7% Inflation: Who’s to Blame?

CPI reached the highest level since 1982. Policymakers are scrambling to assign blame and introduce solutions that won’t sacrifice the economy or the stock market.

Key Takeaways:

  • Gold is up 2.7% this week, driven by a risk-off market attitude.
  • Policymakers are debating over whether current inflation is a macro or micro problem. Hint: it’s probably the former.
  • Jerome Powell, still seeking renomination as Fed Chair, plans to act on his hawkish pivot in coming months. This will undoubtedly trigger an economic turning point.

Gold up 2.7% this week

Gold has reacted well to recent stock market weakness and inflation news, but still looks lackluster. A major turning point will need to take place to send gold out of the consolidating wedge pattern.

Gold in consolidating wedge formation

The next test is the resistance line at $1,832, which served as gold’s ceiling 4 separate times in 2021. Since the flash crash on August 9th, gold has been putting in a solid pattern of higher lows.

Stair stepping up, but needs to break resistance

Strength in the U.S. Dollar Index was a strong headwind for gold in 2021. That momentum looks to be slowing down. Dollar weakness could help gold’s performance tremendously this year.

U.S. Dollar showing some weakness

Macro vs. Micro Inflation

Speaking of turning points, the Consumer Price Index notched 7% on Wednesday. There are two ways to explain this inflation: macroeconomic and microeconomic.

The macro view: the U.S. government is spending more than the economy’s capacity to create new supply of products and services. As the total money supply grows, the value of each individual dollar falls.

The micro view: specific industries and companies are choosing to raise prices (either in a nefarious way to boost profit margins or simply to keep up with temporary supply chain issues, higher labor costs, and other COVID snags).

The former would be the government’s fault. Excessive money printing, ultra-accommodative monetary policy, and COVID stimulus have all artificially skyrocketed consumer demand.

The latter falls at the feet of consumers, companies, and COVID. So, which explanation do you think policymakers are going to lean into? You guessed it – most of the inflation discussion has centered around microeconomic issues.

Inflation reached 7%

Microeconomics are not the issue

Forgive us if we go against the grain and say that current inflation is, first and foremost, a monetary problem. It is difficult to comprehend the volume of dollars created over the last two years. Combine that with other macro factors such as an aging U.S. population (and therefore a smaller labor force and higher labor costs), and you get a perfect recipe for skyrocketing consumer prices.

Even Jerome Powell, the king of blaming current inflation on temporary supply chain issues, admitted in his congressional testimony this week that a smaller U.S. labor force was probably a bigger inflationary threat than crimped supply-chains.

Macro problems, micro solutions

The Biden administration is trying to fix macroeconomic inflation with microeconomic solutions.

In a speech last week President Biden said, “If car prices are too high right now, there are two solutions: You increase the supply of cars by making more of them, or you reduce demand for cars by making Americans poorer… Believe it or not, there’s a lot of people in the second camp. It’s a pessimistic vision, and I reject it.”

By “making Americans poorer,” he means reducing the amount of money floating around the system by tightening monetary policy and cutting government spending. Judging by the $1.9 trillion American Rescue Plan, austerity isn’t in Biden’s playbook. Unfortunately for the president, there might be no other way to fix the problem.

He is right that you can theoretically fix macro inflation by “increasing the supply of cars,” as long as you do the same with every other good and service in America. But is Mr. Biden going to go to start manufacturing new cars himself? How about new homes? Is he going to lug raw materials over from China to build stuff?

The point is, governments cannot legislate new cars into existence. The free market has to do it. The government only has control over the demand side of the equation.

What goes up must come down

That brings us to the Fed’s hawkish shift. They know inflation is a macroeconomic problem that requires tighter monetary policy. But such decisions can’t be taken lightly. Higher interest rates and balance sheet deleveraging could be extremely painful for the economy.

As we demonstrated in last week’s article, the stock market is now inextricably tied to the Fed’s balance sheet.

The Fed's balance sheet is driving stock returns

The Fed has the unfortunate responsibility of deflating their own free money bubble. Could we be approaching the turning point that sends gold barreling back toward all-time highs?

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As always, thank you so much for reading – and happy investing!

Additional Resources:

Inflation Risks Getting Sticky as Big Firms Flex Pricing Power (Yahoo Finance)

‘Be afraid’: Cyberattack hits Ukraine as Russia moves more troops (Reuters)

Investors position for central banks tackling inflation with interest rate rises and an end to large-scale asset purchases (Financial Times)

Wholesale prices jumped a record 9.7% in 2021 (AP News)