Inflation Is Here. Here’s How You Should Respond

CHISWICK, WEST LONDON – Inflation is coming in hot…

The Bureau of Labor Statistics (BLS) released its latest Consumer Price Index reading yesterday. It came in at 271.7… up 5.4% from a year ago.

The BLS also released its latest Producer Price Index reading today. It came in 7.3% higher over the reading from a year ago.

What does this mean for the Dow-to-Gold trade we follow in these Postcards? More below…

Hunkering Down in London

Greetings from London, our current resting place…

Kate, the kids, and I have all been sick this week with flu-like symptoms. We’ve isolated ourselves in our house.

Many people around us, including some of our friends and neighbors, have reported catching COVID-19 in the last week, despite having all been vaccinated.

We thought we might have COVID-19, too. So yesterday, we went to the government testing station nearby and took COVID-19 tests. The results came back negative today.

Either way, we’re just hunkering down in our house doing our “schoolwork.” We’ll be back doing field trips and posting pictures again next week…

Calling the Fed’s Bluff

Turning back to the BLS readings I mentioned above…

In these Postcards, we’ve long thought that inflation was coming. And we made the case that when it came, the Federal Reserve wouldn’t have the courage to fight it by raising interest rates and/or tapering its money-printing.

As regular readers know, the government is bankrupt and corporate America is drowning in debt. If the Fed were to raise interest rates, our hypothesis is that it would pop the debt bubble, and economic growth and the stock market would collapse, leading to a massive decline in prosperity.

So now that inflation is here, what happens next?

It’s simple. The Fed will pretend it’s going to raise interest rates and threaten to taper its money-printing. It has to do this to reassure the bond market their bonds are safe.

Then, the Fed will hope that inflation recedes over the next two years so it doesn’t actually have to raise interest rates and taper its money-printing.

In poker, they call this “bluffing.”

If prices keep rising, it’ll be fascinating to see how the Fed reacts. They’ll have to reveal their bluff.

But if prices back off, the Fed can breathe a big sigh of relief. And the credit bubble can survive for a few more years…

Only One Rational Response

As a long-term investor, there’s only one rational response to this situation, in my opinion.

And that is to stand aside and keep away from harm… until the storm has passed and it’s safe to buy high-quality equities again.

There are two parts to this.

The first is to hold hard currency like gold, silver, and certain value stocks that approximate owning hard currency. (My favorite value stocks are companies that own fleets of cargo vessels, such as shipping and tanker stocks.)

And the second is to keep an eye on the Dow-to-Gold ratio as it returns to “cheap” levels.

As longtime readers know, the Dow-to-Gold ratio tracks the Dow Jones Index priced in gold. The ratio peaked in 1999, and it’s been falling ever since – granted, with a few interruptions along the way.

As you can see, the stock market has bounced over the last year in terms of gold, just like it did in 2011. But I expect it will soon resume its next leg down…

As a trader, there may also be an argument for attempting what we’ve been calling a “Hero Trade.” That is, betting on the decline of the credit bubble.

The best way to do this, in my opinion, is to short the companies that have enormous debt burdens.

In other words, to bet against corporate bonds… and in particular, junk bonds. As I explored in the July 7 Postcard, junk bonds seem to me to be “ground zero” of the credit bubble.

It’s not an easy trade, and personally, I haven’t decided whether or not I’m going to attempt this.

I sleep well at night. By placing this trade, it seems like I’d be inviting a lot of stress into my life. On the other hand, the potential profits could be incredible, life-changing, never-to-be-seen again…

Hmmm. What to do?

More to come…

– Tom Dyson

In Friday’s mailbag, Tom told readers that he doesn’t think the U.S. government will confiscate gold, like it did in 1934. Readers share their thoughts…

Reader comment: I agree that the government won’t confiscate gold, but I do worry about taxes. I suspect that if we were to get some serious inflation, and gold went up to $10,000+ per ounce, Congress might well slap a 90% windfall profits tax on whatever gains we have (in nominal dollar terms).

The resentment of the unprepared against the prepared can be vicious. Why do I fear this? From the government’s point of view, it would be far easier than confiscating gold, and requires no prior planning. And stirring up public opinion in favor of such a tax would be a breeze under those circumstances.

Reader comment: I always look forward to your Postcards, travels, and to your Friday mailbag, wherein you answer readers’ questions. This past Friday, you again gave your reasons why you felt the government would not consider confiscating gold:

“Gold is seen as a pet rock, a relic, a pariah of the banking system. It poses no threat to the ambitions of the state, in my opinion.”

Your take on the government’s money-printing seems to focus on inflating away the national debt. But if I’ve been reading Bill Bonner’s missive correctly, it’s more of a wealth confiscation scheme. I realize you’re both saying the same thing. The crazy debt and out-of-control spending must be paid with someone’s wealth and with this plan, anyone holding dollars (i.e., much of the world) gets to help out.

To illustrate, I calculate that my modest personal retirement savings, estimated as a function of declining buying power, is being reduced by roughly $36,000 per year, or about $100 each day. I arrive at that number using only the loss of CD interest income I’ve experienced over the past year and a half, and a modest 5% inflation estimate.

So if “the ambitions of the state” is wealth confiscation through inflation (and I think it is), then owning gold may, in fact, be a threat to those ambitions.

Tom’s note: As always, thanks for writing in! Please keep your comments and questions coming to [email protected], and I’ll do my best to answer them in a future Friday mailbag edition.