HardAssetsInvestor

Written by Brad Zigler  |

April 18, 2011

Gold And Dollars: The Inflation Year In Review

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Nothing encourages a look back over the past year's financial milestones than a tax deadline. A lot's happened since April 15, 2010, not the least of which is a turnaround in the U.S. dollar's prospects. For inflation, I mean.

Just last week, we were treated to the U.S. Bureau of Labor Statistics' monthly updates on the retail and wholesale price metrics (see "Inflation Scorecard: Goods Prices Up, Gold Prices Mixed").

Government data showed the largest year-over-year increases in both the Producer Price Index (+5.8 percent) and the Consumer Price Index (+2.7 percent) since March 2010.

The hikes in the prices of goods and services dovetailed with a 2.3 percent increase in the Monetary Inflation Index, a currency-adjusted metric of the U.S. dollar's gold purchasing power.

The term "currency-adjusted ... gold purchasing power" befuddles some readers, so perhaps a picture can offer some clarity. Here's the track record for the inflation index, gold's dollar price and the value of the world's second reserve currency, the euro, denominated in terms of the foremost reserve currency, the greenback:

Monetary Inflation Vs. Gold And The Euro

What we can see is that the dollar price of gold rose nearly 28 percent over the past 12 months. Does that mean the dollar's purchasing power declined by a like amount? No, because the dollar's value can also be determined in the foreign exchange market. The greenback's value against the euro pitched and bucked over the year, so we have to factor this effect in determining the dollar's real buying power. In economic terms, only so much of gold's gain (or, put another way, the dollar's loss) is intrinsic. It's this intrinsic value of the dollar that's captured in the Monetary Inflation Index.

Note, for example, how gold's dollar price (the blue line) rose in the spring of 2010 while the U.S. currency strengthened in the forex market. The inflation index declined until the buck peaked (or, more properly, the euro bottomed as depicted by the green line) in early June. The euro then strengthened until early August, diminishing the U.S. currency's bullion buying power.

From September to October 2010, both the dollar price of gold and euros increased simultaneously, putting the double-whammy on the greenback and pushing up the inflation rate from -3.1 percent to +0.2 percent.

It's important to remember that you're looking at day-to-day changes in the value of gold and the euro here, but year-over-year changes in the inflation rate. That -3.1 percent rate reflects the compounded effect of changes in euro and gold dollar values in the 365 days preceding Sept. 13, 2010.

So what do we see now? Just this—it looks like monetary inflation has bottomed out (that is, the disinflationary trend seems to have run its course) and is beginning to surge upward.

We'll take a detailed look at the odds of an inflationary breakout and those of a return to deflation in one of this week's features.