Is the end of transitory inflation the end of the golden bulls?
The debate on the nature of inflation is closed. Now the question is, what does the end of transitory inflation mean for? I offer two perspectives.
Welcome to the inflationary machine. Welcome to the new economic regime of high inflation. It’s official because even central bankers have finally accepted what I’ve been saying for a long time: the current high inflation is not just a one-time, transitory price shock. In testimony to Congress, Jerome Powell agreed that “now is probably a good time to remove” the word “transient” from inflation. Well done, Jay! It only took you several months longer than my freshmen to figure it out, but better late than never. In fact, even a moderately intelligent chimpanzee would notice that inflation isn’t just temporary just by looking at the chart below.
To be clear, I’m not predicting hyperinflation or even runaway inflation. Nor am I claiming that at least some of the current inflationary pressures will not subside next year. No, some supply-side factors behind recent price spikes are expected to ease in 2022. However, other factors will persist or even intensify (think housing inflation or the energy crisis). ).
Let’s be honest: we are currently facing a global inflationary shock. In many countries, inflation has reached its highest rate in decades. In the United States, the annual rate of the CPI is 6.2%, while it reaches 5.2% in Germany, 4.9% in the euro area and 3.8% in the United Kingdom. The shameful secret is that central banks and governments have played a key role in fueling this inflation. As the famous Austrian economist Ludwig von Mises once observed:
The most important thing to remember is that inflation is not an act of God; inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a Politics – a deliberate policy of people resorting to inflation because they consider it a lesser evil than unemployment. But the point is that, in the short term, inflation does not cure unemployment.
This is because the Fed and the banking system pumped a lot of money into the economy and also allowed the government to increase spending and send checks to Americans. The resulting boom in consumer spending clogged supply chains and spiked inflation.
Obviously, policymakers don’t want to admit their guilt and have nothing to do with inflation. At first they claim that there is no inflation at all. Then they say that inflation may exist after all, but it is only caused by the “base effect”, so it will be a short-lived phenomenon that results only from the nature of the annual comparison. Finally, they admit that there is something beyond the “base effect”, but inflation will be transitory because it is only caused by a few exceptional components of the overall index, outliers like used cars this year. Nothing to worry about, then. The higher prices are the result of bottlenecks which will resolve themselves very soon. Inflation is later recognized to be more widespread and persistent, but is said to be caused by greedy companies and speculators maliciously raising prices. Finally, policy makers present themselves as the salvation from the inflation problem (which was caused by them in the first place). âSolutionsâ as brilliant as consumer subsidies and price controls are introduced and further disrupt the economy.
The Fed recently admitted that inflation is not just transient, so if the above-mentioned scheme is correct, we should expect to look for scapegoats and perhaps intervention in the economy as well to heroically fight. against inflation. Gold could benefit from such rhetoric, as it could increase demand for safe-haven assets and inflation hedges.
However, the Fed’s surrender also involves a hawkish turn. If inflation is more persistent, the US central bank will have to act more decisively, because inflation will not subside on its own. The faster pace of quantitative easing and faster hikes in interest rates imply higher bond yields and a stronger greenback, so they are clearly negative for gold prices.
That said, the Fed is and is expected to stay woefully behind the curve. The real federal funds rate (that is, adjusted by the annual rate of the CPI) is currently at -6.1%, which is the lowest level in history, as shown in the graphic below. It’s much deeper than it was in the trough of the stagflation of the 1970s, which could create some problems in the future.
What’s important here is that even when the Fed hikes the fed funds rate by one percentage point next year, and even when inflation drops by two more percentage points, the actual fund rate Feds will only increase by -3%, so it will stay deep in negative territory. Certainly, the upward direction should be negative for gold prices, and the trough in real interest rates would be a strong bearish signal for gold. However, rates remaining well below zero should provide some support or at least a decent floor for gold prices (i.e. higher than the levels hit by gold in the mid-years. 2010).