James Pethokoukis

A great factoid from the Calafia Beach Pundit, Scott Grannis:

Gold prices peaked in January 1980 at $850. In today’s dollars, that would be equivalent to $2,300. (The chart shows a peak of $1,800 because it uses month-end data.) So in rough terms, let’s say that gold today is worth about half of what it was at the peak of the inflation fears in early 1980.

Gold prices rise when there is “too much money” in the system; when people fear that an excess of money will depress the value of their money. Gold prices also rise when people are just plain scared about something going very wrong.  …  Could gold rise above $1000? Why not? Could it get to $2000? Perhaps, but I think things would have to get an awful lot worse than they are today.

The dollar drops and stock rise. If the dollar is supposed to be a reflection of economic strength, this should tend not to happen.  David Goldman find this weird, too — and then explains it:

Something ominous is at work here. Typically, a stronger dollar goes together with a stronger stock market. That is what we observe prior to the bank bailout last fall. Starting in the third quarter of 2008 and going to the present, the correlation turns sharply and persistently negative. A cheaper dollar means higher stock prices, as US assets are marked down for global investors.

What we have is not a stock market rally but an adjustment to global market prices. Fully 80% of the movement in the S&P can be explained by the movement in the dollar index.

That is a profile well known to emerging market investors. Whenever the Brazilians would pull another currency devaluation, stock prices rose to compensate, as tradeable assets floated up to world market prices. The bank bailout has made Americans poorer relative to the rest of the world and created the illusion of a stock market recovery.

That does not necessarily mean that inflation will return to the US, as some analysts believe. Foreign investors are not likely to buy homes in Cleveland (although the dollar devaluation certainly should help real estate prices in New York or San Francisco). And the combination of high unemployment and deferred retirement (greeter jobs at Wal-Mart will be in great demand) will keep wages down. The price of international tradeables, though, will affect US inflation, which is why I continue to recommend classic commodity hedges (including gold and oil) rather than TIPS.

From Gluskin Sheff economist David Rosenberg:

At the same time, it looks as though the Fed is now in the process of snugging monetary policy. We don’t hear from the inflation-ists that the central bank has actually been allowing its bloated balance sheet to lose some weight in recent weeks and that the growth rate in the once-red-hot monetary aggregates is shrinking and the monetary base is also shrinking. Over the last 13-weeks, the monetary base has contracted at a 23% annual rate (!), M2 growth has softened to a 1.4% annual rate and MZM has slowed to a mere 4.6% annual rate.

From David Goldman at Inner Workings:

An aging population increases its purchases of securities and decreases its purchases of goods as it saves for retirement. Americans have saved nothing for the past ten years, and the capital gains that they considered savings-substitutes have vanished. That means that an enormous savings deficit accumulated over more than a decade has been exposed, and that Americans must attempt to correct it quickly and under the worst of circumstances. That creates a deflationary shock that a few trillion dollars’ worth of stimulus cannot begin to mitigate. America may have the worst of both worlds: currency devaluation AND price deflation, as in the 1930s.

I think Mike Darda of MKM Partners nicely encapsualtes the Fed’s thinking:

With the unemployment rate 3-4 percentage points above what is widely deemed to be neutral, the Fed probably believes the economy is running more than $1 trillionbelow potential. In other words, don’t expect the Fed to start laying the groundwork for tighter monetary policy until a sustained turn in both output and employment is underway. Of course, this will risk an eventual inflation problem, but as long as inflation doesn’t escape the mid-single-digit range, it’s a risk the Fed is probably willing to take (as opposed to a relapse in the credit markets, and a third leg down in the economy, if they tighten too soon).

The always great Ed Yardeni has a smart take on the inflation-deflation debate, comparing US quantitative easing efforts to those of Japan in the 1990s:

During that time, the Bank of Japan (BoJ) adopted Quantitative Easing (QE) in a desperate effort to stop deflation and revive bank lending. Nevertheless, bank loans plunged during this entire period, and have been rising anemically since 2005. Japan’s CPI inflation rate, ex food and energy, on a y/y basis has been below zero this decade, with a brief peek just above zero late last year.

Japan was in a liquidity trap. All the reserves pumped into the commercial banking system by the BoJ had absolutely no stimulative impact on bank lending and the economy, and no inflationary consequences. The BoJ abandoned QE in early 2006. Reserve balances plunged 76.2% from January 2005 to November 2006. In other words, the BoJ executed its exit strategy from QE and once again there was no obvious impact on the economy or inflation. …

In any event, Japan’s experience confirms that inflation isn’t always and everywhere a monetary phenomenon. It is more complicated than that. Market structure plays an important role. Competitive markets tend to be less prone to inflation than highly regulated and monopolized ones. Labor costs are the key drivers of inflation. Unions don’t have the power they once had, and productivity has been growing even during this recession. By definition, stimulative monetary policy isn’t inflationary in a liquidity trap, when the banks aren’t lending and the borrowers aren’t borrowing.