[This blog post is an excerpt from a TSI commentary published on 9th May 2021]
The major trends in monetary inflation result in a boom-bust cycle. In particular, a rising trend in the money-supply growth rate leads to increased consumption and investment spending, ushering-in the boom phase of the cycle. A subsequent decline in the rate of money-supply growth reveals the investing errors of the boom and leads to a liquidation process, which is the bust phase of the cycle. In other words, monetary inflation causes the boom and the boom causes the bust.
Once a boom is set in motion by creating lots of money out of nothing, a painful bust that eliminates all or most the boom’s apparent gains is inevitable. The only question is the timing. Even if the central bank tries to keep the boom going forever by maintaining a rapid pace of money-supply growth, all it will do is set the scene for the eventual bust to involve hyperinflation and a total economic breakdown.
Unfortunately, the timing question can’t be answered well in advance of the start of the boom-to-bust transition. However, there are indicators that usually generate warning signals early enough to be useful. Two such signals are credit spreads and the gold/commodity ratio.
When a boom is in progress, credit spreads are relatively narrow or in a narrowing trend and gold is relatively cheap or in a cheapening trend. As evidenced by the following chart, that’s exactly what has been happening over the past 13 months and especially over the past 6 months (the black line on the chart is a credit-spread indicator and the yellow line on the chart is the gold/commodity ratio). Furthermore, although gold has done well in US$ terms since late-March and ended last week at a 2-month high, relative to commodities (as represented by the GSCI Spot Commodity Index – GNX) it tested its 12-month low last week. With credit spreads near their narrowest levels in more than 12 months, this makes sense. It means that the US boom is intact.
When the boom is close to its end the gold/commodity ratio should start trending upward and credit spreads should start widening.
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