The younger people in America (and this likely goes for many parts of the world) are getting ripped off.  They are being taken advantage of by the older people.  Older people know how to vote and influence their so-called representatives in Congress.  This isn’t to say that older people aren’t getting ripped off by the government too.  But as far as wealth being redistributed, after the government and the lobbyists, the older generation is next in line for the plunder.

It is hard to define the specific age groups.  Certainly anyone under 40 is getting ripped off.  I would venture to say that anyone under 50 is too.  Somebody who is 50 years old right now is probably not going to see Social Security and Medicare until at least the age of 70, and I even find that doubtful.

There is nothing in the Social Security trust fund except IOUs.  It is part of the national debt.  Even if those IOUs were good, there would still be a massive shortfall.  And then there is the other, even more massive unfunded liability, called Medicare.  There is no possible way that the program can be sustained anywhere close to its current form.

Working people have to pay taxes to fund wars, pay foreign dictators, provide subsidies to rich farmers, fund all of the bureaucrats who make their lives more difficult, and then pay for the retirement of tens of millions of people on top of it.  Meanwhile, all of the money that is taken from them as part of the payroll taxes is spent immediately.  None of it is saved.

I know of young people who are withdrawing money from their 401k plans because that is the only money they have in reserve.  Many people don’t even have this option because if their 401k plan is with their current employer, they likely cannot take any kind of a withdrawal.  The best you can do is to take a loan and pay yourself back.

Working people are taking on a huge burden.  They are barely scraping by.  It is very difficult to raise a family on a middle class income.  About the only major subsidy you get is for education and the schools are so bad that many parents (and rightly so in my opinion) don’t even use the government schools that they are forced to pay for.

Not only are working people just barely getting by, but they are finding it difficult to fund any kind of a retirement.  Most people are lucky to get a 401k, which is vulnerable not only to market fluctuations, but also the government trying to tax it more in the future.  The thought of retirement seems almost like a fantasy for most people who are under the age of 50.

Meanwhile, these same working people have to pay for senior citizens to play golf and travel.  Many seniors today have company pensions, which aren’t nearly as available to younger people today, except perhaps government workers.  Again, good luck with your 401k plan.

At some point, I think the workers are going to shrug.  It is not to say they will stop working or disappear a la John Galt.  I think the younger people in America are going to realize they are getting ripped off and they will take a stand.  They will no longer feel any sense of guilt or obligation to fund the retirement of the older generation.

At some point, there will be a congressman who stands up and says he is going to cut payroll taxes and lower the so-called benefits of Medicare and Social Security.  Others will see that this is not political suicide.  The younger people will start to demand this of their so-called representatives.  At some point, there will be a major shift.

The major divide in the future of America will not be between Republicans and Democrats.  It will be between young and old.  The young people will eventually get fed up with working hard and seeing few results.  They will get tired of seeing the older people living the good life at their expense, while they have little to look forward to.  The workers outnumber the retirees.  The workers will eventually figure this out and win.

There is a saying that a government big enough to give you everything you want is also big enough to take away everything you have.  In this particular case, we can modify that to say that a Federal Reserve that has a monetary policy to let the good times roll, will also have a monetary policy to bring on the crash.

After the FOMC released its statement on June 19 and Bernanke spoke, the markets were spooked.  Stocks, bonds, and commodities all took a nosedive.  That was last week.  This week, heads of the regional Fed banks are coming out to smooth things over.  The latest person was William Dudley, president of the Federal Reserve Bank of New York.

Dudley said, “If labor market conditions and the economy’s growth momentum were to be less favorable than in the FOMC’s outlook – and this is what has happened in recent years – I would expect that the asset purchases would continue at a higher pace for longer.”

The Dow finished the day up in triple digits.  The same thing happened the day before when the first quarter GDP numbers were revised downward.  It signaled that the economy is still struggling.  Investors liked this news because it meant that we would likely see more monetary inflation by the Fed.

