Do you remember “transitory” inflation?
Maybe I can refresh your memory.
The current inflation cycle began in earnest back in April 2021. As soon as it did, Treasury Secretary Janet Yellen and Federal Reserve Chairman Jerome Powell – co-managers of the world’s largest economy – dismissed rising prices as “transitory.”
The fundamental basis for their assessment was the belief that inflation was a result of factors rooted in the pandemic: primarily supply-chain difficulties, as well as a wave of higher demand that began once businesses, economies and people were free to move about. Once the economy returned to normal, the theory went, inflation would evaporate.
But inflation continued to strengthen throughout 2021. It became abundantly clear rising prices were no temporary phenomenon. By December of that year, both Powell and Yellen decided it was time to retire the word “transitory.”
That probably was a good idea. We now are closing in on the 2nd anniversary of this inflation cycle, one that has seen the consumer price index rise to its highest level in more than four decades.
Not only has this round of inflation not been transitory, it has been more persistent, higher and more confounding than any we’ve had to face since the era of the 1970s and ‘80s “Great Inflation.”
The challenges posed by this inflation cycle are clearly illustrated by the trajectory of CPI over the last several months.
Following October 2022, which saw CPI accelerate at a 0.5% pace month over month, inflation showed significant signs of losing steam in both November and December, dropping 0.2% and 0.1% in those two months, respectively.
But as it turned out, rumors of inflation’s imminent demise circulating around that time proved to be greatly exaggerated. The Labor Department’s January inflation report revealed that CPI accelerated 0.5% month over month, coming in higher than economists’ projections. As a matter of fact, the annual inflation rate for last month – 6.4% – also exceeded expectations.
The irony is that for all the talk early on in this inflation cycle that rising prices were transitory, it may turn out that disinflation (not inflation) is what’s transitory. It appears there are numerous drivers of inflation right now – which means that even if one driver shows signs of running out of steam, others may well continue to keep upward pressure on consumer prices for some time to come.
We’re going to look closer at some of the more prominent inflation drivers at work right now. And because I’d like to examine not only the problem but possible solutions, as well, we also are going to look at one asset that could prove helpful to retirement savers in navigating the current climate of inflation uncertainty.
“There Is More Inflation Complexity Ahead.”
That’s the title of a recent article for Project Syndicate written by well-known economist Mohamed El-Erian. And as you likely surmised from that title, economist El-Erian believes the inflation story this time around is more than a little complicated – and uncertain. Mulling the factors that he says make it so, El-Erian notes at one point:
This sense of uncertainty is evident in the short-term outlook for economic activity, prices, and monetary policy, as well as long-term structural shifts like the clean-energy transition, the rewiring of global supply chains, and the changing nature of globalization. Heightened geopolitical tensions also play a role.
In other words, upward price pressures are rooted in a variety of catalysts, according to El-Erian – each with their own dynamics.
Those catalysts include expansionary fiscal and monetary policies, to be sure, but they also include a host of other causes and intensifying forces, such as the clean-energy movement, the trend away from globalization, and greater geopolitical discord (although some experts would suggest that an increase in geopolitical rivalries actually is a function of deglobalization).
So, it seems, the engine driving inflation right now is comprised of a whole lot of moving parts. Let’s look a little closer at some of the most compelling ones.
Money Supply and Fiscal Policy Among Factors Pushing Prices Upward
For starters, there’s the growth of the money supply.
From early 2020 until early 2022, the nation’s M2 money supply expanded by slightly more than 40%. According to the monetarist view of inflation, the impact of such a rapid increase in the money supply necessarily produces high inflation that lasts for a prolonged period – a condition most certainly in evidence during the current inflation cycle.
However, the Fed has significantly reduced the money supply since last spring. So much so, in fact, that Johns Hopkins economist Steve Hanke says, “This flip from expansion to contraction is the steepest adjustment in money-supply growth in postwar U.S. history.” And it means, according to Hanke, that the high inflation through which Americans have been suffering for so long is approaching an end.
But no more high inflation does not mean no inflation – and there are multiple forces at work that could keep inflation above the Fed’s 2% target for some time to come.
Ultra-generous fiscal policy is said to be another key inflation driver, and there’s good reason to believe it will grow even stronger in the years to come.
