Best of the Week
Most Popular
1. Crude Oil and Water: How Climate Change is Threatening our Two Most Precious Commodities - Richard_Mills
2.The Potential $54 Trillion Cost Of The Fed's Planned Interest Rate Increases - Dan_Amerman
3.Best Cash ISA Savings for Rising UK Interest Rates and High Inflation - March 2018 - Nadeem_Walayat
4.Fed Interest Hikes, US Dollar, and Gold - Zeal_LLC
5.What Happens Next after February’s Stock Market Selloff - Troy_Bombardia
6.The 'Beast from the East' UK Extreme Snow Weather - Sheffield Day 2 - N_Walayat
7.Currencies Will Be ‘Flushed Down the Toilet’ Triggering a ‘Mad Rush into Gold’ - MoneyMetals
8.Significant Decline In Stocks On The Cards! -Enda_Glynn
9.Land Rover Discovery Sport Extreme Driving "Beast from the East" Snow Weather Test - N_Walayat
10.SILVER Large Specualtors Net Short Position 15 Year Anniversary - Clive_Maund
Last 7 days
Strong Earnings Growth is Bullish for Stocks - 17th Mar 18
The War on the Post Office - 17th Mar 18
GDX Gold Mining Stocks Fundamentals - 16th Mar 18
Nationalism, Not the Russians, got Trump Elected - 16th Mar 18
Has Bitcoin Bought It? - 16th Mar 18
Crude Oil Price – Who Wants the Triangle? - 16th Mar 18
PayPal Cease Trading Crypto Currency Bitcoin Warning Email Sophisticated Fake Scam? - 16th Mar 18
EUR/USD – Something Old, Something New and… Something Blue - 16th Mar 18
DasCoin: A 5-Minute Guide to How It Works - 15th Mar 18
Stock Market Downward Pressure Mounting - 15th Mar 18
The Stock Market Trend is Your Friend ’til the Very End - 15th Mar 18
6 Easy Ways to Get What Women Want, for Less! - 15th Mar 18
This Isn’t Your Grandfather’s (1960s) Inflation Scare - 15th Mar 18
Eye Opening Stock Market Index, Volatility, Charts and Predictions - 15th Mar 18
Gold Cup At Cheltenham – Gold Is For Winners, Not For Gamblers - 15th Mar 18
Upcoming Turnaround in Gold - 14th Mar 18
Will the Stock Market Make Another Correction this Year? - 14th Mar 18
4 Ways To Writing An Interesting Education Research Paper - 14th Mar 18
China Toward Sustainable Economic Growth - 14th Mar 18
Stock Market Direction Is No Longer Important - 14th Mar 18
Trade Tariffs Defeat Globalists and Return Prosperity - 14th Mar 18
Stock Market Crash is Underway and Cannot be Stopped! - 14th Mar 18
Are Energy Sector Stocks Bottoming? - 14th Mar 18
Nasdaq Stocks Soars to New Record High After Strong Job Reports - 14th Mar 18
Bitcoin BTCUSD Elliott Wave View Calling for Rally toward $15,000 - 13th Mar 18
Hungary’s Gold Repatriation Adds To Growing Protest Against US Dollar Hegemony - 13th Mar 18
Record Low Volatility in Precious Metals and What it Means - 13th Mar 18
Tips for Writing and Assembling the Classification Essay - 13th Mar 18
Gerald Celente "If Rates go up too High, the Economy goes Down, End of Story" - 13th Mar 18
Stock Market Selloff Showed Gold Can Reduce Portfolio Risk  - 13th Mar 18
Silver Does it Again! Severe Consequences - 12th Mar 18
Has the Stock Market Rally Run Out of Steam? - 12th Mar 18
S&P 500 at 2,800 Again, Stock Market Breakout or Fakeout? - 12th Mar 18
The No.1 Energy Stock To Buy Right Now - 12th Mar 18
What Happens Next When Stock Market Investor Sentiment is Neutral - 12th Mar 18
Economic Pressures To Driving Gold and Silver Prices Higher Long-Term - 12th Mar 18
Labour Sheffield City Councils Secret Plan to Fell 50% of Street Trees Exposed! - 12th Mar 18
Stock Market Uptrend Resuming? - 11th Mar 18
Bond Market Interest Rate Yields Are Rising Again… Stocks Are on Thin Ice - 11th Mar 18
Death of Europe's Greenest City, Police State Sheffield Labour Council to Fell 50% of Street Trees - 11th Mar 18
Do All Bull Stocks Markets Need to Have a Bearish Divergence? - 11th Mar 18
An Inflation Indicator to Watch, Part 3 - 11th Mar 18
Online Stock Trading Tips - Tips about Online Trading & Day Trading - 11th Mar 18
NDX makes a new high. What does that mean? - 10th Mar 18
Blue Chip Companies on Track for $800 billion Buyback Record in 2018 - 10th Mar 18
Cheap Gold Stocks Basing - 10th Mar 18
An Introduction to Online Forex Trading - 10th Mar 18

Market Oracle FREE Newsletter

Urgent Stock Market Message

Mystery of Inflation and Gold

Commodities / Gold and Silver 2017 Nov 17, 2017 - 02:38 PM GMT

By: Arkadiusz_Sieron


At the September FOMC press conference, Yellen admitted that subdued inflation was a puzzle for the Fed. She said:

“This year, the shortfall of inflation from 2 percent, when none of those factors is operative is more of a mystery, and I will not say that the committee clearly understands what the causes are of that.”

