Inflation and the implications for gold

The US inflation target was recently adjusted from having a target of 2 percent inflation annually, to trying to end up above 2 percent.The argument used is that inflation has been below the old target for a long time, and that one therefore wants to allow more stimuli for it to land around 2 on average.

This was not the first time the inflation target was adjusted, and certainly not the last. We have gone from defining inflation as the expansion of the money supply, to measuring it in the form of rising consumer prices. Then the goal was "stable prices", which meant that one would avoid inflation and stay below 2 percent. Later, the target was adjusted to up to 2 percent and then to try to reach 2 percent to now have an inflation rate of at least 2 percent.

That the inflation rate would have been low in recent years is, however, a truth with modification. Not only have inflation targets been adjusted, the way we measure inflation has also changed over the years. If you look at the original definition of inflation; expansion of the money supply (M2), as well as the alternative inflation measure Shadowstats and compare it with the Consumer Price Index (CPI), they show completely different numbers.

There is a clear reason why the CPI shows lower inflation figures than expansion of M2 and Shadowstats. Over the years, the basket of goods and how to measure it has been revised, and since it does not take into account innovation or substitutes for goods, the CPI shows lower figures. This has been widely criticized, especially in recent years, as low inflation figures justify more stimulus from the Federal Reserve.

But why would one want to show lower inflation figures than they actually are? And what are the consequences for the economy and asset prices?

The short answer to the question of incentives is government debt. 

Since we left the gold standard in 1971, the budget deficit has increased massively every year, both in real terms and in relation to GDP. There is no longer any reason not to print money to finance budget deficits, because if we were to suddenly stop, our financial system would collapse.

In other words, we have created a monster that requires more and more stimuli to not completely fail, the problem is that every time we did exactly that throughout history, that is exactly what happened; sooner or later a reset is required.

During the 1970s, the inflation rate was 3-11%, which led to a commodity boom. During the period 1972-74, general commodity indices more than doubled, while individual commodity prices, such as sugar, more than quintupled during the same period. In addition to concerns about low inventories, it was primarily the inflation rate that drove up prices.

Since then, commodity prices have fallen, and are still trading at low levels, while the real inflation rate is rising. In other words, it could be a perfect storm for another boom in commodity prices in the coming years.