A House Divided: The Fed’s Growing Internal Conflict

MIKE BARNES 0:10

Welcome to America’s Gold Authority Podcast. My name is Mike Barnes. Kevin Warsh leads the Fed meeting this week, and interest rates don’t change again. What does that mean for inflation? And what does that mean for gold? Let’s bring in an expert to find out. He is a very noted expert as well. Philip Diehl, 35th Director of the United States Mint, President of U.S. Money Reserve. And Philip, first question for you is did it surprise you that rates did not change?

PHILIP N. DIEHL 0:36

No, it didn’t surprise me. I don’t think the market was surprised at all. This was sort of an unusual meeting in that usually there’s a very strong consensus about what the Fed’s going to do. And it wasn’t quite so strong this time. It was about a two-to-one bet that the uh Fed would sit tight. And in fact, it did. Uh it would have been quite a surprise if it had decided to raise rates. Uh would have been a very big surprise if it had decided to cut rates, as the president uh urged the chairman to do and for the committee to do. But he also said that he understood that that was unlikely because, as he said, that you know, there were a lot of people who were who were programmed really not to cut rates as he wished. So uh it wasn’t a surprise to me, but I tell you what, I ended up being on the side of the the dissenters on this, the ones who wanted to raise rates. There were uh three of the 12 votes uh that went for uh increasing rates. I think there were probably a few others who were also inclined that way, but uh decided for the sake of uh reducing the amount of dissent that was registered to uh go with a majority. And uh but I think there were really strong reasons for the for the FM uh FOMC to uh move to increase rates at this time, and I think they’re gonna end up regretting that they did not.

MIKE BARNES 2:09

Well, this is five meetings in a row. They did not change rates. So do you think something’s coming maybe at the next meeting?

PHILIP N. DIEHL 2:16

Yeah, I think they’re gonna have to raise rates. Uh and I think one of I think one of the reasons, uh course the president has really been putting pressure on the on the Fed for a year and a half now to cut rates, uh, despite all the signs that inflation is heading the wrong direction. Um and there’s been a little bit of a lull and in price increases with the last report, but we know that the the reason for that was that we saw an abrupt drop in oil prices that occurred uh in the wake of the peace agreement. That is all behind us now. Those uh reductions in oil prices have uh have reversed course, and we’re seeing prices uh resume their climb back toward levels they were earlier in the war. Also, it’s it’s a different environment now. There’s more at risk on oil prices than there were uh was back six, eight weeks ago. Uh the world’s reserves of oil are much lower today. We probably have maybe four to six weeks more of breathing room on our reserves here in the U.S. and uh and abroad before the crunch really begins. And the market hasn’t woken up to that yet. Uh people are are sort of whistling through the graveyard on this. Um, and there’s a lot of wishful thinking. There’s wishful thinking that this war is going to be brought to an end uh much more rapidly and that prices will fall much more rapidly after peace is is reached. That’s simply not going to happen. We may see oil prices, crude oil prices drop, but we’re not going to see prices drop at the uh at the pump. We’re not going to see fuel oil prices fall this fall. We’re not going to see jet fuel prices and diesel fuel prices fall. And the reason for that is that the real constraint in the marketplace today is in refining capacity. And that’s true uh in much of the world and certainly here in the U.S. for any number of reasons. And it’s going to get worse this fall. The amount of refining capacity that is available in the world is going to be restricted this fall. One of the reasons is because of what’s happening in Russia with the successful Ukrainian bombing campaign with their drones. Another is that in the U.S., every fall, as it’s like clockwork, uh refineries around the country shut down for their annual maintenance and for their conversion to uh winter fuel. And that takes weeks. Uh, if there’s a hurricane in the Gulf, that also interrupts supplies. And a special uh factor is that there are refineries in California that shut down uh here in the last year, year and a half, and they shut down permanently. I I just think that there’s this huge failure to recognize where uh just on the oil front, where inflation rates are inevitably headed over the next six, twelve, or even uh more months. And like I said, that’s only on the oil front. We also have the food, uh we have food inflation that is already dialed into the economy. And the reason for that is we’ve we haven’t gotten enough attention paid to the impact of the war, uh both wars, uh, on food prices. In the case of the war in Iran, not only has the closure of the Strait of Hormuz prevented oil and gas from leaving the Persian Gulf, but it’s also prevented fertilizer components from leaving the Gulf. And it is a huge source. 20% of the world supply for inputs for fertilizer comes out of the Gulf, and they it’s not escaping. And that has a huge impact and will have a big influence on food prices going forward. And in the case of the uh war in Ukraine, uh the uh ability of Russia to export grain through uh the Black Sea has been crippled by the Ukrainian drone campaign. All of this is going to play out, and also there’s bad news out of the American Midwest because of the combination of drought and heat and their effects on ground uh grain prices. There are there are a number of factors, there are other factors I could mention as well that have just not been calculated into the expectations for inflation. And so at this point, uh, really what we should have seen from the Fed was a move to preempt those uh price increases, to show a commitment to get ahead of those price increases, and to show a willingness to to fight uh inflation now as it emerges. Now, I think the reason why the Fed was not willing to do this was because some members were not willing to risk the ire of the president at this stage. And of course, the president would have been furious at this stage if there had been an increase in uh in rates. And the markets would have been very surprised at an increase of rates because they read the political tea leaves, too. Of course, all of that is happening in the context of the midterm elections that are coming up in November. But is it going to be any easier to increase rates in mid-September, six weeks before the election, when this inflation data is going to be much clearer, or in October, a week or ten days before the election, when the inflation data is even clearer? No, it’s not going to be in any easier. And if the Fed does not beat, uh bite the bullet at that time, then you know its next opportunity is probably going to be in November after the election. And at that point, there’s going to be a lot of question about whether or not the Fed is really serious about uh taking on the threat that inflation represents to us today.

