by Peter Schiff, Euro Pacific Capital:

This week, as investors and economists fixate on record highs set by major stock market indices, they have ignored much more significant developments that emerged from the Federal Reserve’s annual meeting in Jackson Hole, Wyoming. Fed Chairman Jerome Powell delivered a speech that somehow was almost universally interpreted as a reiteration of his commitment to continue to raise rates throughout the next few years. “Steady as she goes” was the takeaway from just about any news outlet. But the Chairman’s actual message was essentially the opposite of what the media reported. From my perspective, it provided evidence that President Trump has succeeded in getting Powell’s mind right on the need for the Fed to continue to stimulate the economy, no matter how much evidence emerges that it is already over-stimulated.

Many reporters, undoubtedly eager to write a story that would cast Trump in a bad light, characterized Powell’s speech as a courageous defiance to the President’s increasingly strident calls for the central bank to end its tightening campaign. Some stories even jumped onto the current “people turning on Trump” narrative to showcase Trump’s foolishness in having appointed someone who would so easily turn on him. I’m not sure what speech they were hearing.

Despite the fact that inflation has moved above the Fed’s target 2% threshold (U.S. Dept. of Labor, Bureau of Labor Statistics News Release, 8/10/18), Powell repeatedly suggested that it isn’t likely to remain there, and as a result, the Fed would be unwise to lean into a tightening policy as if it were. Instead, he argued that the Fed should pursue a “wait and see” attitude as long as possible, and should only move when the data is unmistakable. When the Fed does act, he suggested that bold and decisive moves would make up for prior restraint. Call this the “whites of their eyes” monetary policy: fire should be held until the last possible minute, and when the order to fire is given the intensity should be massive. (Someone should point out to Powell that we lost the Battle of Bunker Hill).

Powell peppered his speech with many cautionary tales of how the Fed erred in the past by fighting inflation that was never really that dangerous in the first place, and he praised former Fed Chair Alan Greenspan for not raising rates in the face of traditional inflation warnings. By focusing on the phantom menace of inflation, Powell suggested that the Fed cut off prior expansions prematurely. Instead, he advocated for a new doctrine that places less emphasis on prevention and more on reaction. In other words, why bother with an ounce of prevention when a pound of cure will do the trick.

While Powell did strongly suggest that he would deliver at least two more rate hikes in 2018, his outlook for 2019 became significantly less hawkish. In fact, based on my understanding, we should not expect any additional hikes in 2019. That means a 2.5% Fed Funds rate may be the highest we get in the current expansion. So despite the supposedly unprecedented strength of the U.S. economy, this cycle’s peak in interest rates would be the lowest by far of any prior economic expansion. This thinking represents a significantly dovish shift in public Fed policy and should certainly play well in the White House.

But investors ignored Powell’s words and continued to arrange their money as if the Fed’s tightening bias remains firmly in place. In fact, this month the net short position in gold held collectively by hedge funds went positive for the first time since 2001. (Not insignificantly, this last occurred when gold traded below $300 per ounce and was on the verge of a six-fold increase over the next decade). This continued myth of a hawkish Fed has strengthened the dollar and punished gold, which earlier this month fell below $1,200 per ounce for the first time since the beginning of the year.

CNBC’s Steve Liesman’s Jackson Hole interviewed St. Louis Fed President James Bullard showcasing the Fed’s thinking in even starker terms. Bullard suggested that the current Fed Funds rate of 2% is already far closer to normal than history would suggest. (In the past, a “normal” rate would be considered two percentage points above the rate of inflation). He claimed that since rates have been trending down since the 1980s, 2% today is not the same things as 2% in the 1990s. In other words, it’s the new normal. He also said the Fed should take care not to invert the yield curve, which would suggest there is not much room to move rates higher in 2019, given his expectation that 10-year yields will remain below 3%.

Although this rhetoric sounds appealing, it forgets, perhaps intentionally, some key maxims that have guided Fed policy for generations. These include the idea that “the Fed should take away the punch bowl just as the party gets going” and perhaps more significantly, “once the inflation genie gets out of the bottle it’s hard to put her back in.” These ideas hint at just how much momentum gets built into a monetary policy and how hard it is to change course once things get out of hand.

The Fed’s new strategy appears to be keeping the party raging by making sure the punch bowl remains spiked. If the inflation genie gets out of her bottle, Powell claims the Fed will “do whatever it takes” to put her back in. But there has always been a high degree of disagreement about when a bull market turns into a bubble. Usually, experts don’t even agree until years later. So how can we expect the Fed to identify a bubble and react decisively, especially given the pushback it would get from investors and politicians for raining on the parade?

The same holds true for inflation, which tends to sneak up on central bankers unexpectedly. On several occasions in the 1970s and 1980s, inflation surged by 3 percentage points or more in one year. (New York Fed, “A Hisotry of Fed Leaders and Interest Rates”, The NY Times, 12/16/15) If that were to occur again, could we really expect the Fed to react quickly and strongly enough to contain the outbreak? And how would the markets digest such a reaction? Recall that the Fed hasn’t raised rates by more than a quarter of a percentage point at one time in more than 18 years. Drastic tightening moves have essentially gone the way of the Dodo Bird. If Powell thinks he could deal with a gathering inflation threat with a few quarter-point increases, he should take a few lessons in threat management. The metaphor of bringing a knife to a gunfight would apply.

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