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Category: Soap Box

Soapbox: Over the horizon

On Friday 10 June 2022 in the early afternoon, gold was trading at around $1,833/ounce. By late afternoon the same day, the price had zoomed to more t...

14 June 2022

Gary Mead

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On Friday 10 June 2022 in the early afternoon, gold was trading at around $1,833/ounce. By late afternoon the same day, the price had zoomed to more than $1,871/ounce, although by late afternoon Monday 13 June, it had slid all the way back to $1,828.

What happened to push the price $38 higher, a gain of more than 2% in a couple of hours, on 10 June?

The answer is – US inflation. The annual rate of inflation in May rose to 8.6% it was announced on 10 June, the highest level since December 1981, and, against most expectations, 0.3% higher than in April. The S&P 500 closed down almost 3%, and the Nasdaq Composite closed 3.5% lower, as investors grappled with worries that the US Federal Reserve will have to tighten monetary policy faster and more extremely than anticipated, if it wants to get inflation under control. Risk assets were out – defensive ones were in.

The following day, adding insult to injury, gasoline prices in the US hit the psychologically important $5/gallon on average, as summer’s peak driving season was just starting to get going. At around £1.07 per litre in the UK, this is still well below gasoline prices on the other side of the Atlantic, but hitting $5 for the first time in history is a huge shock to the US consumer. The gasoline price has now more than doubled since President Joe Biden entered the White House.

If we peer over the horizon there seems scant hope that prices in the US will cool down any time soon. According to Dean Croushore, who was an economist at the Philadelphia branch of the US Federal Reserve for 14 years, the Fed has been too slow to take action on inflation: “It’s always tough to bring inflation down once you let it out of the bottle” he said. He’s right about the Fed being slow to raise interest rates, under the spell of the ‘inflation is transitory’ narrative which Jay Powell, chairman of the Federal Reserve, repeated for much of 2021; but by calling for interest rates to be put up to about 5%, Croushore’s recommendation would still leave rates in negative territory, i.e. still encouraging lending & spending. Croushore is still too timid.

The last time inflation in the US was this strong was in 1978, when it was 7.59%. It then went to 11.35% in 1979 and 13.50% in 1980, despite Paul Volcker, then the Fed chairman, pushing the federal funds rate, which had averaged 11.2% in 1979, to 20% in June 1981. Inflation gradually fell back to 6.16% in 1982 under the crushing weight of very high interest rates. Paul Volcker said in his memoir that it is a “fundamental responsibility of monetary policy” to maintain the value of a currency: “once lost, the consequences can be severe and stability hard to restore”. Volcker acted responsibly, and gradually brought inflation back into line – although since 1980 it’s worth noting the Dollar has lost 71% of its value thanks to what seems a ‘low’ annual average inflation rate of 3.03% since then.

Biden blames the wrong people

“I understand Americans are anxious” said President Biden at the Port of Los Angeles on Friday, after the latest inflation data was released. He blamed President Vladimir Putin’s “tax on both food and gas” (although no such taxes exist – higher prices for both follow from the West’s patchy embargoes on some Russian exports) and also, bizarrely, three main global shipping alliances who use the Western Hemisphere’s busiest port.

“Every once in a while, something you learn makes you viscerally angry” said the President, as he urged US policymakers to pass a bipartisan Bill, the Ocean Shipping Reform Act, unanimously passed by the Senate in March. This Bill would allow the Federal Maritime Commission (FMC) to repress shipping fees charged by international carriers. Bizarrely, because the FMC published a ‘final report’ on 31 May which blamed the high ocean freight rates on “unprecedented consumer demand, primarily in the United States”. Biden wants to blame profiteering for the inflation, or part of the inflation.

The President made no mention however of the massive flow of ‘free’ money (including, in March 2021, a $1.9 trillion Covid-19 ‘relief package’ giving $1,400 to most Americans) that surely played its part in the inflation surge. This helicopter money (scattered from above as if by helicopter) was only ‘free’ in the sense that its recipients got something for nothing. It set a very dangerous precedent. Lobbying for more such helicopter cash will become more intense as the American consumer becomes increasingly stressed by higher prices for staple goods.

Powell lacks Volcker’s spirit

The immediate task facing the Fed was recently summarized by Tara Sinclair, an economist at George Washington University. She told the Financial Times this “is not landing a plane on a regular landing strip. This is landing a plane on a tightrope, and the winds are blowing… the idea that we are going to bring incomes down just enough and spending down just enough to bring prices back to the Fed’s 2% target is unrealistic”.

