Friday, August 19, 2011

Record Gold Prices and Bond Spreads Point to Stagflation

Amidst last night’s second chapter of this year’s global stock market rout, GOLD prices has spiked anew to record highs breaking above the $1,800 level (or added $1,000 in just 10 days!!!).


I have been repeatedly (nauseously) saying here that gold’s rise has been in the account of greatly increased expectations of more inflationary actions by the central bankers.

The US bond markets appear to be echoing gold’s actions.

This from Bloomberg’s Chart of the Day, (bold emphasis mine)


The Federal Reserve’s unprecedented pledge to hold interest rates at a record low risks creating an inflationary surge once the economy starts to accelerate, Treasury bond trading shows.

The CHART OF THE DAY tracks the difference between yields on the 30-year Treasury bond and its Treasury Inflation Protected Securities counterpart and the same comparison for two-year notes. The lower panel shows that the gap between those so-called breakeven rates reached the widest since December this week, as the Fed’s commitment to hold down borrowing costs, announced after an Aug. 9 meeting, intensified concern inflation would accelerate.

“Because the Fed maintained fund rates at exceptionally low levels, that’s causing inflationary expectations to pick up,” said Hiroki Shimazu, senior market economist in Tokyo at SMBC Nikko Securities Inc. “In the long-term, there are much bigger problems for the U.S. economy. This is one of the warning signs.”

The spread between yields on two-year notes and so-called TIPS, which gauges trader expectations for consumer prices over the life of the debt, narrowed to 0.95 percentage point on Aug. 16. When using 30-year bonds and same-maturity TIPS, the figure jumps to 2.61 percentage points. The difference between the measures was 1.66 percentage points, the highest this year.

The establishment's commentary misleads the public when they attribute the cause and effect relationship of inflation to economic growth.

The fact is inflation arises from money printing or expansion of fiduciary media, and can accelerate even when the economy is in the doldrums such as in the stagflation era of the 70s (shown below- US consumer prices on a year annual % change trended up even during 3 recessions).


Or for a more extreme example, Zimbabwe’s hyperinflation episode which came amidst an economic depression (falling GDP, very high unemployment)

Bottom line: Gold and current bond spreads currently point to risks of stagflation

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