The Case for Higher Inflation in 2022
Year-over-year inflation is around 7% today butd is expectedd to level out to approximately 2.4% after base effects and other short-term factors fade. The inflation expectation rate skyrocketed above 2.75% before Fed Chair Powell’s implication to speed up the tapering process last month. This decision has resulted in a rapid decline for both inflation expectations and gold (via GLD).
The market has taken Powell’s “Hawkish shift” as a sign that inflation will remain under control. Of course, the Fed is still stimulating the economy with new money via Q.E until around March, based on the current tapering timeline. Interest rates also remain at record lows compared to inflation. Thus, the Fed’s positioning remains stimulative/inflationary, just slightly less so than before.
In the past, the Fed had to keep short-term interest rates well above inflation for years before inflation slowed. In 1980, the ten-year rate was 5-10% above inflation for four years until the inflation rate normalized. Considering the ten-year interest rate is currently well below the YoY inflation rate, many rate hikes and an immense decline in long-term bonds may be necessary before inflation normalizes.
Presently, inflation may be nearly outside of the Federal Reserve’s control. This is because inflation is occurring primarily due to declines in global production which are being negatively impacted by the resurgence of COVID-19 around the world. For example, in the U.S., oil storage levels are at nearly decade lows and may continue to decline due tod chronically low capital expenditured levels from many significant producers. The Federal Reserve cannot print more oil,d semiconductors,d food, ord nurses. Prices will continue to rise if companies and people compete for increasingly scarce goods and services.
If the Federal Reserve takes drastic measures to increase interest rates rapidly, it may create an economic recession that causes demand to decline enough to stop rising prices. Of course, this would likely spur a significant and lasting crash in stocks and most other risk assets. Overall, this puts the Federal Reserve in a seemingly unfixable position where inflation rises, or the economy falters. Both are politically problematic and, for now, it appears the Fed is attempting to walk the middle ground. However, sharp economic and market fluctuations are seemingly growing worldwide, implying the situation is becoming increasingly difficult to manage.
It’s Time to Be Prepared
Overall, the short-term outlook for gold and other precious metals has a mixture of bullish and bearish factors. On the one hand, gold is a bit cheap compared to real interest rates. On the other hand, the end to QE may cause a spike in real interest rates that are bearish for gold. If the Fed’s efforts to combat inflation become more aggressive, gold will likely decline temporarily, though this is not guaranteed because of multiple other factors that influence the price of gold.
It’s doubtful that inflation will remain stable over the next two years from a longer-term perspective. If the inflation expectation rate rises higher, it seems likely that the Federal Reserve will further quicken its rate hike cycle and could suspend QE even faster. However, this could result in a rapid decline in asset prices as many companies will struggle if interest rates rise due tod their record debt levels. Another recession may temporarily lower inflation enough to encourage the Federal Reserve to return to a stimulative stance. Indeed, a crash in stocks may be met withd another political effort to promote the Fed to use QE to buy stocks directly. Such action comes with a significant risk of causing extremely high inflation or even hyperinflation.
This bullish long-term outlook is “looking around a few curves”. The Fed and other central banks have put themselves in a position where they can no longer sustainably manage both prices and the economy. If they manage prices (i.e., rate hikes), they risk causing the economy to crash. If they control the economy (i.e., stimulus), they risk causing hyperinflation.
The Recent Turkish Lira Collapse May Be the Catalyst
This type of issue is already playing out in Turkey, which has seen itsd currency lose halfd of its value since October. Turkey is undoubtedly a less economically stable country than the U.S., but its economy is still far more prominent than most that have experienced hyperinflation in recent history. The recent collapse in central bank control over the Turkish Lira should be seen as a warning signal for Europe, the U.S., and others.
There may still be some time before the U.S. loses control, but the core issue of the inability to manage inflation in a debt-addicted economy is startlingly similar. Economies worldwide have become increasingly dependent on monetary actions to maintain stability, resulting in colossal debt buildups. Inevitably, this issue will eventually need to unwind. While this has been generally true for decades, there have never been as many signs suggesting and imminent resetd as there are today.
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