The Fed’s Conundrum

Stocks rallied last week interrupting what looked like a possible set-up for a correction.  Despite the rally stocks are extended here.

Gold and silver continued their respective rallies as did US Treasuries.

As inflation is heating up worldwide, there is growing interest in protecting oneself from the loss in purchasing power that comes with higher levels of inflation.

Russia recently passed legislation to allow the country’s sovereign wealth fund to invest in gold.  This from “Zero Hedge” (Source: (emphasis added):

In a significant and strategic development for monetary metals, the Government of the Russian Federation has just introduced legislation which will allow Russia’s giant National Wealth Fund (NWF) to invest in gold and other precious metals. The NWF is Russia’s de facto sovereign wealth fund, and has assets of US$185 billion.

Introduced as a resolution to the procedures for managing the  investments of the National Wealth Fund and signed off by the Russian prime minister Mikhail Mishustin on Friday 21 May, the changes will allow the National Wealth Fund to buy and hold gold and other precious metals with the Russian central bank, the Bank of Russia.

In a note accompanying the gold announcement, the Russian government refers to gold as a traditional protective asset, and says that the move to add gold will introduce more diversification into NWF’s investment allocation, while promoting overall safety and profitability for the fund.

Up until now, the National Wealth Fund, through its 2008 investment management decree has been allowed to allocate funds to all main financial asset classes, such as foreign exchange, debt securities of foreign states, debt securities of international financial organizations, managed investment funds, equities, Russian development bank projects, and domestic bank deposits. The latest amendment now adds gold and precious metals to that list.

As the NWF soon will begin to buy and hold gold as part of its investment remit, it will be interesting to watch the NWF’s asset allocation reports, which can be found in the statistics section of the NWF pages of the Russian Ministry of Finance website here.

If this recent news about the NWF investing in gold look familiar, that’s because it is. Back in November 2020, the Russian government proposed a plan to allow the NWF to buy and hold gold, at the time introducing draft legislation for that purpose. It is this draft legislation which has now been signed into law on 21 May by Prime Minister Mikhail Mishustin.

However, nearly a year earlier in December 2019, Russia’s Finance Minister Anton Siluanov had originally raised the idea that the National Wealth Fund should invest in gold, saying at the time that he saw gold “as more sustainable in the long-term than financial assets.”

Meanwhile, the United States Mint issued a statement last week about silver (Source: (emphasis added):

The United States Mint is committed to providing the best possible online experience to its customers. The global silver shortage has driven demand for many of our bullion and numismatic products to record heights. This level of demand is felt most acutely by the Mint during the initial product release of numismatic items. Most recently in the pre-order window for 2021 Morgan Dollar with Carson City privy mark (21XC) and New Orleans privy mark (21XD), the extraordinary volume of web traffic caused significant numbers of Mint customers to experience website anomalies that resulted in their inability to complete transactions.

In the interest of properly rectifying the situation, the Mint is postponing the pre-order windows for the remaining 2021 Morgan and Peace silver dollars that were originally scheduled for June 1 (Morgan Dollars struck at Denver (21XG) and San Francisco (21XF)) and June 7 (Morgan Dollar struck at Philadelphia (21XE) and the Peace Dollar (21XH)). While inconvenient to many, this deliberate delay will give the Mint the time necessary to obtain web traffic management tools to enhance the user experience. As the demand for silver remains greater than the supply, the reality is such that not everyone will be able to purchase a coin. However, we are confident that during the postponement, we will be able to greatly improve on our ability to deliver the utmost positive U.S. Mint experience that our customers deserve. We will announce revised pre-order launch dates as soon as possible.

Interesting that Russia has adapted her laws to allow the National Wealth Fund to buy gold and the US Mint is openly stating that demand for silver is greater than the supply.  This is something we have noted recently in obtaining precious metals for clients.  We have been able to find the metals but its much more difficult.

