James Bullard, who has been president and CEO of the Federal Reserve Bank of St Louis since 2008, has just contributed his entry for 2022’s “understatement of the year” competition.
Bullard, who sits on the FOMC (the Federal Open Market Committee, which sets US interest rates) has just told CNBC that with US headline consumer inflation now at 7.5%, the highest in 40 years, “our credibility is on the line”. According to some commentators, inflation in the US is actually 15%, if it was still measured as it was 40 years ago.
US consumers don’t really care about Bullard’s credibility; their focus is on gasoline and fuel oil prices (up 50% and 41% respectively in 2021). UK consumers are equally under the cosh of rising prices; when inflation is factored in, wages in the UK fell by 1.2% in December. Andrew Bailey, governor of the Bank of England, who is paid more than £500,000 a year, more than 18 times the UK average wage, said earlier this month that workers should “moderate” their wage demands this year; at the same time UK citizens are facing the biggest fall in living standards since records began, in 1990. Bailey understandably fears a wage-price inflationary spiral, but his tactless advice was called a “sick joke” by trade union leaders.
Bullard’s recommendation for dealing with this “lot of inflation” (as he calls it) is akin to trying to use a plastic swatter to bat away a cruise missile; he said he would like to see the FOMC raise interest rates by 1% by 1 July; the FOMC next meets on 15-16 March.
Admittedly the US central bank, the Federal Reserve, is between a rock and a hard place. A rise to 1% in the main interest rate will do little or nothing to curb the current inflation. The US economist John Taylor created a rule in 1993 which suggested that, to stop inflation and keep it in check, interest rates should rise by 1 ½ times as much as inflation. Which implies that base US interest rates should be 10.5% now, not 1.25% by July.
That isn’t going to happen, for two basic reasons. The first – and most pressing for President Joe Biden’s Democrat Party, who will face testing mid-term elections in November – is that an interest rate of 10.5% would slam the brakes on America’s nascent post-pandemic economic recovery.
The second reason is the US federal debt. When a former chair of the US Federal Reserve, Paul Volcker, started pushing rates much higher to tame runaway inflation in 1980, US federal debt was about 25% of US gross domestic product (GDP). The interest bill then was tolerable. But “the government can borrow as long as people believe that the fiscal reckoning will come in the future. But when people lose that faith, things can unravel quickly and unpredictably”.
But today, with federal debt of almost $30 trillion and around 130% of GDP, any rise in interest rates will vastly increase the $562 billion the US spent in 2021 on interest on its federal debt.
As one commentator puts it, “higher interest rates may be an effective tool to suppress inflation, but with soaring national debt they are an anathema to the economic stability of the nation. Unbalanced budgets, growing debt and higher interest rates mean that every government program becomes at risk, as the percentage of the federal budget consumed by debt interest payments grows”.
Credibility is not so much “on the line” as shredded.
History repeats itself
The Fed has a history of making “occasional but very costly mistakes” according to two members of the Shadow Open Market Committee, which was set up in 1973 with the objective of evaluating the policy choices and actions of the FOMC.
In their opinion, by the end of last year “negative real rates had risen to their highest level ever, money supply had surged, inflation was accelerating and labour markets were severely stressed. Once again, the Fed’s delayed exit from overly aggressive monetary ease poses a significant challenge and economic risks”.
We are all aware of what is being blamed for rocketing inflation – supply-chain disruptions, tight labour markets, spiralling commodity costs (particularly crude oil, surging towards $100 a barrel, for the first time since 2014), China’s zero-Covid policy, but one of the main culprits – massive stimulus programmes – rarely gets a mention. The failure to withdraw its economic stimulus on a timely basis, due to the Fed’s unbalanced approach, which prioritises employment over price stability, is the root cause of inflation getting out of control, according to the Shadow economists.
Inflation is now a global problem. The horror headlines are in Argentina, with inflation above 50%/year, Lebanon (more than 200%), Turkey (around 40%), but few central banks are hitting their targeted inflation level. While policymakers’ attention is currently gripped by Russian sabre-rattling over Ukraine, inflation is arguably as much a threat to global stability than tanks sitting on borders; inflation is a creeping poison rather than a naked threat.
Even Russia, which seems to hold plenty of cards from its gas and crude oil strengths, cannot escape inflation. Russia’s annualised inflation is now almost 9% and its central bank has pushed up the main interest rate to 9.5%, with expectations it will soon go to 10%. In the UK, inflation reached 5.5% in January, exceeding expectations. Gas and electricity prices in the UK are currently forecast to rise by 50% in April, which will push annualised inflation beyond 7%. In the Eurozone annualised inflation in January hit a record 5.1%, primarily driven by soaring energy costs, which rose by more than 28%. Interest rates in the zone – currently at 0.5% – have not moved since 2011.
For some financial commentators, such as the US stock broker Peter Schiff, the most likely outcome of this apparently uncontrolled inflation is stagflation: “there is no interest rate that the Fed could put to fight inflation that the economy could withstand. If the Fed has to fight inflation, we not only have a massive recession, and a crash in the stock market and in the real estate market, but we have a much worse financial crisis than the one we had in 2008”. The US government has persisted in holding taxes low while increasing spending – not least on costly wars – which has resulted in the kind of structural deficits now seen. In the view of one seasoned market observer, “the advanced countries are all in the same boat. They did not take the action they should have taken last year to control inflation before it set in. Share markets have been losing trust in the wisdom of central bankers. There is a danger they end up doing too much too late”.
How can individuals protect themselves against the creeping toxin of inflation? In the US, your Dollar is currently losing some 7% a year of its purchasing power; in the UK, the Pound is losing around 5%. It’s a commonly held view that interest rate hikes are negative for the gold price but that isn’t necessarily the case; through much of the 1970s, gold prices rose sharply, while interest rates rose. And the 1980s saw declining interest rates, yet a bear market in gold.
The bottom line is that fiat currencies are steadily losing value and have been for years. The notes you carry and use are unbacked by anything except the promise of a government. That promise has since the financial crash of 2008 felt increasingly precarious – do we trust the ability of central banks and governments to safeguard our welfare? As distrust has grown, so too have efforts to move beyond fiat currencies. The development of cryptocurrencies, supposedly beyond the control of any individual (although obviously not beyond the influence of celebrities) is one such effort.
But with some 17,000 such ‘currencies’ in existence it’s difficult to envisage any one of those become so ubiquitous as to take on the full roles of currency, although Bitcoin is having a good go. There is however an easier, simpler, and speedier option to either fiat money or the complexities of cryptocurrencies – gold, which has been used as money for centuries. Using gold as money has become simplicity itself with Glint. Gold’s credibility is never on the line.
At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.
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