Sinclair was referring to what might be called ‘Volcker’s Dilemma’. How do you crush inflation? By raising interest rates well above the level of inflation, and thereby demonstrate to the public that spending will fall, because the central bank is making it crystal clear that it will do everything in its power to encourage saving and discourage spending. If inflation is too much money and too few goods, then make money and credit so expensive that it halts spending in its tracks. But go too far or too fast with interest rate rises and the risk is that you push an economy into recession. Volcker’s Dilemma.

It’s difficult to credit, now that US inflation is almost 10%, that the Federal Reserve pre-Covid had an inflation target rate of 2%/year. A majority of academic economists surveyed by the National Bureau of Economic Research (NBER), which is the arbiter of when recessions begin and end, now think that core inflation (which excludes food and energy costs) will exceed 3% in 2023.

Smashing high inflation will take the kind of steely resolve that Paul Volcker showed, even though his rate rises brought about a nationwide recession in 1980-82, with unemployment above 10%. The unemployment rate this year is likely to be around 3.7% according to the NBER. Interest rates are going up this year, but few believe they will exceed current inflation. Even the cautiously low interest rate rises likely to be overseen by Powell are still likely to tip the US into recession, according to almost 70% of the economists surveyed by the NBER. Mohamed El-Erian, chief economic advisor to Allianz, said on CNBC the Federal Reserve would have to get aggressive with interest rate hikes. Powell is “losing total control… He’s got to move because, if he doesn’t, he’s going to be chasing the market, and he’s not going to get there”. El-Erian added that inflation has “not peaked”.

We have been warning of the inflationary pressures face on both sides of the Atlantic since 2019, and sporadically touched on Volcker’s Dilemma. Too much juice and inflation roars, too little juice and economic growth halts. We could easily slip into stagflation says the World Bank. Kristalina Georgieva, managing director of the International Monetary Fund (IMF) puts it very simply: “growth is down and inflation is up”. Larry Summers, former US Treasury Secretary, told Bloomberg in early April that the “combination of overheating, followed by policy delay followed by supply shocks means I think… recession in the next couple of years is clearly more likely than not”.

On 7 June, the World Bank said the global economy is “entering” what might turn out to be a “protracted period of feeble growth and elevated inflation”, raising the risk of stagflation. It said that global growth would be 2.9% this year, against its forecast in January of 4.1% and last year’s 5.7%. Growth would “hover around that pace over 2023-24… As a result of the damage from the pandemic and the [Ukraine] war, the level of per capita income in developing economies this year will be nearly 5% below its pre-pandemic trend”. In advanced economies growth this year is put at 2.2% in 2023.

Not that the immediate outlook for the UK is much better. The 38-country OECD (Organisation for Economic Co-operation and Development) forecast on 8 June that UK economic growth will come to a standstill in 2023. The chance of a recession in the UK in late 2022 or early 2023 must now be high and, if the Bank of England sheers away from higher, inflation-beating interest rates, stagflation seems inevitable.

Stagflationary defences

If we are in for a bout of stagflation where might we shelter? Cryptocurrencies look as vulnerable as equities; Bitcoin dropped to as low as $26,876.51 on 12 June and on Monday 13 June dropped more than another 10%, to some $19,313. Binance, the world’s biggest crypto exchange, suspended customer withdrawals of Bitcoin on 13 June, which sent further shivers down the spines of crypto fans. The value of the broader cryptocurrency market has dropped to some $1 trillion, against an estimated $3.2 trillion in November.

Annualized average adjusted returns since Q1 1973 in percentage terms: Source: Bloomberg, World Gold Council

 

In stagflationary environments, the demand for assets perceived as ‘defensive’ increases. Such things as US treasury bonds, Dollars, gold, consumer staples and real estate tend to be more sought-after than assets seen as more risk associated. The chart immediately above suggests that gold beats other mainstream assets during stagflationary periods.

Jamie Dimon, CEO of JPMorgan Chase & Co., said on 1 June that the US economy might be in for a “hurricane”. There are warning signs of an approaching hurricane, not the least of which is a heavy downpour. Maybe Dimon is right. The 90 year-old US multinational cosmetics company Revlon is one of the most famous brands around. That has not protected it. It is drowning in $3 billion of long-term debt, its shares collapsed by more than 50% on 10 June, and it is preparing for Chapter 11 bankruptcy. If Revlon can become a ‘zombie’ company, which other big brand is a safe investment? A ‘zombie’ company is one that isn’t earning enough to cover their interest expenses. It’s thought that as much as 20% of America’s 3,000 largest publicly-traded companies may be ‘zombies’. The years of cheap credit, now coming to an end, have been used to borrow and pile on even more debt.

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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