There is a growing disparity between the spot price (paper price) of gold and silver that the price one pays (when buying) or receives (when selling) for physical metals.  In the current market, with growing demand for physical metals, both purchases and sales take place above the metal’s spot price.

Despite the Federal Reserve’s insistence that inflation is ‘transitory’, actions of investors in the precious metals’ markets are telling us a different story.  Simply put, precious metals investors don’t believe the Fed.

And with good reason.

When current levels of inflation are adjusted for reality, using inflation calculation methodologies that were used pre-1980, one would have to conclude that we are presently at or near 1970’s inflation levels.

In 1980, as we’ve discussed previously, the Federal Reserve increased interest rates to the 20% level to get inflation under control.  It worked.

Would a similar policy response today do the same thing?

It would.  Inflation is an expansion of the money supply so taking action to reduce the money supply would once again get inflation under control.

So can we expect the Fed to increase interest rates soon?

There are analysts who insist the Fed will have to do so or risk a hyperinflationary outcome.  There are other observers, including me, who think the Fed will keep interest rates low and continue the policy of money creation for the near future.

I believe this is the case for a couple of reasons.

First, the recently proposed budget calls for more than $6 trillion in spending, the highest ever.  (Source:  Federal spending would reach $8.2 trillion by 2031.  The budget deficit under the proposed budget would exceed $1.8 trillion and be twice the $900 billion deficit in 2019, pre-COVID,

Massive deficits combined with a declining economy mean that the Fed will be forced to continue to monetize government spending.  And, I’d bet the biggest steak in Texas that should this proposed budget become reality, the deficit is bigger than the forecasted $1.8 trillion due to overly optimistic tax revenue assumptions.

More and more analysts are predicting deflation.  This from “Fox Business News” (Source: (emphasis added):

Surging consumer prices and gasoline shortages have sparked concerns the U.S. economy could relive the nightmarish stagflation of President Jimmy Carter’s administration in the late 1970s. 

Stagflation is defined as a period of inflation with declining economic output.  

Strategists at Bank of America predict the stagflation narrative will begin to take hold in the second half of this year. 

Second, should the Federal Reserve go full Volcker and raise interest rates to fight inflation, a deflationary collapse is the likely result with real estate and stock valuations at nosebleed levels.

The Fed is painted into the proverbial corner.

Keep printing and the outcome is stagflation.

Begin to tighten monetary policy and risk a deflationary collapse.

Neither choice is a good one but past actions by the Fed and the politicians in charge tell us that they will make the choice that kicks the can down the road a little further.  That probably leads to inflation followed by deflation as Thomas Jefferson predicted two centuries ago.

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Inflation or Deflation?

The Federal Reserve is a little over a week into its program of buying private sector corporate bond ETF’s with newly printed money.  Not surprisingly, corporate bonds have rallied.

The most important analysis I can provide to my clients and friends in my opinion is the ongoing question of what the ultimate outcome will be as a result of extreme conditions in the financial markets.

Will there be severe deflation as a result of debt excesses?  Or, will there be inflation or even hyperinflation because of massive money printing?

Continuing to ask this question and looking for answers to this question supported by evidence and information from trustworthy will provide guidance as to how to manage investment assets moving ahead.

There is presently evidence to support both outcomes.

The evidence to support the deflation outcome is pretty strong at the moment.

Bankruptcies continue at an historical pace.  Rental car giant, Hertz, filed for bankruptcy protection last week as the company looks to downsize its fleet of automobiles.  This is deflationary as the company is flooding the already saturated used car market with still more inventory.

According to “Market Watch” (Source: used car prices fell more than 12% in April from the prior year.  That’s a huge decline and is deflationary.

Another deflationary symptom:  retail landlords are sending out thousands default notices to their tenants who are unable to pay rent.  This from “Bloomberg” (Source:

Retail landlords are sending our thousands of default notices to tenants, a situation that could tip already ailing retailers into bankruptcy or total collapse.

Department stores, restaurants, apparel merchants and specialty chains have been getting the notices as property owners who’ve gone unpaid for as long as three months lose patience, according to people with knowledge of the matter and court filings.

