Forecasts, Commentary & Analysis on the Economy and Precious Metals
Celebrating our 48th year in the gold business
“The lights for the whole world’s economy seem to be flickering.”
Tim Harford, Financial Times
Gold and the Misery Index
Stagflation could force ‘a macro rotation into the precious sector’
Since the launch of the fiat money era in the early 1970s, when economies have gone very wrong, the unemployment and inflation rates have skyrocketed. On the campaign trail in the late 1970s, then-presidential candidate Ronald Reagan added the two numbers together and famously named the result the Misery Index. Subsequently, the Misery Index became the bellwether for stagflation – the combination of economic stagnation and runaway inflation.
Over the past several weeks, with stagflation rising once again to the top of investor concerns, the Misery Index has made something of a comeback. Accordingly, we thought it would be a matter of interest to build a chart showing changes in the index plotted against changes in the price of gold. Though we had an inkling of the result, the uncanny long-term correlation between the two data sets took us by surprise. At a glance, the chart tells the story of gold as a runaway stagflation hedge. The Misery Index nearly doubled in the ten-year period between 1970 and 1980, but gold rose by more than fifteen times. There were instances during the decade when the year-over-year increases in the price of gold surpassed 80%, and in early 1980 it surpassed 175%!
In a certain sense, the U. S. experience during the 1970s was the first of many runaway stagflationary breakdowns following the abandonment of the gold standard in 1971. Subsequently, similar situations cropped up in other nation-states. Argentina (the late 1990s) comes to mind, as does the Asian Contagion (1997), Mexico (1986), and more recently, Zimbabwe (2018) and Venezuela (2013). In each instance, as the Misery Index rose, citizen-investors who took shelter in gold preserved their assets as the crisis moved from one stage of deterioration to the next. In fact, today, gold, not the bolivar, is the preferred medium of exchange in some areas of Venezuela, where stagflation has given way to something even worse – hyperinflation. (Please see ‘Flakes of gold’ below.)
Misery Index and gold
(1971- to present)
Sources: St. Louis Federal Reserve [FRED], Bureau of Labor Statistics, ICE Benchmark Administration • • • Click to enlarge
(For a real-time version of the Misery Index-Gold chart, please visit USAGOLD’s Gold Trends and Indicators page.)
Gold glittered during the 1970s stagflation, but it also closely tracked the index more recently during the 2008 credit crisis and the 2020 pandemic-driven breakdown. Curiously, though, it has lagged the surge in the Misery Index over the past year and a half. This divergence probably has to do with Wall Street largely buying into the Fed’s contention that inflation is transitory. That narrative took a direct hit in late October when Fed Chairman Jerome Powell and Treasury Secretary Janet Yellen warned that high inflation could extend into late 2022. If both high unemployment and high inflation do indeed persist – i.e., if the Misery Index once again begins advancing – that lag on the chart might prove to be temporary. MKS Switzerland’s Nicki Shiels advises that a “stagflation would force a macro rotation out of typical reflation assets or commodities like oil and copper, and into the precious sector.”
Top analysts warn of a repeat of the 1970s, perhaps even worse
Noriel Roubini, the widely-followed professor of economics at Columbia University, believes stagflation is in the cards – one perhaps even worse than the 1970s. “Faced with a debt trap and persistently above-target inflation,” he writes in a recent Project Syndicate analysis, “[central banks] will almost certainly wimp out and lag behind the curve, even as fiscal policies remain too loose. … Over the medium term, as a variety of persistent negative supply shocks hit the global economy, we may end up with far worse than mild stagflation or overheating: a full stagflation with much lower growth and higher inflation.”
Similarly, Deutsche Bank analysts warn that “we do think it worth noting that many factors like debt, demographics and globalization all indicate that we could be facing an even more difficult situation than we saw back then.” Last week, Alan Greenspan, who warned of a coming stagflationary crisis almost two years ago, revisited those concerns. “If growth expectations continue to decline and price expectations continue to rise,” he wrote, “we may be heading into a stagflationary environment as increased supply-side costs erode consumer purchasing power and, ultimately, final demand.”
Hedge fund guru Paul Tudor Jones put it a bit more bluntly in a recent CNBC interview: “The inflation genie is out of the bottle,” he said, “and we run the risk of returning to the 1970s.” Over this past weekend, the Wall Street Journal’s editorial board officially put an end to the speculation on stagflation declaring that it is already here: “We’ve been reluctant to predict stagflation’s return given what should be a robust recovery from the pandemic destruction. But there’s no doubt from the government data that it arrived this summer.”
China leans into an already ‘combustible mix’ fueling a predicament for the Fed
Credit Bubble’s Doug Noland recently chronicled China’s unfolding debt crisis, starting with the Evergrande meltdown, and working his way in careful detail to the possibility of the contagion, as he now labels it, washing up on “our shores.” Secretary of State Blinken directed comments to China last month that serve as a wake-up call for western financial markets as well. He said that China should act “responsibly and deal with the challenges” imposed by the problems in its real estate and credit markets. What the country does economically, he said, “is going to have profound ramifications, profound effects, on literally the entire world because all of our economies are so intertwined.” In short, Blinken, too, is raising the specter of a contagion.
“Beijing waited much too long to begin reining in its Bubble,” writes Noland in a detailed analysis titled Contagion. “Pandemic stimulus stoked already perilous excess. Now Chinese officials face a terrible predicament and onerous decisions. At this point, large liquidity injections could further stoke inflationary pressures, while risking a disorderly decline in the Renminbi. The Fed waited much too long to begin reducing historic monetary stimulus. Pandemic stimulus stoked already perilous excess. Federal Reserve officials could soon face quite a predicament and difficult decisions. …”
“What does the world look like a month from now?” he asks in conclusion. “Has China’s unfolding crisis by then enveloped the ‘Core’? How powerful are de-risking/deleveraging dynamics in November, globally and in U.S. markets? My thoughts harken back to the March 2020 dislocation in bond (and equities) ETFs. Since then, Fed pandemic measures have spurred additional gargantuan bond fund inflows (at historically low bond yields) while simultaneously unleashing powerful inflationary dynamics. Quite a combustible mix. Clearly, the Fed is not about to ‘slam on the brakes.’ Might the bond market?”
Financial Times recently pointed out that Evergrande “for all of the high drama of its meltdown, is merely the symptom of a much bigger problem” – a broader collapse of the Chinese property market brought on by an over-extension of credit. As such, because building and real estate are such significant components of China’s domestic economy, the danger it imposes on the rest of the world economy is not likely to dissipate anytime soon. “The risks that spring from the Evergrande saga,” says FT, “encompass both financial contagion — especially in the offshore U.S. dollar bond market — and the prospect that a flagging property sector will strike at some of the vital organs of the Chinese economy, potentially depressing GDP growth for years to come.” Though the crisis has faded from the headlines over the past several days, South China Morning Post reported late last week that “Evergrande is barely out of the woods, as more payment deadlines loom ahead.”