Now that inflation has been officially elevated to public enemy number one in central banking, courtesy of the Fed Chairman’s chat on Monday, the debate over what forces, if any, might intervene to slow the monster’s approach have begun in earnest. One school of thought argues that the economy will slow, thereby smothering inflationary fires before they have a chance to burn. But for those who think a slowdown offers hope on the inflation front, William Poole, president of the St. Louis Fed, suggests it may be time to reconsider that assumption.
“If inflation turns out to exceed … our target range,” Poole said in a Wall Street Journal (subscription required) story published today, “I do not believe we can count on a slowing economy to bring inflation down, by itself, quickly.”
Of course, one might quibble over the definition of “quickly.” Meanwhile, the jury’s still out on whether inflation is in fact exceeding the target range, and by a meaningful margin that’s more than fleeting. When it comes to finding a definitive answer, there’s only the Bernanke prescription of waiting for more data.
Till then, the more pressing issue Poole raises is one of inflation remaining relatively high, if not rising, while the economy slows. The combination, if it proves durable, is hardly an encouraging prospect, raising the specter of the 1970s, a decade when the central banking proved to be something of a failure in delivering effective monetary policy.
But perceptions count for much when it comes to fighting inflation, and the battle has only just begun. Perhaps then we should take some comfort in seeing that the gold market is listening to the Fed heads and it likes what it’s hearing. Indeed, the precious metal fell yesterday to near its lowest levels in about two months.
If the threat of higher inflation is real, why is the gold market selling off? One answer may be that gold, in addition to be an inflation hedge, is also a commodity and so in the short term it suffers all the usual effects that accompany speculation in other commodities. In other words, gold’s merely correcting after a sharp upward spike.
But lest you think the metal’s price signals all well on the inflation front, Citigroup analyst John Hill predicts that the bull market in gold is still intact. “We have been positive on gold for three years and expect it to ratchet much, much higher over time,” he explains in a recent report, according to The Shanghai Daily via China View. “We would not be surprised to see a test of the old highs of US$850 an ounce.”
Meanwhile, David Gitlitz, chief economist at TrendMacrolytics, reminded in a note to clients yesterday that price indices are “deeply lagging” and so they reflect yesterday’s trend. Tomorrow’s is another story, and on that matter the Fed is now signaling a desire to err on the side of caution.
The road to caution must first go through neutrality as it relates to monetary policy. And neutrality is still a ways off, reckons Brian Wesbury, chief economist of First Trust Advisors L.P. Writing today in an op-ed in the Wall Street Journal, he argues that a 6% Fed funds is probably closer to neutral at the moment.
Six percent is exactly 100 basis points above the current 5% Fed funds. Mr. Bernanke, it would seem, has his work cut out for him. The question is what will be the collateral damage between here and there?