The Fed Doesn’t Understand Inflation, and That Should Terrify You

The Fed Doesn’t Understand Inflation, and That Should Terrify You

Federal Reserve Chairman Jay Powell seems like a nice enough guy. And unlike his predecessors, he seems like a pretty straight shooter. But sometimes the plain English coming from his mouth is enough to scare the bejeesus out of you.

Alan Greenspan was known for developing what is now known as “Fedspeak,” the art of making long, wordy statements that sounded good when you heard them but really meant nothing and could be interpreted to mean anything any listener wanted to hear. The intention was to obfuscate what the Fed was actually doing. As long as stock markets kept climbing, which they did for most of Greenspan’s tenure, everyone seemed to overlook it.

Ben Bernanke and Janet Yellen continued the tradition and, although they weren’t quite as good at it as Greenspan, they still managed to say a whole bunch of nothing. Every Fed press conference and every round of testimony before Congress was met with gobbledygook. Trying to figure out just what the Fed was doing was nearly impossible.

Powell, by comparison, is much easier to understand. He’s a lawyer, not an economist, and so his language is much more straightforward. He also has been pretty explicit about what the Fed is doing and what it plans to do, which is a refreshing change. But sometimes when he speaks you realize that neither he nor the Fed understand the forces they’re dealing with, which is absolutely terrifying.

What Is Inflation?

Powell’s recent comments before Congress on inflation are particularly worrying. It’s important to distinguish once again between the traditional economic understanding of inflation and the modern usage of the word.

Traditionally, economics considered inflation to be an increase in the money supply, the effect of which, all other things being equal, was an increase in the general price level. Today effect has been confused with cause, so that the economics profession today considers inflation to be a rise in prices.

That’s why Powell was able to say with a straight face last week that increases in the money supply had nothing to do with inflation. Per Powell, “there was a time when monetary aggregates were important determinants of inflation and that has not been the case for a long time.” He went on to add, “the correlation between movement in different aggregates, you mentioned M2, and inflation is just very, very low.”

Not only does Powell demonstrate his ignorance of economics, he also gets to demonstrate that he’s completely, 100% dead wrong.

Money Supply and Inflation

Let’s look at Powell’s claim that aggregates like M2 have very little correlation to inflation. Looking at the period from 1980 to the end of 2019 (before COVID stimulus), we see that there’s a 95% correlation between M2 and CPI (consumer price index). That’s pretty strong.

But maybe Powell and the Fed would argue that the age of quantitative easing has undone that, with massive amounts of money creation leading to less inflation than you might otherwise think. That’s certainly a plausible explanation, and seems at least superficially defensible. But is it true?

Let’s take a look at the correlation between M2 and CPI between November 2008 (when QE1 was first announced, and the end of 2019. What do we find? A correlation of over 98%. That’s just about as close a correlation as you can get. Even if you extend that to 2021, there is a 96% correlation. So Powell was clearly off base in his comments.

What Is the Fed Doing?

What Powell may have meant is that after the massive infusion of money into the financial system last year, we haven’t yet seen the effects of that monetary inflation. And that’s certainly true. But it won’t remain that way forever.

The M1 money stock increased nearly 70% last year, while M2 increased nearly 25%. With Congress about to pass a $1.9 trillion stimulus package, and the potential for even more stimulus spending in the future, the money supply is likely to continue increasing significantly this year. At some point we’re going to start seeing major increases in prices of food, clothing, gas, and housing. And when that happens, millions of American households will feel the pinch.

The Fed will probably ignore their pleas, fully believing that nothing it is doing will have any effect on inflation. And by the time inflation really starts to jump, the Fed will find itself well behind the curve and unable to do anything to stop what it has been doing.

That’s particularly true if the Fed continues its subservience to Congressional spending, monetizing every dollar of deficit spending from here on out. The next year or two could change the course of this country for good, and not in a good way.

How to Defend Yourself Against Inflation

Americans haven’t had experience with high inflation since the stagflation of the 1970s that ended in the early 1980s. Once Paul Volcker and Alan Greenspan took the helm of the Fed, official CPI figures have been trending downward ever since. It has been about 30 years since Americans have seen official inflation figures of 5%, with current inflation numbers having been at 2% or below for over a decade.

What that means is that resurgence in inflation will catch many investors completely off guard. They won’t know how to react, how to protect their investments, or what to do. Many will undoubtedly think that the inflationary resurgence is a one-off occurrence, and they may do nothing to protect themselves. If they guess wrong, they could see the value of their retirement savings eroded away bit by bit.

Many investors today are choosing to invest in gold to protect their assets against inflation. With gold’s reputation for holding its value against inflation, that makes it a natural choice for those looking to safeguard their portfolios.

Through a gold IRA, you can buy gold coins or bars while still maintaining the same tax treatment as any other IRA account. You can even roll over or transfer assets from existing retirement accounts such as a 401(k), 403(b), TSP, or IRA account into a gold IRA without tax consequences, allowing you an efficient means of protecting the retirement savings you have worked so hard to accumulate.

If you’re beginning to worry about inflation and the effect it will have on your assets, maybe it’s time for you to start thinking about buying gold. When inflation begins to pick up, the gold price could begin to rise ever higher. And if we return to an economic atmosphere like the stagflation of the 1970s, there’s no telling how much gold could grow.

Don’t wait until it’s too late and inflation has eaten away at your wealth before protecting your assets. Call the experts at Goldco today to learn more about how gold can help you.

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