There is no return to normality, the case for gold and silver

Finally, the US Federal Reserve (Fed) did it: On 16 March 2022, it raised its interest rate by 0.25 percentage points, bringing the Federal Funds Rate to a range between 0.25 – 0.50 per cent. In addition, the Fed indicated that it would continue to raise interest rates in the months to come. Does this mean that the Fed is really ending its ultra-loose, rather inflationary monetary policy? Unfortunately, quite some doubts remain.

With consumer goods price inflation skyrocketing – in February, the US CPI was up close to 8 per cent against last year – the Fed must send a signal of confidence to the general public if it does not want to lose its credibility altogether. At the same time, however, it would take a fairly strong increase in the Federal Funds Rate to bring real interest rates back into positive territory: Currently, the short-term US interest rate is hovering around an estimated minus 7.7 per cent – a record low.

Imagine what would happen if the Fed brought the real interest rates back to a historically more normal level of, say, 2 to 3 per cent. Rising credit and capital costs would most likely shatter the financial and economic system. Stock, bond, and real estate prices would deflate, causing substantial balance sheet losses for investors, firms, and private households. Many investment projects would turn out to be unprofitable; many firms would cut jobs.

In other words: returning interest rates to more normal levels would most likely result in a deep recession in the US economy. This, in turn, would almost certainly have negative consequences for the rest of the world economy. For the latter has also been fuelled by an ultra-easy monetary policy, strong credit and monetary expansion, in particular, made possible by the ultra-easy monetary conditions imposed by the Fed.

The key question is: will the Fed and other major central banks be prepared to defend the purchasing power of their currencies at the cost of decreased production and lost jobs? The answer is more likely no than yes. Of course, this is a rather uncomfortable truth. It is not supposed to become breaking news with the general public – because it could lead people to abscond from cash, which would amount to a worst case scenario for the unbacked paper money system.

While the Fed and other major central banks may well raise their short-term interest rates somewhat further going forward, they are unlikely to push elevated inflation down to around 2 per cent anytime soon. Expect central banks to do their very best to convince investors that the fight against inflation is on hoping that mostly words will suffice to keep people’s confidence in the currency and that real policy tightening can be kept at a minimum.

The ongoing conflict in Ukraine and the economic, political, and military fallout it could have will most likely work in favour of central banks, allowing them to let price inflation to continue longer. That said, a further devaluation of the purchasing power of the US dollar, euro and the like is to be expected. That said, elevated and persistent price inflation is and will remain a key challenge for investors for the foreseeable future.

In this context, it should by no means be overlooked that inflation brings not only economic problems but also political unrest. Inflation encourages malinvestment and excessive consumption, resulting in impoverishment. Inflation can also all too easily result in political instability and radicalisation, posing a real risk to peaceful and production cooperation among people, both nationally and internationally. That said, investors should not underestimate the full cost spectrum of inflation.

There are various strategies to shield the investment portfolio against the vagaries of inflation. One option for the long-term oriented investor is holding some physical gold and silver. The latter cannot be debased by central banks‘ monetary policy, and they do not carry – unlike bank deposits – any payment, or: default, risk. If the conclusion of this article is correct – namely that there is no return to normality as far as monetary policy is concerned –, there is indeed a strong case to be made for holding physical gold and silver.

Thorsten Polleit Chief Economist of Degussa