LAWRIE WILLIAMS: On the cusp: Inflation, equities and gold
The Bank for International Settlements (BIS) general manager Agustin Carstens has recently been quoted as saying that we may well be on the ‘cusp of a new inflationary era’ in tandem with a retreat from globalization. The Basel-based BIS is also known as the central banks’ own central bank, so Carstens’ opinions are well worth taking into account.
Western economies have almost certainly become too reliant on expansionary monetary policies. They had mostly been in an extended period of below target inflation, but now face the opposite problem in the extreme, made even more difficult to counter due to the enormous debt levels that many countries have run up over the past few years. These had already been exacerbated by moves to protect their economies from the effects of the coronavirus pandemic.
In his opinion piece, Carstens noted that "Many of the forces behind high inflation remain in place, and new ones are emerging. There are already signs of increased price spillovers across sectors and between prices and wages, as is common in a high-inflation environment...The structural factors keeping inflation low in recent decades may wane as globalization retreats."
He went on to comment that central banks will need to change strategies as they will no longer be able to boost their domestic economies without impacting prices through increasing money supply. This increase also will not always filter down to the sectors which it may be intended to benefit most.
"That change requires a broader recognition in policymaking that boosting resilient long-term growth cannot rely on repeated macroeconomic stimulus, be it monetary or fiscal. It can only be achieved through structural policies that strengthen the productive capacity of the economy." he said.
He noted further that "Households, firms, financial markets and sovereigns have become too used to low interest rates and accommodative financial conditions. It will be a challenge to engineer a transition to more normal levels and, in the process, set realistic expectations of what monetary policy can deliver...We must strengthen the productive capacity of the economy. Higher potential growth would make it easier for indebted economies to withstand the higher nominal and real interest rates that are likely to prevail in the years ahead."
In many ways Carstens’ stated viewpoints are somewhat obvious to a neutral observer and have been exemplified by what has been happening in terms of central bank action in the U.S. in particular. As the world’s dominant economy for the time being, what happens in the U.S. tends to be followed elsewhere. We are now in a situation in most countries where economies have been artificially stimulated and are now paying the inflationary price for what will, in retrospect, be seen as over–profligate economic largesse to keep economies advancing at a time where one might have expected them to turn down.
But what is perhaps most frightening for the global economic balance is that we were already experiencing almost out-of-control inflation in many countries before Russia commenced its military attack on Ukraine. The Russian leadership has undoubtedly totally misjudged the potential Ukrainian resistance and perhaps the almost universal condemnation of its war of attrition on some Ukrainian towns and cities.
The resultant economic sanctions aimed at debilitating the Russian economy are probably further-reaching, and likely will persist for far longer, than the Russian leadership had predicted. The consequences have been another huge global inflationary stimulus as nations try to reduce their dependence on Russian exports – of oil, gas, fertilizers, wheat and some key metal commodities in particular, by sourcing potentially more expensive supplies from elsewhere.
Russia appears to have believed also in its own propaganda that its forces would be perceived as liberators by the large segment of the Ukrainian population that is predominantly Russian-speaking, but that appears not to be the case. The Russian response has been devastating, and the example of the virtual annihilation of the city of Mariupol, located in a mostly Russian-speaking part of the country, is testimony to the lengths the Russian military will go to try and achieve its aims regardless of the ethnicity of the local population.
Ukraine is very definitely winning the propaganda war too, except perhaps in Russia itself where media outlets are almost wholly state-controlled. Russia’s cloud-cuckoo land explanations and denials for some of the devastation involved in its army’s offensive is almost completely easily countered by readily available satellite imagery of affected areas including the flattening of civilian neighbourhoods.
So, if Carstens is correct – and we believe he is - virtually the whole world is entering an extended period of high inflation which tends to be debilitating for business and economies as a whole. General equity prices tend to drop – often sharply – while safe haven type assets and equities ride the storm far better, and may well advance in price, although liquidity issues may be a mitigating factor.
Even an end to the Russia/Ukraine war may not bring this to a halt. Anti-Russian sentiment in the West is probably sufficient to see the imposed strict economic sanctions remain in place for a long time – if not indefinitely. Reliance on Russian commodities and foodstuffs will be, where possible, reduced to near zero. While this may be a huge blow to the Russian economy, the additional costs likely to be incurred in replacing this source of supply elsewhere will also be a major contributor to inflation - probably for years to come.
Hard assets like gold and silver tend to buck any downwards trend during periods of high inflation. The latter tends to lead to equity weakness which makes more stable assets more attractive as wealth protectors. And periods of negative real interest rates, which follow from high inflation combined with low base interest rates as we have at present - and may still get worse before they even begin to get better - are thus usually gold and silver price positive. We should therefore be in a period where precious metals are the most likely beneficiaries from the current, and likely future, economic environment. Gold and silver are both up over 6% year to date whereas equities have mostly fallen back a little – a situation which we see as accelerating as the year progresses.