The era of federal deficit spending without an inflation spike has come to an end. Given the combination of supply-chain interruptions and monetary expansion, higher prices were inevitable.
The signs are there for all to see—so one would do well to respond accordingly.
1. The Federal Reserve’s ‘Flexible’ Inflation Targeting
On Aug. 27, the Federal Reserve’s Open Market Committee released an update to its monetary-policy strategy—permitting inflation beyond the targeted 2 percent. The update is notable for what it doesn’t say, and this opaqueness appears to be a tactic to loosen accountability and roll out the red carpet for higher inflation in the coming months.
Fed Chairman Jerome Powell describes the shift in inflation targeting as “flexible”—a dovish move away from rules-based monetary policy. As James Mackintosh of The Wall Street Journal assures, “The Fed is stuck at zero [interest] rates,” which means “the reflation trade is back.”
Fed officials acknowledge what many of us expected: Inflation is here and has started appearing in even official measures with Fed approval.
2. Private Metrics Are Pushing Past 10 Percent
Precise measures of the price level are notoriously hard to agree on, and they rest heavily on one’s definition, methodology, and data sources. There’s good reason, however, to doubt official measures and seek private alternatives. Just ask the Argentines, where for years the central government banned private inflation measures and fixed the price of Big Macs to evade international observers.
The official Consumer Price Index (CPI) from the Bureau of Labor Statistics measured 0.6 and 0.4 percent jumps in July and August, respectively, which translate to 6 percent on an annual basis. That’s beyond the 2 percent target, but it lags alternative measures.
The Chapwood Index, for example, tracks the 500 most-purchased items in the 50 largest U.S. cities. It has found average inflation at about 10 percent over the past five years, and New York (12.7), Los Angeles (13.1), and Chicago (11.2), plus 19 other cities, have all broken 10 percent over the first half of 2020.
3. The Gold Price Has Reached a Record High
The U.S. Dollar Index (DXY), which tracks the dollar’s value against a basket of currencies, fell by 0.7 percent on Aug. 28. This crystallized months-long sentiment that confidence in the dollar was waning.
That is in contrast to gold, the ultimate safe haven and indicator of the greenback’s strength or lack thereof. Gold has been rallying for months, and in August, it cracked $2,000 per ounce for the first time. The trend is undeniable: Gold is up 28 percent in the past six months, 31 percent in the past year, and 77 percent in the past five years.
Even institutional investors are accepting what gold bugs have pointed out for decades: A ballooning money supply to feed budget deficits and easy credit cannot go on forever without repercussions. The Chinese and Russian central banks have noticed and been stockpiling gold for nearly a decade.
4. Consumers Are Running to Staple Items
The flipside to inflation is reduced purchasing power—a tax on people with fixed incomes. When people are poorer—from inflation or an economic downturn—they focus their spending on necessities and what economists call inferior goods: more affordable but less desirable substitutes.
This trend is meaningful for two reasons: 1. it demonstrates everyday experiences, as opposed to what comes through the cloud of official metrics, and 2. it shifts the weights of what should be measured in the relevant basket of consumer prices.
Alberto Cavallo of Harvard Business School is a co-founder of the Billion Prices Project, which aggregates prices for millions of items sold by online retailers. This project’s sophistication is leaving conventional measures in the dust.
As reported by Money Week, Cavallo believes “COVID-19 has in effect imposed higher prices on most of us through its impact on our lifestyles. … It has changed our habits so that the average official inflation ‘basket’—which tries to measure the lifestyle of the ‘average’ consumer—is now completely out of whack with real life.”
He points to more grocery spending relative to discretionary items such as travel, and he contends inflation is higher than official metrics. Clues have appeared in some CPI components such as food for home consumption. These prices have risen 4.6 percent in the past year and outpaced restaurant prices.
Is Stagflation Back?
Depending on whether there’s a weak or strong post-pandemic recovery, record-breaking deficits could snowball into stagflation. That’s both high inflation and negative or low economic growth, as warned of by economist Nouriel Roubini of New York University.
Going by the definition of negative growth and above-targeted inflation, Peter Warburton of Economic Perspectives, a UK-based consultancy, sees this as a 25 percent likelihood. Even if he subscribes to the view that we are entering an inflation spike, he remains upbeat about growth.
Warburton explained on Grant’s Current Yield podcast that personal incomes are up even if economic activity is down, given vast transfer payments in the past half-year. Thus far, Americans have increased their saving rates, but “the notion that somehow the saving rate is going to stay up at 20 percent or 15 percent is somewhat fanciful. … Those saving rates will come crashing down to earth pretty quickly, and a lot of spending power will be presented to the market at a time when a lot of producers certainly haven’t got their act together,” he said.
Individuals and institutions need not let transfer payments blur their perceptions and encourage spending. Our focus must remain on our own genuine productivity and real assets. Inflation compels us to avoid holding cash and orient our portfolios toward low-beta investments such as precious metals, mining stocks, and real estate. The S&P 500 price-to-earnings ratio of 29 is double its historical average, so it already reflects easy credit and an artificially inflated stock market.
The Federal Reserve and federal government are letting the genie out of the bottle. Given that higher interest rates are politically implausible—taxpayers would reject them—the Fed may not be able to put it back in.
Fergus Hodgson is the founder and executive editor of Latin American intelligence publication Econ Americas. He is also the roving editor of Gold Newsletter and a research associate with the Frontier Centre for Public Policy.
Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.