The economy has been showing great gains, and that positive trend is fueling fears of a surge in inflation. The Consumer Price Index, the key predictor of inflationary trends, rose .05 percent in January, which greatly exceeded the anticipated rise of 0.2 percent. The market reacted as expected as stocks fell, and government bond yield rose.
The Fed is keeping a close eye on these developments, and that could fuel the inflation fears. The fear of rising prices includes most economic sectors, from gasoline, housing, food, healthcare, to clothing.
Predictably, the market reacted immediately to the CPI rise with a 100-point loss after opening, even though the decline was quickly reversed. Investors are anticipating that the Federal Reserve could raise their interest rates three or more times by year-end.
As the economy continues to grow, unemployment has fallen to a record low and the sale of tangible goods is up. Economists are anticipating the economic upswing to continue as the GDP is expected to grow by 3 percent, faster than anticipated. Since 2009, the GDP has only risen by an annual average of 2.2 percent. As a result, prices for consumer goods have risen predictably and steadily. The Federal Reserve is setting policy with a 2 percent inflation in mind. A higher-than-anticipated inflation rate could raise interest rates, making it more difficult for companies to borrow needed funds. Following the passage of a $300 billion spending package, market-watchers are now convinced of a 62 percent chance that the Feds will raise interest rates three times by December. Rate hikes in March and June are almost a certainty, with the third hike a high possibility. A fourth hike is not out of the question and becoming more likely. This is seen by many as the real problem.
On top of the $300 billion spending package, the government has signed off on a $1.5 trillion tax cut over the next ten years. President Trump has also promised more funding for large and long-overdue infrastructure improvements.
All the signs for economic growth are in place, and economists such as Joel Naroff of Naroff Economic Advisors, Inc. are anticipating the consequences of “too much of a good thing” to be rising costs and rapid inflation.
Between 2000 and 2016, food prices have increased by almost 40 percent. This number is within the norm as it comprised a reasonable 13.1 percent of household income in 2016. For a household in a lower-income bracket, however, this amount jumps to 36.6 percent, making it far more significant to poorer consumers. The chart below from zerohedge depicts the rise in food prices since 2007 and the actual impact of inflation for staples at the dinner table.
Only a handful of food items fell in price, with meat prices increasing by an average of 50 percent.
Consumers are also subjected to higher prices due to tariffs on imports. As a matter of fact, tariffs can double the cost of certain items. The price of certain fruits and vegetable, leather goods, chocolate and dairy products, to name a few, are inflated due to import taxes, or tariffs. The government imposes these tariffs to protect local industries and jobs from unbridled foreign competition.
The import of steel and aluminum has some major financial and security implications. The US is a major steel buyer from across the world, while we only export 25 percent of the amount of the steel we produce. That makes the US a major global player in the steel market. President Trump is considering a tariff of up to 25 percent for worldwide steel imports and a 53 percent tariff for steel imported from 12 specific countries. Aluminum will face a general worldwide tariff of around 8 percent and a 23.6 percent tariff from specific countries. Both steel and aluminum imports will also face import quotas, thus raising prices even more.
Global steelmaking capacity is up 127 percent from 2000, but the demand for steel has not kept up with capacity. Currently, the worldwide capacity for steel production is at 700 million tons; however, this number is 7 times the amount of steel used in the US.
China is the world’s major steel exporter. Its monthly steel production equals the US’s entire annual production of steel. This situation has lead to the demand for a 53 percent import tariff and quotas on all major steel producing countries, including China, Vietnam, Brazil, Thailand, Costa Rica, Turkey Malaysia, Russia, Egypt, Republic of Korea, India, South Africa and India. The purpose of these strict new measures is to increase US steel production from its current 73 percent capacity to 80 percent.
During 2013 to 2016, aluminum suffered the loss of 6 smelters in the US as demand fell by 58 percent. New plans for an improved infrastructure should raise demand considerably. Currently, the government is recommending a minimum 7 percent tariff on all aluminum imports, with a 23.6 percent for aluminum imported for Vietnam, China, Russia, Hong Kong and Venezuela. Imports from all countries can expect an import quota.
All these anticipated measures are expected to benefit the US steel and aluminum industries and raise consumer prices for commodities using these materials. While prices drop in the US, the quotas will help decrease aluminum prices in China, thus allowing for cheaper exports of items manufactured with steel and aluminum. Our policies focus on manufactured good rather than raw material, so the US needs to consider that the quota of these materials will result in cheaper products. The usual remedy is higher tariffs to allow competition with locally-produced goods.
These signs of impending inflation have investors taking another look at gold as the historically most reliable hedge against inflation.
We could be facing a major gold bull market soon. This one will be quite different from the bull markets in the 1970s or the post-2000 market. An entirely new factor is being introduced into the global gold markets with potentially huge consequences. This time, it includes the Islamic factor in the gold trade. One-quarter of the world’s population is Islamic, and investing in gold has been against Islamic law. This is changing, and one-quarter of the world’s population could be infusing the gold market with $3 trillion of investments.
In addition, China has opened the Shanghai Gold Exchange. China has huge gold reserves and wants prices set in actual gold value instead of paper futures. Currently, for each physical ounce of gold, there are 252 ounces of contracted futures on paper. This could change drastically if China has its way, and it could create a gold bull market of historic proportions.
Our growing economy, along with anticipated changes in tariff regulations and entries into the gold market make inflation in 2018 almost a certainty.