April 13, 2022
From the Degussa Market Report
In March 2022, annual US consumer goods price inflation was 8.5%, the highest
level since 1981. While Main Street considers it, and rightfully so, terrifying data,
Wall Street actually sees it as good news of sorts: Financial markets are expecting
US CPI inflation to have peaked, and hopefully inflation rates will come down in
the coming months. However, is this a likely scenario? To answer this question,
let us take a brief look at what inflation really means.
Goods price inflation – the continued increase in the price of goods and services
across the board – is not a natural disaster. The truth is that it is a man-made
tragedy. It is caused by government-sponsored central banks increasing the
quantity of money. Admittedly, there are developments that affect goods prices,
such as a strong increase in energy prices, a VAT hike or an increase in wages.
However, they do not cause inflation (as defined above). This is easy to explain.
Assume the quantity of money in the economy is constant. Suddenly, fuel prices
double. To consume the same amount of fuel as before, people have to reduce
their demand for other things (clothing, travel, cars etc.). The economy ends up
with increased fuel prices and reduced prices of other goods (the demand for
those goods, and therefore their prices have declined). There is no inflation in
the sense of a permanent increase in goods prices across the board over time.
In fact, it makes sense to distinguish between goods price inflation and monetary
inflation, the latter denoting the increase in the quantity of money. In this sense,
goods price inflation is the symptom of a cause, namely monetary inflation. And
since state-sponsored central banks hold the money production monopoly, they
are responsible for inflation. From this perspective, it does not come as a surprise
that goods price inflation has skyrocketed.
The US Federal Reserve (Fed) has increased the money stock M2 by 42 per cent
since the end of 2019, while the European Central Bank (ECB) has expanded the
money stock M3 by 21 per cent. As a result, an enormous “monetary overhang”
was built up. It allows the “negative price shocks” stemming from lockdowns,
green policies, and the war in Ukraine to push up virtually all goods and services
prices, leading to increased goods price inflation.
At the same time, central banks are reluctant to end their ultra-low interest rate
policies and rein in money supply growth to curb inflation. On the one hand, this
is in a way understandable. After many years of excessively easy monetary policy,
economies have become heavily reliant on the continued monetary stimulus. The
heavily leveraged system could all too easily be thrown over the cliff if borrowing
and capital costs rise too much.
On the other hand, monetary policymakers might hope that consumer goods
price inflation will ease off, so they do not have to hike interest rates too much.
This is, of course, a rather dangerous bet. The decision not to raise interest rates
or delay rate hikes means that goods price inflation will be higher than it would
otherwise be. And if future inflation pressure turns out to be higher than expec-
ted today, things could get really messy.
Experience in many countries has shown that persistently high inflation risks
eroding people’s confidence in official currencies. Once that happens, a “crisis of
confidence” requires very a restrictive monetary policy, sending the economy into
a deep recession and disappointing people’s elevated inflation expectations.
However, given the heavily indebted western world, it is particularly difficult to
believe that such a scenario would not be economically and politically
Even so, central banks continue to play with fire. They installed an overly
accommodative monetary policy in the first place, and they did not have the
courage to end it when it still was possible. Even worse: Policymakers now see
elevated inflation as an acceptable „societal price“ and the policy of increased
inflation as the policy of the “least evil”. All of this is, of course, bad news for the
general public, who will suffer most from the debasement of their currencies.
As outlined in previous reports, inflation is quite a challenge for investors. There
tends to be no easy way to avoid the costs and losses caused by inflation. How-
ever, holding physical gold and silver ranks among the viable options. Central
banks’ inflationary policies cannot reduce the exchange value of these precious
metals, and other than bank deposits and short-term debt instruments, physical
gold and silver do not carry any counterparty or default risk.
What is more, holding physical gold and silver would also hedge against the
extreme downside scenario – the unbacked paper money system spiraling
completely out of control. Admittedly, this is a tail risk scenario at this point.
Unfortunately, however, it becomes increasingly likely with central banks allowing
price inflation to edge ever higher, prioritizing ”propping up the system” over
“keeping inflation low”.