From the frying pan into the fire

“Inflation is much too high. We have the necessary tools, and we will use them to restore price stability”. Inflation is much too high — that’s now the message from the chairman of the US Federal Reserve, Jerome Powell, speaking to the National Association for Business Economics Annual Economic Policy Conference the other day.

It’s taken him a while — too long, many think — to grasp this reality. Only a year ago he was telling American households inflation was ‘transitory’. Plenty of people are lining up to tell him ‘I told you so’. Others are pointing out that real interest rates are minus 7% and still falling (with inflation at 7.9% and still growing) — and that cash is fast becoming ‘trash’. To keep ahead of inflation your investments must now return a real (i.e. not merely nominal) 8%.

In the UK, the Chancellor — the person holding the government’s purse-strings, today delivered his ‘Spring Statement’, a kind of mini-Budget that the Treasury delivers to Parliament when it publishes its economic forecasts. Rishi Sunak has been given a “large windfall” from bigger than expected tax revenues. The total government deficit (spending over income) for the 2021–22 financial year is now expected to be £153 ($202) billion. He is under enormous pressure to do something for hard-pressed householders, be that to cut duty on road transport fuel, or drop an increase planned for April in National Insurance (which many see as a tax on jobs).

Cash becomes a candidate for ‘trash’ when inflation erodes its purchasing power. The US Dollar is losing purchasing power by almost 8% a year right now; the Pound Sterling by 6.2%. In both cases the direction is for higher still — and the hands of the US and UK central banks are tied. If, as seems quite likely, inflation reaches double digits, then $100 or £100 today will be worth $90 or £90 next year. If inflation is one percentage point higher than the interest on your savings, the purchasing power of your £100,000 will lose value over the 20 years — down to £81,791. For us unfortunates who are not oligarchs this is a disastrous prospect. Not quite the same as having bombs destroy your home, admittedly, but bad enough.

A central bank’s conventional remedy for high inflation is to raise interest rates. But an uncomfortable side-effect of putting up interest rates is that government interest payments on national debts also rise; in the US, even a small rise to 0.5% in interest rates would push the average annual interest bill on its $30 trillion debt up by $94 billion, to well in excess of $600 billion a year. The UK’s nation debt is officially around £2.65 trillion, although if we factor in all liabilities including state and public sector pensions, the real national debt is closer to £4.8 trillion, around £78,000 for every person in the UK.

Just as the West is exiting the Covid-19 pandemic, which added some $19.5 trillion to global debt , an unprovoked war is started by Russia’s President Putin. Whichever way the war goes, it will stimulate further inflation, cut global economic growth, and exacerbate global debt levels.

Energy costs are going through the roof — in the UK gas and electricity bills are going up by the equivalent of a 6 pence rise in the basic rate of income tax, according to one source. The war will also provoke instability in North Africa, a region where bread is a staple food and which is heavily dependent on grain exports from Russia and Ukraine — from both countries exports of grain will be low this year, pushing up prices and forcing demand rationing.

Powell and Sunak have just cleared the frying pan (Covid) but have strolled into the fire (inflation). We are obsessed with news about refugees and destruction of cities; news that would shock under normal circumstances seems to pass unnoticed, be it inflation in Argentina likely to exceed 60% this year, the posting of troops at gasoline stations as crowds fight over price increases in Sri Lanka , or the higher risk of a global stagflationary recession.

According to a sobering assessment by the Iranian-American economist Nouriel Roubini, as a result of this war “we have entered a geopolitical depression that will have massive economic and financial consequences well beyond Ukraine. In particular, a hot war between major powers is now more likely within the next decade”.

Unintended consequences

One of the unintended consequences of the G7 group of countries seizure of Russia’s foreign exchange reserves might be the appearance of a “new monetary order” according to Zoltan Pozsar, formerly of the Federal Reserve and US Treasury Department and now an investment strategist at Credit Suisse.

His argument is that in future, which country — particularly ruled by an authoritarian regime intent on grabbing territory — will risk not being in control of its foreign exchange reserves? After this war is done, says Pozsar, money will not be the same: “the US dollar should be much weaker and, on the flip side, the Renminbi” (Yuan) “much stronger, backed by a basket of commodities”. He anticipates a “Bretton Woods III”; “from the Bretton Woods era backed by gold bullion, to Bretton Woods II backed by inside money (Treasuries with un-hedgeable confiscation risks), to Bretton Woods III backed by outside money (gold bullion and other commodities)”. He also sees Bitcoin (“if it still exists then”) as probably benefiting. Now that Goldman Sachs has become the first bank to trade cryptocurrency over-the counter, a Bitcoin-linked instrument, Bitcoin looks like it is here to stay; how it will fit alongside planned Central Bank Digital Currencies (CBDCs) is yet to be clarified, although President Joe Biden issued on 9 March an ‘Executive Order on Ensuring Responsible Development of Digital Assets’, which called for a broad review of digital assets and continued research into a US CBDC.

Pozsar’s forecast of such a major re-wiring of our monetary system could be wrong, although the accumulation of gold by Russia’s and China’s central bank in recent years hints that something is going on. But if he is right, then gold and other physical commodities will become more important and probably more sought-after.

The chance that the US Dollar will be displaced from its perch as the international reserve currency has certainly increased in the past 12 months. There are many straws in the wind. One such comes from Saudi Arabia, which sells 25% of its oil exports to China. It has been under pressure by China to accept payment in Yuan (Renmimbi) for several years and is now reportedly seriously considering doing so ; Saudi Arabia pegs its own currency, the Riyal, to the Dollar, so damage to the Dollar would hurt its own currency, but maybe that’s now a lesser concern.

The petrodollar came into existence in 1974. That year Saudi Arabia struck a deal to buy US treasury bills before they were auctioned. In return, Saudi Arabia agreed to price its oil in Dollars, and it lent on other major oil producers to adopt the same policy. The annual global oil trade is estimated to be worth $14 trilllion. If the Yuan replaced the Dollar in that trade countries would have to maintain Yuan reserves, and the Dollar would lose ground. US economic and political hegemony would shrink.

All this may seem quite remote from the tasks facing Rishi Sunak and Jerome Powell, both of whom are facing ever-more strident calls for easing the financial burdens on ordinary consumers. Yet Sunak and Powell are to some extent reaping what they sowed. By overseeing a massive expansion in the supply of money — by putting a lot of cash into consumers’ hands — they uncorked the bottle containing the inflation genie. It will be a superhuman task to get it back in that bottle.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.