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Eric,

Your chart on National Purchasing Manager’s Index (PMI) to Prices Paid Ratio shows an intact downtrend line. In the past, 1974 and 1980, the extremelow points, were also both the high prices for gold. I don't quite understand the ratio and why it is liquidity vs. liquidation. I am assuming that for the graph to continue down to the extreme lows of '74 and '80 the Fed must continue QE which the graph is predicting at least until some time in 2011/12. Is this a correct assumption on my part?

Thanks,
Denny

Dennis,

Yes. In the 70’s the extremes coincided with rising gold prices.

As for the hemorrhage vs. liquidity comparison, PMI to Prices Paid illustrations the relationship between business activity and inflation. This is the “real” economic growth. During liquidity phases, prices are driven up faster than nominal business activity. In other words, PMI to PP ratio, a measure of growth less inflation collapses. As you observed, these phases tend to coincide with gold price accelerations. During hemorrhage phases, prices collapse faster than nominal business activity. This is illustrated by a rising PMI to PP ratio.

The economic cycles, however, have little to do with Fed’s response. QE will continue unabated as long as possible. The limiting factor is confidence. The realization that QE not only carries unpleasant consequences but also does little to solve the underlying problems creates the cycles. Once confidence in the current round of “stimulus” wanes, we’ll see another hemorrhage phase that will, in turn, require another liquidity response. As the cycles repeat, confidence is solving the problem using old tactics will be meet with increasing skepticism. This will result in cycle with greater amplitudes.

Regards,

Eric

Source: NAPM