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Misunderstanding the Monetary System is Hazardous to your Portfolio

I was just perusing the FT and came across this article about gold’s collapse.  This line really jumped out at me:

“Some, at least, are keeping the faith. John Paulson, one of the most prominent gold investors, continues to believe that the expansion of central bank balance sheets through “quantitative easing” and other policies in the US, Japan, Switzerland and the UK will trigger higher inflation and boost gold prices, according to people familiar with his thinking.”

Anyone who understands MR and really understands how the monetary system works would never assume that QE is inflationary.  I’ve been on record for years explaining how QE is essentially just an asset swap that changes the composition of private sector financial assets, but doesn’t actually increase the net financial assets of the private sector.  This is the crucial understanding with regards to QE.

All the other stuff might have some impact.  Yes, QE probably has some impact on interest rates.  It definitely has a psychological impact because it’s so widely misunderstood.  But the one thing it definitely doesn’t seem to do is cause inflation.  And that makes complete sense.  If you own a T-Bond you have something very similar to a savings account.  If the government comes along and takes your savings account from you and replaces it with a bank deposit (a checking account) are you suddenly more inclined to spend?  Of course not.  That’s QE in a nut shell.

Anyone who understands MR knows that QE (as is being implemented) is overrated when it comes to real fundamental economic impacts.  All the hyperbole in recent years about hyperinflation, high inflation, the increasing money supply all leading to the “overweight hard assets” thesis has been based on a fundamentally flawed understanding of the monetary system.  And now those investors are paying the price.

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