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For months now, I've been asked by friends, colleagues and readers of this blog to explain why gold hasn't moved higher on the news that inflation is rising and the Fed is sitting on its hands, doing nothing to inspire confidence in inflation returning to their 2% target.
My answer is simple: gold has already risen significantly.
This chart shows the inflation-adjusted price of gold in today's dollars. (I've used the CPI to do the calculation.)
In the early 1970s, just before Nixon took the dollar off the gold standard, gold was extremely cheap, which is why many of the world's central banks were demanding that the Fed redeem dollars in exchange for gold. The federal government had been ramping up social spending and deficits and monetary policy had been too accommodative—they should have been tightening in the face of declining gold reserves. Faced with a huge drain on the Fed's gold reserves, Nixon chose to devalue the dollar rather than tightening monetary policy, since he (rightly) feared it would lead to a recession.
Gold rose significantly over the course of the next 10 years, as did inflation, oil and most commodity prices. Inflation rose from a low of 2.7% in mid 1973 to a peak of almost 15% in early 1980. Gold peaked in September 1980. Gold then fell as inflation fell, reaching a low of 1.4 % in early 1998; gold hit bottom in 1999. Gold then rose to a peak in 2011, fell to a low in 2005, only to rise again until it peaked in 2020.
One could argue that the rise in gold which began in 2000 was driven by the expectation that the Fed was prone to be too easy (after having been demonstrably "tight" from the early 1980s) and that inflation was a potential risk. Now we are seeing the Fed validate the fears built into gold prices. It's a case of "buy the rumor, sell the fact." Gold correctly anticipated today's inflation and today's Fed error, so now gold is looking into the future to see whether things will eventually get better or worse.
In any event, gold today is only modestly below its all-time high in real terms. It's not cheap by any stretch.
33 comments:
Great post, and chart.
Boy, buying gold is a timing game.
And no dividends.
Today the largest buyers of gold are jewelry buyers in India and China, and central banks.
The jewelry buying is a form of investment in some regards. Why central banks are buying gold I can't tell you.
I am not sold on gold, but if you can time your investment....
Gold is slow and old. Btc is quick and crypto full of new ideas.
Have to agree with didler, crypto the new "gold" but long term both losers Vs stocks.
Good luck getting wealthier using btc going forward. That ship has sailed.
Is an alternative explanation that deflationary pressures, despite the accuracy with which you delineate the inflationary ones, are greater in what is essentially a zero sum game? Not being political, sincerely curious if there is any way that anyone has tried to numerically quantify these opposing forces in making their observations...
Thank you as always for your amazingly helpful posts!
EHR: can you point to some examples of these great deflationary forces? A weak economy, by the way, is not necessarily deflationary. You need only look to Argentina, whose economy has been dreadfully weak for many years all the while inflation has been raging.
Nothing too esoteric intended in that regard. Technological advances including AI/Robotics, fracking (Biden squashing that one though), the web and cloud enabling a massive expansion of the labor pool competing for lower wages to complete tasks...even an app I have recently written out in my field which is clearly NOT economics. Thank you, again, for taking the time to answer my question and for sharing the weak economy perspective.
EHR: there is the example of Japan, which has had 25 years of no inflation or mild deflation and is experiencing mild deflation presently.
Their central bank has been even more expansionary than the US Federal Reserve.
Before the pandemic Japan had 150 job openings for every 100 job hunters. The reverse Phillips Curve applied. They still have more openings than applicants.
I venture that what most American macroeconomists consider to be axiomatic is actually variably true.
But hey, the nice thing about macroeconomics debates is that no one is ever wrong.
thanks Scott, another great column.
EHR: Technological advances and productivity enhancing investments can and do bring down the cost of many goods and services. But that is not what determines the inflation for an entire economy. In fact, as one of my previous posts shows, durable goods prices fell significantly from 1995 to 2019, thanks in large part to the huge increase in the productivity of the Chinese economy. We had durable goods deflation, but not overall inflation. Inflation, as Milton Friedman taught us, is a monetary phenomenon. If an economy suffers from deflation, as Japan has from time to time, it is not because of productivity gains; it is because the Japanese central bank has not supplied enough liquidity.