Actually, the chart below shows that inflation has been subdued for years. The last time when the CPI was above the Fed’s 2-percent target (formally set in January 2012) in a decisive and lasting way was in 2011 and at the beginning of 2012.

Chart 1: CPI (yellow line) and core CPI (red line) as a percent change from year ago over the last 10 years.

The same applies to the PCE price index, which is the Fed’s preferred gauge of inflation), as one can see in the chart below.

Chart 2: PCE Price Index (yellow line) and core PCE Price Index (red line) as a percent change from a year ago over the last 10 years.

Let’s try to solve the ‘mystery’ of low inflation in recent years. According to Yellen, there are several possible explanations. In her September press conference and speech in Cleveland, she pointed out the following factors:

  1. the decline in energy prices;
  2. a strong dollar that pulled down import price inflation,
  3. idiosyncratic shifts in the prices of some items, such as the large decline in telecommunication service prices seen earlier in the year;
  4. the decline in long-term inflation expectations; 
  5. the slack in the labor market;
  6. the growing importance of online shopping; or
  7. increased competition from the integration of China and other emerging market countries into the world economy.

However, we can easily exclude some of them. Surely, the drop in oil prices and the appreciation of greenback contributed to the subdued inflation. But the biggest declines in oil prices and the strongest gains in the greenback occurred only from the mid-2014 to the beginning of 2016, as the chart below shows. Hence, these factors cannot explain the subdued inflation in other periods.

Chart 3: Crude oil price (red line, left axis, WTI) and the U.S. dollar index (green line, right axis, broad trade weighted index) over the last 10 years.

Similarly, although there was a plunge in communication prices this year, as one can see in the chart below, these idiosyncratic changes could not itself explain why inflation was subdued in earlier years. The same applies to the inflationary expectations. Their decline was caused by the drop in oil prices. But when the price of oil stabilized, the expectations of future inflation rebounded.

Chart 4: Consumer Price Index for Communication (red line, left axis) and inflation expectations (red line, right axis, 5-year, 5-year forward inflation expectation rate) over the last 10 years.

Let’s now analyze the slack in the labor market as the potential reason of low inflation. This explanation results relies on a Phillips Curve, which is one of the Fed’s key assumptions. The story goes that when unemployment gets lower, the wages and, thus, the inflation rate should pick up. Hence, the lack of inflation has to result from the hidden slack in the labor market, despite the unemployment rate being at multi-year low. The problem is that the Philips Curve is a flawed concept and it should be discredited completely after the 1970s stagflation. Inflation is not caused by higher wages – the prices may generally rise only if there is increase in the money supply. As Milton Friedman said, inflation is always and everywhere a monetary phenomenon, or, to be more precise, it is caused by too much money chasing too few goods.

Hence, the supply-side factor mentioned by Yellen, i.e. technology and globalization could contribute to limited inflation, as they increase the supply of goods. Just think about the global value chains and the increased integration of low-cost emerging market economies into global economy. The strengthened worldwide economic integration results in the stronger competitive pressures and, thus, limited the pricing power of domestic firms.

There is certainly some truth in that explanation. But China, India and other emerging markets did not emerge in the 2010s. Another problem is that global productivity growth has been actually slowing down since 2010.

So let’s look at monetary factors. The chart below shows that the rate of money supply growth has been declining since 2012. Similarly, one can see the steady decline in the velocity of money over the years.

Chart 5: Velocity of M2 money stock (red line, left axis, rate) and the annual percent growth rate of M2 money stock (green line, right axis) over the last ten years.

Given the equation of exchange, which states that MV=PQ (M stands for money supply, V for velocity of money, P for price level and Q for an index for index of real expenditures; we are aware of significant problems with that formula, but let’s accept it for the sake of discussion), the subdued inflation should not be surprising. Although the money supply growth is rising faster than the productivity, the velocity of money is declining, exerting downward pressure on inflation.

What does it all mean for the gold market? Well, if inflation is a monetary phenomenon, it may rebound only when the money supply or/and the velocity of money will accelerate. We do not see signs of such a pickup. However, the Fed’s tightening may paradoxically trigger higher inflation – this is because higher interest rates will reduce the demand for money. However, given the gradual pace of Fed’s hiking, the U.S. economy should remain in the goldilocks economy, which would not trigger gold’s rally. The yellow metal shines the most during either high inflation or significant deflation – we expect neither of these scenarios to occur in the near future.

Thank you.

If you enjoyed the above analysis and would you like to know more about the gold ETFs and their impact on gold price, we invite you to read the April Market Overview report. If you're interested in the detailed price analysis and price projections with targets, we invite you to sign up for our Gold & Silver Trading Alerts . If you're not ready to subscribe at this time, we invite you to sign up for our gold newsletter and stay up-to-date with our latest free articles. It's free and you can unsubscribe anytime.

Arkadiusz Sieron
Sunshine Profits‘ Market Overview Editor


All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits' associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski's, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits' employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.

Arkadiusz Sieron Archive

© 2005-2018 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules