Inflation Is Under Control… Or Is It?

When inflation data came out last month showing that the consumer price index (CPI) had fallen to 3% year on year, many observers hailed it as evidence that the Federal Reserve’s monetary policy tightening was working, and that it was only a matter of time before inflation got down to the Fed’s 2% target. But the most recent CPI release, showing inflation rising to 3.2%, has brought up some troubling questions.

How could inflation be climbing at a time when the Fed is not only raising interest rates but also drawing down its balance sheet and trying to shrink the money supply? And what could that mean about the future of your finances?

Was the Fed’s Pause to Blame?

The Fed paused its series of interest rate hikes in mid-June for the first time in months, allowing for the potential to see what effect that might have on inflation. So while the 3% inflation rate we saw in June was still at least halfway due to tightening, the 3.2% inflation we saw in July occurred with nearly a full month of paused hikes. Could the pause have been the result of this bump up in the inflation rate?

If so, that would be quite significant, and could leave the Fed in a conundrum. Interest rates are already at the highest level they’ve been in years, and the Fed is obviously concerned that its rate hikes could slow the economy enough to send it into recession. So it wants to ensure that it doesn’t raise rates so high that it chokes off economic growth.

On the other hand, the Fed wants to bring inflation under control, and last year’s inflation that approached 10% was a scary wake-up call. In that sense, the fact that the recent small boost in inflation occurred as a result of the Fed’s pause could be taken as confirmation that the Fed’s rate hikes are indeed responsible for the fall in inflation rates over the past year.

So if the Fed wants to really return to its 2% target inflation rate, it would seem to indicate that the Fed needs to continue raising rates. But the fact that inflation could still be rising despite the money supply having shrunk highlights something else that could be problematic.

Money, Inflation, and Recession

Along with the Fed’s rate hikes, the Fed had been drawing down its balance sheet for months, leading to a fall in the M2 money supply. But there was a big blip in March, as the Fed stepped in to help stabilize the banking sector in the aftermath of several large bank failures.

That assistance was to the tune of hundreds of billions of dollars, counteracting the Fed’s attempts to draw down its balance sheet. And while the Fed has resumed its previous course of reducing the size of its balance sheet, the fall in money supply we saw has now stopped.

On the one hand, that’s not necessarily a bad thing. After all, the last time the money supply dropped significantly was during the Great Depression, and it arguably made the depression worse than it otherwise might have been. But on the other hand, we’re getting an up close lesson in money supply growth and how it impacts inflation and financial markets.

That little blip in mid-March, in which the Fed pumped in nearly $400 billion into the financial system, was followed by an increase in the M2 money supply in both May and June, then by an increase in inflation in July. And stock markets, which had started off the year on a weak footing, all of a sudden began to take off in June too. Are we seeing the lag effects of monetary policy in real time?

We know from economic theory that monetary policy actions don’t always result in immediate effects. But because this decrease in the Fed’s balance sheet hasn’t taken place linearly, thanks to the bank failures, it seems as though we can tell just how the Fed’s actions are impacting inflation and stock markets.

It seems that it took 2-3 months for the Fed’s monetary injections to show up in the form of increased M2. And it took about 3-4 months for it to show up in the form of increased inflation and growing stock markets.

Consequently, if the Fed continues on its present path of drawing down its balance sheet, we might expect to see the money supply start falling once again within the next month or two, with both inflation and stock markets also falling along with M2.

All of this is backward looking, of course, and there’s no way to tell from week to week what the Fed is going to do. That’s why it’s often more important to look at overall trends rather than particular discrete data points. But the trend right now seems to indicate that the temporary CPI and market boost we’ve seen in recent months is the result of that $400 billion infusion in March and, absent any further monetary injections, both CPI and markets should start to fall again once autumn approaches.

Gold and Protection

The potential for recession and economic downturn has had many Americans on edge for months. They’ve been looking for ways to protect their finances against what could be a tremendous financial crisis, and that’s one reason that demand for gold has been so strong.

When the chips are down and things look grim, many people look to buy gold to help protect their financial well-being. Whether it’s through direct cash purchases or through investment vehicles like a gold IRA, gold can provide asset protection through tough times. During the 2008 crisis, for instance, gold gained 25% at the same time markets lost more than 50% of their value.

If you’re looking for ways to protect your hard-earned savings with gold, get in touch with a Goldco representative today. With over $2 billion in precious metals placements and thousands of 5-star reviews, Goldco works hard to provide our customers with precious metals options that can benefit them. Call Goldco today to learn more about how you can put gold to work in safeguarding your savings.