The consumer price inflation numbers were released, and January came in hot at 0.5%.  It isn’t 1970s hot, but it is definitely an acceleration.  This is just one month of course, but if it came in like that every month, then we would be looking at 6% annual price inflation (according to the government’s statistics).

The more stable measure of the median CPI even came in a little higher than usual at 0.3%.  The year-over-year median CPI is at 2.4%.

Perhaps some of the monetary inflation from 2008 to 2014 is leaking out a little faster now.  The Fed will say that they want to see higher inflation (meaning prices), but do they really?

We are in this awkward period where the Fed is actually tightening, while consumer prices seem to be rising at an accelerating pace.  And when I say the Fed is tightening, I don’t just mean raising its target on the federal funds rate or keeping its balance sheet stable.  Currently, the Fed is actually allowing $20 billion per month to roll off of its balance sheet.

Meanwhile, the Fed – under new chair Jerome Powell – is expected to hike its target rate again next month in the FOMC’s March meeting.  This all coincides with the recent explosion of volatility in stocks where the Dow has experienced two days of over 1,000 point drops.

Personally, I celebrate the higher consumer price inflation numbers.  It isn’t that I want to pay higher prices for things I buy, but it is the only thing that will limit the Fed in its monetary policy, and it may be the only thing (along with interest rates) that will eventually limit spending coming out of Congress.

The federal government will likely run a deficit of over $1 trillion in the next fiscal year.  And that is during a supposed recovery.  Imagine if the economy takes a plunge and tax collections fall.  Are we prepared to see our first $2 trillion annual deficit?

If consumer prices continue to show signs of increasing at an accelerating pace, then it will be difficult for the Fed not to follow through with its plan to reduce its balance sheet.  And if the economy takes a major downturn, it will make it harder for the Fed to ramp up monetary inflation.

We need a tight monetary policy for a prolonged period of time.  We need higher interest rates in order to encourage saving (assuming that the market rates would be much higher if not for the implicit backing of the Fed).  We need higher interest rates to stop the distortions and misallocations.  We need higher interest rates in order to put pressure on Congress to reduce its out-of-control spending.

From an investment perspective, it is interesting that stock investors did not react negatively to the news of higher than expected price inflation.  Perhaps they see it as a one-time event that will not impact the coming rate hikes.  Markets have already mostly priced in a rate hike in March, although the 10-year yield did go higher to some extent.

It is also interesting that gold spiked up on the news, especially since most economic news seems to be counterintuitive.  Yes, gold is supposed to be a hedge against inflation.  However, with this news, it makes it more likely the Fed will hike its target rate and keep tightening its monetary policy.  This would be bearish for gold.  Perhaps some investors don’t believe that the Fed will fully follow through.  Maybe some see this as a build up to something resembling the 1970s where there were high interest rates, high price inflation, and periods of recession.  The 1970s was one of the greatest times for gold in U.S. history, at least in comparison to the U.S. dollar.

I recommend something resembling the permanent portfolio.  This shows that it is especially important now to have that 25% in gold, or in investments that reflect the price of gold.  Most financial advisors will not recommend such a high allocation to gold or any other precious metals.  You are lucky if you can find an advisor that recommends 10%.  But they do not understand the threats of a depreciating currency to the extent that they should.  Their clients who take their recommendations and who do not diversify into gold will suffer greatly if we hit anything near a scenario resembling the 1970s.