Supply-Side Forum

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Thursday, August 03, 2006

Supply-Side Forum

Another post from Sean Rushton:

At NRO, Jerry Bower argues against gold as the monetary Polaris. Arguments to the contrary?

7 Comments:

Blogger David Wood said...

Interesting argument as to why commodities are going up more than other goods. Makes sense. I don't see how that invalidates the gold polaris, though. My understanding of the polaris doesn't necessitate a 1:1 gold:inflation rate ratio. And as Ed Breen keeps pointing out, the GVM has been excellent as an inflation rate predictor, which would seem to indicate that there hasn't been any change in the historical relationship.

1:53 PM  
Blogger Henry Meers said...

There have been lots of times in history when people thought some new device would change the world: the steam engine, automobile, telephone; and we still have inflation and deflation when we leave gold. Prices moved up and down quite a bit, although they may have appeared level in aggregate, the trap of microeconomics.

There is no reason for things to change as we become more productive. Good monetary policy is essential to the capitalist system. These breakthrough ideas are not going to take us back to the barter system, where we no longer need money. Quite the opposite, we need sound money even more to finance the development and exploitation of new ideas.

I keep saying that gold will act like a commodity, especially at the extremes of sentiment, absent a link to money. Several of the reasons should be obvious. If you are worried about inflation, a serious problem in times of international crisis, paper money would be less attractive, banks might be closed to you; so, gold makes all kinds of sense. Before WWI, on the other hand, you could buy dollars or pounds, no questions asked, and be certain they would hold value, because of the issuers' ability and demonstrated willingness to convert upon demand.

In this context, gold and oil could easily rise and push the general inflation numbers up. In the present day, prosperity has also been increasing the demand for tradeable commodities. Without conversion and the central banks in the gold market it is more difficult to see how much of the gold price is inflation. We can go further; but, if someone wants the security of gold, and he can't get it in the dollar, gold becomes more attractive and is quite portable. That doesn't mean it is losing value, except in this case.

7:56 PM  
Blogger Melting Snow said...

The Chart is a static representation. As costs move through the production process the high commodities prices will show up later in the ppi, cpi etc. If that is true, then we can expect a jump in the PPI and CPI in the near future.

And why wouldn't competition for goods work equally at the commodities level as well as the consumer level?

9:30 AM  
Anonymous judith said...

Well, obvious to us (and, as we learned from JW) is the fact that different sectors of the economy follow gold with different lag times.
....one would think that even the differing 'factions' within the supply-side group would understand that.
But.
I guess not.
So, we appear to have a battle between the 'superficial' and the 'classical' supply-side folks.

1:00 PM  
Blogger Dick Fox said...

Jerry Bowyer once again proves his limited knowledge of supply side economics. He makes assumptions with no foundation. I am not sure Bowyer would understand that inflation can increase while prices fall.

4:00 AM  
Blogger ebreen said...

The primary error in Bowyer's analysis is that he is focused on prices as the cause of inflation. Greg Ip made the same mistake this morning on CNBC. He attributed inflation to high oil prices passing through the economy. Bowyer sees inflation as rising prices in different things at different times. Of course we know that this happens, that prices of things change and different times and for different reasons. They may be changing becuause of market conditions of supply and demand and they may be changing due to inflation. This is where Bowyer is confused along with Ip. They see the price change as the inflation. They fail to comprehend that inflation is entirely a monetary phenomenon that effects all goods and service prices and is not an issue of the price change of single goods or even classes of goods. Oil price increase does not cause inflation. It raises costs in sectors of the economy and it causes economic responses to those cost increases but this is not inflation. If Bowyer and Ip would start by defining inflation as a monetay phenomenon where the condition is allowed to persist that the supply of currency exceeds the demand for the currency then they could begin to apprehend that the tool the fed uses to combat the situation is wrong headed. If inflation is caused by a supply/demand imbalance in currency then you have two tools to bring it back to balance. You can reduce supply of currency (Sell bonds) or you can act on the fiscal side to increase the demand for currency (Reduce some marginal taxes, increase infrastructure spending, reduce costs of production or trade by regulation, etc.) It is not rational in this understanding of inflation to assume that simply increasing the FFR will bring supply/demand of currency into balance. The test of the past two years shows that it does not. Gold in this scenario is useful becuase its price contains monetary imbalance signals. It is a place currency flows to and flees from depending on the supply and demand imbalance in the currency. Because this imbalance is reflected in the gold price it is possible to have early warnging that the imbalance exists and that the condition is trending to greater or lower imbalance. The work on the GVM model has shown that the auction spot price of gold is not the best indicator of imbalance. None of the pundits that I have heard seem to understand that the gold volatiity is a better inflation indicator than the spot gold price. The spot gold price is influence by a lot of circumstances that are not direct monetary effects but are attenuated monetary effects. Using a longer term moving average of the price of gold and balancing the average with allowance for change in gold price volatility provides a better picture of the monetary forces reflected in gold price. This is basis of the GVM model...which also incorporates bond futures information in order to predict specific government inflation measures. I appologize that this is long winded and certainly all of you have heard this before but this is a new forum and this basic argument needs to be laid out. I do not know a pundit, except Steve Forbes, who understands that the issue is gold volatility. This failure is the basis of the confusion and disagreement on the usefullness of gold as an inflation indicator. Stated again differenty, it is essential that gold polaris theorists understand that the temporal price of gold does not predict inflation, but the persistent change in the price of gold from one level of stability to another level of stability does predict inflation. And of course, this long cycle phenomenon effects all prices of goods and services in different amounts at different times depending on the price elasticity of the good or service.

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