Inflation Calculations and Gold

It’s not only this writer who is distinctly nervous about the US Federal Reserve Bank’s more aggressive approach to attempt to control inflation. This approach has come after numerous suggestions over a period of months that the problem did not exist and any inflationary tendencies were but ‘transitional’.

Other central banks around the world followed the Fed’s mantra but, despite this, global inflation now seems to be running at levels not seen for a couple of decades. Some previously strong economies are seeing near hyperinflation figures – take Turkey for example where inflation is running at close to 50%.

This makes even US levels where the Consumer Price Index (CPI) has hit 7% look modest while even in Europe most countries seem to be hitting inflation levels of well above 5% – and that is on official figures which may underestimate the true picture.

Of course governments around the world, the US included, have nearly all followed the path of moving the inflation calculation goalposts to make figures perhaps look even more respectable than they really are. And the Fed uses yet another inflation measure, the Personal Consumption Expenditure (PCE) Index, which tends to track even lower than the CPI, on which to base its decisions.

By contrast John Williams’ Shadowstats service utilizes the old US methodology for calculating US domestic price increase statistics. These suggest that on this basis US inflation is currently at the even more worrying level of near 15%.

Investopedia defines inflation as the decline of purchasing power of a given currency over time. It is usually calculated as an estimate of the rate at which the decline in purchasing power occurs as reflected in the increase of an average price level of a basket of selected goods and services in an economy over a specific time period.

The selection of what is included in this basket, though, is defined by the body calculating the resultant figures, which leaves it open to the possibility of manipulation .

The figures do not tend to revert, however, if the political control switches to a government of a different persuasion following an election. Governments do have an interest in presenting their domestic economies in a favorable light and lower calculations tend to be clung to whatever the political direction of the political party in power.

A common way of protecting one’s assets against the potential ravages of inflation is investment in equities which, over time, tend to more than compensate in growth terms for levels of annual price inflation of around 2 or 3% seen as acceptable increases by most governments and central banks.

However, there is some aggressive tightening under way, as we are beginning to see in North America and Europe. This has been implemented in the light of above-target inflation levels of 5-7%, but perhaps higher, and could put a severe dent in stock prices that had become used to positive swings from central bank largesse.

If this economic stimulus is brought to an end, or is reversed as seems to be new central bank policy around the world, it could swing purchasers towards traditional safe haven assets like gold which tend to hold their value regardless.

Gold does not itself generate interest, which is often seen to be to the advantage of equity investment in more normal times. But when, as now, inflation is running at a far higher level than the rate that the central banks can raise interest rates, real world rates effectively become negative.

This could make assets which do not generate interest, but tend to hold their value, a preferred asset protection category. Gold fits into this category, which is why it may be coming into its own again.

by Lawrence Williams

Lawrence Williams

Lawrence (Lawrie) Williams is a highly regarded London-based writer and commentator on financial and political subjects, specializing in precious metals news and commentary. He graduated in mining engineering from The Royal School of Mines, a constituent college of Imperial College, London. He has contributed articles on precious metals to the Financial Times, Sharps Pixley, US Gold Bureau and Seeking Alpha among others.

This article can be viewed on the Rosland US website here.