Many retailers have filed for bankruptcy protection already in 2020 including The Shurman Retail Group (Papyrus), Lucky’s Market, Earth Fare, Noah’s Event Venue, Pier One, Art Van Furniture, Modell’s Sporting Goods, Food First Global Restaurants, True Religion, J Crew, Neiman Marcus, Stage Stores, Garden Fresh Restaurants and JC Penney.

This is a very deflationary force.

Deflation, correctly defined, is a contraction of the money supply.  In today’s economy, money is loaned into existence.  That means that money is debt.  While it takes some thinking to get your head around that idea, once you come to grips with the fact that money is debt, it makes perfect sense that when debt levels get too high and defaults on debt occur, the outcome is deflation.

A symptom of deflation is delayed spending by consumers because prices drop.  This has a devastating economic impact on a consumer spending dependent economy like the economy of the United States as people put off spending in the hopes that future prices will decline giving them a better deal on whatever it is they need or want to buy.

Inflation, on the other hand, is defined as an expansion of the money supply.  One of the symptoms of inflation is rising consumer prices.  As the Federal Reserve creates money out of thin air there is potential for inflation if enough money is created.

The Fed is creating money at a rate never before seen – that’s undoubtedly inflationary.

Whether we have deflation or inflation would determine how one manages the invested assets in an IRA, 401(k) or other investment accounts.  Because where we go will depend largely on Federal Reserve policy, I have long recommended a two-bucket approach to managing money – one bucket of assets managed to perform well in a deflationary environment and another bucket of assets that is managed to perform well in an inflationary environment.

In my view, the most likely outcome at this point would be deflation followed at some future point by inflation or even hyperinflation if the Fed continues on its current course of action.

Short-term, I believe it will be difficult to avoid deflation given Depression levels of unemployment and bankruptcies.  Consumer spending will slow, and defaults will grow.

But, Jerome Powell, Chair of the Federal Reserve, has indicated the Fed will print as much money as they need to print for as long as they need to print it.  The Fed will do “whatever is necessary” according to Chairman Powell.

Of course, one of the problems with that policy is that money creation doesn’t have immediate cause and effect.  The full effects of Fed policy may not be totally felt for months or even years.

Another obvious problem with that policy is that the Fed doesn’t know how much money printing is too much.  I have my doubts that they will guess correctly since their forecasting track record is utterly dismal.

As I have previously noted, the US Government will need to sell nearly $3 trillion in debt to fund spending in the third quarter of this fiscal year alone.  That’s hard to imagine.

To help, here are some photographs.

Text Box:
The $2 Trillion Dollar Stimulus Package in $100 Bills

Keep in mind that the debt that needs to be financed in the third quarter alone needs to be 50% greater than the 20,000 pallets of $100 bills pictured in the last photo.

Each of these pallets contains $100 million dollars.

Assuming an 18-wheeler can carry 10 pallets of $100,000,000 each, that means the truck could haul $1 billion.

If the recently passed stimulus package was funded in $100 bills, 2000 semi-trucks loaded with $100 bills would be needed to transport the money.

To fund government spending in the third quarter, 3000 more 18-wheelers would be required.

As remarkable as it is alarming.

At some point, should money printing of this magnitude continue, the deflation will likely give way to hyperinflation.

The tipping point for inflation to appear in earnest is when the Fed has pumped so much money into the system that people begin to expect higher prices.  This is exactly the opposite of the price expectations for deflation.

When the inflation tipping point is reached and consumers expect higher prices, they begin to spend money faster to avoid paying higher prices for the items they desire.  It’s this spending pattern that causes inflation.

At this point, I am of the opinion that we will see short-term deflation followed by inflation unless the Fed changes course which also seems unlikely at this point and under current leadership.

The two-bucket approach remains the best tactic to utilize in your portfolio from my perspective since the timing of the transition from deflation to inflation is very difficult to determine.