Trump, Inflation & Gold

04/10/2017 2:50 am EST

Focus: STRATEGIES

Adrian Day

Chairman and CEO, Adrian Day Asset Management

Despite a sluggish economy, inflation risks are increasing, asserts Adrian Day, manager of Adrian Day Asset Management and editor of Global Analyst.

Indeed, we have already seen inflation stirring over the past year. The probability of rising inflation this year and next is high in any event, but some of the proposed policies of the Trump administration run the risk of accelerating that trend.

First, the trend towards loosening bank regulation and encouraging banks to lend more risks unleashing inflation in the real economy.

The Federal Reserve has created massive amounts of money over the past eight years — with the money supply up 80%—but this money for the most part has not got into the real economy and, therefore, not caused prices to increase.

But the money created out of thin air has not vanished back into thin air. Banks have borrowed from the Fed and put much of the funds back on deposit with the Fed, earning a small but risk-free return. More of the money has gone into assets—stocks, bonds, real estate.

But if the government encourages banks to lend more, then there will be an increase in the supply of money in the real economy, pushing up prices.

The inflation was caused years ago when the Fed created the money out of thin air, but the inevitable effect on prices will come when banks lend it out instead of hoarding it.

As this process takes hold, inflation may increase quite suddenly, perhaps next year more than this. This is how many great inflations have started in the past, with a long, steady increase in the price level until an exponential blow off.

Think of the 1970s when the CPI inflation rate jumped from a relatively benign (seemingly benign) 2.9% in 1972 to over 12% just two years later.

Second, the protectionist policies that Trump threatens—which would be disastrous for the economy— would push up prices of imported goods. Similarly, the lower dollar that he proposes would also make imported goods more expensive.

Third, Trump’s budget plans and infrastructure spending could increase the deficit; plans to increase spending on military hardware and “our boys in uniform” are more likely to be passed by Congress than the various cuts proposed to offset those hikes.

Price inflation does not step up in nice steady increments; it increases more geometrically than arithmetically. We are in the early stages of that process, but one that is underway and likely to accelerate.

Potentially higher government spending and a larger deficit help gold. Protectionism, in as much as it would hurt the dollar and dent the U.S.’s image as a stable country, would help gold.

Inflation obviously would ignite gold. The slow pace of rising interest rates, with rates lagging inflation, would help gold.

The general uncertainty and sense of unpredictability surrounding the U.S. administration helps gold. And the political tensions in Europe and geopolitical flashpoints around the world also support gold.

Inflation, it's a'coming. And this year could see gold move up sharply, certainly to last year’s highs, but possibly breaking out above that.

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