Wednesday, October 07, 2009

Does The Increase In The Price Of Gold Mean More Inflation In The Near Future?

We are discussing inflation this week in my principles of macro course. In August of 2008, the Consumer Price Index, or "CPI" equaled 219.086 (meaning that what cost $100 in 1983, cost about $219 in Aug. of 2008-that sounds like alot of inflation, with prices more than doubling over this time but it really isn't as I explain below). You can see this data at Consumer Price Index. In August of 2009, the CPI = 215.834. So prices actually fell by about 3.25 points. That is 1.48% of 219.086, so prices are 1.48% lower than they were a year ago. The last year the CPI fell for a whole calender year was 1954.

But, the CPI = 210.228 in December of 2008. So prices have actually gone up since then and they are up by 2.67% (just in 8 months). For a 12 month period, that would be about 4%. But you might have already figured out that prices must have fallen in the last few months of 2008. They also fell in the last few months of both 2006 and 2007. Maybe they will fall again. The CPI was actually 215.693 in June 2009 and dropped to 215.351 in July 2009. With 215.834 in August, we can see that prices are starting to hold steady. It seems like the high unemployment and excess capacity in the economy will keep prices from rising very much.

But, gold recently shot up to 1,045 an ounce, for a new high. That is from the article Gold Jumps to Record as Inflation Outlook Fuels Investor Demand. It said:

"Gold rose to a record on speculation that currencies will depreciate, spurring inflation and boosting the appeal of the precious metal for investors seeking to preserve their wealth.

Gold futures climbed as high as $1,045 an ounce in New York, topping the previous record of $1,033.90 in March 2008. The spot price is headed for a ninth straight annual gain, the longest rally since at least 1948. The dollar fell as much as 0.7 percent against a basket of six major currencies.

“Gold is acting like the ultimate currency,” said Chip Hanlon, the president of Delta Global Advisors Inc. in Huntington Beach, California. “Central banks are following the same monetary course and trying to stimulate and inflate their way back to growth. Everyone’s concerned about the dollar, but it’s not like you can hate the dollar and fall in love with the euro or the yen.”"

As I mentioned earlier, we have actually had a good rate of inflation since 1983. The CPI for all of 1983 = 99.6. Let's call it 100. For all of 2008, it was 215.3. So prices increased 2.153 times. For prices to rise that much in 25 years, they increase 3.11% compouned annually. That is because 1.0311 raised to the 25th power = 2.153. This is very close to what we call price stability. If we started from 1991, over the last 17 years the compouned annual inflation rate is just 2.73%.

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