MIKE BARNES 9:10

Kevin Warsh says that he’s watching inflation. He wants to lower those numbers. I kind of wonder if he thinks that, well, messing with the rates isn’t going to do as much as worrying about the war. Because, as you mentioned, the trickle down with oil, with gas, with gas prices, with food prices, all of that trickle down affects inflation, it seems like, more right now than just the rates.

PHILIP N. DIEHL 9:32

You would think that raising the rates would increase, increase the inflation rate because it makes borrowing more expensive and it makes everything else. When you have to uh it’s an economy based on debt. And therefore, when the cost of borrowing goes up, you’d think the cost of everything else goes up. But what actually happens is less borrowing occurs, there’s less consumption in the economy, and that uh suppresses price uh rises. And that’s been shown over and over again. And what has also been shown repeatedly, and we saw this back in the hyperinflation period of the 1970s leading into the 1980s, and we saw sort of the opposite effect of this in the most recent inflationary period, and that is the last thing you want to allow happen is for inflationary expectations to get baked into the economy. And by that I mean labor begins to expect uh inflation, and therefore unions begin to uh expect them in their labor negotiations and bake them into their cost requests. Also, companies in their pricing decisions begin to bake the expectations of uh product increases, uh price increases. All that gets baked into the process. And we saw that in the 70s, and it was really tough to break that beast’s back. Uh, and it was painful to do it. One of the things the Fed was able to do, even though it was late in turning its fight uh to inflation uh back during the POL uh POW Fed was once it turned its attention to the fight, the market never had doubt that the Fed was going to do what it needed to do to restrain prices. And that’s where we are right now. Here in the next month or so, uh, certainly between now and the midterms, this Fed is going to be facing a challenge in which it has to show that it is determined to fight inflation. And it faces this tremendous challenge in the context of this administration. And one is that, as we all know, the president wants to cut rates, not increase them. But the other is there’s this enormous fiscal policy challenge to monetary policy. And that is this administration doesn’t mind running up deficits. And the the level in which the debt, the pace at which debt is rising is astonishing these days. And we now have this war underway in which uh, as a result, we are seeing like a $79 billion request for additional defense spending with no offsets, and we are uh firing off armaments as if there’s no tomorrow, and there’s no other possible challenge in the world that we might need them, like you know, facing a challenge from China. And there’s this uh ever-present demand now to replace those munitions and not just replace those munitions, but to bring our munitions up to, you know, the current standards of drone warfare. So um that’s that’s a that that’s a huge challenge for a stricter monetary policy to see fiscal policy and deficit spending really begin to run away.

