Dollar vs. Gold In A Dual Inflation-Deflation Economy Part 1

Every time you hear “the dollar’s down” or “the dollar’s up,” what exactly does that mean? If they say the dollar is currently trading at 76.54, as it is today, what does that tell you about the relative strength of the dollar or its purchasing power? The truth is, it doesn’t tell you much at all.

I began to make this case in Why Gold Is a Better Currency Indicator Than the U.S. Dollar Index. In this article I will further explain how looking at the dollar as represented by the dollar index alone doesn’t paint a complete picture and how inflation and deflation are occurring at the same time and what that means for gold investors.

The Dollar Has Been Up and Down the Last Three Years

We can see from the following chart that the dollar, as represented by the Dollar Index, has been above and below the 80 line a couple of times in each direction the last few years. Does this picture paint whether we have inflation or deflation? How?

Inflation and Deflation Have Battled It Out the Last Three Years

While the inflationist and deflationists battle it out, what’s important to everyone is the purchasing power of the dollar. We have clearly had an inflationary bout the past 8 months with food prices and oil bouncing off their post financial crash of 2008/2009 lows. But is this really inflation, defined as an increase in the money supply? Yes, we have seen the Federal Reserve implement quantitative easing (QE2) to the tune of $600 billion at the end of last year and the dollar has fallen since that time versus other currencies. But didn’t we have $2 trillion of the first round of quantitative easing? How come the dollar didn’t fall like a rock during this first round of easing which was more than three times larger than the latest round of easing? How come the treasuries actually increased in value during the time frame of the $2 trillion easing? What excuse did the inflationist have for this  result?

Take a look at TBT, the ultra short 20 year treasury the last five years. Is there a sign of inflation in this chart? If so, then why has the 20 year treasury got stronger during the last five years? Yes, I do realize there is a current upswing that is taking place, but does that paint a true picture of what’s occurring since June of 2008? All of this prior inflation was eaten up by the credit contraction occurring…the unwinding of all the credit that was extended during the boom period (see Part 3 for more on this). There is still much of that credit hanging over our heads.


What Does the Price of Oil Tell Us About Inflation?

As of yet, oil is still 30% below its July 2008 high of just north of 130. Some of the reason oil is priced higher has nothing to do with the dollar, but rather Mideast turmoil surrounding the revolutions in Egypt, Libya and elsewhere. This disruption has driven the price of oil higher. This should not be misconstrued as a result of inflation.

The fact of the matter is, the BP disaster in the Gulf of Mexico contributed to the rising price of oil too and while the dollar was rising from November 2009 to May of 2010, oil went from around $50 a barrel to almost $90 a barrel. Look at the dollar Index chart above and notice the dollar rising in value during this time versus the chart below showing oil rising in value along with it. Does this indicate inflation? Does this paint a clear picture of the value of the dollar? It’s not all as black and white as some would have you believe.

What Does the Price of Corn Tell us About Inflation?

Inflationist will point to the CRB index and the price of corn for example to show how inflation has kicked into gear. But supply and demand also play into this picture too. China and India had an increase in demand and more recently there has been a shortage of corn supplyJim Rogers predicted this in January of 2010. It’s not just a dollar/inflation issue. Supply and demand also have to be taken into account.


Government Induced Inflation

Anything that the U.S. government is involved in that causes higher prices (health care, college tuition), can’t be associated 100% with normal inflation (increase in money supply) because these are not free market programs. Colleges raise their fees and governments provide the bigger loans to the students. Cost of health care goes higher and Medicare/Medicaid pays the bill. There is no free market to allow companies to compete for business when the government pays the bill. In the end though, it is the student and the tax payer who ends up paying more.

Continue to Part 2

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About Doug Eberhardt

Doug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534


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