Seeking Alpha
Profile| Send Message|
( followers)

Most mainstream economists will tell you that inflation is mild and under control. This may be true for things like housing, wages, and consumer electronics but other parts of the economy such as health care and college tuition among other things have seen a steady increase in inflation.

Although inflation seems to be relatively calm on the surface, it may just be the calm before the storm. If we have learned anything from history we know that inflation usually doesn't increase gradually - it comes out of nowhere and just hits you when you least except it. Amity Shlaes, a senior fellow of economic history at the Council on Foreign Relations explained in a recent article how inflation can quickly accelerate and spiral out of control.

She compares monetary policy to sailing. "You're gliding along, passing the peninsula, and you come about. Nothing. Then the wind fills the sail so fast it knocks you into the sea. Right now, the U.S. is a sailboat that has just made open water, and has already come about. That wind is coming. The sailor just doesn't know it."

The proverbial "wind" in this case is the currency and credit that the FED has pumped into the system, and there is plenty of it. Since the financial crisis of 2008 the FED has doubled the M1 money supply and most of this money sits idle, just waiting to blow into the boats sails and knock the sailors out of the water.

A sudden jolt in inflation and a shock in the consumer price index wouldn't be anything new. This has happened on numerous occasions and usually as a result of increased spending. The chart below shows how inflation has historically come out of nowhere and exploded almost overnight.

While a sudden rise in inflation often comes as a surprise to some, anyone familiar with Austrian economics knows that inflation is a consequence of an increase in the money supply. Higher prices are merely a symptom of the problem. The inflation that is created by the expansion of the money supply comes with a lag because it takes time for the newly created money to make it out into the economy and bid up asset prices.

But inflation is not only a monetary phenomenon; there is also a psychological mechanism involved. For example, the people who think inflation could climb higher usually come to that conclusion because they think it should be higher. Perception of reality creates reality and if market participants believe that inflation is imminent they will act accordingly. The velocity of money will increase as market participants become more and more reluctant to hold cash - passing it along as a "hot potato" and thereby creating a self reinforcing feedback loop.

The bond market for example doesn't act merely on what it sees; it acts on what it expects of the Fed or the government. And our own Fed has let us known it's capable of just about anything, which includes inflationary monetary policy.

We have already started seeing inflation in the system. The chart shows an increase in the official inflation rate versus the inflation rate reported by Shadowstats, a free market organization calculating inflation without hedonic adjustments and other tricks governments use to make inflation appear lower.

The chart shows that inflation has already started to accelerate and there is no way of telling exactly when we will feel the dreaded jolt of higher prices. A problem with money printing and ultra low interest rates is that the undesirable effects of inflation occurs with a time lag, making it difficult to know when it's gone too far. Central banks can only measure the effects after the fact, and by then it may well be too late. The dollar and all other fiat currencies are not backed by anything other than confidence and promises. If this confidence is lost it cannot easily be regained.

To protect against the adverse consequences of inflation I urge retail investors to purchase physical gold and silver. In absence of physical metal the Central Fund of Canada (CEF), Sprott Physical Silver Trust (PSLV) and SPDR Gold Trust (GLD) are alternatives.

Senior gold mining stocks, such as Barrick Gold Corporation (ABX), Goldcorp (GG), Newmont Mining (NEM), Yamana Gold (AUY), and Silver Wheaton Corp (SLW) (a silver steaming company) may also serve as an inflation hedge. Although they are more volatile and could easily plunge in price if the economy goes back into recession.

Disclosure: I am long GLD, AUY.

Source: Prepare For A Sudden Jolt Of Inflation And Protect Yourself With Gold