Is
there such thing as too little inflation?
To listen to some economists the answer is an emphatic “no!” Fed chief Ben Bernanke certainly doesn’t
believe in the concept of low inflation.
Neither does ECB president Mari Draghi.
But the question must be asked: with so much official opposition to low
inflation, how will America’s middle class ever fully recover from its current
malaise?
Economists
were shocked last week when Europe’s inflation fell to a “dangerously low” annual
rate of 0.7 percent. It’s commonly
assumed that when the rate is that low, companies, households, and even
governments have a difficult time reducing debt. What economists fail to consider, though, is
that low inflation is beneficial to the working class because it lowers the
cost of living, which can outweigh the cost of servicing debt. Since food, fuel and housing costs make up
the bulk of the middle class budget a lower inflation level will only help the struggling
middle class and can even serve to stimulate consumption.
One
of the major flaws in the Fed’s inflationist response to the credit crisis is
that retail prices for many goods were never allowed to fall. Consequently, the unnaturally high price
levels that were established between 2004 and 2008 were never “corrected.” This means that when the next long-term
inflationary cycle begins in late 2014 consumers will likely be forced to
contend with even higher prices in the years ahead. There is a reason why a 60-year boom/bust
cycle exists: it’s nature’s way of cleansing the economy of imbalances and
excessively high (or excessively low) prices.
When central banks refuse to let the natural cycle take its course it
only creates long-term imbalances which in turn can result in major social,
political and economic conflagrations.
In
the U.S. it was recently announced by the Labor Department that consumer prices
for September rose by only 1.2 percent year-over-year. This came short of the Fed’s arbitrary 2
percent inflation target, giving the Fed yet another reason to consider its
ill-advised stimulus measures. While a
case could be made for the Fed’s intervention in the immediate wake of the 2008
credit crash, its continued stimulus over the last five years has paved the way
for future inflation – and significant trouble for the U.S. middle class.
According
to The New York Times, inflation is
“not rising fast enough” for Washington’s liking. The article by Binyamin Appelbaum stated
economists are nearly unanimous in asserting that “a little inflation is
particularly valuable when the economy is weak.” That’s not the testimony of history or even
the recent past. Just ask Japan: for the
better part of 20 years the country experienced extremely low inflation and
periods of deflation, yet consumers were content with the low cost of living
that enabled them to get by when the economy was slack. Moreover, inflation is an indirect form of
taxation since it erodes the savings and purchasing power of consumers and
thereby chokes off economic growth.
Apparently,
Ben Bernanke’s successor Janet Yellen is another believer that a controlled
amount of inflation is a good thing. Like
Bernanke, she’s being encouraged by policymakers to continue the Fed’s policy
of artificial inflation for the sake of juicing the economy. The fallacy behind this policy is that by
keeping the Fed funds rate at or near zero and providing copious amounts of
liquidity, demand can be stimulated. Far
from being the case, creating artificial inflation by money printing will do
nothing to increase spending on a broad scale, as the chart showing monetary
velocity suggests. Instead, the evidence
strongly suggests that the Fed’s QE program has only succeeded in increasing
the demand for money itself, that is, money that is kept in safe havens and not
spent directly into the economy.
There’s
an old saying that has become trite through its frequent repetition: “Be
careful what you wish for, you just might get it.” This bromide rings true, however, when
applied to the current Federal Reserve policy.
By obsessing over the lack of inflation in the U.S. economy these past
five years, the Fed will very likely be surprised by the vigorous growth of
inflation in the years following 2014 after the commencement of a new economic
Super Cycle. The trillions that were
created by the world’s central banks to fight deflation will then become tinder
for the fires of inflation that will sooner or later be kindled.
Gold
The
price of gold fell sharply on Tuesday, declining 1.23% in a day of active
trading. The downside move was blamed on
investor speculation that the Fed would begin tapering its QE monetary policy
as soon as December. Such speculation
has been rife in recent weeks and has consistently been “whipsawed” by the
Fed. It’s akin to short-term “noise” and
should be ignored as such. What can’t be
ignored, however, is the action of the gold price.
Historical
evidence suggests that perhaps the single best indicator for tracking the gold
price in a bear market is the 30-week (150-day) moving average. The dominant direction of gold tends to
follow the slope of this psychologically important trend line during the course
of a bear market. This has certainly
been the case so far this year, as the following graph shows.
Gold
has now returned to its previous closing low from mid-October of $1,268. This is the all-important “moment of truth”
for the metal. A close below this
benchmark level would pave the way for additional technical selling since many
algorithm and technical traders will view this as a “double bottom failure.” A self-fulfilling prophetic decline could
then ensue as momentum traders seize the initiative to push gold even
lower. It would likely be a short-lived
affair but could be a nasty spill if $1,268 is decisively broken.
