There is a growing view that post-Covid we will see a rapid increase in inflation, maybe hyperinflation, and that gold will surge in price as a result. Is that view, right?
Will the post-Covid world see inflation, hyperinflation and surging gold prices?
Central banks are trying to create money again. Quantitative easing is back. But at the same time, because of Covid, we are producing fewer goods and services worldwide. As a result, or so many are arguing, inflation is about to return with a vengeance.
If that view is right, then gold is likely to soar in value but is that right?
There are arguments on both sides.
Prices rise if demand exceeds supply and inflation occurs if demand consistently exceeds supply.
The role of the money supply comes into the debate. The Irving Fisher Equation explains it. The equation states PT=MV. It means average price times transactions equals money in circulation times the velocity of money in circulation.
The economist Milton Friedman argued “that inflation is always a monetary phenomenon.”
There is a misconception on how the money supply grows under the banking system we have today. When banks lend, they create money. If bank lending falls, the so-called broad-money supply falls. This is why interest rates are seen as a way to control the money supply. Low-interest rates encourage borrowing, leading to growth in the money supply.
Post-1929 crash, in the US, banks collapsed. As a result, the money supply contracted sharply. Milton Friedman argued that this was the cause of the Great Depression.
Ben Bernanke was an expert on the relationship between the Great Depression and money supply before he became chair of the US Federal Reserve.
There can come a point with the economy when people and businesses do not want to borrow, no matter how low-interest rates. The economist Keynes likened cutting interest rates under those conditions with pushing on a piece of string.
Friedman argued that in extreme circumstances, when the economy is performing poorly, and demand is weak, if all else fails, central banks could print money and scatter it across the land from a metaphorical helicopter.
The fall in inflation has occurred despite rising prices in grocery stores.
Central banks have attempted to create money via quantitative easing, but while the so-called narrow money supply has risen sharply, the velocity of money has fallen equally sharply. That is why central bank activity has not led to inflation so far.
It is argued that during the lockdown, households saved. The creation of furlough schemes has meant that household income has remained relatively high, but output has fallen. It is feared that post lockdowns; households will go out and spend, long before output recovers, creating inflation.
But post-Covid, we are likely to see unemployment remain high for some time. Business will be hit hard by the crisis; many will go bust; others will seek to repair balance sheets. Under such circumstances, I expect private-sector borrowing to fall, putting downward pressure on the money supply.
Demand is one part of the equation that determines price. Supply is the other part.
Global capacity is likely to be pushed both ways. The latest data on Covid infections reveals that worldwide, the virus is still spreading fast with daily infections still increasing rapidly.
I also think there is a real risk of a second wave.
These factors could lead to weak global output at a time when consumers in Europe and the US are spending as a result of lockdowns coming to an end. This would be inflationary.
On the other hand, the acceleration in the move towards digital technology is likely to see an increase in productivity. As a result, there is a very real possibility that output will recover faster than jobs. This will be deflationary.
Reversal of globalisation
I am seriously worried, however, that the Covid crisis will see even more pressure on the reversal of globalisation. But globalisation is perhaps the main reason why inflation has been so weak these last 20-years or so. If it reverses, we may indeed see inflation return.
In my opinion, deflation is more likely than inflation in the medium term. However, if we see a continued reversal of globalisation, the longer-term implications will be much more serious.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees