Gold, Money Supply, and the End of the Dollar

Subscriber Kerry B wrote to me recently:

I would love to see a long running value of the U.S. M3 in gold. I've wondered if this pool equals a relatively fixed gold value while the dollar price of gold reflects mainly the fluctuation in the amount of money in the pool. Thanks.

I'm not sure which measure of the money supply would be best for that purpose… M3 hasn't been published since 2006. I did do a chart of M2 in gold, but it looks pretty much like GDP – for the most part the change in USD purchasing power relative to gold overshadows the changes in M2 or GDP, making the charts look pretty similar:

M2 money supply in gold grams

There are many other measures (M0, M1, M2, MZM, etc. as well as private measures like Paul van Eeden's Actual Money Supply) that might be more informative. I have not tried to investigate them all.

To my mind, the direct mathematical relationship between number of dollars and their purchasing power is only a minor part of the story. The dollar really has no basis on which to have any value at all, and it is simply people's confidence that someone else will take them that gives them utility. So things that shake that confidence tend to drive down purchasing power in a big way. This shows up first in highly liquid, heavily traded commodities like gold and oil, but eventually works it's way through the system into everything else.

When people feel things are on the right track and improving, like they did under Reagan in the 80s, the dollar gains strength even though the government is running big deficits that logically should be pushing it down. Bank failures, defaults, bailouts, rising unemployment, stock market crashes ("flash" or otherwise) etc. shake confidence and lead to concern about the future viability of the fiat money, whether or not they cause net additions to the number of dollars actually chasing after the available goods in a monetarist calculation.

But eventually, the numbers will have their due. We now have so much debt, and are creating more at such a great rate, and have announced plans to do so for the foreseeable future, that the whole house of cards pretty much has to tumble at some point. We are already past the point where there is any reasonable hope of repaying the principal in a meaningful way. Interest can still be paid, but there is a finite tax base from which to pay it. As the amount owed continues to rise, and interest rates continue to rise, and taxes continue to rise, there will be more big downdrafts in the USD value, followed by smaller updrafts as the fear eases off from time to time. When super high taxes can't confiscate enough to cover the interest due, default, either explicit or through hyper-inflation, will occur.

This is one point where my view differs fundamentally from that of most analysts and economists. They are looking at gold and wondering how high it can go. They think gold will enter a "mania" phase that will push it up like tech stocks at the end of the 90s, or gold and silver in late 70s. They want to be able to recognize the top of the gold market so that they can get out before it falls like it did back in 1980.

I do not foresee a gold mania. I foresee the end of the dollar (really, the end of the fiat currency experiment all around the world.) Others talk about "the end of the dollar", but in the next paragraph, they talk about how to recognize the "blow off" in gold prices, and the importance of selling at the right time. This totally misses the point.

There is a basic difference between fiat money and gold, silver, real estate, tech stocks, or even tulips. The fiat money HAS NO INTRINSIC VALUE AT ALL. The others all have some real value, independent of what their "price" in some monetary unit is. They serve a real purpose, even if it is only to decorate your window box or make your house smell nice. Someone will always want them for what only they can do better than anything else.

Although I often point out that gold can be priced in dollars or dollars can be priced in gold, and that one is just the mathematical inverse of the other, gold and dollars are not in fact interchangeable. Dollars can, just like all the earlier failed fiat money experiments, go all the way to zero. Disappear from the monetary scene. Become a footnote in the history books. Become "as worthless as a Continental", just like the current dollar's predecessor, the bills issued by the Continental Congress during the American Revolution. Gold will not. It is too useful in its own right, and has been through the fire that has consumed hundreds of other forms of money over thousands of years and always come out shining.

Will the dollar eventually be replaced by the "New Dollar"? By the "Amero"? By the Renminbi? Or the Euro? Or the Islamic Dinar? Who knows – and who cares!

Use gold as your money. Keep your savings in gold. Measure the prices of things in gold. Watch the demise of the dollar from the comfort of your easy chair, drink in hand, as it continues to head, in fits and starts, toward its intrinsic value of zero. If the dollar enters an updraft, or even a mania, feel free to speculate a little, but watch carefully for your exit point near the top of the rally, or use trailing stops to get you out. The same holds true for stocks, real estate, and other investments. Keep the gold value of your investments growing. Take some profits off the table from time to time, adding them to your store of gold savings.

And whatever happens to the US dollar, you will still have your gold. And you will be able to exchange bits of it for whatever you need: to eat, to start a new business, to help your friends and family, to travel, to LIVE!

And that's what it's all about.