It’s probably just coincidence but it’s a striking one just the same.
Frederic Mishkin, a voting member of the Federal Open Market Committee, has a new research paper that considers the evidence that monetary policy has become more science than art over the past generation. By Mishkin’s reckoning, nine “key principles” form “a set of basic scientific principles, derived from theory and empirical evidence, that now guide thinking at almost all central banks and explain much of the success in the conduct of monetary policy.” First among the nine he cites: Milton Friedman’s widely repeated observation that inflation is always and everywhere a monetary phenomenon.
Against that backdrop we turn to the latest money supply numbers from the Fed, which brings us through September 10. Considering the 50-basis-point cut in Fed funds earlier this week it comes as no surprise to learn that a bull market prevails in M2 money supply, the broadest measure published. In fact, in late August, the 52-week percentage change in M2 topped 7% for the first time in nearly four years, as our chart below shows. Although the surge pulled back in the last two weeks, the ascent remains intact. Until and if the Fed gives reason to think otherwise, a prudent observer of monetary trends would do well to assume M2’s pace will go higher still.
No one should be shocked. M2’s flight skyward has had a long and steady takeoff over the past several years and the Fed’s now operating on the assumption that the economy’s slowing. Trying to juice growth, as a result, is priority one and the weapon of choice is pumping up liquidity.
The question is what a strategic-minded investor should do? Some are opting for a hedge by voting with their wallets and converting paper into gold, the traditional store of wealth and insurance policy against the inherent risks of fiat money. Indeed, the precious metal yesterday had another big day, rising nearly $14 to almost $736 an ounce. That’s the highest price for gold since the early 1980s.
In a related move, the dollar plumbed new lows. The historic inverse relationship between gold and the buck is alive and kicking, feeding off one another like gasoline and fire.
Ironically, the clear inflation warning emanating from the gold and currency markets finds no sympathy in the official inflation statistics published by the United States government. On Wednesday, the Bureau of Labor Statistics reported that consumer prices fell in August by 0.1%. Rarely has gold run up so quickly and sharply in the face of officially stated deflation. For the moment, at least, this divergence is in the running for the mother of all statistical disconnects in the field of economics and finance.
It requires no great insight to realize that someone’s wrong about future inflation. CPI and gold can’t both be right. One side or the other’s headed for a massive dose of attitude adjustment. No one can be sure who’s going to get stuck, or when, but we have our suspicions.

3 thoughts on “INFLATION…OR DEFLATION???

  1. Leonardo Cecchini

    Not that I can prove this, but from my (historical) observation/analysis gold tends to be a better leading indicator of deflation than (re/hyper) inflation
    If one needs clues, perhaps a dusting of the theories from The Austrian School of Economics could help. They suggest that all assets tend to correlate in the last leg of reinflation and this is undoubtedly what we are witnessing in this current boom cycle. Ultimately, as they suggest, debt is deflationary as it inevitably has to be paid back at some stage. This tends to be brought about by economic slowdowns.
    We are already in the midst of a US slowdown and I feel that the US may follow Japan in its wake. But in my view for this to fully materialise it would require another big economy to slowdown somewhat, such as China possibly. Forget Europe in this equation….
    The point however, is that these are macro-economic scenarios that can, if at all, take years to materialise. Consequently, we probably have a long way still before deflation ala Japan style really sets in. People have beed frettting about the US current account for more than 20 years now…

  2. DH

    GS,MER,MS are running up the price of gold in order to sell them to the europeans and chinese as their currency devalues against the dollar once the ECB cuts rates and Chinese inflation finally gets way out of hand. The race to the bottom has already begun.

  3. Marc

    Let me ask a neophyte question. Why does an increase in the price of gold signal inflation? Is this historical (anecdotal) or a direct cause/effect relationship?

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