The Fed is beginning to wake up from its dream. At least to a degree. After having been told for months that inflation doesn’t represent a real danger to the recovery of the US economy, all of a sudden Fed chairman Jay Powell has turned hawkish.
As it turns out, the Fed doesn’t have inflation quite as much under control as it thought it did, and while there’s a general consensus amongst establishment economists that the current inflationary pressures will pass, the threat has now become serious enough for talk of countermeasures in the form of interest rate rises.
Whether or not much in the way of real interest rate rises will be delivered is an open question. It’s long been recognised that the Western world, led by the Fed, has been artificially stimulating its economy with low rates, and that if we are ever going to get anything like a normal economy back again, rates will have to rise. That can’s been kicked down the road so many times now though that people had given up talking about it.
So, is it real this time?
The trouble is that in this world of hourly news cycles, long-term thinking like rate rises benefits no-one. Raising rates in a meaningful manner will cause economic pain, will cause job creation to slow, and will put a damper on growth. In as fractured an economic and social polity as the US, no career politician can be seen to be supporting such a move.
And Jay Powell at the Fed knows well enough that having thus far exhibited a remarkable capacity for survival in the transition from the Trump to the Biden regime, he’s unlikely to survive the next election cycle if unemployment starts to rise.
This is the classic dilemma that central bankers have faced over the decades – how to deliver growth without inflation.
In the past decade and a half since the financial crisis, though, they’ve added a major new tool to their armoury – quantitative easing.
This has proved so successful, that it’s common currency amongst market watchers to argue that the Fed is addicted to it. The argument has some force, partly because as addicts do, the Fed has constructed a false narrative around its actions. In this case it’s called Modern Monetary Theory, and it argues that you can print money without causing inflation, conveniently ignoring the massive inflation in asset and commodity prices that has taken place over the past two decades. It ignores too that in the newly globalised economy wages have been kept down around the world by the use of Chinese labour paid at rates far below any Western world minimum wage.
In this environment of false narratives and Modern Monetary Theory, it was just about possible to hold up the rotten edifice of the international banking system after it bankrupted itself in 2008.
At this point the metaphors come thick and fast. The Fed has been kicking the can down the road ever since.
But it won’t be long before the chickens to come home to roost. After all, how much longer can the plates keep on spinning?
The answers won’t be metaphorical. If rates rise, that’ll only be one of several fixes that the world economy needs to apply really to be able to move on from 2008. It’ll also need to roll back quantitative easing and, which is almost impossible to envisage, perhaps even tighten the monetary supply.
But addicts are rarely ever inclined to cut off the supply of their drug. They do, of course, occasionally make grand gestures about quitting – like suggesting a rise in interest rates now and again. But the underlying pattern of addiction remains.
And given all that, the bull case for gold remains as strong as ever, and any short term price weakness likely represents nothing more than a cheap entry point for one of the world’s most enduring stores of value.