Financial markets tend to be short-sighted, particularly when it comes to inflation expectations. The market has fixated on the Fed’s target of a 2% inflation rate over the next decade, but I believe this is unrealistic. It overlooks key factors such as unchecked government spending and potential commodity shortages driven by increasing infrastructure demands. Why am I skeptical? Because the gold market is signaling something different. Gold, in my view, is the most important inflation indicator to watch if you want to navigate the economic challenges of the next decade.
First, the core hypothesis underlying my premise and this article: Gold, as it has been for 3,000 years, is a hard currency. It is nothing more, nothing less – not a fear asset or a geopolitical risk asset, but simply a noble metal which is no governments’ liability. As such, it has, and will continue to, preserve its purchasing power against inflation, regardless of the underlying causes – especially fiscal largesse and fiat currency profligacy. If you agree with me so far, then gold’s value, over an extended period of time, should oscillate around the true measure of inflation in any currency.
Ok, let’s take a look at the U.S. dollar price of gold over the past 50 years. Has it tracked closely with the reported CPI? No. Gold has far outpaced the government’s official inflation measure. So, is my premise wrong, or CPI severely understated? Here’s the part you may not know: starting in the 1980s, the government decided it had been reporting CPI “incorrectly”. Numerous economists, far more accomplished than myself, contributed to these revisions. But 40 years later, is anyone questioning the validity of these changes? Not really.
One economist, John Williams of ShadowStats [1], has consistently maintained the original CPI calculation methods and reports numbers as they would have been before the revisions. Using his data, we compared the contemperary CPI calculation, original CPI calculation, and gold. Lo and behold, gold trades much closer to the inflation level indicated by these pre-revision methods. Is it an exact science? No, but look at the chart yourself – it seems far more aligned with reality than the “revised” CPI methodology.
Let’s broadly review the major revisions to CPI, as they shed light on the diminution of the American Dream, the rise of populism, and my premise: the current mega bull market in gold. The government’s stated CPI is a critical factor in labor negotiations, retirement planning, and Social Security calculations.
Substitution: Prior to the 1980s, the government measured a fixed basket of goods to track price changes. Then the dream was downgraded –if you bought steak last year but couldn’t afford it this year and switched to hamburger, the assumption was made that your needs were still being met in the same way.
Financed Charges: Increases in car loan, mortgage, and credit card rates were removed from the inflation calculation. So, if your car payments go up due to higher rates, it is not considered inflation. Huh?
Hedonics: Products improve over time. For example, an iPhone may have more memory and processing power than it did a few years ago. As a result, even if the price rises, it is not considered inflation because you’re supposedly getting “more” for your money.
What else validates the price of gold and the original CPI method? The broadest measure of money supply – M3. Though still published by the St. Louis Fed, M3 gets little attention today. However, Nobel laureate Milton Friedman argued that money supply times velocity equals real GDP times inflation. Now, look at the chart of M3 and ask yourself how inflation could possibly be “tamed” (assuming velocity holds roughly constant). Friedman famously said, “Inflation is always and everywhere, a result of too much money, of a more rapid increase in quantity of money than output.[2]” So, take another look at that M3 chart, using Williams’ data, and tell me you don’t need to manage for future inflation risks.
In these charts, I believe we can see the root of disillusionment that has affected substantial portions of the population in achieving what was once my generation’s American Dream – homeownership, cars, and steak. This frustration may well be fueling the rise of populism in today’s politics. As the Fed takes its inflation victory lap, keep an eye on M3, commodities like copper, and especially gold. Inflation is far from dead, and the notion of a 2% inflation rate forever is a dangerous fantasy you cannot afford to believe in.