We know that something isn’t right in the world when the stock market is going up because of bad news with the economy.  It seems like the whole thing is built up by the Fed.  But this also means that the whole thing will come crashing down one day, if and when the Fed halts, or even slows down, its digital money printing.

In the short term, I have no idea if stocks are going to go up or down.  It is anybody’s guess.  It is so highly dependent upon the decisions of the Federal Reserve and the establishment, that it almost doesn’t seem worth gambling on.  If you are going to own stocks, I would recommend that you either own specific stocks for specific reasons, or else you simply limit yourself to a 25% maximum as part of your permanent portfolio.

If we all of a sudden see a small spike in price inflation, we could quickly see interest rates go higher and stocks tumble.  So much of the stock market is built up by funny money right now, it is hard to trust it at all.  Specific words coming out of Bernanke’s mouth or other Fed officials can cause your investment portfolio to go up or down in wild swings.  There is something truly wrong when just a few individuals can speak and control the market of a country with over 300 million people.  In fact, it really affects the entire world.

In conclusion, I would be very careful about putting money in the stock market to speculate.  It is not always true that what goes up must come down.  But when it is built on artificial stimulus, it is likely to hold true.

Yesterday, I wrote about the permanent portfolio and how you should still stick to this methodology of investing, despite its relatively poor performance of late.  In this post, I want to offer some possible tweaks that may enhance the portfolio and allow you to sleep even better at night, knowing your money is as safe as it can be.

I have made this suggestion in the past and I want to reiterate it now, especially with interest rates having gone up in the last few weeks.  You don’t have to be a libertarian to invest in the permanent portfolio, but I find that most people who do subscribe to the advice tend to be libertarians.  I suppose it is because it was offered by Harry Browne, who himself was a great libertarian.  But beyond that, libertarians understand that monetary inflation is a major threat to their assets, so the 25% gold portion is appealing.  How many other portfolios will you find where the recommended gold holdings are at least 25%?

Right now, a lot of libertarians are scared about bonds.  There are certainly a lot of good reasons to be fearful of them.  There is a possibility of higher interest rates due to many factors, including inflation, the threat of default, and, as recently shown, the possibility of the Fed’s tapering of its buying of government bonds.  With a huge national debt and the possibility of higher price inflation in the future, there are definitely reasons to be bearish on bonds.

But at the same time, we can’t completely abandon bonds in the permanent portfolio.  They are there for a reason.  It is possible that Bernanke and company could decide tomorrow that it will stop all monetary inflation.  If that happens, we would likely see some kind of a recession/ depression, with the possibility of price deflation and lower interest rates.  While this is not highly likely, we really shouldn’t speculate to the point where we leave ourselves vulnerable.  There are less extreme scenarios where we could still see falling rates and rising bond prices.

So I recommend that if you have a home mortgage, you should consider paying down the loan.  While you won’t derive a huge benefit from falling interest rates as you would with owning bonds, you will still be locking in a rate of return that is equivalent to whatever the interest rate is on your home loan.  And you won’t have to pay taxes on your hidden gain.

This is a deflation hedge because you are locking in a rate of return.  If your home loan has an interest rate of 4%, then you will be locking in the equivalent of a 4% return.  If rates fall to 2%, then at least you will be getting a better “return” from paying down your mortgage than you would have if you kept it in cash or a cash equivalent.

I don’t recommend abandoning bonds entirely, no matter what you think is going to happen.  You still need some upside if a deflationary depression comes along.  Instead of having 25% in long-term bonds as the permanent portfolio calls for, you could have 12.5% in bonds and use the other 12.5% to pay down your mortgage.

This may not be a perfect strategy, but it is a way to diversify even a little bit more and you won’t have to worry as much about rising rates.

If you own a home and don’t have a mortgage, then you already have somewhat of a deflation hedge with that.  Because of that, you could lighten up the bond portion of your portfolio just a little bit.  Perhaps you could have just 15 to 20 percent in bonds instead.  This will depend on how much money you have and how much your house is worth.

If you rent and you don’t have the money for a down payment to buy a house, then you probably don’t have enough money to worry about the whole thing.  You should be concentrating more on saving money (earning more and cutting costs) than investing.

