Why increasing money supply is related to inflation

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What’s money supply?

Money supply is the total amount of currency and other liquid instruments in circulation in an economy. M0, M1, M2, and M3 are defined according to the type and size of the account in which the instrument is kept.

M0 and M1 are called narrow money. They include coins and notes in circulation. M2 includes M1. M3 includes M2. M3 is the broadest measure of money. However, definitions vary from country to country.

Money supply data is usually collected and published by the country’s central bank.

Money supply

How are money supply and gold related?

The money supply can grow as a by-product of economic growth. When money supply growth is used to support the financial and economic system—instead of fueling strong economic growth—the price of gold is related to the growth of money supply.

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When money supply in the system increases without any corresponding increase in the supply of goods, it leads to inflationary pressures. More money chases the same amount of goods and services. It also leads to currency debasement. As discussed above, the U.S. dollar (or USD) weakness and inflation lead to more demand for gold. So, gold has a positive relationship to money supply.

Global money supply

We’ve substituted global supply as money supply for the following countries:

  • U.S.
  • Europe—represented by the Eurozone and the United Kingdom
  • Japan
  • India
  • China
  • Russia
  • Brazil
  • Turkey

Money supply used is M2. It’s expressed in the USD for each country at prevailing exchange rates. In the above chart, we can see that the pace of money supply stabilized in recent months. For August, it was similar to July at $1.286 trillion.

Global money supply has been increasing very rapidly. Until recently, the gold price increase kept pace with the global money supply. The relationship between gold price and global money supply appears to have broken.

There are other factors that were probably more important. They put downward pressure on prices. An example is the expectation of the Fed’s taper. There was a huge sell-off by gold-backed exchange-traded funds (or ETFs)—like the SPDR Gold Shares (GLD).

However, the impact of money supply on gold prices gives a partial view. It’s important to look at other factors to get a complete view of what impacts gold prices and gold stocks—like Goldcorp Inc. (GG), Barrick Gold Corp. (ABX), Newmont Mining Corporation (NEM), and Kinross (KGC).

It also impacts ETFs that invest in the above stocks—like the Gold Miners Index (GDX).

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