Bernanke doesn't fear inflation. And neither do I.
Inflation isn't a near-term threat and
hyperinflation won't happen
any time soon.
Not only has CPI not gone above 4% in over a year, it hasn't
marched above 3% over the past 12 months. Furthermore, CPI data
last week showed a 0.6% rise in September. There is not enough
evidence suggesting CPI will dramatically spike higher within the
next few years.
Though the Fed has increased its balance sheet to a level
previously thought insurmountable, inflation remains low.
Quantitative easing is not igniting inflation in the way that
many have deemed probable. The program is four years old and CPI
hasn't budged throughout its implementation.
But gold continues to march higher even though inflation is
subdued. And I think the gold ascent has further to go.
Despite the lack of CPI growth, the yellow metal should continue
its trajectory if GDP stays above nominal bond rates.
Bridgewater (a top investment company) research explains that the
relationship between GDP and interest rates is a major factor
between good and painful deleveraging. We'll also see how this is
bullish for gold later on.
Recall (here)
that deleveragings need more than one pill to fix. Quantitative
easing provides some relief, but more help will be necessary.
In order to maneuver through the deleveraging process
successfully, it takes a combination of debt restructurings,
wealth distributions, austerity, increasing the money supply, and
businesses lowering breakeven basis. And nominal interest rates
need to be below economic growth rates.
To its dismay, the Fed has less control over deleveragings than
it would prefer. The Fed cannot control wealth distribution
(higher taxes), austerity (spending cutbacks) and lowering the
breakeven basis for businesses (increasing efficiency and firing
workers). Through quantitative easing, the Fed is trying to
control money supply, debt restructurings and the interest rate
premium over GDP - with the latter being extremely important.
Good deleveragings unfold when GDP growth stays above bond
yields, which is why the Fed is buying bonds from the open market
(quantitative easing). It must keep nominal bond rates extremely
low because GDP growth has been anemic. As GDP improves, the Fed
can be tighter (hawkish) with bond yields.
But the real key to the deleveraging equation is not just keeping
bond rates low, it's keeping the rate below GDP growth.
This has proven more difficult lately because annual GDP growth
has struggled to stay above 3%. And most analysts predict GDP
will drop below 2.4% next year. If interest rates and GDP don't
drop in tandem, investors will have reason for fear.
This table shows what happens when interest rates are above GDP
rates during a deleveraging. The relationship explains why
Japan's economy remains sluggish more than 20 years later.
Present indicates through 2011, The World Index (
TWI
), U.S. Dollar (
USD
), foreign exchange (FX)
The above deleveraging time frames were some of the worst periods
for investors, consumers and businesses. These examples stress
how painful a recovery period can be when GDP growth is below
bond rates during deleveragings. These are also great times for
the domestic currency.
However, the recovery process is not nearly as trying for
investors, consumers and businesses when GDP is above bond rates.
In fact, this has typically been an excellent period for stocks
and commodities investors.
This table shows what happens when interest rates are below GDP
rates. Investors have typically flourished during these periods.
The impact on the local currency was also small, although some of
its vale tended to be lost against other currencies.
Present indicates through 2011, The World Index (
TWI
), U.S. Dollar (
USD
)
Deleveragings are tough periods to manage, but there are
solutions available that have proven to work. One of the less
painful ways to reflate appears to involve keeping GDP above bond
rates.
Ben Bernanke recently explained why GDP is important so much
better than I ever could, "The crisis and recession have led to
very low interest rates, it is true, but these events have also
destroyed jobs, hamstrung economic growth, and led to sharp
declines in the values of many homes and businesses. The best and
most comprehensive solution is to find ways to a stronger
economy. Only a strong economy can create higher asset values and
sustainably good returns for savers. And only a strong economy
will allow people who need jobs to find them."
You have it from the horse's mouth - Bernanke wants GDP growth.
This is his primary objective. And he wants to achieve it by
keeping interest rates low (making open market purchases).
This is fantastic news for investors holding gold.
Quantitative easing takes a toll on savers, but it raises the
values of other assets, such as gold. Gold tends to rise during
deleveragings, and it performs incredibly well when GDP is above
bond yields.
This means that gold should continue to climb higher as long as
GDP growth stays above 3%, which is roughly what bonds yield.
Through quantitative easing the Fed is keeping interest rates low
and targeting GDP. This combination should result in a GDP rate
that exceeds bonds. When that combination occurs, gold tends to
shine.