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Inflation: Dr.Frankenstonk's Monster

It's alive! It's aliii-iiiiive...!
 
YOU KNOW the myth of Frankenstein, says Adrian Ash at BullionVault.
 
The mad professor...
 
...wanting to do good but soon dreaming of power to match God himself...
 
...brings a corpse back to life.
 
The Creature proves to be a monster, breaking out of the laboratory, causing havoc and killing Frankenstein's fiancé.
 
The poor Doctor then spends what remains of his sorry life chasing his Monster, hoping to kill it and undo his terrible experiment. But to no avail.
 
Remind you of anything?
 
Mad professors at work in the lab
 
"Central banks, to be true to their mandates, need to raise inflation rather than lower it," said Larry Summers – a key US policymaker of the 1990s and 2000s – back in March 2020.
 
The need to revive inflation was consensus among Summers' policy-wonk friends and colleagues. It had already been consensus for a decade or more. It remains the stated aim of most major central banks today.
 
Why?
 
Low inflation, they feared, risks slipping into a Japan-style deflation...
 
...where falling prices lead to falling wages...
 
...driving up the real cost of servicing and repaying debt...
 
...and spiralling into a long economic decline punctuated by debt defaults and bankruptcies.
 
Hence the low interest-rate policies imposed since the DotCom Crash of 2001.
 
Hence the huge QE money creation and bond-buying schemes starting in 2008.
 
Better to raise inflation from the dead at any cost, in other words.
 
Inflation failed to respond, however.
 
All those massive electric shocks did nothing to revive inflation in consumer prices. Not on the official measures at least. Nor in shop and store prices.
 
In the 20 years ending December 2019, US consumer-price inflation averaged 1.7% per year on the Fed's favourite measure, the core PCE index.
 
That was less than half the average 3.8% of the previous 2 decades.
 
This failure didn't stop central bankers from pressing on with their experiment.
 
Rates stayed low – lower than any time in history – while QE became a permanent "tool", helping keep longer-term borrowing costs at record lows in the bond market.
 
Then Covid struck...
 
...and the mad professors were faced with a global economy sunk into an induced coma of lockdowns, shuttered shopping malls and restaurants, social restrictions and collapsing commodity costs.
 
Crude oil prices went negative because nobody wanted the stuff.
 
What to do?
 
Even with the world deep asleep in that induced coma, it got a massive adrenaline shot from monetary policy.
 
Rates were slashed yet lower and QE went into overdrive.
 
At the same time, fiscal policy also pulled the lever marked 'Danger!' and shot a million volts through the system...
 
...flooding households and business with 'helicopter drops' of free cash and zero-cost loans to see them through.
 
The result? Meet Dr.Frankenstonk.
 
Chart of US Fed QE holdings, Nasdaq stock index, gold. Source: St.Louis Fed
 
You can pronounce the 's' as a 'sh' if you like, for extra comic effect.
 
Frankenschtonk.
 
Either way, 'stonks' you will remember are what young private investors trading the financial markets on their mobile phones came to call 'stocks' over the last couple of years.
 
That's because, in their brief money-soaked experience, stocks only ever go up.
 
Stonkingly so.
 
House prices too have surged even though social and economic activity has been squashed, rising far out of reach for younger home-buyers as they pile into crypto and fractionalized equities instead.
 
Can you guess why?
 
Starting with the US chapter of this sorry tale, the green line above shows the quantity of assets bought and held by the US Federal Reserve using QE money creation.
 
The Fed's mountain of assets has pretty much doubled since the Covid Coma began, rising from $4.5 trillion of government and mortgage-backed bonds 18 months ago...
 
...up to nearly $9 trillion-worth as of Wednesday.
 
During lockdown of course, all this extra money – like the stimulus checks sent by Washington to almost every US adult – had few places to go.
 
Not in terms of the 'real' economy. Not beyond all those extra streaming TV services, Amazon orders and pizza deliveries.
 
But the money had to go somewhere. And as you can see, the US stock market (blue line) has also pretty much doubled since the Covid Coma phase of this crisis.
 
The tech-heavy Nasdaq Index has now risen from below 8,000 during the initial crash of Feb-March 2020 to more than 16,000 as of Friday's new record highs in New York.
 
Gold has also risen, of course. But because it was already rising – and because it then didn't crash with everything else when Covid first hit – it hasn't sprung into life in anything like the way that stonks have responded to the Fed's mad-scientist Pandemic Shock Therapy.
 
Gold (and silver) now continue to tread sideways, having offered safe haven from the initial financial and monetary chaos of the Covid pandemic.
 
Lots of people are disappointed by this. Lots more are crowing about how it proves gold is actually a useless lump of metal. Because it is trading sideways below $1800 per ounce even though the Fed's creation has now broken out of the lab.
 
Meet Dr.Frankenstonk's Monster.
 
Chart of US producer price index, commodity costs. Source: St.Louis Fed
 
The black line charts the Producer Price Index of commodity costs for US businesses.
 
The red line charts its year-on-year change. And here in autumn 2021, the cost of raw materials is jumping at its fastest pace since the first 1970s' oil crisis.
 
Inflation is very much back from the dead...
 
...finally electrified into life by helicopter money, central bank QE, zero interest rates and now pent-up demand all coursing through the system ...
 
...just like the giant Creature sewn together and re-animated by Dr.Frankenstein.
 