If you rent, yet have a decent net worth, then perhaps you should consider buying if you plan to stay in the area.  You could also consider buying an investment property, something that I advocate if you are in the right position to do so.  If your situation is such that you just can’t buy a house right now or you simply don’t want to, then it will probably be best to stick with something close to the 25% portion of bonds in your portfolio.

I am a strong advocate of investing a majority of your money in something similar to the permanent portfolio as described by Harry Browne in his book Fail-Safe Investing (also see Kindle version).  It is set up to withstand any kind of economic environment and to avoid the need to speculate.

After the FOMC’s statement on June 19, 2013 and Bernanke’s press conference, investment markets turned sour.  The stock market plunged, the bond market plunged, and the gold price plunged.  In other words, even if you were invested in the permanent portfolio, you took significant losses in the couple of days that followed.  75% of your investments took a hit, while the cash portion stays almost the same due to low interest rates.

While the permanent portfolio has not been a great performer as of late, I also don’t think it is time to abandon the strategy.  There are going to be days when all of the asset classes (except the cash portion) are highly correlated and some of those days will be on the down side.  There will even be short periods of time when they all do poorly.

Stock market investors who advocate a buy and hold strategy often say that we should be in it for the long term.  But the long term in the stock market could be decades.  If you had bought an index fund in the Japanese stock market 25 years ago, you would still be down.  While this example may seem unfair, it illustrates the power of the permanent portfolio in that it rarely has a negative return for longer than a year.

It is important to realize that there will be periods of losses, but these periods should not last a long period of time.  Harry Browne recognized this.  To quote his book, he said the following:

“Tight money is usually characterized by rising interest rates, which are bad for most investments.  The only attractive investment during a recession is cash.  And your cash holdings may not completely offset the losses that tight money may inflict on the rest of your portfolio.

“But tight money is by nature a temporary condition.  Unlike prosperity, inflation, or depression, it can’t go on indefinitely.  Either the economy adjusts to the new level of money and returns to prosperity, or the supply of money changes – leading to inflation or a full-scale deflation.”

He understood free market economics.  He understood that if there was a recession due to a tight monetary policy (or I suppose an expected tight monetary policy), then things would readjust and prosperity would eventually return, unless the central bank kept interfering.  Either way, you end up with prosperity, inflation, or a deflationary depression.  A recession cannot go on forever without turning into one of those other things, which are all covered in the portfolio.

So while I actually think that interest rates are likely to go back down in the near term, we don’t need to lose sleep over the possibility of continually rising interest rates.  This means we will either get higher inflation (and higher gold prices) or we will get a recession to clear out much of the malinvestment.

I’m guessing even Harry Browne could not have imagined that the Fed would be creating new money at a pace of $1 trillion per year.  But he did understand the various threats to your portfolio and developed something to help people avoid significant losses.  While the permanent portfolio is far from perfect, I am still waiting on someone to come up with something better.

Edward Snowden, the whistleblower who exposed the secret spying on Americans by the NSA, is on the run from the federal government.  Government officials don’t like whistleblowers when it exposes lies, corruption, and crimes being committed by the government.  Therefore, the government is trying to extradite Snowden, while Snowden is seeking asylum in another country.

Some people are faced with one or two life-changing decisions during the course of their life.  There are a few people who are faced with this several times.  There are others who never face a real life-changing decision.  I am not talking about a decision about whether to get married or change jobs.  I am talking about something that is really life altering.  Snowden’s case is extreme, but it is worth examining.

It is difficult to know how you would act in such a situation.  It is easy to say you would or wouldn’t do something in a particular situation when you aren’t in it and you aren’t the one facing the consequences. If Snowden is caught by the U.S. government, he is likely to face a lifetime in prison.  He can’t even be certain that he won’t be tortured.  And it is unlikely he will get any kind of a fair jury trial.

Even if he does get asylum in a place like Ecuador, he will probably always live with a feeling of paranoia.  He will always be looking over his shoulder, not knowing who he can really trust.