MIKE BARNES 13:30

You know, everything I think we’re talking about right now, more short-term problems, something with the rates, inflation affecting us short term. But I want to talk about long-term investors right now, people who are gonna retire in five years, ten years, maybe even 15 years. I think, and I want you to correct me if I’m wrong, that everything that’s happening right now, with the war, with inflation, with the rates, we don’t really have to worry about that long term because especially with the price of gold, it’s gonna go back up and continue to go up. So there’s no reason to worry about it long term. It’s more of a short-term concern. Is that correct?

PHILIP N. DIEHL 14:05

What’s really happening from a gold buyer’s perspective and a gold holder’s perspective is we’ve seen a pullback in gold prices this year. After an extraordinary run over the previous two years, we actually, by the time the market hit peak in January this year, gold prices had tripled from uh 27 months earlier. Just a remarkable historic run. There were a lot of people who kicked themselves that they hadn’t bought during that incredible run. But the reality is now today, at current prices around $4,100 an ounce, you can buy gold at the same price it was at uh back in November of last year. It’s like climbing into a time machine and going back to November of last year when gold had only doubled. So, yes, so that is that is a significant opportunity. Now, of course, the question is how can I be assured that you know gold is actually going to go up in value? And of course, there are no promises. Anyone who promises you a return on any kind of investment, walk away. But what I do is I turn and look at the most uh the most reputable independent analysts for any kind of investment. And I’ve looked at them and looked at their short-term and their long-term outlooks for gold prices. And I’ve looked at the top eight analysts, and these are all name brand analysts. Anybody would recognize the banks and the investment firms that they they represent. It shows that by the end of the year, from today’s price to the end of the year, the most conservative of them expect an 8.2% increase in gold prices. The there are two firms that they’re the most bullish and they’re expecting a 50% increase by the end of this year. The consensus expectation for the S P 500 is 7.7%. So that’s less than the most conservative of these eight forecasters for gold. Now, those around the table here are not looking at really gold over the short term. We’re not gold traders, but this is reassuring uh uh statistics for the short term, because so many people are looking at should I, you know, should I sell my stocks, any of my stocks? They’ve done so well over the last several years in order to, you know, rebalance the equation of my portfolio and and add gold. And even over the short term, the answer to that question is a resounding yes. You are not giving up the potential for gains. That’s what these analysts are telling us. And the history, which I won’t go into here, tells us the same thing over the last 20 years. And what I’m doing here is myth busting, and I’ll have more information on that. So, but what we’re interested in is the long term, like what you’re saying, Mike. And over the long term, when you look at uh what these uh same uh analysts and others are saying, is that they’re expecting gold to by uh 2030 to rate reach between $8,000 and $10,000 an ounce. Uh again, these are name brand analysts. These are not people from inside the gold industry, you know, who are patting themselves on the back. Uh, these are independent analysts. And so we’re talking about a uh a doubling to a 2.5 times increase in price over really about three and a half years. And I think the average, if I recall correctly, among these uh among uh eight uh companies is an increase of about 128% for gold. Their assessment for uh stocks is about 68%, so far below what the the analyst expectation is for gold. So over that long term, absolutely, uh it’s it’s a runaway case for gold. And those estimates for uh for stocks are an optimistic estimate. It does not fit, it it does not include the possibility of a recession in the next four years. And economists give the odds of no recession over the next four years at less than 50-50. And we know from the last three recessions, the three recessions in the last 25 years, stock prices plunge every time they plunge during recessions, and every time gold prices soar. So all the indicators, whether you’re an optimist about the next four and a half, three and a half years, or whether you’re a pessimist, the data shows clearly that uh gold needs to be, doesn’t need to be your entire portfolio by any means. That’s not what I’m arguing. It needs to be a substantial part of your portfolio.