That, at least, is what the markets think. Pundits agree. So too, bizarrely, do central bankers themselves.
 
"Monetary policy cannot solve supply-side problems," said Bank of England governor Andrew Bailey last month.
 
He's not wrong. Not entirely.
 
Higher interest rates won't build more containers or load them faster onto more container ships. But they could help squash the consumer and business demand which is making the post-lockdown gaps and blockages in global manufacturing, shipping, transport and labour markets so very expensive.
 
That would be madness, of course. Central bankers today are tasked with boosting GDP (and fixing climate change. And inequality) as well as keeping a lid on prices.
 
Cue the mad professor.
 
"[We] will have to act and must do so if we see a risk, particularly to medium-term inflation and to medium-term inflation expectations," Bailey went on, even though acting to raise rates wouldn't in his own analysis do anything to help.
 
"And that's why we at the Bank of England have signalled, and this is another such signal, that we will have to act."
 
Bailey's stance was so messed up, it's hard to know where to start.
 
Yet his failure to follow through last Thursday looks crazier still.
 
Bailey's plain promise of mid-October primed the bond and interest-rate markets. Going into this week's decision, two-thirds of traders betting on UK interest rates were betting on a rise to 0.25%.
 
But the Bank kept rates at 0.1% even as it forecast that inflation will hit 5% in New Year 2022...
 
...and upturning market expectations worse again, Bailey then took to the airwaves on Friday to claim that "at no point did I or any other member of the Monetary Policy Committee say rates are going to rise at the meeting on November the 4th."
 
Say wut?
 
Dr.Bailey isn't alone in muttering that the Creature which central bankers have for so long dreamt of reanimating is in fact a Monster which needs hunting down and killing...
 
...even as he loses his bottle and hides inside his lab rather than heading out to try undoing his own mischief.
 
Last week the Bank of Canada surprised everyone by ending its pandemic QE programme...
 
...ceasing the creation of yet more new money to buy yet more government debt...
 
...while also bringing forward its timeline for raising interest rates from zero to sometime in mid-2022...
 
...but leaving rates unchanged for now at a record low 0.25%.
 
That's more than 4 full percentage points behind the latest reading of Canada's consumer-price inflation.
 
Australia's central bank also "stunned investors" at the end of October (to quote the Wall Street Journal) by not interfering in the bond market and so failing to keep 3-year interest rates at or below its stated target of 0.1% when yields moved up through that level ahead of start-November's Reserve Bank policy meeting.
 
The RBA then went ahead with what one economist called a "startling about-face" at that meeting, formally abandoning its 'yield curve' plan. Yet at the same time the RBA vowed to continue with longer-term bond purchases until February, and it squashed any thought that rates might rise next year as pundits and traders expected.
 
"The latest data and forecasts," said RBA governor Philip Lowe on Tuesday, "do not warrant an increase in the cash rate in 2022."
 
The US Fed on Wednesday then announced the beginning of the end for its $120 billion per month in new QE, but chair Jerome Powell refused "to even countenance a discussion of when rates should go up" in his post-decision press conference as the Financial Times put it.
 
Eurozone central-bank chief Christine Lagarde meantime said that the European Central Bank is "very unlikely" to raise its rate from minus 0.5% next year, because inflation looks "subdued" long term. 
 
That's despite inflation currently running at 3-decade highs in No.1 Euro economy Germany, earning the ECB president the title "Madame Inflation" from tabloid paper Bild.
 
"Surging global prices have prompted central banks from New Zealand to Mexico to raise interest rates," says Bloomberg. "Just outside the Euro area, Poland and the Czech Republic surprised with bigger-than-expected hikes this week."
 
But inside the 19-nation currency bloc?
 
Bloomberg gamely tries to make the ECB debate around maybe raising rates from below zero sound balanced, if not fractious.
 
Its own 'hawks vs. doves' graphic however shows the odds deeply stacked against Germany's Jens Weidmann or Austria's Robert Holzmann for winning over France, Italy, Spain or Portugal to the idea of raising borrowing costs any time this side of never.
 
Long story short, central bankers might say they're enraged by the monster they have finally unleashed after decades of trying.
 
They might even vow that they are going to try hunting it down...
 
...waving pistols and daggers of 'tapering' and slightly higher interest rates.
 
But for some of these academics, finally reviving inflation is the culmination of a lifetime's long, lonely work.
 
And when they do wake up to the nature of the monster they have let loose – and like the poor, mad scientist in Mary Shelley's novel – they will surely find that the Creature is always one step ahead...
 
...leading them (and us) into a frozen wasteland.
 
No, gold and silver haven't yet responded to the inflation monster. But today looks very early into its rampage.
 

Adrian Ash is director of research at BullionVault, the world-leading physical gold, silver and platinum market for private investors online. Formerly head of editorial at London's top publisher of private-investment advice, he was City correspondent for The Daily Reckoning from 2003 to 2008, and he has now been researching and writing daily analysis of precious metals and the wider financial markets for over 20 years. A frequent guest on BBC radio and television, Adrian is regularly quoted by the Financial Times, MarketWatch and many other respected news outlets, and his views from inside the bullion market have been sought by the Economist magazine, CNBC, Bloomberg, Germany's Handelsblatt and FAZ, plus Italy's Il Sole 24 Ore.

See the full archive of Adrian Ash articles on GoldNews.

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