Consider this: If durable goods (computers, TVs, appliances) decline in price that is a great thing. But all it does is to allow consumers to spend more on other things. As another of my charts shows, We have had sustained deflation in durable goods but sustained inflation in services and non durable goods. A cheaper TV allows you to spend more on electricians and plumbers, for example. Cheaper durable goods have allowed wages for most workers to increase, not only in nominal terms but in relative terms (i.e., it takes fewer hours of work to buy a TV). Monetary policy sets the financial budget for the economy: spend less on one thing, and you have more to spend on another. But if monetary policy restricts the amount of money in the economy, then everyone has to spend less in aggregate.
Productivity is what allows living standards to rise, because the average worker can buy more with his earnings. It doesn’t determine inflation.
Hyperinflations throughout history have more often than not coincided with the destruction or misallocation of productivity. It is the rapid decline in productivity that create the circumstances for a devalued currency. The most recent examples, Zimbabwe and Venezuela, can trace their woes to egregious government malfeasance. Of course their central banks print larger and larger denominations in a tragic attempt to maintain services and government obligations. But the printing of money (or reserves) is a symptom of poor governance, and hence inflation, not the cause .
skydude: "the printing of money (or reserves) is a symptom of poor governance, and hence inflation, not the cause."
I respectfully disagree. The wanton printing of money is a symptom of poor governance, and the principal cause of inflation.
Thought experiment: If all the bank accounts in the country were to one day receive an additional dollar for every dollar deposited, what would be the most likely result?
It's the same thing that happens when a company decides on a two for one stock split. With twice as many shares now outstanding, the value of each share instantly falls by half.
A decline in the value of a currency is the very definition of inflation.
I agree that the wonton printing of money is poor governance, but I don't agree that it is historically the principal cause of large inflations. Most episodes of large inflationary events coincide with a notable decline in productivity. That is the principal cause currency devaluations.
I do agree that the wonton printing of money leads to inflation as well, but I don't think it has historically been the primary impetus.
Great blog by the way, I have been reading for years and recommending it as well!
It could also be who holds the available M2 that was printed. I recently saw an interview where a former FED open market desk trader mentioned recent policy caused M2 increase in accounts lower than $250K where the MPC would be higher. Whereas older policy it ended up in accounts greater than $250K finding it's way into financial and not consumer goods markets.
During this debacle, aggregate supply shocked left (and tilted more inelastic due to human stay in place mandates). Big business handed a wonderful increase in market share from small business destruction.
Aggregate demand shifted sharply right via direct payments in the form of federal supplemental! unemployment insurance, child tax credits, stimulus checks, and rent subsidies via eviction moratoriums- a material number of people stopped paying rent thus increasing their income even greater than the aforementioned direct payments.
So there was printed money ready to cause inflation, it just needed to be directed to greater MPC.
I also firmly believe the remaining big business have been able to simply front run the publicized and obvious policy related income increases.
If I have tons of consumer spending data and know their income has increased by x, the new data scientists and business analytics will quickly clear out that increased income in the form of higher prices.
In terms of "opposing forces", there are segments that are pushing for higher inflation and other segments pushing for lower inflation. So yes paying less for TV screens mitigates the higher price of higher education
https://medium.com/@6pranavk/insight-of-the-day-cost-disease-c14f50c1cd2e
Baumol's cost disease is for real. Prices are rising fast in low-productivity sectors (domestic) and prices are deflating in high-productivity sectors (foreign, developing), building an entrenched and growing negative trade balance. The inflating sectors are 'services' oriented and occur in areas where governments (not good or bad in itself; let's just look at the math for now) is heavily involved. The 'services' sector has been growing at the expense of other sectors (not good or bad in itself; let's just look at the math for now). This development is inflationary but the productivity input is one among many and as Japan has shown, lower productivity trends can be associated with low inflation or even deflation. There are potentially greater forces (whichever they are) and the outcome of those forces is captured in secular decreasing trends in monetary velocity. Nothing indicates (IMO) that these trends are changing and, because of that, outside of 'transient' effects, velocity decreasing with increasing debt will likely continue to mitigate rising money supply (unless the monetary Rubicon is crossed).
