Inflation Risk: Milton Friedman Would Buy Gold Right Now
Sunshine Profits | Nov 19, 2021 10:59AM ET
Fed Chair Jerome Powell maintains that inflation is transitory, but the monetary theory of inflation suggests otherwise. So, elevated inflation could stay with us!,
Some economists downplay the risk stemming from elevated pandemic and the ensuing recovery.” Are those analysts right?
Well, in a sense, they are. The economy is not in stagnation with little or no growth and a rising unemployment rate . On the contrary, the U.S. labor market is continuously improving. It’s also true that both the bargaining power of workers and energy’s share in overall expenditure have diminished over the last 50 years.
However, general inflation is neither caused by wages nor energy prices. Higher wages simply mean lower profits, so although employees can consume more, employers can spend less. If wages are set above the potential market rates, then unemployment emerges – not inflation.
Similarly, higher energy prices affect the composition of spending, but not the overall monetary demand spent on goods and services. It works as follows: when the price of oil increases, people have to spend more money on oil (assuming the amount of consumed oil remains unchanged), which leaves less money available for other goods and services. So, the overall money spent on goods won’t change. As a consequence, the structure of relative prices will change, but widespread prices increases won’t happen.
In other words, Frank Shostak put it , “must lead to more money being spent on the unchanged stock of goods – an increase in the average price of goods.”
Let’s look at the chart below, which displays the annual growth rates in the broad CPI (green line). We can notice two important things. First, in the 1970s, the pace of broad money supply growth was relatively high, as it reached double-digit values at some point. As a consequence, inflation accelerated, jumping above 10% for a while. In other words, stagflation was born.
Since then, the rate of growth in the money supply never reached double-digit numbers on a prolonged basis, including the Great Recession , so high inflation never materialized. And then the pandemic came. In March 2020, the money supply growth rate crossed the 10% threshold and never came back. In February 2021, it reached its record height of 27.1%. The pace of growth in the M2 money aggregate has slowed down since then, dropping to a still relatively high rate of 13%. This is a rate that is almost double the pre-pandemic level (6.8% in February 2020) and the long-term average (7.1% for the 1960-2021 period ). So, actually, given the surge in the broad money supply and the monetary theory of inflation, rapidly rising prices shouldn’t be surprising at all.
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Second, there is a lag between the money supply growth and the increase in inflation rates. That’s why some analysts don’t believe in the quantity theory of money – there is no clear positive opinion for Wall Street Journal ,
According to monetarism, asset-price inflation should have occurred with a lag of one to nine months. Then, with a lag of six to 18 months, economic activity should have started to pick up. Lastly, after a lag of 12 to 24 months, generalized inflation should have set in.
If this relationship is true, then inflation won’t go away anytime soon. After all, the money supply accelerated in March 2020 and peaked in February 2021, growing at more than four times the “optimal” rate that would keep inflation at the 2-percent target, according to Greenwood and Hanke. In line with the monetarist description, the CPI rates accelerated in March 2021, exactly one year after the surge in the money supply. So, if this lag is stable, the peak in inflation rates should happen in Q1 2022, and inflation should remain elevated until mid-2022 at least.
What does it mean for the gold market? Well, if the theory of inflation outlined above is correct, elevated inflation will stay with us for several more months. Therefore, it’s not transitory, as the central bank tells us. Instead, inflation should remain high for a while, i.e., as long as the money supply growth won’t slow down and go back below 10% on a sustained basis. What’s more, the velocity of money, which plunged when the epidemic started, is likely to rise in the coming months, additionally boosting inflation.
So, I would say that Milton Friedman would probably forecast more persistent inflation than gold as a safe-haven asset .
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