Gold and the Shrinking Money Supply

In this article I will be talking about the possible effects of an ongoing contraction as they relate to the price of gold.

A recent article (Credit Crunch: The Money Supply Has Shrunk For Eight Months In A Row) by Ryan McMaken of the Mises Institute explained clearly the historical significance of the contraction in the money supply that has occurred over the past eight months.

Historically, the money supply is nearly always expanding. The expansion of the supply of money and credit is how governments and central banks create inflation.

The inflation (expansion of the supply of money and credit) cheapens the value of all the money in circulation and leads to a loss of purchasing power in the currency (U.S. dollar).

The loss of purchasing power shows up in the form of higher prices for goods and services. The higher prices for goods and services are the effects of that inflation.

In general, because of government and central bank inflation, the money supply is always growing.


Almost everyone refers to higher prices as inflation. That is not correct. Think about it this way...

When you overinflate a balloon with air, it can pop. The popping of the balloon is an effect of inflation. Even before that point, the effects of inflation show up in the changing shape of the balloon.

Once the balloon is inflated fully, the skin is taut. A simple pin prick can deflate and collapse the balloon. Again, the deflation of the balloon is an outgrowth of the effects of previous inflation.


Gold was money before paper currencies. Everything was measured in fractional units of gold.  All paper currencies are substitutes for gold (real money).

At one time, gold and the U.S. dollar were convertible at a fixed ratio. Roughly, $20 (paper dollars) was convertible into one ounce of gold and vice versa.

The effects of ongoing inflation created by the Federal Reserve for more than one hundred years has led to a loss of purchasing power in the U.S. dollar amounting to ninety-nine percent.

That loss of purchasing power means that a dollar today is worth only one penny compared to one dollar a century ago.

The dollar's loss of purchasing power is reflected in a gold price that is one hundred times higher today ($2000/20 = 100).


  1. The increase in the money supply from expansion of the supply of money and credit IS inflation.
  2. The loss of purchasing power and higher consumer prices in general are the effects of inflation.
  3. The effects of inflation are not proportionate to the amount of inflation created.
  4. The effects of inflation are cumulative, volatile, and unpredictable.

The above items are important to a proper understanding of implications for the gold price as a result of a shrinking money supply.


A higher gold price over time doesn't tell us anything about gold. Since gold is priced in dollars, the only thing its price tells us is how much purchasing power the U.S. dollar has lost; and, only in hindsight.

A shrinking money supply portends effects and conditions that are exactly opposite to those which have made the U.S. dollar nearly worthless compared to a century ago and seen the gold price increase one hundred-fold.

Any extended period of disinflation or deflation resulting from ongoing contraction in the money supply would take the gold price much lower.

A decline in the gold price under those conditions would reflect an INCREASE in U.S. dollar purchasing power.

During deflation, dollars would buy MORE, not less; as prices for goods and services decline.  

We don't know yet how all of this will play out, but the shrinking money supply is indicative of a credit crisis and potential collapse, both financially and economically.

If something like that happens, expect a much lower gold price. (also see Effect Of Deflation On The Gold Price)

Kelsey Williams

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN'T, AND WHO'S RESPONSIBLE FOR IT and ALL HAIL THE FED!