If you know inflation is going to increase, would you sell your inflation hedge?
Me neither. That would be dumb, right?
However, that’s what a lot of people did yesterday (Wednesday, March 18), and they're still doing it this morning. This hints at the Catch-22 still haunting the Federal Reserve and the market's inability to make sense out of it.
I've been writing about this Catch-22 for months. In a nutshell, the Fed simultaneously needs to hold interest rates higher (and arguably raise them) to deal with increasing inflation pressure while also needing to cut interest rates due to the massive Debt Black Hole warping the economy.
It can't do both. Ultimately, it will have to choose between inflation and propping up the debt-riddled bubble economy. Right now, markets are betting they'll go after inflation.
I think anybody who believes that is underestimating the force of the debt black hole and the level of malinvestment in the economy as a result of decades of easy money.
Price Inflation Spooks Markets Desperate for Interest Rate Cuts
If you follow the markets, you know that gold fell sharply, breaking below the $5,000 support level. Gold was already under selling pressure. A lot of investors are using the liquidity of their gold holdings to raise cash to navigate the volatility in the markets.
However, a specific headline seemed to spark yesterday’s sell-off – news that producer prices rose far more than anticipated.
Producer prices are considered a leading inflation indicator because companies generally pass on at least some of their higher costs to consumers.
Well, the PPI for February came in red hot. The forecast was for a 0.3 percent month-on-month increase. Instead, producer prices spiked 0.7 percent.
Core PPI, stripping out more volatile food and energy prices, was up a healthy 0.5 percent in February.
On an annual basis, PPI came in at 3.4 percent, with core producer prices rising 3.9 percent.
And of course, this was before the oil price shocks we’re now seeing due to the war with Iran.
Keep in mind that rising prices don’t measure inflation when you define the term properly. Rising producer and consumer prices are one symptom of inflation – an increase in the supply of money and credit. Inflation is caused by money printing. This can result in rising prices.
As I pointed out when the February CPI data came out. While it seemed to signal cooling inflation, a quick look at the trajectory of the money supply reveals that inflation is increasing rapidly, despite the perception that monetary policy is still tight.
So, the fact that producer prices are going up isn’t really a shock, especially when coupled with the impact of tariffs.
But why are people selling gold when inflation is apparently heating up?
It’s a matter of perception. Investors imagine that the Federal Reserve will hold rates higher for longer due to this inflationary pressure (that has been ongoing but is more noticeable when prices start going up). In fact, after the PPI data came out, the expectation for the next rate cut was pushed back to December.
Why does this matter to gold investors?
Because gold is a non-yielding asset. Conventional wisdom holds that investors will spurn gold and turn to other assets as rates increase to capture yield.
I watched this happen over and over again when the Fed was raising rates a few years ago. Every data point indicating inflation was still sticky led to a gold selloff.
Here we go again.
But Will the Fed Really Keep Interest Rates Higher for Longer?
I think not.
Remember that Catch-22.
It can’t keep rates higher – inflation or no inflation. That’s because it must contend with the Debt Black Hole.
The perception that the Fed should hold interest rates higher is absolutely correct. Price inflation remains well above the mythical 2 percent target, and as I’ve mentioned, the money supply is increasing rapidly. In fact, I could make an argument for rate hikes at this point, because the central bank never did enough to kill the inflation dragon. Keep in mind that then-Fed chair Paul Volcker had to jack up interest rates to 20 percent to slay the price inflation of the 1970s.
The fact is, the Federal Reserve never did enough to slay inflation. The central bank tightened monetary policy just enough to subdue the inflation dragon and hoped it wouldn’t get up off the mat. Now it has gone back to creating inflation.
By declaring victory over price inflation and easing monetary policy over the last couple of years, the Fed effectively committed to creating more inflation.
So, why don’t they hike?
Because they know that rate hikes would run a dagger through the heart of this debt-riddled bubble economy.
And that’s the Catch-22. The Fed simultaneously needs to hike interest rates to fight inflation and cut them to rescue the economy.
It obviously can’t do both.
Powell’s comments during his post-meeting press conference on Wednesday reveal the quandary facing the central bank. He conceded that the economic projections and dot-plots released by the central bank weren’t worth a whole lot, saying they had to "write something down," but there is still a lot of uncertainty.
"If we were ever going to skip an SEP [Summary of Economic Projections], this would be a good one because we just don't know.”
To date, the central bankers at the Fed have been trying to walk the tightrope. But at some point, economic realities will force their hands. They’ll be forced to cut aggressively when the bottom falls out of the economy. The oil price shock could cause that sooner rather than later.
We also need to address the big elephant standing in the middle of the kitchen. The Fed already wrecked the economy with well over a decade of easy money. It pumped nearly $9 trillion in new money (inflation) into the economy through quantitative easing alone from the onset of the Great Recession through the pandemic. That’s on top of the inflation it created with nearly a decade of zero percent interest rates.
That monetary malfeasance has consequences. It created a massive debt bubble and all kinds of malinvestments in the economy. The impact hasn't manifested yet.
When the economy visibly cracks, the Fed will be forced to get even more aggressive in loosening monetary policy - elevated inflation or not. If history is any indication, it will cut rates to zero again and launch more rounds of quantitative easing (QE). That means even more inflation.
The worst-case scenario is a protracted period of stagflation.
In fact, CNBC reported on stagflation worries earlier this week. The reporter tried to downplay the potential, but the fact that the mainstream is talking about it at all is telling.
You should take note of the fact that despite all the worry about hot inflation (that they’ll conveniently blame on the war), the Fed still projects a rate cut this year. Think about that. Inflation remains well above the target and appears to be heating up, and the Fed still plans to loosen monetary policy.
That reveals their priorities. If you watch the Fed closely, you will realize that central bankers tend to talk a lot about controlling inflation, but their actions tend toward looser policy to boost the economy.
That won’t likely change.
In other words, expect the inflation to continue.
And you might want to hold onto that inflation hedge.
Mike Maharrey is a journalist and market analyst for Money Metals with over a decade of experience in precious metals. He holds a BS in accounting from the University of Kentucky and a BA in journalism from the University of South Florida.
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