There is no question that Snowden has given up his normal life.  He left a well-paying job and he left his girlfriend.  I suppose if he gets protection somewhere, his girlfriend could decide to join him.

Snowden could have just quit his job contracting with the government in its spying operations.  He could have left on principle and given up a nice income, yet kept his mouth shut.  At the very least, he could have made the decision not to release sensitive documents (sensitive to the criminals in the government).

If I had been in his position, I don’t think I could have done what he did.  I have a family who relies on me.  But even if I were single with no children, it would be a difficult thing to do.

If you were in Snowden’s position, do you think you would have a moral obligation to do what he did? I don’t.  If a majority of Americans strongly opposed the U.S. government’s attempt to extradite Snowden, then he would have little to worry about.  The only reason the government can get away with such criminality (which includes going after Snowden) is because the American people consent to it.  They don’t have to explicitly give their consent, but just enough that they won’t kick up a fuss.

Therefore, I wouldn’t blame someone in Snowden’s position who doesn’t blow the whistle.  If a majority of Americans don’t care enough to speak out strongly in favor of a whistleblower who is exposing government wrongdoing, then why should anyone give up his life for the cause?  We have already seen what happened to Bradley Manning.  It is no surprise that the government is going after Snowden.  Snowden’s case is much more well known than Bradley Manning’s at this point, but we still don’t have anything close to a majority of Americans who strongly support the whistleblower who exposes government crime.

It would be a much tougher situation if by blowing the whistle you could potentially save lives.  But if you aren’t going to get strong support from a majority of the people, then in most cases you should not feel obligated to become something of a martyr.

We don’t really need more brave people like Snowden to blow the whistle.  Anyone with their eyes open can see the massive corruption and crime that is the U.S. government.  We really need for more Americans to support people like Snowden and for more Americans to withdraw their consent.  The government in DC cannot survive without the consent of most Americans.

Markets reacted negatively on Wednesday, June 19, 2013, after the FOMC released its latest statement and Bernanke spoke.  There was an indication that the Fed might start to reduce its rate of monetary inflation towards the end of the year.  Since the stock market has been juiced up by the Fed, it also sinks when the Fed gives a sign that it might be pulling back.

It was the following day that markets turned really sour.  Almost everything was hit bad.  The Dow was down well over 300 points, after having already suffered big losses the day before.  Gold was down as much as $100 and closed the week under $1,300.  And bonds really took a hit too.

Perhaps the bonds might be the biggest story out of this.  The 10-year yield ended the week over 2.5%. While this is still historically low, it is vastly higher from the rates we saw just a couple of months ago.  This is driving mortgage rates higher as well.

I continue to maintain that we are not going to see a huge spike in interest rates without seeing a rise in consumer price inflation.  The bonds fell and rates increased on fears that the Fed will be buying less government debt.  This is logical.  But it is important to think through the different scenarios with bonds and interest rates.

If the economy falls into recession or depression, then rates are not likely to go higher, unless it is accompanied by higher inflation.  Recessions tend to bring rates down as people look for safety for their investments.  In addition, if the economy goes into a deep recession and price inflation remains low, then it is likely that the Fed will jump back into action and create more new money.  This means more bond buying, which will bid up prices and bid down interest rates.  So while it is not surprising to see rates come off their near all-time lows, they are still really low by historical standards.

This whole thing is playing out at a seemingly slower pace than what we have seen in Japan.  In Japan, the central bank started inflating like crazy and the stock market there went crazy.  But then, within 6 months, it started having huge down days.  When the stock market is built up because of central bank monetary inflation, it doesn’t take much to spook the markets and reverse the trend.

The scary part about this whole thing is that the Fed is currently monetizing debt at a pace of $85 billion per month.  That is about $1 trillion in a year.  The monetary base was only at about $800 billion back in early 2008.  The Fed has quadrupled the monetary base since then, and yet it still isn’t enough to even give an illusion that things are getting better.  If the current “quantitative easing” isn’t enough to keep things going, then the Fed really is in a bind.  It will either have to up the ante again or let a deep recession happen.  It will try to walk a tightrope between the two, but it can only last for so long.

