Vancouver Investment Advisor Ritch Wigham

The Great Inflation!!

By Ritch Wigham

In the last piece I wrote on the gold bear argument I used the term “The Great Inflation”.” What the heck does that mean”, I was asked by a friend.

Let me try and explain:

Back in the old days of the late 1970′s and early 1980′s interest rates were taken into the stratosphere and reached into the high teen’s and low twenties for borrowers in North America and Europe. It wasn’t pleasant. They reached these levels because the world was caught in a spiral of ever increasing costs directly related to ever increasing wage pressures. If it costs me more to feed my family, you must pay me more and therefore it costs more now to produce the product that my company sells. This nasty circle created a time when everyone went on strike for a “fair” living wage. It is when “cost of living” clauses were introduced into almost everything. Consequently,” The Great Inflation” became the economy’s greatest test.

In Canada wage and price controls were tried for a period but ultimately it was the use of interest rates to sky-rocket that was the mechanism that brought inflation back into check. This of course shut down the economy and a recession ensued that can be argued lasted until the great expansion of the nineties. Productivity was crushed and inflation finally receded.

See the following report. (opens a .pdf)

If you look at the charts from the link above you will see a very close correlation from 1980 onward between the CPI (consumer price index) and the bond rates in the U.S. The interest rates were how the Federal Reserve and the Bank of Canada here in Canada were able to finally get inflation in check. At different times the economy suffered but it was realized (or at least believed) that short term interest pain was much better than longer term price pressures that were more economically deleterious. So the balance between price and interest rates has dictated what has happened since roughly 1980. So far that balancing act has been relatively successful with the central banks world wide collectively patting them selves on the back for their collective interest rate policy.

Gold and the present

Sooooo, this is why the gold bugs are saying that gold prices are going to the MOON. The theory is that the central banks will no longer be able to control inflation through monetary policy (interest rates) without throwing the entire world into a deflationary recession. Raise interest rates, stop the economy or allow rates to stay low and allow inflation to rear its ugly head and recreate the wage/price/production cycle of the 80′s but on steroids. What has been left out of all of this is the effect that these rates have on the currency markets.

Normally low rates happen when your currency is strong and getting stronger. Everybody else is “buying” your currency and consequently rates on your financial instruments decline. Hence lower rates. But if inflation is causing your currency to “cheapen” or decline, so you have to raise interest rates to support your currency and make yourself more attractive to foreign investors. i.e. Give them a better rate of return on your financial instruments (T-bills, Bonds, Corporate paper)

Well the problem has been that we have effectively no interest rates on anybody’s financial instruments and the currencies of the world (in general) have been appreciating against the U.S. dollar anyway. So the price of gold has gone up, and so have most other commodities relative to the U.S. unit since most world commodities are priced in U.S. dollars. The problem that the gold bugs have is that inflation may seem to be happening in the U.S. but it is not happening in everybody else’s terms.

The really big question is how long this balancing act can continue were the currency market in effect is enough of a proxy to keep inflation in check.

The simple answer is as long as money continues to plow into the American bond market. There is effectively no return on this money at this time, and as I have said before, coverage on U.S. bond auctions has been stunning. This means that if you are buying these bonds it must be that you think your “safe” return will be made up from an appreciating U.S. currency. And if you believe this than the appreciation in gold will come from tightness of supply and not inflation on the near term. This last week saw gold go back under $1000/ounce the stock market slightly decline, and the U.S. dollar to appreciate against most currencies. Sooooo,”Where is the GREAT INFLATION”?

Talk to you soon,

Ritch

Mackie Research Capital Corporation (MRC) makes no representations whatsoever about any other website which you may access through this one. When you access a non-MRC website please understand that it is independent from MRC and that MRC has no control over the content on that website. The content, accuracy, opinions expressed, and other links provided by these resources are not investigated, verified, monitored, or endorsed by MRC.

The opinions, estimates and projections contained herein are those of the author as of the date hereof and are subject to change without notice and may not reflect those of Mackie Research Capital (”MRC”). The information and opinions contained herein have been compiled and derived from sources believed to be reliable, but no representation or warranty, expressed or implied, is made as to their accuracy or completeness. Neither the author nor MRC accepts liability whatsoever for any loss arising from any use of this report or its contents. Information may be available to MRC which is not reflected herein. This report is not to be construed as an offer to sell or a solicitation for an offer to buy any securities. Member CIPF.