All Signs Point to Inflation

Wow! It’s getting harder and harder not to take rising inflation seriously. My IDW rose 1.1% during the week to hit a new high of 187.66. And while Equities rose a bit, the real zingers were Copper (+6.29%), Silver (+6.11%), Housing (+4.90%), and the Rogers Raw Materials Index (+3.85%). This is in keeping with the rise of commodity prices since March of 2020 when Fed Chairman Powell gave up on any responsible monetary policy whatsoever.

At the same time, gold and T-Bonds, which are considered the go-to safe havens, also gained. You can make the case for gold as an inflation hedge, but money flowing to T-Bonds doesn’t make a lot of sense. But then why would we think the Fed would keep its mitts off of the bond markets when inflation is starting to appear to be a problem?

The fact is that the markets are so screwed up now by decades of monetary and fiscal manipulation that there can be no return to equilibrium until the system breaks down completely. I realize that massive debt that is being undertaken now is by nature deflationary and I would buy that as a likely outcome if the system could withstand even slightly higher interest rates than we have now. Given the Powell Pivot that commenced in March 2020 after the stock market lost 32% in just five weeks, there should be no doubt whatsoever that as soon as there is a whiff of deflation, helicopter money in whatever number of trillions of dollars required will be showered over America. 

Alasdair Macleod in his May 6 article titled, “Rising bond yields threaten financial markets,” explained the underlying market dynamics as follows: “As the much-vaunted post-lockdown consumer spending is unleashed, the lack of available production supply together with supply chain chaos can only result in consumer prices rising significantly above the Fed’s average target of 2%. Not only will this naturally lead to higher bond yields, but the valuation basis for equity markets will shift, undermining prices. Even if the Fed tries to offset it by increasing QE to feed more cash into bonds and equities, it will be impossible to offset the valuation effect. Equities will almost certainly succumb to an interest rate shock. At the same time, the increase in bond yields will undermine government finances. The prospect of increasing losses on portfolio investments will inevitably lead to the foreign liquidation described above, causing a weaker dollar and yet higher bond yields. 

“In these conditions the Fed will be trapped. It cannot let bond and equity prices slide and risk commercial banks accelerating the contraction of bank credit, leading inexorably to the liquidation of loan collateral. Investment sentiment would turn deeply negative. Nor can it stand back and let markets sort themselves out, because of the record levels of corporate and other debt which would become impossible to refinance. Nor can it just print money in order to rescue everything, because the dollar will be further undermined. That leaves it with only one alternative left to pursue, albeit with the greatest reluctance. And that is to raise interest rates — substantially. 

“Neo-Keynesians, who appear to subscribe to the belief that interest is usuary and savers must be denied returns for the benefit of everyone else, are embedded in central banks and are certain to denounce this attempt at a remedy. But the experience of the 1970s confirms that central banks will raise rates, too little too late, before eventually deciding to kill market expectations of higher interest rates by pre-empting them. Famously, this is what Paul Volcker did in 1979-81. What is less remembered is that despite prime rates hitting 20%, money supply growth continued, so that the interest cost was covered by inflationary means. This is illustrated in the chart below.”

“From this earlier precedent, we can conclude that in the choice between ceasing to print money and raising interest rates, the Fed will raise interest rates. This adds to the growth of money supply, as can be detected by the increased rate of climb from 1979 onwards. But what would be the effect of such a policy today? In the 1970s, the build-up of domestic debt beyond that required to genuinely finance production had yet to occur, and the financialisation of the US economy did not happen until the mid-1980s. The increase in debt was mainly sovereign as US banks recycled oil dollars to Latin America. The only significant domestic casualty from high interest rates was the Savings & Loan industry. 

“Today, the US and other economies are loaded up with debt, much of which is unproductive. A sharp rise in interest rates to contain price inflation would drive the world’s economy into an humungous debt-induced slump. And while that is exactly what is needed to clear out all the zombie deadwood, it is not within the Fed’s remit to take such action. Furthermore, with government borrowing already out of control, the US Government would be forced to curtail its spending dramatically at a time of rapidly escalating welfare obligations. 

But we are previewing the end of the road, describing events which logically procede from the dangers before us today. But for now, the consequences of rising bond yields are that they will bring a rapid shift from overtly bullish assumptions to a more considered bearish outlook, bringing with it a wholly different perspective. Instead of bad and inflationary  policies being tolerated or even demanded by investors, their thinking turns on a dime to afear of anything and everything. Under bearish circumstances, every turn of the central management of economic outcomes only makes things worse, when before it appeared to resolve them. Greenspan and the Fed chairmen who followed him were correct about the psychology of improving markets, while they kept quiet about the negative psychology of bear markets. Suddenly, we will find that Charon is waiting to ferry the bodies of the bulls over the river Styx. 

Such is the violence of market imbalances that when they are unleashed from the Fed’s control, not only will financial markets face rapid value destruction, but fiat currencies will also be undermined by the need to accelerate the pace of monetary inflation. The emphasis for inflationary policies will shift from financing governments by debauching the money to debauching the money in order to rescue the wider economy. The Fed and its sister central banks will seek to supplement contracting bank credit, make capital freely available to businesses which would otherwise collapse, continue with helicopter drops of money to consumers, and compensate for supply chain disruption. The policy planners are likely to be so confused and the task so enormous that they will end up robbing Peter to pay… who else but Peter himself. 

The relevant precedent for this madness comes from 1720, when John Law in France, who among other things was appointed Controller General of Finance, printed unbacked livres to inflate and then support the collapsing Mississippi bubble. His venture lived on to fight Clive in India, but the livre became worthless within seven months. Today, some contemporary corporations will survive, as did Law’s Mississippi venture, but by tying the bubble to the currency, the currency failed completely and is almost certain to do so again today. 

Years ago, economist John Williams, who will be my guest on my radio show next week, started talking about hyperinflation. John understood as well as anyone that deflation was the likely outcome until the dollar entered the dustbin of history, as all fiat money in history has. His view was that, given the unspeakably high obligations the U.S. has promised its citizens, not to mention endless trillions of dollars spent since the fall of the Soviet Union on endless wars, the demolition of the dollar would be inevitable. That is most certainly the conclusion that Alasdair has reached and it is looking more and more like that future is not very far away now.

Perhaps that’s why the average monthly price of gold now seems to have pivoted off a march low of $1,704 to an average so far in May of   $1,731.95. Indeed Michael Oliver’s requirement for confirmation of the next leg up was a weekly close for gold during the month of May above $1,779. It closed this week at $1,836. So, after the all-time monthly high of $1,969.22 in August of 2020, we may now be in the early days of a climax for gold that may even signal a major turning point in American and world financial history. Alasdair Macleod made a very compelling argument in his April 15, 2021, article titled, “Why the future of money is gold and silver” about why, much to their chagrin, governments around the world will have no choice but to revert to gold and/or silver as money once again.

About Jay Taylor

Jay Taylor is editor of J Taylor's Gold, Energy & Tech Stocks newsletter. His interest in the role gold has played in U.S. monetary history led him to research gold and into analyzing and investing in junior gold shares. Currently he also hosts his own one-hour weekly radio show Turning Hard Times Into Good Times,” which features high profile guests who discuss leading economic issues of our day. The show also discusses investment opportunities primarily in the precious metals mining sector. He has been a guest on CNBC, Fox, Bloomberg and BNN and many mining conferences.