Perspective By Rich Checkan
Information Line - May 2023
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Editor's Note: Mark Nestmann is the founder of The Nestmann Group, a US-centric consultancy that helps mostly American clients protect your assets, preserve your wealth and safeguard your future. This article was originally published in Nestmann's Notes on April 11, 2023. You can subscribe to Nestmann's Notes or learn more about the Nestmann Group by clicking here.
Editor's Note: Omar Ayales is the Senior Trading Strategist & Editor at GCRU (Gold Charts R Us). If you have any questions, you can reach him at firstname.lastname@example.org or visit www.goldchartsrus.net.
The Inside Story
The Inflation Conundrum
By Omar Ayales
Inflation continues to run rampant despite the Federal Reserve’s ongoing attempt to bring it down, applying forceful monetary policy that has not been seen in decades. And it hasn’t been the Fed alone; it’s acting in coordination with some other central banks around the world too, particularly Europe. But price pressures simply won’t abate, and social distress makes it hard for monetary authorities to remain a course that is technically correct.
A big part of the problem is that inflation is a global phenomena; it’s not something that can be cured by the efforts of one single country or central bank. There have been deeper shifts in global, geo-political and societal trends.
The reasons fueling inflation are many, the most important being de-globalization caused by global fragmentation stemming out of the Russo-Ukrainian affair. This war has changed global commerce completely in that it’s not about buying cheap anymore, it’s about buying ‘right’. It’s about making stronger deals with allied or like minded/cultured countries; about geo-politics and military defense; about natural resources and food… The convenience of buying ‘right’ doesn’t come cheap and will unavoidably translate into higher prices across all goods and services in society.
Consider Europe for example. Europe is a net importer of energy. It spent billions building Nord Stream Pipelines to have access to cheap gas from Russia, a known geo-political threat. Now it’s shifting given global fragmentation; Europe’s now buying gas from the U.S. and other parts, having to pay higher for their gas and additional costs to ship it in.
Convenience = Higher Costs = Inflationary Pressures.
And it doesn’t stop … there are other more imminent reasons that will fuel inflation even more such as economic re-opening in many parts of the world, particularly China. Consider until recently, China had been shut down for nearly 3 years, growing at a record low pace last year of 2.9%. But in 2022 it has already started the year with a growth rate of 4.5% in the first quarter of 2023. A trend that could continue to grow as China’s economy returns to normal and a historical mean. Keep in mind, in a good year, China consumes half of the world’s resources…
Constant (or slower) supply + Increasing Demand = Inflationary Pressures.
After the shock of Covid-19, many people also changed their views on their place within society, causing an abrupt change in the way people live their lives. The change is also inflationary as it involves big changes in people’s lives. Big changes usually mean big expenses, like moving away, changing your home, improving your home, leaving the office, setting up a new office at home, among others…
Moreover, the U.S. economy remains very strong by the numbers. Yes, economic activity has scaled down from its peak last year; but remains very strong within historical context. Unemployment is at historical lows, job openings are down but remain stubbornly high, consumer prices, consumer expectations, home sales, and home permits continue to show resilience… sectors of the economy that are the biggest and strongest within the. U.S. economy remain robust.
Although the failure of certain regional banks has rattled Wall Street, they do not pose systemic implications and remain isolated events given internal issues as to how the individual banks managed their own risk. Some of them had exposure to certain sectors of the economy that were too stretched related to certain more speculative tech and cryptos.
The Money Supply (M2) in the U.S. remains grossly above its organic rate of growth. Keep in mind, a decade or so of policies of QE, adding liquidity to the banking system, will not go away overnight. Moreover, the Velocity of Money, which is the frequency at which the money is used within the economy, is starting to rise after decades of declines.
When Does Inflation Hurt?
The pain of inflation can be seen with the increases in costs of things. However, until now, the labor market has been so strong that wage increases have kept up with the rate of inflation. This means the average consumer is aware of the increases in prices but does not have a problem making ends meet as they’re probably doing better off overall themselves.
Keep in mind, due to constant inflationary pressures, the Fed will likely remain on its rate hike path. It’s not likely to get distracted by failed regional banks that pose no systemic risk when inflation and the labor market both remain strong. But ongoing rate hikes will likely slowdown the economy in the U.S. at some point, and could stop the wage hikes or push unemployment up higher all together without necessarily affecting ongoing inflationary pressures; a recipe for stagnation…
The Fed is going into a tough time as they know they must hike rates to keep the fight against inflation alive. But the Fed also knows they will be inflicting pain on people’s lives as unemployment rises and in the U.S. treasury’s own capacity to pay the increase in financing costs from higher rates.
The Fed could eventually drop its 2% inflation target and adopt something closer to where the neutral rate would stand today. This measure would be yet another way to ease the stance against inflation and let it develop organically. It would allow the Fed to remove some of the pain that comes from the needed hikes to bring inflation down.
Gold’s Perfect Storm
The entire situation is very bullish for gold. Starting with global fragmenting, to de-globalization to geo-political tensions, to the nuts and bolts of what drives inflation.
Gold will grow in relevance as a currency to arbitrage the differences between global economic systems that are being forged. Countries and blocks will continue to increase their reserves of gold to remain globally relevant (it’s no coincidence central bank are buying gold at a record pace in historical context).
Gold will grow as the haven of choice, particularly as the gap between inflation and interest rates (the ‘real rate’) remains zero or negative. It’s no coincidence gold remains within its secular bull market since the early 2000's.
The trend of inflation is here to stay. The shift in mega trends point toward higher inflation for longer; the new normal. We must adapt our thinking, investing, and trading to a new reality that systemically differs from what most have become accustomed to over the last 30-40 years.
We must go back to basics, to investing in what’s real…