The primary purpose of rising interest rates is the lack of savings in the consumer. All their earnings are being used to consume. When interest rates are high then savings are low. At some point high interest rates will realize better gains than other markets and the incentive will be to hold cash and curb borrowing. With the consumer slows spending and holds cash Interest Rates will go down and eventually reach a point when that excess cash base can be used to borrow against or begin the consumption process all over again.
The inflation that is out there was generated through creating a real estate market boom. The excess money that was created in that market was fabricated as future debt. Equity value in real estate holders has dropped dramatically so that people could either reinvest it in the real estate market, spend to improve homes or invest into retirement funds. Regardless of how it happened that money flowed into ramping up the economy.
Consumer demand picked up and in turn companies produced to appease the consumer. Unfortunately the money flowed into foreign arms of these companies where they expanded Chinese economy to provide low cost products. With all that money flowing overseas there was little if any growth in the US economy and after such an amazing real estate boom we pretty much went nowhere in growth.
What we did do is tried to reflate the economy. Because it generated demand for commodities (energy and metals) overseas creating further downward pressure on the US economy, consumer’s earnings did not keeping pace with the pressures of high energy prices. Real estate boom capital and the earnings received from the 2003-2005 market rallies have either flowed out overseas or are being held out long term.
Because of all that excess money generated and all that flow outside the US is it any wonder why the economy is slowing?
Rising rates are normally seen with rising commodity prices only because interest rates lag commodities. When consumers are spending commodity markets go up. With fewer people holding savings in the form of treasuries or bonds interest rates go up almost in tandem with Inflation rates. Gradually money flows back into savings when people realize that growth is slowing and almost equal gains can be met by holding cash. That flow of money out of the economy and into savings further drags down the economy and demand for commodities.
Over the long term (30 years) Inflation has been slowing. It can be seen in the trend in Interest rates and the change in inflation rate. It’s not a deflation it’s a gradual pace where prices have not been accelerating as fast as they did years ago. IMO we still eventually reach a point when inflation will slow and possibly roll over into deflation sometime in the future. No more monetary policy tricks can be used to spark reflation because the amount of manipulation required will cause even more damage. What they will have to do is let prices collapse and when the economy slows and inflation shows signs of coming down to keep rates up high.
IMO Gold acts like a commodity in the sense that it moves with inflation, but it is also a speculative investment to hedge against a financial calamity. When prices collapse and debt outstrips the current value of assets people will want to hold hard currencies that are not easily identified in a bankruptcy court. That gold will depreciate along with other assets and it would be more lucrative to hold dollars in a mattress than gold coins. In a hyper inflationary scenario where money supply is out of control then everything becomes over inflated and holding anything except currency is good as dollars depreciate by the minute. While you can’t barter a house as payment for groceries a few ounces of gold will carry you a long way.
I don’t think we have reached a point of economic crisis yet. Even though real rates went below zero the Fed has been keeping up on raising rates for over a year now effectively pulling us form the brink of hyperinflation with the accommodation they pulled back in the early part of this decade. Gold will only be a good hold if the Fed hints that they may become accommodative again with real rates so close to zero. If they do then I don’t think we will just brush up against the potential of hyperinflation. I think we might actually bury ourselves in it. Even a pause might be too detrimental to our economy in the state it is in now.
If the Fed finally accepts the fact that inflation is slowing to a crawl and they can’t afford more monetary stimulation without the risk of causing more than just simple inflation then they will no combat deflation. They will be forced to let it run its course. The value of the dollar will climb, prices will collapse and money will flow into the US until equilibrium is met and this country’s debts are resolved. Interest Rates will more than likely cycle up over that time as real inflation (not the monetary policy fabricated kind) will take hold. Putting in trade tariffs is the weapon of last resort. No country wants to be cut off from the consumers that demand its products. While at first it might work eventually tarrifs will cause isolationism or possible military action between countries as tariffs will start being used liberally. Eventually world trade slows and then currencies deteriorate causing hyperinflation and spikes in interest rates which will eventually result in a deflation I doubt that tariffs are a good idea in this global economy. With so many corporations having such a global reach I doubt they would allow such a thing to happen. Wal Mart would collapse instantly.
I’m not expecting a deflation in the next couple years, its very low IMO at this point in time. I also feel the same way about hyperinflaiton. I feel we are getting close to it with all this talk of trade tariffs against china and the potential of a floating yuan. I do expect more of a recession of prices in equities and commodities and eventually a recession in the economy albeit a minor one. Macroscopic events like hyperinflation or deflation take many years to resolve themselves and writing on the wall is very apparent no matter how much data gets manipulated. The last jobs report is a good example. I think they “seasonally adjusted” that report to float the markets until the summer comes along and helps boost numbers naturally. Then in a few months they can revisit that numbers and bring it back down to realistic levels. That gives the markets another 6-12 months of flat trading and probably 50 to 100 basis points of rate hikes as they promote strong jobs going into a good Christmas retail season but I expect it to be much weaker than they are going to promote.
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