Dollar Debasement: Reality or a Dangerous Narrative?

Defining Dollar Debasement

The following bullet points are the most popular traits of dollar debasement:

• Excessive increase in the money supply
• Declining purchasing power
• Loss of confidence in the currency

Instead of assuming all or some of the three factors are facts, let's quantify them, put them into proper context, and see how well the debasement theory holds up.

Before proceeding, it's worth noting that the true definition of dollar debasement is different than those above. Per our article Debasement: What It Is And Isn’t.:

Conversely, debasement implies a structural dilution of a currency’s value. This is vastly different than inflation. In a “debasement” scenario, governments take conscious actions to reduce the “structure” of the currency. In Rome, for example, the government reduced the amount of silver in minting coins to increase the number of coins produced to pay its creditors. However, debasement is not a reality in a fiat system like ours, where the linkage to gold or silver is nonexistent. In other words, when the government is “printing paper,” it is impossible to dilute the “structure.”

Regardless of which definition of dollar debasement you prefer, the popular ones — bullet-pointed above — are what support the surge in gold prices. Accordingly, that’s what matters for this discussion.

Excessive Increase in the Money Supply

This is believed to happen when the government and/or the central bank print much more money than the economy demands. To appreciate how that could happen in America, it's essential to recognize that neither the Fed nor the government prints money. All money is lent into existence. Per my article Where Does Money Come From?:

The money supply changes based on the banking system’s willingness and ability to lend money and consumers’ demand and ability to borrow it.

While the Fed doesn’t print money, it can incentivize lending and borrowing — i.e., money creation — with its policies. It can also disincentivize money creation.

Currently, the Fed is disincentivizing money creation. As I share below, the fed funds rate is currently well above the current and expected inflation and economic growth rates. Furthermore, the Fed is reducing its balance sheet (QT) by $40 billion per month. Doing so leaves banks with fewer reserves to generate loans.

Bottom line: The Fed, via restrictive monetary policy, is disincentivizing money supply growth.

The government can borrow money, which in turn creates money. One can argue that its massive fiscal deficits over the past few years should be concerning from a money supply perspective. However, doing so fails to consider that banks have limited reserves. If they are forced to buy government debt, which is akin to making a loan, they have fewer reserves in which to lend to the public.

The graph below compares the money supply (M2) to economic activity (GDP). While the ratio of M2 to GDP has increased in recent decades, it currently remains around its level in 2016.

There was a spike in M2 related to the pandemic, but the graph above does not indicate that the trend growth of the money supply is suddenly excessive.

Declining Purchasing Power

In 1950, you could go to the movies for fifty cents. Today, movie tickets can run between $15 and $25. As they say, a dollar doesn’t buy what it used to.

In that respect, the purchasing power of the dollar has plummeted. But that argument only holds for people who store their dollars in a tin can or under a mattress. It fails to consider our ability to purchase. Consider that wages have gone up substantially since 1950. The wealth of the populace has also significantly risen.

The graph below shows that real (after inflation) disposable income has grown steadily since 1959. Thus, wages and disposable income are more than keeping up with inflation.

The overwhelming majority of people keep their wealth in a bank or brokerage account. The graph below shows that a rolling investment in a three-month U.S. Treasury bill since 1950 has outpaced inflation moderately. Now consider that most people’s wealth earns a higher rate than that of a Treasury bill.

It's not clear to us that purchasing power, including wages and wealth, has declined. In fact, the standard of living for both the wealthy and the poor has improved since the days when it cost 50 cents to go to a movie.

Loss of Confidence in the Currency

Some pundits believe that the recent 10%–15% decline in the dollar index is proof enough that the dollar is falling out of favor as fiscal deficits and inflation erode its value. Does the graph below provide any evidence that the recent decline is anything out of the norm?

Moreover, if the currency were no longer trusted, who in their right mind would buy U.S. Treasury bonds? The fact is that bond yields have been drifting lower despite the growth of the debasement narrative.

Surely, foreign bondholders would sell Treasury bonds and all dollar-based holdings if they lacked faith in the dollar, right? The first graph below shows that federal debt held by foreigners is at a record high. Further, the growth rate has picked up over the last few years. The second graph highlights that foreign investors are buying U.S. equities as well.

Based on actual monetary transactions rather than vague sentiment readings and hearsay, there is as much confidence in the dollar today as in the past.

Gold

Despite the overwhelming evidence I have presented showing that the dollar debasement narrative lacks facts, some will argue that gold is the arbiter of the dollar debasement argument. To their point, gold is up 50% this year and almost 200% since 2020. They argue that the price of gold is quoted in ounces per dollar. Therefore, they say, the price of gold isn’t rising per se, but the denominator — the dollar — is declining. If that were true, wouldn’t the prices of commodities and houses be surging too?

The graph in the Tweet below shows the price ratio of gold to oil. Oil, like gold, is a hard asset. Why is its price floundering?

Another popular but misleading argument is that foreign central banks' reserves in gold are increasing rapidly. That is true. However, as I share, central banks have barely added physical gold to their gold reserves. Instead, gold, as a percentage of reserves, has grown significantly because its price increases the value of the gold compared to other reserves.

Highly speculative activities characterize the current investment environment. Gold, like cryptocurrencies, AI-related companies, meme stocks, and a host of other assets, is running hot as sentiment is uber-bullish.

The chart below is courtesy of tweet by @SubuTrade. It shows that the volume of gold calls exceeds that of puts by the widest margin in the past 15 years. Call buyers are speculative traders who tend to follow narratives rather than fundamentals. The record call buying reflects the highly speculative enthusiasm in the gold market.

Summary

Unless there is a new definition of debasement, we see no fundamental reason for gold to be behaving as it is. The dollar debasement narrative may keep gold prices rocketing higher for a while.

However, don’t lose sight of the fact that gold prices, at such elevated levels, are highly susceptible to the narrative losing steam. When it inevitably does, we should expect the price to fall back to historical norms. Will that be the 200-day moving average, which is 25% `lower than current prices? Maybe closer to $2,000, where gold initially exploded from in early 2024?

We don’t have the answer, but we do know that some profit-taking and risk management — even for those who believe in dollar debasement — is prudent at current levels.

Michael Lebowitz is a portfolio manager with RIA Advisors and author for Real Investment Advice. For more information, contact him at [email protected] or 301.466.1204.

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