Gold gave back about half of a $100 gain and closed just above 4,050, up around $50 on the day. Silver rose about a dollar to 58.58 after getting hit a couple of bucks the day before. The sharpest move happened in the bond market, which lost almost all of its gain. By the close, the 30-year Treasury yield was back up to 5.1 and the 10-year back to 4.59, near their high points, even after a better-than-expected inflation report.
The inflation number was noise
Markets cheered a soft inflation reading. Bond yields fell, bonds rose, and gold spiked $100 an ounce. The reaction made no sense. The main driver of the 0.4% drop was oil. Oil fell about 30% in June because the war with Iran looked over, with an MOU and a ceasefire in place. That ceasefire is now off, the war is back on, and oil sits at $80 a barrel, up 20% so far in July with the month only half done. The entire oil decline that pulled the number down is being reversed. Celebrating this backward-looking figure is pointless. Inflation is far above 2% and will not get near 2% no matter what the Fed does. The official government measures probably capture only about half of the price increases Americans actually face.
The Producer Price Index comes out tomorrow morning, before the second day of testimony on Capitol Hill. Producer prices have been running hotter than consumer prices, and PPI also got a temporary boost from last month's oil drop that is now being undone. Algorithms are programmed to trade off these numbers, so the moves happen anyway. People should use these swings to their advantage. The belief that higher inflation is bad for gold is backwards. Gold is an inflation hedge, and the more inflation there is, the more you need to hedge. The idea rests on the notion that the Fed will fight harder to bring inflation down. What high inflation really proves is that the Fed cannot bring it down. It lacks the ability, because doing so would expose all the other problems in the system.
Inflation is not rising prices
The whole debate in Congress centers on a term nobody defines. Everyone acts as if inflation means rising prices. It does not. Inflation is an expansion of the supply of money and credit. That is what gets inflated. You cannot inflate a price; "inflate" means to expand, and what expands is the money supply. If you misdefine the term, the entire discussion is meaningless. Prices go up and down for many reasons. Inflation is a separate problem that pushes the general price level higher than it would have been otherwise. It does not even require prices to rise. It can simply stop prices from falling.
The government insists falling prices would be a disaster. That claim collapses on contact. So many people are suffering from high prices, and food prices have climbed sharply over the past several years. Lower prices would help, not hurt. Setting a target of 2% more per year does not fix prices that are already too high; it makes them higher. Consumers want everything to cost less. The government treats that as a threat and works to keep prices from ever coming down.
It takes two to inflate
Congressmen and women rage at the Fed and demand a plan to stop inflation, while they are part of the cause. It takes two to do the inflation tango. Congress spends money it does not have and runs deficits. The Fed then monetizes those deficits and artificially holds down interest rates, largely so the government can finance its deficits without crowding out private credit and pushing rates up. The president signs onto the spending. Monetary and fiscal policy work hand in glove, and that is the source of inflation. The same lawmakers voting for deficit spending yell at the Fed as if they had nothing to do with it. They need to look in the mirror. Fed chairs, for their part, always deny responsibility and reach for excuses, blaming tariffs or the war. The cause sits right there in the hearing room: the representatives and the Fed, debating a problem they created while pretending an outside solution exists.
Who wins and who loses from cheap money
Kevin Warsh talked about doing things differently and solving the problem without saying what solving it would take, which is exactly why it will not get solved. Artificially low interest rates have clear winners and losers. Debtors win. Creditors lose. Low rates favor borrowers over savers, especially wealthy leveraged borrowers who took on debt to buy assets. Cheap borrowing plus inflation that erodes the value of what they owe makes them big winners. The losers are savers, who tend to be middle class. Even middle-class households with little savings left, after taxes and inflation wiped much of it out, still hold pensions, annuities, and cash value in insurance policies, all of which inflation harms.
The biggest debtor of all is the federal government, so it wins from suppressed rates. The people who lend to the government by buying its bonds lose, earning a lower return. Insurance companies own a large share of those bonds. Because they earn less on them, they charge higher premiums for fire, life, and car insurance. The middle class pays the cost from several directions at once. Warsh seemed not to grasp that a loan has two parties, a lender and a borrower, and that helping one side hurts the other, a surprisingly incompetent thing to miss.
What the Fed cannot do
At these hearings an African-American representative typically asks the Fed chairman what he will do specifically to help African-Americans, in this case black workers she said were hit disproportionately by unemployment or inflation. She asked several times. Warsh ignored the question. He should have leveled with her. The Fed has only a couple of levers: print money or not, cut rates or raise them. There is no lever aimed at African Americans and no policy that can target one group. If black households are disproportionately poor and middle class, they may suffer more from inflation, which may well be true, but the Fed cannot direct relief to them.
The honest answer goes further. Congress should repeal the laws that disadvantage black workers. The War on Poverty, Great Society, and welfare programs starting in the 1960s, along with the anti-discrimination laws, have backfired and harmed the people they claimed to help. That has nothing to do with the Fed, which harms everyone equally through bad monetary policy. Policies should be judged by their results, not their stated intentions. The road to hell is paved with good intentions, and here it is African-Americans who ended up trapped by that legislation. In many cases the intentions were not even good. The real purpose was to keep African-Americans in poverty to secure their votes, holding out an escape rather than delivering one.
