Inflation at All Costs

Our new governor of the Reserve Bank of Australia gave his maiden speech yesterday and it was all about the battle against low inflation.  Australia like most of the rest of the world (except the US) is stuck in a low inflation slump.  Why is that bad you ask?  Well if you (Australia) have $6 trillion of debt, $1 trillion of that to overseas lenders (as we discussed recently here) and your economic growth and fiscal policy mean you are unable to pay that back, other than defaulting the only option is to inflate it away.  Inflation is their only hope after this unprecedented credit cycle.

The other reason for the need for inflation is to give the appearance of economic growth.  Real growth is below expectations despite all the monetary stimulus.  Nominal growth includes inflation, and so looks better.  Problem solved.  Lowe barely touched on the resulting property bubble yesterday (nothing to see here, you’re “all” getting “richer”…).  But that comes at a time when wage growth is stuck at a 25 year low.  So there is a very real erosion in disposable income.  Its arguably worse in the US where the monetary stimulus through both QE (money printing) and ZIRP (zero interest rates) has stimulated inflation, but to date largely just in shares and property which enriches the top 1-10% at the expense of the rest who struggle with stagnant income and inflation on real things not always included in the CPI basket.  Topically, US Core CPI (released yesterday) is on the rise, hitting 2.2% in September, and has now been above the Fed’s 2% target for 11 straight months.  Rather than raising rates in September they deferred to ‘maybe’ December.  Surprise surprise…

The risk is, that with all this new and easy money in the system, that inflation can ‘get away from you’ and you lose control.  Gold historically thrives most in a high inflation environment, and in particular a negative real rates environment.  The US interest rate is 0.5%, less CPI and you are firmly in negative real rates territory.  Likewise here we are at 1.5%, less our CPI and again you are in the red.

This all comes at a time when the calls for an imminent US recession are growing louder.  Should that happen you could almost bet the US Fed will throw the monetary stimulus kitchen sink at it.  Under that scenario, ex hedge fund head at Goldman Sachs Raoul Pal recently said gold would double.  On the chances of that happening, and remember a US recession when they are supposedly the only thing saving the global economy at present will see a global sell off, he said:

“The business cycle points to that [its now been over 7 years], and 100% of all two-term elections have had a recession within 12 months since 1910.”

It seems gold wins in either scenario.  Business as usual and “this time is different” with no recession (after already one of the longest non-recession streaks in history), and gold will enjoy central banks attempts to get high inflation at all costs.  A US recession happens and you see a global sell off of all those inflated financial assets, a run to the safe haven of gold, followed by central banks throwing more stimulus at the fire and boosting gold further.