In a recent Augusta Precious Metals economic update, director of education Devlyn Steele discusses the Congressional Budget Office’s latest projections of annual budget deficits averaging $2 trillion over the next 10 years as well as the gross national debt rising by a stunning $19 trillion over the same period.
As for the inflationary effects of fiscal policy during the current price-pressure cycle, here’s something I think is pretty revealing: A Federal Reserve study published last year determined that roughly one-third of the U.S. inflation rate during the 12-month period ending February 2022 was directly attributable to just the stimulus doled out in the name of COVID-19 economic rescue.
That study flatly contradicts repeated assertions by President Biden that fiscal generosity has not been at all responsible for the inflation we’ve experienced over the last couple of years.
In fact, Howard Adler, deputy assistant Secretary of the Treasury for the Financial Stability Oversight Council, recently went as far as to say that “while the Fed has been battling to reduce inflation by raising interest rates, the Biden administration has been working at cross purposes to boost inflation by increasing government spending.”
Last year, a paper published by the Federal Reserve emphasized the significant impact that spendthrift fiscal policy by itself can have on the inflation rate. Here is an excerpt:
Trend inflation is fully controlled by the monetary authority only when public debt can be successfully stabilized by credible future fiscal plans. When the fiscal authority is not perceived as fully responsible for covering the existing fiscal imbalances, the private sector expects that inflation will rise to ensure sustainability of national debt. As a result, a large fiscal imbalance combined with a weakening fiscal credibility may lead trend inflation to drift away from the long-run target chosen by the monetary authority.
Beyond the antagonistic impact that fiscal policy can have on inflation, there are numerous other factors right now that may – at a minimum – aggravate inflation, or even trigger it outright. As Mohamed El-Erian suggests, these include structural influences such as the transition to clean energy and the trend toward deglobalization.
In the case of the former, the clean-energy push can exert upward pressure on fossil fuel prices as well as on the prices of the commodities essential to the technologies and processes associated with clean energy. As for the latter, it’s expected that the reduced competition resulting from a move away from globalization will result in a higher inflation premium.
Latest Fed Minutes Underscore Central Bank’s Uncertainty About Containing Inflation
So, it is a rather complicated inflation picture, as the reacceleration of price pressures following months of declines illustrate.
That makes it difficult for the central bank to achieve any real clarity with the respect to either the near-term inflation outlook or to best contain rising prices.
This absence of clarity in any regard is underscored in the Fed’s minutes from its most recent meeting, where it hiked rates another 25 basis points. Against a backdrop of repeated references to “ongoing” rate hikes, the minutes effectively say that inflation seems to be headed in the right direction even as it remains a long way from its ideal destination. Here’s an excerpt:
Participants noted that inflation data received over the past three months showed a welcome reduction in the monthly pace of price increases but stressed that substantially more evidence of progress across a broader range of prices would be required to be confident that inflation was on a sustained downward path.
It seems a variety of analysts and strategists had different ideas of how the year would evolve and what the economy ultimately would look like once we arrived at the end of 2023. Steele kicked off his economic updates this year with a presentation on the outlook for 2023 and the overarching theme of uncertainty as the defining characteristic of the year.
I would suggest that this uncertainty has only grown since the publication of Steele’s presentation – and that the latest revival of inflation serves as a prime “Exhibit A” of that increase in uncertainty.
In previous articles, I’ve discussed metals’ solid performances during notable periods in economic history that have been characterized by high inflation, recession and/or volatility. Among them: the “Great Inflation” of the 1970s and early ‘80s, the Great Recession and the pandemic lockdowns.
But we don’t need to travel back even as far as the lockdown year of 2020 to see the resilience of precious metals in action during an especially turbulent period.
Take last year, for example. The year 2022 was characterized by both the highest inflation and the fastest rate-tightening cycle in the previous 40 years. The clash of fast-rising rates with soaring prices produced a level of volatility during which U.S. households lost more than $13 trillion in real net worth. Yet when the dust settled on the year, both gold and silver had finished in positive territory – and that’s despite the headwinds generated by rapid rate hikes.
Now 2023 is underway, and once again the year is shaping up to be one of persistent inflation, higher interest rates and significant volatility. There’s no way to know, of course, how metals will fare this year. The fact that they’ve demonstrated strength in similar environments during previous years doesn’t mean they’ll demonstrate that strength again this year or any other year.
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