The Austrian Business Cycle Theory is reality.  When the central bank creates monetary inflation, it misallocates resources.  Those resources have to be realigned to more productive uses in accordance with consumer demand.  For this to occur, there has to be a correction.  The central bank can continue to increase its rate of monetary inflation to keep the game going a little longer.  But at some point, we either see massive price inflation or the central bank has to cut back and we get a recession.  Sometimes we can even see massive price inflation with a recession.

The central bank doesn’t have to stop monetary inflation.  If it just reduces the rate, this can be enough to start the correction process, even though the central bank’s continuing inflation will prevent a full correction from taking place.

It is not being pessimistic to point out that a correction must occur.  It is realistic.  It is the consequence of the previous mistakes.  The Fed shouldn’t continue to exacerbate its mistakes.  I really don’t think Bernanke and company know what to do.  They are stuck.  Bernanke will be glad to retire.

With Edward Snowden blowing the whistle on the NSA surveillance program, I have heard a lot of liberty advocates saying that this isn’t about Snowden.  It is about the wrongdoing of the federal government.  Even Snowden himself has said that this whole thing shouldn’t be about him.

I think it is important to realize that there are several issues we are dealing with here.  I can break it down into 3 separate categories.

1) The NSA has been, and is currently, spying on Americans with no reason to expect that most of them have done anything wrong or illegal.

2) The NSA and the federal government have kept this surveillance program a secret, even though they are now defending it, saying it is necessary for national security.

3) Whistleblowers, like Edward Snowden, will be attacked by most politicians in DC, and they will try to prosecute him to teach others a lesson.  They will say that they encourage transparency in government and they will say that whistleblowers should be protected when it is involving a non-governmental entity.  However, any whistleblower who is exposing lies and wrongdoings of the government will be attacked, smeared, and prosecuted if possible.

So while many libertarians, along with Snowden himself, are saying that this whole thing shouldn’t be about Snowden, they are not entirely correct.  Perhaps the biggest issue in this whole saga isn’t about the NSA’s surveillance program (which people should have already known existed), but how whistleblowers are treated when they expose government wrongdoing.

Just to clarify, when I say that this is about Snowden, it has nothing to do with his level of education or how he acted when he was a teenager.  Those are just smears by people who are trying to change the subject and make him look bad.  But this whole thing is about Snowden as a symbol of how politicians in DC will treat someone who exposes the truth.  We have already seen it with Bradley Manning and Julian Assange.

This serves as a message that the establishment in DC will not tolerate anyone who exposes the truth, especially when it damages their own reputation.  The more serious the crime that is exposed, the more these thugs will go after the whistleblower.  As long as the American people let these criminals in Washington DC get away with these things, then they will keep happening.  There is no one person, even President Obama, who is capable of ending it.  There is probably a very logical reason that John F. Kennedy was taken out.  The establishment didn’t like what he was doing.

Again, the only way this will stop is if a majority (or close to it) of Americans strongly oppose any prosecution of Edward Snowden and others like him.  Americans must view these people as heroes.

It is ridiculous to think of someone like Snowden as a traitor who has committed treason.  It is not as if he was selling secrets to another government to make money.  He released this information, knowing that it would likely ruin his life.  He sacrificed almost everything he has and derived absolutely no benefit other than his knowing that he acted morally and in accordance with his principles.

So while the NSA surveillance program is a big issue that Americans should be outraged about, perhaps the treatment of government whistleblowers is an even bigger issue.  We cannot hope to be free unless the truth is allowed to be spoken.  The truth shall set you free.

The FOMC released its latest statement on June 19, 2013.  Compared to its previous statement on May 1, 2013, there was not much change.  There were a few sentences that were tweaked.

In the May 1, 2013 statement, the last two sentences of the first paragraph reads as follows:

“Inflation has been running somewhat below the Committee’s longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices.  Longer-term inflation expectations have remained stable.

