Looking in the rear view mirror won't tell you where we're going, but it will provide absolute clarity on what's come, and gone. The conceit in giving historical analysis more than passing reference is that maybe, perhaps we can glean clues about the future despite all the compelling evidence to the contrary.
Yes, the jury's forever out on the value of looking back, but it lends a veneer of credibility to an art form that's always in need of a plausibility boost. With that caveat, we're about to engage in activity that, by our own definition, is questionable.
If anyone's still reading, we refer you to the chart below, which shows that oil and gold have been in the lead over U.S. equities and the dollar, as defined by the U.S. Dollar Index. What lessons can we draw from said chart? One is that investors (or at least gold traders) are increasingly concerned with inflation.
Inflation, as officially calculated by the Department of Labor, has risen by around 3% in the past five years. By that measure, one could be forgiven for yawning at the idea that inflation's a growing threat. On the other hand, gold has paid no mind to official government numbers and instead has climbed by nearly 16% a year since 2002. The greenback, in its usual role as moving inversely to gold, has lost roughly 5% a year over the same stretch.
An op-ed in Thursday's Wall Street Journal from the principals of Wainwright & Co. Economics, warned that increased concern with inflation risk is warranted. "For several years now, as was the case in the 1970s, all the world's currencies have been depreciating relative to stable benchmarks such as gold," the essay claimed. Why, then, doesn't the CPI echo the warning?
"Gold is a fast-moving leading indicator, whereas consumer-price indices are slow-moving indicators that lag far behind," the authors wrote. "We all learned in the period between 1975 and 1985 that consumer prices do eventually catch up. It is the size of the move in the gold price, rather than in the consumer price index, that is a true and timely indicator of the magnitude of the inflation problem."
For the moment, the bond market disagrees. Although the benchmark 10-year Treasury yield shot up to over 5.3% last month - the highest in five years - the surge was brief. At one point on Tuesday, the 10-year yield dipped under 5%, before closing at 5.05%.
But if inflation fears raise no eyebrows in the U.S., it's percolating elsewhere on the planet. That includes Britain, where the Bank of England just raised its benchmark interest rate by 25 basis points to 5.75%, the highest in six years. It was the fifth straight increase in less than a year. David Brown, an economist at Bear Stearns, predicted that more rate hikes may be coming for England, in an article that appeared in Reuters.
The pace of expansion of the world economy remains robust," the BoE's statement advised. "The margin of spare capacity in businesses appears limited, and most indicators of pricing pressure remain elevated. The balance of risks to the outlook for inflation in the medium term continued to lie to the upside.
By contrast, The European Central Bank left rates unchanged, although hints of a rate hike accompanied the non action. Jean-Claude Trichet, the ECB's president, said in a prepared statement that inflation risks in the medium term are "on the upside." He explained that, "as capacity utilization in the euro area economy is high and labor markets continue to improve, constraints are emerging which could lead in particular to stronger than expected wage developments."
So far, none of this has made an impression on Fed funds futures, which remain priced in anticipation that Fed funds will stay at 5.25% in the coming months. Perhaps the U.S. economy rationalizes the current state of no action by the Fed. Debate rages about whether the economy's fated to contract or grow (albeit modestly) for the rest of the year, and on into 2008.
Regardless, the pressure on the dollar looks set to grow if foreign interest rates rise while U.S. rates remain unchanged. If Fed policy is intent on weakening the dollar as a means of boosting exports, the plan is riding high. The question is what a further weakening of the greenback implies for inflation, or vice versa. The gold market seems to have an answer at the ready.