Stagflation Is Coming, and Gold’s Gonna Love It
The comments below are an edited and abridged synopsis of an article by Arkadiusz Sieroń
As central banks globally tighten their monetary policies, analysts fear that Fed Chair Powell et al are hiking interest rates too aggressively, risking going too far. They believe that inflation will soon decline, so the Fed is braking too hard.
There is some truth to this. Inflation is likely to decrease as money supply growth decelerates/declines below pre-pandemic rates. And monetary policy operates with a long lag, meaning that the Fed’s actions haven’t been fully felt by the economy. Hence, the Fed could overdo.
Although the pace of money supply growth has normalized, there is still an excess of relative to output. Since the global financial crisis, the increase in M2 money supply has been outpacing real GDP growth, reaching a peak during the pandemic. This growth differential hasn’t turned negative yet, so with too many people chasing too few goods, inflation won’t go away soon.
The real federal funds rate is still deeply negative, but inflation won’t disappear without the real federal funds rate being positive. What’s fundamental for inflation is what’s happening with the money supply.
However, positive real funds rates are high enough to slow nominal growth and reduce demand in excess of supply. It may be difficult to re-anchor inflation expectations without positive interest rates.
For the gold market, this means the Fed still has a too-easy monetary policy. Lending conditions have tightened, but this is because the financial sector has been cautious, not because the Fed has become restrictive.
A recession is coming just when the real federal funds rate is negative and calls for a softening of the Fed’s stance are louder. This is a recipe for stagflation, not disinflation. So far, the Fed has been hawkish, but when the situation deteriorates, it will blink. Stagflation is certain in the sense that the next recession will be accompanied by higher inflation than the last few. The only question is how serious it will be.
That’s good for gold, because in a stagflation, there is both economic stagnation and high inflation. When hit by both, most assets become vulnerable, and gold tends to outperform. This is not surprising; during stagflation there is economic uncertainty, confidence in the central bank is low, and real interest rates are declining, sometimes going negative. In other words, stagflation makes gold’s fundamental factors bullish.