Since early this month, stock prices have pulled back. Commodities, including gold, have followed suit. Some in the media have chalked this up to a renewed weakening of the economy, along with other fundamentals. That’s incorrect.
If it were truly economic fundamentals that were weighing on stocks, that wouldn’t explain the coordinated action in gold prices. Stocks and gold have been practically joined at the hip. When a broad range of disparate assets seems to all behave similarly, you have to look for the common element. Otherwise you’re left with theories of spooky metaphysical conspiracy between assets or artificial complex rationalizations. The common element? The pricing unit … in this case the US dollar.
Digging for answers in the latest employment reports or coronavirus statistics would be a waste of time. What’s really happening is simple. Inflation – the rapid dollar depreciation we saw earlier this year – has gone on hiatus. (FDI 2020 0919) While the Fed stands ready to deploy a firehose of liquidity (read: freshly created dollars) aimed at the financial system, the nozzle is clogged. Earlier this year Congress had little trouble coming to an agreement to spray trillions of Fed-created dollars into the system. But now with looming elections, partisan gamesmanship has gummed up the works.
We’re not merely Monday morning quarterbacking here. This is a testable hypothesis. If it is correct (and it is!), the dollar will resume its downward trajectory once there is any clear sign of progress in breaking this logjam. Proof will come in the form of a broad rally in stock and commodity prices. Absence of such progress means that the deflationary undertow of debt left over from prior “stimulus” has the upper hand and prices will remain weak. (Do Low Interest Rates Cause Inflation?) But make no mistake … it has little to do with genuine fundamentals … no more than the post-crash rally in stock and commodity prices – infamously disconnected from real economy – was proof of economic recovery.