Via email, Albert Edwards of Societe Generale discusses the subject in Global Strategy Weekly.
US core CPI and wage inflation have surprised on the downside for four successive months. Usually only two data points are sufficient for most of us to be able to draw a trend, but four data points surely provide clear evidence of the decisive re-emergence of a deflationary trend. At the very least this recent data is grounds for a dismissal of the argument that ‘end of cycle’ inflationary pressures might make a brief appearance before the long-term deflationary secular trend reasserts itself in the next downturn.
If inflationary pressures are indeed ebbing in the US economy, this begs the question that if the third-longest cycle in US history cannot produce a cyclical uplift in wages and prices, what on earth will happen in the next recession! Investors might give some thought to the fact that we are now just one recession away from Japanese-style outright deflation!
The US is not alone, however. The ever topical Gerard Minack shows in the chart above that although the number of OECD countries in absolute deflation at the core CPI level has receded, those undershooting a typical core CPI target of 2% are at an all-time high. This is quite amazing given where we are in the global economic cycle.
What’s That Mean for Gold?
Contrary to popular belief, gold is not an inflation hedge. We had inflation every step of the way from 1980 to 2000 with gold falling from $850 to $250 along the way.
To be more precise, we had disinflation, a falling, but positive rate of inflation as measured by the CPI. Those are conditions in which gold tends to perform miserably.
Gold tends to do well in deflation, stagflation, and times of credit stress. More importantly, gold does well when confidence in central banks is on the wane.
On June 24, I gave a presentation to the Venture Alliance group. Here are a few slides on gold from my presentation.
Faith in Central Banks
The second to last slide above is worth a detailed inspection. Here is the timeline.
- August 15, 1971: Nixon closed the gold redemption window. Gold was $43.15 per ounce.
- January 21, 1980: Gold closed at $850 an ounce. That was the market top for decades.
- March 1980: US inflation peaked at 14.8%. The Federal Reserve Board led by Paul Volcker raised the federal funds’ rate to a peak of 20% in June 1981. It was not the rate of hikes that directly led to the plunge in gold. Rather, the rate hikes convinced the public and the markets that the Fed had everything under control.
- August 11, 1987: Greenspan took over as Fed chair. The “Great Moderation” started. Disinflation and slowing falling interest rates were the norms. Greenspan was labeled the “Maestro”. Faith in central banks peaked under Greenspan.
- May 7, 1999: The Bank of England announced plans to dump gold for other assets. The price of gold was $282 per ounce. The advance notice of the sale drove the price down by 10% by the time of the first auction on July 6, 1999. With many traders shorting, gold reached a low of $252.80 on July 20. This is frequently called “Brown’s Bottom” after Gordon Brown, the UK Chancellor of the Exchequer.
- 2000-2007: The DotCom bubble burst and Greenspan slashed interest rates to a then record low. This was followed by a housing bubble, a housing bubble bust, and Greenspan leaving the Fed. Ben Bernanke took over. Bernanke slashed interest rates to nearly zero and kicked off three rounds of QE. Faith in central banks was again in question for most of this timeline.
- August 23, 2011: Gold peaked at $1923.70 with a European debt crisis underway, worries about Greece, and with the Fed involved in a series of QE actions.
- July 26, 2012: Mario Draghi gave his famous “Whatever it Takes” speech. “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” Faith in central banks was temporarily restored.
- November 22, 2015: Gold touched $1056. In the chart, I gave a December date. That timeframe is when faith in central banks hit a rebound peak.
- Present: A debate is on whether or not the Fed is behind or a head of the curve. Dissent at the Fed as to whether it should be hiking or cutting is widespread. Many economists advocate a higher range of inflation even though the Fed cannot get to 2% inflation. Asset bubbles are numerous and obvious to many observers, but not the Fed.
The price of gold closely follows faith in central banks. If you think faith in central banks will again come into widespread question, then add to your gold stash.
Deflation on Deck?
Is deflation on deck? Yes, asset deflation, a very destructive kind of deflation.
CPI deflation is not to be feared. More precisely, CPI deflation is a benefit. Falling prices increase purchasing power by definition and thus raise standards of living.
Yet, central banks (especially the Fed, ECB, Bank of Japan, and the People’s Bank of China) foolishly poured trillions of dollars into the economy an attempt to boost CPI inflation.
Instead of boosting the CPI, central banks created numerous asset bubbles. When asset bubbles burst, and they always do, bank loans based on inflated asset values come into question.
This is precisely what happened in the housing bubble, and it will happen again, perhaps not as severely globally, but it may be crippling in the EU.
Economic Challenge to Keynesians
Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.
I have commented on this many times and have been vindicated not only by sound economic theory but also by actual historical examples.
There is no answer because history and logic both show that concerns over consumer price deflation are seriously misplaced.
BIS Deflation Study
The BIS did a historical study and found routine deflation was not any problem at all.
"Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the study.
It’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results.
Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse.
Meanwhile, economically illiterate writers bemoan deflation, as do most economists and central banks. The final irony in this ridiculous mix is central bank policies stimulate massive wealth inequality fueled by soaring stock prices.
Mike “Mish” Shedlock