If you thought inflation had disappeared, well, think again Inflation has been quietly picking up steam again, rising the past two months The latest inflation data from the Bureau of Labor Statistics...
Today’s consumer price index (CPI) release showed that inflation slowed to 4% year on year, from 4.9% year on year last month. The news headlines of course play this up as a positive result of the Federal Reserve’s monetary policy. But if you look behind the numbers, everything isn’t quite as rosy.
While Americans have suffered under high inflation for the past several years, a reduction in the increase of the inflation rate isn’t necessarily going to make things better. And there are two primary reasons that even slowing inflation could remain problematic.
Permanently Higher Prices
The first of course is that inflation has driven prices to permanent new highs. That $4 bottle of orange juice isn’t going to drop back to $2.89, nor will its size increase from 52 oz. back to 59 or 64. The price increases we’ve had to deal with for food, clothing, and rent are the new normal.
Many Americans haven’t seen their paychecks increase anywhere as fast as prices did, so the new higher prices have been slowly eroding their standard of living. While paychecks may eventually catch up to inflation, that’s not helpful in the short term.
And with inflation still at 4%, that’s still double the Fed’s target rate. It also means that prices will double in just under 18 years. While 4% may be lower than it was several months ago, it doesn’t mean that the dangers of inflation have been overcome yet.
Falling Money Supply
The other problem we’re seeing today with slowing inflation is a falling money supply. Now, if you know anything about inflation you may be wondering, why is a falling money supply a problem? Wasn’t the increase in the money supply the whole reason inflation happened?
Yes, the traditional definition of inflation was always an increase in the money supply, the effect of which, all other things being equal, was a rise in prices. So when the money supply began to increase significantly in 2020, and the Fed didn’t try to neutralize its monetary injections like it did post-2008, it was all but inevitable that the inflation rate was going to rise.
The M2 money supply rose 42 percent from January 2020 to March 2022. During that same period the CPI only rose 11 percent. Even taking a longer period, from January 2020 until today, CPI has only risen 17 percent. Tell me, does it feel to you like your costs have risen 17% or 42%?
Monetary policy is notorious for working with a lag. It can take months for monetary policy actions to manifest themselves in the economy, whether that’s in the form of higher prices, more unemployment, or greater economic growth. So it’s not surprising that it took a while for a rising money supply to show up in the form of higher prices.
What’s happening now is that the money supply is falling. The M2 money supply has fallen about 5% since March 2022, in what could be the first really sustained contraction of the money supply since the Great Depression. Yet prices are still increasing even with a falling money supply.
There are two things to consider here. First, the scale of the Fed’s monetary injections from 2020 onward were so massive that inflation is still rising even as the money supply is falling, because we never saw the full effect of the 42% increase.
Second, if the Fed continues on its current course of monetary tightening, we may eventually start seeing deflation, which would be defined by a fall in the price level. Now, falling prices aren’t necessarily a bad thing. When prices fall as a result of increased production, everyone ends up better off. But when prices fall as a result of an engineered reduction of the money supply, the effects aren’t benign.
Inflation isn’t something that can be undone by deflation. Deflation after inflation doesn’t automatically reverse the effects of inflation. Instead, imagine inflation as driving over someone with your car. Purposeful deflation is when you put the car in reverse and drive back over the person again. Deflation in this case is something that has negative consequences every bit as dire as inflation.
One of the most important of these effects is that it strengthens the value of the dollar. Now again, you may be asking yourself here, why is a strong dollar a bad thing? A stronger dollar with greater purchasing power isn’t a bad thing, except when its creation is through monetary manipulation.
The US economy today is sitting on a mountain of debt. The US government is approaching $32 trillion in debt. Total household debt is above $17 trillion. And total corporate debt is closing in on $13 trillion, nearly double what it was before the 2008 crisis.
One of the reasons for the proliferation of this debt is that inflation benefits debtors. If you take on debt but know that you can repay it in currency that is worth less in the future, it incentivizes you to take on more debt. These $60 trillion in debt have been taken on with the understanding that the dollars used to pay that debt off in the future will be worth less than today’s dollars.
Now imagine that you have to pay off your debt with money that is worth more in the future. That would be incredibly painful financially. It benefits bondholders and creditors, but it punishes debtors.
Businesses and households that have to pay off their debts in such a deflationary environment find that the debts they have incurred become more expensive, and are thus more difficult to pay off. Both businesses and individuals may find themselves unable to pay off those debts, and thus may have to declare bankruptcy to try to discharge their debts. And that could have dire consequences for the health of the economy.
The Fed Is Playing With Fire
By deliberately shrinking the money supply, the Fed is playing with fire. It is hoping that it can contract the money supply enough to bring inflation down to its 2% target, but not contract it enough that deflation results. Given the lag effect of monetary policy and the Fed’s track record over the past 15 years, it’s hard to place much trust in Fed policymakers to get things just right.
If the Fed ends up pushing too far and ushers in major deflation, the effects could be catastrophic to the economy. But while debtors would suffer the ill effects of this deflation, savers and investors in appreciating assets could very well benefit. One of the assets that could benefit greatly from deflation is gold.
Gold has served as a safe haven, store of wealth, and hedge against inflation for centuries. It has a reputation for maintaining its value through recessions and economic crises, and for maintaining its purchase power in the face of high inflation.
Gold has been a popular means of asset protection during recent crises too, in the aftermath of the 2008 crisis, during the 2020 recession, and over the past couple of years as gold demand has increased among those looking to safeguard their wealth against a coming recession. If the Fed’s policies end up pushing the economy into a severe recession, many people expect the gold price to take off.
With over $2 billion in precious metals placements and thousands of satisfied customers, Goldco has worked hard to become one of the biggest and most trusted names in the precious metals industry. We work directly with mints around the world to bring our customers genuine precious metals coins that they can purchase directly with cash or hold as part of a gold IRA.
With the money supply steadily decreasing and the Fed coming ever closer to the point at which it has to decide where the trade-off comes between tackling inflation and keeping the economy healthy, there isn’t an unlimited amount of time left for Americans to safeguard their savings. Call Goldco today to learn more about how gold can help you protect your wealth, before the economy falls into another recession.
Request Your Free Guide
Free Precious Metals Guide
Complete the Form Below
Request Your Free Guide
Free Precious Metals Guide
Complete the Form Below