WASHINGTON – The 38 percent surge in gold prices in the past eight months is a sure sign that the Federal Reserve has let inflation get out of control, some economists and strategists say.
But others argue that gold bears little relation to consumer prices, and that the surge in gold prices nothing to worry about, certainly compared with the jump in oil prices.
The two camps have divergent views about what causes inflation. On one side are those who argue that central banks have created too much money that isn’t backed by something solid, like gold.
Rising commodity prices, including the price of gold, are just a symptom of a world awash in worthless cash.
In the other camp are the majority of Wall Street economists who subscribe, in some fashion, to the notion that inflation works mainly through labor markets, with rising wages leading to higher prices that then lead to higher wages in a never-ending spiral.
“Gold is like the canary in the coal mine – a warning signal that inflationary or deflationary pressures are building,” said Brian Wesbury, chief economist for First Trust Advisors.
“Commodity prices and gold clearly suggest that monetary policy remains accommodative,” Wesbury said.
Wesbury is encouraged that the Federal Reserve mentioned the risk of higher commodity prices in its latest policy statement. “Using commodity prices will significantly decrease the risk of Fed mistakes.”
But others are skeptical.
“There hasn’t been a lot of correlation between commodity prices and inflation since 1990,” said Peter Kretzmer, an economist for Bank of America.
“We don’t have a lot of inflation,’ Kretzmer said.
Gold really began in its move in August, after the Fed had been raising rates for a year and has continued to climb despite further rate hikes from the Fed. The value of gold fell by 64 percent between 1980 and 1999, although consumer prices rose by 119 percent in that period.
“The price of gold is not particularly well explained by monetary policy,” Kretzmer said.
Gold is attracting buyers who want to hedge against “catastrophic events,” Kretzmer said.
To gauge inflationary pressures, Kretzmer prefers to look beyond gold to broader commodity prices, including materials actually used by industry, such as steel, aluminum, chemicals, petroleum and textiles.
The CRB index peaked in January. The JOC-ECRI commodity index has been basically flat this year. Crude goods prices in the producer price index peaked in November.
Commodity prices are reacting to strong global demand for industrial metals, chemicals and energy goods. But the impact of high commodity prices on consumer inflation has been muted thus far.
Commodities represent a small portion of cost of consumer goods; labor is a far greater cost.
Kretzmer said the best gauge of pipeline inflationary pressures remains the core intermediate producer price index. This index measures the prices of goods halfway through the production process.
The core intermediate PPI peaked in January of 2005 and fell for most of 2005 until the hurricanes hit. It is slowing again, Kretzmer said.
Since the mid-1980s, the Fed has always stopped raising short-term interest rates soon after the core intermediate PPI peaked.
(c) 2006, MarketWatch.com Inc.
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