Compare this to the June statement which reads as follows:

“Partly reflecting transitory influences, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.”

The other change comes at the end of the second paragraph.  The May statement reads:

“The Committee continues to see downside risks to the economic outlook.  The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.”

Compare this to the June statement which reads:

“The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall.  The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.”

These are really the only 2 differences between the two statements.  That little change from the last paragraph is saying that the FOMC sees the economy as improving.  Investors are taking that as a signal that the so-called quantitative easing of $85 billion per month is going to slow down at some point, perhaps as early as the end of the calendar year.  Market jitters over the Fed reducing its rate of monetary inflation sent stocks and bonds down significantly for the day.

The one other interesting change from the previous statement is the voting of the members.  In May, there was only one dissenting vote and that was by Esther L. George, who actually shows some concern for inflation.  In this latest June statement, there was another dissenting vote, in addition to George.

James Bullard dissented because he “believed that the Committee should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings”.  This is truly remarkable that there is someone on the committee who actually believes that the Fed needs to inflate even more.

Other than that, things remain the same.  The Fed is still buying $45 billion per month in longer-term treasuries and $40 billion in mortgage-backed securities to bail out the banks (although they don’t say it like that).  In addition, the federal funds rate will continue to stay between 0 and .25 percent for a long while.

One thing I have noted is that many people are under the impression that the Fed is going to keep up its monetary inflation of $85 billion per month as long as unemployment stays above 6.5% and price inflation expectations stay below 2.5%.  I have even read more than one libertarian saying this.  It is incorrect.  This only applies to the federal funds rate and not to the monetary inflation.  The FOMC statement is clear that these measures are for keeping the federal funds rate below .25%, which is essentially meaningless because the Fed is not really controlling that rate now anyway.  It could raise this rate if it decided to pay banks a higher interest rate for excess reserves, but changes in the monetary base have little or no effect on the federal funds rate because banks are holding huge amounts of excess reserves.

In conclusion, not much has changed.  Investors didn’t like the latest statement, but it should be no surprise that the Fed could not keep pumping in new money at the rate of $1 trillion per year.  We are still living in unprecedented times and it will be interesting and painful to watch this whole thing play out.

In an interview on PBS, Obama has hinted that Ben Bernanke’s time as chairman of the Federal Reserve will end in early 2014.  Obama said, speaking of Bernanke, “he’s already stayed a lot longer than he wanted or he was supposed to.”  This is about as strong an indication that you can get, without either Obama or Bernanke himself saying it directly.

I wrote about Bernanke’s possible departure a short while ago.  With Bernanke leaving, I think it means that Bernanke is in a mess and he knows it.  Perhaps I am wrong about this, but I have trouble believing that Bernanke believes the things that are coming out of his own mouth.  I just can’t imagine he is that stupid.

Of course, it is possible that Obama wants Bernanke to go.  Bernanke was originally put in as chairman by Bush, but that obviously doesn’t mean much.  Obama re-nominated him, which is an indication of just how different (not much at all) the two major parties really are.  But is it possible that Obama wants someone who is even more of a Keynesian than Bernanke?  Does Obama want someone even more dovish (on inflation) than Bernanke?  Is this even possible?

There are very few people I can imagine who would be worse than Bernanke.  Then again, I seem to say that about presidents and then their successor turns out to be as much of a disaster or worse than the one he is replacing.

One of the frontrunners being discussed by the media as the next chair of the Fed is Janet Yellen.  Believe it or not, she might actually be worse than Bernanke.  Her rhetoric is certainly worse.  It is hard to imagine that policy would be worse, but I suppose the Fed could create $2 trillion in new money each year, instead of “just” $1 trillion.  If Janet Yellen becomes the next head of the Fed, hold on to your hat.  I think I would be changing in most of my Federal Reserve notes in exchange for precious metals or any other hard assets.  Obama may as well choose the head of the Zimbabwe central bank.

