Are We Entering an Era of High Inflation Levels?

Ever since Paul Volcker killed inflation with double digit interest rates in 1980, which set the stage for multi-decade-long bull markets in the financial markets, with some exceptions we have had a roaring bull market in Bonds. In fact, as great as the equity market has been, it would have been possible to make more money simply by buying U.S. Treasuries back when Volcker slammed the brakes on money creation. I remember those days of my youth very well, because Mrs. Taylor and I had to manage a 17.5% mortgage on the house we bought in Woodside, New York. After Volcker killed inflation, the table was set for a money-printing orgy to fund the Military Industrial Complex and massive government growth as well as provide fuel for Wall Street’s multi-decade-long stock market party. Sure, there were some huge disruptions in the stock markets like those in 1987, 2000, and 2008. But following those equity market calamities, investors remained confident in the financial system as a result of the draconian measures taken by Paul Volcker in 1980. Which leads me to the topic of my talk at the Metals Investor Forum in Vancouver on Friday, January 18, titled “Which Safe Haven Markets Will Dominate in 2019?”

Gwen Preston, one of the newsletter writers who are a part of the Metals Investor Forum, requested a summary of the talks given by each of us newsletter writers. By the way, you can watch my presentation, which includes many slides, here: https://t.co/8JGSRvJ76d. This is how I summarized my presentation at the Metals Investor Forum: 

The topic assumes 2019 will be a rough year for equities and fixed income assets. If investors are confident 2019 will be a year of profitable tranquility, then no need to listen to the talk. But if you buy the idea that the end of 2018 was the beginning of a major bear market and that 2019 will see its continuation and very possibly the start of a severe recession, then the question is where will proceeds of stocks sales flow? When confidence in the global monetary system holds together then the normal flow is from stocks to U.S. Treasuries and other financial asset safe havens. Such has been the flow from around November to the present, although much of 2018 saw some leakage into gold.

But if you believe that the financial system is on the verge of lost confidence, then a portion of the flows may go to hard assets in 2019, most notably portable hard assets, like gold. There have been a number of times since the current monetary regime was instituted in August 1971, when money flowed out of stocks and U.S. Treasuries into gold. And in some of those years, especially in the early 1970s, gold rose dramatically. The only exception was in 1981 when the Fed squashed inflation by raising U.S. Treasury rates to double digits. But the ability to raise rates now is extremely limited, given massive government and public sector debt load now. The recent stock market reaction in the second half of 2018 to very modest interest rate increases makes that point obvious. Clearly, surging debt in the U.S. guarantees declining living standards and rising levels of discontent domestically and globally.  Out of self protection, since the 2008 financial crisis, adversarial nations like China, Russia, and Iran among others have been building up their gold reserves and directly challenging dollar hegemony by increasing global trading, using currencies other than dollars. On various fronts, storm clouds are rising.  After one of the longest U.S. equity bull markets in history and a generations-long U.S. Treasury bull market, odds are growing for a break from financial assets into anti-establishment safe havens, most notable of which is gold. 2019 should be a good year for gold and, by extension, gold shares.

Now let me direct your attention to my Inflation/Deflation Watch on your left. This is a non-weighted index that tracks prices of commodities as well as financial assets since January 31, 2005. 

Note the massive decline when the world teetered on the brink of a civilization-ending lights-out depression. The Fed used all its dry powder and then some to keep the system from totally imploding. As I noted in my presentation, this was hugely costly for the dollar’s reputation, which Chairman Powell has been trying to resurrect. But the tight monetary policy he has engaged started to wreak havoc on the stock market toward the end of 2018. There seems to be little doubt now that the Fed Chairman has capitulated in his fight to normalize interest rates. He would have liked to do what Chairman Volcker did in 1980. But painful and frightening memories of 2008 demon­strates that whoever is Fed Chairman cannot do what Volcker did in 1980 because it would obliterate the global economy. Thus it is my growing belief that the V-shaped recovery of my IDW may well start a major inflationary episode and a demise of the dollar that may end dollar hegemony. The big run in gold on Friday, January 25, may be just the start of a major rise in inflation that would end the bull market in both stocks and bonds but become extremely bullish for gold and silver. This is not wishful thinking, because with inflation we will see growing social unrest on top of what is already a very uncomfortable environment. But one thing you can count on is politicians and central bankers to seek to avoid pain and blame, and most of all for the Fed to protect its client shareholders—namely, commercial banks of the U.S.