Why Higher Inflation is Here to Stay – “super bull case for gold”

Is higher inflation here to stay? Are we looking at stagflation? when will the Fed cut rates? We’re in a market trying to make sense of the current mix of data. Last week saw the 6^th straight week of Bloomberg’s U.S. Macro Surprise data declining to a low not seen since January 2023. That fuelled stagflation pressures and rate cut expectations and of course saw gold and silver take off. But will rate cuts cool inflation or are there broader forces at play?

The chart below is telling as the mix of U.S. economic data continues to decline.

Last night, head of the U.S.’s biggest bank, J P Morgan’s Jamie Dimon gave a sobering account of where he sees things in regard to the Fed’s winding back of its Quantitative Tightening program.

“I'm cautiously pessimistic. We have the most complicated geopolitical situation that most of us have seen since World War II, if you study history. We don't really know the full effect of QT. I find it mysterious that, somehow, it had this beneficial effect, but it's not going to have a negative effect when it goes away. I personally think inflation is a little bigger than people think and that rates may surprise people.”

And taking the inflation piece further:

“It's possible that inflation is embedded in the system at 4% for next year & there's not a damn thing anyone can do about it. That is possible. And I'm not saying it's going to happen. We don't make bets in the future, though I don't believe in central base cases at all. But that is a risk.”

Dimon is one of many now openly questioning the Fed’s resolve to get inflation down to their traditional target of 2%. One of the most respected minds on Wall Street is Queen’s College Cambridge President and Bloomberg Opinion columnist Mohamed El-Erian who had this to say recently in Bloomberg:

““The Fed is going to have to pivot — not on the basis of inflation numbers, but the basis of the real economy,” he added.

Like other market watchers, El-Erian has previously raised the possibility that the U.S. central bank should look beyond its 2% inflation target in a new era of structurally higher pressures on price growth.

Is the inflation target the right target? We all talk about wanting to go back to 2%,” El-Erian said. “Two percent is totally arbitrary. If we are pursuing the wrong inflation target, the risk of a mistake — that mistake would mean sacrificing growth unnecessarily — the risk of a mistake is high.

It’s a world that’s subjected to higher inflation. And we’ve come from a world that was subject to lower inflation,” he added.”

So what does this mean? Tolou Capital Management’s Spencer Hakimian puts it perfectly (in reference to El-Erian’s comments):

“He's right. 2% inflation is arbitrary. But so is 3%, or 4%, or 5%. The only real thing is the entire financial world is priced off an understanding of a 2% inflation target in the United States.

Risk free rates are priced off the fact that inflation is supposed to be 2% over time in the U.S. Every other asset in the world is priced relative to that understanding of risk free rates.

If inflation was suddenly allowed to be 3% rather than 2%, than risk free rates immediately have to be 100 bps higher (even more if you ask me, because you have to price in the risk that they'd abandon 3% inflation one day for 4% tolerable inflation - why not? 3% is arbitrary too after all). And if that happens, all risk assets MUST yield higher (price lower).

Abandoning 2% inflation targeting would be catastrophic for equities, real estate, treasuries, corporate bonds, everything.

It would only benefit gold (as people would distrust dollar assets).

Factor in comments like these [El-Erian’s], and you get the super bull case for gold.

Obviously not a guarantee. But there is a scenario where gold moves upwards out of control for the remainder of the decade. Many of the stars are aligning.”

It is worth noting these comments and El-Erian’s remark that “The Fed is going to have to pivot — not on the basis of inflation numbers, but the basis of the real economy,”. The tweet below is on the basis of rate cuts in ‘normal’ environments when rates are cut when inflation is low and employment weak. The fact that the Fed may be forced to cut with neither adds enormous fuel to the fire described below.

The more cynical or ‘aware’ will note that when the world is sitting on an historically unprecedented pile of debt and nearly every government is running deficits, expanding that debt, there are only 3 ways to reduce that debt. 1. Pay it off with growth income exceeding additional debt (that hasn’t happened in a very long time and shows NO sign of changing), 2. ‘Forgive’ it / wipe slate clean / ‘Debt Jubilee’ (virtually impossible now in a multi polar world with widespread geopolitical disunity), 3. Inflate it away. i.e. reduce the effective size of it by deflating its value by inflating the currency.

Fundamentally inflation is always and everywhere the result of government policies that increase the supply of money circulating in the economy faster than the productive sectors of the economy can expand their capacity to produce goods and services for purchase.

i.e. They will be quietly happy with a ‘new norm’ of 3 or 4% inflation compared to 2%. They’ve just doubled the rate that your Fiat currency depreciates.

And that, in a nutshell, is the difference between depreciating currency and the resulting appreciating gold and silver.

On an unrelated note… Dimon announced he will be retiring earlier than expected.