By: Tim Fortier — June 2, 2021
Here's The Most Important Chart in Finance
In my article last week, I discussed how inflation was going unchecked and discussed that one of the Fed's money press casualties was a weaker U.S. Dollar.
Today, I'll share why this so important to everyone and the potential impact it can have on you and your investment portfolio.
First some history...
Before World War II, most countries kept gold as currency in circulation. Thus the value of a country’s currency was pegged to gold, and for reason, all currencies were automatically pegged against each other.
But during World War, all European countries, which were the major economic powerhouse previously, had to spend huge sums on their military. Those military spending needs were greater than the gold reserves.
Result? Most countries printed money that was unbacked by any corresponding gold reserves.
The U.S however, accumulated a trade surplus, mostly from the sale of weapons, and thus accumulated currencies from European countries.
After the war, there was a huge need to finance the reconstruction of Europe. Trouble was, the European countries had no physical gold in their coffers. They were essentially bankrupt. The only currency backed by gold reserves was the US dollar.
In a meeting at Bretton Woods, New Hampshire, in 1946, the allied countries decided on a new monitory policy. The chief architect of this new design, known as the Bretton Woods agreement, was John Maynard Keynes.
In it, US dollars would be backed by a proportionate gold reserve. Every other country would, in turn, keep USD as its reserves against which to print its own currency at a fixed exchange rate.
The Agreement set the U.S. Dollar as the global reserve dollar while allowing Europe to rebuild without having to accumulate its own reserves.
(Click any image to enlarge)
Fast-forward to America in the 1970s. With expenses rising from the ongoing Vietnam War, the US did exactly what the Europeans had done thirty years before. It began secretly printing dollars without having adequate gold reserves to back them up.
As nations began redeeming dollars for gold, President Richard M. Nixon famously and abruptly "closed the gold window." That is, he canceled the convertibility of the US dollar to gold.
But by this point, the US dollar had become deeply integrated into virtually every global economy. That meant that any country demanding that America devalue the dollar, would face having its own reserves also fall in value. This would set off a chain reaction no one was in a position to endure.
Thus the USD was allowed to fluctuate against other countries' currencies without the backing of gold reserves. And the current fiat currency system was born.
And so it has been that the money supply of the US has been allowed to grow, untethered to anything other than faith.
And grow it has...
The Exploding Money Supply.
The chart below shows M1 money supply growth since the 1970s. The hockey stick on the right represents growth since 2020.
That should make obvious the sheer enormity of what has taken place in just this past year.
When too much money chases too few goods and services the cost of goods and services rises. This is Econ 101 -- good old "Supply and demand."
When the money supply is increased gradually, the effects of inflation are more insidious. They sneak up on us. And like the proverbial frog being boiled in a slowly-heated pot of water... we hardly notice as inflation picks our pocket.
But what has happened in the last year is anything but gradual. The money supply has gone from $4 trillion to over $19 trillion!
In the chart below of the USD, the red dotted line represents the recent lows which are around the 88-89 level. Remember inflation erodes the value of the dollar.
Last Friday, the all-important PCE deflator index (the metric that the Fed uses to measure inflation and inform monetary policy) beat expectations. The index was up 3.6% in April, revealing faster-than-anticipated price increases in the economy. On a year-over-year basis that's the biggest rise in 29 years.
As more investors realize that the Fed is not going to fight inflation, the dollar will be sold, its value will fall, and this will accelerate the cost of everyday goods.
Walk into your local Walmart and look around. It is estimated that 70-80% of everything that you see comes from China.
China and Hong Kong dollar reserves are over $3 trillion. What do you think those countries might do when they see the value of those reserves begin falling at a faster and faster rate?
If you said "sell those dollars"... you'd be right.
And this will only spiral inflation out of control even faster for the American consumer because it will take more dollars to buy the same goods from overseas manufacturers.
The bottom line is this - prices on everyday goods are likely to be going up. And you'd best have a plan for dealing with it.
I think investors are waking up to the reality of inflation and I think one of the most bullish trades on the planet right now is gold. Gold has built a decade-long base and looks ready to explode higher.
Zooming in on the weekly chart we can see that gold recently broke through the downtrend line that has been in place for nine months. This is bullish.
So a strategy to combat rising inflation would be to buy physical gold, silver, and shares such as VanEck Gold Miners (GDX).
I would expect to see gold trade somewhere around $2,500 in the coming months. Since gold mining stocks are typically leveraged to the prices of precious metals, this means that GDX should reflect an even greater increase percentage-wise.
Stay smart, and stay safe.
I'll see you soon,
Editor, True Market Insiders