The Federal Reserve’s Giant Auction

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In today’s world of central banking, it is monetary inflation that is the primary driver of these bubbles and manias. It drives people to do crazy things. They take on massive debt in many cases, and they buy things that — under normal conditions — wouldn’t make sense to buy.

It is no surprise that these bubbles and manias occur. As long as central banking and fiat currencies exist, then unsustainable bubbles will exist alongside them.

Imagine you go to an auction where people are bidding on items to buy. Everyone in the room has an average of $100 to spend at the auction.

What would happen if everyone’s money doubled and they had to spend it at the auction? Now there is an average of $200 per person to spend. What do you think will happen to the prices of the items up for bid? You would expect them to roughly double as compared to before. The number of items up for sale hasn’t changed, but the amount of money being used to bid on them has.

This is what the Fed does in our economy — similar to a great big auction.

Some people assume inflating the money supply isn’t that big of a deal because all prices will rise. But this isn’t necessarily true, and the prices do not rise uniformly.

Federal Reserve inflation is harmful anyway because it misallocates resources. It directs capital towards things that are not necessarily the highest priority for consumers. It also distorts savings and investment.

But even with the question of prices, newly created money does not flow evenly through the economy. It gets injected into certain sectors early. Unfortunately, it is usually wages that lag behind. It is a redistribution of wealth that benefits the people who receive the new money early on in the process.

The new money gets injected into certain sectors, which are really your bubbles and manias. This can be stocks, gold, bonds, housing, classic cars, art, or virtually anything. Without the easy money and credit and the artificially low interest rates, you simply wouldn’t have the money to blow up these unsustainable bubbles. You also wouldn’t see people taking as big of risks in search for a good yield.

Eating Money

I have heard critics of gold say that gold is not a good hedge against disaster because you can’t eat it. While this is true, you can’t eat your paper currency either. And you certainly can’t eat your digital currency in your bank account.

Whether we like it or not, the U.S. dollar serves as money in the United States (and in other places, too). You can’t walk into Wal-Mart and buy items with your gold coins, unless you get a really smart cashier who is willing to take them and pay your amount due out of their own pocket.

You also can’t walk into Wal-Mart and pay with a classic car or a nice piece of art. And just like gold and dollar bills, you can’t eat your car or your painting.

Still, it is understandable why people buy into collectibles and hard assets. You can’t make more of them on a printing press or a computer screen. This goes for cars, art, and gold coins. You can’t say the same thing for dollar bills.

If there is another downturn in the economy, collectors should beware, especially if they are doubling as investors. Bubbles eventually pop.

If something in particular makes you tick, then go for it if you can afford it. But you may be getting into a risky game if you are looking to sell it for big bucks down the road.

While Picasso paintings are unique, only gold and silver have a long history of being used as a store of value. There are no guarantees with anything, but following history is usually a smart choice.

Until next time,

Geoffrey Pike for Wealth Daily

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