Stagflation: The Worse for Us, the Better for Gold
The comments below are an edited and abridged synopsis of an article by Arkadius Sieroń
History tells us whenever inflation has been above 5%, the Fed’s interest rate hikes have always resulted in an economic downturn. The yield curve has recently inverted, meaning the most reliable recessionary indicator is flashing red.
Given the slowdown in money supply growth, high inflation will likely continue through 2023 and perhaps 2024 due to increased money supply during the pandemic. A recession is likely to come with high inflation, forming a powerful, negative combo: Stagflation.
Stagflation means the recession won’t be mild or short. During stagflation, there is uncertainty in the economy, and monetary policy becomes more complicated. The Fed could ease its monetary policy to address declining aggregate demand and neutralize deflationary pressure but if inflation remains high, the Fed’s hands are tied.
Some argue that today’s financial imbalances are not as severe as those in the run-up to the 2007/2009 global financial crisis. Commercial banks seem to be in better shape. Inflation has reduced the real value of debts, and it remains higher than most interest rates, implying that governments and companies can still issue cheap debt.
However, financial markets remain fragile. The level of private and public debt as a share of global GDP is higher today than before, having risen to about 350%. Fiscal expansion will be more limited this time, and the tightening of monetary policy globally could have repercussions. There are already symptoms: Financial bubbles are bursting and asset prices are declining, reducing financial wealth and the value of many collaterals.
Gold shone during the 1970s stagflation and the global financial crisis of 2007/2009, and it will likely rally this time as well. It could decline during asset sell-offs as investors attempt to raise cash, but it should later outperform.
It’s possible that inflation will decline and stagflation will be avoided, or that the Fed will blink and prevent the debt crisis instead of fighting with inflation at all costs, but one or another economic crisis is going to happen. Gold should therefore rebound. Next year will be better for gold as recession approaches and the Fed becomes less hawkish.