If the Fed Had Only Listened to Gold

In this commentary at Forbes, Brian Wesbury and Robert Stein are concerned that the Federal Reserve is once again ignoring the signals being sent by the gold price and, like Steve Forbes, seem to favor some sort of a gold price or commodity basket targeting rather than the two percent inflation target that is getting an increasing amount of attention now that the consumer price data is falling short of that mark.

If the Fed would have listened to gold (or the nominal GDP model) over the past 15 years, the U.S. would probably not be in the mess it is in today. Gold prices fell from $400 per ounce to $255 an ounce between 1996 and 1999. This signaled deflation, but the Fed chose to ignore the signal and raised interest rates anyway in 1998 and 1999. Deflation, recession and a stock market crash were the result.In the wake of the stock market crash, the Fed started cutting rates because it feared deflation. Gold started to rise, and by late 2003 it was back above $400 per ounce. But the Fed held rates at 1% anyway, which created a housing bubble. When that bubble burst, the Fed started cutting rates again, and gold prices have now moved to more than $1,300 per ounce. At this point one would think the Fed would pause before pumping even more money into the system and targeting higher inflation.

But it isn’t. The Fed continues to hold interest rates at zero, proposes another round of quantitative easing and plans to target 2% inflation. All because it won’t listen to gold and it’s unable to see that banks are afraid to use the money the Fed is pumping in because, down the road, the Fed will be forced to take it out or face serious inflation.

That’s what gold is saying. By signaling that it won’t quit anytime soon, the Fed is trying to force banks to change their behavior. If it works, look out for inflation to reach multiples of 2% in the years ahead. The Fed hasn’t been successful yet, when it ignores gold and commodity prices.

Not long ago, in response to a question posed by some elected official during one of his many trips up to Capitol Hill, Fed Chief Ben Bernanke said that gold is “out there doing something different”. With the central bank talking about more money printing, deflation, and “liquidity traps”, that would appear to be quite an understatement.

Tim Iacono

Iacono Research.com

Tim Iacono is the founder of Iacono Research which provides market commentary and investment advisory services specializing in macroeconomic analysis and commodity based investing. He also writes the popular blog The Mess That Greenspan Made.

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