Another name, that I am sure we will eventually hear, is Paul Krugman.  He is another person who could rival Janet Yellen as being one of the most disastrous choices.  Regardless of how powerful the Fed chair actually is, this would be a symbol that much more monetary inflation is coming.

I don’t think Krugman would accept the job, even if offered.  Krugman likes to have his cake and eat it too.  If he replaced Bernanke, he would actually be held responsible for the policy.  Whenever the economy turns sour now, he simply says that there was not enough government spending and not enough monetary inflation.  If he was the one in charge of the policy of monetary inflation, then he would have nobody to pin the blame on.  I think Krugman knows better than to get involved with the Fed.  His lies would be harder to cover up.

There are other names being thrown around too, like Tim Geithner, but it is hard to predict what will happen.  It might also depend on what happens with the economy between now and then.  We must not forget that Paul Volcker, who stopped the monetary inflation and let interest rates rise, was appointed by Jimmy Carter.  Despite appearances, the establishment has more of a say of who will run the Fed and what the policy will be, as opposed to the president.  The president is just the face of the establishment.

When Jimmy Carter was in office, we had double-digit price inflation.  We are nowhere near that now, at least as measured by the CPI figures.  While things can change quickly, it is doubtful it will be anything close to that by the end of the year.  For that reason, I expect that the next chair of the Federal Reserve will be as much of a disaster as the current one.

While I often focus on the money supply as measured by the adjusted monetary base, as well as the excess reserves held by commercial banks, it is important not to ignore the issue of velocity.  Velocity is the demand for money.  If velocity is high, then it means the demand for money is low.  High velocity means that money is changing hands quickly.

Low velocity is the opposite.  Low velocity means that people are trying to hold on to their money.  They are not spending as much.  This has the effect of lowering prices, or at least keeping them lower than they otherwise would have been.

Velocity is very difficult to measure, but I believe we have been in a low velocity environment ever since the fall of 2008.  Even though the Fed has quadrupled the monetary base, consumer price inflation has not reflected this.  A big reason for this is due to the fact that most of this additional new money has gone into excess reserves.  The new money is not multiplying via the fractional reserve lending process as it normally would have in the past.  But I also believe that the high demand for money (low velocity) is the other major factor keeping price inflation in check.

It is certainly logical that velocity would be low, despite the massive monetary inflation by the Fed.  People are afraid of the current economy.  After the boom times ended about 5 years ago, people have been getting out of debt (aside from the huge number of foreclosures), or at least trying to pay down debt.  Unemployment is high and wages have been stagnant at best.  It is reasonable to expect people to cut back on consumer purchases in favor of setting aside some emergency cash.

We must also remember that things can change quickly.  Velocity is as much about perception as anything.  If people perceive that their money will be worth significantly less in the future, then they will be more apt to spend it, even if it is on something that they don’t need right away.

If your car is getting older and you think car prices will be 10% higher next year than they are right now, then you may decide to go ahead and buy your new car now instead of waiting.  This is rational thinking.

I expect the gold price will be a good measure of what is happening with velocity.  If the economy is headed back into a recession (if it ever got out of one), then the gold price could drop further from where it is now.  Velocity will stay low or go even lower.

On the other hand, if we see another artificial boom, propped up with more “quantitative easing” from the Fed, then we could easily see velocity go higher.  We can also expect a much higher gold price.  The stock market is already indicating that this is a possibility, but we can’t be absolutely sure.

The interesting thing with velocity is that it feeds on itself.  If people expect higher prices next year, then they will spend more now for consumer goods.  This in turn drives up prices, fueling the fear of rising prices.  This is really what started to happen in the late 1970’s, until Paul Volcker and the Fed stepped on the monetary brakes and stopped inflating.  Interest rates skyrocketed and the economy went through a deep recessionary period.  However, it also cleared out most of the previous malinvestment and allowed resources to be reallocated to better uses (according to consumer demand).  This allowed for some genuine prosperity to follow.

So while Fed policy will be important going forward, we must consider how people are reacting to Fed policy and what their expectations are for the future.  The demand for money will play a major factor in future price inflation, as well as the overall state of the economy.