Given the meteoric rise in gold prices over the last few months and the beating bonds have taken over the last 2 years, “the Dollar Debasement” trade has been in vogue of late. But in some sense, both the DJIA and Gold have been Dollar Debasement trades since 1971, when the US Government officially decided to debase the dollar in perpetuity.
Both the Dow Jones Industrial Average Index and Gold have delivered returns far superior to the Price inflation during the above period. Also, given that both the DJIA and gold are quoting at all-time highs, it is very puzzling to most investors. That the last 50+ years have been pretty much the same debasement trade that has caused the DJIA to vault higher is wholly lost.
Quite obviously, the trend in gold prices has just started and has miles to go. As I wrote just a couple of weeks ago, we are very likely to see a 10-fold increase in gold prices over the next 5 to 10 years. How about the DJIA? The answer to that is not straightforward, but suffice it to say that we are close to the end rather than the beginning. But the more important point than the nominal gains ahead is the price-inflation-adjusted returns. Read on.
What is “Debasement?” – Webster’s defines Debasement as “the process of lowering in value, quality, character, or dignity”. In the context of currencies, it is the depreciation of value or, more objectively, a decline in purchasing power.
How do governments debase the currency? By creating more of them and increasing the quantity in circulation through the banking system. While there is a natural phenomenon even under the Classical Gold Standard for a modest increase in the money supply, debasement becomes a factor when this growth in money supply is faster than the economy’s GDP growth. The most common route of debasement is deficit spending, in which a Central Bank monetizes the deficit (or conjures currency into existence) to cover the Federal/Union Government’s budget shortfall. More sophisticated mechanisms for debasement include QE.
To paraphrase a famous line from “Romeo and Juliet”, debasement by any means or purpose is just as bad in terms of the effects on the citizens through a loss in purchasing power of the currency. But of course, debasement doesn’t affect everyone equally. In fact, it’s worse because debasement transfers wealth from the middle class and the poor to the affluent.
Currency Debasement Since 1971
The growth in the money supply (M2) since 1971 has far outpaced that of the GDP. A simple difference between the M2 growth rate and the GDP growth rate indicates that the US Dollar has been losing purchasing power by about 3.2% per year since 1971.
The US is expected to end FY2026 with a National debt of more than $40 trillion, and a 4% interest rate would imply an interest outgo of nearly $1.6 trillion. That is almost 1/3 of federal revenue. The interest expense was just a little over $500 billion at the start of this decade, and a tripling of liabilities in 6 years doesn’t portend well.
The reason for alarm is the extraordinary growth in the National debt and the money supply that have underpinned GDP growth post-1971. The US cannot afford an increase in the national debt – if not on an absolute basis, at the very least as a % of GDP – as this threatens the solvency of the Federal government and the stability of the US dollar. Gold’s rise this year is a direct consequence of the US government’s solvency crisis and the potential currency crisis it points to in the years ahead.
The Accelerated Debasement Trade Ahead
What the industry means by the “Debasement Trade” now is actually the “Accelerated Debasement Trade”. It has been the Debasement trade right from 1971.
Two events of the last week must indeed send an ominous signal to a rational Investor.
- Powell signalling the end of the QT program: Speaking at the National Association of Business Economics earlier this week, Powell remarked, “may approach that point in the coming months”. In any case, with the onset of rate cuts and a monetary easing cycle, QT had to end logically – whether Powell admits it or otherwise.
- Jamie Dimon signalling buying gold as Semi-Rational: Far more than Powell’s admission on QT, Jamie Dimon stating that buying gold in the current environment is Semi-Rational and that gold could well easily go to $5000 or $10,000/oz portends a bleak future for the US dollar.
This is as much of a confession as can be made by people in the mainstream of Economics about the accelerated debasement ahead and how it will affect asset prices.
What happens to the DJIA? This is a more interesting question to address. Ofcourse if one were to look for an answer in price-inflation-adjusted terms (DJIA measured in terms of ounces of gold rather than the debased US dollar), the answer is an easy one.
What we have been witnessing over the last century is higher tops and lower bottoms. An excellent case can be made that the Inflationary Depression ahead will be worse than the Great Depression of 1929-1946. The US was on a quasi-gold standard during the Great Depression, which limited the debasement of the US dollar. With that constraint no longer in force, the sky is the limit for deficit spending, and “0” could be a possible outcome for the US dollar.
Even ignoring the hyperinflationary scenario mentioned above, we can easily expect a “1” handle on the DJIA/Gold ratio over this cycle and that could imply as much as a 90% fall from the current ratio of 10.5 (DJIA – $46,000 / Gold – $4,400/oz).
What about the Nominal Values for DJIA? That is much harder to predict, and the nominal DJIA could enter a bull market with a much-debased dollar and could touch 100,000. But in terms of what can be purchased with it, it will decline as the DJIA’s nominal gains lag price inflation.
From the start of this century, the DJIA has lost more than 70% when measured in terms of ounces of gold. This has largely been lost on most investors, and how they would have been better off holding the barbaric relic in their basements. In part because the fall has been spread over 25 years. The next 70% (or perhaps even 90%) decline will be much swifter, and hopefully, investors will wake up to the US government’s dollar-debasement policy.
Mises had said that a fiat monetary system and inflationism/debasement go hand-in-hand. Greenspan had echoed something similar when he wrote, “In the absence of the gold standard, there is no way to protect savings from confiscation through inflation (i.e. debasement)”. The world is about to learn the immutable lessons of economics one more time the very hard way.
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About the Author
Shanmuganathan N (aka Shan) is an Economist based in India and can be contacted at [email protected]