, home prices, and the housing market in general—to argue that the United States is finally back to where it was, economically speaking, in 2007 prior to the crisis. However, comparing the economy in 2016 to the markers from a decade ago is problematic. Perhaps most glaring is the fact that, if there was no financial crisis and economic activity remained flat from 2007 to 2016, economists and market analysts would be hammering on about how stagnant we were. Yet, in the context of where we were in 2008 and 2009, they call it a recovery.

Too Much Money—Not Enough Gold

Another factor that’s overlooked in this erroneous apples-to-apples comparison is the flagrant growth of the money supply (often called the M2 money supply; it is a broader measure than the M1 base money supply but not as inclusive as the M3 money supply measure). In order to combat the financial crisis and the attendant economic downturn, the Federal Reserve engaged in “quantitative easing”—a euphemism for stimulating inflation and spending through extensive monetary stimulus.

Essentially, the central bank “printed” new money into the economy at a rapid pace in the hopes of encouraging steady consumer spending and new corporate investment. However, the positive effect of this policy has been largely negligible. In fact, the velocity of money (i.e. how fast it circulates, based on how many transactions are being conducted) has collapsed to its lowest point ever. People aren’t spending and businesses aren’t investing. In the meantime, the downside risks continue to loom larger the longer that this trend continues.

Because of its historical function as a monetary metal and the key role it plays in global finance, gold is often seen as the counterpoint to an expanding money supply. While printing money is an inflationary policy, gold is seen as a hedge against inflation. It’s telling that the ratio of gold to the money supply is also at an all-time low, suggesting that a reversion to the mean may be in order in the near future. According to research firm Palisade Global Investments, at today’s grossly inflated money supply, the average price of gold should be $3,770/oz—almost a threefold increase over the current spot price!


The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.