Could Inflation Reignite?

The coronavirus-triggered business shutdown is battering the American economy, leading to discussion in financial circles of the risk of deflation. Due to an unprecedented jump in unemployment, there is less cash in people’s pockets, which may lead to less demand for goods and services, potentially causing prices to spiral downward.

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Economists at the San Francisco Federal Reserve Bank recently studied this concern and concluded otherwise, stating, “the perceived risks of a substantial decline in inflation are limited in the near term despite the economic standstill caused by the coronavirus.”

In fact, there is a school of thought that by slamming on the economy’s brakes, COVID-19 may create conditions that position the United States for a sudden acceleration of inflation. Prominent in this camp is David Kelly, chief global strategist for J.P. Morgan Asset Management.

Kelly refers to the classic Road Runner cartoons in which Wile E. Coyote buries a box of ACME dynamite beneath birdseed. Of course, the dynamite fails to detonate when Road Runner stops for a snack. Only when the coyote returns and inspects the dynamite and determines it is a dud, does it go off.

In Kelly’s analogy, inflation is the dynamite that ignites only when least expected. There are several factors that could set it off in the coming years in his view.

To support the economy, Washington is spending more aggressively than at any point in recent history. As a result, the federal deficit is skyrocketing. The Congressional Budget Office forecasts the deficit will be 108 percent of Gross Domestic Product by the end of next year, equaling the record set in 1946 after huge war-time military spending. The Federal Reserve is aggressively monetizing this debt, printing money at an unprecedented pace, which could devalue the dollar and revive inflation.

Once a vaccine is widely available, there will be huge pent-up demand for goods and services, a surge in buying that could be inflationary.

Finally, if the Democrats win the November election, they may take steps to address income inequality by raising minimum wages and creating a more progressive tax system that will redistribute income from the wealthy, who tend to save more, to households that are far likelier to spend whatever they take in. This increased spending may prove to be inflationary.

Kelly advises J.P. Morgan clients that real assets including precious metals “can serve an important, although long-redundant role, in protecting a portfolio against the risk of inflation.”

Protect your investments against inflation.

Diversify your portfolio with precious metals.