In terms of where the new money is coming from and where it is going (versus potential inflation risk), most of the increase in money supply happened as a result of the simple asset swap (quantitative easing) that the Fed orchestrated. Most new deposits then happened as a result of institutions that swapped the quasi-equivalent short-term government debt (not counted in money supply) for new virtual dollars printed that ended up on the expanded Fed balance sheet as reserve liabilities. Net result: an institution now holds USD instead of a 3-month Treasury bill. How is that supposed to initiate runaway inflation? The majority of the residual minority of new supply apart from QE came from banks expanding their own balance to hold more government debt (in straight English: banks deciding to directly finance the government, creating money the old traditional way in the process).
BTW, this shift (move from private loans to holding securities, including government debt securities at commercial banks) started to occur in Japan in 1998. In the US, this shift has started since the GFC.
From Baumol’s cost disease, we know that government’s involvement tend to favor lower productivity domestic sectors. We also learned more recently that people do not necessarily want to go back to work when they are paid not to do so and when their deposit accounts get garnished with cash resulting from the issuance of government debt. Cash ending up in accounts for people with relatively high MPC may cause transient inflation but, due to the matched government debt that was issued, this means that the demand curve will adjust lower, resulting in lower prices. This is well illustrated in chart 2 in the following:
https://hoisington.com/pdf/HIM2021Q2NP.pdf
This goes a long way in explaining negative trends in the real or ‘natural’ rate of interest and in monetary velocity, trends which have been overriding overall inflationary effects of overall declining productivity effects.
Gold is hard to predict but tends not to do that well in deflationary episodes, even if the deflation is associated with flight-to-safety components.
This inflation outlook is from S&P, in the June forecast. Delta has gotten worse since then, but not sure how Delta will affect inflation. Anyway, these guys study credit for living, are hired by major institutions, have spreadsheets and PhDs, and computers and probably even the Master Cylinder on their side.
Core CPI (year % ch.) 1.7 (2020) 2.8 (2021) 2.4 (2022) 2.5 (2023) 2.3 (2034).
https://www.spglobal.com/ratings/en/research/articles/210624-economic-outlook-u-s-q3-2021-sun-sun-sun-here-it-comes-12014595
Well, that's what they say.
My guess is inflation gets up into the 3%-4% PCE core, but then goes back down.
But the guys who buy 10-year Treasuries say otherwise....
Divining the future...well, hard to do.
Benjamin, re Wall Street "experts." In my 40+ years of investment experience, I long ago acquired a reflexive instinct which tells me that forecasts produced by a team of experts should be strongly doubted until proved correct. Some people have made careers of betting against forecasts produced by Moody's and S&P. Those guys may be full of PhDs and computer models, but if they were really smart they wouldn't be working for those ossified institutions.
As for the buyers of Treasuries: There are many many trillions of dollars of institutional money which MUST be invested in fixed income securities at all times. They have no choice. I'm sure glad I no longer work at a fixed income firm.
Thank you for these thoughtful replies and the link to "Hoisington" and other material. I have my reading cut out for me.
Best wishes to all for a good September.
Scott Grannis: I dunno. A savvy college buddy of mine is now a big shot at Moody's (in contrast to myself).
Maybe he has been "absorbed by the Borg" as they say. But he does not strike me as calcified.
Certainly, any organization can go sideways or ossify, an interesting topic. Credit-rating agencies do not seem to go out of business, both a good and bad sign.
Well, time will tell. My crystal ball is fogging up. This is the most unusual economy of my lifetime, what with the pandemic and heavy-handed government responses thereto.
There is a huge upside if governments quit their war on Covid-19 and declare victory.
"There is a huge upside if governments quit their war on Covid-19 and declare victory."
In the sense of unleashing animal spirits?
This has been a recurrent (but unfulfilled) theme for quite some time here (more than 10 years?) including for the period, one could argue, when the US had its first MMT President as 'we' are starting to appreciate that sliding into a debt spiral is a process, not an event.
http://scottgrannis.blogspot.com/2016/11/closing-obama-gap.html
In Japan too, they are again suggesting that animal spirits are about to be unleashed and recently reported higher GDP growth as a result of higher government spending!?
