With the exception of most Anglo-Saxon central banks, the majority of foreign central banks continue to hike lending rates this year amid surging inflation. As food and energy inflation climb to their highest levels since 1990 worldwide, central banks in Latin America, the Baltics, Balkans and South Africa are raising interest rates. And the European Central Bank, or ECB, remains vigilant in its inflation fight, claiming oil prices must decline before lending rates can relax.
If not for the deflationary effects of the ongoing credit squeeze, the Fed and other central banks in Canada and England would probably be raising, not lowering, short-term rates in 2008. The United States, of course, is mired in its worst financial debacle in decades with the forces of inflation (food, energy) and deflation (housing, contracting bank credit) tugging the economy into a slowdown or recession in 2008. This “inverse” stagflation is unique and marks the first time since 2001 that both inflation and deflation are running hard side by side.
For most central banks, however, target inflation rates have now been breached. This helps to explain why commodities are soaring and gold prices heading to new post-March all-time highs. Investors are losing confidence that central banks can arrest inflation. Gold, which hit an all-time intraday high of $1,033 an ounce in March, is now heading to breach that level over the next few weeks, if not sooner. Gold continues to blast past all currencies since 2005 – including the mighty euro, Brazilian real and the Canadian dollar. This tells me that despite big gains for most currencies against the dollar this decade, they pale in comparison to gold and other hard assets.
Monetary reflation is now alive and kicking just about everywhere. Central bank broader monetary aggregates continue to post high single or double-digit gains over the last 12 months as authorities grow desperate to revive sagging growth triggered by a major American slowdown (see chart above).
The U.S. dollar is probably one of the most undervalued currencies in the world at this point following a severe decline since 2002. I would not dump dollars now. Most U.S. assets from a foreign currency perspective are absolutely dirt cheap!
But if you expect a “muddle through” economic recovery to persist over the next 12 months -- and I do -- then the Fed will have to remain accommodative as housing attempts to establish a bottom. This doesn’t imply the dollar must fall further, but it does suggest commodities and gold will continue to rally because most central banks will continue to print credit while simultaneously appearing concerned about rising inflation.
The majority of central banks raising rates in 2008 are only gradually draining liquidity from the financial system. These banks are also largely smaller players on the global stage. The banks that matter most in creating inflation – the Fed and the ECB, however, continue to print credit and inject funds. Inflation is trying to win and overcome deflation. In time, I’m betting on inflation.
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