At a crossroads. It is time for gold and silver

Price inflation is rearing its ugly head – worldwide. In the US, the annual increase in consumer goods prices was 5.4% in September 2021, in the euro area 3.4%, and in China 4.1%. It is not only rising energy prices that are driving consumer goods prices up. The upward price pressure affects all types of goods and services prices – food, clothing, furniture, etc. The inflationary development is also raging in asset markets. For instance, housing prices in many countries rise sharply. In the US, house prices were up 19.7% year-on-year in July 2021, while German house prices edged up 13.3% year-on-year in Q3 2021.

There is plenty of evidence that price inflation is very much alive and could even continue to rise. Against this backdrop, it is important to note that price inflation – meaning an ongoing rise in goods and services prices across the board – is not a natural disaster. Price inflation is man made, the result of an excessive increase in the quantity of money. In fact, without a fairly substantial increase in the money supply, it is hardly imaginable that all goods and services prices would start trending upwards over time. (To reject this statement, one would have to assume that the demand for money relative to the supply of money would continuously decrease. This, however, is very unlikely if and when there is no increase in the supply of money.)

In their “fight” against the consequences of the politically dictated lockdown crisis, central banks around the world have slashed interest rates to historic lows and opened up the monetary spigots. The result is a build-up of a huge “monetary overhang”, money that has not yet found its way into higher production and/or higher prices. For instance, we estimate that in the US the monetary overhang is now around 20 per cent, and in the euro area, around 15 per cent – constituting a price increase potential of the same magnitude. To make matters worse, the US M2 money stock keeps growing at a rate of 12 per cent year-on-year, which means that the monetary overhang continues to grow. A similar development is also becoming apparent in the euro area. 

This strongly suggests that central banks will have to raise interest rates to keep price inflation from getting out of hand. However, it should be clear that a monetary policy of interest rate hikes and containment of credit and money supply expansion would be tantamount to an earthquake for the global economic and financial system – because the latest economic recovery has been driven by extremely low interest rates and a most generous supply of credit and money. The upswing in the current business cycle would most likely come to an end if and when central banks embark on a policy course to bring down price inflation. In fact, it doesn’t take much to expect that it would trigger the next big crisis. 

What if central banks don’t end their inflationary policy? In the extreme, price inflation could spin out of control if and when market agents lose confidence in central banks’ ever abandoning their inflationary course. This, in turn, could lead to a brutal currency collapse. In all likelihood, central banks would not want to take such a risk, so that at some point, they will have to put their money where their mouths are and raise interest rates. Any such action, however, will most likely be “cosmetic” in nature, meaning that central banks will likely do their very best to avoid bringing real (that is: inflation-adjusted) interest rates back into positive territory; especially because global debt levels are already crushingly high, and many borrowers could not survive in an environment of higher real borrowing costs.

As noted earlier, if central banks meant business and were to combat price inflation by raising interest rates back to “normal levels”, a recession-depression would be inevitable. However, from today’s “macro-economic management consensus”, a sharp drop in output and rise in unemployment would clearly be unacceptable. All this points to the conclusion that central banks will most likely maintain their “passive stance” as long as possible, refraining from bringing real interest rates back to economically meaningful, hoping that the current increase in consumer goods price inflation will prove to be temporary.

Against this backdrop, it should become evident that central banks’ inflationary monetary policy has reached a crossroads. The best Investors can hope for is that price inflation does not spin out of control, but they have little reason to believe that price inflation – be it in the form of soaring consumer goods and/or asset prices – will decline towards more modest levels. First and foremost, the purchasing power of the currency – be it the US dollar, the euro, the Chinese renminbi, the Japanese yen – will fall victim to the ongoing inflationary policies of the central banks. It is fair to assume that escaping the “inflation tax” will be a key challenge for any saver and investor in the coming years.

Since August 2020, stocks and crypto units have outperformed, while gold and silver have underperformed. However, the savvy investor should not get carried away. Central banks are creating a “make-believe world” of epic proportions, and they have been relatively successful in allaying investor risk and inflation concerns so far. But people will increasingly realise that with the issue of ever greater amounts of money, price inflation will eat away the fruits of their labour, that their standard of living is declining, that some get rich while a great many people get poorer. Once people wake up, inflationary policies become self-defeating, and the economic and political structure it helped to build will break down.  

While physical gold and silver have fallen out of investor favour lately, they represent one solid option to shield your portfolio against the debasement of the currencies orchestrated by central bank policy. These precious metals represent truly “sound money”. The exchange value of gold and silver cannot be permanently manipulated downwards by central banks, especially not when times get really hard. What is more, physical gold and silver do not – in contrast to bank deposits – carry a counterparty or default risk. Last but not least, physical gold and silver make the investor independent from the financial system, its trading hours, settlement and delivery procedures and costs.

In summary, adding physical gold and silver to your portfolio at current prices makes perfect sense to those long-term oriented investors who share the view that central banking has actually arrived at a crossroads – and those who believe that the most likely scenario is the inflationary regime continuing to push its limits, a scenario that is much more probable than the return to prudent monetary policy.

Thorsten Polleit. Economista jefe de Degussa