Oh yes, i was forgetting that stock markets were reaching new highs:
https://www.longtermtrends.net/us-debt-to-gdp/
Seems relevant to the thread.
https://www.wsj.com/articles/digital-currencies-pave-way-for-deeply-negative-interest-rates-11631091581?st=het5mdi2pp7gr6q&reflink=desktopwebshare_permalink
"Accept that interest rates might be deeply negative in serious recessions, and there is still a puzzle: Does that make long bond yields lower, or higher?"
I have skepticism that bitcoin and it's cousins will soon (ever) be accepted as reliable interchangeable with dollars - maybe I don't have quite enough doomsday view of the US dollar or quite enough imagination. I've read others (smarter) opinions here that think otherwise. But digital US currency seems inevitable. Does the article premise (more negative rates) mean the long bull market for bonds can continue?
^In places where negative interest rates have become the norm, it has been found that retail depositors will not accept negative rates (common sense really,; no need for PhD in economics). One way to maintain rates negative across the board is to control the currency through a CBDC. Another fella had thought of a similar (equivalent in a way) idea in order to prevent cash hoarding, the Gesell stamped currency. Interesting idea but IMO only to be considered in very unusual circumstances and only for short periods of time as the efficacy of such 'money' would depreciate quite rapidly.
https://www.npr.org/sections/money/2019/08/27/754323652/the-strange-unduly-neglected-prophet
i think Adam-Smith-type of thinking should dominate and Maynard-Keynes-type of thinking should be reserved for unusual and short-lived liquidity events.
How likely are we to see negative interest rates in the US? Of course we may disagree on the odds and the timing but keep in mind the following: during each recession since the 1970s, the Fed has cut short-term interest rates by more than 500 bps. The funds rate went from 19.0% to 8.5% over 1981-1983, from 9.75% to 3.0% over 1989-1992, from 6.5% to
1.0% over 2001-2003 and from 5.5% to essentially zero over 2007-2008. So, if there is a recession before they raise Fed Fund rates to 5%, there we go.
Of course, a Fed Fund rate of 5% is not compatible with government solvency (debt burden) unless inflation moves up durably to 5% or more. Interesting times.
Even more interesting is the possibility for even the 30-yr risk-free government bond to go negative. Wow!
Of course, the Fed people adamantly refuse to consider the possibility. The Federal Reserve Act does not seem to allow it but the Fed has been unusually creative at times. As the renowned economist Mike Tyson revealed in one of his theses: "Everyone has a plan until they get punched in the face".
In addition, with all this talk that all this free money "injected" into the money supply system (M2 and all) is bound cause some type of inflation, it is interesting to watch what is happening in the reverse repo market. Money market funds who inherited a lot of this free money (more than 1T) are putting so much pressure on the demand side of the equation to give this cash back to the Fed (against short-term Treasury debt collateral) that the Fed has difficulty maintaining a floor at 0.05%. i guess there's still a margin of safety as overnight rates often went slightly negative when the Fed had set their floor at 0%.
https://fred.stlouisfed.org/series/RRPONTSYD
i'm only a noob in most fields but have had some training in medical topics and if this were an EKG (heart rhythm tracing), it looks like the resuscitation efforts are far from over but what do i know?
Thanks for sharing this article with us, I really like appreciate your content & efforts.
Hayden B Jewelry
This is Mr. Grannis' turf but if you want more content, here's more:
https://www.kansascityfed.org/documents/8337/JH_paper_Sufi_3.pdf
You can spend anywhere between 1 to 30 minutes on it.
Here's a 15-second summary:
In a typical and academically sophisticated way, the authors formulate the conclusion that inequality is a potential predictor (cause-effect) of low interest rates.
That's all very fancy (equations and all) but it doesn't make sense (common sense).
It's more likely the other way around. Lower and low interest rates are "good" like greed is "good" (up to a certain degree). Ultra-low interest rates (imagine negative interest rates) stand at the origin of many poor trends. Ultra-low interest rates to the overall economy are what high blood pressure and high cholesterol levels are to the human body: silent killers. Of course there are 'easy'-policy medications to treat specific 'numbers' but fundamental changes only occur with improved diets and lifestyles. My bet is on the US but the transition looks more and more interesting every day passing by.
