Politics & Policy

Four Dead Bodies

Right now, gold, the dollar, bond spreads, and commodities all point to inflationary money from the Fed.

In my book American Abundance, published in 1998, I talked about the Four Dead Bodies theorem of inflation. Just as you should strongly suspect murder if you discover four dead bodies in an alley, you should be very wary of future inflation if four key market-price indicators are acting in unison. These include rising gold, a soft dollar, expanding bond spreads, and strong commodities. Right now, all point to inflationary money from the Fed.

Some of my supply-side colleagues have been warning of higher inflation for the last few years on the basis of three dead bodies: rising gold and commodity prices and a soft dollar index. But I have avoided the inflation call because the bond market hasn’t signaled a move to higher price indexes. Frankly, the bond market is a far more broad, deep, and resilient indicator than gold, commodities, or the dollar. Hence, it deserves a disproportionately high ranking in the body-count scheme.

Additionally, the Treasury bond has even greater analytical meaning because of the inflation-adjusted bonds (or TIPS) that trade in the open market. Basically, the 10-year Treasury bond can be deconstructed into a growth component (the real rate) and an inflation component (the TIPS spread). And so far this year the 10-year TIPS inflation spread has risen about 21 basis points, putting it above its 5-year average.

So is it the fourth dead body? Well, the modest widening of the TIPS inflation spread may be a weak signal of inflation risk. But it also may be confirming the other inflation warning signals. The Fed must take notice.

The JoC industrial metals index is up 16.5 percent year-to-date, gold is up 12 percent, and the dollar index has declined 3 percent. Added to this, the core inflation rate for the personal consumption price index (which is closely tracked by the Federal Reserve) has climbed from 1.4 percent last December to 2.8 percent in February on a 3-month annualized basis.

In short, the body count is climbing. Therefore, the Fed should maintain the current 5.25 percent fed funds rate in order to protect the value of the dollar and limit the risk of future inflation. Meanwhile, there is good reason to believe Fed chair Ben Bernanke is watching all of these indicators, with a particular emphasis on the TIPS spread. (He has revealed as much in speeches and congressional testimony.) If so, the chief detective on the inflation case may very well make the right policy call.

As he must.

Inflation is the bane of financial assets. Bonds lose value when future interest and principal payments are made in cheaper dollars. And stocks lose value when the rising interest rates necessary to compensate for inflation reduce the present value of future earnings.

And since the capital-gains tax is not indexed for inflation, significantly higher inflation elevates the effective tax rate on real capital gains in the stock market. Think of it as an inflation tax on top of statutory cap-gains taxes. What’s more, higher inflation increases capital costs for businesses and reduces consumer purchasing power for individuals. It doesn’t matter if you’re the head of a family or a business CEO — those greenbacks in your bank account are worth a lot less when inflation rises.

And here’s another problem. Contrary to the Keynesian/Phillips-curve dogma, economic slowdowns do not necessarily produce lower inflation. If the economy’s output of goods and services continues to slow, the existing money stock will become more inflationary in relation to the scarcity of goods. This would weaken the dollar and raise inflation.

Today the housing slump and a slowdown in business investment are both drags on the economy. Yet inflation remains a threat. We’ve seen this before: During the 1990-91 recession, inflation actually increased by 4.5 percent. Going back a couple decades, when the economy was in recession between 1980 and 1982, the inflation rate was nearly 8 percent. Milton Friedman labeled this inflationary recession. However, during the 1992-99 economic boom, inflation was only 2 percent annually. When the Reagan boom took over, inflation eased to about 3 percent.

In other words, bad money is what causes inflation, not strong economic growth. But it is a strong dollar that will curb inflation.

Loose talk from a protectionist-leaning Congress is arguing for a lower dollar to curb the trade deficit. This would be exactly the wrong policy. The Fed should ignore this banter and instead keep its eye on all four dead bodies in the inflationary morgue.

 

Larry Kudlow is the author of JFK and the Reagan Revolution: A Secret History of American Prosperity, written with Brian Domitrovic.

Most Popular

World

Jared Kushner Was Right

Over the past several years, a new certainty was added to death and taxes: Jared Kushner would fail in his role as the administration’s Middle East point man. It caused considerable merriment among President Donald Trump’s critics (and even some of his well-wishers) when he put his son-in-law in charge of ... Read More
World

Jared Kushner Was Right

Over the past several years, a new certainty was added to death and taxes: Jared Kushner would fail in his role as the administration’s Middle East point man. It caused considerable merriment among President Donald Trump’s critics (and even some of his well-wishers) when he put his son-in-law in charge of ... Read More
Law & the Courts

Barr Is Right About the Prosecution Power

Attorney General Bill Barr gave a speech at Hillsdale College on Wednesday that attracted a lot of attention. Much of that attention was for his ill-considered remark (in a question-and-answer session following the speech) that "Other than slavery, which was a different kind of restraint, [the pandemic lockdowns ... Read More
Law & the Courts

Barr Is Right About the Prosecution Power

Attorney General Bill Barr gave a speech at Hillsdale College on Wednesday that attracted a lot of attention. Much of that attention was for his ill-considered remark (in a question-and-answer session following the speech) that "Other than slavery, which was a different kind of restraint, [the pandemic lockdowns ... Read More

Snobs or Mobs?

A   lot of us were feeling pretty good about the future of the media in late September of 2004. Dan Rather and the CBS news division had just tried to derail George W. Bush’s reelection campaign with some genuine fake news — based on fake documents — and, in spite of the manful attempts of ... Read More

Snobs or Mobs?

A   lot of us were feeling pretty good about the future of the media in late September of 2004. Dan Rather and the CBS news division had just tried to derail George W. Bush’s reelection campaign with some genuine fake news — based on fake documents — and, in spite of the manful attempts of ... Read More
U.S.

Zoomers and the Constitution

A 2019 study by the Pew Research Center compared generational views on key social and political issues, focusing on the similarities between Millennials and Generation Z. The topics probed include race relations, diversity, climate change, capitalism, socialism, and the role of government. This last item, ... Read More
U.S.

Zoomers and the Constitution

A 2019 study by the Pew Research Center compared generational views on key social and political issues, focusing on the similarities between Millennials and Generation Z. The topics probed include race relations, diversity, climate change, capitalism, socialism, and the role of government. This last item, ... Read More

The Mystery of Robert E. Lee

No one who ever met Robert Edward Lee -- whatever the circumstances of the meeting -- failed to be impressed by the man. From his earliest days as a cadet at West Point, through 25 years as an officer in the U.S. Army’s Corps of Engineers and six more as a senior cavalry officer, and then as the supreme ... Read More

The Mystery of Robert E. Lee

No one who ever met Robert Edward Lee -- whatever the circumstances of the meeting -- failed to be impressed by the man. From his earliest days as a cadet at West Point, through 25 years as an officer in the U.S. Army’s Corps of Engineers and six more as a senior cavalry officer, and then as the supreme ... Read More
World

How Trump Changed U.S. Foreign Policy

On September 16 the editorial board of the New York Times did the impossible. It said something nice about President Trump. “The normalization of relations between Israel and two Arab states, the United Arab Emirates and Bahrain, is, on the face of it, a good and beneficial development,” the editors wrote. ... Read More
World

How Trump Changed U.S. Foreign Policy

On September 16 the editorial board of the New York Times did the impossible. It said something nice about President Trump. “The normalization of relations between Israel and two Arab states, the United Arab Emirates and Bahrain, is, on the face of it, a good and beneficial development,” the editors wrote. ... Read More