Fed Speech Lifts Gold
Jerome Powell, Chairman of the Federal Reserve (the Fed), gave a highly anticipated speech on Friday (August 27, 2021), which I will refer to often in this article. He outlined the reasoning behind how we got where we are today economically, and where he perceives we are going. The markets were quick to react to the speech, including the precious metals sector, which moved markedly higher. This does not imply that everyone believes what Mr. Powell said in the speech to be accurate, but rather, that expected Fed actions may be supportive of asset prices in the future. We have previously discussed many of the uncertainties surrounding future Fed policy decisions, and how it is difficult for the Fed to determine what the current data reveals. It appears that not everyone agrees with Chairman Powell’s assessment of current and future inflation numbers, for good reasons we will discuss today.
Precious Metals Move Higher
If the one-day performance of the precious metals sector is an indication of where we are headed from here, the future looks bright. The metals launched forward following Chairman Powell’s speech, with gold up over 1%, silver up 2.2%, platinum up 3.2%, and palladium higher by 0.8%, on the first day following the speech alone. Granted, Chairman Powell did not expressly mention that he thought precious metals prices should move higher. It was what he didn’t say that helped move the metals. Many were expecting him to announce a timeline to begin tapering excess liquidity injections from the marketplace. Because he did not definitively state when tapering would occur, many took that as a sign that excessive liquidity would continue into the foreseeable future. In the past, excessive liquidity has been associated with higher inflation.
Transitory Inflation - Not!
In the speech, Chairman Powell repeated his opinion that inflation was largely transitory and not likely to last for an extended period. In a recent Metals Minute episode, we explained what “transitory” typically means versus what it likely means for inflation today. If Mr. Powell believed that inflationary concerns were only temporary, he would have been more willing to announce a timeline for tapering, in my opinion. Because he didn’t, it calls into question whether he really believes inflation is transitory. Even the inflation graphs included with the policy speech transcripts make it clear that inflation levels are much higher for the average American than the official numbers suggest. In the body of the speech, Chairman Powell explains that spending on durable goods is “…running about 20 percent above the pre-pandemic level.” Yet, as the graph shows, they removed the impact of durable goods spending when defining the level of inflation.
Faulty Inflation Measurements
Therein lies the rub, which helps explain the difference between the level of inflation experienced by the consumer versus the inflation rate bandied about by the Fed. When items rising the most in price are excluded or limited from consideration, while those falling in price are included completely, it can skew the results towards a lower official inflation number. Chairman Powell admitted that spending on services has decreased, while spending on durable goods has increased. When spending on services (such as travel, restaurants, hotels, etc.) drops, it means fewer Americans are affected by lower airfare and hotel room prices the market may be experiencing, for example. As such, expenses that are less in demand when the inflation rate is calculated should, in my view, play a diminished role in determining that inflation rate. By continuing to weigh them the same, it skews the official inflation rate lower. By excluding or diminishing the impact of the items increasing the most in price (durable goods, etc.), the analysis skews the inflation rate lower still.
This helps explain why we have an official inflation rate that is often lower than the actual inflation rate experienced by the average consumer. The Chapwood Index is a measure of the “unadjusted actual cost and price fluctuation” experienced by consumers (those who were included in the Index’s samples, anyway) for the 500 items most purchased by those consumers across America’s 50 largest cities. As described on the Index’s website, Ed Butowsky, the Index’s founder, “began calculating the Chapwood Index in 2008. Using social media, he surveyed his friends across the country to determine what they bought with their after-tax income. He narrowed the list down to the most frequent 500 items and asked his friends in America’s 50 largest cities to check the prices on those items periodically. The Index shows the fluctuation in each city in the cost of items such as: Starbucks coffee, Advil, insurance, gasoline, sales and income taxes, tolls, fast food restaurants, toothpaste, oil changes, car washes, pizza, cable TV and Internet service, cellphone service, dry cleaning, movie tickets, cosmetics, gym memberships, home repairs, piano lessons, laundry detergent, light bulbs, school supplies, parking meters, pet food, underwear and People magazine.”
This measurement of inflation is often more than double the official inflation rate quoted by the Fed, because it is made up of items the people in the Index’s samples actually purchase, and not items they do not purchase. In the Fed’s measurements, items not frequently purchased (that have often had price decreases, as a result) are fully counted, thereby lowering the official inflation rate. But people are not affected by lower prices on items not purchased, only by items actually purchased.
On pages five and six of the speech transcript, Chairman Powell projects lower spending on used cars. But what he doesn’t mention is the difference between lower overall spending on used cars versus higher prices on fewer used cars available for purchase. While total spending in this category might be lower, the experience of the individual consumer purchasing a used car has been highly inflationary. Due to a chip shortage, fewer new cars are being produced. This has put greater pressure on the used car market, raising prices and reducing supply. When demand increases and available supply decreases, prices tend to rise.
Taper Talk - Just Talk
Besides the speech given by Chairman Powell, many other Fed governors released statements concerning their expectations for tapering and the timing and likelihood of interest rate increases. But much of this talk, in my opinion, is meant to distract the public from the realities of current and future debt levels that prevent the Fed from being able to raise interest rates in a meaningful way. Even at today’s historically low interest rates, net interest payments on the national debt are currently $345 billion, according to Ryan McMaken at the Mises Institute. McMaken further states that this amount would cover the annual budgets of the Department of Transportation, the Department of the Interior, and the Department of Veterans Affairs combined. Raising interest rates to historically normal levels would wipe out most of the federal budget. Regardless of the discussions about tapering and/or raising interest rates, the Fed seems trapped in a future of low interest rates and high inflation.
The realities of where we are financially as a nation seem to limit what the Fed can do to respond. Just as the metals moved instinctively higher, real yields on the 10-year U.S. Treasury moved farther into negative territory following the speech (see graph). The last time the debt-to-GDP ratio approached these levels was during and after WWII. Real yields were pushed into negative territory then, too, as it was seen as the only way to reduce the national debt and keep rates low. When we consider the immediate move up in the metals, and the move down in the interest rates, it is almost as if the metals and interest rates are paying more attention to what the Chairman didn’t say than to what he did say. For the sake of our own personal financial futures, perhaps we should do the same.