Gold prices are telling us that monetary policy is too tight – or maybe not

Over the last week commodity prices has dropped quite a bit – and especially the much watched gold price has been quite a bit under pressure.

A lot of the alarmists who seem to be suffering from permanent inflation paranoia have pointed to gold prices as a good (the best?) indicator for further inflation. Now gold prices are dropping sharply (in fact much in the same manner as prior to the collapse of Lehman Brothers in 2008). So shouldn’t the inflation alarmists now come out as deflation alarmists? Of course they should – at least if they want to be consistent.

While I certainly agree that market prices – including that of commodity prices – give us a lot of information about the stance of monetary policy (remember money matters and markets matter) I would also argue never just to look at one market price. So if a numbers of market indicators of monetary policy is pointing in the same direction then we can safely conclude that monetary policy is becoming tighter or looser, but one or two more or less random prices will not tell us that.

All prices – including the price of gold – is determined by supply and demand. By (just) observing the drop in gold prices we can not say whether it is driven by a shift in demand for gold or a shift in the supply of gold. Furthermore, if it indeed is driven by a drop in demand we can not say that this is a result of a drop in only the demand for gold or a general drop in overall demand (monetary tightening).

So while there is no doubt that the move in gold prices is telling us something and surely indicating that monetary conditions might be tightening further I would like to warn against drawing to clear conclusions from this drop in gold prices.

I hope the inflation alarmists will think in the same way once and if gold prices again start to rise.





Leave a comment



    I really really want to construct a price index that can conceivably show that there is deflation when other times they insist there is hyperinflation. It’s confirmation bias run rampant.

  2. Thanks RH…

    You are absolutely right – it seems like some (Rothbardian) Austrians are seeing inflation everywhere where it is not. However, even worse some central bankers seem to think in the same way. The ECB apparently continue to think that there are inflationary risks in the euro zone.

  3. David Pearson

     /  December 16, 2011

    I agree: gold (and other commodities) are signaling deflation. The line corridor deflationary and inflationary outcomes narrows during a systemic banking crisis. Do nothing and risk deflation (the current risk). Do enough and jeopardize price stability. Austrians have been wrong because central banks — the ECB, Fed and BOJ all — have been reluctant to do enough. For the same reason, we are stuck in a sub-par recovery that repeatedly threatens to tip into de-levering and deflation. BTW, when I say “do enough”, I mean threaten safe-asset hoarders with a considerable inflation penalty, just as FDR did. The modest, temporary increase in inflation proposed by MM’s is not such a penalty.

  4. David Pearson

     /  December 16, 2011

    Sorry — I meant to write, “the corridor between deflationary and inflationary outcomes narrows during a systemic banking crisis.”

  5. David, I fully agree. The central banks have not done “enough” – or rather they have failed to undo the damage done.

    To me it is really not about creating inflation in the sense it is about undoing the deflationary trends. So I certainly agree with you.

  6. David Pearson

     /  December 16, 2011

    The reason “undoing the deflationary trends,” is insufficient has to do with the asymmetric payoffs from “safe” assets that are becoming “unsafe”. If I hold on to these, I earn at best a small return; if I sell them, I can avoid a large loss. Faced with this payoff structure, I would rather sell the asset and hoard the truly safe ones. The resulting de-levering leads to deflation. The only ways to reverse this outcome are to 1) guarantee unsafe assets (a fiscal actions that exposes the central bank to large losses); or 2) impose a large inflation penalty on safe asset hoarding. A small inflation penalty will not change the dynamic.

  1. Browsing Catharsis – 12.17.11 « Increasing Marginal Utility

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: