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Inflation Won’t Die
James Rickards

The January inflation numbers came out this morning, and they weren’t good for Wall Street.

The consumer price index (CPI) rose 3.1% in January. That’s a decrease from December’s 3.4%, but it exceeded consensus estimates of 2.9%.

Core inflation, which excludes food and energy, rose 3.9% on an annualized basis, which is unchanged from December. But the consensus estimate was 3.7%. Core inflation also rose at its highest rate since April 2023.

Here I want to make an important point about core inflation. From the point of view of everyday Americans, core inflation is nonsense.

Gas in the car, home heating and food on the table are large parts of the total spending of most Americans. Taking them out of the inflation calculation is something only the eggheads would do.

When Americans provide for their families, they don’t pay “core,” they pay regular CPI. That’s all you need to know when it comes to public policy, citizens’ well-being and (for politicians) how people will vote. For the record, 3.9% inflation cuts the value of the dollar in half in 18 years.

Sorry, Wall Street — No “Pivot” 

The stock market threw a temper tantrum once the inflation news broke this morning, with all three major averages tanking. By the end of the day, the Dow lost 661 points, while the S&P lost 90 and the Nasdaq lost 350.

But the good news for Wall Street is that today’s inflation data won’t cause the Fed to raise rates. In the Fed’s December meeting, Jay Powell essentially confirmed that the Fed had reached what they call the “terminal rate.”

The terminal rate is defined as a rate that’s high enough to bring inflation down on its own without further rate hikes. By the way, a terminal rate is an invention by the Fed. There is no discussion of terminal rates in economic literature, and it’s not something the Fed has ever used as a policy tool. The Fed just made it up.

But the Fed believes in it. So Wall Street can at least be thankful that the Fed is done raising rates. But today’s report also signaled to the Fed that inflation remains an issue, and that its ideal 2% target remains elusive.

Inflation and the Economy

What does inflation indicate for the real economy outside of Wall Street? It’s hard to say. Inflation is meaningful on its own, but it has no correlation to the business cycle.

In the early 1960s, we had low inflation and strong growth. In the late 1970s, we had high inflation and weak growth. In the late 1990s, we had moderate inflation and strong growth. In the 2010s, we had low inflation and low growth.

Does anyone see a correlation there? There isn’t one. Growth and inflation are empirically uncorrelated. We can agree that inflation is bad, but inflation tells us nothing about the prospects for growth.

At any rate, you can basically rule out a March rate cut. The Wall Street crowd who’s been waiting for the Fed to “pivot” will have to keep waiting. After today’s report, the market’s giving just 8.5% odds that the Fed will cut rates next month.

Having said all that, today’s report doesn’t come as a surprise to me. As I said almost a month ago, “Is inflation over? Actually, no. And it may be getting worse.”

(I’ll be going live tonight at 7:00 p.m. ET as part of the Zero Hedge debate series on the future of the U.S. dollar. If you want to check it out, go here to learn how.)

Inflation Is Often out of the Fed’s Control

Inflation can increase on its own for reasons that have nothing to do with Fed policy. Supply chain disruptions, economic sanctions, pandemics and demographics are all examples of factors that can drive inflation higher or lower regardless of the Fed.

The first flaw in the model-based forecasts is the failure of analysts to distinguish between inflation that emerges from the supply side and that which emerges from the demand side. The difference is crucial from a forecasting perspective.

The inflation of 2021–2023 was real but it was caused by supply chain bottlenecks and shortages of critical goods and industrial inputs. The supply chain disruptions were exacerbated by unprecedented economic and financial sanctions because of the war in Ukraine.

This kind of supply-side inflation tends to be self-negating. The high prices cause reduced demand, which in turn tends to lower prices. We’re seeing this every day starting at the gas pump where the record high prices of the summer of 2022 have come down significantly (although still higher than 2021).

The Psychology of Inflation

The second flaw in the models is the failure to understand the process by which inflation can shift from the supply side to the demand side if inflation persists long enough. This is a change in the psychology of consumers and plays out in behavioral responses.

Neither the psychology nor the behavior is accounted for by standard models.

If inflationary psychology takes hold in the general public, it can feed on itself despite recession and declining real wages. The models don’t show this but history does. This is exactly what happened in the 1970s.

Even in periods of economic stress, consumers respond to inflation in ways that make sense. They accelerate purchases because they expect prices to rise further.

If you look at the data since June, you’ll see that inflation isn’t actually going down; it’s stuck in a range of 3.0–3.7%. Some months are higher in the range than others, but none is lower. Inflation is stuck and the January data doesn’t change that.

The Fed and the Phillips Curve

Where do these inflation numbers leave us? Again, it appears that inflation well above the Fed’s 2% target will persist for some months.

The Fed likely blames persistent inflation on the low unemployment rate (3.7%). But one of the biggest failures in the Fed reading of economic signals relates to unemployment and inflation. The Fed considers low unemployment to be a sign of economic strength and a source of inflation.

The idea that low unemployment leads to inflation (which is what links the Fed’s obsessions with unemployment and inflation) is an artifact of the discredited Phillips curve beloved by Bernanke and Yellen and adhered to by Powell on the bad advice of Fed economists.

So the Fed is almost certainly misreading the economy because of its faith in faulty models like the Phillips curve.

In terms of inflation, the political implications for Joe Biden are strongly negative. He’ll definitely be blamed for the inflation of the past three years. Even if inflation is much lower by Election Day, Biden will be tarnished with the legacy of three years of price increases (I won’t get into how his cognitive decline will impact the election today).

Remember, lower inflation does not mean price declines; it just means prices are going up but at a slower rate. The damage of price increases from 20212023 is embedded in current price levels and will not go away.

They could ultimately get Trump elected.




James G. Rickards is the editor of Strategic Intelligence. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He was the principal negotiator of the rescue of Long-Term Capital Management L.P. (LTCM) by the U.S Federal Reserve in 1998. His clients include institutional investors and government directorates. His work is regularly featured in the Financial Times, Evening Standard, New York Times, The Telegraph, and Washington Post, and he is frequently a guest on BBC, RTE Irish National Radio, CNN, NPR, CSPAN, CNBC, Bloomberg, Fox, and The Wall Street Journal. He has contributed as an advisor on capital markets to the U.S. intelligence community, and at the Office of the Secretary of Defense in the Pentagon. Rickards is the author of The New Case for Gold (April 2016), and three New York Times best sellers, The Death of Money (2014), Currency Wars (2011), The Road to Ruin (2016) from Penguin Random House.

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