Scott an excellent question, to a complex problem. In the early 2000 I worked with a Swiss bank on gold instruments, to say that the products were popular would be an understatement. it was a hugely popular form of investment for many investors that like the idea of gold but didn't like the European ETF products -- for good reasons.
One challenge was buying gold, and we were buying a lot, maybe 20 gold bars every other week, kid if a lot. Now out of the 200 or sold gold bars that were purchased I would say about 10% had issues and required expensive testing to ensure that the gold was actually gold, in the case of three bars, they were fakes, yet acquired from very reputable dealers. Just goes to show.
Now, that really put a stop to the program because the cost of owning the gold was high, testing of the bars is surprisingly expensive and complex, and despite that, we got "rolled" three times.
The problem with high gold prices is that it is because of a huge incentive to make fake gold bars, the cost of fakes is not low, they have to replace the gold with equal density metals, all of which are expensive.
In a sense that's the huge advantage of cryptos -- aside from that Gold and crypto share a lot as stores of value (such as it is). I stopped getting all worried about crytos when Tesla's P/E hit 500..
Hi Scott,
Wouldn't it be good to be invested solely in companies that benefit from an increase in inflation. for example, consumer good companies that can pass increases on to consumers easily or commodity companies like oil, copper etc. Avoid fixed income and tech?? Thanks!
I know I wish I gotten into P&G a few months back!
It's been all FED for a long time. Those days are utterly, 100% finished. It's now reckless fiscal policy and that will lead, finally to bank lending and then inflation - big time.
Where to hide? The dollar is cooked. Gold since it has been released to float in 1971 has perfectly matched an equity index fund. Do the math and do not forget to account for yearly taxes on dividends, index fund costs and capital gains. It's uncannily identical, and don't give me teh lien of storage costs for gold. If you do not have possession of gold you're nuts.
Then read about Weimar. Stocks great at the beginning and then even they got crushed. Hard assets were the only way through and that includes precious metals and real estate. Bitcoin to me are tulips. I will not buy and I will not short. That's pretty much it if we survive Biden and Harris.
"Global Capex Booms as Companies Prepare for Post-Pandemic Era"--Bloomberg, 9/12
Government is clunky, even backward, but the private-sector does most things very well, and they are spending big on capital outlays. This has to be good news.
The big threat today is governments won't let us go back to normal. Yes, vaccinate the elderly, and give succor to all who fall ill. No one asked for a pandemic, or to get sick. But other than that, declare victory and move on.
Too-heavy federal spending? Maybe so, but remember the federal government will spend $13 trillion in the next 10 years on DoD and VA alone. That makes Biden's infrastructure plan (which is probably mostly pork) look like small potatoes.
Inflation? Maybe. Will moderate inflation matter? Maybe.
Huge increases in housing production are needed, on the order of millions of units a years for many years. The private sector will do it, if we can unzone property.
I haven't been here in well over a year, but I used to enjoy looking at the chart called, Stocks Climb a Wall of Worry. It used to be an interesting indicator showing the VIX/10yr yield relationship, but it's modified now, where it seems like more of a new bias that's more slanted towards fear mongering.
Obviously inflation fears are being hyped as Fed watchers spin various takes on jawboning and future growth, but it seems like this is yet another time where the Stocks Climb a Wall of Worry Chart is useful. In fact, I think there's a very long string of evidence that deficits don't matter and that QE after the GFC, also didn't matter, in terms of hyperinflation and an irrational panic to think gold plays some role in future value.
I was disappointed to not see the old chart, so had to add my two cents.
Inflation numbers released this AM were so impressive that the 30-yr Treasury bond yield went to 1.86% (!), a yield that includes (according to Fisher) the expected real yield and the expected inflation expectations over the entire period (!) to which one must add the term premium that makes sense to tie money up for such a long time, even in a time of Great Moderation.
And Gold...gold is at the same price as 10 years ago.
Still, i assume that gold will overperform the S&P500 over the next 10 years but that may end up being an easy hurdle.
Here's a FRED link on VIX/10yr
Things are pretty tame and if anything, the dip will be bought, as stocks climb a wall of worry.
https://fred.stlouisfed.org/graph/?g=GS8L
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