September 14, 2022

Inflation continues to plague the U.S. and global economies, with the August U.S. Consumer Price Index data released Tuesday 13 September showing stronger, more persistent inflation even as other segments of the report reinforced the view that prices are plateauing. The main concern for the broader economy is that prices may not decline as rapidly and as far as the Federal Reserve has repeatedly suggested over the past year and a half. 

This report examines the relationship between inflation and gold prices, and additionally the relationship between large, perhaps what could be called excessive periods of money creation and inflation.

CPM often is asked about the relationship of money supply to inflation quite often, by investors who are wondering why inflation rates are not even higher than they are given the unprecedented increase in money supply during the economic lockdown of 2020 and recovery programs of 2021 and early 2022. 

We also are frequently asked why gold prices are not higher than they are, or rising more than they have, given the increased inflation since March 2021. 

The Simple Answers 

Regarding why we do not focus on the relationship between money supply and inflation, the answer is we do, and we give it the respect and attention it deserves. 

However, there is a very poor statistical relationship between money supply growth and inflation. There were seven periods of economic and political crises from 1982 through 2019 in which the Fed poured massive amounts of money into the economy to stave off even worse conditions. In each instance, when the crisis was contained the Treasury sold bonds to sop up the excess liquidity, sterilizing any inflationary consequences that might appear later. 

The chart shows how since the early 1980s these periods of massive increases in money supply have not led to higher inflation, at least until 2021. 

We stopped that chart at December 2019 to allow readers to see the relationship. The chart below runs through July of this year. The massive increase and then decrease in the M1 growth rate in 2020 and 2021 skew the scale, rendering the longer term lack of relationship less visible. 

It is not just that there is no strong direct correlation statistically that causes us seem to downplay the relationship between money supply and inflation. 

There also are theoretical underpinnings to expect this, and the empirical evidence since 1982 supports the theory. 

Another reason for CPM’s stance is that we additionally pay a lot of attention to supply and demand trends in the real economy and to fiscal policies’ effects on inflation. These two sets of factors appear to have a lot more influence on inflation than to monetary policies, with all due respect to Milton Friedman and the Monetarist economists to still hold to his concepts that money supply was the only thing that mattered. 

Inflation and Gold 

The second set of relationships is inflation’s effects on gold prices. 

Again, the statistical relationship is not as great as many people seem to believe. Since gold prices were freed to float in 1968, from 1970 through last year the correlation between money changes in inflation rates and real gold prices has been 9%. Gold prices do not move tick-for-tick with inflation. 

In fact, between 2000 and 2021 the correlation has been a negative -5%. Gold prices have risen from around $266 in 2000 to more than $2,000 on an intraday basis in 2020, in an absence of rising inflation and actually a period of declining inflation.

Gold responds to many factors, including inflation, but also including overall economic conditions, currency market moves, equity and bond market trends, political crises, and more. So far this century, until last year, gold prices have been rising sharply in an absence of inflation, due to a long list of problems, issues, and crises. 

Gold wears many hats, serves many purposes. That is why we buy it and hold it.