The next chart (Figure 2) takes a longer view. It shows how the same currencies, including the venerable Swiss franc, have performed against gold since President Nixon closed the gold window in 1971.

What is the cause of this loss of purchasing power, and will it continue? Currencies lose purchasing power against gold for one simple reason: Currency supplies are expanding faster than gold supplies. Bullion is the one form of money governments cannot artificially multiply. Since 1980, above-ground gold bullion supplies have risen, on average, about 3 percent per year. We can see in the next chart (Figure 3) a comparison with the much more rapid rate of currency creation provided by MZM, one of the most reliable indicators of currency supply.

Another way to understand this loss of purchasing power is by looking at the number of ounces it would have taken at different periods to buy a house, a car or the Dow.  In 1971, an average car cost 66 ounces of gold; an average house cost 703 ounces of gold and the Dow cost 25 ounces of gold. Today, 66 ounces of gold would buy nearly four cars, 703 ounces of gold would buy two houses and only 6.5 ounces of gold would be needed to buy the Dow (Figure 4).

2. The inflationary effects of currency creation

In 1983 Webster’s Dictionary defined inflation as:

“Inflation is an increase in the amount of money, resulting in a fall in its value and a rise in prices of goods and services.” 

Since the presidency of Bill Clinton, government Consumer Price Index (CPI) reports have moved from being a fixed measure of a standard of living to a flexible measure of a standard of living. Through a variety of machinations such as hedonic regression and substitution (if steak becomes too expensive, remove it and substitute with hamburger), these measures grossly understate true inflation. Currency debasement (a term derived from the Roman practice of hollowing out gold and silver coins and filling them with base metals), leads directly to inflation. In the few dozen hyperinflations that have occurred throughout history, all have been the direct result of governments attempting to compensate for slowing growth through currency creation, which is exactly what we see happening today. Figure 5 shows that this currency creation has already turned exponential.

Fortunately, one economist, John Williams of ShadowStats  (Figure 6) continues to track the original basket of goods governments used to track inflation prior to the early 1990s. His data shows inflation running at a much higher rate than is publicly acknowledged. His CPI is at 12 percent, over eight points higher than the “official” inflation reports.

Eventually, we will have to admit the truth about inflation, the truth that anyone who eats, drives or sends their children to college already knows. Figure 7 shows what gold and silver would trade at if we were to accept Mr. Williams’ CPI numbers.

3. Irreversible Trends Will Continue to Cause Gold to Rise

Finally, there are many independent trends that are having a direct impact on the price of gold. The most prominent are central bank buying, Chinese and Indian buying, the movement away from the US dollar, peak gold and under-investment in gold by pension funds.

Central banks were net sellers for nearly two decades until 2009, when they officially became net buyers. We can expect this trend to last two decades as well. During the gold “bull” market of the late 1970s, the Chinese public was not allowed to own gold. Today, their government encourages gold ownership, and has even made several significant innovations to facilitate this goal. The Chinese government has also led by example, with China’s central bank publicly stating it would like to increase its reserves from 1,100 to 6,000 tonnes. Unofficially, they have stated a target of 10,000 tonnes.

There can be little doubt that a race to exit the dollar is underway, as governments feel the US has no choice but to continue debasing their currency just to meet existing obligations. Peak gold, like peak oil, occurs when gold miners fail to increase production or discovery despite the rising price of the underlying commodity. Gold production has fallen since 2005, and is only slightly higher in 2010. To quote a recent exhaustive Standard Chartered Bank report:

“In our study of 375 global gold mines and projects, we note that after 10 years of a bull market, the gold mining industry has done little to bring on new supply. Our base-case scenario puts gold production growth at only 3.6 percent CAGR over the next five years .”

With pension funds holding less than 1.5 percent of their assets under management (AUM) in gold bullion, they will have little choice but to increase their position as gold continues to outperform all other asset classes.

These trends are significant, but they are all capable of being changed, however unlikely that may be. What cannot be changed are the “irreversible trends.” These have an indirect impact on the price of gold; they are causing growth to slow, and are therefore creating the need for governments to compensate through ever-increasing currency creation.

Three of the most significant “irreversible” trends are:

1. The aging population
2. Outsourcing
3. Peak oil

The largest population sector, the baby boomers, are starting to retire, and living longer than any previous generation. Their demands, which previously fuelled growth in the global economy, will reverse. They will downsize, reduce spending, liquidate investments and draw down on pension funds, social security and medical benefits. This will reduce GDP, increase unemployment, reduce government revenues, increase budget deficits and require even greater currency creation. This will reduce confidence, further debase currencies and result in increasing gold prices.

With the advent of globalization and outsourcing, politicians and multi-national corporations have let the genie out of the bottle; this has resulted in the decimation of the manufacturing base in Western economies. This will manifest as systemically high unemployment, reduced GDP, higher government deficits and further currency debasement. Again, this will lead to higher gold prices.

In September 2010, a German military think tank  reported the German government was taking the threat of peak oil seriously and preparing accordingly. Numerous studies around the world have concluded that we are very close to peak oil production, which will be accelerated due to Gulf drilling bans. This will lead to higher price inflation for most goods, reduced GDP, higher trade deficits, and higher budget deficits.  More monetization will result, thereby debasing currencies.  Higher price inflation together with further currency debasement will again be a driver for higher gold prices.

Like a spinning top must continue spinning or fall, our modern economic debt-based fiat system depends on perpetual growth. It is disturbingly similar to a classic Ponzi scheme, which requires new borrowers to bring currency into existence that can be used to pay the interest on the previous loans. The greatest threat to its health is slowing growth or deflation. With interest rates near zero, central banks have only one tool left to combat slowing growth—currency creation, which means inflation. These irreversible trends, therefore, virtually ensure gold will continue rising in value for years to come.

In conclusion, I know many readers are hesitant to buy as they feel they have “missed the boat.” Perhaps this Chinese proverb will help:

The best time to plant a tree is twenty years ago.
The second best time is today.