MIKE BARNES 20:06

And I’m not saying to ignore the short-term problems that we may be seeing right now, whether we’re talking about the war, inflation, gas prices, any of that, because yes, it does affect us right now, but you have to just kind of split your mind between short-term and long-term. And when you’re talking about, again, retirement, which is so important to so many of us, 2031, 2036, 2041, it’s gonna be here before we know it, but we have to plan for that future as well, correct?

PHILIP N. DIEHL 20:33

That that’s exactly right. And you need to plan for it, even if you’re in retirement, of course, um, you are you’re counting on on the performance of your portfolio to uh to outlive you. And uh so you need to be looking at what are what is that, what are the what is the typical performance of a portfolio with a a balanced portfolio? And and really that’s hard to, it’s not so easy to make that calculation. For the longest time, really for several decades, the advice was a balanced 60-40 portfolio, 60% stocks, 40% bonds. That that advice is 20 years out of date. I am really shocked when I went back and looked at the data. I thought maybe it was five or 10 years out of date. It’s only recently come under question from inside the industry. But when you go back and really look at the data, it’s 20 years out of date, and you have to ask you know some impertinent questions about why it hasn’t been questioned before now. But it is out of date, and what is absolutely clear in the data is that a well Balanced portfolio requires a gold component. Uh, and a a uh an increasingly what you’re seeing recommendations of a 60% stock, 20% bond, 20% gold uh portfolio is being recommended. I have actually run a 60% stock, 10% bond, 30% gold portfolio, and it it outperforms the 60 2020 portfolio at less risk, and that is crucial. You know, any portfolio that performs better but carries a lot more risk, you need to really look at carefully. It’s the balance of risk and reward that matters, and that is the secret to gold, especially in a situation in the environment we’ve been in recently, and that we are going to go into much more deeply, in which bonds do not play the shock-absorbing role that they have in the past of countering falls in in uh stock prices. It used to be bonds would go up when stocks went down. That’s not so reliable anymore. And but gold as a hard asset does play that role. And so that is why you have people like the CIO of Morgan Stanley, who last fall came out and broke from the pack and said, Well, we ought to be looking at a you know, advising clients for a 60-2020 portfolio instead of this old traditional 6040 portfolio. The typical portfolio in the United States has about 2%, 1 to 2% uh in gold. And the moment people begin to move toward having more gold in their portfolio, just increasing it from 2% to 4%, not going to 10 or 15 to 20 percent, just an average of 2% to 4%, the impact on gold prices will be uh historic. We will see something like we’ve never seen before, because the gold market, all of the gold that has ever been mined in human history is a very small amount. And about 20% of it right now is in central bank vaults, stored away, locked away, and is not really available for sale. And another significant part is distributed into manufacturing and tiny little, you know, silicon wafers and the like, and is not easily recovered. And a lot of it is in jewelry, Western jewelry, where you know it’s sold for far more than melt value. So it’s a tiny market. And when bond or stock uh value starts flowing into gold, KD barred the door when uh when when that begins to happen. So, and I think we’re entering a uh an environment where political events and economic events are gonna touch that off. I don’t know exactly when it’s going to happen, but uh I think over, you know, it could happen uh in the next year, it could happen in the next four years.

MIKE BARNES 25:45

Katie Bar the Door. Great suggestions and great insight as always. Philip Diehl, thanks so much for joining me today. Thanks, Mike. Again, interest rates don’t change with the July meeting with the feds. Kevin Worst doesn’t touch anything, but that doesn’t mean it won’t change in the future, so keep your eyes on the short term, but keep your eyes on the long term as well. That’s all the time we have for today’s episode. On behalf of all of us here in the U.S. Money Reserve Studios, thank you for tuning in. If you have any questions or you want to learn more about today’s episode, you can call the number in our episode description and speak with one of our friendly account executives. They’re going to be more than happy to answer any questions you may have about precious metals and the strategic role they can play in achieving a secure and comfortable financial future. I’m Mike Barnes. We will see you next time on America’s Gold Authority Podcast.